Federal Taxation

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Table of Contents

Introduction ................................................................................................................................................................... vii

Course Description ....................................................................................................................................................... vii

Course Learning Objectives ........................................................................................................................................ viii

CTEC Registration Requirements ................................................................................................................................. x

California Legislation Changes CTEC Requirements for CRTPs ................................................................................ xii

Taxes 101 .................................................................................................................................................................... xiv

General Filing Information .......................................................................................................................................... 1-1

Preliminary Work and Collection of Taxpayer Data ................................................................................................... 1-1

Accounting Periods .................................................................................................................................................... 1-4

Accounting Methods ................................................................................................................................................... 1-5

Filing Dates ................................................................................................................................................................ 1-8

Determining the Tax ................................................................................................................................................. 1-10

Completion of the Filing Process ............................................................................................................................. 1-12

Safeguarding Taxpayer Information ......................................................................................................................... 1-21

Significance of Signatures ........................................................................................................................................ 1-22

Rejected Electronically Filed Returns ...................................................................................................................... 1-24

Refunds .................................................................................................................................................................... 1-26

Paying the Tax ......................................................................................................................................................... 1-28

Review Feedback ..................................................................................................................................................... 1-37

Tax Forms .................................................................................................................................................................. 2-1

Returns not Qualifying for Use of the Tax Table ........................................................................................................ 2-1

Amended Returns and Claims for Refund ................................................................................................................. 2-4

Form W-4 - Employee's Withholding Certificate ...................................................................................................... 2-11

Form W-2 - Wage and Tax Statement ..................................................................................................................... 2-17

Form W-3 - Transmittal of Wage and Tax Statements ............................................................................................ 2-23

Form W-9 - Request for Taxpayer Identification Number and Certification ............................................................. 2-23

Various Form 1099 ................................................................................................................................................... 2-24

Review Feedback ..................................................................................................................................................... 2-27

Taxable Income, Filing Status .................................................................................................................................... 3-1

Taxable and Nontaxable Income ............................................................................................................................... 3-1

Who is Subject to the Tax .......................................................................................................................................... 3-1

General Filing Information .......................................................................................................................................... 3-3

Sources of Taxable and Non-Taxable Income ........................................................................................................... 3-5

Tax Liability .............................................................................................................................................................. 3-11

Filing Status .............................................................................................................................................................. 3-15

Special Filing Situations ........................................................................................................................................... 3-21

Table of Contents

Review Feedback ..................................................................................................................................................... 3-31

Standard Deduction, Dependents .............................................................................................................................. 4-1

The Standard Deduction ............................................................................................................................................ 4-1

Special Rules on the Standard Deduction ................................................................................................................. 4-3

Personal Exemptions ................................................................................................................................................. 4-5

Dependents ................................................................................................................................................................ 4-5

Tests to Be a Qualifying Child .................................................................................................................................... 4-5

Tests to Be a Qualifying Relative ............................................................................................................................... 4-9

Review Feedback ..................................................................................................................................................... 4-15

Income ........................................................................................................................................................................ 5-1

Earned Income ........................................................................................................................................................... 5-1

Foreign Earned Income .............................................................................................................................................. 5-2

Unemployment and Other Compensation .................................................................................................................. 5-3

Special Rules for Certain Employees ....................................................................................................................... 5-20

Passive Income ........................................................................................................................................................ 5-21

Rental Income .......................................................................................................................................................... 5-22

Separation or Divorce Income .................................................................................................................................. 5-23

Review Feedback ..................................................................................................................................................... 5-25

Investment Income ..................................................................................................................................................... 6-1

Dividends .................................................................................................................................................................... 6-1

Interest Subject to the Tax ......................................................................................................................................... 6-6

How To Report Interest Income ............................................................................................................................... 6-11

Review Feedback ..................................................................................................................................................... 6-14

Capital Gains and Losses, Sale of Personal Residence ............................................................................................ 7-1

Capital Gains and Losses .......................................................................................................................................... 7-7

Sale of Personal Residences ................................................................................................................................... 7-13

Like-Kind Exchanges ................................................................................................................................................ 7-17

Other Nontaxable Exchanges .................................................................................................................................. 7-18

Involuntary Conversions ........................................................................................................................................... 7-19

Review Feedback ..................................................................................................................................................... 7-20

Sole Proprietor, Small Business Income and Taxation .............................................................................................. 8-1

Schedule C - Profit or Loss From Business ............................................................................................................... 8-4

Self-Employment (SE) Tax ....................................................................................................................................... 8-14

Special Rules and Exceptions .................................................................................................................................. 8-18

Household Employment - Schedule H ..................................................................................................................... 8-20

Farming Taxation - Schedule F ................................................................................................................................ 8-21

Table of Contents

Rent .......................................................................................................................................................................... 8-23

Other Income ............................................................................................................................................................ 8-23

Review Feedback ..................................................................................................................................................... 8-26

Specialized Returns ................................................................................................................................................... 9-1

Corporation Filing Information .................................................................................................................................... 9-1

Partnership Filing Information .................................................................................................................................. 9-12

S Corporations ......................................................................................................................................................... 9-18

Limited Liability Company (LLC) .............................................................................................................................. 9-24

Trust and Estate Income Tax ................................................................................................................................... 9-27

Tax Exempt Organizations ....................................................................................................................................... 9-32

Retirement Plans ...................................................................................................................................................... 9-34

Farms ....................................................................................................................................................................... 9-38

Farm Sales and Exchanges ..................................................................................................................................... 9-41

Deductible Expenses ................................................................................................................................................ 9-42

Depreciation ............................................................................................................................................................. 9-47

Rental Real Estate ................................................................................................................................................... 9-51

Review Feedback ..................................................................................................................................................... 9-54

Depreciation ............................................................................................................................................................. 10-1

Section 179 Election ............................................................................................................................................... 10-12

Capitalization and Repairs ..................................................................................................................................... 10-18

Review Feedback ................................................................................................................................................... 10-22

Retirement Income ................................................................................................................................................... 11-1

Social Security and Medicare Taxes ........................................................................................................................ 11-1

Pensions and Annuities ............................................................................................................................................ 11-3

Individual Retirement Arrangements (IRAs)............................................................................................................. 11-5

Review Feedback ................................................................................................................................................... 11-22

Exclusions, Deductions, Expenses, Employee Compensation ................................................................................ 12-1

Exclusions ................................................................................................................................................................ 12-1

Deductions for Adjusted Gross Income .................................................................................................................... 12-4

Coverdell Education Savings Accounts (CESA) ...................................................................................................... 12-5

Health Savings Account Deduction .......................................................................................................................... 12-9

Other Deductions ................................................................................................................................................... 12-10

Other Employee Compensation ............................................................................................................................. 12-15

Review Feedback ................................................................................................................................................... 12-23

Itemized Deductions ................................................................................................................................................. 13-1

Medical Expenses .................................................................................................................................................... 13-2

Table of Contents

Taxes ........................................................................................................................................................................ 13-5

Deduction for Qualified Business Income .............................................................................................................. 13-14

Charitable Contributions ......................................................................................................................................... 13-16

Casualty and Theft Losses ..................................................................................................................................... 13-20

Interest.................................................................................................................................................................... 13-20

Other Miscellaneous Deductions ........................................................................................................................... 13-23

Review Feedback ................................................................................................................................................... 13-28

Credits ...................................................................................................................................................................... 14-1

Earned Income Tax Credit ....................................................................................................................................... 14-3

Earned Income Tax Credit (EITC) Limitations ......................................................................................................... 14-6

Child and Dependent Care Credit ............................................................................................................................ 14-8

Child Tax Credit ...................................................................................................................................................... 14-10

Credits and Deductions for Higher Education Tuition and Related Expenses ....................................................... 14-13

Student Loan Interest Deduction ............................................................................................................................ 14-13

American Opportunity Tax Credit (AOTC) ............................................................................................................. 14-14

Lifetime Learning Credit ......................................................................................................................................... 14-16

Affordable Care Act Tax Credits ............................................................................................................................ 14-18

Adoption Credit ....................................................................................................................................................... 14-20

Credit for the Elderly or the Permanently and Totally Disabled ............................................................................. 14-22

Retirement Savings Contribution Credit (Saver’s Credit) ....................................................................................... 14-23

Other Tax Credits ................................................................................................................................................... 14-24

Review Feedback ................................................................................................................................................... 14-34

Additional Taxes ....................................................................................................................................................... 15-1

Alternative Minimum Tax .......................................................................................................................................... 15-1

Affordable Care Act Tax Provisions ......................................................................................................................... 15-4

Other Taxes .............................................................................................................................................................. 15-8

Household Employment Taxes .............................................................................................................................. 15-12

Voluntary Classification Settlement Program (VCSP) ........................................................................................... 15-15

Review Feedback ................................................................................................................................................... 15-16

Penalties ................................................................................................................................................................... 16-1

Civil Penalties ........................................................................................................................................................... 16-1

Failure to File ............................................................................................................................................................ 16-1

Accuracy ................................................................................................................................................................... 16-2

Fraud ........................................................................................................................................................................ 16-3

Criminal Prosecution ................................................................................................................................................ 16-5

Review Feedback ..................................................................................................................................................... 16-9

2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders ............................... 17-1

Table of Contents

Administration ........................................................................................................................................................... 17-1

Inflation Reduction Act ............................................................................................................................................. 17-3

American Rescue Plan (ARP) .................................................................................................................................. 17-4

Tax Cuts and Jobs Act (TCJA) ................................................................................................................................. 17-5

Setting Every Community Up for Retirement Enhancement (SECURE) Act ........................................................... 17-5

Tax Forms ................................................................................................................................................................ 17-5

Individual and Capital Gains Tax Rates ................................................................................................................... 17-6

Standard Deduction and Filing Requirements ......................................................................................................... 17-8

Personal Exemption ............................................................................................................................................... 17-11

Income .................................................................................................................................................................... 17-11

Adjustments to Income ........................................................................................................................................... 17-11

Schedule C Provisions ........................................................................................................................................... 17-13

Itemized Deductions - Schedule A ......................................................................................................................... 17-16

Credits .................................................................................................................................................................... 17-24

Overview Topics ..................................................................................................................................................... 17-25

Reminders .............................................................................................................................................................. 17-32

Tax Planning .......................................................................................................................................................... 17-36

The Setting Every Community Up for Retirement Enhancement (SECURE 2.0) Act ............................................ 17-36

Review Feedback ................................................................................................................................................... 17-39

Bibliography .................................................................................................................................................................... I

Index ............................................................................................................................................................................ VII

Tax Tables ................................................................................................................................................................... A-I

Tax Return Preparation Instructions ....................................................................................................................... RP-1

Federal Tax Return Scenarios ................................................................................................................................ RP-1

Scenario 1 ............................................................................................................................................................... RP-1

Scenario 2 ............................................................................................................................................................... RP-5

Scenario 3 ............................................................................................................................................................... RP-9

Scenario 4 ............................................................................................................................................................. RP-13

Scenario 5 ............................................................................................................................................................. RP-16

Scenario 6 ............................................................................................................................................................. RP-20

Scenario 7 ............................................................................................................................................................. RP-24

Scenario 8 ............................................................................................................................................................. RP-27

Examination Instructions - CTEC Qualifying Education - 43 Hour Federal Tax Law .............................................. EX-1

Examination Questions - 43 Hour Federal Tax Law ............................................................................................... EX-2

Lesson 1 .................................................................................................................................................................. EX-2

Lesson 2 .................................................................................................................................................................. EX-4

Lesson 3 .................................................................................................................................................................. EX-6

Lesson 4 .................................................................................................................................................................. EX-8

Lesson 5 ................................................................................................................................................................ EX-10

Lesson 6 ................................................................................................................................................................ EX-13

Lesson 7 ................................................................................................................................................................ EX-15

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Lesson 8 ................................................................................................................................................................ EX-17

Lesson 9 ................................................................................................................................................................ EX-19

Lesson 10 .............................................................................................................................................................. EX-21

Lesson 11 .............................................................................................................................................................. EX-23

Lesson 12 .............................................................................................................................................................. EX-25

Lesson 13 .............................................................................................................................................................. EX-29

Lesson 14 .............................................................................................................................................................. EX-32

Lesson 15 .............................................................................................................................................................. EX-37

Lesson 16 .............................................................................................................................................................. EX-38

Lesson 17 .............................................................................................................................................................. EX-39

Course Evaluation ................................................................................................................................................... CE-1

CP36-01 – Provider Notification to New Preparers ................................................................................................. CP-1

Introduction

Thank you for choosing Golden State Tax Training Institute, Inc. This basic self-study 60 hour Qualifying Education (QE) course is approved by the California Tax Education Council (CTEC). This section contains 43 hours of Federal tax law and can be done at your own pace. Successful completion of the full 60-Hour QE course will enable you to register with CTEC as a California Registered Tax Preparer (CRTP) and prepare taxes within the State of California. We know your time is important to you, so we have produced the most comprehensive and innovative tax education products on the market today. We focus on customer service and satisfaction, and we strive to look for new and responsive ways to make earning your CTEC qualifying education requirements as convenient as possible. Since this is a self-study course, you can complete it at your own pace and on your own schedule. The minimum passing requirement is 70% on the examination questions at the end of the material. The exam has no time limit and is open book, so you are allowed to look up answers in the text we provide. You do not need to finish the exam in one continuous sitting as all of the answers you enter online are automatically saved. After you submit the exam to us, we will grade it and, upon successful completion, e-mail you a Certificate of Completion. Additionally, we notify the California Tax Education Council (CTEC) that you passed the Qualifying Education (QE) allowing you to apply for your CRTP registration. If you should fail the exam on your first attempt, you will have the option to re-take the exam at no additional charge. You have unlimited attempts to pass an exam.

Course Description This 43-Hour Federal tax law section focuses on key provisions recently enacted or indexed for inflation. Among other topics, this part includes information about the Inflation Reduction Act and the Tax Cuts and Jobs Act (TCJA). The material includes tax provision related to taxable income, exclusions, the most common tax credits and deductions, capital gains and losses, small business taxation and noteworthy tax filing documents and dates. The course also highlights important small business tax topics including sole proprietorships, depreciation, and the Section 179 deductions. Additionally, the course covers filing requirements for corporations, partnerships, S corporations and limited liability companies. Please Note: Due to the major tax reforms implemented by several new acts of Congress, the IRS recommends students watch for additional IRS guidance as the year progresses and the 2024 filing season approaches. The IRS also recommends students do the appropriate research as they encounter issues affected by the Tax Cuts and Jobs Act. This specifically applies to the pass-through deduction for qualified trade or business. Please review the IRS Tax Reform webpage located at https://www.irs.gov/newsroom/tax-reform for updated guidance and the most current information. This section includes a table of contents and comprehensive index to help guide your search for specific topics. Additionally, if you are using the electronic version of the course, you can use the word search function by pressing “CTRL + F” on your keyboard and entering the word(s) you would like to look up. Along with the extensive course content, you will also find a bibliography you can use to find additional reference material when searching for particular topics or answers to review and examination questions. The numbers in parentheses at the end of a sentence correspond to the numbers in the bibliography. Completion Deadline & Exam: This California Tax Education Council (CTEC) course must be completed within one year of the date of purchase. Course Level: This basic course is appropriate for individuals interested in becoming a California Registered Tax Preparer (CRTP). CTEC QE Credits: 43 Hours Category: Federal Taxation Prerequisite: None Advanced Preparation: None

Introduction

Course Learning Objectives

1. Revisit taxpayer accounting periods, methods, preliminary work and completing the filing process. 2. Review various tax forms and their specific application to various taxpayer return scenarios. Analysis includes

Form W-2, Form W-4, Form 1040, Schedule A, various Form 1099s, and others. 3. Ascertain modifications to taxable income, tax liability and special situations regarding filing status. 4. Examine changes affected by inflation and recent tax law especially as they relate to the Affordable Care Act,

individual tax credits and deductions, certain retirement income and filing the tax return. 5. Identify important small business and sole proprietor tax issues including the Section 179 election, standard

mileage rates, the Affordable Care Act and home office deductions. 6. Recognize important filing requirements for corporations, partnerships, S corporations and limited liability

companies. 7. Develop a familiarity with the changes affected by inflation and recent tax law especially as they relate to the

Inflation Reduction Act and the Tax Cuts and Jobs Act (TCJA).

Review Questions and Feedback

Throughout each lesson there are several review questions that are designed to help you learn the material you have just studied. Review questions are for instructional use only and you will not be graded on these questions. We provide both the answers to each question and an explanation or feedback as to how we arrived at each answer at the end of the lesson. Best practice suggests that you should try to answer these questions on your own first, and only then refer to the answer key and feedback to see how well you did in terms of learning the material. As with all self-study CPE courses, you can refer back to the course material to locate the answers - the so called 'open book' learning method is permissible.

Tax Return Preparation Practice Scenarios

Included with the course there are several tax return preparation scenarios that are designed to increase your practical working knowledge. The tax return preparation scenarios vary in complexity and are for instructional use only. You will not be graded on these questions however you should complete the return in its entirety. We provide both the answers to each question and an explanation or feedback as to how we arrived at each answer. The California Tax Education Council (CTEC) allows Qualifying Education (QE) credit for preparing Federal and California tax forms and their related schedules. We have included tax return scenarios that are based on the 2023 tax year so that you can obtain qualifying education credit and also get familiar with the Federal and state forms and their associated schedules. You should use the information provided in the 2023 tax tables in the appendix at the back of the course and on the 2023 forms included with each scenario to complete each return exercise. We also recommend, as a best practice, that you locate any additional 2023 tax year forms when they are made available and review them prior to preparing returns for possible changes from the previous year. For the tax return preparation scenarios, best practice suggests that you should try to answer the questions on your own first, and only then refer to the answer key and feedback to see how well you did in terms of learning the material.

Final Examination

The final examination is intended to test your overall comprehension of the course. Each question will relate to topics found throughout the course so all of the answers can be found in the material. Passing the final exam from a self-study course is contingent upon scoring 70% or higher on the exam questions related to the course material. The Federal tax law examination consists of 260 multiple-choice questions, meaning you must correctly answer 182 in order to pass. How To Submit The Online Examination:

➢ Log into www.GSTTI.com. ➢ Enter your email address and your password. ➢ Click link to take online exam. ➢ Answer questions (There is no time limit). ➢ Submit answers (The exam does not need to be completed in one sitting).

Introduction

➢ Get certificate by email within 24 hours. ➢ We electronically notify CTEC that you earned Qualifying Education (QE) course credits.

The exam has no time limit, and is open book, so you are allowed to look up answers in the text we provide. You do not need to finish the exam in one continuous sitting as all of the answers you enter online are automatically saved. After you submit the online exam to us you will receive a message if you do not pass the exam. If you should fail the exam on your first attempt, you will have the option to re-take the exam at no additional cost. You have unlimited attempts to pass an exam. Upon successful completion of the full 60-Hour QE course, we will e-mail you a Certificate of Completion. Additionally, we notify the California Tax Education Council (CTEC) that you passed the Qualifying Education (QE) allowing you to apply for your CRTP registration online at www.CTEC.org. You must register with CTEC within 18 months from the completion date on the certificate of completion. After your initial registration, you must complete 20 hours of continuing education each year and register with CTEC by October 31st. There is a late registration period from November 1st to January 15th, but you will have to pay CTEC a late registration fee during this period. Golden State Tax Training has a 20-Hour CTEC approved continuing professional education course that you can take each year to meet this requirement. We wish you every success and thank you for choosing Golden State Tax Training Institute, Inc.

Understanding the Icons Used in this Book

Important: Update or change

Tip: Significant information

Note: Additional information

Review Question: Learning opportunity

Golden State Tax Training Institute, Inc. is an approved education provider for the California Tax Education Council (CTEC) and the Internal Revenue Service (IRS). Our CTEC provider number is 2040 and can be verified at www.CTEC.org. Our IRS provider number is P619F and can be verified on the IRS list of Approved Continuing Education Providers.

Introduction

CTEC Registration Requirements IMPORTANT: Just because you successfully completed the 60-hour qualifying education (QE) course does not mean you can prepare tax returns in the state of California. You must also complete the registration process with the California Tax Education Council (CTEC). Carefully read the instructions below to complete that process. You have 18 months from the completion date listed on the 60-hour qualifying education (QE) completion certificate provided by Golden State Tax Training Institute to register with CTEC. If you do not register with CTEC within the allowed 18 months, you will be required to complete another 60-hour qualifying education course before being able to register. CTEC registration MUST be completed online at https://www.ctec.org/tax-professionals. You will need the following to complete your registration: An online application for new preparers; a background check and fingerprinting procedure (Live Scan); a $5,000 tax preparer bond; a valid IRS PTIN; and payment of a $100 nonrefundable application fee plus a $2 processing fee with a Visa, Master Card or Debit card. You have two registration options:

1. CAUTION - If you register as a new preparer before November 1 – you are registering for the cycle year ending on October 31 of that year. Example: If you register as a new preparer on October 15, 2024, that registration is only valid through October 31, 2024. You would be required to take another 20 hours of continuing education sometime between October 15, 2024 and October 31, 2024 to renew your registration for the next registration cycle.

2. If you register as a new preparer after October 31 – you are registering for the next cycle year beginning November 1 of the current year and ending on October 31 of next year. Example: If you register as a new preparer on November 2, 2024, your registration is valid through October 31, 2025. From November 2, 2024 through October 31, 2025, you will be required to take 20 hours of continuing education from a CTEC approved provider in order to meet the renewal requirements for the next registration cycle, which will begin on November 1, 2025.

Education providers do not register students with CTEC, it is up to you to take the final step and complete the registration process.

CTEC Application Process for New Preparers

Step 1 - Complete Online Application for New Preparers - Visit https://ctec.org/App/Preparer/NewApplication/index and click the link to begin your Online Application. You will be required to enter all required personal information, complete a background questionnaire, and create your login account. Be sure the email address you provide is current and accurate. Add a secondary email address (optional). Email addresses are used for communication during the background review process as well as registration renewal notification. You will be required to create a New User ID and Password. The New User ID and Password you create here will replace any previous User ID and Password that exists from your old account.

You will be required to pay a $100 nonrefundable application fee plus a $2 processing fee in order to submit a new application.

NOTE: You have the option to start your required 60-Hour Qualifying Education (QE) Course before beginning the Online Application; however, if you take the 60-Hour QE Course but do NOT pass the new CTEC requirements of a background check and fingerprinting procedure (Live Scan), you will not be able to register with CTEC. The application process allows you to select the education provider you will be using for your education. This information will be in a drop-down list of All Current Approved Education Providers in the CTEC system. You should use the drop-down menu to select Golden State Tax Training Institute, Inc. Our provider number is 2040.

Step 2 - Complete Live Scan Process - CTEC now requires all new applicants to pass a background check and fingerprinting procedure (Live Scan) in order to become registered with CTEC. Login to your account, which you created in STEP 1, by visiting https://ctec.org/App/Preparer/Login to access Live Scan forms and find Live Scan locations near you.

You will be required to complete the background questionnaire section. All offenses MUST be fully reported, even if they have been adjudicated, dismissed, expunged, or have occurred more than 10 years ago. You will have the ability to upload any supporting documents to be used in the background investigation process.

Introduction

You will be required to download and complete a Live Scan Form. Take the completed Live Scan Form with you to the Live Scan location you have selected where they will complete the fingerprinting process and send the information electronically to the California Department of Justice (DOJ). The Live Scan Facility will return the completed form to you for your records. DO NOT send this form to CTEC. The California Department of Justice (DOJ) will notify CTEC electronically with your background information, which then will be reviewed by CTEC. This process can take anywhere from 2 weeks to 2 months. NOTE: Your application will remain “Pending” until CTEC receives your Live Scan report from the California Department of Justice. Step 3 - CTEC Notification of Live Scan Approval or Denial - CTEC Live Scan reviewers will receive and review reports from the California Department of Justice. Either an approval or denial notification will be sent to the applicant. If approved, the notification will be sent via email. If denied, the notification will be sent via USPS. If approved, the applicant can then continue with the registration process below. If denied, the process to appeal will be outlined in the denial letter. You may be contacted by CTEC (via email) if additional information is needed regarding your background check. If additional information is requested and no response is received, you may receive a proposed denial letter. If approved, you will receive an email from CTEC with instructions on how to proceed with the Registration Process. If denied, the notification will be sent via email and USPS.

CTEC Registration Process

Step 1 - Take a 60-Hour Qualifying Education (QE) Course from a CTEC Approved Provider - Complete the required 60-Hour Qualifying Education (QE) Course from Golden State Tax Training Institute, Inc., a CTEC Approved Provider. Step 2 - Obtain a Personal Tax Identification Number (PTIN) from the IRS - Go to IRS.gov/tax-professionals to apply for a Personal Tax Identification Number (PTIN). You are required to have this number for CTEC registration. Step 3 - Purchase a Tax Preparer Surety Bond - As required by law, you must purchase a $5,000 Tax Preparer Surety Bond from a surety bond company in order to register with CTEC. Use the Internet to search for surety bond companies. Once you receive the bond, you will need to upload a copy of that bond to your CTEC account. You will find directions on the uploading process once you are in your account. Step 4 - Complete Online CTEC Registration and Submit Payment - Once you have completed your 60-hour QE course from your CTEC approved provider, received your PTIN number from the IRS, and received your $5,000 tax preparer surety bond, you will need to complete the online CTEC registration process. As part of the final process, CTEC allows you to select either the current or subsequent cycle year. Visit ctec.org/App/Preparer/Login to access your CTEC account and finalize your registration. As a reminder, education providers do not register students with CTEC, it is up to you to take the final step and complete the registration process.

Important Information

The following items are important registration topics to remember:

➢ The CTEC cycle year registration period runs from November 1st to October 31st of the following year. ➢ Renewal registration opens August 1st and ends October 31st. ➢ After your initial registration, you must complete 20 hours of continuing education annually from a CTEC approved

provider and renew your registration with CTEC by October 31st each year. ➢ There is a late renewal period that runs from November 1st through January 15th of the following year. If you renew

during that time period, a late registration fee will apply. Remember, you are not permitted to prepare taxes during this late renewal registration period.

➢ If you fail to renew by January 15th of any given year, you will be required to retake the 60-hour qualifying education course from a CTEC approved provider; complete an online application for new preparers; complete a background check and fingerprinting procedure (Live Scan); have a $5,000 tax preparer bond; have a valid IRS PTIN; and, register as a new preparer.

Introduction

California Legislation Changes CTEC Requirements for CRTPs California Assembly Bill 3143 was signed into law in September 2018 with new provisions and requirements that will extend the CTEC program until January 1, 2023. The renamed Tax Preparation Act (California Business and Professions Code Section 22250-22259) stipulates revisions that will impact CTEC Registered Tax Preparers (CRTPs).

CRTPs Must Provide CTEC’s Website to Clients

As of January 1, 2019, CRTPs, prior to rendering any tax preparation services, shall provide their customer, in writing, with the following:

1. The tax preparer’s name, address, and telephone number. 2. Evidence of compliance with the bonding requirement, including the name of your bond company, the bond

number, the bond effective date and expiration date. 3. The address of the CTEC website, www.ctec.org.

Upload a Copy of a Valid Tax Preparer Bond

CTEC registration now requires an individual to upload a copy of a valid tax preparer bond when registering or renewing. The bond policy must include the following:

➢ Tax preparer’s name. ➢ The name of the surety bond company. ➢ Bond policy number. ➢ Bond effective date. ➢ Bond expiration date.

Disciplinary Actions Against CRTPs Made Public

As of July 1, 2019, CTEC will post the following on its website:

➢ All disciplinary actions taken against registrants by the Council, including, but not limited to, misconduct that resulted in a suspension or revocation of a CRTP registration.

➢ A list of registrants on probation, including the misconduct that resulted in the probation and any terms of probation.

➢ A notice of the paid surety bond claims.

Reporting Bond Claims

As of July 1, 2019, a CRTP is required to report all paid claims against their surety bond to CTEC. CTEC is also required to post a notice of the paid surety bond claims on ctec.org.

Background Checks and Fingerprint Images

Effective July 1, 2020, California Business & Professions Code Section 22251.3 was amended to require new applicants interested in becoming CRTPs to pass a criminal background check and submit fingerprint images to CTEC to determine an individual’s eligibility to register as a CRTP. The new requirements are NOT applicable to current CRTPs, only new applicants who register on or after July 1, 2020. Also, as of July 1, 2020, if a CRTP allows their CTEC registration to expire and they would like to reregister with CTEC, they not only will be required to retake the 60-hour qualifying education (QE) course, but they will also be required to go through a background check and resubmit fingerprint images to CTEC.

Enforcement

During the 2022/2023 fiscal year, the Franchise Tax Board Tax Preparer Enforcement Team contacted more than 1,400 questionable tax preparers, including some who failed to comply the prior year. Unregistered tax preparers who are caught preparing, or assisting with preparing, tax returns for a fee will be issued a $2,500 penalty letter from the Franchise Tax Board (FTB).

Introduction

They have 90 days to register with CTEC before the penalty is enforced. If a tax preparer does not comply, the $2,500 penalty is assessed. If a tax preparer still fails to comply the next year, a $5,000 penalty will be issued each year until they either register with CTEC or agree to stop preparing tax returns for a fee. CTEC pays for the entire enforcement program. All penalties collected by FTB are deposited into the state’s general fund.

California Consumer Privacy Act

Effective January 1, 2020, the California Consumer Privacy Act, or CCPA, will go into effect. The new law, which the California Attorney General will begin to enforce on July 1, 2020, requires any business that collects or stores the personal information of California residents, regardless of where the business is located, must comply with the CCPA. This bill gives a consumer the right to control what a business does with the personal information that has been collected about the consumer. Under the CCPA, a consumer must file a verifiable request to obtain information from a business or request that a business handle the consumer’s personal information in a certain way. The request must be verifiable; the business must be able to verify the requestor’s identity. Under the CCPA, among other items, a consumer may request:

➢ To know the categories of a consumer’s personal information that the business collects. ➢ To know the specific items of a consumer’s personal information that the business has collected. ➢ To know the business purpose for the collection of the consumer’s personal information. ➢ That their personal information is not sold. ➢ That their personal information be deleted.

Under the CCPA, a business has 45 days to respond to a request with the opportunity to get additional time. For more information, visit the California Attorney General’s website at oag.ca.gov/privacy/ccpa.

Introduction

Taxes 101 Tax is a complex and technical area of law with frequent changes. It is common for there to be ten or twelve amendments to the Internal Revenue Code in a single year and more than fifty Revenue Rulings. In addition, there are dozens of regulatory and administrative documents generated by the IRS every year. (1)

Tax History

The origin of the income tax on individuals is generally cited as the passage of the 16th Amendment, passed by Congress on July 2, 1909, and ratified February 3, 1913; however, its history actually goes back even further. During the Civil War Congress passed the Revenue Act of 1861 which included a tax on personal incomes to help pay war expenses. The tax was repealed ten years later. Additionally, in 1894 Congress enacted a flat rate Federal income tax, which was ruled unconstitutional the following year by the U.S. Supreme Court because it was a direct tax not apportioned according to the population of each state. The 16th amendment, ratified in 1913, removed this objection by allowing the Federal government to tax the income of individuals without regard to the population of each State. April 15th has not always been the filing deadline. March 1st was the date specified by Congress in 1913, after the passage of the 16th amendment. In 1918 Congress pushed the date forward to March 15th, where it remained until the tax overhaul of 1954, when the date was again moved ahead to April 15th. (2)

Tax Law

Article I Section 7 of the U.S. Constitution is the starting point for new tax law. This Section states that all revenue bills must originate in the House of Representatives. Within the House of Representatives, revenue bills are dealt with by the House Ways and Means Committee. The Ways and Means Committee initially writes a tax law bill. There is no specific time frame for the introduction of new proposed tax law by committee members. Proposals are sent to the committee chairman on a rolling basis as they work their way through regular business. Once the bill specifies the text for the new tax law being proposed it is passed on to the Rules Committee. The Rules Committee has control over when new legislation will be considered by the House. If the Rules Committee permits consideration, the new bill will then be presented to the House for ratification. If passed, the tax law bill may be considered by the Senate. Much like the House Ways and Means Committee, the Senate Finance Committee has jurisdiction over tax law bills. The Senate can amend the bill written by the House. The Senate can amend and even go as far as deleting everything in a tax law bill and start over (all tax law bills still must technically originate in the House, even if they are rewritten from scratch). Fifty-one votes are needed to pass a bill in the Senate. If passed, the tax law bill will be signed into law by the President or vetoed by the President.

Brief History of the IRS

The roots of the IRS go back to the Civil War when President Lincoln and Congress, in 1862, created the position of commissioner of Internal Revenue and enacted an income tax to pay war expenses. The income tax was repealed 10 years later. Congress revived the income tax in 1894, but the Supreme Court ruled it unconstitutional the following year. In 1913, Wyoming ratified the 16th Amendment, providing the three-quarter majority of states necessary to amend the Constitution. The 16th Amendment gave Congress the authority to enact an income tax. That same year, the first Form 1040 appeared after Congress levied a 1% tax on net personal incomes above $3,000 with a 6% surtax on incomes of more than $500,000. In 1918, during World War I, the top rate of the income tax rose to 77% to help finance the war effort. It dropped sharply in the post-war years, down to 24% in 1929, and rose again during the Depression. During World War II, Congress introduced payroll withholding and quarterly tax payments.

Introduction

In the 50s, the agency was reorganized to replace a patronage system with career, professional employees. The Bureau of Internal Revenue name was changed to the Internal Revenue Service. Only the IRS commissioner and chief counsel are selected by the President and confirmed by the Senate. The IRS Restructuring and Reform Act of 1998 prompted the most comprehensive reorganization and modernization of IRS in nearly half a century. The IRS reorganized itself to closely resemble the private sector model of organizing around customers with similar needs. (3)

General Filing Information At the conclusion of this lesson you should have a basic knowledge of:

➢ Preliminary Work. ➢ Accounting Periods. ➢ Accounting Methods. ➢ Filing Dates. ➢ Types of Taxes. ➢ e-Filing. ➢ Paying the Tax. ➢ Presidential Election Campaign Contribution Fund.

Preliminary Work and Collection of Taxpayer Data

Review of Prior Year’s Return for Accuracy, Comparison and Carryovers for Current Year Return

Before completing a tax return, be sure to review the taxpayer’s return from last year not just for accuracy but also for comparison to the current year return. This return will provide you with a wealth of information that can be valuable in the preparation of the current year's return, including:

➢ Tax loss carry forward information. ➢ Withholding information. ➢ Information about how certain income may have been treated, such as capital gains or traditional income.

Many tax preparers neglect to go over last year's return. But it is worth the time because very often he or she will find an applicable item that is not common for all individuals such as itemized deductions, sale of a residence, retirement pay, applicable taxes or some other important piece of information that might be beneficial to this year's return. Certain items from the prior year return may be needed to complete the current-year return (state income tax refund, AMT for credit, gain/loss carryover, charitable gift carryover, etc.).

A comparison may show that there were no important changes from the previous tax year. If this is the case, the current year return should total similar amounts and have a similar tax liability or refund. As you can see, the accuracy of the previous year’s return is significant as a resource. It can also increase efficiency when completing the current year’s return.

Collect Taxpayer’s Biographical Information

Verify taxpayer’s identity, date of birth, citizenship, and age by examining government issued identification of taxpayer such as passport, driver’s license, or national identity card. Interview the taxpayer to determine filling status. The age of a taxpayer determines if he or she qualifies for certain deductions, retirement distribution and/or dependency. Also, taxpayers using the married, filing jointly status often increase dollar limits for deductions and credits.

Nationality

If an individual is an alien, he or she is considered to be a nonresident alien unless either the green card or substantial presence test for the calendar year is met. However, if the individual does not meet either of these tests he or she may choose to be treated as a U. S. resident for part of the year as a dual status alien. This usually occurs in the year of arrival or departure from the United States.

U.S. Citizen: (4)

➢ An individual born in the United States. ➢ An individual whose parent is a U.S. citizen.* ➢ A former alien who has been naturalized as a U.S. citizen. ➢ An individual born in Puerto Rico.

Lesson 1 - General Filing Information

➢ An individual born in Guam. ➢ An individual born in the U.S. Virgin Islands.

*The Child Citizenship Act, which applies to both adopted and biological children of U.S. citizens, amends Section 320 of the Immigration and Nationality Act (INA) to provide for the automatic acquisition of U.S. citizenship when certain conditions have been met. Specifically, these conditions are: (4)

1. One parent is a U.S. citizen by birth or through naturalization. 2. The child is under the age of 18. 3. The child is residing in the United States as a lawful permanent resident alien and is in the legal and physical

custody of the U.S. citizen parent. 4. If the child is adopted, the adoption must be final.

A U.S. National is an individual who owes his sole allegiance to the United States, including all U.S. citizens, and including some individuals who are not U.S. citizens. For tax purposes the term "U.S. national" refers to individuals who were born in American Samoa or the Commonwealth of the Northern Mariana Islands. (4) An Alien is an individual who is not a U.S. citizen or U.S. national. An Immigrant is an alien who has been granted the right by the United States Citizenship and Immigration Services (USCIS) to reside permanently in the United States and to work without restrictions in the United States. Also known as a Lawful Permanent Resident (LPR). All immigrants are eventually issued a "green card" (USCIS Form I-551), which is the evidence of the alien’s LPR status. LPRs who are awaiting the issuance of their green cards may bear an I-551 stamp in their foreign passports. (4) Dual Status Aliens determine their residency status under both the Internal Revenue Code and tax treaties. If an individual changes status during the current year from a nonresident alien to a resident alien or from a resident alien to a nonresident alien, he or she is a Dual Status Alien and must file a special tax return called a Dual Status Return described in Publication 519 - U.S. Tax Guide for Aliens. If the individual is a Nonresident Alien who will become a Resident Alien under the Substantial Presence test in the year following this taxable year, he or she may elect to be treated as a Dual Status Alien for this taxable year and a Resident Alien for the next taxable year if he or she meets certain tests. (Refer to section "Dual-Status Aliens" – "First Year Choice" in Publication 519 - U.S. Tax Guide for Aliens.) Most Tax Treaties contain an article which defines tax residency for purposes of the Tax Treaty. Tax residency determined under the residency article of a tax treaty may differ from the residency provisions of the Internal Revenue Code. A dual status alien married to a U.S. citizen or to a resident alien may elect to file a joint income tax return with his or her U.S. citizen or resident alien spouse. If, at the end of the taxpayer’s tax year, an individual is married, and one spouse is a U.S. citizen or a resident alien and the other spouse is a nonresident alien, he or she can choose to treat the nonresident spouse as a U.S. resident. This includes situations in which one spouse is a nonresident alien at the beginning of the tax year, but a resident alien at the end of the year, and the other spouse is a nonresident alien at the end of the year. (5) If the taxpayer makes this choice, he or she and his or her spouse are treated as residents for the entire tax year for the purpose of the Federal individual income tax return, and for the purpose of withholding U.S. Federal income tax from wages. However, for the purpose of Chapter 3 withholding the taxpayer may still be treated as a nonresident alien. In addition, the taxpayer may still be treated as a nonresident alien for the purpose of withholding Social Security and Medicare tax. Generally, neither the taxpayer nor his or her spouse can claim tax treaty benefits as a resident of a foreign country for a tax year for which the choice is in effect and they are both taxed on worldwide income. However, the exception to the saving clause of a particular tax treaty might allow a resident alien to claim a tax treaty benefit on certain specified income. The taxpayer must file a joint income tax return for the year he or she makes the choice, but he or she and his or her spouse can file joint or separate returns in later years. (5)

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If the taxpayer files a joint return under this provision, the special instructions and restrictions for dual-status taxpayers do not apply.

An Illegal Alien, also known as an "Undocumented Alien," is an alien who has entered the United States illegally and is deportable if apprehended, or an alien who entered the United States legally but who has fallen "out of status" and is deportable. A Nonimmigrant Visa allows a nonimmigrant to enter the United States in one of several different categories, which correspond to the purpose for which the nonimmigrant is being admitted to the United States. For example, a foreign student will usually enter the United States on an F-1 visa, a visitor for business on a B-1 visa, an exchange visitor (including students, teachers, researchers, trainees, alien physicians, au pairs, and others) on a J-1 visa, a diplomat on an A or G visa, etc. The categories of nonimmigrant visas correspond exactly to the "nonimmigrant status" assigned to each nonimmigrant upon his arrival, based on the purpose for which the nonimmigrant was admitted to the United States. For example, a foreign student who enters the United States on an F-1 visa is considered to be in F-1 student status after he enters the United States; and he will remain in that status until he violates the conditions prescribed for that status, or until he changes to another nonimmigrant or immigrant status with USCIS permission, or until he leaves the United States. The Visa Waiver Program (VWP) enables citizens of participating countries to travel to the United States for tourism or business for 90 days or less without obtaining a United States visa. The VWP is administered by the Attorney General in consultation with the Secretary of State. The Visa Waiver Program (VWP) was created by an act of Congress as a pilot program in 1986 and implemented in 1988. Congress passed legislation to make the program permanent in October 2000, and the President signed the legislation on October 30, 2000.

Accuracy

The IRS reminds filers that e-filing their tax return greatly lowers the chance of errors. In fact, taxpayers are about twenty times more likely to make a mistake on their return if they file a paper return instead of e-filing their return. Here are eight common errors to avoid: (6)

1. Wrong or missing Social Security numbers. Be sure to enter SSNs for the taxpayer and others on the tax return exactly as they are on the Social Security cards.

2. Names wrong or misspelled. Be sure to enter names of all individuals on the tax return exactly as they are on their Social Security cards.

3. Filing status errors. Choose the right filing status. There are five filing statuses: Single, Married Filing Jointly, Married Filing Separately, Head of Household and Surviving Spouse With Dependent Child.

4. Math mistakes. When filing a paper tax return, double check the math. When e-filing, the software does the math. For example, if Social Security benefits are taxable, check to ensure the taxable portion is figured correctly.

5. Errors in figuring credits, deductions. Take time and read the instructions in the tax booklet carefully. Many filers make mistakes figuring their Earned Income Tax Credit, Child and Dependent Care Credit and the standard deduction. For example, if the taxpayer is age 65 or older or blind, check to make sure to claim the correct, larger standard deduction amount.

6. Wrong bank account numbers. Direct deposit is the fast, easy and safe way to receive a tax refund. Make sure to enter the bank routing and account numbers correctly.

7. Forms not signed, dated. An unsigned tax return is like an unsigned check – it is invalid. Remember both spouses must sign a joint return.

8. Electronic signature errors. If the taxpayer e-files his or her income tax return, he or she will sign the return electronically using a Personal Identification Number. For security purposes, the software will ask him or her to enter the Adjusted Gross Income from the originally filed 2022 Federal tax return. Do not use the AGI amount from an amended 2022 return or an AGI provided to the taxpayer if the IRS corrected the return. The taxpayer may also use last year's PIN if he or she e-filed last year and remembers the PIN.

Tax Return Preparers Must Use IRS e-File

The law requiring paid tax return preparers to electronically file Federal income tax returns prepared and filed for individuals, trusts and estates started January 1, 2011. The e-file requirement phased in over two years starting in 2011. As a result of the rule, preparers who anticipate filing 11 or more 1040, 1040-NR and 1041 during the year will be required to use IRS e-file.

Lesson 1 - General Filing Information

The rule requires members of firms to compute the number of returns in the aggregate that they reasonably expect to file as a firm. If that number is 11 or more in a calendar year, then all members of the firm must e-file the returns they prepare and file. This is true even if a member prepares and files fewer than the threshold on an individual basis. Clients may independently choose to file on paper.

Tax Preparers Must have a Preparer Tax Identification Number

IRS regulations require all paid tax return preparers and enrolled agents (including attorneys, and CPAs if they prepare for compensation all or substantially all of a Federal tax return or claim for refund) to obtain a Preparer Tax Identification Number (PTIN) before preparing any Federal tax returns. A PTIN meets the requirements under Section 6109(a)(4) of furnishing a paid tax return preparer’s identifying number on returns that you prepare. In February of 2013 the United States District Court for the District of Columbia modified its order from January of 2013 to clarify that the order does not affect the requirement for all paid tax return preparers to obtain a preparer tax identification number (PTIN). You must renew your PTIN every year during the renewal season which generally starts in October and must be completed by December 31. Your PTIN is your Federal license to prepare taxes and it must be included on all returns you prepare.

Taxpayer Identification Numbers

A Taxpayer Identification Number (TIN) is an identification number used by the Internal Revenue Service (IRS) in the administration of tax laws. It is issued either by the Social Security Administration (SSA) or by the IRS. Most taxpayers will use a Social Security number (SSN) issued by the SSA. Additional TINs issued by the IRS include:

➢ Employer Identification Number "EIN". ➢ Individual Taxpayer Identification Number "ITIN". ➢ Taxpayer Identification Number for Pending U.S. Adoptions "ATIN". ➢ Preparer Taxpayer Identification Number "PTIN".

A taxpayer generally must list on his or her individual income tax return the Social Security number (SSN) of any person for whom he or she claims the Child Tax Credit.

Identity Protection Personal Identification Number (IP PIN)

If a taxpayer received an IRS notice providing him or her with an Identity Protection Personal Identification Number (IP PIN), enter it in the IP PIN spaces provided below daytime phone number on the tax return form. The taxpayer must enter the IP PIN exactly as it is shown on the Notice CP01A. If the taxpayer did not receive a notice containing an IP PIN, leave these spaces blank. An IP PIN is a number the IRS gives to taxpayers who have: (7)

➢ Reported to the IRS they have been victims of identity theft. ➢ Given the IRS information that verifies their identity. ➢ Had an identity theft indicator applied to his or her account.

The IP PIN helps to prevent the misuse of a taxpayer's Social Security number or Taxpayer Identification Number on income tax returns. New IP PINs are issued every year. An IP PIN should be used only for the tax year it was issued. IP PINs for 2023 income tax returns generally are sent in December 2023. A new CP01A notice will be issued each subsequent year in January for the new filing season as long as the taxpayer's tax

account remains at risk for identity theft. If the taxpayer is filing a joint return and both taxpayers receive an IP PIN, only the taxpayer whose Social Security number (SSN) appears first on the tax return should enter his or her IP PIN.

Accounting Periods The taxpayer must use a tax year to figure his or her taxable income. A tax year is an annual accounting period for keeping records and reporting income and expenses. An annual accounting period does not include a short tax year. The taxpayer can use one of the following tax years:

➢ A calendar year. ➢ A fiscal year (including a 52-53-week tax year).

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Unless the taxpayer has a required tax year, he or she adopts a tax year by filing his or her first income tax return using that tax year. A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. The taxpayer cannot adopt a tax year by merely:

➢ Filing an application for an extension of time to file an income tax return. ➢ Filing an application for an employer identification number (Form SS-4). ➢ Paying estimated taxes.

Calendar Year

A calendar year is 12 consecutive months beginning on January 1st and ending on December 31st. If the taxpayer adopts the calendar year, he or she must maintain his or her books and records and report his or her income and expenses from January 1st through December 31st of each year. If the taxpayer files his or her first tax return using the calendar tax year and he or she later begins business as a sole proprietor, becomes a partner in a partnership, or becomes a shareholder in an S corporation, he or she must continue to use the calendar year unless he or she obtains approval from the IRS to change it, or is otherwise allowed to change it without IRS approval. Generally, anyone can adopt the calendar year. However, the taxpayer must adopt the calendar year if:

➢ He or she keeps no books or records. ➢ He or she has no annual accounting period. ➢ His or her present tax year does not qualify as a fiscal year. ➢ He or she is required to use a calendar year by a provision in the Internal Revenue Code or the Income Tax

Regulations.

Fiscal Year

A fiscal year is 12 consecutive months ending on the last day of any month except December 31st. If the taxpayer is allowed to adopt a fiscal year, he or she must consistently maintain his or her books and records and report his or her income and expenses using the time period adopted.

52-53-Week Tax Year

The taxpayer can elect to use a 52-53-week tax year if he or she keeps his or her books and records and report his or her income and expenses on that basis. If the taxpayer makes this election, the 52-53-week tax year must always end on the same day of the week. The 52-53-week tax year must always end on:

➢ Whatever date this same day of the week last occurs in a calendar month. ➢ Whatever date this same day of the week falls that is nearest to the last day of the calendar month.

Short Tax Year

A short tax year is a tax year of less than 12 months. A short period tax return may be required when the taxpayer (as a taxable entity):

➢ Is not in existence for an entire tax year. ➢ Changes his or her accounting period.

Tax on a short period tax return is figured differently for each situation.

Accounting Methods An accounting method is a set of rules used to determine when income and expenses are reported on the taxpayer’s tax return. His or her accounting method includes not only the overall method of accounting, but also the accounting treatment he or she uses for any material item. The taxpayer can choose an accounting method when he or she files his or her first tax return. If the taxpayer later wants to change his or her accounting method, he or she must get IRS approval.

Lesson 1 - General Filing Information

No single accounting method is required of all taxpayers. The taxpayer must use a system that clearly reflects his or her income and expenses, and he or she must maintain records that will enable him or her to file a correct return. In addition to the taxpayer’s permanent accounting books, he or she must keep any other records necessary to support the entries on his or her books and tax returns. The taxpayer must use the same accounting method from year to year. An accounting method clearly reflects income only if all items of gross income and expenses are treated the same from year to year. If the taxpayer does not regularly use an accounting method that clearly reflects his or her income, the taxpayer’s income will be refigured under the method that, in the opinion of the IRS, does clearly reflect income. In general, a taxpayer can compute his or her taxable income under any of the following accounting methods: (8)

➢ Cash method. ➢ Accrual method. ➢ Special methods of accounting for certain items of income and expenses. ➢ A hybrid method which combines elements of two or more of the above accounting methods.

Cash Method

Most individuals and many small businesses use the cash method of accounting. Generally, if the taxpayer produces, purchases, or sells merchandise, he or she must keep an inventory and use an accrual method for sales and purchases of merchandise. Under the cash method, the taxpayer includes in his or her gross income all items of income he or she actually or constructively receives during the tax year. If the taxpayer receives property and services, he or she must include their fair market value (FMV) in income. Under the cash method, generally, a taxpayer deducts expenses in the tax year in which he or she actually pays them. This includes business expenses for which he or she contests liability. However, the taxpayer may not be able to deduct an expense paid in advance. Instead, he or she may be required to capitalize certain costs. An expense a taxpayer pays in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following: (8)

➢ 12 months after the right or benefit begins. ➢ The end of the tax year after the tax year in which payment is made.

If the taxpayer has not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses he or she paid in advance, the taxpayer must obtain approval from the IRS before using the general rule and/or the 12-month rule.

Review Question 1 Cindy is a calendar year taxpayer, and she uses the cash method for her accounting. Her bank credited, and made available, interest to her bank account in December 2023. She did not withdraw it or enter it into her books until 2024. Which of the following statements is true regarding the amount she must include in gross income?

A. Cindy must include the amount in gross income for 2023 B. Cindy must include the amount in gross income for 2024 C. Cindy has the option to include the amount in gross income for 2023 or 2024 D. Cindy does not have to include the amount in gross income for 2023 or 2024

See Review Feedback for answer.

Excluded Entities

In 2023, the following entities cannot use the cash method, including any combination of methods that includes the cash method:

Lesson 1 - General Filing Information

➢ A corporation (other than an S corporation). ➢ A partnership with a corporation (other than an S corporation) as a partner. ➢ A tax shelter, as defined in Section 448(d)(3).

The following entities can use the cash method of accounting:

➢ Any corporation or partnership, other than a tax shelter, which meets the gross receipts test. ➢ A qualified personal service corporation (PSC).

Organizations that are members of an affiliated service group or a controlled group of corporations treated as a single employer for tax purposes must aggregate their gross receipts to determine whether the gross receipts test is met. A corporation or partnership that fails to meet the gross receipts test for any tax year cannot use the cash method and must change to an accrual method of accounting, effective for the tax year in which the entity fails to meet this test. The entity must file Form 3115 to request the change.

Accrual Method

Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs rather than when payment is received or made. Under the accrual method of accounting, generally the taxpayer reports income in the year it is earned and deducts or capitalizes expenses in the year incurred. The purpose of an accrual method of accounting is to match income and expenses in the correct year. Generally, the taxpayer includes an amount in gross income for the tax year in which all events that fix his or her right to receive the income have occurred and he or she can determine the amount with reasonable accuracy. Under this rule, the taxpayer reports an amount in his or her gross income on the earliest of the following dates: (8)

➢ When he or she receives payment. ➢ When the income amount is due to him or her. ➢ When he or she earns the income. ➢ When title has passed. ➢ When included as revenue in the taxpayer’s applicable financial statement (AFS), if the taxpayer has an AFS.

Advance Payment for Services

Generally, the taxpayer reports an advance payment for services to be performed in a later tax year as income in the year he or she receives the payment. However, if the taxpayer receives an advance payment for services he or she agrees to perform by the end of the next tax year, the taxpayer can elect to postpone including the advance payment in income until the next tax year. However, he or she cannot postpone including any payment beyond that tax year. The taxpayer can postpone reporting income from an advance payment he or she receives for a service agreement on property he or she sells, leases, builds, installs, or constructs. This includes an agreement providing for incidental replacement of parts or materials. However, this applies only if the taxpayer offers the property without a service agreement in the normal course of business. Generally, a taxpayer cannot postpone including an advance payment in income for services if either of the following applies: (8)

➢ He or she is to perform any part of the service after the end of the tax year immediately following the year, he or she receives the advance payment.

➢ He or she is to perform any part of the service at any unspecified future date that may be after the end of the tax year immediately following the year, he or she receives the advance payment.

Advance Payment for Sales

Special rules apply to including income from advance payments on agreements for future sales or other dispositions of goods held primarily for sale to customers in the ordinary course of a taxpayer’s trade or business. However, the rules do not apply to a payment (or part of a payment) for services that are not an integral part of the main activities covered under the agreement. An agreement includes a gift certificate that can be redeemed for goods. Amounts due and payable are considered received.

Lesson 1 - General Filing Information

Generally, include an advance payment in income in the year in which the taxpayer receives it. However, the taxpayer can use the alternative method. Under the alternative method, generally include an advance payment in income in the earlier tax year in which the taxpayer:

➢ Includes advance payments in gross receipts under the method of accounting he or she uses for tax purposes. ➢ Includes any part of advance payments in income for financial reports under the method of accounting used for

those reports. Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements.

Changing Accounting Methods

If a taxpayer is a qualifying taxpayer or qualifying small business taxpayer and wants to change to the cash method or to account for inventoriable items as non-incidental materials and supplies, he or she must file Form 3115 - Application for Change in Accounting Method. Both changes can be requested under the automatic change procedures of Revenue Procedures 2001-10 and 2002-28, as modified, amplified, and clarified by Revenue Procedure 2011-14 (or any successor). The taxpayer can file one Form 3115 if he or she chooses to request to change to the cash method and to account for inventoriable items as non-incidental materials and supplies.

Inventories

An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income- producing factor. If the taxpayer must account for an inventory in his or her business, he or she must use an accrual method of accounting for his or her purchases and sales. To figure taxable income, the taxpayer must value his or her inventory at the beginning and end of each tax year. To determine the value, the taxpayer needs a method for identifying the items in his or her inventory and a method for valuing these items. The rules for valuing inventory are not the same for all businesses. The method the taxpayer uses must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. The taxpayer’s inventory practices must be consistent from year to year.

Filing Dates The annual income tax return for individuals is due by the 15th day of the fourth month after the close of the tax year, usually April 15th. However, when the 15th falls on a weekend (Saturday or Sunday) or a holiday, the due date becomes the next regular working day. Therefore, if the 15th happened to be Saturday, the return would be due on Monday, April 17th. The due date for the 2023 filing season is April 15, 2024 for most individual taxpayers. If the taxpayer uses a fiscal year, the return is due the 15th day of the fourth month after the close of the fiscal year. For example, if the fiscal year ends June 30, his or her tax return due date would be October 15. If the taxpayer is a U.S. citizens or resident alien abroad and files on a fiscal year basis (a year ending on the last day of any month except December), the due date is 3 months and 15 days after the close of the fiscal year. If the taxpayer is a U.S. citizen or resident alien residing overseas or is in the military on duty outside the U.S., on the regular due date of the return, he or she is allowed an automatic 2-month extension to file the return and pay any amount due without requesting an extension. For a calendar year return, the automatic 2-month extension is to June 15. Also, as of December 31, 2015:

➢ Partnership tax returns are due March 15, not April 15 as in the past. If the taxpayer’s partnership is not on a calendar year, the return is due on the 15th day of the third month following the close of his or her tax year.

➢ C corporation tax returns are due April 15, not March 15. For non-calendar year taxpayers, it is due on the 15th day of the fourth month following the close of the tax year.

➢ S corporation tax returns remain unchanged. The returns are still due March 15, or the third month following the close of the taxable year. If the S corporation is unable to file by March 15, it can obtain an automatic six-month extension of time to file by filing IRS Form 7004.

➢ C corporations with tax years ending on June 30 will continue to have a due date of September 15 until 2025. For years beginning after 2025, the due date for these returns will be October 15.

➢ FBARs (FINCEN Form 114) will be due on April 15th, not June 30th. An extension for six months will be available (until October 15th).

Lesson 1 - General Filing Information

The deadline for filing tax returns, paying taxes, filing claims for refund, and taking other actions with the IRS is automatically extended if either of the following statements is true: (9)

➢ The taxpayer serves in the Armed Forces in a combat zone or he or she has qualifying service outside of a combat zone.

➢ The taxpayer serves in the Armed Forces on deployment outside the United States away from his or her permanent duty station while participating in a contingency operation. A contingency operation is a military operation that is designated by the Secretary of Defense or results in calling members of the uniformed services to active duty (or retains them on active duty) during a war or a national emergency declared by the President or Congress.

The deadline for taking actions with the IRS is extended for 180 days after the later of: (9)

➢ The last day the taxpayer is in a combat zone, have qualifying service outside of the combat zone, or serve in a contingency operation (or the last day the area qualifies as a combat zone or the operation qualifies as a contingency operation).

➢ The last day of any continuous qualified hospitalization for injury from service in the combat zone or contingency operation or while performing qualifying service outside of the combat zone.

In addition to the 180 days, the deadline is extended by the number of days that were left for the taxpayer to take the action with the IRS when he or she entered a combat zone (or began performing qualifying service outside the combat zone) or began serving in a contingency operation. If the person entered the combat zone or began serving in the contingency operation before the period of time to take the action began, the deadline is extended by the entire period of time he or she has to take the action. For example, the individual has 3½ months (January 1– April 15, 2024) to file his or her 2023 tax return. Any days of this 3½ month period that were left when he or she entered the combat zone (or the entire 3½ months if he or she entered the combat zone by January 1, 2024) are added to the 180 days when determining the last day allowed for filing the 2023 tax return. If the return is mailed, it must be placed in the mail and postmarked on or before the due date. The practice of filing sooner is encouraged by the IRS. Generally, the earliest possible date is January 1, although few, if any, taxpayers are in a position to file this soon. Employees, for example, must wait for Form W-2 to be issued by the employer. The tax law allows the employer until January 31 to prepare and issue the necessary Forms 1099 or W-2 for the previous year. If the taxpayer anticipates a refund, the sooner the tax return is filed, the sooner results can be expected. Because of the increased workload of the IRS as April 15 approaches, an early filing of a return means that a refund will be processed in less time. If a taxpayer sends his or her return by registered or certified mail, the date of the filing is the postmark date. The registration receipt is evidence that the return was filed on the postmarked date. If a taxpayer sends a return by certified mail and has a receipt postmarked by a postal employee, the date on the receipt is the postmark date. The postmarked certified mail receipt is evidence that the return was delivered and postmarked on the date stamped by the United States Post Office. Most returns are filed at regional centers geographically dispersed across the United States. The address of the Internal Revenue Service Office serving the states in which the taxpayer lives can be found in the instructions to Form 1040.

A taxpayer may simplify the money listings on the return by rounding off to whole dollar amounts. Any amount less than $0.50 would be eliminated, and any amount from $0.50 through $0.99 would be increased to the next higher dollar.

Death of a Taxpayer

If a taxpayer died before filing a return for 2023, the taxpayer's spouse or personal representative may have to file and sign a return for that taxpayer. A personal representative can be an executor, administrator, or anyone who is in charge of the deceased taxpayer's property. If the deceased taxpayer did not have to file a return but had tax withheld, a return must be filed to get a refund. The person who files the return must enter “Deceased,” the deceased taxpayer's name, and the date of death across the top of the return. If this information is not provided, it may delay the processing of the return.

Lesson 1 - General Filing Information

The final income tax return is due at the same time the decedent's return would have been due had death not occurred. A final return for a decedent who was a calendar year taxpayer is generally due on April 15 following the year of death, regardless of when during that year death occurred. However, when the due date falls on a Saturday, Sunday, or legal holiday, the return is filed timely if filed by the next business day.

The tax return must be prepared on a form for the year of death regardless of when during the year death occurred.

If the taxpayer’s spouse died in 2023 and he or she did not remarry in 2023, or if his or her spouse dies in 2024 before filing a return for 2023, the taxpayer can file a joint return. Enter “Filing as surviving spouse” in the area where the taxpayer signs the return. If someone else is the personal representative, he or she must also sign. The surviving spouse or personal representative should promptly notify all payers of income, including financial institutions, of the taxpayer's death. This will ensure the proper reporting of income earned by the taxpayer's estate or heirs. A deceased taxpayer's social security number should not be used for tax years after the year of death, except for estate tax return purposes.

Determining the Tax The main problem in completing a tax return is to figure out what income is taxable and the deductions that can be claimed. The rest is largely mechanical: add and subtract correctly, follow the instructions on the tax return, and comply with procedural requirements. The following checklist might be useful:

1. Collect the taxpayer’s data. 2. Review taxpayer’s prior returns. 3. Select the proper tax return form. 4. Determine Gross Income by totaling all income not specifically excluded. 5. Compute the adjusted gross income (AGI) by subtracting the adjustments. 6. Subtract itemized deductions from AGI, if their total exceeds the correct standard deduction amount. 7. Use the Tax Table (if taxable income is under $100,000) or the Tax Computation Worksheet (if taxable income is

$100,000 or more) to determine/calculate tax amount. 8. In the following order:

a. Add any Alternative Minimum Tax. b. Reduce any tax due by any tax credits (such as Child tax credit, credit for child and dependent care

expense, Adoption credit, etc.). c. Add other taxes (such as Self-employment tax, Household employment taxes). d. Reduce tax by any payments (such as withholdings, estimated tax payments, Earned Income Tax Credit,

etc.). 9. Determine the tax refund amount or the amount owed. 10. Sign and file the tax return on time.

Types of Taxes

In addition to the income tax, which is calculated on a yearly basis using the Form 1040 and associated schedules, there are various other taxes people pay throughout the year.

Estate Tax

The estate tax is a tax on the right to transfer property at a taxpayer’s death. It consists of an accounting of everything he or she owns or has certain interests in at the date of death. The executor of a decedent's estate uses Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return to figure the estate tax imposed by Chapter 11 of the Internal Revenue Code. This tax is levied on the entire taxable estate and not just on the share received by a particular beneficiary. Form 706 is also used to figure the generation-skipping transfer (GST) tax imposed by Chapter 13 on direct skips (transfers to skip persons of interests in property included in the decedent's gross estate).

Gift Tax

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The gift tax applies to the transfer by gift of any property. The taxpayer makes a gift if he or she gives property (including money), or the use of, or income from property, without expecting to receive something of at least equal value in return. If the taxpayer sells something at less than its full value or if he or she makes an interest-free or reduced-interest loan, he or she may be making a gift. For 2023, the annual exclusion for gifts is $17,000.

Sales Tax

Sales tax is a tax imposed by a state or local government on sales collected by retailers at the point-of-sale. It is based on a percentage of the selling prices of the goods and services. Forty-five states, plus the District of Columbia impose a sales tax. If the taxpayer files a Form 1040, and itemizes deductions on Schedule A, he or she has the option of claiming either state and local income taxes or state and local sales taxes. (The taxpayer cannot claim both.) If the taxpayer saved his or her receipts throughout the year, he or she can add up the total amount of sales taxes actually paid and claim that amount.

Property Tax

Property tax is a capital tax on property imposed by municipalities; based on the estimated value of the property. Deductible real estate taxes are generally any state, local, or foreign taxes on real property. They must be charged uniformly against all property in the jurisdiction at a like rate. Many states and counties also impose local benefit taxes for improvements to property, such as assessments for streets, sidewalks, and sewer lines. These taxes cannot be deducted. However, a taxpayer can increase the cost basis of the property by the amount of the assessment. Local benefits taxes are deductible if they are for maintenance or repair, or interest charges related to those benefits. Deductible personal property taxes are those based only on the value of personal property such as a boat or car. The tax must be charged to the taxpayer on a yearly basis, even if it is collected more than once a year or less than once a year.

Excise Tax

Excise taxes are taxes paid when purchases are made on a specific good, such as gasoline. Excise taxes are often included in the price of the product. There are also excise taxes on activities, such as on wagering or on highway usage by trucks. Excise Tax has several general excise tax programs. One of the major components of the excise program is motor fuel.

Sin Tax

A sin tax is a state-sponsored tax that is added to products or services that are seen as vices, such as alcohol, tobacco and gambling. These types of taxes are levied by governments to discourage individuals from partaking in such activities without making the use of the products illegal. These taxes also provide a source of government revenue.

Self-Employment Tax

Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. An individual figures self- employment tax (SE tax) using Schedule SE (Form 1040). Social Security and Medicare taxes of most wage earners are figured by their employers. Also, the taxpayer can deduct the employer-equivalent portion of the SE tax in figuring adjusted gross income. Wage earners cannot deduct Social Security and Medicare taxes.

Employment Taxes

Employment taxes are Federal income tax withholding, Social Security tax, Medicare tax, and Federal unemployment tax that an employer must submit on behalf of employees. Under the Federal Insurance Contributions Act (FICA) 12.4% of earned income up to an annual limit must be paid into Social Security, and an additional 2.9% must be paid into Medicare. If the taxpayer is a wage or salaried employee, he or she pays only half the FICA bill, and the tax is automatically withheld. The employer contributes the rest. The employees and the employer’s FICA tax rate for 2023 consists of the Social Security tax rate of 6.2% of each employee’s first $160,200 of wages, salaries, etc. and the Medicare tax of 1.45% of each employee’s total wages, salaries, etc. In other words, the FICA tax rate for 2023 is 7.65% of each employee’s first $160,200 of wages, salaries, etc. and then 1.45% of each employee’s wages, salaries, etc. that are above $160,200. In addition to withholding Medicare tax at 1.45%, an employer must withhold a 0.9% Additional Medicare Tax from wages he or she pays to an employee in excess of $200,000 in a calendar year. The employer is required to begin withholding Additional

Lesson 1 - General Filing Information

Medicare Tax in the pay period in which he or she pays wages in excess of $200,000 to an employee and continue to withhold it each pay period until the end of the calendar year. Additional Medicare Tax is only imposed on the employee. There is no employer share of Additional Medicare Tax. The Federal Unemployment Tax Act (FUTA), with state unemployment systems, provides for payments of unemployment compensation to workers who have lost their jobs. Most employers pay both a Federal and a state unemployment tax. Only the employer pays FUTA tax; it is not deducted from the employee's wages. Old-age, survivors, and disability insurance benefits (OASDI) payments under Section 202 of title II of the Social Security Act are not includible in the gross income of the individuals to whom they are paid. This applies to old-age insurance benefits, and insurance benefits for wives, husbands, children, widows, widowers, mothers and fathers, and parents, as well as the lump- sum death payment.

Completion of the Filing Process

Tax Return Preparers Must Use IRS e-File

As of January 1, 2012, any tax return preparer who anticipates preparing and filing 11 or more Forms 1040, 1040-NR and 1041 during a calendar year must use IRS e-file (unless the preparer or a particular return is administratively exempt from the e-file requirement, or the return is filed by a preparer with an approved hardship waiver). Members of firms must count returns in the aggregate. If the number of applicable income tax returns is 11 or more, then all members of the firm generally must e-file the returns they prepare and file. This is true even if a member expects to prepare and file fewer than 11 returns on an individual basis. Specified tax return preparers may request an undue hardship waiver from the e-file requirement using Form 8944 - Preparer e-file Hardship Waiver Request. Form 8944 generally must be submitted to the IRS no later than February 15 of the year for which a waiver is being requested.

Modernized e-File (MeF)

MeF is a web-based system that allows electronic filing of corporate, individual, partnership, exempt organization and excise tax returns through the Internet. MeF uses the widely accepted Extensible Markup Language (XML) format. This is an industry standard that is used when identifying, storing and transmitting data rather than the proprietary data transmission formats used by older e-file programs. The following form types can be e-filed through the MeF Platform: (28)

➢ Corporations (Forms 1120, 1120-F and 1120-S). ➢ Employment Tax (Forms 940, 940-PR, 941, 941-PR, 941-SS, 943, 943-PR, 944, and 945). ➢ 94x Online Signature PIN Registration. ➢ Exempt Organizations (Forms 990, 990-EZ, 990-N, 990-PF, 990-T, 1120-POL and 4720). ➢ Excise Tax (Forms 720, 2290 and 8849). ➢ Extensions (Forms 2350, 4868, 7004 and 8868). ➢ Fiduciaries (Form 56). ➢ Individual (Form 1040/SR/SS/PR/NR). ➢ Estate and Trust (Form 1041). ➢ Installment Agreements (Form 9465). ➢ Partnerships (Form 1065). ➢ Withholding Tax (Form 1042).

Production filing generally ends on October 15 and the last day to retransmit rejected returns is October 20 so tax returns for prior years are not eligible for the e-file program.

Authorized e-File Provider

Before a tax preparer begins the online e-file application, he or she must have an IRS e-Services account. e-Services are a suite of web-based products that will allow tax professionals and payers to conduct business with the IRS electronically. These services are only available to approved IRS business partners and not available to the general public. All tax professionals who wish to use e-services products must register online to create an individual electronic account. The registration process is a one-time automated process where the user selects a username, password and PIN. When the registration information has been validated, the registrant will receive an on-screen acknowledgement.

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When a tax preparer applies for an e-Services account, he or she will need to complete all of the following: (10)

1. Provide his or her legal name, Social Security Number (SSN), birth date, phone number, e-mail address and home mailing address (confirmation of the account will be mailed).

2. Provide his or her Adjusted Gross Income (AGI) from the current or prior tax year. 3. Create a username, a password and a PIN, and provide an answer to a reminder question for his or her username. 4. Make sure that every principal and responsible official in his or her firm signs up for e-Services. 5. Return to e-Services to confirm his or her registration within 28 days of receiving the confirmation code in the mail.

The verification and approval process for creating an account with IRS e-Services can take several days. The tax preparer’s firm can start the application to become an Authorized IRS e-file Provider once all principals are approved for e-Services. The application process is not simple; however, the complexity is necessary to protect the integrity and security of the electronic filing system. The e-file application process is comprehensive, designed to allow you to save your data during the session and to return to the application when convenient. Plan accordingly since the IRS may take up to 45 days to approve an Authorized IRS e-file Provider application. After the tax preparer submits the application and related documents, the IRS will conduct a suitability check on the firm and each person listed on the application as either a principal or responsible official. This may include: a credit check; a tax compliance check; a criminal background check; and a check for prior non-compliance with IRS e-file requirements. Once approved, the tax preparer will get an acceptance letter from the IRS with his or her Electronic Filing Identification Number (EFIN).

Electronic Filing Identification Number (EFIN)

The IRS assigns an EFIN to identify firms that have completed the IRS e-file Application to become an Authorized IRS e- file Provider. After the provider completes the application and passes a suitability check, the IRS sends an acceptance letter, including the EFIN, to the provider. Providers need the EFIN to electronically file tax returns. The firm owns the EFIN. The principals of the firm use either their Social Security Number or Employer Identification Number to apply for an EFIN. On their application, the firm's ‘Doing Business As’ name and business address should be used, not a personal address. Authorized IRS e-file Providers do not have to reapply each year as long as they continue to e-file returns. However, if a Provider does not e-file returns for two consecutive years, the IRS will notify the Provider of removal from the IRS active Provider list. The IRS may reactivate a Provider if the Provider replies within sixty days and requests reactivation. Otherwise, the Provider will have to complete and submit a new application. Providers must update their application information within 30 days of the date of any changes to the information on their current application. Make all changes using the IRS e-file Application. See Changes to Your IRS e-file Application. The EFIN is not transferable and neither is the password. Even if Authorized IRS e-file Provider transfers his or her business by sale, gift or other disposition, he or she may not transfer his or her EFIN. The Provider must protect his or her EFINS, Electronic Transmitter Identification Numbers (ETINs) and passwords from unauthorized use.

Statute of Limitations

The IRS has three years to give the taxpayer a refund, three years to audit a tax return, and ten years from the day a tax liability has been finalized to collect any tax due. If a taxpayer filed his or her taxes before the deadline, the time is measured from the April 15th deadline. Together, these laws are called the statute of limitations.

Reporting Agent Authorization

Use Form 8655 - Reporting Agent Authorization to authorize a reporting agent to:

➢ Sign and file certain returns. Reporting agents must file returns electronically except as provided under Revenue Procedure 2012-32.

➢ Make deposits and payments for certain returns. ➢ Receive duplicate copies of tax information, notices, and other written and/or electronic communication regarding

any authority granted. ➢ Provide IRS with information to aid in penalty relief determinations related to the authority granted on Form 8655.

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Once Form 8655 is signed, any authority granted is effective beginning with the period indicated on lines 15 or 16 and continues indefinitely unless revoked by the taxpayer or reporting agent. A new authorization must be submitted to the IRS for any increase or decrease in the authority of a reporting agent to act for its client. The preceding authorization remains in effect except as modified by the new one. No authorization or authority is granted for periods prior to the period(s) indicated on Form 8655.

IRS e-File Rules and Requirements

An Authorized IRS e-file Provider is a business or organization authorized by the IRS to participate in IRS e-file. It may be a sole proprietorship, partnership, corporation, or other entity. The firm submits an e-file application, meets the eligibility criteria, and must pass a suitability check before the IRS assigns an Electronic Filing Identification Number (EFIN). Applicants accepted for participation in IRS e-file are Authorized IRS e-file Providers. A Provider may be an Electronic Return Originator (ERO), Intermediate Service Provider, Transmitter, Software Developer, or Reporting Agent. These roles are not mutually exclusive. For example, a Provider that is an ERO may also be a Transmitter. Providers may also be tax return preparers, but the activities and responsibilities for IRS e-file and return preparation are distinct and different from each other. The IRS conducts a suitability check on the applicant and on all Principals and Responsible Officials listed on the application. The IRS does not complete suitability checks on applicants only applying to be Software Developers. Suitability checks may include the following: (11)

➢ A criminal background check. ➢ A credit history check. ➢ A tax compliance check to ensure that all required returns are filed and paid, and to identify assessed penalties. ➢ A check for prior non-compliance with IRS e-file requirements.

All Authorized IRS e-file Providers must adhere to IRS e-file rules and requirements to continue participation in IRS e-file. Requirements are included in Revenue Procedure 2007-40 - e-file Providers of Individual Income Tax Returns, Publication 1345 - Handbook for Authorized IRS e-file Providers of Individual Income Tax Returns and in other publications and notices that govern IRS e-file. All Providers must adhere to all rules and requirements, regardless of where published. Some rules and requirements are specific to the activities performed by the Provider and are included in Electronic Return Origination, Transmission and e-file Provider. The following list, while not all-inclusive, applies to all Providers of Individual Income Tax Returns, except Software Developers that do not engage in any other IRS e-file activity other than software development. A Provider must: (12)

1. Maintain an acceptable cumulative error or reject rate. 2. Adhere to the requirements for ensuring that tax returns are properly signed. 3. Properly use the standard/non-standard Form W-2 indicator. 4. Properly use the Refund Anticipation Loan (RAL) indicator. 5. Include the Electronic Return Originator's (ERO’s) Electronic Filing Identification Number (EFIN) as the return

EFIN for returns the ERO submits to an Intermediate Service Provider or Transmitter. 6. Include the Intermediate Service Provider's EFIN in the designated Intermediate Service Provider field in the

electronic return record. 7. Submit an electronic return to the IRS with information that is identical to the information provided to the taxpayer

on the copy of the return.

A Refund Anticipation Loan (RAL) is money borrowed by a taxpayer from a lender based on the taxpayer’s anticipated income tax refund. Financial Institutions also offer a variety of other financial products to taxpayers based on their refunds. The IRS is in no way involved in or responsible for RALs or the other financial products. Providers that assist taxpayers in applying for a RAL or other financial product have additional responsibilities and may be sanctioned by the IRS if they fail to adhere to certain requirements.

Electronic Return Originator

An Electronic Return Originator (ERO) is the Authorized IRS e-file Provider that originates the electronic submission of a return to the IRS. The ERO is usually the first point of contact for most taxpayers filing a return. Although an ERO may also engage in return preparation, that activity is separate and different from the origination of the electronic submission of the return to the IRS. An ERO originates the electronic submission of a return after the taxpayer authorizes the filing of

Lesson 1 - General Filing Information

the return via IRS e-file. An ERO must originate the electronic submission of only returns that the ERO either prepared or collected from a taxpayer. An ERO originates the electronic submission by either of the following: (13)

➢ Electronically sending the return to a Transmitter that will transmit the return to the IRS. ➢ Directly transmitting the return to the IRS. ➢ Providing a return to an Intermediate Service Provider for processing prior to transmission to the IRS.

In originating the electronic submission of a return, the ERO has a variety of responsibilities, including, but not limited to:

➢ Timely originating the electronic submission of returns. ➢ Submitting any required supporting paper documents to the IRS. ➢ Providing copies to taxpayers. ➢ Retaining records and making records available to the IRS. ➢ Accepting returns only from taxpayers and Authorized IRS e-file Providers. ➢ Having only one Electronic Filing Identification Number (EFIN) for the same firm for use at one location, unless

the IRS issued more than one EFIN to the firm for the same location. For this purpose, the business entity is generally the entity that reports on its return the income derived from electronic filing. The IRS may issue more than one EFIN to accommodate a high volume of returns, or as it determines appropriate.

An ERO must clearly display the firm’s “doing business as” name at all locations and sites including Web sites at which the ERO or a third party obtains information from taxpayers for electronic origination of returns by the ERO.

ERO Fees

An ERO can charge a fee for providing the e-file service to their clients while others may offer it free of charge. However, this fee cannot be based on any figure from the tax return. An ERO must never charge a separate fee for Direct Deposit and must accept any Direct Deposit election by a taxpayer to any eligible financial institution. (14) When assisting a taxpayer in applying for a RAL or other financial product, the ERO may charge a flat fee for that assistance. The fee must be identical for all customers and must not relate to the amount of the refund or the financial product. The Provider must not accept a fee that is contingent upon the amount of the refund or a RAL or other financial product from a financial institution for any service connected with a financial product. The IRS has no responsibility for the payment of any fees associated with the preparation of a return, the transmission of the electronic portion of a return or a RAL or another financial product.

ERO Advertising

An ERO must comply with the advertising and solicitation provisions of Circular 230. This circular prohibits the use or participation in the use of any form of public communication containing a false, fraudulent, misleading, deceptive, unduly influencing, coercive, or unfair statement or claim. Providers must not use improper or misleading advertising in relation to IRS e-file, including the time frames for refunds and RALs or other financial products. Any claims by Providers concerning faster refunds by virtue of electronic filing must be consistent with the language in official IRS publications. If Providers advertise the availability of a RAL or financial product, the Provider and financial institution must clearly refer to or describe the funds they advance as a loan or other financial product, not as a refund. The advertisement on a RAL or other financial product must be easy to identify and in readable print. That is, it must make clear in the advertising that the taxpayer is borrowing against the anticipated refund or receiving another financial product and is not obtaining the refund itself from the financial institution. Participants in Online Filing must also adhere to the following: (12)

1. Ensure that no more than five electronic returns are filed from one software package or one e-mail address. 2. Supply a taxpayer with an accurate Declaration Control Number (DCN) (Exception: Submission Identification

Number (SID) for MeF). 3. Provide effective instructions to a taxpayer concerning the entry of the DCN on Form 8453, if required. 4. Submit any changes to the following information to the IRS Headquarters Online Filing Analyst,

SE:W:CAS:SP:ES:I, 5000 Ellin Road, Lanham, MD 20706, by the 31st day of December preceding the filing season:

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a. The brand name of the software the Provider will be using, has developed or will use for transmission. Required information about the software includes its Software Developer, Transmitter, retail cost and any additional costs for transmitting the electronic portion of the taxpayer’s return. Additionally, software changes involving its use to file Federal/State returns, Internet availability (including the Internet address), successful completion of Participants Acceptance Testing (PATS) (Exception: Assurance Testing System (ATS) for MeF) and the Professional Package name under which the software was tested must be reported.

b. The Provider’s point of contact for matters relating to Online Filing and the telephone number for the point of contact.

c. The applicant’s customer service number. d. The procedures the applicant will use to ensure that one software package or one e-mail address

transmits no more than five returns.

Submitting a Timely Filed Electronic Tax Return

All prescribed due dates for filing of returns apply to e-file returns. All Providers must ensure that returns are promptly processed. However, a Provider that receives a return for electronic filing on or before the due date of the return must ensure that it transmits the electronic portion of the return on or before the due date (including extensions). An electronically filed return is not considered filed until the IRS acknowledges acceptance of the electronic portion of the tax return for processing.

The IRS accepts individual income tax returns electronically only if the taxpayer signs the return using a Personal Identification Number (PIN). If Providers transmit the electronic portion of a return on or shortly before the due date and the IRS ultimately rejects it, but the Provider and the taxpayer comply with the requirements for timely resubmission of a correct return, the IRS considers the return timely filed. (15) Once signed, an ERO must originate the electronic submission of a return as soon as possible. However, authorized IRS e-file Providers are prohibited from submitting electronic returns to the IRS prior to the receipt of all Forms W-2, W-2G, and 1099-R from the taxpayer. If the taxpayer is unable to secure and provide a correct Form W-2, W-2G, or 1099-R, the return may be electronically filed after Form 4852 - Substitute for Form W-2, Wage and Tax Statement or Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. is completed in accordance with the use of that form. This is the only time information from Pay stubs or Leave and Earning Statements (LES) is allowed. The IRS monitors Authorized IRS e-file Providers for compliance with the Revenue Procedure 2007-40 and IRS e-file rules and requirements. Monitoring visits will be conducted to investigate complaints and to ensure compliance.

Violations of IRS e-file requirements may result in warning or sanctioning an Authorized IRS e-file Provider. Sanctioning may be a written reprimand, suspension or expulsion from participation from IRS e-file, or other sanctions, depending on the seriousness of the infraction. The IRS categorizes the seriousness of infractions as Level One, Level Two, and Level Three. Providers may appeal sanctions through the Administrative Review Process. Un-reversed suspensions make Authorized IRS e-file Providers ineligible to participate in IRS e-file for a period of either one or two years from the effective date of the sanction. (15)

Submission of Paper Documents to the IRS

IRS e-file returns must contain all the same information as returns filed completely on paper. EROs are responsible for ensuring that they submit to the IRS all paper documents required to complete the filing of returns. Attach all appropriate supporting documents that the IRS requires to the Form 8453 - U.S. Individual Income Tax Transmittal for an IRS e-file Return and send them to the IRS. Use Form 8453 to send any required paper forms or supporting documentation listed next to the checkboxes on Form 8453 (do not send Forms W-2, W-2G, or 1099-R). If you are an ERO, you must mail Form 8453 to the IRS within 3 business days after receiving acknowledgement that the IRS has accepted the electronically filed tax return. (15)

Recordkeeping and Documentation Requirements

EROs must retain the following material until the end of the calendar year at the business address from which it originated the return or at a location that allows the ERO to readily access the material as it must be available at the time of an IRS request. An ERO may retain the required records at the business address of the Responsible Official or at a location that allows the Responsible Official to readily access the material during any period of time the office is closed, as it must be available at the time of an IRS request through the end of the calendar year. (15)

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Check Return for Completeness and Accuracy

Before signing a tax return and sending it to your client, be sure to double check your work. This includes verifying all data from W-2, 1099, and any form that the taxpayer provided to you for the purposes of completing their tax return. Check filing status, deduction, and credit amounts and go over any information that was determined using a tax table or schedule. Also, perform your calculations again even though they may appear as simple arithmetic, it is important to ensure everything is accurate. Lastly, and importantly, review the prior year’s return even if you did not prepare it. This return will provide you with a wealth of information that can be valuable to this year's return, including Tax loss carry forward information, withholding information and information about how certain income may have been treated, such as capital gains or traditional income. Many tax preparers neglect to go over last year's return. But it is worth the time because very often you will find a carry forward or some other important piece of information that might be beneficial to this year's return.

Explain and Review Tax Return

Once you have completed preparing the tax return it is important that you take the time to go over it in detail with the taxpayer. This review represents an additional opportunity to check your work and verify information you used to complete the return with the taxpayer. In addition to checking all available tax credits and deductions, it gives you the chance to explain what the outcome of the return was and what the necessary next steps are.

Recordkeeping for Individuals

As a tax preparer you have an obligation to explain the record keeping requirements to the taxpayer. The length of time a taxpayer should keep a document depends on the action, expense, or the event the document records. Generally, he or she must keep his or her records that support an item of income or deductions on a tax return until the period of limitations for that return runs out. There are many reasons to keep records. In addition to tax purposes, a taxpayer may need to keep records for insurance purposes or for getting a loan. Good records will help the taxpayer: (16)

➢ Identify sources of income. ➢ Keep track of expenses. ➢ Keep track of the basis of property. ➢ Prepare tax returns. ➢ Support items reported on tax returns.

The IRS does not require a taxpayer to keep his or her records in a particular way. The records should be kept in a manner that allows the taxpayer and the IRS to determine the correct tax. The taxpayer can use his or her checkbook to keep a record of income and expenses. In his or her checkbook the taxpayer should record amounts, sources of deposits, and types of expenses. The taxpayer also needs to keep documents, such as receipts and sales slips, which can help prove a deduction. All requirements that apply to hard copy books and records also apply to electronic storage systems that maintain tax books and records. When the taxpayer replaces hard copy books and records, he or she must maintain the electronic storage systems for as long as they are material to the administration of tax law.

FOR items concerning... KEEP as basic records...

Income • Form(s) W-2

• Form(s) 1099

• Bank statements

• Brokerage statements

• Form(s) K-1

Expenses • Sales slips

• Invoices

• Receipts

• Canceled checks or other proof of payment

• Written communications from qualified charities

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Home • Closing statements

• Purchase and sales invoices

• Proof of payment

• Insurance records

• Receipts for improvement costs

Investments • Brokerage statements

• Mutual fund statements

• Form(s) 1099

• Form(s) 2439

Table 1-1 - Publication 552 - Table 1. Proof of Income and Expense (2023)

A taxpayer should keep copies of his or her tax returns as part of his or her tax records. They can help the taxpayer prepare future tax returns, and he or she will need them if he or she files an amended return. Copies of the returns and other records can be helpful to the survivor or the executor or administrator of a taxpayer’s estate. Basic records are documents that everybody should keep. These are the records that prove the taxpayer’s income and expenses. If he or she owns a home or investments, the basic records should contain documents related to those items.

Proof of Payment

One of the basic records is proof of payment. The taxpayer should keep these records to support certain amounts shown on his or her tax return. Proof of payment alone is not proof that the item claimed on the return is allowable. The taxpayer also should keep other documents that will help prove that the item is allowable. Generally, the taxpayer proves payment with a cash receipt, financial account statement, credit card statement, canceled check, or substitute check. If he or she makes payments in cash, he or she should get a dated and signed receipt showing the amount and the reason for the payment.

If the taxpayer makes payments by electronic funds transfer, he or she may be able to prove payment with an account statement.

Some items require specific records in addition to basic records including, but not limited to, the following: (16)

➢ Alimony. ➢ Business Use of the Home. ➢ Casualty and Theft Losses. ➢ Child Care Credit. ➢ Contributions. ➢ Credit for the Elderly or the Disabled. ➢ Education expenses. ➢ Gambling Winnings and Losses. ➢ Health Savings Account (HSA) and Medical Savings Account (MSA). ➢ Individual Retirement Arrangements (IRAs). ➢ Medical and Dental Expenses. ➢ Moving Expenses. ➢ Pensions and Annuities. ➢ Taxes. ➢ Sales tax on vehicles. ➢ Tips.

The taxpayer must keep records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means he or she must keep records that support items shown on the return until the period of limitations for that return runs out.

Period of Limitations

The period of limitations is the period of time in which an individual can amend his or her tax return to claim a credit or

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refund, or that the IRS can assess additional tax. The information below contains the periods of limitations that apply to income tax returns. Unless otherwise stated, the years refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date. (17)

1. The taxpayer owes additional tax and situations (2), (3), and (4), below, do not apply to him or her; keep records for 3 years.

2. The taxpayer does not report income that he or she should report, and it is more than 25% of the gross income shown on the return; keep records for 6 years.

3. The taxpayer files a fraudulent return; keep records indefinitely. 4. The taxpayer does not file a return; keep records indefinitely. 5. The taxpayer files a claim for credit or refund after he or she files the return; keep records for 3 years from the

date the taxpayer filed the original return or 2 years from the date he or she paid the tax, whichever is later. 6. The taxpayer files a claim for a loss from worthless securities or bad debt deduction; keep records for 7 years. 7. Keep all employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever

is later. Keep copies of filed tax returns. They help in preparing future tax returns and making computations if the taxpayer files an amended return.

Keep records relating to property until the period of limitations expires for the year in which the taxpayer disposes of the property in a taxable disposition. The taxpayer must keep these records to figure any depreciation, amortization, or depletion deduction and to figure the gain or loss when he or she sells or otherwise disposes of the property. Generally, if an individual received property in a nontaxable exchange, the basis in that property is the same as the basis of the property he or she gave up, increased by any money paid. The taxpayer must keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which he or she disposes of the new property in a taxable disposition. (17)

Schedule H - Household Employment Taxes

If your client pays wages subject to FICA tax, FUTA tax, or if he or she withholds Federal income tax from an employee's wages, he or she will need to file a Schedule H - Household Employment Taxes. Attach Schedule H to the individual income tax return. If the taxpayer is not required to file a return, he or she must still file Schedule H to report household employment taxes. If an individual pays a household employee $2,600 or more in cash wages during 2023, he or she must report and pay Social Security and Medicare taxes on all the wages. The test applies to cash wages paid in 2023 regardless of when the wages were earned. To figure the total cash wages the taxpayer paid in 2023 to each household employee, do not include amounts paid to any of the following individuals:

➢ His or her spouse. ➢ His or her child who was under age 21. ➢ His or her parent. ➢ His or her employee who was under age 18 at any time during 2023. If the employee was not a student and

providing household services was his or her principal occupation.

However, a sole proprietor who must file Form 940 - Employer's Annual Federal Unemployment (FUTA) and Form 941 - Employer's QUARTERLY Federal Tax Return, or Form 944 - Employer's ANNUAL Federal Tax Return for business employees, or Form 943 - Employer's Annual Federal Tax Return for Agricultural Employees, for farm employees, may report household employee tax information on these forms instead of on Schedule H. If the taxpayer chooses to report the wages for a household employee on the forms shown above, be sure to pay any taxes due by the date required based on the form, making Federal tax deposits if required. Additional information is available in the instructions for the form.

Name Change

If the taxpayer changed his or her name or his or her dependent had a name change during the year, he or she should be sure to notify the Social Security Administration (SSA) before filing a tax return with the IRS. This is important because the

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name on the taxpayer’s tax return must match SSA records. If the names do not match the taxpayer is likely to get a letter from the IRS about the mismatch. And if he or she is expecting a refund, this mismatch may delay receiving it. The taxpayer should be sure to contact SSA if:

➢ He or she got married or divorced and he or she changed his or her name. ➢ A dependent he or she claims had a name change. For example, this would apply if the taxpayer adopted a child

and that child’s last name changed. The taxpayer should file Form SS-5 - Application for a Social Security Card with the SSA to let them know about a name change.

Joint and Several Liability

Many married taxpayers choose to file a joint tax return because of certain benefits this filing status allows. In filing jointly, both taxpayers are jointly and severally liable for the tax and any additions to tax, interest, or penalties that arise as a result of the joint return even if they later divorce. Joint and several liability means that each taxpayer is legally responsible for the entire liability. Thus, both spouses are generally held responsible for all the tax due even if one spouse earned all the income or claimed improper deductions or credits. This is also true even if a divorce decree states that a former spouse will be responsible for any amounts due on previously filed joint returns. In some cases, however, a spouse can get relief from joint and several liability. There are three types of relief from joint and several liability for spouses who filed joint returns: (18)

1. Innocent Spouse Relief provides the taxpayer relief from additional tax he or she owes if his or her spouse or former spouse failed to report income, reported income improperly or claimed improper deductions or credits.

2. Separation of Liability Relief provides for the allocation of additional tax owed between the taxpayer and his or her former spouse or his or her current spouse from whom the taxpayer is separated because an item was not reported properly on a joint return. The tax allocated to the taxpayer is the amount for which he or she is responsible.

3. Equitable Relief may apply when the taxpayer does not qualify for innocent spouse relief or separation of liability relief for something not reported properly on a joint return and generally attributable to his or her spouse. The taxpayer may also qualify for equitable relief if the correct amount of tax was reported on the joint return but the tax remains unpaid.

she paid, then his or her request must be made within the time period for seeking a refund, which is generally three years after the date the return is filed or two years following the payment of the tax, whichever is later. To seek innocent spouse relief, separation of liability relief, or equitable relief, the taxpayer should submit to the IRS a completed Form 8857 - Request for Innocent Spouse Relief or a written statement containing the same information required on Form 8857, which is signed under penalties of perjury. Relief from joint and several liability should not be confused with an injured spouse claim. The taxpayer is an "injured spouse" if he or she files a joint return and all or part of his or her share of the refund was, or will be, applied against the separate past-due Federal tax, state tax, child support, or Federal non-tax debt (such as a student loan) of his or her spouse with whom the taxpayer filed the joint return. If your client is an injured spouse, he or she may be entitled to recoup his or her share of the refund.

Review Question 2 All of the following are types of relief from joint and several liability for spouses who filed joint returns except:

A. Prenuptial Agreement B. Equitable Relief C. Separation of Liability Relief D. Innocent Spouse Relief

See Review Feedback for answer.

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Quick Reference Guide

IRS Publication 4591- Small Business Federal Tax Responsibilities, can help a taxpayer find the information that he or she needs, quickly and easily. Pub 4591 includes information regarding IRS publications, www.IRS.gov and phone resources, information about small business Federal tax responsibilities, tax help for small businesses and the self- employed and small business resources.

Safeguarding Taxpayer Information Safeguarding taxpayer information is a top priority for the Internal Revenue Service. It is the responsibility of governments, businesses, organizations, and individuals that receive, maintain, share, transmit, or store taxpayers’ personal information. Tax return information is all the information tax return preparers obtain from taxpayers or other sources in any form or manner that is used to prepare tax returns or is obtained in connection with the preparation of returns. It also includes all computations, worksheets, and printouts preparers create; correspondence from IRS during the preparation, filing and correction of returns; statistical compilations of tax return information; and tax return preparation software registration information. Authorized IRS e-file Providers must safeguard taxpayer information from unauthorized disclosure, use, and destruction. Authorized IRS e-file Providers must have security systems in place to prevent unauthorized access by third parties to taxpayer accounts and personal information. The Gramm-Leach-Bliley Act, codified at 15 U.S.C. Section 6801-6827, and the implementing rules and regulations promulgated by the Federal Trade Commission include rules that are designed to ensure the security and privacy of taxpayer information and are applicable to Providers. The Safeguards Rule requires financial institutions, which include return preparers, data processors, transmitters, affiliates, service providers, and others who are significantly engaged in providing financial products or services that include preparation and filing of tax returns, to ensure the security and confidentiality of customer records and information. Financial institutions must develop, implement, and maintain a written Information Security Program that contains administrative, physical, and technical safeguards that are appropriate. The Financial Privacy Rule requires financial institutions, which include return preparers, data processors, transmitters, affiliates, service providers, and others who are significantly engaged in providing financial products or services that include preparation and filing of tax returns, to give their customers privacy notices that explain the financial institution’s information collection and sharing practices. In turn, customers have the right to limit some sharing of their information. Also, financial institutions and other companies that receive personal financial information from a financial institution may be limited in their ability to use that information. Title 26 - Internal Revenue Code (IRC) Section 301 7216.1 imposes criminal penalties on any person engaged in the business of preparing or providing services in connection with the preparation of tax returns who knowingly or recklessly makes unauthorized disclosures or uses of information furnished to them in connection with the preparation of an income tax return. Title 26 - Internal Revenue Code (IRC) Section 6713 imposes monetary penalties on the unauthorized disclosures or uses of taxpayer information by any person engaged in the business of preparing or providing services in connection with the preparation of tax returns. (19) 26 USC Section 6713 states “if any person who is engaged in the business of preparing, or providing services in connection with the preparation of, returns of tax imposed by chapter 1, or any person who for compensation prepares any such return for any other person, and who discloses any information furnished to him for, or in connection with, the preparation of any such return, or uses any such information for any purpose other than to prepare, or assist in preparing, any such return, shall pay a penalty of $250 for each such disclosure or use, but the total amount imposed under this subsection on such a person for any calendar year shall not exceed $10,000”. (20) Providers must implement security and privacy practices that are appropriate for the size, complexity, nature, and scope of their business activities. The IRS Publication 4600 - Safeguarding Taxpayer Information and Publication 4557 - Safeguarding Taxpayer Data contain information to help non-governmental businesses, organizations, and individuals to understand and meet their responsibility to safeguard taxpayer information.

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Identity Theft

Identity theft occurs when someone uses the taxpayer’s personal information such as his or her name, Social Security number (SSN) or other identifying information, without his or her permission, to commit fraud or other crimes. The taxpayer should be alert to possible identity theft if he or she receives an IRS notice or letter that states that: (21)

➢ More than one tax return for the taxpayer was filed. ➢ The taxpayer has a balance due, refund offset, or has had collection actions taken against him or her for a year

he or she did not file a tax return. ➢ IRS records indicate the taxpayer received wages from an employer unknown to him or her.

If the taxpayer receives a notice from IRS, respond immediately. If he or she believes someone may have used his or her SSN fraudulently, please notify IRS immediately by responding to the name and number printed on the notice or letter. The taxpayer will need to fill out the Form 14039 - Identity Theft Affidavit.

Significance of Signatures

Penalty of Perjury

You must explain to the taxpayer that by signing their return that they are declaring that they have examined a copy of their individual income tax return and accompanying schedules and statements for the tax year, and to the best of their knowledge and belief, it is true, correct, and complete. By signing their return, the taxpayer is doing so ‘under penalty of perjury”. Perjury is the willful act of swearing a false oath or affirmation to tell the truth, whether spoken or in writing and is punishable by Federal law. The rules for perjury also apply when a person has made a statement “under penalty of perjury”. An example of this is the United States' income tax return, which, by law, must be signed as true and correct under penalty of perjury. Federal tax law provides criminal penalties of up to three years in prison for violation of the tax return perjury statute.

Filing Instructions

A person filling out an 8879 form either declares on the form that he or she will enter the personal identification number on an electronically filed tax return or authorizes another party such as an electronic return originator, to do so. All 8879 forms are to be retained by the taxpayer/signee for a minimum of 3 years. Form 8879 is not sent to the IRS unless the department requests it.

Form 8879 IRS e-file Signature Authorization

Form 8879 - IRS e-file Signature Authorization is the declaration document and signature authorization for an e-filed return filed by an electronic return originator (ERO). Complete Form 8879 when the Practitioner PIN method is used or when the taxpayer authorizes the ERO to enter or generate the taxpayer’s personal identification number (PIN) on his or her e-filed individual income tax return. Many types of these forms are available, and the form used depends on the business type. When completing Form 8879 the Electronic Return Originator (ERO) has specific responsibilities. The ERO will do the following: (22)

1. Enter the name(s) and Social Security number(s) of the taxpayer(s) at the top of the form. 2. Complete Part I using the amounts (zeros may be entered when appropriate) from the taxpayer’s 2023 tax return.

Form 1040-SS filers leave lines 1 through 3 and line 5 blank. 3. Enter or generate, if authorized by the taxpayer, the taxpayer’s PIN and enter it in the boxes provided in Part II. 4. Enter on the authorization line in Part II the ERO firm name (not the name of the individual preparing the return)

if the ERO is authorized to enter the taxpayer’s PIN. 5. After completing items (1) through (4) above, give the taxpayer Form 8879 for completion and review. This can

be done in person or by using the U.S. mail, a private delivery service, fax, email, or an Internet website. 6. Enter the 14-digit Declaration Control Number (DCN) assigned to the tax return, after the taxpayer completes Part

II. See Part I of Publication 1346 - Electronic Return File Specifications for Individual Income Tax Returns.

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Taxpayers have the following responsibilities for completing Form 8879 correctly: (22)

1. Verify the accuracy of the prepared income tax return, including direct deposit information. 2. Check the appropriate box in Part II to authorize the ERO to enter or generate their PIN or to do it themselves. 3. Indicate or verify their PIN when authorizing the ERO to enter or generate it (the PIN must be five numbers other

than all zeros). 4. Sign and date Form 8879. Taxpayers must sign Form 8879 with a handwritten signature. 5. Return the completed Form 8879 to the ERO in person, or by U.S. mail, private delivery service, fax, email, or an

Internet website.

Form 8879-C - IRS e-file Signature Authorization for Form 1120

A corporate officer and an electronic return originator (ERO) use Form 8879-C when the corporate officer wants to use a personal identification number (PIN) to electronically sign a corporation’s electronic income tax return and, if applicable, consent to electronic funds withdrawal. A corporate officer who does not use Form 8879-C must use Form 8453-C - U.S. Corporation Income Tax Declaration for an IRS e-file Return. Do not send this form to the IRS. The ERO must retain Form 8879-C. (23)

Form 8879-PE - IRS e-file Signature Authorization for Form 1065

A general partner or limited liability company member manager and an electronic return originator (ERO) use Form 8879- PE when the general partner or limited liability company member manager wants to use a personal identification number (PIN) to electronically sign a partnership’s electronic return of partnership income. A general partner or limited liability company member manager who does not use Form 8879-PE must use Form 8453-PE - U.S. Partnership Declaration for an IRS e-file Return. Do not send this form to the IRS. The ERO must retain Form 8879-PE. (24)

Form 8879-EO - IRS e-file Signature Authorization for an Exempt Organization

An organization officer and an electronic return originator (ERO) use Form 8879-EO when the organization officer wants to use a personal identification number (PIN) to electronically sign an organization’s electronic return and, if applicable, authorize an electronic funds withdrawal. An organization officer who does not use Form 8879-EO must use Form 8453- EO - Exempt Organization Declaration and Signature for Electronic Filing. The ERO must retain Form 8879-EO. An organization may qualify for exemption from Federal income tax if it is organized and operated exclusively for one or more of the following purposes: (25)

➢ Religious. ➢ Charitable. ➢ Scientific. ➢ Testing for public safety. ➢ Literary. ➢ Educational. ➢ Fostering national or international amateur sports competition (but only if none of its activities involve providing

athletic facilities or equipment). ➢ The prevention of cruelty to children or animals.

To qualify, the organization must be a corporation, community chest, fund, articles of association, or foundation. A trust is a fund or foundation and will qualify. However, an individual or a partnership will not qualify. Qualifying organizations include:

➢ Nonprofit old-age homes. ➢ Parent-teacher associations. ➢ Charitable hospitals or other charitable organizations. ➢ Alumni associations. ➢ Schools. ➢ Chapters of the Red Cross. ➢ Boys' or Girls' Clubs. ➢ Churches.

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Return of Organization Exempt From Income Tax

Form 990 - Return of Organization Exempt From Income Tax is used by tax-exempt organizations, nonexempt charitable trusts, and Section 527 political organizations to provide the IRS with the information required by Section 6033. Most organizations exempt from income tax under Section 501(a) must file an annual information return (Form 990 or 990-EZ) or submit an annual electronic notice (Form 990-N), depending upon the organization's gross receipts and total assets. An organization does not have to file Form 990 or 990-EZ even if it has at least $200,000 of gross receipts for the tax year or $500,000 of total assets at the end of the tax year if they are: (26)

➢ A church, an interchurch organization of local units of a church, a convention or association of churches, or an integrated auxiliary of a church as described in Regulations Section 1.6033-2(h) (such as a men's or women's organization, religious school, mission society, or youth group).

➢ A church-affiliated organization that is exclusively engaged in managing funds or maintaining retirement programs and is described in Revenue Procedure 96-10, 1996-1 C.B. 577. But see the filing requirements for Section 509(a)(3) supporting organizations in A, Who Must File.

➢ A school below college level affiliated with a church or operated by a religious order described in Regulations Section 1.6033-2(g)(1)(vii).

➢ A mission society sponsored by, or affiliated with, one or more churches or church denominations, if more than half of the society's activities are conducted in, or directed at, persons in foreign countries.

➢ An exclusively religious activity of any religious order described in Revenue Procedure 91-20, 1991-1 C.B. 524. ➢ A state institution whose income is excluded from gross income under Section 115. ➢ A governmental unit or affiliate of a governmental unit described in Revenue Procedure 95-48, 1995-2 C.B. 418.

But see the filing requirements for Section 509(a)(3) supporting organizations. ➢ An organization described in Section 501(c)(1). A Section 501(c)(1) organization is a corporation organized under

an Act of Congress that is an instrumentality of the United States and exempt from Federal income taxes. ➢ Certain political organizations that are:

o A state or local committee of a political party; o A political committee of a state or local candidate; o A caucus or association of state or local officials; or o Required to report under the Federal Election Campaign Act of 1971 as a political committee (as defined

in Section 301(4) of such Act). ➢ An organization whose gross receipts are normally $50,000 or less. ➢ Foreign organizations and organizations located in U.S. possessions, whose gross receipts from sources within

the United States are normally $50,000 or less and which did not engage in significant activity in the United States (other than investment activity). But if a foreign organization or U.S. Possessions organization is required to file Form 990 or Form 990-EZ, then its worldwide gross receipts, as well as assets, are taken into account in determining whether it qualifies to file Form 990-EZ.

➢ A private foundation (including a private operating foundation) exempt under Section 501(c)(3) and described in Section 509(a). The taxpayer should use Form 990-PF - Return of Private Foundation. The taxpayer should also use Form 990-PF for a taxable private foundation, a Section 4947(a)(1) nonexempt charitable trust treated as a private foundation, and a private foundation terminating its status by becoming a public charity under Section 507(b)(1)(B) (for tax years within its 60-month termination period). If the organization successfully terminates, then it files Form 990 or 990-EZ in its final year of termination.

➢ A black lung benefit trust described in Section 501(c)(21). Use Form 990-BL, Information and Initial Excise Tax Return for Black Lung Benefit Trusts and Certain Related Persons.

➢ A religious or apostolic organization described in Section 501(d). Use Form 1065, U.S. Return of Partnership Income.

➢ A stock bonus, pension, or profit-sharing trust that qualifies under Section 401. Use Form 5500 - Annual Return/Report of Employee Benefit Plan.

Rejected Electronically Filed Returns A rejected electronic return (from E-file) is usually the result of an identity problem which triggers IRS correspondence and slows down processing of tax returns. This unique feature of e-file enables preparers and taxpayers to fix mistakes before returns are processed, decreasing overall processing time and shortening the time it takes to receive a refund. If the reject is for a simple mistake, correct the error and resubmit the return electronically. If a mistake was made when entering a Social Security number, a payer’s identification number, omitting a form, or misspelling a name; the errors can be corrected, and the return can be resubmitted electronically with the IRS.

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However, you may not be able to correct some rejects. For example, if the return is rejected because the Child Tax Credit has been claimed on another taxpayer’s return, check that the Social Security number for the credit was entered correctly on the return. If the SSN is correct, you will not be able to file this return electronically unless the credit is removed from the return. If you believe the taxpayer is entitled to claim the credit, it is not necessary to remove the credit, but the return must be filed on paper. Attach Form 8948 - Preparer Explanation for Not Filing Electronically to the paper return; check box 4 and enter the reject code number. There are other situations where the rejected return may or may not be corrected but it takes one or more tries to resolve. For example, some rejects are based on information on file with the Social Security Administration (SSA). Tax returns often require that both the name and date of birth associated with an SSN match SSA records. Taxpayers sometimes forget to update their records with SSA when they marry or divorce and this can cause their tax returns to be rejected. This can be resolved by matching SSA records, but if there is some other problem at SSA like a problem with the date of birth, the reject sometimes cannot be resolved. When this happens, the return must be filed on paper. Attach Form 8948 to the paper return and check box 4; enter the reject code number and the number of attempts you made to resolve the reject before deciding that the error could not be fixed.

Resubmission of Rejected Tax Returns

If the IRS rejects the electronic portion of a taxpayer’s individual income tax return for processing, and the ERO cannot rectify the reason for the rejection, the ERO must take reasonable steps to inform the taxpayer of the rejection within 24 hours. When the ERO advises the taxpayer that it has not filed the return, the ERO must provide the taxpayer with the reject code(s) accompanied by an explanation. If the taxpayer chooses not to have the electronic portion of the return corrected and transmitted to the IRS, or if the IRS cannot accept the return for processing, the taxpayer must file a paper return. In order to timely file the return, the taxpayer must file the paper return by the later of the due date of the return or ten calendar days after the date the IRS gives notification that it rejected the electronic portion of the return or that the return cannot be accepted for processing. Taxpayers should include an explanation in the paper return as to why they are filing the return after the due date. (27) Notice 2010-13 provides that a taxpayer required to e-file can request a waiver from the electronic filing requirement when it cannot meet the electronic filing requirements. Before filing a paper return, corporations, partnerships and tax-exempt organizations required to e-file must contact the e-Help Desk (1-866-255-0654) to attempt to resolve the rejection conditions. If the rejection conditions cannot be resolved, these taxpayers must receive authorization from the e-Help Desk before filing a paper return. To be considered timely filed, the paper return must be postmarked by the later of the due date of the return, including extensions, or 10 calendar days after the date the IRS last gives notification the return was rejected as long as: (28)

1. The first transmission was made on or before the due date of the return (including extensions). 2. The last transmission was made within 10 calendar days of the first transmission.

Timeframe for Submitting Electronic Returns

There are several key dates related to electronic filing:

Important Dates and Filing Deadlines in 2024 for 2023 Federal Income Tax Returns

January 16 4th Quarter 2023 Estimated Tax Payment Due

March 15 S Corporation and Partnership Tax Returns Due

April 15 Last day to e-file timely 2023 Income Tax Returns

April 15 Last day to e-file timely for 2023 Income Tax Return Extensions

April 15 Corporation Tax Returns Due

April 15 1st Quarter 2024 Estimated Tax Payment Due

June 17 Last day to e-file timely extension request for overseas taxpayer

June 17 2nd Quarter 2024 Estimated Tax Payment Due

September 16 3rd Quarter 2024 Estimated Tax Payment Due

October 15 Last day to e-file returns that received 6-month extension

Table 1-2 Important Dates and Filing Deadlines for Federal Tax Returns (2024)

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If the taxpayer files his or her 2023 Form 1040 or 1040-SR by February 1, 2024 and pays the rest of the tax he or she owes, he or she did not need to make the payment due on January 16, 2024.

Refunds Taxpayers have the following options for receiving their individual Federal income tax refund: (29)

➢ Direct deposit (electronic funds transfer) into a checking or savings account, including an individual retirement arrangement (IRA).

➢ Purchase of U.S. Series I Savings Bonds. ➢ Paper check. ➢ Apply any portion of their overpayment to the following tax year.

If the taxpayer chooses to receive his or her refund by direct deposit, he or she can request that the refund be deposited in up to three separate accounts, such as checking, savings, or retirement accounts – just complete Form 8888 - Allocation of Refund (Including Savings Bond Purchases).

However, if the taxpayer files Form 8379 - Injured Spouse Allocation, he or she cannot have his or her refund direct- deposited into more than one account. The refund should only be deposited directly into accounts that are in the taxpayer’s own name, his or her spouse’s name or both if it is a joint account. Please note that to receive the refund by direct deposit (whether into one account or more) the total refund amount must be $1.00 or more.

Providers should caution taxpayers that some financial institutions do not permit the deposit of joint individual income tax refunds into individual accounts. The IRS is not responsible if the financial institution refuses Direct Deposit for this reason. Check or share draft accounts that are "payable through" another institution may not accept Direct Deposit. Taxpayers should verify their financial institution's Direct Deposit policy before they elect the Direct Deposit option.

If the taxpayer files a complete and accurate tax return, the refund should be issued within 21 days of the received date. This timeframe does not include mail and IRS handling time for paper returns. Even though the IRS issues most refunds in less than 21 days, it is possible the tax return may require review and take longer.

Use Where's My Refund? (https://www.irs.gov/refunds) to get personalized refund status. The taxpayer can also use IRS2Go, the free mobile app, for an iPhone or Android device, or go to www.IRS.gov. Both are available 24 hours a day, 7 days a week. The taxpayer can start checking on the status of the return within 24 hours after the IRS receives the e-filed return or 4 weeks after he or she mails a paper return. Processing may take longer under certain circumstances. Refunds from amended returns will generally be issued within 12 weeks. Injured spouse claims can take longer depending on the circumstances. If the taxpayer receives a refund to which he or she is not entitled, or one for an amount that is more than he or she expected, the person should not cash the check until he or she receives a notice explaining the difference; then follow the instructions on the notice. On the other hand, if the taxpayer receives a refund for a smaller amount than he or she expected, the person may cash the check, and, if it is determined that he or she should have received more, the person will later receive a check for the difference. The taxpayer will also get a notice explaining the difference.

Direct Deposit Limits

Effective January 2015 the IRS limited the number of refunds electronically deposited into a single financial account or pre-paid debit card to three. The fourth and subsequent refunds automatically will convert to a paper refund check and be mailed to the taxpayer. Taxpayers also will receive a notice informing them that the account has exceeded the direct deposit limits and that they will receive a paper refund check in approximately four weeks if there are no other issues with the return.

The vast majority of taxpayers will not be affected by this limitation, and we would encourage taxpayers and tax preparers to continue to use direct deposit. It is the fastest, safest way for taxpayers to receive refunds. The direct deposit limit is intended to prevent criminals from easily obtaining multiple refunds. The limit applies to financial accounts, such as bank savings or checking accounts, and to prepaid, reloadable cards or debit cards. The limitation may affect some taxpayers, such as families in which the parent’s and children’s refunds are deposited into a family-held bank account. Taxpayers in this situation should make other deposit arrangements or expect to receive paper refund checks.

Lesson 1 - General Filing Information

Form 8888 - Allocation of Refund (Including Savings Bond Purchases)

A taxpayer should use Form 8888 - Allocation of Refund (Including Savings Bond Purchases) if he or she wants to directly deposit his or her refund (or part of it) to one or more accounts at a bank or other financial institution (such as a mutual fund, brokerage firm, or credit union) in the United States or he or she wants to use the refund to buy up to $5,000 in paper series I savings bonds.

Overpayment

If a taxpayer thinks he or she paid too much tax, he or she may file a claim for refund. The taxpayer must generally file the claim within 3 years from the date he or she filed the original return or 2 years from the date he or she paid the tax, whichever is later. The law generally provides for interest on the refund if it is not paid within 45 days of the date the taxpayer filed the return or claim for refund. Publication 556 - Examination of Returns, Appeal Rights, and Claims for Refund, has more information on refunds. If the taxpayer was due a refund but he or she did not file a return, the taxpayer generally must file the return within 3 years from the date the return was due (including extensions) to get that refund. (30)

Refund Offsets

Certain financial debts from the taxpayer’s past may affect his or her current Federal tax refund. The law allows the use of part or all of a Federal tax refund to pay other Federal or state debts that an individual owes. Here are six facts from the IRS that every taxpayer should know about tax refund offsets: (31)

1. A tax refund offset generally means the U.S. Treasury has reduced a Federal tax refund to pay for certain unpaid debts.

2. The Treasury Department’s Bureau of Fiscal Service (BFS) is the agency that issues tax refunds and conducts the Treasury Offset Program.

3. If a taxpayer has unpaid debts, such as overdue child support, state income tax or student loans, BFS may apply part or all of the tax refund to pay that debt.

4. The taxpayer will receive a notice from BFS if an offset occurs. The notice will include the original tax refund amount and the offset amount. It will also include the agency receiving the offset payment and that agency’s contact information.

5. If the taxpayer believes he or she does not owe the debt or wants to dispute the amount taken from the refund, he or she should contact the agency that received the offset amount, not the IRS or BFS.

6. If the taxpayer filed a joint tax return, he or she may be entitled to part or all of the refund offset. This rule applies if the taxpayer’s spouse is solely responsible for the debt. To request his or her part of the refund, file Form 8379 - Injured Spouse Allocation.

The Department of Treasury's Bureau of Fiscal Service (BFS), which issues IRS tax refunds, has been authorized by Congress to conduct the Treasury Offset Program. Through this program, a refund or overpayment may be reduced by BFS and offset to pay: (32)

➢ Past-due child support. ➢ Federal agency non-tax debts. ➢ State income tax obligations. ➢ Certain unemployment compensation debts owed to a state. (Generally, these are debts for compensation that

was paid due to fraud or for contributions due to a state fund that were not paid due to fraud).

A taxpayer can contact the agency with which he or she has a debt, to determine if the debt was submitted for a tax refund offset. If the debt was submitted for offset, BFS will take as much of the taxpayer’s refund as is needed to pay off the debt and send it to the agency he or she owes. Any portion of the refund remaining after offset will be issued in a check to the taxpayer or direct deposited. BFS will send a notice if an offset occurs. The notice will reflect the original refund amount, the offset amount, the agency receiving the payment, and the address and telephone number of the agency. BFS will notify the IRS of the amount taken from the refund. Contact the agency shown on the notice if the taxpayer believes he or she does not owe the debt, or if the taxpayer is disputing the amount taken from the refund. If a notice is not received, contact BFS.

Amended Returns

If the taxpayer discovers an error after his or her return has been filed, he or she may need to amend the return. The IRS

Lesson 1 - General Filing Information

may correct errors in math on a return and may accept returns with certain forms or schedules left out. In these instances, do not amend the return. However, do file an amended return if there is a change in the taxpayer’s filing status, income, deductions, or credits. Generally, to claim a refund, Form 1040-X - Amended U.S. Individual Income Tax Return must be filed within 3 years from the due date of the original return or within 2 years from the date the taxpayer paid the tax, whichever is later. Returns filed before the due date (without regard to extensions) are considered filed on the due date.

Paying the Tax

Balance Due Returns

Taxpayers who owe additional tax must pay their balances due by the original due date of the return or be subject to interest and penalties. An extension of time to file may be filed electronically by the original return due date, but it is an extension of time to file the return, not an extension of time to pay a balance due. Providers should inform taxpayers of their obligations and options for paying balances due. Taxpayers have several choices when paying any taxes owed on their returns as well as estimated tax payments. The taxpayer is considered to have reasonable cause for the period covered by an automatic extension if at least 90%of the current tax year’s actual tax liability is paid before the regular due date of the return through withholding, estimated tax payments, or payments made with Form 4868.

Electronic Funds Withdrawal

Taxpayers can e-file and, at the same time, authorize an electronic funds withdrawal (EFW). Taxpayers who choose this option must provide account numbers and routing transit numbers for qualified savings, checking or share draft accounts to the Provider. The IRS tax return instructions describe how to find and identify these numbers. Providers should encourage their clients to confirm their account numbers and routing transit numbers with their financial institution. If a financial institution is unable to locate or match the numbers entered in a payment record with account information they have on file for a given taxpayer, they reject (return) the direct debit request. Taxpayers can schedule a payment for withdrawal on a future date. Scheduled payments must be effective on or before the return due date. For example, the Provider may transmit an individual income tax return in March and the taxpayer can specify that the withdrawal be made on any day on or before the return due date. The taxpayer does not have to remember to do anything at a later date. For returns transmitted after the due date, the payment date must be the same as the date the Provider transmitted the return. The taxpayer must authorize EFW payments by completion of a payment record at the time the balance due return or form is e-filed. Taxpayers can make payments by EFW for the following:

➢ Current year - Form 1040 series return. ➢ Form 4868 - Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. ➢ Form 2350 - Application for Extension of Time to File U.S. Income Tax Return for Citizens and Resident Aliens

Abroad Who Expect to Qualify for Special Tax Treatment. ➢ Form 1040-ES - Estimated Tax for Individuals (Taxpayers can make up to four estimated tax payments at the time

that they electronically file the Form 1040 series return). Providers should be careful to ensure that all the information needed for the EFW request is included with the return.

Review Question 3 Taxpayers can make payments by electronic funds withdrawal (EFW) for all of the each of the following forms except:

A. Form 4868 - Application for Automatic Extension of Time to File U.S. Individual Income Tax Return B. Form 2350 - Application for Extension of Time to File U.S. Income Tax Return for Citizens and

Resident Aliens Abroad Who Expect to Qualify for Special Tax Treatment C. Form 1040-ES - Estimated Tax for Individuals (Taxpayers can make up to four estimated tax

payments at the time that they electronically file the Form 1040 series return) D. Form 433-F - Collection Information Statement

See Review Feedback for answer.

Lesson 1 - General Filing Information

Estimated Taxes

Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self- employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards. The taxpayer may also have to pay estimated tax if the amount of income tax being withheld from his or her salary, pension, or other income is not enough. Estimated tax is used to pay income tax and self-employment tax, as well as other taxes and amounts reported on the tax return. If the taxpayer does not pay enough through withholding or estimated tax payments, he or she may be charged a penalty. If the taxpayer does not pay enough by the due date of each payment period, he or she may be charged a penalty even if he or she is due a refund when the tax return is filed. If the taxpayer is filing as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual, he or she generally will have to make estimated tax payments if he or she expects to owe tax of $1,000 or more when filing the return. If the taxpayer is filing as a corporation, he or she generally has to make estimated tax payments for the corporation if he or she expects it to owe tax of $500 or more when filing its return. The taxpayer does not have to pay estimated tax for the current year if he or she meets all three of the following conditions: (34)

1. The taxpayer had no tax liability for the prior year. 2. The taxpayer was a U.S. citizen or resident for the whole year. 3. The taxpayer’s prior tax year covered a 12-month period.

When figuring the estimated tax for the current year, it may be helpful to use the taxpayer’s income, deductions, and credits for the prior year as a starting point. Use the worksheet in Form 1040-ES - Estimated Tax for Individuals to figure the estimated tax. It is important to remember to make adjustments both for changes in the taxpayer’s work situation and for recent changes in the tax law. For estimated tax purposes, the year is divided into four payment periods. Each period has a specific payment due date. If the taxpayer does not pay enough tax by the due date of each of the payment periods, he or she may be charged a penalty even if he or she is due a refund when the taxpayer files the income tax return. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. The penalty may also be waived if: (34)

➢ The failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty.

➢ The taxpayer retired (after reaching age 62) or became disabled during the tax year for which estimated payments were required to be made or in the preceding tax year, and the underpayment was due to reasonable cause and not willful neglect.

As of January 2013, a Net Investment Income Tax (NIIT) applies at a rate of 3.8% to individuals, estates, and trusts that have certain investment income above threshold amounts. When calculating the 2023 estimated tax payments, the taxpayer may need to take account of any additional tax liability associated with the NIIT.

Penalty for Underpayment

In general, the taxpayer may owe a penalty for 2023 if the total of his or her withholding and timely estimated tax payments did not equal at least the smaller of:

➢ 90% of his or her 2023 tax. ➢ 100% of his or her 2022 tax. (The taxpayer‘s 2022 tax return must cover a 12-month period.)

If the taxpayer did not pay enough tax, either through withholding or by making timely estimated tax payments, he or she will have underpaid his or her estimated tax and may have to pay a penalty. Because the penalty is figured separately for each payment period, the taxpayer may owe a penalty for an earlier payment period even if he or she later paid enough to make up the underpayment. This is true even if the taxpayer is due a refund when he or she files his or her income tax return. The taxpayer will owe a penalty for any 2023 payment period for which his or her estimated tax payment plus his or her withholding for the period and overpayments for previous periods was less than the smaller of: (35)

Lesson 1 - General Filing Information

➢ 22.5% of his or her 2023 tax. ➢ 25% of his or her 2022 tax. (The taxpayer’s 2022 tax return must cover a 12-month period.)

If the taxpayer thinks he or she owes the penalty but does not want to figure it when he or she files the tax return, the taxpayer may not have to. Generally, the IRS will figure the penalty for him or her and send a bill. The taxpayer only needs to figure his or her penalty in the following three situations: (35)

➢ The taxpayer is requesting a waiver of part, but not all, of the penalty. ➢ The taxpayer is using the annualized income installment method to figure the penalty. ➢ The taxpayer is treating the Federal income tax withheld from his or her income as paid on the dates actually

withheld. However, if these situations do not apply to the taxpayer, and he or she thinks he or she can lower or eliminate his or her penalty, complete Form 2210 - Underpayment of Estimated Tax by Individuals, Estates, and Trusts or Form 2210-F - Underpayment of Estimated Tax by Farmers and Fishermen and attach it to the return. The IRS calculates the amount of the Underpayment of Estimated Tax by Individuals Penalty based on the tax shown on the taxpayer’s original return or on a more recent return that he or she filed on or before the due date. The tax shown on the return is taxpayer’s total tax minus his or her total refundable credits. The IRS calculates the penalty based on:

➢ The amount of the underpayment. ➢ The period when the underpayment was due and underpaid. ➢ The interest rate for underpayments that we publish quarterly.

Also, the IRS charges interest on penalties. The date from which the IRS begins to charge interest varies by the type of penalty. Interest increases the amount the taxpayer owes until he or she pays his or her balance in full. If the taxpayer does not qualify for penalty removal or reduction due to retirement or disability, the IRS cannot adjust the Underpayment of Estimated Tax by Individuals Penalty for reasonable cause. The IRS may consider making an adjustment if they imposed the penalty after the taxpayer relied on incorrect written advice the IRS gave him or her.

Exceptions

The taxpayer does not owe a penalty if the total tax shown on his or her return minus the amount he or she paid through withholding (including excess Social Security and tier 1 railroad retirement (RRTA) tax withholding) is less than $1,000. Also, the taxpayer does not owe a penalty if he or she had no tax liability last year and he or she was a U.S. citizen or resident for the whole year. For this rule to apply, the taxpayer’s tax year must have included all 12 months of the year. The taxpayer had no tax liability for the last year if his or her total tax was zero or he or she was not required to file an income tax return. Additionally, the penalty does not apply to either of the following: (36)

➢ A decedent's estate for any tax year ending before the date that is 2 years after the decedent's death. ➢ A trust that was treated as owned by the decedent if the trust will receive the residue of the decedent's estate

under the will (or if no will is admitted to probate, the trust primarily responsible for paying debts, taxes, and expenses of administration) for any tax year ending before the date that is 2 years after the decedent's death.

Lastly, if the taxpayer meets both tests 1 and 2 below, he or she does not owe a penalty for underpaying estimated tax:

1. His or her gross income from farming or fishing is at least two-thirds of the taxpayer’s annual gross income from all sources for 2022 or 2023.

2. He or she filed Form 1040 or 1041 and paid the entire tax due by March 1, 2024.

Overpayments

If the taxpayer pays more tax than he or she owes, the IRS pays interest on the overpayment amount. Overpayment interest rates vary and may change quarterly. In general, the IRS pays interest on the amount the taxpayer overpays starting from whichever is later:

➢ Tax return filing due date.

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➢ Late filed tax return received date. ➢ Date the IRS gets the taxpayer’s return in a format they can process. ➢ Date the payment was made.

The IRS stops paying interest on overpayments on the date they refund taxpayer’s overpayment (and interest) or offset it to an outstanding liability. The IRS has administrative time (typically 45 days) to issue the taxpayer’s refund without paying interest on it.

Electronic Federal Tax Payment System (EFTPS)

Electronic Federal Tax Payment System (EFTPS) is a system for paying Federal taxes electronically using the Internet, or by phone using the EFTPS Voice Response System. EFTPS is offered free by the U.S. Department of Treasury. Once enrolled, individual and business taxpayers can use the internet to make all their Federal tax payments or via the phone using the EFTPS Voice Response System. Both payment methods are interchangeable. (37)

Debit or Credit Card

A taxpayer can pay by debit or credit card whether he or she e-files, paper files or is responding to a bill or notice. The IRS uses standard service providers and commercial card networks. (38)

➢ The payment will be processed by a payment processor who will charge a processing fee, which may be tax deductible. The fees vary by service provider.

➢ The taxpayer’s information will only be used to process the payment. ➢ No part of the service fee goes to the IRS. ➢ The types of payments (Individual or Business) and limits on how many debit or credit card payments a taxpayer

can make in a year, quarter, or month, vary according to the type of tax he or she is paying.

The following table shows the tax form, payment type, tax year, and payment transaction limit, for which a taxpayer can make using a debit or credit card.

Individuals

Tax Form Payment Type and Tax Year Limit

Form 1040 series

Current Tax Due

Current Tax Notice

Prior Tax Year

Proposed Tax Assessment - CP

2000/2501/ CP 3219A

Installment Agreement

2 per year

2 per month

Form 1040-ES Estimated Tax 2 per quarter

Form 1040-X Amended 2 per year

Form 4868 Extension to File 2 per year

Form 5329 Current Tax Year 2 per year

Health Care - Form 1040 Proposed Tax Assessment/CP 2000/

CP 2501/CP 3219a (2021-2023) 2 per year

Health Care - Form 1040-X Amended (2019 - 2023) 2 per year

Trust Fund Recovery Penalty

2004-2023

Installment Agreement

2 per quarter

2 per month

Table 1-3 - Frequency Limit Table by Type of Tax Payment (2023)

When a taxpayer is using a debit or credit card for payment, keep in mind these additional considerations: (38)

➢ High balance payments of $100,000 or greater may require special coordination with the service provider chosen.

Lesson 1 - General Filing Information

➢ The taxpayer cannot make Federal tax deposits with a debit or credit card. ➢ The taxpayer cannot get an immediate release of a Federal Tax Lien by making a debit or credit card payment. ➢ Making an electronic payment eliminates the need to use a voucher. ➢ On the monthly debit or credit card statement, the payment to the IRS will be listed as "United States Treasury

Tax Payment." The convenience fee paid to the service provider will be listed as "Tax Payment Convenience Fee" or something similar.

➢ If the taxpayer made an overpayment, the IRS will refund it after the return is processed, except in circumstances such as offsets or debt on the account.

Review Question 4 When a taxpayer uses a debit or credit card to pay for high balance payments of what amount or greater may require special coordination with the service provider chosen?

A. $50,000 B. $75,000 C. $100,000 D. $125,000

See Review Feedback for answer.

Check or Money Order

If the taxpayer chooses to mail the tax payment: (39)

➢ Make the check, money order or cashier's check payable to U.S. Treasury. Enter the amount on the check using all numbers ($###.##), and do not use staples or paper clips to affix a payment to a voucher or return.

➢ Include the taxpayer’s name, address, daytime phone number, Social Security number (the SSN shown first if it is a joint return) or employer identification number, tax period and related tax form or notice number on the form of payment.

➢ Mail the payment to the address listed on the notice or instructions. Do not send cash through the mail. Check the services provided at the local IRS office to see if cash payments are accepted.

Installment Agreements

If a taxpayer is financially unable to pay his or her tax debt immediately, he or she can make monthly payments through an installment agreement. As long as the taxpayer pays his or her tax debt in full, he or she can reduce or eliminate his or her payment of penalties or interest and avoid the fee associated with setting up the agreement. Before applying for any payment agreement, the taxpayer must file all required tax returns. The following taxpayers may request a pre-assessment installment agreement on current tax liabilities by using the Online Payment Agreement (OPA) application on the www.irs.gov website:

➢ Individuals who owe $50,000 or less in combined individual income tax, penalties, and interest, and have filed all required returns.

➢ Businesses that owe $25,000 or less in payroll taxes and have filed all required returns. The taxpayer may also submit Form 9465 - Installment Agreement Request, or attach a written request for a payment plan to the front of the return. Most installment agreements meet the IRS streamlined installment agreement criteria. The maximum term for a streamlined agreement is 72 months. In certain circumstances, a taxpayer can have longer to pay or his or her agreement can be approved for an amount that is less than the amount of tax he or she owes. The taxpayer is eligible for a guaranteed installment agreement if the tax he or she owes is not more than $10,000 and:

1. During the past 5 tax years, the taxpayer (and his or her spouse if filing a joint return) have timely filed all income tax returns and paid any income tax due, and have not entered into an installment agreement for payment of income tax;

Lesson 1 - General Filing Information

2. The taxpayer agrees to pay the full amount he or she owes within 3 years and to comply with the tax laws while the agreement is in effect; and,

3. The taxpayer is financially unable to pay the liability in full when due.

It is the practice of the Internal Revenue Service (IRS) to grant these installment agreements even if the taxpayer can pay his or her liability in full if the tax he or she owes is not more than $10,000 and he or she meets the other criteria.

If the taxpayer owes more than $50,000 or cannot pay the amount he or she owes in six years or less, his or her request for an installment agreement begins with an IRS collector's analyzing his or her Collection Information Statement on Form 433- A. The collector uses the information on the form to determine the amount the taxpayer can pay. Payment amounts are at the discretion of the IRS. The IRS provides various options for making monthly payments, such as: (40)

➢ Direct debit from the taxpayer’s bank account. ➢ Payroll deduction from the taxpayer’s employer. ➢ Payment via check or money order. ➢ Payment by Electronic Federal Tax Payment System (EFTPS). ➢ Payment by credit card via phone or Internet. ➢ Payment by Online Payment Agreement (OPA).

The taxpayer may request a pre-assessment installment agreement on current tax liabilities by using the Online Payment Agreement (OPA) application on the www.irs.gov website. The taxpayer may also submit Form 9465 - Installment Agreement Request or attach a written request for a payment plan to the front of the return.

The IRS can deny the request, and a request cannot be made if the taxpayer is already making payments on an existing installment agreement.

The IRS charges a user fee to set up an installment agreement. The amount of the user fee can vary depending on whether the taxpayer uses the online payment application and how he or she proposes to make his or her monthly payments.

Long-term Payment Plans (Installment Agreement)

Payment Options Costs

Option 1: Pay through Direct Debit (automatic monthly payments from the taxpayer’s checking account), also known as a Direct Debit Installment Agreement (DDIA).

Apply online: $31 setup fee.

Apply by phone, mail, or in-person: $107 setup fee.

Low income: Apply online, by phone, or in-person: setup fee waived.

Option 2: After applying for a long-term payment plan, payment options include:

• Make monthly payment directly from a checking or savings account (Direct Pay) (Individuals only).

• Make monthly payment electronically online or by phone using Electronic Federal Tax Payment System (EFTPS) (enrollment required).

• Make monthly payment by check, money order or debit/credit card (Fees apply when paying by card).

Apply online: $130 setup fee.

Apply by phone, mail, or in-person: $225 setup fee

Low income: Apply online, by phone, or in-person: $43 setup fee which may be reimbursed if certain conditions are met.

Table 1-4 - Information on Payment Plans (2023)

Change an Existing Payment Plan

Payment Method Costs

• Pay through Direct Debit (automatic monthly payments from the taxpayer’s checking account), also known as a Direct Debit Installment Agreement (DDIA).

Apply (revise) online: $10 fee.

Apply (revise) by phone, mail, or in-person: $89 fee.

Low income:

Lesson 1 - General Filing Information

• Make monthly payment directly from a checking or savings account (Direct Pay) (Individuals only).

• Make monthly payment electronically online or by phone using Electronic Federal Tax Payment System (EFTPS) (enrollment required).

• Make monthly payment by check, money order or debit/credit card (Fees apply when paying by card).

Apply (revise) online: $10 fee, which may be reimbursed if certain conditions are met.

Apply (revise) by phone, mail, or in-person: $43 fee, which may be reimbursed if certain conditions are met.

$0 fee for changes made to existing Direct Debit installment agreements.

Table 1-5 - Information on Payment Plans (2023)

Taxpayers with income at or below 250% of the Department of Health and Human Services poverty guidelines may apply for a reduced user fee of $43.

The IRS Form 1040-V - Payment Voucher should be completed and sent in with the payment with a tax return having a balance due to the IRS. Taxpayer(s) must simply fill in the amount he or she is paying, their name, address and Social Security Number(s).

Offer in Compromise

An offer in compromise allows the taxpayer to settle his or her tax debt for less than the full amount he or she owes. It may be a legitimate option if the taxpayer cannot pay his or her full tax liability or doing so creates a financial hardship. The IRS will consider each taxpayer’s unique set of facts and circumstances based on: (41)

➢ Ability to pay. ➢ Income. ➢ Expenses. ➢ Asset equity.

Before the IRS can consider the taxpayer’s offer, he or she must be current with all filing and payment requirements. The taxpayer is not eligible if he or she is in an open bankruptcy proceeding. The taxpayer can use the Offer in Compromise Pre- Qualifier on the IRS website to confirm his or her eligibility and prepare a preliminary proposal. The taxpayer’s completed offer package that is submitted to the IRS will include: (41)

1. Form 433-A (OIC) - Collection Information Statement for Wage Earners and Self-Employed Individuals or Form 433- B (OIC) - Collection Information Statement for Businesses and all required documentation as specified on the forms.

2. Form 656 - Offer Income Compromise - individual and business tax debt (Corporation/ LLC/ Partnership) must be submitted on separate Form 656(s).

3. $205 application fee (non-refundable) in 2023. 4. Initial payment (non-refundable) for each Form 656.

The taxpayer’s initial payment will vary based on his or her offer and the payment option he or she chooses:

➢ Lump Sum Cash - The taxpayer submits an initial payment of 20% of the total offer amount with his or her application. He or she then waits for written acceptance, then pays the remaining balance of the offer in five or fewer payments.

➢ Periodic Payment - The taxpayer submits his or her initial payment with his or her application. He or she continues to pay the remaining balance in monthly installments while the IRS considers the offer. If accepted, the taxpayer continues to pay monthly until it is paid in full.

If the taxpayer meets the Low-Income Certification guidelines, he or she does not have to send the application fee or the initial payment and he or she will not need to make monthly installments during the evaluation of the offer.

Lesson 1 - General Filing Information

While the taxpayer’s offer is being evaluated:

➢ His or her non-refundable payments and fees will be applied to the tax liability (the taxpayer may designate payments to a specific tax year and tax debt).

➢ A Notice of Federal Tax Lien may be filed. ➢ Other collection activities are suspended. ➢ The legal assessment and collection period is extended. ➢ He or she should make all required payments associated with the offer. ➢ He or she is not required to make payments on an existing installment agreement. ➢ His or her offer is automatically accepted if the IRS does not make a determination within two years of the IRS

receipt date. If the taxpayer’s offer is accepted:

1. He or she must meet all the Offer Terms listed in Section 8 of Form 656, including filing all required tax returns and making all payments.

2. Any refunds due within the calendar year in which the offer is accepted will be applied to the tax debt. 3. Federal tax liens are not released until the offer terms are satisfied. 4. Certain offer information is available for public review at designated IRS offices.

If the taxpayer’s offer is rejected he or she may appeal a rejection within 30 days using Form 13711 - Request for Appeal of Offer in Compromise.

Review Question 5 Generally, the fee is $89 to modify the taxpayer’s installment agreement ($43 if he or she is a low-income taxpayer). However, as of January 1, 2019, the user fee is what amount for installment agreements reinstated or restructured through an Online Payment Agreement (OPA)?

A. $0 B. $10 C. $43 D. $89

See Review Feedback for answer.

IRS Notices and Letters

Each year, the IRS sends millions of notices and letters to taxpayers for a variety of reasons. Here are ten things to know in case one shows up in the taxpayer’s mailbox.

1. The taxpayer should not panic. He or she often only needs to respond to take care of a notice. 2. There are many reasons why the IRS may send a letter or notice. It typically is about a specific issue on the

taxpayer’s Federal tax return or tax account. A notice may tell him or her about changes to his or her account or ask the taxpayer for more information. It could also tell him or her that he or she must make a payment.

3. Each notice has specific instructions about what the taxpayer needs to do. 4. The taxpayer may get a notice that states the IRS has made a change or correction to his or her tax return. The

taxpayer should review the information and compare it with his or her original return. 5. If the taxpayer agrees with the notice, he or she usually does not need to reply unless it gives him or her other

instructions or he or she needs to make a payment. 6. If the taxpayer does not agree with the notice, it is important that he or she responds. The taxpayer should write

a letter to explain why he or she disagrees. The taxpayer should include any information and documents he or she wants the IRS to consider. The taxpayer mails the reply with the bottom tear-off portion of the notice and sends it to the address shown in the upper left-hand corner of the notice. Allow at least 30 days for a response.

7. The taxpayer should not have to call or visit an IRS office for most notices. If he or she does have questions, call the phone number in the upper right-hand corner of the notice. The taxpayer should have a copy of the tax return and the notice when he or she calls.

8. The taxpayer should keep copies of any notices he or she receives with his or her other tax records.

Lesson 1 - General Filing Information

9. The IRS sends letters and notices by mail. The IRS does not contact people by email or social media to ask for personal or financial information.

10. For more on this topic, the taxpayer can visit IRS.gov and click on the link ‘Responding to a Notice’ at the bottom left of the home page. He or she can also see Publication 594 - The IRS Collection Process.

Where to File Tax Returns

The Internal Revenue Service (IRS) is the nation’s tax collection agency. The taxes the taxpayer owes to the government are generally paid through withholding (money taken out of his or her paycheck), estimated tax payments, and payments made when he or she files his or her taxes each year. An individual taxpayer files online or finds the address for mailing his or her paper return. The four electronic filing options for individual taxpayers are:

1. Use IRS Free File or Fillable Forms: a. In 2023, the taxpayer uses IRS Free File if his or her adjusted gross income is $79,000 or less. b. If the taxpayer is comfortable doing his or her own taxes, he or she can use the Free File Fillable Forms.

2. Use a Free Tax Return Preparation Site: a. The IRS Volunteer Income Tax Assistance (VITA) and the Tax Counseling for the Elderly (TCE) programs

offer free tax help and e-file for taxpayers who qualify. 3. Use Commercial Software:

a. The taxpayer can use commercial tax prep software to prepare and file his or her taxes. b. Transmitted through IRS approved electronic channels.

4. Find an Authorized e-file Provider: a. Tax pros accepted by the IRS electronic filing program are authorized IRS e-file providers. b. They are qualified to prepare, transmit and process e-filed returns.

Mailing addresses for all types of returns: individual, corporation, partnership, and many others differ as each form has its own required mailing address. For example, addresses are grouped by state for Form 1040, 1040ES, 1040V, amended returns, and extensions. Also, specific addresses exist for taxpayers in foreign countries, U.S. possessions, or with other international filing characteristics. See Where to File Paper Tax Returns With or Without a Payment on the IRS Website.

Presidential Election Campaign Fund

This fund helps pay for Presidential election campaigns. The fund reduces candidates' dependence on large contributions from individuals and groups and places candidates on an equal financial footing in the general election. If the taxpayer wants $3 to go to this fund, check the box on the tax form. If the taxpayer is filing a joint return, his or her spouse can also have $3 go to the fund. If the taxpayer checks the box on the tax form, his or her tax or refund will not change.

Lesson 1 - General Filing Information

• Current year - Form 1040 series return.

• Form 4868 - Application for Automatic Extension of Time to File U.S. Individual Income Tax Return (Choice A).

• Form 2350 - Application for Extension of Time to File U.S. Income Tax Return for Citizens and Resident Aliens Abroad Who Expect to Qualify for Special Tax Treatment (Choice B).

• Form 1040-ES - Estimated Tax for Individuals (Taxpayers can make up to four estimated tax payments at the time that they electronically file the Form 1040 series return) (Choice C).

Choice D, Form 433-F - Collection Information Statement, is not listed among the forms for which a taxpayers can make payments by electronic funds withdrawal (EFW) and is therefore incorrect. Topic - Electronic Funds Withdrawal Source - IRS.GOV - Electronic Funds Withdrawal for Individuals Question 4 - C. $100,000 When a taxpayer is using a debit or credit card to pay for high balance payments of $100,000 (Choice C) or greater it may require special coordination with the service provider chosen. Additionally, the taxpayer cannot make Federal tax deposits with a debit or credit card. Choices A, B and D all have amounts other than $100,000 and are therefore incorrect. Topic - Debit or Credit Card Source - IRS.GOV - Pay your Taxes by Debit or Credit Card

Lesson 1 - General Filing Information

Question 5 - B. $10 Generally, the fee is $89 (Choice D) to modify the taxpayer’s installment agreement ($43 (Choice C) if he or she is a low- income taxpayer). However, as of January 1, 2019, the user fee is $10 (Choice B) for installment agreements reinstated or restructured through an Online Payment Agreement (OPA). The fee is $0 (Choice A) for low-income taxpayers for changes made to existing Direct Debit installment agreements. Topic - Installment Agreements Source - IRS.GOV - Topic No. 202 - Tax Payment Options

Tax Forms At the conclusion of this lesson you should have a basic knowledge of:

➢ Form 1040. ➢ Schedules 1 - 3. ➢ Form 1040-NR. ➢ Form 1040-X. ➢ Form W-4. ➢ Form W-2. ➢ Form 1099.

Returns not Qualifying for Use of the Tax Table

Several restrictions exist which make it impossible for some taxpayers to use the Tax Table provided by the Internal Revenue Service. The primary restriction is that the Tax Table only covers taxable incomes under $100,000. Taxpayers with taxable income of $100,000 or more must use the Tax Computation Worksheet (which is based on the Tax Rate Schedules) to determine their tax.

Tax Computation Worksheet

The Tax Computation Worksheet is based on filing status, as follows: (42)

➢ Section A is to be used by Single Taxpayers. ➢ Section B is to be used by Married Taxpayers filing a joint return and Surviving Spouses. ➢ Section C is to be used by Married Taxpayers filing separate tax returns. ➢ Section D is to be used by persons qualifying as Heads of Household.

Review Question 1 The taxpayer must use the Tax Computation Worksheet (based on the Tax Rate Schedules) provided by the IRS if he or she has an income of what amount or more?

A. $50,000 B. $75,000 C. $100,000 D. $125,000

See Review Feedback for answer.

Form 1099-NEC

The IRS has reintroduced Form 1099-NEC - Nonemployee Compensation as the new way to report self-employment income instead of Form 1099-MISC as traditionally had been used. This was done to help clarify the separate filing deadlines on Form 1099-MISC and Form 1099-NEC. As of the 2020 tax year, the IRS requires business taxpayers to report nonemployee compensation on the new Form 1099-NEC instead of on Form 1099-MISC. Businesses need to use this form if they made payments totaling $600 or more to a nonemployee, such as an independent contractor. In general, a business must report payments it makes if it meets the following four conditions:

1. The payment is made to someone who is not an employee.

Lesson 2 - Tax Forms

2. The payment is made for services in the course of trade or business. 3. The payment is made to an individual, partnership, estate, or corporation. 4. The payment total is at least $600 for the year.

Additionally, businesses will need to file Form 1099-NEC:

➢ When they pay an individual at least $10 in royalties, or ➢ If the business has withheld any federal income tax under the backup withholding rules regardless of the amount

of payments for the year to the nonemployee. Nonemployee compensation can include:

➢ Fees. ➢ Benefits. ➢ Commissions. ➢ Prizes and awards for services performed by a nonemployee. ➢ Other forms of compensation for services performed for trade or business by an individual who is not an employee.

Generally, payers need to file these forms by January 31 and have no automatic 30-day extensions to file unless the business meets certain hardship conditions.

Form 1040-NR Revision

The taxpayer will no longer use Form 1040-NR-EZ as he or she may have in the past. Instead, he or she will use the redesigned Form 1040-NR. The lines on Form 1040-NR have been rearranged so that, in most instances, they are for the same tax items as the lines on Form 1040 or 1040-SR. The taxpayer may also need the three Form 1040 numbered schedules: Schedule 1 (Form 1040), Additional Income and Adjustments to Income; Schedule 2 (Form 1040), Additional Taxes; and Schedule 3 (Form 1040), Additional Credits and Payments. Certain lines formerly found on Form 1040-NR are now on those schedules.

Form 1040 - U.S. Individual Income Tax Return

The Form 1040 - U.S. Individual Income Tax Return has been rewritten to only include the five most common types of income, Federal withholding, Earned Income Tax Credit (EITC), Additional Child Tax Credit and the Education Credit. The detail for all other types of income, adjustments to income, nonrefundable, refundable credits, other payments and other taxes that existed on the previous Form 1040 have been moved to one of three schedules:

➢ Schedule 1 - Additional Income and Adjustments to Income: o Includes the remaining income types such as from Schedule C, D, E and F, unemployment compensation,

etc. o All adjustments to income such as Educator expenses, IRA contributions, student loan interest, etc.

➢ Schedule 2 - Additional Taxes: o Includes all lines that are used to calculate total tax such as the regular tax, tax on child’s unearned

income, alternative minimum tax, etc. o Includes all other taxes such as self-employment tax, household employment tax, etc.

➢ Schedule 3 - Additional Credits and Payments: o Includes nonrefundable credits such as the Foreign Tax Credit, Education credits, Retirement Savings

Contributions Credit, and Residential energy credits. o Includes the lines for other payments and refundable credits such as, net Premium Tax Credit, excess

Social Security and tier 1 RRTA tax withheld, and the Credit for Federal Tax on Fuels.

The Form 1040 also includes changes that are a result of the Tax Cuts and Jobs Act such as:

➢ Removal of exemption amount boxes and the total exemptions line. ➢ Line 13 for the qualified business income deduction (20% deduction for pass-through business income - Section

199A). Here are some details about how the new forms are alike and how they differ from the previous version:

Lesson 2 - Tax Forms

➢ Names and Social Security Numbers. The spaces for names and Social Security numbers remain the same. ➢ Signatures. The spaces for signatures and Third-Party Designee are on page two. ➢ Filing Status. Form 1040 retains the choices for the five filing statuses: Single, Married filing jointly, Married filing

separately, Head of household or Surviving Spouse. ➢ Presidential election campaign. The option to contribute to the Presidential election campaign is the same. ➢ Personal exemptions. There are no personal exemptions available for the tax years 2018 through 2025, so those

line items have been removed on the first and second pages of the Form 1040. ➢ Dependents. There is space on the front page to list four dependents again. ➢ Income reporting. Income from each of Schedules C, D, E, and F are now reported on a Schedule 1. ➢ Adjusted income reporting. Adjusted gross income (AGI) is now line 11 of page one. ➢ Standard deduction. The taxpayer’s standard deduction amounts appear on page one and are updated annually. ➢ Qualified business deduction (Section 199A Deduction). The qualified business income deduction gets just

one line on the Form 1040 (line 13) with instructions to attach Form 8995 or Form 8995-A. Tax preparers who filed Federal tax return electronically last year may not notice any changes, as the tax return preparation software will automatically use their answers to the tax questions to complete the Form 1040 and any needed schedules.

Form 1040-SR - U.S. Tax Return for Seniors

Form 1040-SR is available as an optional alternative to using Form 1040 for taxpayers who are age 65 or older. Form 1040-SR uses the same schedules and instructions as Form 1040 does. Anyone age 65 or older can opt to use Form 1040-SR instead of Form 1040. There are not any limitations that come with using this form. For example, the taxpayer is not forced to take the standard deduction if he or she chooses to file with Form 1040-SR. Since these Form 1040 and Form 1040-SR are virtually identical in function, the main reason to use Form 1040-SR is if the taxpayer is filling out his or her tax return by hand rather than online. Form 1040-SR has larger type and larger boxes to write numbers in, making it slightly easier for seniors to read and fill out.

Form 1040-NR - U.S. Nonresident Alien Income Tax Return

The U.S. imposes a tax on worldwide income for its citizens and residents. If the taxpayer is a nonresident alien, he or she pays Federal income tax only on U.S. source income. In most cases, the taxpayer must file a tax return if he or she is a nonresident alien even if he or she has no income from his or her trade or business in the U.S., he or she has no U.S. source income or if his or her income is exempt from U.S. tax under a tax treaty. There is an exception: the taxpayer does not need to file if, as a nonresident alien, his or her only U.S. trade or business was the performance of personal services with wages of less than $4,700 in 2023 and he or she does not need to file to claim a refund of over-withheld taxes, satisfy additional withholding or claim partially exempt income. Exceptions also apply if the taxpayer is a nonresident alien student, teacher, or trainee in the U.S. temporarily on an “F,” “J,” “M,” or “Q” visa, and he or she has no taxable income. The taxpayer must file Form 1040-NR if any of the following conditions apply: (43)

1. A nonresident alien individual engaged or considered to be engaged in a trade or business in the United States during the year.

2. A nonresident alien individual who is not engaged in a trade or business in the United States and has U.S. income on which the tax liability was not satisfied by the withholding of tax at the source.

3. A representative or agent responsible for filing the return of an individual described in (1) or (2), 4. A fiduciary for a nonresident alien estate or trust, or 5. A resident or domestic fiduciary, or other person, charged with the care of the person or property of a nonresident

individual may be required to file an income tax return for that individual and pay the tax. An individual does not need to file Form 1040-NR if: (43)

1. He or she was a nonresident alien student, teacher, or trainee who was temporarily present in the United States under an "F," "J," "M," or "Q" visa, and he or she has no income that is subject to tax under Section 871 (that is, the income items listed on page 1 of Form 1040-NR, lines 1a, 1b, 2b, 3b, 4b, 5b, 7, and 8, and Schedule NEC (Form 1040-NR), lines 1 through 12).

Lesson 2 - Tax Forms

2. He or she was a student or business apprentice who was eligible for the benefits of Article 21(2) of the United States-India Income Tax Treaty, he or she is single or a surviving spouse, and his or her gross income for 2023 was less than or equal to $13,850 if single ($27,700 if a surviving spouse). See chapter 5 of Publication 519 for more details on these treaty benefits.

3. He or she was a partner in a U.S. partnership that was not engaged in a trade or business in the United States during 2023 and his or her Schedule K-1 (Form 1065) includes only income from U.S. sources reportable on Schedule NEC (Form 1040-NR), lines 1 through 12. As of 2020, the 1040NR-EZ has been made obsolete. The IRS has simplified the 1040-NR, which will be used instead. The 1040NR-EZ may be used for filing a previous year return.

Form 1040-SS - U.S. Self-Employment Tax Return

The Form 1040-SS is a short form for reporting self-employment (SE) income if the taxpayer, or his or her spouse (if filing a joint return), does not have to file a Form 1040 but had net earnings from self-employment of $400 or more (or he or she had church employee income of $108.28 or more); and are a resident of Guam, American Samoa, the U.S. Virgin Islands, Commonwealth of the Northern Mariana Islands or Puerto Rico. One purpose of the form is to report net earnings from self-employment to the United States and, if necessary, pay SE tax on that income. The Social Security Administration (SSA) uses this information to figure the taxpayer’s benefits under the Social Security program. SE tax applies no matter how old the taxpayer is and even if he or she already is receiving Social Security or Medicare benefits.

Extensions

Beginning with 2005, an individual is granted an automatic extension of six months for filing a return (but not for payment of tax), provided that Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return is properly filed before the normal due date of the return. (Previously, the automatic filing extension was good for four months.) Also, filing extensions may be obtained via telephone or via internet on the IRS website.

If a taxpayer pays part of their tax liability by using a credit card using one of the prescribed IRS service providers, an automatic extension will be granted, and a confirmation of such extension will be provided at the end of the credit card transaction. To obtain more information please visit the www.PAY1040.com internet site. The late payment penalty is usually ½ of 1% of any tax (other than estimated tax) not paid by the filing due date. It is charged for each month or part of a month the tax is unpaid. The maximum penalty is 25%. Filing extensions can be obtained without making tax payments if taxpayers properly estimate their tax liability on the form. If tax is not properly estimated, the extension request will be disallowed, and the late-filing penalty will be assessed. If the amount of tax included with the extension request is less than sufficient to cover the taxpayer's liability, the taxpayer will be charged interest on the overdue amount. The taxpayer is considered to have reasonable cause for the period covered by this automatic extension if at least 90% of the actual tax liability is paid before the regular due date of the return through withholding, estimated tax payments, or payments made with Form 4868. (44)

Review Question 2 Form 4868 - Application for Automatic Extension of Time to File U.S. Individual Income Tax Return will provide the taxpayer with the following:

A. An automatic extension of 6 months to pay the taxes due

B. An automatic extension of 6 months to file the return

C. An automatic extension of 8 months to file the return

D. An automatic extension of 2 months for taxpayers out of the country on April 15th

See Review Feedback for answer.

Amended Returns and Claims for Refund

What should a taxpayer do if he or she has already filed the Federal tax return and then discovers a mistake? The taxpayer

Lesson 2 - Tax Forms

has a chance to fix errors by filing an amended tax return. Here are 10 facts every taxpayer should know about filing an amended tax return:

1. Use Form 1040-X - Amended U.S. Individual Income Tax Return, to file an amended tax return. Generally, the taxpayer must file an amended return on paper. However, he or she can file Form 1040-X electronically with tax filing software to amend 2019 or later Forms 1040 and 1040-SR, and 2021 or later Forms 1040-NR and Forms 1040-SS - U.S. Self-Employment Tax Return (Including the Additional Child Tax Credit for Bona Fide Residents of Puerto Rico) and Forms 1040-PR - Self-Employment Tax Return – Puerto Rico.

2. The taxpayer should consider filing an amended tax return if there is a change in his or her filing status, income, deductions or credits.

3. The taxpayer normally does not need to file an amended return to correct math errors. The IRS will automatically make those changes. Also, do not file an amended return because the taxpayer forgot to attach tax forms, such as W-2s or schedules. The IRS normally will send a request asking for those.

4. Generally, the taxpayer must file Form 1040-X within three years from the date he or she filed the original tax return or within two years of the date he or she paid the tax, whichever is later. Be sure to enter the year of the return the taxpayer is amending at the top of Form 1040-X.

5. If the taxpayer is amending more than one tax return, prepare a 1040-X for each return and mail them to the IRS in separate envelopes. The taxpayer will find the appropriate IRS address to mail the return to in the Form 1040- X instructions.

6. If the taxpayer’s changes involve the need for another schedule or form, he or she must attach that schedule or form to the amended return.

7. If the taxpayer is filing an amended tax return to claim an additional refund, wait until he or she has received the original tax refund before filing Form 1040-X. Amended returns take up to 12 weeks to process. The taxpayer may cash the original refund check while waiting for the additional refund.

8. If the taxpayer owes additional taxes with Form 1040-X, file it and pay the tax as soon as possible to minimize interest and penalties.

9. The taxpayer can track the status of the amended tax return three weeks after it is filed with the IRS’s new tool called, ‘Where’s My Amended Return?’ The automated tool is available on IRS.gov and by phone at 866-464- 2050. The online and phone tools are available in English and Spanish. The taxpayer can track the status of the amended return for the current year and up to three prior years.

10. To use either ‘Where’s My Amended Return’ tool, just enter the taxpayer identification number (usually a Social Security number), date of birth and zip code. If the taxpayer has filed amended returns for more than one year, he or she can select each year individually to check the status of each. If the taxpayer uses the tool by phone, he or she will not need to call a different IRS phone number unless the tool tells him or her to do so.

A taxpayer should correct his or her return if, after it was filed, it is determined that:

➢ The taxpayer did not report some income. ➢ The taxpayer claimed deductions or credits the taxpayer should not have claimed. ➢ The taxpayer did not claim deductions or credits that could have been claimed. ➢ The taxpayer should have claimed a different filing status.

A taxpayer cannot change his or her filing status from married filing jointly to married filing separately after the due date of the original return. An executor may be able to make this change for a deceased spouse.

Form 1040-X

If an individual discovers an error after the return has been filed, he or she may need to amend the return. The IRS may correct errors in math on a return and may accept returns with certain forms or schedules left out. In these instances, do not amend the return. However, do file an amended return if there is a change in filing status, income, deductions, or credits. (33)

File Form 1040-X - Amended U.S. Individual Income Tax Return only after the taxpayer filed the original return. Use Form 1040-X to correct the Form 1040 already filed. On Form 1040-X write the taxpayer’s income, deductions, and credits as originally reported on the return, the changes being made, and the corrected amounts. Then figure the tax on the corrected amount of taxable income and the amount the taxpayer owes or will be refunded.

Do not file more than one original return for the same year, even if the taxpayer has not received the refund or has not heard from the IRS since he or she filed. Filing more than one original return for the same year or sending in more than one copy of the same return (unless requested by the IRS), could delay the refund.

Lesson 2 - Tax Forms

If the taxpayer owes tax, pay the full amount with Form 1040-X. The tax owed will not be subtracted from any amount the taxpayer had credited to his or her estimated tax. If the taxpayer overpaid tax, he or she can have all or part of the overpayment refunded, or the taxpayer can apply all or part of it to his or her estimated tax. If the taxpayer chose to get a refund, it will be sent separately from any refund shown on his/her original return.

File a separate Form 1040-X for each year the taxpayer is amending. Mail each form in a separate envelope. Be sure to enter the year of the return being amended at the top of Form 1040-X. The form has three columns. Column A shows original or adjusted figures from the original return. Column C shows the corrected figures. The difference between Columns A and C is shown in Column B. There is an area on the back of the form to explain the specific changes being made and the reason for each change. Attach any forms or schedules that are affected by the change.

Attach copies of any forms or schedules that are being changed as a result of the amendment, including any Form(s) W-2 received after the original return was filed. A taxpayer can file Form 1040-X electronically with tax filing software to amend Forms 1040 and 1040-SR. Normal processing time for Form 1040-X is 8 to 12 weeks from the IRS receipt date.

Time for Filing a Claim for Refund

Generally, a taxpayer must file a claim for a credit or refund within 3 years after the date the taxpayer filed the original return or within 2 years after the date the taxpayer paid the tax, whichever is later. Returns filed before the due date (without regard to extensions) are considered filed on the due date (even if the due date was a Saturday, Sunday, or legal holiday). If a claim is not filed within this period, the taxpayer may not be entitled to a credit or a refund.

The state tax liability may be affected by a change made on the Federal return. For information on how to correct the state tax return, contact the state tax agency.

Interest and Penalties

The IRS will charge the taxpayer interest on taxes not paid by their due date, even if he or she had an extension of time to file. The IRS will also charge interest on penalties imposed for failure to file, negligence, fraud, substantial valuation misstatements, substantial understatements of tax, and reportable transaction understatements. Interest is charged on the penalty from the due date of the return (including extensions).

If the taxpayer does not pay the additional tax due on Form 1040-X within 21 calendar days from the date of notice and demand for payment (10 business days from that date if the amount of tax is $100,000 or more), the penalty is usually ½ of 1% of the unpaid amount for each month or part of a month the tax is not paid. The penalty can be as much as 25% of the unpaid amount and applies to any unpaid tax on the return. This penalty is in addition to interest charges on late payments. The taxpayer will not have to pay the penalty if he or she can show reasonable cause for not paying the tax on time.

If the taxpayer files a claim for refund or credit in excess of the amount allowable, he or she may have to pay a penalty equal to 20% of the disallowed amount, unless the taxpayer can show a reasonable basis for the way he or she treated an item. The penalty will not be figured on any part of the disallowed amount of the claim that relates to the Earned Income Tax Credit or on which accuracy-related or fraud penalties are charged.

In addition to any other penalties, the law imposes a penalty of $5,000 for filing a frivolous return. A frivolous return is one that does not contain information needed to figure the correct tax or shows a substantially incorrect tax because the taxpayer takes a frivolous position or desire to delay or interfere with the tax laws. This includes altering or striking out the preprinted language above the space where the taxpayer signs. (45)

Review Question 3 If a taxpayer does not pay the additional tax due on Form 1040-X within how many calendar days from the date of notice and demand for payment, the penalty is usually ½ of 1% of the unpaid amount for each month or part of a month the tax is not paid?

A. 14 days B. 20 days C. 21 days D. 30 days

See Review Feedback for answer.

Lesson 2 - Tax Forms

Form 1040-X Line Instructions

If the taxpayer has questions such as “what income is taxable” or “what expenses are deductible”, the instructions for the form from the year being amended should help. Also use those instructions to find the method to figure the correct tax. Be sure to use tax laws from the year the original tax was filed. If the taxpayer is not changing any dollar amounts originally reported, but is sending in only additional information, do the following: (45)

1. Check the box for the calendar year or enter the other calendar or fiscal year being amended. 2. Complete name, address, and SSN. 3. Check a box in Part II, if applicable, for the Presidential Election Campaign Fund. 4. Complete Part III, Explanation of changes.

If the taxpayer and his or her spouse are changing from separate returns to a joint return, follow these steps: (45)

1. Enter in column A the amounts from the return as originally filed or as previously adjusted (either by the taxpayer or the IRS).

2. To determine the amounts to enter in column B, combine the amounts from the spouse’s return as originally filed or as previously adjusted with any other changes. If the spouse did not file an original return, include the spouse’s income, deductions, credits, other taxes, etc., in the amounts entered in column B.

3. Read the instructions for column C to figure the amounts to enter in that column. 4. Both must sign and date Form 1040-X.

If the taxpayer is changing amounts on the original return or as previously adjusted by the IRS, follow the rules below:

1. Always complete the top of page 1 through Amended return filing status. 2. Complete the lines according to what the taxpayer is changing. 3. Check a box in Part II, if applicable, for the Presidential Election Campaign Fund. 4. Complete Part III, Explanation of changes. 5. Sign and date the form.

Columns A Through C

Column A. Enter the amounts from the original return. However, if the taxpayer previously amended that return or it was changed by the IRS, enter the adjusted amounts. Column B. Enter the net increase or decrease for each line the taxpayer is changing. Explain each change in Part III. If more space is needed, attach a statement. Attach any schedule or form relating to the change. For example, attach Schedule A (Form 1040) if amending Form 1040 to itemize deductions. If the taxpayer is amending the return because he or she received another Form W-2, attach a copy of the new W-2. Do not attach items unless required to do so. Column C. To figure the amounts to enter in this column, the taxpayer should:

➢ Add the increase in column B to the amount in column A. ➢ Subtract the decrease in column B from the amount in column A.

For any item not changed, enter the amount from column A in column C. Show any negative numbers (losses or decreases) in Columns A, B, or C in parentheses. Line 1 - Adjusted Gross Income The taxpayer enters adjusted gross income (AGI), which is the total of income minus certain deductions (adjustments). Any change to the income or adjustments on the return being amended will be reflected on this line. A change made to AGI can cause other amounts to increase or decrease. For example, changing AGI can change:

➢ Miscellaneous itemized deductions, credit for child and dependent care expenses, child tax credit, education credits, retirement savings contributions credit, or making work pay credit.

➢ Allowable charitable contributions deduction or the taxable amount of Social Security benefits. Line 2 - Itemized Deductions or Standard Deduction If the taxpayer itemized deductions, enter in column A the total from the original Schedule A (Form 1040) or the deduction as

Lesson 2 - Tax Forms

previously adjusted by the IRS. If the taxpayer is now itemizing deductions instead of using the standard deduction, or has changed the amount of any deduction, attach a copy of the corrected Schedule A to this amended return. If the taxpayer is using the standard deduction, enter the amount for the filing status for the year being amended. Remember that the standard deduction for all years can be increased for the age and/or blindness of the taxpayer(s). See the form instructions for the year being amended. Line 4a - Exemptions The taxpayer must complete the Exemptions section on page 2 of Form 1040-X if:

➢ He or she is increasing or decreasing the number of dependents claimed. ➢ He or she is claiming a personal exemption for him or herself or his or her spouse that was not previously claimed. ➢ He or she is eliminating a personal exemption for him or herself or his or her spouse previously claimed but was

not entitled to claim. ➢ If any of these situations apply to the taxpayer, complete Form 1040-X, lines 24 through 30.

Line 4b - Qualified business income deduction Line 5 - Taxable Income If the taxable income on the return the taxpayer is amending is $0 and he or she has made changes on Form 1040-X, line 1, 2, or 4, enter on line 5, column A, the actual taxable income instead of $0. Enclose a negative amount in parentheses. Line 6 - Tax Figure the tax on the taxable income shown on line 5, column C. Generally, the taxpayer will use the tax table or other method he or she used to figure the tax on the original return. However, the taxpayer may need to change to a different method if, for example, he or she amends the return to include or changes the amount of certain types of income, such as capital gains or qualified dividends. Line 7 - Credits The taxpayer enters the total nonrefundable credits in column A. Nonrefundable credits are those that reduce the tax, but any excess is not refunded. If the taxpayer made any changes to Form 1040-X, lines 1 through 6, be sure to refigure the original credits. Attach the appropriate forms for the credits he or she is adding or changing. Line 9 - Health Care: Individual Responsibility If the taxpayer made any changes to Form 1040-X lines 1 through 5, he or she may need to refigure his or her individual shared responsibility payment. Line 10 - Other Taxes The taxpayer enters other taxes paid in column A. Line 12 - Withholding In column A, enter from the return the taxpayer is amending any Federal income tax withheld and any excess Social Security and tier 1 RRTA tax withheld (SS/RRTA). If he or she is changing the withholding or excess SS/RRTA, attach to the front of Form 1040-X a copy of all additional or corrected Forms W-2 received after the original return was filed. Also attach additional or corrected Forms 1099-R that showed any Federal income tax withheld. Line 13 - Estimated Tax Payments In column A, enter the estimated tax payments claimed on the original return. If the taxpayer filed Form 1040-C - U.S. Departing Alien Income Tax Return, include on this line the amount paid as the balance due with that return. Also include any of prior year's overpayment that the taxpayer elected to apply to estimated tax payments for the year being amended. Line 14 - Earned Income Tax Credit (EITC) If the taxpayer is amending the return to claim the EITC and he or she has a qualifying child, attach Schedule EITC (Form 1040). If the taxpayer is amending the EITC based on a nontaxable combat pay election, enter “nontaxable combat pay” and the amount in Part III of Form 1040-X. Line 15 - Refundable Credits A refundable credit can give the taxpayer a refund for any part of a credit that is more than the total tax. If the taxpayer is

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amending the return to claim or change a refundable credit, attach the appropriate schedule(s) or form(s). In addition, specify any credit not listed in the blank area after “other (specify):” and include this amount in the line 15 total. Line 16 - Amount Paid With Extension or Tax Return On this line, the taxpayer enters the total of the following amounts:

➢ Any amount paid with the taxpayer’s request for an extension on Form 4868 or 2350. Also include any amount paid with a credit or debit card or the Electronic Federal Tax Payment System (EFTPS) used to get an extension of time to file, but do not include the convenience fee charged. Also include any amount paid by electronic funds withdrawal.

➢ The amount of the check or money order the taxpayer sent with the original return, the amount paid with a credit or debit card or the EFTPS, or by electronic funds withdrawal. Also include any additional payments made after it was filed. However, do not include payments of interest or penalties, or the convenience fee charged for paying with a credit or debit card.

Line 17 - Total Payments The taxpayer includes in the total on this line any payments shown on Form 8689 - Allocation of Individual Income Tax to the U.S. Virgin Islands, lines 40 and 45. Enter “USVI” and the amount on the dotted line to the left of line 17. Line 18 - Overpayment The taxpayer enters the overpayment from the original return. If the original return was changed by the IRS and the result was an additional overpayment of tax, also include that amount on line 18. Do not include interest received on any refund. Any additional refund the taxpayer is entitled to on Form 1040-X will be sent separately from any refund not yet received from the original return. Line 19 - Amount Available To Pay Additional Tax If line 18 is larger than line 17, line 19 will be negative. The taxpayer will owe additional tax. To figure the amount owed, treat the amount on line 19 as positive and add it to the amount on line 11. Enter the result on line 20. Line 20 - Amount Taxpayer Owes The taxpayer can pay online or by phone, mobile device, cash (maximum $1,000 per day and per transaction), check, or money order. Line 22 - Overpayment Received as Refund

If the IRS does not use the overpayment to pay past due Federal or state debts, the refund amount on line 22 will be sent separately from any refund claimed on the original return. The IRS will figure any interest and include it in the refund. The taxpayer will receive a check for any refund due. A refund on an amended return cannot be deposited directly to his or her bank account.

Line 23 - Overpayment Applied to Estimated Tax Enter on line 23 the amount, if any, from line 21 the taxpayer wants applied to estimated tax for next year. Also, enter that tax year in the box indicated. No interest will be paid on this amount. The taxpayer will be notified if any of the overpayment was used to pay past due Federal or state debts so that he or she will know how much was applied to estimated tax. Part I - Exemptions If the taxpayer is changing the number of exemptions claimed on the return, he or she should complete lines 24 through 29, and line 30, if necessary. He or she enters the new exemption amount on line 29 and line 4, column C. Line 29 - Exemption Amount To figure the amount to enter on line 29, the taxpayer may need to use the Deduction for Exemptions Worksheet in the Form 1040 instructions for the year being amended. Line 30 - Dependents The taxpayer lists all dependents claimed on this amended return. This includes:

➢ Dependents claimed on the original return who are still being claimed on this return. ➢ Dependents not claimed on the original return who are being added to this return.

If the taxpayer is now claiming more than four dependents, attach a separate statement with the required information.

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Part II - Presidential Election Campaign Fund The taxpayer can use Form 1040-X to have $3 go to the Presidential Election Campaign Fund if he or she (or his or her spouse on a joint return) did not do so on the original return. This must be done within 20½ months after the original due date for filing the return. For calendar year 2023, this period ends on January 2, 2026. A previous designation of $3 to the fund cannot be changed. Part III - Explanation of Changes The IRS needs to know why the taxpayer is filing Form 1040-X. For example:

➢ Received another Form W-2 after the taxpayer filed the original return. ➢ Forgot to claim the child tax credit. ➢ Changed filing status from surviving spouse to head of household. ➢ Are carrying an unused NOL or credit to an earlier year.

Review Question 4 The taxpayer can use Form 1040-X to have what amount go to the Presidential Election Campaign Fund if he or she did not do so on the original return?

A. $3 B. $5 C. $7 D. The taxpayer cannot use Form 1040-X to specify that money goes to the Presidential Election

Campaign Fund

See Review Feedback for answer.

Assembling the Return

Assemble any schedules and forms behind Form 1040-X in order of the “Attachment Sequence No.” shown in the upper right corner of the schedule or form. If the taxpayer has supporting statements, arrange them in the same order as the schedules or forms they support and attach them last. Do not attach correspondence or other items unless required to do so, including a copy of the original return. Attach to the front of Form 1040-X:

➢ A copy of any Forms W-2, W-2c (a corrected Form W-2), and 2439 that support changes made on this return. ➢ A copy of any Form W-2G and 1099-R that support changes made on this return, but only if tax was withheld. ➢ A copy of any Forms 1042S, SSA-1042S, RRB-1042S and 8288-A that support changes made on this return.

Attach to the back of Form 1040-X any Form 8805 that supports changes made on this return. If the taxpayer owes tax, enclose (do not attach) the check or money order in the envelope with the amended return.

Reduced Refund

was paid due to fraud or for contributions due to a state fund that were not paid due to fraud).

State Tax Liability

If a taxpayer’s return is changed for any reason, it may affect his or her state income tax liability. This includes changes made as a result of an examination of the taxpayer’s return by the IRS. (33)

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Superseding Tax Return

A superseding return is a return filed subsequent to the originally filed return and filed within the filing period (including extensions). A superseding return must be a complete XML filing of the entire return, with all required forms, schedules, and attachments (XML or PDF, if applicable). A taxpayer filing a superseding return must indicate the return is such by selecting the Superseded Return checkbox (designation) in the software, or the return will be rejected as a duplicate filing. An amended return is a return filed subsequent to the originally filed or superseding return and filed after the expiration of the filing period (including extensions). Superseding returns are defined and discussed in IRM 21.6.7.4.10.

Form W-4 - Employee's Withholding Certificate The Form W-4 design reduces the form’s complexity and increases the transparency and accuracy of the withholding system. While it uses the same underlying information as the old design, it replaces complicated worksheets with more straightforward questions that make accurate withholding easier for employees. To provide maximum accuracy, the taxpayer is encouraged to use the Tax Withholding Estimator available at www.irs.gov/W4app. An employed taxpayer must complete a Form W-4 - Employee's Withholding Certificate. Form W-4 tells an employer whether taxpayer is married or has multiple jobs, whether the taxpayer can claim tax credits such as the Child Tax Credit or the Credit for Other Dependents, and any other adjustments such as an additional amount to use when the employer deducts Federal income tax from the employee's pay. If an employee fails to give the employer a properly completed Form W-4, the employer must withhold Federal income taxes from his or her wages as if he or she were single and claiming no tax credits. Also, employees who have submitted Form W-4 in any year before 2020 are not required to submit a new form merely because of the redesign. Employers will continue to compute withholding based on the information from the employee’s most recently submitted Form W-4. (47)

Allowances are no longer used for the redesigned Form W-4 to increase transparency, simplicity, and accuracy. In the past, the value of a withholding allowance was tied to the amount of the personal exemption. Due to changes in law, currently the taxpayer cannot claim personal exemptions or dependency exemptions.

A revised Form W-4 from an employee must be put it into effect no later than the start of the first payroll period ending on or after the 30th day from the date the revised Form W-4 was received. An exception is made when the taxpayer receives a notice (commonly referred to as a lock-in-letter) from the IRS specifying the withholding rate. The employer must then honor the lock-in letter. (47)

The redesigned Form W-4 makes it easier for the taxpayer to have his or her withholding match his or her tax liability. But some taxpayers may prefer to have more of their money withheld from their paychecks throughout the year and then get that money back as a refund when they file their tax returns. The simplest way to increase the taxpayer’s withholding is to enter on line 4c the additional amount he or she would like his or her employer to withhold from each paycheck after his or her Form W-4 takes effect. The taxpayer can also check the box in Step 2(c) to have an additional amount withheld for reasons other than multiple jobs. (48) The taxpayer should increase his or her withholding if:

➢ He or she holds more than one job at a time or he or she and his or her spouse both have jobs (Step 2). ➢ He or she has income from sources other than jobs that is not subject to withholding (line 4a).

If the taxpayer does not make these adjustments, he or she will likely owe additional tax when filing his or her tax return, and he or she may owe interest and penalties. With regard to income from other sources, the taxpayer can pay estimated tax instead of having extra withholding.

The taxpayer is more likely to need to increase his or her withholding if he or she has more than one job or if he or she is married filing jointly and his or her spouse also works. If the taxpayer chooses the option in Step 2(b) on Form W-4, he or she completes the Multiple Jobs Worksheet (which calculates the total extra tax for all jobs) on only ONE Form W-4. Withholding will be most accurate if the taxpayer completes the worksheet and enters the result on the Form W-4 for the highest paying job. If more than one job has annual wages of more than $120,000 or there are more than three jobs, the

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taxpayer should see Publication 505 for additional tables; or, he or she can use the online withholding estimator at www.irs.gov/W4App. If the taxpayer is eligible for income tax credits such as the Child Tax Credit or Credit for Other Dependents, and/or he or she is eligible for deductions (other than the standard deduction), he or she can follow the instructions described in lines 3 and 4b to decrease his or her withholdings by the appropriate amount.

If the taxpayer has self-employment income, he or she will generally owe both income tax and self-employment tax. Form W-4 is primarily intended to be used by employees who are not subject to self-employment tax. Thus, like the old Form W-4, the redesigned Form W-4 does not compute self-employment tax.

The taxpayer is not required to have tax on non-wage income withheld from his or her paycheck. Instead, he or she can pay estimated tax on this income using Form 1040-ES - Estimated Tax for Individuals. However, if the taxpayer wants to use Form W-4 to have tax for this income withheld from his or her paycheck, he or she has two options:

➢ The taxpayer can report the income on line 4a. If he or she does not want to report this income directly on line 4a, he or she can use the Tax Withholding Estimator at www.irs.gov/W4app. The estimator will help the taxpayer calculate the additional amount of tax that should be withheld from his or her paycheck. The taxpayer will then enter that amount on line 4c, without reporting the income to his or her employer.

➢ The taxpayer can also check the box in Step 2(c) to have an additional amount withheld for reasons other than multiple jobs. If he or she expects to have dividend or capital gain income, his or her withholding will be more accurate if he or she has the estimator compute the withholding adjustment rather than reporting this income on line 4a.

Review Question 5 Which form tells an employer the marital status and any additional amount to use when the employer deducts Federal income tax from the employee's pay?

A. Form W-2 B. Form W-4 C. Form 1040 D. Form 1040-X

See Review Feedback for answer.

Exemption from Withholding

The taxpayer may claim exemption from withholding for 2023 if he or she meet both of the following conditions: (47)

1. He or she had no Federal income tax liability in 2022, and 2. He or she expects to have no Federal income tax liability in 2023.

The taxpayer had no Federal income tax liability in 2022 if (1) his or her total tax on line 24 on his or her 2022 Form 1040 or 1040-SR is zero (or less than the sum of lines 27, 28, 29, and 30), or (2) he or she was not required to file a return because his or her income was below the filing threshold for his or her correct filing status. If the taxpayer claims exemption, he or she will have no income tax withheld from his or her paycheck and may owe taxes and penalties when he or she files his or her 2023 tax return. To claim exemption from withholding, the taxpayer certifies that he or she meets both of the conditions above by writing “Exempt” on Form W-4 in the space below Step 4(c). Then, he or she completes Steps 1(a), 1(b), and 5. The taxpayer does not complete any other steps. The taxpayer will need to submit a new Form W-4 by February 15, 2024. If the taxpayer is a student, he or she is not automatically exempt. If the taxpayer works only part-time or during the summer, he or she may qualify for exemption from withholding. If another person can claim the employed taxpayer as a dependent on his or her tax return, the employee cannot claim exemption from withholding if his or her income exceeds $1,250 and includes more than $400 of unearned income (for example, interest and dividends) in 2023. An exemption is good for only 1 year. The taxpayer must give his or her employer a new Form W-4 by February 15 each year to continue the exemption. If the taxpayer claims exemption, but later his or her situation changes so that he or she

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will have to pay income tax after all, the taxpayer must file a new Form W-4 within 10 days after the change. If he or she claims exemption in 2023 but he or she expects to owe income tax for 2023, he or she must file a new Form W-4 by December 1, 2023. (49)

Basic Form W-4 Instructions

The taxpayer completes Form W-4 so that his or her employer can withhold the correct Federal income tax from his or her pay. If the employee is not exempt, he or she may complete the Multiple Jobs and Deductions worksheets. The worksheets adjust the withholding amount based on two-earners/multiple jobs situations, certain credits, adjustments to income or itemized deductions. Complete all worksheets that apply. When completing Step 1(c) the taxpayer should check his or her anticipated filing status. This will determine the standard deduction and tax rates used to compute his or her withholding. The taxpayer should use Step 2 if he or she has more than one job at the same time or he or she is married filing jointly and the taxpayer and his or her spouse both work. The taxpayer should consider checking the box in Step 2 if there are only two jobs in the household. The standard deduction and tax brackets will be divided equally between the two jobs. Step 3 of Form W-4 provides instruction for determining the amount of the Child Tax Credit and the Credit for Other Dependents that the taxpayer may be able to claim when he or she files his or her tax return. The taxpayer can also include other tax credits in this step, such as education tax credits and the foreign tax credit. To do so, he or she adds an estimate of the amount for the year to his or her credits for dependents and enters the total amount in Step 3. Including these credits will increase the taxpayer’s paycheck and reduce the amount of any refund he or she may receive when he or she files his or her tax return. Step 4 is optional. In Step 4(a), the taxpayer should enter the total of his or her other estimated income for the year, if any. The taxpayer should not include income from any jobs. If he or she completes Step 4(a), he or she likely will not have to make estimated tax payments for that income. If the taxpayer prefers to pay estimated tax rather than having tax on other income withheld from his or her paycheck, he or she should see Form 1040- ES - Estimated Tax for Individuals. In Step 4(b), the taxpayer should enter the amount from the Deductions Worksheet, line 5, if he or she expects to claim deductions other than the basic standard deduction on his or her 2023 tax return and wants to reduce his or her withholding to account for these deductions. This includes both itemized deductions and other deductions such as for student loan interest and IRAs. In Step 4(c), The taxpayer should enter any additional tax he or she wants withheld from his or her pay each pay period, including any amounts from the Multiple Jobs Worksheet, line 4. Entering an amount here will reduce the taxpayer’s paycheck and will either increase his or her refund or reduce any amount of tax that he or she owes. (50)

Invalid Forms W-4

Any unauthorized change or addition to Form W-4 makes it invalid. This includes taking out any language by which the employee certifies that the form is correct. A Form W-4 is also invalid if, by the date an employee gives it to the employer, he or she indicates in any way that it is false. An employee who submits a false Form W-4 may be subject to a $500 penalty. When the employer gets an invalid Form W-4, they do not use it to figure Federal income tax withholding. The employer tells the employee that it is invalid and asks for another one. If the employee does not give the employer a valid one, withhold taxes as if the employee was single and claiming no tax credits. However, if the employer has an earlier Form W-4 for this worker that is valid, they withhold as before. (51)

Nonwage Income

If the employee has a large amount of nonwage income, such as interest or dividends, consider making estimated tax payments using Form 1040-ES - Estimated Tax for Individuals. Otherwise, the employee may owe additional tax. If he or she has pension or annuity income, see Publication 505 - Tax Withholding and Estimated Tax to find out if the employee should adjust the withholding on Form W-4 or W-4P.

Verify Withholding

The IRS encourages taxpayers to use the Tax Withholding Estimator to perform a “paycheck checkup.” This will help him

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or her make sure he or she has the right amount of tax withheld from his or her paycheck. Checking the taxpayer’s withholding can help protect against having too little tax withheld and facing an unexpected tax bill or penalty at tax time next year. At the same time, the taxpayer may prefer to have less tax withheld up front, so he or she receives more in his or her paychecks and get a smaller refund at tax time. If the taxpayer changed his or her withholding for 2023, the IRS reminds him or her to be sure to recheck his or her withholding at the start of 2024. A mid-year withholding change in 2023 may have a different full-year impact in 2024. So, if the taxpayer does not file a new Form W-4 for 2024, his or her withholding might be higher or lower than he or she intends. Also, if the taxpayer had a major life change, such as marriage, the birth of a child, adoption or bought a home, he or she should use the results from the Tax Withholding Estimator to help him or her complete a new Form W-4 - Employee's Withholding Certificate and submit the completed Form W-4 to his or her employer as soon as possible. (52)

Backup Withholding

Banks or other businesses that pay certain kinds of income must file an information return Form 1099 with the IRS. The information return shows how much an individual was paid during the year. It also includes his or her name and taxpayer identification number (TIN). These payments generally are not subject to withholding. However, "backup" withholding is required in certain situations. Backup withholding can apply to most kinds of payments that are reported on Form 1099 including: (53)

➢ Interest payments (Form 1099-INT). ➢ Dividends (Form 1099-DIV). ➢ Patronage dividends, but only if at least half of the payment is in money (Form 1099-PATR). ➢ Rents, profits, or other gains (Form 1099-MISC). ➢ Commissions, fees, or other payments for work the taxpayer does as an independent contractor (Form 1099-

MISC). ➢ Payments by brokers/barter exchanges (Form 1099-B). ➢ Payments by fishing boat operators, but only the part that is in money and that represents a share of the proceeds

of the catch (Form 1099-MISC). ➢ Royalty payments (Form 1099-MISC). ➢ Gambling winnings (Form W-2G) may also be subject to backup withholding. ➢ Original issue discount reportable on (Form 1099-OID), Original Issue Discount, if the payment is in cash. ➢ Certain Government Payments, Form 1099-G.

Backup withholding also may apply to gambling winnings (Form W-2G), unless they are subject to regular gambling withholding.

When the taxpayer opens a new account, makes an investment, or begins to receive payments reportable on Form 1099, he or she must furnish his or her TIN to the bank or other business. In some cases, the taxpayer must furnish the TIN in writing and certify under penalties of perjury that it is correct. The bank or business will give the taxpayer Form W-9 - Request for Taxpayer Identification Number and Certification or a similar form. The taxpayer must enter the TIN on the form and, if the account or investment will earn interest or dividends, he or she also must certify that they are not subject to backup withholding due to previous underreporting of interest and dividends. The payer must withhold at a flat 24% rate in the following situations: (53)

➢ The taxpayer does not give the payer the TIN in the required manner. ➢ The IRS notifies the payer that the TIN the taxpayer gave is incorrect. ➢ The IRS notifies the payer to start withholding on interest or dividends because the taxpayer underreported interest

or dividends on the income tax return. The IRS will do this only after it has mailed the taxpayer four notices over at least a 120-day period.

➢ The taxpayer fails to certify that he or she is not subject to backup withholding for underreporting of interest and dividends.

If the taxpayer receives a “B” notice from a payer, notifying him or her that the TIN given is incorrect, the taxpayer usually can prevent backup withholding from starting, or stop backup withholding once it has begun, by giving the payer the correct name and TIN. The taxpayer must certify that the TIN given is correct. If the taxpayer receives a second “B” notice from that payer, he or she will need to provide the payer with verification of the TIN from the Social Security Administration or the IRS.

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If the taxpayer has been notified that he or she underreported interest or dividends, the taxpayer must request and receive a determination from the IRS to prevent backup withholding from starting or to stop backup withholding once it has begun. If income tax has been withheld under the backup withholding rule, the taxpayer takes credit for it on the tax return for the year in which he or she received the income.

Gambling Withholding

There are two types of withholding on gambling winnings: regular gambling withholding at 24% (31.58% for certain noncash payments) and backup withholding which is also at 24%. If a payment is already subject to regular gambling withholding, it is not subject to backup withholding.

Regular Gambling Withholding

A gambling business may be required to withhold 24% of gambling winnings for Federal income tax. This is referred to as regular gambling withholding. Withhold at the 24% rate if the winnings minus the wager are more than $5,000 and are from:

➢ Sweepstakes. ➢ Wagering pools. ➢ Lotteries. ➢ Other wagering transactions if the winnings are at least 300 times the amount wagered.

Do not withhold at the 24% rate on winnings from bingo, keno, slot machines, or any other wagering transaction if the winnings are $5,000 or less. Regular gambling withholding is figured on the total amount of gross proceeds (the amount of winnings minus the amount wagered), not merely on the amount in excess of $5,000. The business reports the amount withheld in box 4 of Form W-2G. A noncash payment, such as a car, must be taken into account at its fair market value (FMV) for purposes of reporting and withholding. If the FMV exceeds $5,000, after deducting the price of the wager, the winnings are subject to 24% regular gambling withholding. The tax the business must withhold is computed and paid under either of the following two methods:

1. The winner pays the withholding tax to the payer. In this case, the withholding is 24% of the FMV of the noncash payment minus the amount of the wager.

2. The gambling business pays the withholding tax. In this case, the withholding is 31.58% of the FMV of the noncash payment minus the amount of the wager.

If the business uses method 2, enter the sum of the noncash payment and the withholding tax in box 1 of Form W-2G and the withholding tax paid by the payer in box 4.

Backup Gambling Withholding

A gambling business may be required to withhold 24% of gambling winnings (including winnings from bingo, keno, slot machines, and poker tournaments) for Federal income tax. This is referred to as backup withholding. The business should backup withhold if:

➢ The winner does not furnish a correct taxpayer identification number (TIN). ➢ 24% has not been withheld. ➢ The winnings are at least $600 and at least 300 times the wager (or the winnings are at least $1,200 from bingo

or slot machines or $1,500 from keno or more than $5,000 from a poker tournament). Figure any backup withholding on the total amount of the winnings reduced, at the option of the payer, by the amount wagered. This means the total amount, not just the payments in excess of $600, $1,200, $1,500, or $5,000, is subject to backup withholding. Report the amount withheld in box 4 of Form W-2G. Use Form W-9 - Request for Taxpayer Identification Number and Certification to request the TIN of the recipient.

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Tip Withholding

Employees, who receive cash tips of $20 or more in a calendar month while working, are required to report to their employer the total amount of tips they receive. Service charges added to a bill or fixed by the employer that the customer must pay, when paid to an employee, will not constitute a tip but rather constitute non-tip wages. These non-tip wages are subject to Social Security tax, Medicare tax, and Federal income tax withholding. Employers must collect the employee's portion of the Social Security and Medicare taxes and the Federal income taxes. As of January of 2013, the Additional Medicare Tax applies to an individual’s Medicare wages that exceed a threshold amount based on the taxpayer’s filing status.

Pensions and Annuity Withholding

Generally, pension and annuity payments are subject to Federal income tax withholding. The withholding rules apply to the taxable part of payments from an employer pension annuity, profit-sharing, stock bonus, or another deferred compensation plan. The rules also apply to payments from an individual retirement arrangement (IRA), an annuity, endowment, or life insurance contract issued by a life insurance company. There is no withholding on any part of a distribution that is not expected to be includible in the recipient's gross income. Generally, periodic payments are pension or annuity payments made for more than 1 year that are not eligible rollover distributions. Periodic payments include substantially equal payments made at least once a year over the life of the employee and/or beneficiaries or for 10 years or more. For wage withholding purposes, these payments are treated as if they are wages. The taxpayer can figure withholding by using the recipient's Form W-4P - Withholding Certificate for Pension or Annuity Payments. Unless the taxpayer chooses no withholding, the withholding rate for a non-periodic distribution (a payment other than a periodic payment) that is not an eligible rollover distribution, is 10% of the distribution. He or she can also ask the payer to withhold an additional amount using Form W-4P. The part of any loan treated as a distribution (except an offset amount to repay the loan), is subject to withholding under this rule.

Review Question 6 Generally, pension and annuity payments are subject to Federal income tax withholding. The withholding rules apply to the taxable part of payments from which of the following except:

A. Employer pension annuity B. Profit-sharing C. Stock bonus D. A distribution that is not expected to be includible in the recipient's gross income

See Review Feedback for answer.

Fringe Benefit Exclusion

A fringe benefit is a form of pay for the performance of services. For example, the employer provides an employee with a fringe benefit when they allow the employee to use a business vehicle to commute to and from work. Some excluded fringe benefits are not subject to Federal income tax withholding. Also, in most cases, they are not subject to Social Security, Medicare, or Federal unemployment (FUTA) tax and are not reported on Form W-2. There are exclusion rules for the following fringe benefits: (54)

➢ Accident and health benefits. ➢ Achievement awards. ➢ Adoption assistance. ➢ Athletic facilities. ➢ De minimis (minimal) benefits. ➢ Dependent care assistance. ➢ Educational assistance. ➢ Employee discounts. ➢ Employee stock options.

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➢ Employer-provided cell phones. ➢ Group-term life insurance coverage. ➢ Health savings accounts (HSAs). ➢ Lodging on the business premises. ➢ Meals. ➢ No-additional-cost services. ➢ Retirement planning services. ➢ Transportation (commuting) benefits. ➢ Tuition reduction. ➢ Working condition benefits.

Form W-2 - Wage and Tax Statement Every employer engaged in a trade or business who pays remuneration, including noncash payments of $600 or more for the year (all amounts if any income, Social Security, or Medicare tax was withheld) for services performed by an employee must file a Form W-2 - Wage and Tax Statement for each employee (even if the employee is related to the employer) from whom any of the following applies: (55)

➢ The employer withheld any income, social security, or Medicare tax from wages regardless of the amount of wages; or

➢ The employer would have had to withhold income tax if the employee had claimed no more than one withholding allowance or had not claimed exemption from withholding on Form W-4; or

➢ The employer paid $600 or more in wages even if they did not withhold any income, social security, or Medicare tax.

Only in very limited situations will the employer not have to file Form W-2. This may occur if the taxpayer was not required to withhold any income tax, social security tax, or Medicare tax and they paid the employee less than $600, such as for certain election workers and certain foreign agricultural workers.

Review Question 7 If Medicare tax was withheld, an employer engaged in a trade or business who pays remuneration of what amount or more for the year for services performed by an employee must file a Form W-2 - Wage and Tax Statement?

A. $500 B. $600 C. $700 D. All amounts

See Review Feedback for answer.

An employer must e-file if he or she is required to file 250 or more Forms W-2 or W-2c. If the employer is required to e-file but fails to do so, he or she may incur a penalty. An employer can request a waiver from this requirement by filing Form 8508 - Request for Waiver From Filing Information Returns Electronically. Submit Form 8508 to the IRS at least 45 days before the due date of Form W-2, or 45 days before filing the first Form W-2c.

Extensions of time to file Form W-2 with the Social Security Administration (SSA) are no longer automatic. An employer may request one 30-day extension to file Form W-2 by submitting a complete application on Form 8809 - Application for Extension of Time to File Information Returns including a detailed explanation of why the employer needs additional time and signed under penalties of perjury. The IRS will only grant the extension in extraordinary circumstances or catastrophe. The due date for filing 2023 Forms W-2, W-2AS, W-2CM, W-2GU, W-2VI, W-3, and W-3SS with the SSA is January 31, 2024, whether the employer files using paper forms or electronically. If an individual has not received a W-2, follow these four steps: (56)

1. If the individual has not received a W-2, contact his or her employer to inquire if and when the W-2 was mailed. If it was mailed, it may have been returned to the employer because of an incorrect or incomplete address. After contacting the employer, allow a reasonable amount of time for them to resend or issue the W-2.

Lesson 2 - Tax Forms

2. If the individual does not receive a W-2 by February 14, contact the IRS for assistance at 800-829-1040. Provide the individual’s name, address, Social Security number, phone number and have the following information:

a. Employer’s name, address, and phone number. b. Dates of employment. c. An estimate of the wages the individual earned, the Federal income tax withheld, and when he or she

worked for that employer during 2023. The estimate should be based on year-to-date information from the final pay stub or leave-and-earnings statement, if possible.

3. The individual still must file a tax return or request an extension to file by April 15, 2024, even if he or she does not receive a Form W-2. If the taxpayer has not received a Form W-2 in time to file the return by the due date, and have completed steps 1 and 2, he or she may use Form 4852 - Substitute for Form W-2, Wage and Tax Statement. Attach Form 4852 to the return, estimating income and withholding taxes as accurately as possible. There may be a delay in any refund due while the information is verified.

4. The individual may receive the missing W-2 after filing the return using Form 4852, and discover the information is different from what he or she reported on the return. If this happens, the taxpayer must amend the return by filing a Form 1040-X - Amended U.S. Individual Income Tax Return.

Form Not Correct

If the taxpayer receives a form with incorrect information, he or she should ask the payer for a corrected form. Call the telephone number or write to the address given for the payer on the form. The corrected Form W-2G or Form 1099 he or she receives will have an “X” in the “CORRECTED” box at the top of the form. A special Form W-2C - Corrected Wage and Tax Statement is used to correct a Form W-2. In certain situations, the taxpayer will receive two forms in place of the original incorrect form. This will happen when his or her taxpayer identification number is wrong or missing, his or her name and address are wrong, or he or she received the wrong type of form (for example, a Form 1099-DIV instead of a Form 1099-INT). One new form the taxpayer receives will be the same incorrect form or have the same incorrect information, but all money amounts will be zero. This form will have an “X” in the “CORRECTED” box at the top of the form. The second new form should have all the correct information, prepared as though it is the original (the “CORRECTED” box will not be checked).

If the taxpayer’s attempts to have an incorrect Form W-2 corrected by his or her employer are unsuccessful and it is after February 14, the taxpayer can request that an IRS representative initiate a Form W-2 complaint. The taxpayer may call the IRS toll free at 800-829-1040 or visit an IRS Taxpayer Assistance Center (TAC) in person. A letter will be sent to the employer requesting that they furnish a corrected Form W-2 to the taxpayer within ten days. The letter advises the employer of their responsibilities to provide a correct Form W-2 and of the penalties for failure to do so.

The taxpayer will be sent a letter that provides instructions and Form 4852 - Substitute for Form W-2, Wage and Tax Statement or Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The Form 4852 may be used in the event that the employer does not provide the taxpayer with the corrected Form W-2 in time to file his or her tax return. If the taxpayer files his or her return and attaches Form 4852 to support the withholding amount claimed instead of a Form W-2, the taxpayer’s refund can be delayed while the information he or she supplies the IRS is verified.

If the taxpayer receives a corrected Form W-2 after he or she file his or her return and it does not agree with the income or withheld tax the taxpayer reported on his or her return, he or she should file an amended return on Form 1040-X - Amended U.S. Individual Income Tax Return.

Review Question 8 If the taxpayer’s attempts to have an incorrect Form W-2 corrected by his or her employer are unsuccessful and it is after February 14, the taxpayer can request that an IRS representative initiate a Form W-2 complaint. When the complaint is initiated a letter will be sent by the IRS to the employer requesting that they furnish a corrected Form W-2 to the taxpayer within how many days?

A. 10 days B. 14 days C. 21 days D. 30 days

See Review Feedback for answer.

Lesson 2 - Tax Forms

Fiscal Years

If the taxpayer files his or her tax return on the basis of a fiscal year (a 12-month period ending on the last day of any month except December), he or she must follow special rules to determine his or her credit for Federal income tax withholding. For fiscal year withholding, the taxpayer can claim credit on his or her tax return only for the tax withheld during the calendar year ending within his or her fiscal year. The taxpayer cannot claim credit for any of the tax withheld during the calendar year beginning in his or her fiscal year. The taxpayer will be able to claim credit for that withholding on his or her return for his or her next fiscal year. The Form W-2 or 1099 the taxpayer receives for the calendar year that ends during his or her fiscal year will show the tax withheld and the income he or she received during that calendar year. Although the taxpayer takes credit for all the withheld tax shown on the form, report only the part of the income shown on the form that he or she received during his or her fiscal year. Add to that the income the taxpayer received during the rest of his or her fiscal year. If income tax has been withheld under the backup withholding rule, the taxpayer takes credit for it on his or her tax return for the fiscal year in which he or she received the income. (57)

Form W-2 Specific Instructions

The entries on Form W-2 must be based on wages paid during the calendar year. Use Form W-2 for the correct tax year.

Box a - Employee's Social Security number. The employer enters the number shown on the employee's Social Security card. The employer does not accept an ITIN in place of an SSN for employee identification or for work. An ITIN is only available to resident and nonresident aliens who are not eligible for U.S. employment and need identification for other tax purposes. Box b - Employer identification number (EIN). The employer shows the EIN assigned by the IRS (00-0000000). This should be the same number used on the Federal employment tax returns (Forms 941, 941-SS, 943, 944, CT-1, or Schedule H (Form 1040)). Box c - Employer's name, address, and ZIP code. This entry should be the same as shown on Forms 941, 941-SS, 943, 944, CT-1, or Schedule H (Form 1040). The U.S. Postal Service recommends that no commas or periods be used in return addresses. Box d - Control number. This box is optional and is used to identify individual Forms W-2. Boxes e and f - Employee's name and address. The employer enters the name as shown on the employee's Social Security card (first name, middle initial, last name). The employer includes in the address the number, street, and apartment or suite number (or P.O. box number if mail is not delivered to a street address). The U.S. Postal Service recommends that no commas or periods be used in delivery addresses. Box 1 - Wages, tips, other compensation. The employer shows the total taxable wages, tips, and other compensation (before any payroll deductions) that the employer paid to the employee during the year. However, the employer does not include elective deferrals (such as employee contributions to a Section 401(k) or 403(b) plan) except Section 501(c)(18) contributions. Box 2 - Federal income tax withheld. The employer shows the total Federal income tax withheld from the employee's wages for the year. Include the 20% excise tax withheld on excess parachute payments. The term excess parachute payment means an amount equal to the excess of any parachute payment over the portion of the base amount allocated to such payment. The term “parachute payment” means any payment in the nature of compensation to (or for the benefit of) a disqualified individual if: (58)

1. Such payment is contingent on a change: a. In the ownership or effective control of the corporation. b. In the ownership of a substantial portion of the assets of the corporation.

2. The aggregate present value of the payments in the nature of compensation to (or for the benefit of) such individual which are contingent on such change equals or exceeds an amount equal to 3 times the base amount.

Lesson 2 - Tax Forms

Box 3 - Social Security wages. The employer shows the total wages paid (before payroll deductions) subject to employee Social Security tax but not including Social Security tips and allocated tips. If reporting these amounts in a subsequent year (due to lapse of risk of forfeiture), the amount must be adjusted by any gain or loss. Box 4 - Social Security tax withheld. The employer shows the total employee Social Security tax (not the employer’s share) withheld, including Social Security tax on tips. For 2023, the amount should not exceed $9,932.40 ($160,200 × 6.2%). Include only taxes withheld (or paid by the employer for the employee) for 2023 wages and tips. Box 5 - Medicare wages and tips. The wages and tips subject to Medicare tax are the same as those subject to Social Security tax (boxes 3 and 7) except that there is no wage base limit for Medicare tax. Enter the total Medicare wages and tips in box 5. The employer should be sure to enter tips that the employee reported even if the employer did not have enough employee funds to collect the Medicare tax for those tips. Box 6 - Medicare tax withheld. The employer enters the total employee Medicare tax (including any Additional Medicare Tax) withheld. The employer does not include the employer’s share. Include only tax withheld for 2023 wages and tips. Medicare tax is calculated at 1.45% of wages and tips. Box 7 - Social Security tips. The employer shows the tips that the employee reported to the employer even if the employer did not have enough employee funds to collect the Social Security tax for the tips. The total of boxes 3 and 7 should not be more than $160,200 (the maximum Social Security wage base for 2023). Box 8 - Allocated tips. If the employer is a food or beverage establishment, show the tips allocated to the employee. See the Instructions for Form 8027 - Employer's Annual Information Return of Tip Income and Allocated Tips. The employer does not include this amount in boxes 1, 3, 5, or 7. Box 9. Do not enter an amount in box 9. Box 10 - Dependent care benefits. The employer shows the total dependent care benefits under a dependent care assistance program paid or incurred by an employer for an employee. The employer includes the fair market value (FMV) of care in a daycare facility provided or sponsored by the employer for an employee and amounts paid or incurred for dependent care assistance in a Section 125 (cafeteria) plan. In 2023, the employer reports all amounts paid or incurred (regardless of any employee forfeitures), including those in excess of the $5,000 exclusion. For married employees filing separate returns, the maximum amount is $2,500. Box 11 - Nonqualified plans. The purpose of box 11 is for the SSA to determine if any part of the amount reported in box 1 or boxes 3 and/or 5 was earned in a prior year. The SSA uses this information to verify that they have properly applied the Social Security earnings test and paid the correct amount of benefits. Box 12 - Codes. The employer completes and codes this box for all items that are listed as codes A through EE. If more than four items need to be reported in box 12, the employer uses a separate Form W-2 to report the additional items (but enter no more than four items on each Copy A (Form W-2)). On all other copies of Form W-2 (Copies B, C, etc.), the employer may enter more than four items in box 12 when using an approved substitute Form W-2. Some of the codes are reviewed below.

Code A - Uncollected Social Security or RRTA tax on tips. The employer shows the employee Social Security or Railroad Retirement Tax Act (RRTA) tax on all of the employee's tips that the employer could not collect because the employee did not have enough funds from which to deduct it. The employer should not include this amount in box 4.

Code B - Uncollected Medicare tax on tips. The employer shows the employee Medicare tax or RRTA Medicare tax on tips that the employer could not collect because the employee did not have enough funds from which to deduct it. The employers should not show any uncollected Additional Medicare Tax. Do not include this amount in box 6.

Code C - Taxable cost of group-term life insurance over $50,000. The employer shows the taxable cost of group-term life insurance coverage over $50,000 provided to an employee (including a former employee). The employer also includes this amount in boxes 1, 3 (up to the Social Security wage base), and 5.

Code D - Elective deferrals under Section 401(k) cash or deferred arrangement (plan). The employer also shows deferrals under a SIMPLE retirement account that is part of a Section 401(k) arrangement.

Lesson 2 - Tax Forms

Code E - Elective deferrals under a Section 403(b) salary reduction agreement. Code F - Elective deferrals under a Section 408(k)(6) salary reduction SEP.

Code G - Elective deferrals and employer contributions (including non-elective deferrals) to any governmental or nongovernmental Section 457(b) deferred compensation plan. The employer should not report either Section 457(b) or Section 457(f) amounts that are subject to a substantial risk of forfeiture. Code H - Elective deferrals under Section 501(c)(18)(D) tax-exempt organization plan. The employer should be sure to include this amount in box 1 as wages. The employee will deduct the amount on his or her Form 1040.

Code J - Nontaxable sick pay. The employer shows any sick pay that was paid by a third-party and was not includible in income (and not shown in boxes 1, 3, and 5) because the employee contributed to the sick pay plan. Do not include nontaxable disability payments made directly by a state. Code K - 20% excise tax on excess golden parachute payments. If the employer made excess “golden parachute” payments to certain key corporate employees, report the 20% excise tax on these payments. If the excess payments are considered to be wages, report the 20% excise tax withheld as income tax withheld in box 2.

Code L - Substantiated employee business expense reimbursements. The employer uses this code only if the employer reimbursed an employee for employee business expenses using a per diem or mileage allowance and the amount that the employer reimbursed exceeds the amount treated as substantiated under IRS rules.

Code M - Uncollected Social Security or RRTA tax on taxable cost of group-term life insurance over $50,000 (for former employees). If the employer provided former employees (including retirees) more than $50,000 of group-term life insurance coverage for periods during which an employment relationship no longer exists, enter the amount of uncollected Social Security or RRTA tax on the coverage in box 12.

Code N - Uncollected Medicare tax on taxable cost of group-term life insurance over $50,000 (for former employees). If the employer provided former employees (including retirees) more than $50,000 of group-term life insurance coverage for periods during which an employment relationship no longer exists, enter the amount of uncollected Medicare tax or RRTA Medicare tax on the coverage in box 12. The employer should not show any uncollected Additional Medicare Tax.

Code P - Excludable moving expense reimbursements paid directly to employee. The employer shows the total excludable moving expense reimbursements paid directly to a member of the U.S. Armed Forces (not included in box 1, 3, or 5).

Code Q - Nontaxable combat pay. If the employer is a military employer, report any nontaxable combat pay in box 12. Code R - Employer contributions to an Archer MSA. The employer shows any employer contributions to an Archer MSA. Code S - Employee salary reduction contributions under a Section 408(p) SIMPLE plan. The employer shows deferrals under a Section 408(p) salary reduction SIMPLE retirement account. However, if the SIMPLE plan is part of a Section 401(k) arrangement, use code D. Code T - Adoption benefits. The employer shows the total that the employer paid or reimbursed for qualified adoption expenses furnished to an employee under an adoption assistance program. The employer also includes adoption benefits paid or reimbursed from the pre-tax contributions made by the employee under a Section 125 (cafeteria) plan. Code V - Income from the exercise of non-statutory stock option(s). The employer shows the spread (that is, the fair market value of stock over the exercise price of option(s) granted to an employee with respect to that stock) from an employee's (or former employee's) exercise of non-statutory stock option(s). Include this amount in boxes 1, 3 (up to the Social Security wage base), and 5. Code W - Employer contributions to a health savings account (HSA). The employer shows any employer contributions (including amounts the employee elected to contribute using a Section 125 (cafeteria) plan) to an HSA.

Lesson 2 - Tax Forms

Code Y - Deferrals under a Section 409A nonqualified deferred compensation plan. It is not necessary to show deferrals in box 12 with code Y. Code Z - Income under Section 409A on a nonqualified deferred compensation plan. The employer enters all amounts deferred (including earnings on amounts deferred) that are includible in income under Section 409A because the NQDC plan fails to satisfy the requirements of Section 409A. Code AA - Designated Roth contributions under a Section 401(k) plan. Use this code to report designated Roth contributions under a Section 401(k) plan. Do not use this code to report elective deferrals under code D. Code BB - Designated Roth contributions under a Section 403(b) plan. The employer uses this code to report designated Roth contributions under a Section 403(b) plan. The employer should not use this code to report elective deferrals under code E. Code DD - Cost of employer-sponsored health coverage. The employer uses this code to report the cost of employer- sponsored health coverage. The amount reported with code DD is not taxable. Code EE - Designated Roth contributions under a governmental Section 457(b) plan. The employer uses this code to report designated Roth contributions under a governmental Section 457(b) plan. The employer should not use this code to report elective deferrals under code G. Code FF - Permitted benefits under a qualified small employer health reimbursement arrangement. The employer uses this code to report the total amount of permitted benefits under a QSEHRA. The maximum reimbursement for an eligible employee under a QSEHRA for 2023 is $5,850 ($11,800 if it also provides reimbursements for family members). Box 13 - Checkboxes. The employer will check all boxes that apply for the following: Statutory employee. Check this box for statutory employees whose earnings are subject to Social Security and Medicare taxes but not subject to Federal income tax withholding. Do not check this box for common-law employees. There are workers who are independent contractors under the common-law rules but are treated by statute as employees. They are called statutory employees. Retirement plan. Check this box if the employee was an “active participant” covered by (a) a defined benefit plan for any tax year that he or she is eligible to participate in or (b) a defined contribution plan (for example, a Section 401(k) plan) for any tax year that employer or employee contributions (or forfeitures) are added to his or her account.

Third-party sick pay. Check this box only if the employer is a third-party sick pay payer filing a Form W-2 for an insured's employee or are an employer reporting sick pay payments made by a third party.

Box 14 - Other. If the employer included 100% of a vehicle's annual lease value in the employee's income, it also must be reported here or on a separate statement to an employee. The employer also may use this box for any other information that he or she wants to give to an employee. Label each item. Examples include state disability insurance taxes withheld, union dues, uniform payments, health insurance premiums deducted, nontaxable income, educational assistance payments, or a member of the clergy's parsonage allowance and utilities. Boxes 15 through 20 - State and local income tax information. The employer uses these boxes to report state and local income tax information. The employer enters the two-letter abbreviation for the name of the state. The employer's state ID numbers are assigned by the individual states. The state and local information boxes can be used to report wages and taxes for two states and two localities. The employer keeps each state's and locality's information separated by the broken line. If the employer needs to report information for more than two states or localities, prepare a second Form W- 2. Contact the state or locality for specific reporting information.

Dependent Care Benefits

This exclusion applies to household and dependent care services an employer directly or indirectly pays for or provides to an employee under a dependent care assistance program that covers only his or her employees. The services must be for a qualifying person's care and must be provided to allow the employee to work. These requirements are basically the same as the tests the employee would have to meet to claim the dependent care credit if the employee paid for the services. An employer can exclude the value of benefits he or she provides to an employee under a dependent care

Lesson 2 - Tax Forms

assistance program from the employee's wages if he or she reasonably believes that the employee can exclude the benefits from gross income. For 2023, the maximum amount is $5,000. For married employees filing separate returns, the maximum amount is $2,500. However, the exclusion cannot be more than the smaller of the earned income of either the employee or employee's spouse. Special rules apply to determine the earned income of a spouse who is either a student or not able to care for him or herself. The employer reports the value of all dependent care assistance he or she provides to an employee under a dependent care assistance program in box 10 of the employee's Form W-2. The employer includes any amounts he or she cannot exclude from the employee's wages in boxes 1, 3, and 5. The employer reports both the nontaxable portion of assistance (up to $5,000 in 2023) and any assistance above the amount that is taxable to the employee.

Form W-3 - Transmittal of Wage and Tax Statements Anyone required to file Form W-2 must file Form W-3 to transmit Copy A of Forms W-2. A Form W-3 - Transmittal of Wage and Tax Statements is completed only when paper Copy A of Form W-2 - Wage and Tax Statement is being filed. Do not file Form W-3 alone. Do not file Form W-3 for a Form W-2 that was submitted electronically to the SSA. All paper forms must comply with IRS standards and be machine readable. Photocopies are not acceptable. Use a Form W-3 even if only one paper Form W-2 is being filed. Make sure both the Form W-3 and Form(s) W-2 show the correct tax year and Employer Identification Number (EIN). Make a copy of this form and keep it with Copy D (For Employer) of Form(s) W-2 for the employer’s records. The IRS recommends retaining copies of these forms for four years. Even employers with only one household employee must file Form W-3 to transmit Copy A of form W-2. On Form W-3 check the “Hshld. emp.” checkbox in box b. For more information, see Schedule H - Household Employment Taxes and its separate instructions. The employer must have an employer identification number (EIN). A transmitter or sender (including a service bureau, reporting agent, paying agent, or disbursing agent) may sign Form W- 3 (or use its PIN to e-file) for the employer or payer only if the sender satisfies both of the following:

1. He or she is authorized to sign by an agency agreement (whether oral, written, or implied) that is valid under state law.

2. He or she writes “For (name of payer)” next to the signature (paper Form W-3 only). The due date for filing 2023 Forms W-2, W-2AS, W-2CM, W-2GU, W-2VI, W-3, and W-3SS with the SSA is January 31, 2023, whether the employer files using paper forms or electronically.

Form W-9 - Request for Taxpayer Identification Number and Certification The taxpayer uses Form W-9 - Request for Taxpayer Identification Number and Certification to provide his or her correct Taxpayer Identification Number (TIN) to the person who is required to file an information return with the IRS to report, for example:

➢ Income paid to the taxpayer. ➢ Real estate transactions. ➢ Mortgage interest the taxpayer paid. ➢ Acquisition or abandonment of secured property. ➢ Cancellation of debt. ➢ Contributions the taxpayer made to an IRA.

Form W-9 is most commonly used by individuals when they are working as a freelancer or independent contractor. The information taken from a Form W-9 is often used to generate a 1099 tax form, which is required for income tax filing purposes. The information collected by an entity on a W-9 form cannot be disclosed for any other purpose, under strict privacy regulations.

Lesson 2 - Tax Forms

Various Form 1099 An information return (generally a Form 1099) is a tax document that businesses are required to file to report certain business transactions to the Internal Revenue Service (IRS). The requirement to file Information Returns is mandated by the Internal Revenue Service and associated regulations. Any person, including a corporation, partnership, individual, estate, and trust, who makes reportable transactions during the calendar year must file information returns to report those transactions to the IRS. Persons required to file Information Returns to the IRS must also furnish statements to the recipients of the income. Filers who have 250 or more must file these returns electronically. Most forms in the 1099 series are not filed with the return. In general, these forms should be furnished to the taxpayer by January 31, 2023. Unless instructed to file any of these forms with the return, keep them for the taxpayer records. There are several different forms in this series, including: (59)

➢ Form 1099-A - Acquisition or Abandonment of Secured Property. ➢ Form 1099-B - Proceeds From Broker and Barter Exchange Transactions. ➢ Form 1099-C - Cancellation of Debt. ➢ Form 1099-DIV - Dividends and Distributions. ➢ Form 1099-G - Certain Government Payments. ➢ Form 1099-INT - Interest Income. ➢ Form 1099-K - Payment Card and Third-Party Network Transactions. ➢ Form 1099-MISC - Miscellaneous Income. ➢ Form 1099-NEC - Nonemployee Compensation. ➢ Form 1099-OID - Original Issue Discount. ➢ Form 1099-PATR - Taxable Distributions Received From Cooperatives. ➢ Form 1099-Q - Payments From Qualified Education Programs (Under Sections 529 and 530). ➢ Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance

Contracts, etc. ➢ Form SSA-1099 - Social Security Benefit Statement. ➢ Form RRB-1099 - Payments by the Railroad Retirement Board.

Form 1099-A - Acquisition or Abandonment of Secured Property

If the taxpayer borrows money from a lender to purchase property, the lender may require the loan to be secured by the purchased property. If the taxpayer transfers an interest in the secured property to the lender (such as in a foreclosure) or abandons the property, he or she may be required to treat the transfer or the abandonment as a sale of the property. If the lender acquires an interest in the secured property or has reason to know that the taxpayer abandoned, or permanently discarded from use, the secured property, the lender should send the taxpayer a Form 1099-A. On Form 1099-A, the lender reports the amount of the debt owed (principal only) and the fair market value of the secured property. The taxpayer (the debtor) uses these values to determine a gain or loss on the disposition of the property. (60)

Form 1099-C - Cancellation of Debt

When the taxpayer borrows money, he or she is not required to include the loan proceeds in gross income because he or she has an obligation to repay the lender later. If that obligation is subsequently canceled, the taxpayer may be required to include the amount of the canceled debt in gross income. A commercial lender canceling a debt will issue a Form 1099- C. On Form 1099-C, the lender reports the amount of the canceled debt. If the lender's acquisition of an interest in the secured property (or the debtor's abandonment of the property) and the cancellation of the debt occur in the same calendar year, the lender may issue a Form 1099-C only. In general, the taxpayer must report any taxable amount of a canceled debt as ordinary income.

In certain situations, a taxpayer may exclude cancellation of debt income in whole or in part. For example, if he or she has cancellation of debt income on his or her principal residence, the taxpayer may be able to exclude part or the entire amount canceled from his or her income.

Debt canceled in a title 11 bankruptcy case is not included in a taxpayer’s income. A title 11 bankruptcy case is a case under title 11 of the United States Code (including all chapters in title 11 such as chapters 7, 11, and 13), but only if the debtor is under the jurisdiction of the court and the cancellation of the debt is granted by the court or occurs as a result of a plan approved by the court.

Lesson 2 - Tax Forms

A taxpayer shows that his or her debt was canceled in a bankruptcy case and is excluded from income by attaching Form 982 - Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) to his or her Federal income tax return and checking the box on line 1a. Lines 1b through 1e do not apply to a cancellation that occurs in a title 11 bankruptcy case. The taxpayer enters the total amount of debt canceled in his or her title 11 bankruptcy case on line 2. The taxpayer must also reduce his or her tax attributes in Part II of Form 982.

Form 1099-MISC - Miscellaneous Income

An individual should file Form 1099-MISC - Miscellaneous Income for each person to whom he or she has paid during the year: (61)

➢ At least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest. ➢ At least $600 in rents, services (including parts and materials), prizes and awards, other income payments,

medical and health care payments, crop insurance proceeds, cash payments for fish (or other aquatic life) he or she purchases from anyone engaged in the trade or business of catching fish, or, generally, the cash paid from a notional principal contract to an individual, partnership, or estate.

➢ Any fishing boat proceeds. ➢ Gross proceeds of $600 or more paid to an attorney.

The requirement described in the 2011 instructions for persons receiving rental income from real estate to report payments for certain rental property expenses on Form 1099-MISC was repealed by Congress. An individual does not have to report those payments on Form 1099-MISC.

Form 1099-DIV - Dividends and Distributions

An individual should file Form 1099-DIV - Dividends and Distributions for each person: (62)

➢ To whom he or she has paid dividends (including capital gain dividends and exempt-interest dividends) and other distributions on stock of $10 or more.

➢ For whom he or she has withheld and paid any foreign tax on dividends and other distributions on stock. ➢ For whom he or she has withheld any Federal income tax on dividends under the backup withholding rules. ➢ To whom he or she has paid $600 or more as part of a liquidation.

If an individual makes a payment that may be a dividend but he or she is unable to determine whether any part of the payment is a dividend by the time he or she must file Form 1099-DIV, the entire payment must be reported as a dividend. See the regulations under Section 6042 for a definition of dividends.

Form 1099-INT - Interest Income

An individual should file Form 1099-INT - Interest Income for each person: (63)

➢ To whom he or she paid amounts reportable in boxes 1, 3, and 8 of at least $10 (or at least $600 of interest paid in the course of his or her trade or business described in the instructions for Box 1. Interest Income).

➢ For whom he or she withheld and paid any foreign tax on interest. ➢ From whom he or she withheld (and did not refund) any Federal income tax under the backup withholding rules

regardless of the amount of the payment. The individual reports only interest payments made in the course of his or her trade or business including Federal, state, and local government agencies and activities deemed nonprofit, or for which he or she was a nominee/middleman. The individual reports tax-exempt interest, only on Form 1099-INT. He or she does not need to report tax-exempt interest that is original issue discount (OID). He or she reports interest that is taxable OID on Form 1099-OID not on Form 1099-INT.

Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs,

Insurance Contracts, etc.

An individual should file Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. for each person to whom he or she has made a designated distribution or are treated as having made a distribution of $10 or more from profit-sharing or retirement plans, any individual retirement arrangements (IRAs),

Lesson 2 - Tax Forms

annuities, pensions, insurance contracts, survivor income benefit plans, permanent and total disability payments under life insurance contracts, charitable gift annuities, etc. Also, an individual should report on Form 1099-R death benefit payments made by employers that are not made as part of a pension, profit-sharing, or retirement plan. Additionally, reportable disability payments made from a retirement plan must be reported on Form 1099-R. Generally, an individual does not report payments subject to withholding of Social Security and Medicare taxes on this form. Report such payments on Form W-2 - Wage and Tax Statement. Generally, an individual does not report amounts totally exempt from tax, such as workers' compensation and Department of Veterans Affairs (VA) payments. However, if part of the distribution is taxable and part is nontaxable, report the entire distribution. There is no special reporting for qualified charitable distributions under Section 408(d)(8), qualified health savings account (HSA) funding distributions described in Section 408(d)(9) or for the payment of qualified health and long-term care insurance premiums for retired public safety officers described in Section 402(l). (64)

Form SSA-1099 - Social Security Benefit Statement

Every person who received Social Security benefits will receive a Form SSA-1099 - Social Security Benefit Statement. If the person receives benefits on more than one Social Security record, he or she may get more than one Form SSA-1099. IRS Notice 703 will be enclosed with this form. It contains a worksheet to help the person figure if any of his or her benefits are taxable. The person does not mail Notice 703 to either the IRS or the SSA. An SSA-1099 is mailed to the taxpayer in January showing the total amount of benefits he or she received in the previous year. If the taxpayer is a nonresident alien who received or repaid Social Security benefits last year, he or she will receive an SSA-1042S instead. (65)

Form 1099-K - Payment Card and Third-Party Network Transactions

Form 1099-K - Payment Card and Third-Party Network Transactions is an IRS information return used to report certain payment transactions to improve voluntary tax compliance. Most individuals’ Form 1099-K reports payments to their trade or business. As such, the income for sole proprietors is reported on their Schedule C as gross receipts subject to the self- employment tax. The American Rescue Plan of 2021 changed the reporting threshold for third-party settlement organizations (TPSO). The new threshold for business transactions is $600 per year; changed from the previous threshold of more than 200 transactions per year, exceeding an aggregate amount of $20,000. The law is not intended to track personal transactions such as sharing the cost of a car ride or meal, birthday or holiday gifts, or paying a family member or another for a household bill.

The Internal Revenue Service released Notice 2023-74 announcing a delay of the new $600 Form 1099-K reporting threshold for third party settlement organizations for calendar year 2023. As the IRS continues to work to implement the new law, the agency will treat 2023 as an additional transition year. This will reduce the potential confusion caused by the distribution of an estimated 44 million Forms 1099-K sent to many taxpayers who would

not expect one and may not have a tax obligation. As a result, reporting will not be required unless the taxpayer receives over $20,000 and has more than 200 transactions in 2023. The IRS is planning for a reporting threshold of $5,000 for tax year 2024 as part of a phase-in to implement the $600 reporting threshold enacted under the American Rescue Plan (ARP).

Form 1099-K includes the gross amount of all reportable payment transactions. The taxpayer will receive a Form 1099-K from each payment settlement entity (PSE) from which he or she received payments in settlement of reportable payment transactions. A reportable payment transaction is defined as a payment card transaction or a third-party network transaction. Reporting requirements do not apply to personal transactions such as birthday or holiday gifts, sharing the cost of a car ride or meal, or paying a family member or another for a household bill. These payments are not taxable and should not be reported on Form 1099-K. However, the casual sale of goods and services, including selling used personal items like clothing, furniture, and other household items for a loss, could generate a Form 1099-K for many people, even if the seller has no tax liability from those sales.

Payment card transaction means any transaction in which a payment card, or any account number or other identifying data associated with a payment card, is accepted as payment. Third-party network transaction means any transaction that is settled through a third-party payment network.

Lesson 2 - Tax Forms

Review Feedback Review feedback provides both the answers to each question and an explanation or feedback as to how we arrived at each answer at the end of the lesson. Review feedback also contains evaluative feedback explaining why incorrect answers are wrong. You are also provided the course topic from which we derived our answer and the external source material we used for verification. If you are using the online version of the course, Ctrl+click on the topic to find the section from which we arrived at the answer for the question. You can also Ctrl+click on the question number to return to the specific review question. Question 1 - C. $100,000 The Tax Table is set up based on amounts of taxable income below $100,000. A column is provided for each tax status, and the tax is determined by locating the amount shown under the correct column to the right of the taxable income amount. A person having taxable income of $100,000 or more must use the Tax Computation Worksheet (based on the Tax Rate Schedules) also provided by the IRS. Choices A, B, and D all have amounts other than $100,000 and are therefore incorrect. Topic - Returns not Qualifying for Use of the Tax Table Source - Form 1040 Instructions - Tax Computation Worksheet Question 2 - B. An automatic extension of 6 months to file the return Beginning with 2005, an individual is granted an automatic extension of six months (Choice B) for filing a return (but not for payment of tax), provided that Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return is properly filed before the normal due date of the return. Choice A is incorrect because the extension is not for the payment of tax. Choice C and have the incorrect number of months granted by an automatic extension. Topic - Extensions Source - Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return Question 3 - C. 21 days If the taxpayer does not pay the additional tax due on Form 1040-X within 21 calendar days from the date of notice and demand for payment (10 business days from that date if the amount of tax is $100,000 or more), the penalty is usually ½ of 1% of the unpaid amount for each month or part of a month the tax is not paid. The penalty can be as much as 25% of the unpaid amount and applies to any unpaid tax on the return. This penalty is in addition to interest charges on late payments. The taxpayer will not have to pay the penalty if he or she can show reasonable cause for not paying the tax on time. Choices A, B, and D all have days other than 21 and are therefore incorrect. Topic - Interest and Penalties Source - Instructions for Form 1040-X Question 4 - A. $3 The taxpayer can use Form 1040-X to have $3 (Choice A) go to the Presidential Election Campaign Fund if he or she (or his or her spouse on a joint return) did not do so on the original return. This must be done within 20½ months after the original due date for filing the return. For calendar year 2023, this period ends in January of 2026. A previous designation of $3 to the fund cannot be changed. Choices B and C have incorrect amounts. Choice D is incorrect because the taxpayer can use Form 1040-X to have $3 go to the Presidential Election Campaign Fund. Topic - Part II - Presidential Election Campaign Fund Source - Instructions for Form 1040-X

Lesson 2 - Tax Forms

Question 5 - B. Form W-4 An employee must complete a Form W-4 - Employee's Withholding Certificate. Form W-4 tells an employer whether taxpayer is married or has multiple jobs, whether the taxpayer can claim tax credits such as the Child Tax Credit or the Credit for Other Dependents, and any other adjustments such as an additional amount to use when the employer deducts Federal income tax from the employee's pay (Choice B). If an employee fails to give the employer a properly completed Form W-4, the employer must withhold Federal income taxes from his or her wages as if he or she were single and claiming no tax credits. Form W-2 (Choice A) is filed Form(s) W-2 if an employer has one or more employees to whom they made payments (including noncash payments) for the employees’ services in their trade or business during 2023. Form 1040 (Choice C) is used by U.S. taxpayers to file an annual income tax return. Form 1040-X (Choice D) is used to correct Form 1040, 1040-SR, or 1040-NR. Topic - Form W-4 - Employee's Withholding Certificate Source - Form W-4 - Employee's Withholding Certificate Question 6 - D. A distribution that is not expected to be includible in the recipient's gross income Generally, pension and annuity payments are subject to Federal income tax withholding. The withholding rules apply to the taxable part of payments from an employer pension annuity (Choice A), profit-sharing (Choice B), stock bonus (Choice C), or another deferred compensation plan. The rules also apply to payments from an individual retirement arrangement (IRA), an annuity, endowment, or life insurance contract issued by a life insurance company. There is no withholding on any part of a distribution that is not expected to be includible in the recipient's gross income (Choice D). Topic - Pensions and Annuity Withholding Source - IRS.GOV - Pensions and Annuity Withholding Question 7 - D. All amounts Every employer engaged in a trade or business who pays remuneration, including noncash payments of $600 or more for the year (all amounts if any income, Social Security, or Medicare tax was withheld) for services performed by an employee must file a Form W-2 - Wage and Tax Statement for each employee (even if the employee is related to the employer) from whom income, Social Security, or Medicare tax was withheld and income tax would have been withheld if the employee had claimed no more than one withholding allowance or had not claimed exemption from withholding on Form W-4 - Employee's Withholding Certificate. Because an employer must file a Form W-2 for each employee for all amounts of pay if any income, Social Security, or Medicare tax was withheld Choice D is correct as Choices A, B, and C all have payment amounts more than $0. Topic - Form W-2 - Wage and Tax Statement Source - General Instructions for Forms W-2 and W-3 Question 8 - A. 10 days If the taxpayer’s attempts to have an incorrect Form W-2 corrected by his or her employer are unsuccessful and it is after February 14, the taxpayer can request that an IRS representative initiate a Form W-2 complaint. The taxpayer may call the IRS toll free at 800-829-1040 or visit an IRS Taxpayer Assistance Center (TAC) in person. A letter will be sent to the employer requesting that they furnish a corrected Form W-2 to the taxpayer within ten days. The letter advises the employer of their responsibilities to provide a correct Form W-2 and of the penalties for failure to do so. Choices B, C, and D all have days other than 10 and are therefore incorrect. Topic - Form Not Correct Source - IRS.GOV - Form W-2 - Additional, Incorrect, Lost, Non-Receipt, Omitted

Taxable Income, Filing Status At the conclusion of this lesson you should have a basic knowledge of:

➢ Taxable and Non-Taxable Income. ➢ Tax Liability. ➢ Filing Status. ➢ Special Filing Situations.

Taxable and Nontaxable Income Most types of income are taxable, but some are not. Income can include money, property or services that the taxpayer receives. Here are some examples of income that are usually not taxable: (66)

➢ Child support payments. ➢ Gifts, bequests, and inheritances (subject to limitations). ➢ Welfare benefits. ➢ Damage awards for physical injury or sickness. ➢ Cash rebates from a dealer or manufacturer for an item the taxpayer buys. ➢ Reimbursements for qualified adoption expenses.

Some income is not taxable except under certain conditions. Examples include: (66)

➢ Life insurance proceeds paid to the taxpayer because of an insured person’s death are usually not taxable. However, if the taxpayer redeems a life insurance policy for cash, any amount that is more than the cost of the policy is taxable.

➢ Income the taxpayer gets from a qualified scholarship is normally not taxable. Amounts the taxpayer uses for certain costs, such as tuition and required course books, are not taxable. However, amounts used for room and board are taxable.

All income, such as wages and tips, is taxable unless the law specifically excludes it. This includes non-cash income from bartering - the exchange of property or services. Both parties must include the fair market value of goods or services received as income on their tax return. If the taxpayer received a refund, credit or offset of state or local income taxes in 2023, he or she may be required to report this amount. If the taxpayer did not receive a 2023 Form 1099-G, check with the government agency that made the payments. That agency may have made the form available only in an electronic format. The taxpayer will need to get instructions from the agency to retrieve this document. Report any taxable refund received even if the taxpayer did not receive Form 1099-G.

Who is Subject to the Tax If the taxpayer is a U.S. citizen or resident, whether he or she must file a return depends on three factors:

➢ Gross income. ➢ Filing status. ➢ Age.

Every citizen of the U.S. and every resident alien is subject to the income tax. All citizens must pay the tax even if they are residents of a foreign country. A limited exclusion applies to income earned from foreign sources. The tax is also levied on citizens of foreign countries who are residents of the U.S., and on citizens of foreign countries who earn income in the U.S. The rates and procedures for nonresident aliens are different from those for citizens and resident aliens. In addition, the U.S. has tax treaties with many countries that exempt certain items of income from taxation or decreases the rates.

Lesson 3 - Taxable Income, Filing Status

Tax Rate Schedules for 2023

One of the keys to the Tax Cuts and Jobs Act is a reduction in individual tax rates. While the current number of tax brackets has been retained, each one has been reduced. There are seven tax rates for individual taxpayers. They are: 10%, 12%, 22%, 24%, 32%, 35% and 37%. The tax rate of 37% applies to joint filers with taxable income over $693,750 (single filers over $578,125). The following are the tax rates schedules for tax year 2023 based on certain filing status. (67)

Unmarried Individuals (other than Surviving Spouses and Heads of Households)

If Taxable Income Is: The Tax Is:

Not over $11,000 10% of the taxable income

Over $11,000 but not over $44,725 $1,100 plus 12% of the excess over $11,000

Over $44,725 but not over $95,375 $5,147 plus 22% of the excess over $44,725

Over $95,375 but not over $182,100 $16,290 plus 24% of the excess over $95,375

Over $182,100 but not over $231,250 $37,104 plus 32% of the excess over $182,100

Over $231,250 not over $578,125 $52,832 plus 35% of the excess over $231,250

Over $578,125 $174,238.25 plus 37% of the excess over $578,125

Table 3-1 - Revenue Procedure 2022-38 (2023)

Married Individuals Filing Joint Returns and Surviving Spouses

If Taxable Income Is: The Tax Is:

Not over $22,000 10% of the taxable income

Over $22,000 but not over $89,450 $2,200 plus 12% of the excess over $22,000

Over $89,450 but not over $190,750 $10,294 plus 22% of the excess over $89,450

Over $190,750 but not over $364,200 $32,580 plus 24% of the excess over $190,750

Over $364,200 but not over $462,500 $74,208 plus 32% of the excess over $364,200

Over $462,500 but not over $693,750 $105,664 plus 35% of the excess over $462,500

Over $693,750 $186,601.50 plus 37% of the excess over $693,750

Table 3-2 - Revenue Procedure 2022-38 (2023)

Married Individuals Filing Separate Returns

If Taxable Income Is: The Tax Is:

Not over $11,000 10% of the taxable income

Over $11,000 but not over $44,725 $1,100 plus 12% of the excess over $11,000

Over $44,725 but not over $95,375 $5,147 plus 22% of the excess over $44,725

Over $95,375 but not over $182,100 $16,290 plus 24% of the excess over $95,375

Over $182,100 but not over $231,250 $37,104 plus 32% of the excess over $182,100

Over $231,250 not over $346,875 $52,832 plus 35% of the excess over $231,250

Over $346,875 $93,300.75 plus 37% of the excess over $346,875

Table 3-3 - Revenue Procedure 2022-38 (2023)

Heads of Households

If Taxable Income Is: The Tax Is:

Not over $15,700 10% of the taxable income

Over $15,700 but not over $59,850 $1,570 plus 12% of the excess over $15,700

Over $59,850 but not over $95,350 $6,868 plus 22% of the excess over $59,850

Over $95,350 but not over $182,100 $14,678 plus 24% of the excess over $95,350

Over $182,100 but not over $231,250 $35,498 plus 32% of the excess over $182,100

Over $231,250 not over $578,100 $51,226 plus 35% of the excess over $231,250

Over $578,100 $172,623.50 plus 37% of the excess over $578,100

Table 3-4 - Revenue Procedure 2022-38 (2023)

Lesson 3 - Taxable Income, Filing Status

Estates and Trusts

If Taxable Income Is: The Tax Is:

Not over $2,900 10% of the taxable income

Over $2,900 but not over $10,550 $290 plus 24% of the excess over $2,900

Over $10,550 but not over $14,450 $2,126 plus 35% of the excess over $10,550

Over $14,450 $3,491 plus 37% of the excess over $14,450

Table 3-5 - Revenue Procedure 2022-38 (2023)

Long Term Capital Gains and Qualified Dividends

Tax Bracket Short-term Long-term

10%, 12% brackets Ordinary rate 0%

22%, 24%, 32%, 35% brackets Ordinary rate 15%

37% bracket Ordinary rate 20%

Table 3-6 - Revenue Procedure 2022-38 (2023)

An additional 3.8% Federal Net Investment Income Tax (NIIT) applies to individuals on the lesser of net investment income or modified adjusted gross income (MAGI) in excess of $200,000 (single) or $250,000 (married/filing jointly and qualifying surviving spouses). The tax also applies to any trust or estate on the lesser

of undistributed net income or AGI in excess of the dollar amount at which the estate/trust pays income taxes at the highest rate.

The 15% and 20% tax rates on long-term capital gains and qualified dividends have been retained in the Tax Cuts and Jobs Act. Those in the 10% or 12% tax bracket pay zero tax on these gains and dividends. Also, there had been proposals to require the use of first-in, first-out (FIFO) in determining basis on the sale of stock and

mutual fund shares rather than allowing investors to designate which shares are being sold when shares were acquired at different times. This measure was not included in the final tax law.

Federal Insurance Contributions Act (FICA)

The 2022 Combined (Employee and Corporate) FICA tax is 7.65% each for the employee and employer on the first $160,200 plus 2.9% on earnings greater than $160,200. The result for most American wage earners is a total FICA tax of 15.3% (Social Security plus Medicare). Self-employed individuals are responsible for the entire FICA tax rate of 15.3% (12.4% Social Security plus 2.9% Medicare). The tax rate and the overall tax obligation have remained the same as 2021.

General Filing Information

General Information 2022 2023

IRA contributions under age 50 $6,000 $6,500

IRA contributions age 50 and over $7,000 $7,500

SIMPLE Contributions $14,000 $15,500

SEP, Keogh Maximum Dollar Allocations $61,000 $66,000

401(k), 403(b), most 457 plans and the Federal government’s Thrift Savings Plan

$20,500 $22,500

Annual compensation limit under Sections 401(a)(17), 404(l), 408(k)(3)(C) and 408(k)(6)(D)(ii)

$305,000 $330,000

Annual Benefit Limit under Defined Benefit Plans under Section 415(b)(1)(A)

$245,000 $265,000

Limitation used in definition of highly compensated employee

$135,000 $150,000

Elective catch-ups

SIMPLEs $3,000 $3,500

401(k), 403(b), 457 plans $6,500 $7,500

Lesson 3 - Taxable Income, Filing Status

Health Savings Accounts (HSA) Contributions

Self-only $3,650 $3,850

Family $7,300 $7,750

55 and over additional contribution $1,000 $1,000

Alternative Minimum Tax (AMT) Exemptions

Single $75,900 $81,300

Married Filing Jointly and Surviving Spouse $118,100 $126,500

Married Filing Separately $59,050 $63,250

Table 3-7 - IRS.GOV - COLA Increases for Dollar Limitations on Benefits and Contributions (2023)

Age, occupation, and mental or physical conditions have no influence on who is subject to the tax. A minor must pay the tax on his or her income just like any adult, including the President of the United States. Persons institutionalized because of mental incapacity are still subject to the tax. However, not every person has to file an annual tax return with the Internal Revenue Service (IRS). Taxpayers have to file a tax return only if their gross income exceeds the total of their standard deduction. The amount varies depending on the taxpayer's filing status and, for tax year 2023, the minimum income requirements are:

Filing Status Minimum Income Requirements

Single individual $13,850

Single individual 65 or older $15,700

Married couple, filing jointly $27,700

Married couple, one spouse 65 or older $29,200

Married couple, both 65 or older $30,700

Head of household $20,800

Head of household 65 or over $22,650

Surviving spouse $27,700

Surviving spouse 65 or older $29,200

Table 3-8 - Publication 17 - Filing Requirements for Most Taxpayers (2023)

Gross income means all income the taxpayer received in the form of money, goods, property, and services that is not exempt from tax, including any income from sources outside the United States or from the sale of his or her main home (even if the taxpayer can exclude part or all of it). The taxpayer does not include any Social Security benefits unless:

1. He or she is married filing a separate return and he or she lived with his or her spouse at any time in 2023. 2. One-half of the taxpayer’s Social Security benefits plus his or her other gross income and any tax-exempt interest

is more than $25,000 ($32,000 if married filing jointly). If (1) or (2) applies, figure the taxable part of Social Security benefits the taxpayer must include in gross income. Gross income also includes gains, but not losses, reported on Form 8949 or Schedule D. Gross income from a business means, for example, the amount on Schedule C, line 7, or Schedule F, line 9. But, in figuring gross income, do not reduce the taxpayer’s income by any losses, including any loss on Schedule C, line 7, or Schedule F, line 9. Regardless of a taxpayer’s gross income, he or she is generally required to file an income tax return if any of the following items apply:

➢ The taxpayer owes Alternative Minimum Tax. ➢ The taxpayer owes household employment taxes. ➢ The taxpayer owes additional taxes on a retirement plan (an individual retirement arrangement (IRA) or other tax-

favored account) or health savings account.

Lesson 3 - Taxable Income, Filing Status

➢ The taxpayer owes Social Security and Medicare taxes on unreported tip income. ➢ The taxpayer had net self-employment income of $400 or more. ➢ The taxpayer earned $108.28 or more from a tax-exempt church or church-controlled organization. ➢ The taxpayer received distributions from an MSA or Health Savings Account.

There are a number of reasons why a taxpayer may want to file a tax return even if he or she does not meet the minimum income requirements:

➢ If the taxpayer had taxes withheld from his or her pay, he or she must file a tax return to receive a tax refund. ➢ If the taxpayer qualifies, he or she must file a return to receive the refundable Earned Income Tax Credit. ➢ If the taxpayer is claiming education credits, he or she must file to be refunded the American Opportunity Tax

Credit. ➢ If the taxpayer has a qualifying child but owes no tax, he or she can file to be refunded the Additional Child Tax

Credit. ➢ If the taxpayer adopted a qualifying child, he or she must file to claim the Adoption Tax Credit. ➢ If the taxpayer overpaid estimated tax or applied a prior year overpayment to this year, he or she must file to

receive the refund. Federal Income Tax Withheld - The taxpayer should file to get money back if Federal Income Tax was withheld from his or her pay, he or she made estimated tax payments, or had a prior year overpayment applied to this year’s tax. Earned Income Tax Credit - The taxpayer may qualify for the EITC if he or she worked but did not earn a lot of money. The EITC is a refundable tax credit, which means the taxpayer could qualify for a tax refund. Additional Child Tax Credit - This refundable credit may be available if the taxpayer has at least one qualifying child and did not get the full amount of the Child Tax Credit. American Opportunity Tax Credit - In 2023, the maximum credit per student is $2,500 and the first four years of postsecondary education qualify.

Sources of Taxable and Non-Taxable Income

Wages

Wages, salaries, and tips a taxpayer received for performing services as an employee of an employer must be included in gross income. Amounts withheld for taxes, including but not limited to income tax, Social Security and Medicare taxes are considered "received" and must be included in gross income in the year they are withheld.

If the taxpayer receives advance commissions or other amounts for services to be performed in the future and he or she is a cash-method taxpayer, the taxpayer must include these amounts in his or her income in the year received. Also, include in income amounts the taxpayer is awarded in a settlement or judgment for back pay. These include payments made to him or her for damages, unpaid life insurance premiums, and unpaid health insurance premiums. They should be reported to the taxpayer by his or her employer on Form W-2.

Bonuses or awards a taxpayer receives for outstanding work are included in income and should be shown on his or her Form W-2. These include prizes such as vacation trips for meeting sales goals. If the prize or award the taxpayer receives is goods or services, he or she must include the fair market value of the goods or services in his or her income. However, if the taxpayer’s employer merely promises to pay a bonus or award at some future time, it is not taxable until he or she receives it or it is made available.

If the taxpayer receives tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award for length of service or safety achievement, he or she generally can exclude its value from income. However, the amount he or she can exclude is limited to his or her employer's cost and cannot be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards the taxpayer receives during the year.

Interest

Interest is rent on money, paid by the borrower to the lender. With few exceptions, interest is fully taxable to the taxpayer receiving it. Taxable interest includes interest received from bank accounts, loans made to others, and other sources.

Lesson 3 - Taxable Income, Filing Status

Non-taxable interest includes interest received from tax-free securities, most municipal bonds, and insurance dividends left on deposit with the U.S. Department of Veterans Affairs. See Publication 17 - Part Two - Interest Income for details.

Business Income

Business income is income received from the sale of products or services. For example, fees received by a professional person are considered business income. Rents received by a person in the real estate business are business income. Payments received in the form of property or services must be included in income at their fair market value. Normally a business is organized as a sole proprietorship, partnership, or corporation. A sole proprietorship is an unincorporated business owned by an individual. A sole proprietorship has no existence apart from its owner. Business debts are personal debts of the owner. A limited liability company (LLC) with one individual owner generally is treated as a sole proprietorship for Federal income tax purposes unless the owner elects to treat the LLC as a corporation. A sole proprietor files Form 1040 - Schedule C - Profit or Loss From Business to report the income and expenses of the business. A partnership is an unincorporated business organization that is the result of two or more persons joining together to carry on a trade or business. Each person contributes money, property, services, or a combination thereof, in return for a right to share in the profits and losses of the partnership. An LLC with more than one owner is generally treated as a partnership for tax purposes. A partnership's income and expenses are generally reported on Form 1065 - U.S. Return of Partnership Income annually. The term "corporation," for Federal income tax purposes, generally includes legal entities separate from the people who formed them under Federal or state law or the shareholders who own them. It also includes certain businesses that elect to be taxed as a corporation by filing Form 8832 - Entity Classification Election. The tax on a corporation's income is figured on Form 1120 - U.S. Corporation Income Tax Return. (68)

Sale of Principal Residence

Under the Tax Cuts and Jobs Act a taxpayer may continue to exclude from income up to $250,000 of gain ($500,000 on a joint return in most situations) realized on the sale or exchange of a principal residence if all of the following are true: (69)

➢ He or she meets the ownership test. ➢ He or she meets the use test. ➢ During the 2-year period ending on the date of the sale, taxpayer did not exclude gain from the sale of another

home. If the taxpayer has gain that cannot be excluded, it is taxable. Report it on Form 8949 - Sales and Other Dispositions of Capital Assets and Schedule D (Form 1040) - Capital Gains and Losses. The taxpayer may also have to complete Form 4797 - Sales of Business Property. See Publication 523 - Selling Your Home for details. Do not report the 2023 sale of a main home on the tax return unless: (69)

➢ The taxpayer has a gain and does not qualify to exclude all of it. ➢ The taxpayer has a gain and chooses not to exclude it. ➢ The taxpayer received Form 1099-S.

If the taxpayer has a gain that he or she cannot or chooses not to exclude, if he or she received a Form 1099-S, or if he or she has a deductible loss, report the sale on the tax return. Report the sale on Part I, line 1 or Part II, line 3 of Form 8949 as a short-term or long-term transaction, depending on how long the taxpayer owned the home. Report the proceeds from the sale (Worksheet 2, line 1) in column (d) and the cost or other basis (Worksheet 2, line 4) in column (e). If there are any selling expenses, enter “E” in column (f) and the necessary adjustment in column (g). See the Instructions for Form 8949. Separate a taxpayer’s capital gains and losses according to how long he or she held or owned the property. The holding period for short-term capital gains and losses is 1 year or less. Report these transactions on Part I of Form 8949. The holding period for long-term capital gains and losses is more than 1 year. Report these transactions on Part II of Form 8949. To figure the holding period, begin counting on the day after the taxpayer received the property and include the day he or she disposed of it.

Lesson 3 - Taxable Income, Filing Status

Generally, if the taxpayer disposed of property that he or she acquired by inheritance, report the disposition as a long- term gain or loss regardless of how long he or she held the property. However, if the taxpayer acquired the property from someone who died in 2010 and the executor of the estate made the election to file Form 8939, see Publication 4895 - Tax Treatment of Property Acquired From a Decedent Dying in 2010.

Dividends

For many years, millions of people have invested in corporate stocks. For this reason, dividends are a popular source of income. A dividend on stock is similar to an interest payment received on a savings account, note or bond, but with two important differences. Unlike interest, the amount of the dividend is not specified by contract and dividends are not necessarily paid at regular intervals but depend upon the decision of the corporate directors to make a distribution. The most common kinds of distributions are: (70)

➢ Ordinary dividends. ➢ Capital gain distributions. ➢ Non-dividend distributions.

Most distributions are paid in cash (check). However, distributions can consist of more stock, stock rights, other property or services. See Publication 550 - Investment Income and Expenses for details. Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as stock options) are distributions by a corporation of rights to acquire the corporation's stock. Generally, stock dividends and stock rights are not taxable to an individual. However, there are some exceptions. If the stock dividends are not taxable, a taxpayer must divide his or her basis for the old stock between the old and new stock. The basis of stock must be adjusted for certain events that occur after purchase. For example, if the taxpayer receives more stock from nontaxable stock dividends or stock splits, he or she must reduce the basis of the original stock. The taxpayer must also reduce the basis when he or she receives non-dividend distributions. These distributions, up to the amount of the basis, are a nontaxable return of capital. Example Eddie bought 100 shares of stock of XYZ Corporation in 2008 for $10 a share. In January 2009 he bought another 200 shares for $11 a share. In July 2009 he gave his son 50 shares. In December 2011 he bought 100 shares for $9 a share. In April 2023 he sold 130 shares. Eddie cannot identify the shares he disposed of, so he must use the stock he acquired first to figure the basis. The shares of stock he gave his son had a basis of $500 (50 × $10). Eddie figures the basis of the 130 shares of stock he sold in 2023 as follows:

➢ 50 shares (50 × $10) balance of stock bought in 2008 - $500. ➢ 80 shares (80 × $11) stock bought in January 2009 - $880. ➢ Total basis of stock sold in 2023 = $1,380.

The basis of shares in a mutual fund (or other regulated investment company) or a real estate investment trust (REIT) is generally figured in the same way as the basis of other stock and usually includes any commissions or load charges paid for the purchase. Example The taxpayer bought 100 shares of Fund A for $10 a share. She paid a $50 commission to the broker for the purchase. Her cost basis for each share is $10.50 ($1,050 ÷ 100).

Rental Income

Generally, cash or the fair market value of property a taxpayer receives for the use of real estate or personal property is taxable to him or her as rental income. Most individuals operate on a cash basis, which means they count their rental income as income when it is actually or constructively received and deduct their expenses as they are paid. Some specific types of income are: (71)

➢ Amounts paid to cancel a lease – If a tenant pays a taxpayer to cancel a lease, this money is also rental income and is reported in the year received.

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➢ Advance rent – Generally the taxpayer includes any advance rent paid in income in the year he or she receives it regardless of the period covered or the method of accounting used.

➢ Expenses paid by a tenant – If the tenant pays any of the taxpayer’s expenses, those payments are rental income. The taxpayer may be allowed to deduct the expenses if they are considered deductible expenses.

➢ Security deposits – Do not include a security deposit in taxpayer’s income if he or she may be required to return it to the tenant at the end of the lease. But if the taxpayer keeps part or all of the security deposit because the tenant did not live up to the terms of the lease, this money is taxable income in the year the determination is made. If the taxpayer keeps the security deposit because the tenant damaged the property, the security deposit is not taxable. If the security deposit is to be used as the tenant's final month's rent, include the money as income when received, rather than when it is applied to the last month's rent.

If the rental agreement gives the tenant the right to buy the rental property, the payments received under the agreement are generally rental income. If the tenant exercises the right to buy the property, the payments received for the period after the date of sale are considered part of the selling price. (72)

If the taxpayer uses a dwelling unit as a home and he or she rents it less than 15 days during the year, its primary function is not considered to be a rental and it should not be reported on Schedule E (Form 1040). However, if the taxpayer uses a dwelling unit as a home and rents it 15 days or more during the year, include all rental income in his or her income. Since the taxpayer used the dwelling unit for personal purposes, he or she must divide the expenses between the rental use and the personal use. The expenses for personal use are not deductible as rental expenses. If the taxpayer had a net profit from renting the dwelling unit for the year (that is, if rental income is more than the total of rental expenses, including depreciation), deduct all of the rental expenses. However, if the taxpayer had a net loss from renting the dwelling unit for the year, the deduction for certain rental expenses is limited. See Publication 527 - Residential Rental Property to figure the deductible rental expenses and any carryover to the next year. Some examples of expenses that may be deducted from total rental income are: (72)

➢ Depreciation - the taxpayer begins to depreciate his or her rental property when it is placed in service. The taxpayer can recover some or all of his or her original acquisition cost and improvements by using Form 4562 - Depreciation and Amortization beginning in the year the rental property is first placed in service, and beginning in any year the taxpayer makes improvements or adds furnishings. The rental is considered placed in service when it was ready and available for rent.

➢ Repairs - repairs to keep the property in good working condition but do not add to the value of the property. ➢ Operating Expense - other expenses necessary for the operation of the rental property, such as the salaries of

employees or fees charged by independent contractors (groundkeepers, bookkeepers, accountants, attorneys, etc.) for services provided.

➢ Uncollected rents - unless taxpayer is a cash basis taxpayer and cannot deduct uncollected rents as an expense because he or she has not included those rents in income.

If the taxpayer uses a dwelling unit for both rental and personal purposes, divide the expenses between the rental use and the personal use based on the number of days used for each purpose. When dividing the expenses, follow these rules: (72)

➢ Any day that the unit is rented at a fair rental price is a day of rental use even if the taxpayer used the unit for personal purposes that day. (This rule does not apply when determining whether the taxpayer used the unit as a home.)

➢ Any day that the unit is available for rent but not actually rented is not a day of rental use.

Flow-Through Entities

The payees of payments (other than income effectively connected with a U.S. trade or business) made to a foreign flow- through entity are the owners or beneficiaries of the flow-through entity. This rule applies for purposes of Nonresident Alien (NRA) withholding and for Form 1099 reporting and backup withholding. Income that is, or is deemed to be, effectively connected with the conduct of a U.S. trade or business of a flow-through entity, is treated as paid to the entity. All of the following are flow-through entities: (73)

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➢ A foreign partnership (other than a withholding foreign partnership and partnerships claiming treaty benefits as entities that are not fiscally transparent).

➢ A foreign simple or foreign grantor trust (other than a withholding foreign trust), and foreign simple and foreign grantor trusts claiming treaty benefits as entities that are not fiscally transparent.

➢ An entity receiving income for which treaty benefits are claimed by an interest holder in the entity and the entity is considered fiscally transparent.

Generally, an individual treats a payee as a flow-through entity if it provides him or her with a Form W-8IMY - Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding on which it claims such status. The person may also be required to treat the entity as a flow-through entity under the presumption rules.

Alimony

After the divorce or legal separation, the wife or husband loses the right to participate in the former spouse’s earnings. If many years of marriage have intervened, he or she may have lost marketable job skills, and advanced age could place such a person at a disadvantage in the labor market. This person may be entitled to alimony. A taxpayer cannot deduct alimony or separate maintenance payments made under a divorce or separation agreement (1) executed after 2018, or (2) executed before 2019 but later modified if the modification expressly states the repeal of the deduction for alimony payments applies to the modification. Also, alimony and separate maintenance payments a taxpayer receives under such an agreement are not included in his or her gross income.

An amendment to a divorce decree may change the nature of the taxpayer’s payments. Amendments are not ordinarily retroactive for Federal tax purposes. However, a retroactive amendment to a divorce decree correcting a clerical error to reflect the original intent of the court will generally be effective retroactively for Federal tax purposes.

Review Question 1 A court order retroactively corrected a mathematical error under a taxpayer’s divorce decree to express the original intent to spread the payments over more than 10 years. Which of the following is true regarding this change for Federal tax purposes?

A. This change is not effective for Federal tax purposes B. This change is effective retroactively for Federal tax purposes C. This change is only effective for the current tax year for Federal tax purposes D. This change is only effective for future tax years for Federal tax purposes

See Review Feedback for answer.

Certain Government Payments

Federal, state, or local governments file Form 1099-G - Certain Government Payments if they made taxable payments of unemployment compensation; state or local income tax refunds, credits, or offsets; reemployment trade adjustment assistance (RTAA) payments; taxable grants; or agricultural payments. They also file this form if they received payments on a Commodity Credit Corporation (CCC) loan.

Pensions and Annuities

The pension or annuity payments that a taxpayer receives are fully taxable if he or she has no cost in the contract because any of the following situations: (74)

➢ The taxpayer did not pay anything or is not considered to have paid anything for the pension or annuity. Amounts withheld from his or her pay on a tax-deferred basis are not considered part of the cost of the pension or annuity payment.

➢ The taxpayer’s employer did not withhold contributions from his or her salary. ➢ The taxpayer received all of his or her contributions tax free in prior years.

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or her when contributed. Partly taxable pensions are taxed under either the General Rule or the Simplified Method. If the starting date of the pension or annuity payments is after November 18, 1996, the taxpayer generally must use the Simplified Method to determine how much of the annuity payments are taxable and how much is tax free. See Publication 575 - Pension and Annuity Income for details.

Virtual Currency

The sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability. This guidance applies to individuals and businesses that use virtual currencies. Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies. For Federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency. The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset. (75)

Gross Income

Generally, a taxpayer must file a return if his or her gross income equals or exceeds the standard deduction amount applicable to the taxpayer. The Standard Deduction is based on filing status, age and eyesight. Gross income is income from all sources, except for items specifically excluded by the Internal Revenue Code. Income on an individual's annual income tax return typically is the sum of wages and other items of income less the exclusions. The precise amount of gross income is important in order to determine whether the taxpayer must file a return. Except as otherwise provided, gross income means all income from whatever source derived, including (but not limited to) the following items: (76)

➢ Compensation for services, including fees, commissions, fringe benefits, and similar items. ➢ Gross income derived from business. ➢ Gains derived from dealings in property. ➢ Interest. ➢ Rents. ➢ Royalties. ➢ Dividends. ➢ Alimony and separate maintenance payments. ➢ Annuities. ➢ Income from life insurance and endowment contracts. ➢ Pensions. ➢ Income from discharge of indebtedness. ➢ Distributive share of partnership gross income. ➢ Income in respect of a decedent. ➢ Income from an interest in an estate or trust.

Adjustments to Gross Income

The following are major items, within limits, allowed by law to be subtracted from gross income: ➢ Educator Expenses. ➢ Health savings account deduction. ➢ One-half of self-employment tax.

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➢ Self-employed SEP, SIMPLE, and qualified plans. ➢ Self-employed health insurance deduction. ➢ IRA deduction. ➢ Student loan interest deduction.

Adjusted Gross Income (AGI)

Adjusted gross income is the remainder of gross income after subtraction of allowed adjustments above. This intermediate amount is important because it is used for computing deductions, tax credits, and other tax benefits that are based on or limited by income. The deductions for medical expenses, contributions, casualty losses and miscellaneous itemized deductions are all based on or limited by the amount of adjusted gross income.

Deductions from Adjusted Gross Income

Some deductions are allowed for expenses of a personal nature. These are divided into the following categories:

1. Certain Medical and Dental Expenses. 2. Paid interest and taxes on the home. 3. Gifts to Charity. 4. Casualty and Theft Losses (only for those losses attributable to a Federal disaster as declared by the President).

Deductions from adjusted gross income are sometimes referred to as personal deductions; however, calling these expenses personal deductions can result in confusion. Most personal expenses, such as food, clothing, shelter, entertainment, and the like, are not deductible. A more appropriate designation is itemized deductions.

Standard Deduction

In 2023, the standard deduction amounts increased to $13,850 for individuals, to $20,800 for heads of household, and to $27,700 for married couples filing jointly and surviving spouses. (77)

Standard Deductions - 2023 Tax Year

Filing Status Standard Deduction Amount

Single $13,850

Married Filing Jointly $27,700

Married Filing Separately $13,850

Heads of Household $20,800

Surviving Spouse $27,700

Table 3-9 - Revenue Procedure 2022-38 (2023)

For 2023, the additional standard deduction for married taxpayers 65 or over or blind will be $1,500. For a single taxpayer or head of household who is 65 or over or blind, the additional standard deduction for 2023 will be $1,850. A person is considered to reach age 65 on the day before his or her 65th birthday. The taxpayer cannot claim the higher standard deduction for an individual other than him or herself and his or her spouse. For 2023, the standard deduction amount for an individual who may be claimed as a dependent by another taxpayer cannot exceed the greater of $1,250 or the sum of $400 and the individual’s earned income.

Net Taxable Income

The final remainder is the net taxable income. This amount is the base for the tax; the rates are applied to this amount to determine the gross tax liability.

Tax Liability

Computation of Gross Tax Liability using the Tax Table

After determining a taxpayer's taxable income and his or her filing status, arriving at his or her gross tax liability is a relatively simple chore. In fact, today’s tax preparation software will do this for the taxpayer. Remember, he or she can still

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refer to or check the amount by referring to the correct column (filing status) on the Tax Table provided by the Internal Revenue Service.

The Tax Table is set up based on amounts of taxable income below $100,000. A column is provided for each tax status, and the tax is determined by locating the amount shown under the correct column to the right of the taxable income amount. A person having taxable income of $100,000 or more must use the Tax Computation Worksheet (based on the Tax Rate Schedules) also provided by the IRS.

Net Tax Liability

The final step in the tax formula is the determination of the net tax liability, the amount of money, which the taxpayer must pay with the filed tax return, or the amount that the tax filer will receive back from the government. To determine this amount, the following taxes, credits, and payments must be either added or subtracted.

Alternative Minimum Tax

The Alternative Minimum Tax (AMT) applies to taxpayers who have certain types of income that receive favorable treatment, or who qualify for certain deductions, under the tax law. These tax benefits can significantly reduce the regular tax of some taxpayers with higher economic incomes. The AMT sets a limit on the amount these benefits can be used to reduce total tax. Here are some facts the Internal Revenue Service wants the taxpayer to know about the AMT and changes for 2023: (78)

1. Tax laws provide tax benefits for certain kinds of income and allow special deductions and credits for certain expenses. These benefits can drastically reduce some taxpayers’ tax obligations. Congress created the AMT in 1969, targeting higher-income taxpayers who could claim so many deductions they owed little or no income tax.

2. The taxpayer may have to pay the AMT if his or her taxable income for regular tax purposes, plus any adjustments and preference items that apply to the taxpayer, are more than the AMT exemption amount.

3. The AMT exemption amounts are set by law for each filing status. 4. For tax year 2023, Congress raised the AMT exemption amounts to the following levels:

a. $126,500 for a married couple filing a joint return and surviving spouses. b. $81,300 for singles and heads of household. c. $63,250 for married, filing separately.

5. The minimum AMT exemption amount for a child whose unearned income is taxed at the parents' tax rate has increased to $8,800 for 2023.

Tax Credits

There are several credits that can be taken to further offset tax liability. The major tax credits are as follows:

➢ Earned Income Tax Credit (EITC). ➢ Credit for the Elderly or the Disabled. ➢ Education credits. ➢ Retirement Savings Contributions Credit. ➢ Adoption Credit. ➢ Foreign Tax Credit. ➢ Child Tax Credit. ➢ Child and Dependent Care Credit.

Tax credits do not have the same effect as deductions. Deductions such as IRA deductions and excess itemized deductions reduce the income amount on which the tax is levied. Credits, on the other hand, are subtracted directly from the gross tax liability. If a taxpayer, for example, is in the 15% bracket on the applicable tax table, a $100 deduction reduces their tax liability by only $15. If, on the other hand, he or she has a tax credit of $100, this will reduce their tax liability by a full $100. See Publication 17 - Part Four - Figuring Your Taxes and Credits for complete details.

Tax Payments

Most taxpayers who earned income will have already paid some portion of their tax liability during the course of the year. Examples include: (79)

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➢ Federal income tax withheld from Forms W-2 and 1099. ➢ 2023 estimated tax payments and amount applied from 2022 return. ➢ Earned Income Tax Credit (EITC). ➢ Nontaxable combat pay election. ➢ Additional Child Tax Credit. ➢ American Opportunity Tax Credit. ➢ Amount paid with request for extension to file. ➢ Excess Social Security and tier 1 RRTA tax withheld.

The most obvious subtraction in this category is the amount of Federal income tax that has been withheld from the employee's pay (reported by employers on Form W-2 - Wage and Tax Statement). Other forms of payments are estimated taxes paid by self-employed individuals, and excess amounts of Social Security taxes that have been withheld from an employee's pay. Also included here is the amount for Earned Income Tax Credit, the additional Child Tax Credit, and the American Opportunity Tax Credit.

Form W-2 - Wage and Tax Statement

Every employer engaged in a trade or business who pays remuneration, including noncash payments of $600 or more for the year (all amounts if any income, Social Security, or Medicare tax was withheld) for services performed by an employee must file a Form W-2 for each employee (even if the employee is related to the employer) from whom: (80)

➢ Income, Social Security, or Medicare tax was withheld. ➢ Income tax would have been withheld if the employee had claimed no more than one withholding allowance or

had not claimed exemption from withholding on Form W-4, Employee's Withholding Certificate.

Tax Withholding

The Federal income tax is a pay-as-you-go tax. There are two ways to pay-as-you-go. The first is withholding. If the taxpayer is an employee, his or her employer probably withholds income tax from his or her pay. Tax may also be withheld from certain other income - including pensions, bonuses, commissions, and gambling winnings. In each case, the amount withheld is paid to the IRS in the taxpayer’s name. See Publication 17 - Part One - Tax Withholding and Estimated Tax for complete information. The amount of income tax the employer withholds from regular pay depends on two things: (81)

➢ The amount the taxpayer earns. ➢ The information the taxpayer gives his or her employer on Form W-4 - Employee's Withholding Certificate.

Form W-4 includes three types of information that the employer will use to figure the withholding: (81)

➢ Whether to withhold at the single rate or at the lower married rate. ➢ How many withholding allowances the taxpayer claims (each allowance reduces the amount withheld). ➢ Whether the taxpayer wants an additional amount withheld.

The taxpayer must specify a filing status and a number of withholding allowances on Form W-4. He or she cannot specify only a dollar amount of withholding.

Estimated Tax Payments

The second pay-as-you-go method is estimated tax payments. Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards. The taxpayer may also have to pay estimated tax if the amount of income tax being withheld from his or her salary, pension, or other income is not enough. (82) Estimated tax is used to pay income tax and self-employment tax, as well as other taxes and amounts reported on the tax return. If the taxpayer does not pay enough through withholding or estimated tax payments, he or she may be charged a penalty. If the taxpayer does not pay enough by the due date of each payment period, he or she may be charged a penalty even if he or she is due a refund when the tax return is filed. U.S. citizens with no tax liability in the previous full 12-month tax year are not required to pay estimated tax.

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Estimated tax liability exists for 2023 when both of the following apply: (82)

1. The taxpayer expects to owe at least $1,000 in tax for 2023, after subtracting his or her withholding and refundable credits.

2. The taxpayer expects his or her withholding plus his or her refundable credits to be less than the smaller of either: a. 90% of the tax to be shown on the taxpayer’s 2023 tax return. b. 100% of the tax shown on the taxpayer’s 2022 tax return (there are special rules for farmers, fishermen,

and higher income taxpayers). The taxpayer’s 2022 tax return must cover all 12 months. If the taxpayer is filing as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual, he or she generally will have to make estimated tax payments if he or she expects to owe tax of $1,000 or more when filing the return. If the taxpayer is filing as a corporation, he or she generally has to make estimated tax payments for the corporation if he or she expects it to owe tax of $500 or more when filing its return. The taxpayer does not have to pay estimated tax for the current year if he or she meets all three of the following conditions:

1. The taxpayer had no tax liability for the prior year. 2. The taxpayer was a U.S. citizen or resident for the whole year. 3. The taxpayer’s prior tax year covered a 12-month period.

When figuring the estimated tax for the current year, it may be helpful to use the taxpayer’s income, deductions, and credits for the prior year as a starting point. Use the worksheet in Form 1040-ES - Estimated Tax for Individuals to figure the estimated tax. It is important to remember to make adjustments both for changes in the taxpayer’s work situation and for recent changes in the tax law. See Publication 17 - Part One - Tax Withholding and Estimated Tax for complete information. For estimated tax purposes, the year is divided into four payment periods. Each period has a specific payment due date. If the taxpayer does not pay enough tax by the due date of each of the payment periods, he or she may be charged a penalty even if he or she is due a refund when the taxpayer files the income tax return. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. The penalty may also be waived if: (82)

➢ The failure to make estimated payments was caused by a casualty, disaster, or other unusual circumstance and it would be inequitable to impose the penalty.

Review Question 2 If a taxpayer is filing as a sole proprietor, he or she generally will have to make estimated tax payments if he or she expects to owe tax of what amount or more when filing the return?

A. $1,000 B. $2,000 C. $3,000 D. $4,000

See Review Feedback for answer.

Presidential Election Campaign Fund

This fund helps pay for Presidential election campaigns. If the taxpayer would like $3 to go to this fund, check the box on the tax return. If the taxpayer is filing a joint return, his or her spouse can also have $3 go to the fund. If the taxpayer checks a box on the tax return, his or her tax or refund will not change.

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Computations

The taxpayer can round off cents to whole dollars on his or her return and schedules. If he or she does round to whole dollars, he or she must round all amounts. To round, drop amounts under 50 cents and increase amounts from 50 to 99 cents to the next dollar. For example, $1.39 becomes $1 and $2.50 becomes $3. If the taxpayer has to add two or more amounts to figure the amount to enter on a line, include cents when adding the amounts and round off only the total.

Filing Status The tax law divides taxpayers into five status categories based on their family responsibilities. This is referred to as the taxpayer's filing status. Because the tax rates differ for each filing status, separate tax rate schedules and tax tables are prepared by the Internal Revenue Service. See Publication 17 - Part One - Filing Status for details. Here are eight facts about the five filing status options the IRS wants the taxpayer to know so that he or she can choose the best option for their situation. (83)

1. Marital status on the last day of the year determines marital status for the entire year. 2. If more than one filing status applies, choose the status that gives the taxpayer the lowest tax obligation. 3. Single filing status generally applies to anyone who is unmarried, divorced or legally separated according to state

law. 4. A married couple may file a joint return together. The couple’s filing status would be Married Filing Jointly. 5. If a spouse died during the year and the taxpayer did not remarry during the tax year, usually he or she may still

file a joint return with that spouse for the year of death. 6. A married couple may elect to file their returns separately. Each person’s filing status would generally be Married

Filing Separately. 7. Head of household generally applies to taxpayers who are unmarried. The taxpayer must also have paid more

than half the cost of maintaining a home for him or her and a qualifying person to qualify for this filing status. 8. In 2023, the taxpayer may be able to choose Surviving Spouse with Dependent Child as his or her filing status if

a spouse died during 2021 or 2022, he or she has a dependent child and he or she meets certain other conditions.

Single

A taxpayer’s filing status is single if the person never married or if, on the last day of the year, the person is unmarried or legally separated under a divorce or separate maintenance decree. The taxpayer is considered unmarried for the whole year if, on the last day of his or her tax year, he or she is either: (84)

➢ Unmarried, or ➢ Legally separated from his or her spouse under a divorce or separate maintenance decree.

State law governs whether the taxpayer is married or legally separated under a divorce or separate maintenance decree. If the taxpayer is divorced under a final decree by the last day of the year, he or she is considered unmarried for the whole year. If the taxpayer obtains a divorce for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce he or she intends to and does, in fact, remarry each other in the next tax year, the taxpayer and his or her spouse must file as married individuals in both years. If the taxpayer obtains a court decree of annulment, which holds that no valid marriage ever existed, he or she is considered unmarried even if he or she filed joint returns for earlier years. The taxpayer must file amended returns (Form 1040-X) claiming single or head of household status for all tax years that are affected by the annulment and not closed by the statute of limitations for filing a tax return. Generally, for a credit or refund, the taxpayer must file Form 1040-X within 3 years (including extensions) after the date he or she filed his or her original return or within 2 years after the date he or she paid the tax, whichever is later. If the taxpayer filed his or her original tax return early (for example, March 1), his or her return is considered filed on the due date (generally April 15). However, if the taxpayer had an extension to file (for example, until October 15) but he or she filed early and the IRS received it on July 1, his or her return is considered filed on July 1.

Married, Filing a Joint Return

The determination of whether an individual is married shall be made as of the close of his or her taxable year; except that

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if his or her spouse dies during the taxable year such determination shall be made as of the time of such death or an individual legally separated from his or her spouse under a decree of divorce or of separate maintenance shall not be considered as married. There are many advantages to filing a joint tax return. The IRS gives joint filers one of the largest standard deductions each year, allowing them to deduct a significant amount of their income immediately. Also married couples who file together qualify for multiple tax credits such as the Earned Income Tax Credit, the American Opportunity and Lifetime Learning Credits, the exclusion or credit for adoption expenses, and the Child and Dependent Care Credit. Joint filers also receive higher income thresholds for certain taxes and deductions which means they can earn a larger amount of income and still qualify for certain tax breaks. A joint return may be filed under the following conditions: (83)

➢ If the individuals are married as of the last day of the taxable year. A couple could be married at 11:59.59 p.m. on December 31 of the taxable year and still file a joint return for the entire year.

➢ If one spouse dies during the taxable year, provided that the surviving spouse has not remarried during the year. If remarried, the taxpayer may file jointly with his or her new spouse.

➢ If the individuals are not divorced or legally separated before the end of the taxable year under a final decree. ➢ If both spouses agree to file a joint return. ➢ If a non-resident alien is married to a citizen of the United States and they both elect to be taxed on their worldwide

income. ➢ If the tax years of both spouses begin on the same date.

In some cases, one spouse may be relieved of joint responsibility for tax, interest, and penalties on a joint return for items of the other spouse that were incorrectly reported on the joint return. The taxpayer can ask for relief no matter how small the liability. There are three types of relief available: (42)

1. Innocent spouse relief. 2. Separation of liability, (available only to joint filers who are divorced, widowed, legally separated, or have not lived

together for the 12 months ending on the date the election for this relief is filed). 3. Equitable relief.

The taxpayer must file Form 8857 - Request for Innocent Spouse Relief to request relief from joint responsibility. Publication 971 - Innocent Spouse Relief, explains these kinds of relief and who may qualify for them.

Surviving Spouse With Dependent Child

Surviving spouses with a dependent child may also use the same tax tables and tax rate schedules as used by joint filers (up to 2 years after year of spouse’s death). A surviving spouse is a widow or widower whose spouse died not earlier than the second preceding taxable year and who has a dependent child, stepchild, adopted child, or foster child living with him or her for the entire year. To illustrate, a taxpayer's husband died in July 2023. The taxpayer has a dependent son who lives with her. For 2023, she may file a joint return because she was still married on the date of her spouse's death. For 2024 and 2025, she qualifies as a surviving spouse. For 2026 and later years, she is not a surviving spouse because her husband died earlier than the second preceding taxable year. A taxpayer is eligible to file his or her 2023 income tax return as a surviving spouse with dependent child if he or she meets all of the following tests: (85)

1. The taxpayer was entitled to file a joint return with his or her spouse for the year his or her spouse died. It does not matter whether the taxpayer actually filed a joint return.

2. The taxpayer’s spouse died in 2021 or 2022 and the taxpayer did not remarry before the end of 2023. 3. The taxpayer has a child or stepchild for whom he or she can claim as a dependent. 4. This child lived in the taxpayer’s home all year, except for temporary absences. There are exceptions for a child

who was born or died during the year and for a kidnapped child. 5. The taxpayer paid more than half the cost of keeping up a home for the year.

Lesson 3 - Taxable Income, Filing Status

Example Reed Johnson's wife died in 2021. Reed has not remarried. He has continued during 2022 and 2023 to keep up a home for himself and his child, who lives with him and for whom he can claim as a dependent. For 2021, he was entitled to file a joint return for himself and his deceased wife. For 2022 and 2023, he can file as a surviving spouse with a dependent child. After 2023, he can file as head of household if he qualifies.

Married Taxpayers Filing Separately

Taxpayers who are married but elect to file separate returns must use a rate schedule which provides for the highest tax of all the classes. Normally, it will not be advantageous for married taxpayers to make this election. One consideration, however, which might lead a married person to file separate return, is the joint liability for the tax on a joint return. If one spouse fails to pay the tax, the other will have to pay the spouse’s portion. If the taxpayer chooses married filing separately as his or her filing status, the following special rules apply. Because of these special rules, the taxpayer usually pays more tax on a separate return than if he or she uses another filing status for which he or she qualifies: (86)

1. The taxpayer’s tax rate generally is higher than on a joint return. 2. The taxpayer’s exemption amount for figuring the alternative minimum tax is half that allowed on a joint return. 3. In 2023, the taxpayer cannot take the Credit for Child and Dependent Care Expenses in most cases, and the

amount he or she can exclude from income under an employer's dependent care assistance program is limited to $2,500 (instead of $5,000 on a joint return). If the taxpayer is legally separated or living apart from his or her spouse, the taxpayer may be able to file a separate return and still take the credit. See Joint Return Test in Publication 503 - Child and Dependent Care Expenses, for more information.

4. The taxpayer cannot take the exclusion or credit for adoption expenses in most cases. 5. The taxpayer cannot take the education credits (the American Opportunity Tax Credit and Lifetime Learning

Credit) or the deduction for student loan interest. 6. The taxpayer cannot exclude any interest income from qualified U.S. savings bonds he or she used for higher

education expenses. 7. If the taxpayer lived with his or her spouse at any time during the tax year:

a. The taxpayer cannot claim the Credit for the Elderly or the Disabled. b. The taxpayer must include in income a greater percentage (up to 85%) of any Social Security or equivalent

railroad retirement benefits he or she received. 8. The following credits are reduced at income levels half those for a joint return:

a. The Child Tax Credit. b. The Retirement Savings Contributions Credit.

9. The taxpayer’s capital loss deduction limit is $1,500 (instead of $3,000 on a joint return). 10. If the taxpayer’s spouse itemizes deductions, the taxpayer cannot claim the standard deduction. If the taxpayer

can claim the standard deduction, his or her basic standard deduction is half the amount allowed on a joint return.

Head of Household

If the taxpayer qualifies to file as head of household, his or her tax rate usually will be lower than the rates for single or married filing separately. The taxpayer will also receive a higher standard deduction than if he or she files as single or married filing separately. To qualify as a head of household, a taxpayer must meet the following conditions: (87)

1. The taxpayer is unmarried or considered unmarried on the last day of the year. 2. The taxpayer paid more than half the cost of keeping up a home for the year. 3. A qualifying person lived with the taxpayer in the home for more than half the year (except for temporary absences,

such as school). However, if the qualifying person is the taxpayer’s dependent parent, he or she does not have to live with him or her.

If the taxpayer’s qualifying person is his or her father or mother, he or she may be eligible to file as head of household even if his or her father or mother does not live with him or her. However, the taxpayer must be able to claim his or her father or mother as a dependent. Also, he or she must pay more than half the cost of keeping up a home that was the main home for the entire year for his or her father or mother. If the taxpayer pays more than half the cost of keeping his or her parent in a rest home or home for the elderly, that counts as paying more than half the cost of keeping up his or her parent's main home.

Lesson 3 - Taxable Income, Filing Status

Example The taxpayer is unmarried. His or her mother, for whom the taxpayer can claim as a dependent, lived in rest home by herself. She died on September 2. The cost of the upkeep of her apartment for the year until her death was $6,000. The taxpayer paid $4,000 and his or her brother paid $2,000. The taxpayer’s brother made no other payments towards his mother's support. The taxpayer’s mother had no income. Because the taxpayer paid more than half of the cost of keeping up the mother's apartment from January 1 until her death, and the taxpayer can claim her as a dependent, the taxpayer can file as a head of household.

If the person is the taxpayer’s qualifying child (such as a son, daughter, or grandchild who lived with him or her more than half the year and meets certain other tests), and he or she is married and the taxpayer cannot claim him or her as a dependent, then that person is not a qualifying person.

To qualify for head of household status, the taxpayer must be either unmarried or considered unmarried on the last day of the year. He or she is considered unmarried on the last day of the tax year if he or she meets all the following tests: (88)

1. The taxpayer files a separate return. 2. The taxpayer paid more than half the cost of keeping up his or her home for the tax year. 3. The taxpayer’s spouse did not live in his or her home during the last 6 months of the tax year. The taxpayer’s

spouse is considered to live in his or her home even if he or she is temporarily absent due to special circumstances. 4. The taxpayer’s home was the main home of his or her child, stepchild, or foster child for more than half the year. 5. The taxpayer must be able to claim the child as a dependent. However, the taxpayer meets this test if he or she

cannot claim the child as a dependent only because the noncustodial parent can claim the child.

To qualify for head of household status, the taxpayer must pay more than half of the cost of keeping up a home for the year. If the total amount the taxpayer paid is more than the amount others paid, he or she meets the requirement of paying more than half the cost of keeping up the home. A taxpayer should include in the cost of keeping-up-a-home expenses such as rent, mortgage interest, real estate taxes, insurance on the home, repairs, utilities, and food eaten in the home. Do not include the costs of clothing, education, medical treatment, vacations, life insurance, or transportation. Also, do not include the rental value of a home the taxpayer owns or the value of his or her services or those of a member of his or her household. If the taxpayer used payments he or she received under Temporary Assistance for Needy Families (TANF) or other public assistance programs to pay part of the cost of keeping up the home, he or she cannot count them as money he or she paid. However, the taxpayer must include them in the total cost of keeping up the home to figure if he or she paid over half the cost.

The taxpayer may be eligible to file as head of household even if the individual who qualifies him or her for this filing status is born or dies during the year. The taxpayer must have provided more than half the cost of keeping up a home that was the individual's main home for more than half the part of the year he or she was alive.

Review Question 3 Which of the following is a requirement that must be met in determining whether a taxpayer is eligible for head of household filing status purposes?

A. The taxpayer’s spouse must not have lived in their home for the entire tax year B. The taxpayer must be divorced or legally separated for over one year C. A taxpayer must pay less than one-half the cost of keeping up a home for the tax year D. The taxpayer’s home must be, for at least 6 months, the main home of his or her child, stepchild, or

adopted child whom he or she can properly claim as a dependent

See Review Feedback for answer.

Qualifying Child for Head of Household Filing Status

Five tests must be met for a child to be the taxpayer’s qualifying child. The five tests are: (88)

1. Relationship. 2. Age. 3. Residency.

Lesson 3 - Taxable Income, Filing Status

4. Support. 5. Joint return.

To meet the relationship test, a child must be: (88)

➢ The taxpayer’s son, daughter, stepchild, foster child, or a descendant (for example, his or her grandchild) of any

of them. ➢ The taxpayer’s brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant (for example, his

or her niece or nephew) of any of them. ➢ An adopted child is always treated as the taxpayer’s own child. The term “adopted child” includes a child who was

lawfully placed with him or her for legal adoption. A foster child is an individual who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction.

To meet the age test, a child must be: (88)

➢ Under age 19 at the end of the year and younger than the taxpayer. ➢ A student under age 24 at the end of the year and younger than the taxpayer. ➢ Permanently and totally disabled at any time during the year, regardless of age.

To meet the residency test, the taxpayer’s child must have lived with him or her for more than half the year. There are exceptions for temporary absences, children who were born or died during the year, kidnapped children, and children of divorced or separated parents. For example, the taxpayer’s child is considered to have lived with him or her during periods of time when the taxpayer, the child, or both, are temporarily absent due to special circumstances such as illness, education, business, vacation, or military service. To meet the support test to be a qualifying child, the child cannot have provided more than half of his or her own support for the year. To meet the joint return test, the child cannot file a joint return for the year. An exception to the joint return test applies if the taxpayer’s child and his or her spouse file a joint return only to claim a refund of income tax withheld or estimated tax paid.

Qualifying Relative for Head of Household Filing Status

Four tests must be met for a person to be the taxpayer’s qualifying relative. The four tests are: (88)

1. Not a qualifying child test. 2. Member of household or relationship test. 3. Gross income test. 4. Support test.

Unlike a qualifying child, a qualifying relative can be any age. There is no age test for a qualifying relative.

For the not a qualifying child test, a child is not the taxpayer’s qualifying relative if the child is his or her qualifying child or the qualifying child of any other taxpayer.

To meet the member of household or relationship test, a person must either: (88)

➢ Live with the taxpayer all year as a member of his or her household. ➢ Be related to the taxpayer in one of the ways listed below who does not have to live with the taxpayer.

If at any time during the year the person was the taxpayer’s spouse, that person cannot be his or her qualifying relative. A person related to the taxpayer in any of the following ways does not have to live with the taxpayer all year as a member of the household to meet the relationship test: (88)

➢ The taxpayer’s child, stepchild, foster child, or a descendant of any of them (for example, a grandchild). (A legally adopted child is considered the taxpayer’s child the year the adoption becomes final.)

Lesson 3 - Taxable Income, Filing Status

➢ The taxpayer’s brother, sister, half-brother, half-sister, stepbrother, or stepsister. ➢ The taxpayer’s father, mother, grandparent, or other direct ancestor, but not foster parent. ➢ The taxpayer’s stepfather or stepmother. ➢ A son or daughter of the taxpayer’s brother or sister. ➢ A son or daughter of the taxpayer’s half-brother or half-sister. ➢ A brother or sister of the taxpayer’s father or mother. ➢ The taxpayer’s son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.

To meet the gross income test, a person's gross income for the year must be less than $4,700 in 2023. To meet support test to be a qualifying relative, the taxpayer generally must provide more than half of a person's total support during the calendar year.

Examples of a Qualifying Person

Example 1 - Child The taxpayer’s unmarried son lived with him or her all year and was 18 years old at the end of the year. He did not provide more than half of his own support and does not meet the tests to be a qualifying child of anyone else. As a result, he is the taxpayer’s qualifying child and, because he is single, the taxpayer’s qualifying person for head of household purposes. Example 2 - Child who is not qualifying person The facts are the same as in Example 1 except the taxpayer’s son was 25 years old at the end of the year and his gross income was $5,000. Because he does not meet the age test, the taxpayer’s son is not his or her qualifying child. Also, he does not meet the gross income test, so he is not a qualifying relative. As a result, he is not the taxpayer’s qualifying person for head of household purposes. Example 3 - Girlfriend The taxpayer’s girlfriend lived with him all year. Even though she may be a qualifying relative if the gross income and support tests are met, she is not a qualifying person for head of household purposes because she is not related to the taxpayer in one of the ways listed above under relatives who do not have to live with the taxpayer. Example 4 - Girlfriend's child The facts are the same as in Example 3 except the taxpayer’s girlfriend's 10-year-old son also lived with him all year. He is not a qualifying child and, because he is the taxpayer’s girlfriend's qualifying child, he is not a qualifying relative. As a result, he is not the taxpayer’s qualifying person for head of household purposes.

Due Diligence Requirements

The Tax Cuts and Jobs Act (TCJA) expands a paid preparer’s due diligence and record keeping requirements under IRC Section 6695(g) to include determining a client’s eligibility to file as head of household. It also imposes a penalty for each failure. Due diligence requirements are already in place on Form 8867 - Paid Preparer’s Due Diligence Checklist for Child Tax Credit, American Opportunity Tax Credit and Earned Income Tax Credit.

Review Question 4 Tanya is single and lives in an apartment for which she pays all the expenses. An unrelated 6-year-old child has been living with her since May. She is raising the child on her own and receives no financial assistance. The child was not placed by an authorized adoption agency and Tanya has filed for adoption although it is not yet final. She has no other dependents. Which of the following statements is correct?

A. Tanya can file as head of household B. Tanya can claim a credit for qualified adoption expenses in the current year, even if the adoption is

not final C. Tanya can claim the child as her dependent on her return D. None of the above

See Review Feedback for answer.

Lesson 3 - Taxable Income, Filing Status

Special Filing Situations

Nonresident and Dual Status Aliens

If the taxpayer is an alien (not a U.S. citizen), he or she is considered a nonresident alien unless he or she meets one of two tests: (89)

➢ The green card test. ➢ The substantial presence test for the calendar year (January 1-December 31).

For tax purposes, the taxpayer is a Lawful Permanent Resident of the United States, at any time, if he or she has been given the privilege, according to the immigration laws, of residing permanently in the United States as an immigrant. He or she generally has this status if the U.S. Citizenship and Immigration Service (USCIS) issued the taxpayer an alien registration card, Form I-551, also known as a green card. The taxpayer will be considered a U.S. resident for tax purposes if he or she meets the substantial presence test for the calendar year. To meet this test, the taxpayer must be physically present in the United States on at least: (89)

1. 31 days during the current year, and 2. 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:

a. All the days he or she was present in the current year, and b. 1/3 of the days he or she was present in the first year before the current year, and c. 1/6 of the days he or she was present in the second year before the current year.

If the individual meets the green card test at any time during the calendar year but does not meet the substantial presence test for that year, his or her residency starting date is the first day on which he or she is present in the United States as a Lawful Permanent Resident. However, an alien who has been present in the United States at any time during a calendar year as a Lawful Permanent Resident may choose to be treated as a resident alien for the entire calendar year.

Review Question 5 Carla will be considered a U.S. resident for tax purposes if she meets the substantial presence test for calendar year 2023. Carla was physically present in the United States on 120 days in each of the years 2021, 2022, and 2023. She counts how many days in this 3-year period to determine if she meets the substantial presence test for 2023?

A. 20 days B. 120 days C. 180 days D. 360 days

See Review Feedback for answer.

The taxpayer is a dual status alien when he or she has been both a resident alien and a nonresident alien in the same tax year. Dual status does not refer to citizenship, only to resident status for tax purposes in the United States. In determining U.S. income tax liability for a dual-status tax year, different rules apply for the part of the year the taxpayer is a resident of the United States and the part of the year he or she is a nonresident. The most common dual-status tax years are the years of arrival and departure. For the part of the year the taxpayer is a resident alien, he or she is taxed on income from all sources. Income from sources outside the United States is taxable if he or she receives it while a resident alien. The income is taxable even if the taxpayer earned it while he or she was a nonresident alien or if he or she became a nonresident alien after receiving it and before the end of the year. For the part of the year the taxpayer is a nonresident alien, he or she is taxed on income from U.S. sources only. If a taxpayer is a nonresident alien, he or she may file a joint return if he or she is married to a U.S. citizen or resident at the end of the year. If the couple files a joint return, both spouses are treated as U.S. residents for the entire year and both spouses are taxed on worldwide income. Most types of U.S. source income received by a foreign taxpayer are subject to a tax rate of 30%.

Lesson 3 - Taxable Income, Filing Status

A scholarship, fellowship or grant received by a nonresident alien for activities conducted outside the United States is treated as foreign source income.

If the taxpayer is a resident alien on the last day of the tax year and reports income on a calendar year basis, he or she must file no later than April 15 of the year following the close of the tax year. If the taxpayer reports his or her income on other than a calendar year basis, file the return no later than the 15th day of the 4th month following the close of the tax year. In either case, file the return with the Internal Revenue Service indicated in the Form 1040 Instructions. If the taxpayer is a nonresident alien on the last day of the tax year and reports income on a calendar year basis, he or she must file no later than April 15 of the year following the close of the tax year if he or she receives wages subject to withholding. If the taxpayer reports income on other than a calendar year basis, file the return no later than the 15th day of the 4th month following the close of the tax year. If the taxpayer did not receive wages subject to withholding and reports income on a calendar year basis, he or she must file no later than June 15 of the year following the close of the tax year. If the taxpayer reports income on other than a calendar year basis, file the return no later than the 15th day of the 6th month following the close of the tax year. In any case, file the return with the Internal Revenue Service indicated in the Form 1040-NR Instructions. (90) Nonresident aliens are not subject to self-employment tax unless an international Social Security agreement in effect determines that they are covered under the U.S. Social Security system. Residents of the U.S. Virgin Islands, Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, or American Samoa are considered U.S. residents for this purpose and are subject to the self-employment tax.

Review Question 6 A nonresident alien received a $40,000 scholarship from a U.S. corporation to go to a gymnastic camp in the individual’s resident country, which has a 10% flat tax. How much U.S. tax must be paid on the scholarship? A. $0 B. $4,000 C. $8,000 D. $12,000

See Review Feedback for answer.

Abandoned Spouse

When married persons file separate returns, several unfavorable tax consequences result. For example, the taxpayer must use the Tax Rate Schedule for married taxpayers filing separately. To mitigate such harsh treatment, Congress enacted provisions commonly referred to as the abandoned spouse rules. These rules allow a married taxpayer to file as a head of household if all of the following conditions are satisfied. Per IRC Section 7703(b), an individual who is married but meets the following requirements shall not be considered as married: (91)

➢ The abandoned individual pays more than half the cost of maintaining his or her household for the taxable year. ➢ The individual files a separate tax return. ➢ The individual’s household is the principal home of a dependent child for more than six months of the tax year. ➢ The individual lives in a separate residence from his or her spouse for the last six months of the tax year.

Lesson 3 - Taxable Income, Filing Status

Review Question 7 The IRS has clearly stated that per IRC Section 7703(b), a spouse is considered abandoned when which of the following conditions have been met?

A. The abandoned individual pays more than half the cost of maintaining his or her household for the taxable year

B. The individual files a separate tax return C. The individual’s household is the principal home of a dependent child for more than six months of the

tax year D. All of the above

See Review Feedback for answer.

Community Property

Generally, the laws of the state in which the taxpayer is domiciled govern whether he or she has community property and community income or separate property and separate income for Federal tax purposes. This information applies to married taxpayers who are domiciled in one of the following community property states:

➢ Arizona. ➢ California. ➢ Idaho. ➢ Louisiana. ➢ Nevada. ➢ New Mexico. ➢ Texas. ➢ Washington. ➢ Wisconsin.

If the taxpayer’s domicile is in a community property state during any part of his or her tax year, he or she may have community income. The taxpayer’s state law determines whether his or her income is separate or community income. If the taxpayer and his or her spouse file separate returns, the taxpayer must report half of any income described by state law as community income and all of his or her separate income, and the taxpayer’s spouse must report the other half of any community income plus all of his or her separate income. Each taxpayer can claim credit for half the income tax withheld from community income.

Payments that may otherwise qualify as alimony are not deductible by the payer if they are the recipient spouse's part of community income. They are deductible as alimony only to the extent they are more than that spouse's part of community income.

Generally, community property is property:

➢ That the taxpayer, his or her spouse (or his or her registered domestic partner), or both acquire during their marriage (or registered domestic partnership) while the taxpayer and his or her spouse (or his or her registered domestic partner) are domiciled in a community property state.

➢ That the taxpayer and his or her spouse (or his or her registered domestic partner) agreed to convert from separate to community property.

➢ That cannot be identified as separate property.

Generally, community income is income from:

➢ Community property. ➢ Salaries, wages, and other pay received for the services performed by the taxpayer, his or her spouse (or his or

her registered domestic partner), or both during their marriage (or registered domestic partnership) while domiciled in a community property state.

➢ Real estate that is treated as community property under the laws of the state where the property is located.

Lesson 3 - Taxable Income, Filing Status

For income tax purposes, community property laws apply to annuities payable under the Civil Service Retirement Act (CSRS) or Federal Employee Retirement System (FERS). Whether a civil service annuity is separate or community income depends on the taxpayer’s marital status (or his or her status as a registered domestic partner) and domicile of the employee when the services were performed for which the annuity is paid. Even if the taxpayer now lives in a noncommunity property state and he or she receives a civil service annuity, it may be community income if it is based on services he or she performed while married (or during the registered domestic partnership) and domiciled in a community property state. If a civil service annuity is a mixture of community income and separate income, it must be divided between the two kinds of income. The division is based on the employee's domicile and marital status (or registered domestic partnership) in community and noncommunity property states during his or her periods of service. Ordinarily, filing a joint return will give the taxpayer a greater tax advantage than filing a separate return. But in some cases, his or her combined income tax on separate returns may be less than it would be on a joint return. If the taxpayer files a separate return, he or she and his or her spouse must each report half of their combined community income and deductions in addition to their separate income and deductions. Each of the taxpayers must complete and attach Form 8958 - Allocation of Tax Amounts Between Certain Individuals in Community Property States to the Form 1040 showing how he or she figured the amount he or she is reporting on the return. On the appropriate lines of the separate Form 1040, list only the taxpayer’s share of the income and deductions on the appropriate lines of his or her separate tax returns (wages, interest, dividends, etc.). An extension of time for filing the separate return does not extend the time for filing the spouse's separate return. If the taxpayer and his or her spouse file a joint return, they cannot file separate returns after the due date for filing either separate return has passed.

Relief From Community Property

Married persons who live in community property states, but who did not file joint returns, may also qualify for relief from liability arising from community property law or for equitable relief. The taxpayer is not responsible for the tax on an item of community income if all five of the following conditions exist: (91)

1. The taxpayer did not file a joint return for the tax year. 2. The taxpayer did not include an item of community income in gross income on the separate return. 3. The item of community income the taxpayer did not include is one of the following:

a. Wages, salaries, and other compensation the taxpayer’s spouse (or former spouse) received for services he or she performed as an employee.

b. Income the taxpayer’s spouse (or former spouse) derived from a trade or business he or she operated as a sole proprietor.

c. The taxpayer’s spouse's (or former spouse's) distributive share of partnership income. d. Income from the taxpayer’s spouse's (or former spouse's) separate property (other than income described

in (a), (b), or (c)). Use the appropriate community property law to determine what is separate property. e. Any other income that belongs to the taxpayer’s spouse (or former spouse) under community property

law. 4. The taxpayer establishes that he or she did not know of, and had no reason to know of, that community income. 5. Under all facts and circumstances, it would not be fair to include the item of community income in the taxpayer’s

gross income. In some states a husband and wife may enter into an agreement that affects the status of property or income as community or separate property. Check state law to determine how it affects the taxpayer. All other forms of income are taxed in accordance with normal community property laws. This includes dividend, interest, rents, royalties, capital gains, and earnings of unemancipated minor children.

Divorce and Separation

State law governs whether a taxpayer is married or legally separated under a divorce or separate maintenance decree. A taxpayer is unmarried for the whole year if either of the following applies: (91)

➢ The taxpayer has obtained a final decree of divorce or separate maintenance by the last day of the tax year. He or she must follow state law to determine if he or she is divorced or legally separated.

Lesson 3 - Taxable Income, Filing Status

➢ The taxpayer has obtained a decree of annulment, which holds that no valid marriage ever existed. He or she must file amended returns for all tax years affected by the annulment that are not closed by the statute of limitations. The statute of limitations generally does not end until 3 years (including extensions) after the date the taxpayer files the original return or within 2 years after the date, he or she pays the tax.

On the amended return the taxpayer will change his or her filing status to single, or if he or she meets certain requirements, head of household.

If the taxpayer and his or her spouse obtain a divorce in one year for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce the taxpayers intend to remarry each other and do so in the next tax year, the taxpayer and his or her spouse must file as married individuals.

If the taxpayer is divorced, he or she is jointly and individually responsible for any tax, interest, and penalties due on a joint return for a tax year ending before the divorce. This responsibility applies even if the divorce decree states that the former spouse will be responsible for any amounts due on previously filed joint returns. In some cases, a spouse may be relieved of the tax, interest, and penalties on a joint return. The taxpayer can ask for relief no matter how small the liability. There are three types of relief available: (91)

1. Innocent Spouse Relief provides a taxpayer relief from additional tax he or she owes if his or her spouse or former spouse failed to report income, reported income improperly or claimed improper deductions or credits.

3. Equitable Relief may apply when the taxpayer does not qualify for innocent spouse relief or separation of liability relief for something not reported properly on a joint return and generally attributable to the taxpayer’s spouse. He or she may also qualify for equitable relief if the correct amount of tax was reported on the joint return but the tax remains unpaid.

A taxpayer must request innocent spouse relief or separation of liability relief no later than 2 years after the date the IRS first attempted to collect the tax from him or her. For equitable relief, the taxpayer must request relief during the time the IRS has to collect the tax from him or her. If the taxpayer is looking for a refund of tax he or she paid, then the request must be made within the time period for seeking a refund, which is generally three years after the date the return is filed or two years following the payment of the tax, whichever is later.

The taxpayer must meet all of the following conditions to qualify for innocent spouse relief: (92)

1. The taxpayer filed a joint return that has an understatement of tax (deficiency) that is solely attributable to his or her spouse's erroneous item. An erroneous item includes income received by his or her spouse, but which was omitted from the joint return. Deductions, credits, and property basis are also erroneous items if they are incorrectly reported on the joint return.

2. The taxpayer establishes that at the time he or she signed the joint return he or she did not know, and had no reason to know, that there was an understatement of tax.

3. Taking into account all the facts and circumstances, it would be unfair to hold the taxpayer liable for the understatement of tax.

To qualify for separation of liability relief the taxpayer must have filed a joint return and must meet one of the following requirements at the time he or she requests relief: (92)

➢ The taxpayer is divorced or legally separated from the spouse with whom he or she filed the joint return. ➢ The taxpayer is widowed. ➢ The taxpayer has not been a member of the same household as the spouse with whom he or she filed the joint

return at any time during the 12-month period ending on the date he or she files Form 8857 - Request for Innocent Spouse Relief.

The separation of liability relief does not apply to any part of the understated tax due to the taxpayer’s spouse's (or former spouse's) erroneous items of which he or she had actual knowledge. The taxpayer and his or her spouse (or former spouse) remain jointly and severally liable for this part of the understated tax.

Lesson 3 - Taxable Income, Filing Status

If the taxpayer had actual knowledge of only a portion of an erroneous item, the IRS will not grant relief for that portion of the item. A taxpayer had actual knowledge of an erroneous item if:

➢ He or she knew that an item of unreported income was received. (This rule applies whether or not there was a receipt of cash.)

➢ He or she knew of the facts that made an incorrect deduction or credit unallowable. ➢ For a false or inflated deduction, he or she knew that the expense was not incurred, or not incurred to the extent

shown on the tax return. Knowledge of the source of an erroneous item is not sufficient to establish actual knowledge. Also, the taxpayer’s actual knowledge may not be inferred when he or she merely had a reason to know of the erroneous item. Similarly, the IRS does not have to establish that the taxpayer knew of the source of an erroneous item in order to establish that he or she had actual knowledge of the item itself. The taxpayer’s actual knowledge of the proper tax treatment of an erroneous item is not relevant for purposes of demonstrating that he or she had actual knowledge of that item. Neither is the taxpayer’s actual knowledge of how the erroneous item was treated on the tax return. For example, if the taxpayer knew that his or her spouse received dividend income, relief is not available for that income even if he or she did not know it was taxable.

To qualify for equitable relief the taxpayer must establish that, under all the facts and circumstances, it would be unfair to hold him or her liable for the understatement or underpayment of tax. In addition, the taxpayer must meet other requirements listed in Publication 971 - Innocent Spouse Relief.

Decedent Issues

The personal representative must file the final income tax return (Form 1040) of the decedent for the year of death and any returns not filed for preceding years. A surviving spouse, under certain circumstances, may have to file the returns for the decedent. The final income tax return is due at the same time the decedent's return would have been due had death not occurred. A final return for a decedent who was a calendar year taxpayer is generally due on April 15 following the year of death, regardless of when during that year death occurred. However, when the due date falls on a Saturday, Sunday, or legal holiday, the return is filed timely if filed by the next business day. If the taxpayer’s spouse died during the year, he or she is considered married for the whole year for filing status purposes. If the taxpayer did not remarry before the end of the tax year, he or she can file a joint return for him or herself and his or her deceased spouse. For the next 2 years, the taxpayer may be entitled to the special surviving spouse with dependent child benefits. The Surviving Spouse With Dependent Child benefits filing status entitles the taxpayer to use joint return tax rates and the highest standard deduction amount (if he or she does not itemize deductions). It does not entitle the taxpayer to file a joint return. If the taxpayer files as surviving spouse with dependent child, he or she should use the Married filing jointly column of the Tax Table or Section B of the Tax Computation Worksheet to figure the tax. As previously noted, a taxpayer is eligible to file the 2023 return as a surviving spouse with dependent child if he or she meets all of the following tests: (93)

➢ The taxpayer was entitled to file a joint return with his or her spouse for the year his or her spouse died. It does

not matter whether the taxpayer actually filed a joint return. ➢ The taxpayer’s spouse died in 2021 or 2022 and the taxpayer did not remarry before the end of 2023. ➢ The taxpayer has a child or stepchild for whom he or she can claim as a dependent. This does not include a foster

child. ➢ This child lived in the taxpayer’s home all year, except for temporary absences. ➢ The taxpayer paid more than half the cost of keeping up a home for the year.

After the due date of the return, the taxpayer and his or her spouse cannot file separate returns if they previously filed a joint return. However, a personal representative for a decedent can change from a joint return elected by the surviving spouse to a separate return for the decedent. The personal representative has one year from the due date (including extensions) of the joint return to make the change. (91) A taxpayer may be eligible to file as head of household if the individual who qualifies him or her for this filing status is born or dies during the year. The taxpayer must have provided more than half of the cost of keeping up a home that was the individual's main home for more than half of the year, or, if less, the period during which the individual lived. (91)

Lesson 3 - Taxable Income, Filing Status

Review Question 8 Mr. Jones, a calendar-year taxpayer, died January 15 of Year 2. His widow, Mrs. Jones, who has a five- year-old daughter, remarried December 15 of Year 2. Which year is the last year for which a joint return may be filed by or for Mr. and Mrs. Jones?

A. Year 1 B. Year 2 C. Year 3 D. Year 4

See Review Feedback for answer.

Common Law Marriage

A common law marriage is a legally recognized marriage that can arise in some jurisdictions without a license or ceremony. Many states recognize a common law marriage when two people capable of getting married live together as spouses and hold themselves out as such for a specified amount of time. Common law marriages can be contracted in nine states (Alabama, Colorado, Iowa, Kansas, Montana, Rhode Island, South Carolina, Texas, and Utah) and the District of Columbia. New Hampshire recognizes common law marriage for purposes of probate only, and Utah recognizes common law marriages only if they have been validated by a court or administrative order. For Federal tax purposes, a taxpayer and his or her spouse are considered married for the whole year if on the last day of the tax year they are living together in a common law marriage recognized in the state where they now live or in the state where the common law marriage began.

Same-Sex Married Couples

Obergefell v. Hodges is a landmark United States Supreme Court case in which the Court held in a 5–4 decision that the fundamental right to marry is guaranteed to same-sex couples by both the Due Process Clause and the Equal Protection Clause of the Fourteenth Amendment to the United States Constitution. Decided on June 26, 2015, Obergefell requires all states to issue marriage licenses to same-sex couples and to recognize same-sex marriages validly performed in other jurisdictions. This legalized same-sex marriage throughout the United States, its possessions and territories. The Supreme Court found that states have used marital status as the basis for other government rights, benefits and responsibilities including tax and inheritance and property rights. Tax, of course, was the driving factor in one of two same sex marriage cases United States v. Windsor and Hollingsworth v. Perry, decided at the Supreme Court just two years ago. The Obergefell case does not change the analysis in Windsor. The case does advance the analysis by clarifying that states may not have differing standards of marriage by gender. In other words, individual states may not ban same sex marriages and they may not fail to recognize same sex marriages in other states. That makes a huge difference for same sex couples at tax time. Under the ruling, same-sex couples will be treated as married for all Federal tax purposes, including income and gift and estate taxes. The ruling applies to all Federal tax provisions where marriage is a factor, including filing status, claiming dependents, taking the standard deduction, employee benefits, contributing to an IRA and claiming the earned income tax credit or child tax credit. Any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country will be covered by the ruling. However, the ruling does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law. For tax year 2013 and going forward, same-sex spouses generally must file using a married filing separately or jointly filing status. For tax year 2012 and all prior years, same-sex spouses who filed an original tax return on or after September 16, 2013 (the effective date of Revenue Ruling 2013-17), generally must have filed using a married filing separately or jointly filing status. For tax year 2012, same-sex spouses who filed their tax return before September 16, 2013, may have chosen (but are not required) to amend their Federal tax returns to file using married filing separately or jointly filing status. (94)

Lesson 3 - Taxable Income, Filing Status

Combat Zone Service

The time for taking care of certain tax matters can be postponed. These postponements are referred to as extensions of deadlines. The deadline for IRS to take certain actions, such as collection and examination actions, may also be extended. The deadline for filing tax returns, paying taxes, filing claims for refund, and taking other actions with the IRS is automatically extended if either of the following statements is true: (95)

➢ The taxpayer serves in the Armed Forces in a combat zone, or he or she has qualifying service outside of a combat zone.

The deadline for taking actions with the IRS is extended for 180 days after the later of: (95)

➢ The last day the taxpayer is in a combat zone, have qualifying service outside of the combat zone, or serve in a contingency operation (or the last day the area qualifies as a combat zone, or the operation qualifies as a contingency operation).

➢ The last day of any continuous qualified hospitalization for injury from service in the combat zone or contingency operation or while performing qualifying service outside of the combat zone.

Taxation of Nonresident Aliens

An alien is any individual who is not a U.S. citizen or U.S. national. A nonresident alien is an alien who has not passed the green card test or the substantial presence test. Any of these individuals must file a return: (96)

1. A nonresident alien individual engaged or considered to be engaged in a trade or business in the United States during the year. The taxpayer must file even if:

a. The taxpayer’s income did not come from a trade or business conducted in the United States. b. The taxpayer has no income from U.S. sources. c. The taxpayer’s income is exempt from income tax.

2. A nonresident alien individual not engaged in a trade or business in the United States with U.S. income on which the tax liability was not satisfied by the withholding of tax at the source.

3. A representative or agent responsible for filing the return of an individual described in (1) or (2). 4. A fiduciary for a nonresident alien estate or trust. 5. A resident or domestic fiduciary, or other person, charged with the care of the person or property of a nonresident

individual may be required to file an income tax return for that individual and pay the tax (Refer to Treas. Reg. 1.6012-3(b)).

If the taxpayer was a nonresident alien student, teacher, or trainee who was temporarily present in the United States on an “F”, “J”, “M”, or “Q” visa, he or she is considered engaged in a trade or business in the United States. The individual must file Form 1040-NR only if he or she has income that is subject to tax, such as wages, tips, scholarship and fellowship grants, dividends, etc.

Lesson 3 - Taxable Income, Filing Status

A nonresident alien must also file an income tax return if he or she wants to: (96)

➢ Claim a refund of overwithheld or overpaid tax. ➢ Claim the benefit of any deductions or credits. For example, if the individual has no U.S. business activities but

has income from real property that he or she chooses to treat as Effectively Connected Income (ECI), the individual must timely file a true and accurate return to take any allowable deductions against that income.

A nonresident alien's income that is subject to U.S. income tax must generally be divided into two categories: (96)

➢ Income that is Effectively Connected with a trade or business in the United States. ➢ U.S. source income that is Fixed, Determinable, Annual, or Periodical (FDAP).

Effectively Connected Income, after allowable deductions, is taxed at graduated rates. These are the same rates that apply to U.S. citizens and residents. FDAP income generally consists of passive investment income; however, in theory, it could consist of almost any sort of income. FDAP income is taxed at a flat 30% (or lower treaty rate) and no deductions are allowed against such income. Effectively Connected Income should be reported on page one of Form 1040-NR. FDAP income should be reported on page four of Form 1040-NR. Nonresident aliens who are required to file an income tax return must use Form 1040-NR. If the individual is an employee or self-employed person and received wages or non-employee compensation subject to U.S. income tax withholding, or he or she has an office or place of business in the United States, the individual must generally file by the 15th day of the 4th month after the tax year ends. For a person filing using a calendar year this is generally April 15. Generally, the taxpayer cannot file as married filing jointly if either spouse was a nonresident alien at any time during the tax year. However, nonresident aliens married to U.S. citizens or residents can choose to be treated as U.S. residents and file joint returns. Also, a taxpayer cannot file as head of household if he or she is a nonresident alien at any time during the tax year. If the taxpayer is a married nonresident alien, but his or her spouse is not a U.S. citizen or residents, the taxpayer must use the Tax Table column or the Tax Rate Schedule for married filing separate returns when determining the tax on income effectively connected with a U.S. trade or business. The taxpayer normally cannot use the Tax Table column or the Tax Rate Schedule for single individuals. If the taxpayer is not an employee or self-employed person who receives wages or non-employee compensation subject to U.S. income tax withholding, or if he or she does not have an office or place of business in the United States, the individual must file by the 15th day of the 6th month after the tax year ends. For a person filing using a calendar year this is generally June 15. If the taxpayer cannot file the return by the due date, he or she should file Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return to request an automatic extension of time to file. The individual should file Form 4868 by the regular due date of the return. To get the benefit of any allowable deductions or credits, the taxpayer must timely file a true and accurate income tax return. For this purpose, a return is timely if it is filed within 16 months of the due date discussed. The Internal Revenue Service has the right to deny deductions and credits on tax returns filed more than 16 months after the due dates of the returns. Before leaving the United States, all aliens (with certain exceptions) must obtain a certificate of compliance. This document, also popularly known as the sailing permit or departure permit, must be secured from the IRS before leaving the U.S. The individual will receive a sailing or departure permit after filing a Form 1040-C or Form 2063 - U.S. Departing Alien Income Tax Statement. Even if the person has left the United States and filed a Form 1040-C - U.S. Departing Alien Income Tax Return on departure, he or she still must file an annual U.S. income tax return. If the taxpayer is married and both he and she and his or her spouse are required to file, the individual must each file a separate return, unless one of the spouses is a U.S. citizen or a resident alien, in which case the departing alien could file a joint return with his or her spouse.

Lesson 3 - Taxable Income, Filing Status

Review Question 9 To get the benefit of any allowable deductions or credits, a nonresident alien must timely file a true and accurate income tax return. For this purpose, a return is timely if it is filed within how many months of the specified due date?

A. 3 months B. 6 months C. 12 months D. 16 months

See Review Feedback for answer.

Refund Due a Deceased Taxpayer

Form 1310 - Statement of Person Claiming Refund Due a Deceased Taxpayer is used to claim a Federal tax refund due to a recently deceased taxpayer. In general, Form 1310 is filed by a surviving spouse or the executor of an estate. The person filing must submit a Form 1040 along with Form 1310. If the taxpayer is claiming a refund on behalf of a deceased taxpayer, he or she must file Form 1310 if:

1. He or she is NOT a surviving spouse filing an original or amended joint return with the decedent; and 2. He or she is NOT a personal representative (defined later) filing, for the decedent, an original Form 1040, 1040-

SR, 1040A, 1040EZ, 1040NR, or 1040-NR that has the court certificate showing his or her appointment attached. For purposes of this form, a personal representative is the executor or administrator of the decedent’s estate, as appointed or certified by the court. A copy of the decedent’s will cannot be accepted as evidence that the taxpayer is the personal representative. If the executor or personal representative is filing a full tax return on behalf of the deceased individual, they must submit Form 1040 along with Form 1310 directing the IRS to pay a refund. The executor may also need to file taxes owed by the estate rather than the individual. In this case, the representative will be required to file a Form 1041 along with a 1310 form. The 1041 form would be required only if the estate generates more than $600 in income per year. Additionally, Form 1310 must be mailed to the IRS, the taxpayer cannot e-file it.

Lesson 3 - Taxable Income, Filing Status

• 90% of the tax to be shown on this year's tax return.

• 100% of the tax shown on last year's return (110% if AGI over $150,000). If the taxpayer is filing as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual, he or she generally will have to make estimated tax payments if he or she expects to owe tax of $1,000 or more when filing the return. If the taxpayer is filing as a corporation, he or she generally has to make estimated tax payments for the corporation if he or she expects it to owe tax of $500 or more when filing its return. Only Choice A has the correct amount and is therefore the correct response. Topic - Estimated Tax Payments Source - IRS.GOV - Estimated Taxes Question 3 - D. The taxpayer’s home must be, for at least 6 months, the main home of his child, stepchild, or adopted child whom he or she can properly claim as a dependent The taxpayer may be able to file as head of household if he or she is unmarried or considered unmarried on the last day of the year (Choice B is incorrect), paid more than half the cost of keeping up a home for the year (Choice C is incorrect), and the taxpayer’s spouse did not live in his or her home during the last 6 months of the tax year (Choice A incorrect). Also, if taxpayer’s home was the main home of his or her child, stepchild, or foster child for more than half the year he or she is eligible for the head of household filing status, making Choice D the correct answer. Topic - Head of Household Source - Publication 501 - Dependents, Standard Deduction, and Filing Information

Lesson 3 - Taxable Income, Filing Status

Question 4 - D. None of the above A dependent must be a qualifying child or a qualifying relative. The child is not a qualifying child, as the adoption is not final. The child did not live with Tanya the entire year, and therefore is also not a qualifying relative (Choice C). Tanya cannot file as head of household without a dependent (Choice A). For expenses paid prior to the year the adoption becomes final, the credit generally is allowed for the year following the year of payment. A taxpayer who paid qualifying expenses in the current year for an adoption which became final in the current year, may be eligible to claim the credit for the expenses on the current year return, in addition to credit for expenses paid in a prior year (Choice B). Since none of the choices are accurate, Choice D, None of the above, is the correct response. Topic - Qualifying Relative for Head of Household Filing Status Source - Publication 501 - Dependents, Standard Deduction, and Filing Information Question 5 - C. 180 days The taxpayer will be considered a U.S. resident for tax purposes if he or she meets the substantial presence test for the calendar year. To meet this test, the taxpayer must be physically present in the United States on at least:

1. 31 days during 2023, and 2. 183 days during the 3-year period that includes the 2023, 2022 and 2021, counting:

a. All the days he or she was present in 2023, and b. 1/3 of the days he or she was present in 2022, and c. 1/6 of the days he or she was present in 2021.

To determine if Carla meets the substantial presence test for 2023, count the full 120 days of presence in 2023, 40 days in 2022 (1/3 of 120), and 20 days in 2021 (1/6 of 120). Because the total for the 3-year period is 180 days (Choice C), she is not considered a resident under the substantial presence test for 2023. Topic - Nonresident and Dual Status Aliens Source - IRS.GOV - Determining an Individual’s Tax Residency Status Question 6 - A. $0 A scholarship, fellowship, grant, etc. received by a nonresident alien for activities conducted outside of the U.S. is treated as foreign source income. Because the scholarship will not be treated as U.S. source income, there is no U.S. tax. Only Choice A has the correct amount and is therefore the correct response. Topic - Nonresident and Dual Status Aliens Source - IRS.GOV - Determining an Individual’s Tax Residency Status Question 7 - D. All of the above Per IRC Section 7703(b), an individual who is married but meets the following requirements shall not be considered as married:

• The abandoned individual pays more than half the cost of maintaining his or her household for the taxable year (Choice A).

• The individual files a separate tax return (Choice B).

• The individual’s household is the principal home of a dependent child for more than six months of the tax year (Choice C).

• The individual lives in a separate residence from his or her spouse for the last six months of the tax year. All choices are listed among the requirements making Choice D, All of the above, the correct response. Topic - Abandoned Spouse Source - Publication 504 - Divorced or Separated Individuals

Lesson 3 - Taxable Income, Filing Status

Question 8 - A. Year 1 The determination of whether an individual is married is made as of the close of the taxable year, except that, if his or her spouse dies during the taxable year, such determination is made as of the time of the death. Since the decedent was married at the time of his death, he is considered married for purposes of filing status. A decedent (through a personal representative) and a surviving spouse may file a joint return unless the surviving spouse remarries before year end. Since Mrs. Jones remarried prior to the end of Year 2, they may not file a joint return for Year 2 (Choice B). The last year they could file a joint return was Year 1 making Choice A the only response with the correct number of years. Topic - Decedent Issues Source - Publication 559 - Survivors, Executors, and Administrators Question 9 - D. 16 months To get the benefit of any allowable deductions or credits, a nonresident alien must timely file a true and accurate income tax return. For this purpose, a return is timely if it is filed within 16 months of the specified due date (Choice D). The Internal Revenue Service has the right to deny deductions and credits on tax returns filed more than 16 months after the due dates of the returns. Only Choice D has the correct number of months and is therefore the correct response. Topic - Taxation of Nonresident Aliens Source - IRS.GOV - Taxation of Nonresident Aliens

Standard Deduction, Dependents At the conclusion of this lesson you should have a basic knowledge of:

➢ The Standard Deduction. ➢ Dependents.

The Standard Deduction The standard deduction is based upon the principle that every taxpayer should be allowed some deduction for personal living expenses. This deduction will be allowed even if the taxpayer cannot prove that he or she spent the amount involved. In passing this part of the tax law, Congress was well aware that many taxpayers do not keep complete records of their expenditures. Without such a provision, these taxpayers might, unjustly, not be allowed to take any deduction at all. The standard deduction is more than just an escape hatch for those who are unable to itemize for want of proof; it also serves as a minimum deduction for all taxpayers. The law provides that this minimum deduction will be adjusted annually to prevent inflation-caused tax increases. See Publication 17 - Part Three - Standard Deduction for details. If the taxpayer(s) check any of the boxes on page 1 of Form 1040, they MUST use the standard deduction chart for people age 65 or older (unless Schedule A - Itemized Deductions is used) to determine their correct standard deduction amount. There is also a standard deduction for dependents. If none of the boxes on page 1 are checked, then the standard deduction amount shown below which applies to the filing status of the taxpayer(s) is selected from the options on line 12 of Form 1040. In 2023, the standard deduction amounts increased to $13,850 for individuals, to $20,800 for heads of household, and to $27,700 for married couples filing jointly and surviving spouses. (77)

Standard Deductions - 2023 Tax Year

Filing Status Standard Deduction Amount

Single $13,850

Married Filing Jointly $27,700

Married Filing Separately $13,850

Heads of Household $20,800

Surviving Spouse $27,700

Table 4-1 - Revenue Procedure 2022-38 (2023)

Review Question 1 What is the amount of the Standard Deduction for a single taxpayer, under the age of 65 with good eyesight in 2023?

A. $4,700 B. $13,850 C. $20,800 D. $27,700

See Review Feedback for answer.

Lesson 4 - Standard Deduction, Dependents

Elderly and/or Blind Taxpayers

The standard deduction chart for people age 65 or older (shown below) lists the additional standard deduction for taxpayers who are age 65 or older and/or blind at the end of the tax year. The standard deduction is calculated by adding the person's standard deduction (based on their filing status), plus the additional amount. Additional standard deduction amounts for 2023 are $1,850 for single or head of household or $1,500 for married filing jointly, married filing separately, or surviving spouse. For example, if the taxpayer is married, filing a joint return and both he and his wife are 68 years of age, what would their standard deduction amount come to for 2023? When completing his or her income tax return, the taxpayer would check off the box for him as being 65 or older, as well as the same box for his spouse. Two boxes are checked, and looking at the married filing joint return section, we see that their available standard deduction would be $30,700. If one was also blind, the standard deduction for 2023 would be $32,200 having three boxes checked.

Partial blindness qualifies, with a certified statement from an eye doctor (ophthalmologist or optometrist) attesting that the vision in the taxpayer’s better eye is 20/200 or worse after being corrected with glasses or contact lenses or that the taxpayer’s field of vision is not more than 20 degrees. If the taxpayer’s eye condition is not likely to improve beyond these limits, the statement should include this fact. The taxpayer should keep the statement with his or her records. If the taxpayer is blind on the last day of the year, he or she is entitled to the higher standard deduction.

Standard Deduction Chart for People Age 65 or Older or Blind

Filing Status Number from the boxes checked on

Page 1 of Form 1040 Standard Deduction for 2023

Single 1 2

$15,700 $17,550

Married filing jointly or surviving spouse

1 2 3 4

$29,200 $30,700 $32,200 $33,700

Married filing separately

1 2 3 4

$15,350 $16,850 $18,350 $19,850

Head of household 1 2

$22,650 $24,500

Table 4-2 - Publication 501 - Table 7 – Standard Deduction Chart for People who are 65 or Older or Who are Blind (2023)

Example 1 Larry, 46, and Carolyn, 33, are filing a joint return for 2023. Neither is blind, and neither can be claimed as a dependent. They decide not to itemize their deductions. Their standard deduction is $27,700. Example 2 Scott and Mary Jane are filing a joint return for 2023. Both are over age 65. Neither is blind, and neither can be claimed as a dependent. If they do not itemize deductions their standard deduction is $30,700.

If the taxpayer’s spouse died in 2023 before reaching age 65, he or she cannot take a higher standard deduction because of his or her spouse. Even if his or her spouse was born before January 2, 1959, he or she is not considered 65 or older at the end of 2023 unless he or she was 65 or older at the time of death. A person is considered to reach age 65 on the day before his or her 65th birthday.

Lesson 4 - Standard Deduction, Dependents

Review Question 2 What is the Standard Deduction for a single taxpayer, age 65 or older with good eyesight in 2023?

A. $13,850 B. $15,700 C. $17,550 D. $18,550

See Review Feedback for answer.

Special Rules on the Standard Deduction

Taxpayers Not Eligible for the Standard Deduction

A taxpayer’s standard deduction is zero and the taxpayer should itemize his or her deductions if:

➢ The taxpayer is married and filed a separate return and the taxpayer’s spouse itemized his or her deductions when filing. This rule prevents shifting of itemized deductions between spouses in a way which will reduce the tax burden.

➢ The taxpayer files a tax return for a short tax year due to a change in the taxpayer’s annual accounting period. ➢ The taxpayer is a non-resident or a dual status alien during the tax year. But, if the non-resident alien is married

to a U.S. citizen or is a resident at the end of the tax year, such a taxpayer can choose to be treated as a U.S. resident and, as such, would be eligible to take the standard deduction.

Dependents of Other Taxpayers

The 2023 standard deduction for an individual who can be claimed as a dependent on another person's tax return is generally limited to the greater of: (97)

➢ $1,250, or ➢ The individual's earned income for the year plus $400 (but not more than the regular standard deduction amount,

generally $13,850 in 2023). If the taxpayer (or his or her spouse if filing jointly) can be claimed as a dependent on someone else's return, use the Standard Deduction Worksheet for Dependents (see below) to determine the standard deduction. Earned income is salaries, wages, tips, professional fees, and other amounts received as pay for work the taxpayer actually performs. For purposes of the standard deduction, earned income also includes any part of a scholarship or fellowship grant that he or she must include in gross income.

Standard Deduction Worksheet for Dependents

Use this worksheet only if someone can claim the taxpayer, or his or her spouse if filing jointly, as a dependent.

Check the correct number of boxes below.

Taxpayer: Born before January 2, 1959 □ Blind □

Taxpayer’s Spouse: Born before January 2, 1959 □ Blind □

Total number of boxes the taxpayer checked: □

1. Enter taxpayer’s earned income (defined below). If none, enter -0-. checked……….... 1. _______________________

2. Additional amount. checked……….... 2. ___________________$400

3. Add lines 1 and 2. checked……….... 3. _______________________

4. Minimum standard deduction. checked……….... 4. _________________ $1,250

Lesson 4 - Standard Deduction, Dependents

5. Enter the larger of line 3 or line 4. checked……….... 5. _______________________

6. Enter the amount shown below for the taxpayer’s filing status.

• Single or Married filing separately - $13,850

• Married filing jointly - $27,700

• Head of household - $20,800

6. ______________________

7. Standard deduction.

a. Enter the smaller of line 5 or line 6. If born after January 1, 1959, and not

blind, stop here. This is the taxpayer’s standard deduction. Otherwise, go on to line 7b.

b. If born before January 2, 1959, or blind, multiply $1,850 ($1,500 if married) by the number in the box above.

c. Add lines 7a and 7b. This is the taxpayer’s standard deduction for 2023.

7a. _____________________ 7b. _____________________

7c. _____________________

Earned income includes wages, salaries, tips, professional fees, and other compensation received for personal services the taxpayer performed. It

also includes any taxable scholarship or fellowship grant.

Table 4-3 - Publication 501 - Standard Deduction Worksheet for Dependents (2023)

Review Question 3 Michael is 16 years old and single. His parents can claim for him as a dependent on their 2023 tax return. He has interest income of $780 and wages of $150. He has no itemized deductions. He uses the Standard Deduction Worksheet for Dependents to determine his standard deduction. He enters $1,250 (because his earned income is less than $750) on line 5 and $13,850 on line 6 because he is single. His standard deduction, on line 7a of the worksheet, is what amount?

A. $0 B. $750 C. $1,250 D. $13,850

See Review Feedback for answer.

Example 1 Joe, a 22-year-old full-time college student, can be claimed as a dependent on his parents' 2023 tax return. Joe is married and files a separate return. His wife does not itemize deductions on her separate return. Joe has $1,500 in interest income and wages of $3,800. He has no itemized deductions. Joe enters his earned income, $3,800, on line 1. He adds lines 1 and 2 and enters $4,200 on line 3. On line 5, he enters $4,200, the larger of lines 3 and 4. Because Joe is married filing a separate return, he enters $13,850 on line 6. On line 7a, he enters $4,200 as his standard deduction because it is smaller than $13,850, the amount on line 6. Example 2 Amy, who is single and 18 years old, can be claimed as a dependent on her parents' 2023 tax return. She is 18 years old and blind and checks the appropriate box and enters 1 on line 1. She has interest income of $1,300 and wages of $2,900. She has no itemized deductions. Amy enters her wages of $2,900 on line 1. She adds lines 1 and 2 and enters $3,300 on line 3. On line 5, she enters $3,300, the larger of lines 3 and 4. Because she is single, Amy enters $13,850 on line 6. She enters $3,300 on line 7a. This is the smaller of the amounts on lines 5 and 6. Because she checked one box in the top part of the worksheet, she enters $1,750 on line 7b. She then adds the amounts on lines 7a and 7b and enters her standard deduction of $5,050 on line 7c. Example 3 Ed is 18 years old and single. His parents can claim him as a dependent on their 2023 tax return. He has wages of $7,000, interest income of $500, and a business loss of $3,000. He has no itemized deductions. Ed enters $4,000 ($7,000 − $3,000) on line 1. He adds lines 1 and 2 and enters $4,400 on line 3. On line 5, he enters $4,400, the larger of lines 3 and

Lesson 4 - Standard Deduction, Dependents

4. Because he is single, Ed enters $13,850 on line 6. On line 7a, he enters $4,400 as his standard deduction because it is smaller than $13,850, the amount on line 6.

Personal Exemptions

Under the Tax Cuts and Jobs Act, for tax years beginning after December 31, 2017 until January 1, 2026, the deduction for personal exemptions is effectively suspended by reducing the exemption amount to zero. Therefore, for 2023, the taxpayer cannot claim a personal exemption deduction for him or herself, his or her spouse, or his or her dependents. Since there will be no personal exemption amounts, the taxpayer will figure whether he or she needs to file a return either:

➢ For individual taxpayers, he or she will be required to file a tax return if his or her gross income for the taxable year is more than the standard deduction.

➢ For married taxpayers, he or she will be required to file a tax return if his or her gross income, when combined with his or her spouse’s gross income, is more than the standard deduction for a joint return, provided that the taxpayer and his or her spouse lived in the same home; his or her spouse does not file a separate tax return; and neither the taxpayer nor his or her spouse is a dependent of another taxpayer who has income other than earned income in excess of $500 (indexed for inflation).

Also, a number of corresponding changes are made throughout the Tax Code where specific provisions contain references to the personal exemption amount and, in each of these instances, the dollar amount to be used is $4,700, as adjusted by inflation. In 2026, taxpayers can claim personal and dependent exemptions again.

Dependents

Rules for Claiming for a Dependent

The term "dependent" means a qualifying child, or a qualifying relative.

➢ A taxpayer cannot claim any dependents if he or she, or his or her spouse if filing jointly, could be claimed as a dependent by another taxpayer.

➢ A taxpayer cannot claim a married person who files a joint return as a dependent unless that joint return is filed only to claim a refund of withheld income tax or estimated tax paid.

➢ A taxpayer cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident alien, U.S. national, or a resident of Canada or Mexico (There is an exception for certain adopted children).

➢ A taxpayer cannot claim a person as a dependent unless that person is a qualifying child or qualifying relative.

Tests to Be a Qualifying Child

1. The child must be the taxpayer’s son, daughter, stepchild, foster child, brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of them.

2. The child must be: a. Under age 19 at the end of the year and younger than the taxpayer (or his or her spouse, if filing jointly) b. Under age 24 at the end of the year, a full-time student, and younger than the taxpayer (or his or her

spouse, if filing jointly). c. Any age if permanently and totally disabled.

3. The child must have lived with the taxpayer for more than half of the year (there are exceptions for temporary absences, children who were born or died during the year, children of divorced or separated parents (or parents who live apart), and kidnapped children).

4. The child must not have provided more than half of his or her own support for the year. 5. The child is not filing a joint return for the year (unless that return is filed only to get a refund of income tax withheld

or estimated tax paid).

A taxpayer must provide over one-half of the support for a person to be considered a dependent. The term support includes food, shelter, clothing, medical and dental care, education, and other items contributing to the individual’s maintenance and livelihood. Although medical care is an item of support, medical insurance benefits

are not included. Medical insurance premiums are included. See Publication 501 - Dependents, Standard Deduction and Filing Information for complete details.

Lesson 4 - Standard Deduction, Dependents

Example 1 - Age Test The taxpayer’s son turned 19 on December 10. Unless he was permanently and totally disabled or a full-time student, he does not meet the age test because, at the end of the year, he was not under age 19. Example 2 - Child not younger than the taxpayer or his or her spouse The taxpayer’s 23-year-old brother, who is a student and unmarried, lives with the taxpayer and his or her spouse. He is not disabled. Both the taxpayer and his or her spouse are 21 years old and file a joint return. The taxpayer’s brother is not a qualifying child because he is not younger than the taxpayer or his or her spouse. Example 3 - Child younger than the taxpayer’s spouse but not younger than the taxpayer The facts are the same as in Example 2 except the taxpayer’s spouse is 25 years old. Because the taxpayer’s brother is younger than the taxpayer’s spouse and they are filing a joint return, the taxpayer’s brother is a qualifying child, even though he is not younger than the taxpayer. To qualify as a student, the taxpayer’s child must be, during some part of each of any 5 calendar months of the year: (86)

➢ A full-time student at a school that has a regular teaching staff, course of study, and a regularly enrolled student body at the school.

➢ A student taking a full-time, on-farm training course given by a school, or by a state, county, or local government agency.

The 5 calendar months do not have to be consecutive. Support Test Example Adam provided $4,000 toward his 16-year-old son's support for the year. His son has a part-time job and provided $6,000 to his own support. Adam’s son provided more than half of his own support for the year. He is not Adam’s qualifying child.

Review Question 4 Mary and Matthew are the parents of four children, ages 5, 9, 13, and 22. Their 22-year-old child is a full- time student with income of $4,800. Mary and Matthew provided more than 50% of the support for all their children. If they file a joint return, how many dependents can they claim for the above family members on their 2023 income tax return?

A. 3 B. 4 C. 5 D. 6

See Review Feedback for answer.

Social Security Numbers (SSNs) for Dependents

The taxpayer must show the SSN of any dependent he or she lists in the Dependents section of his or her Form 1040 or 1040-SR. If a person whom the taxpayer expects to claim as a dependent on his or her return does not have an SSN, either the taxpayer or that person should apply for an SSN as soon as possible by filing Form SS-5 - Application for a Social Security Card with the Social Security Administration (SSA). If taxpayer’s dependent does not have and cannot get an SSN, he or she must show the individual taxpayer identification number (ITIN) or adoption taxpayer identification number (ATIN) instead of an SSN.

Exceptions

Even if the taxpayer has a qualifying child or qualifying relative, he or she can claim that person as a dependent only if these three tests are met:

1. Dependent taxpayer test. 2. Joint return test. 3. Citizen or resident test.

Lesson 4 - Standard Deduction, Dependents

Dependent Taxpayer Test

If the taxpayer can be claimed as a dependent by another person, the taxpayer cannot claim anyone else as a dependent. Even if he or she has a qualifying child or qualifying relative, he or she cannot claim that person as a dependent. If the taxpayer is filing a joint return and his or her spouse can be claimed as a dependent by someone else, the taxpayer and his or her spouse cannot claim any dependents on their joint return.

Joint Return Test

The taxpayer generally cannot claim a married person as a dependent if he or she files a joint return. However, the taxpayer can claim a person as a dependent who files a joint return if that person and his or her spouse file the joint return only to claim a refund of income tax withheld or estimated tax paid.

Citizen or Resident Test

A taxpayer generally cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident alien, U.S. national, or a resident of Canada or Mexico. However, there is an exception for certain adopted children. If the taxpayer is a U.S. citizen or U.S. national who has legally adopted a child who is not a U.S. citizen, U.S. resident alien, or U.S. national, this test is met if the child lived with the taxpayer as a member of his or her household all year. This exception also applies if the child was lawfully placed with the taxpayer for legal adoption. Children usually are citizens or residents of the country of their parents. If the taxpayer was a U.S. citizen when his or her child was born, the child may be a U.S. citizen and meet this test even if the other parent was a nonresident alien and the child was born in a foreign country. Foreign students brought to this country under a qualified international education exchange program and placed in American homes for a temporary period generally are not U.S. residents and do not meet this test. However, if he or she provided a home for a foreign student, he or she may be able to take a charitable contribution deduction.

A U.S. national is an individual who, although not a U.S. citizen, owes his or her allegiance to the United States. U.S. nationals include American Samoans and Northern Mariana Islanders who chose to become U.S. nationals instead of U.S. citizens. Five tests must be met for a child to be the taxpayer’s qualifying child. The five tests are:

1. Relationship. 2. Age. 3. Residency. 4. Support. 5. Joint return.

Relationship Test

To meet this test, a child must be the taxpayer’s son, daughter, stepchild, foster child, or a descendant (for example, his or her grandchild) of any of them; or the taxpayer’s brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant (for example, his or her niece or nephew) of any of them. An adopted child is always treated as the taxpayer’s own child. The term “adopted child” includes a child who was lawfully placed with him or her for legal adoption.

Age Test

To meet this test, a child must be:

➢ Under age 19 at the end of the year and younger than the taxpayer (or his or her spouse if filing jointly), ➢ A student under age 24 at the end of the year and younger than the taxpayer (or his or her spouse if filing jointly),

or ➢ Permanently and totally disabled at any time during the year, regardless of age.

Age Test Example The taxpayer’s son turned 19 on December 10. Unless he was permanently and totally disabled or a student, he does not meet the age test because, at the end of the year, he was not under age 19.

Lesson 4 - Standard Deduction, Dependents

Residency Test

To meet this test, the taxpayer’s child must have lived with him or her for more than half the year. There are exceptions for temporary absences, children who were born or died during the year, kidnapped children, and children of divorced or separated parents. The taxpayer’s child is considered to have lived with him or her during periods of time when one of them, or both, is temporarily absent due to special circumstances, such as:

➢ Illness. ➢ Education. ➢ Business. ➢ Vacation. ➢ Military service. ➢ Detention in a juvenile facility.

The taxpayer can treat his or her adopted child or foster child as meeting the residency test as follows if he or she adopted the child in 2023, the child was lawfully placed with him or her for legal adoption by him or her in 2023, or the child was an eligible foster child placed with him or her during 2023. This child is considered to have lived with the taxpayer for more than half of 2023 if his or her main home was this child's main home for more than half the time since this child was adopted or placed with the taxpayer in 2023. Residency Test Example The taxpayer provides all the support of his children, ages 6, 8, and 12, who live in Mexico with his mother and have no income. The taxpayer is single and lives in the United States. His mother is not a U.S. citizen and has no U.S. income, so she is not a taxpayer. His children are not his qualifying children because they do not meet the residency test. Also, they are not the qualifying children of any other taxpayer, so they are his qualifying relatives, and he can claim them as dependents if all the tests are met. The taxpayer may also be able to claim his mother as a dependent if all the tests are met, including the gross income test and the support test.

Support Test

To meet this test, the qualifying child cannot have provided more than half of his or her own support for the year. For a qualifying relative to meet this test, the taxpayer generally must provide more than half of a person's total support during the calendar year. To figure if the taxpayer provided more than half of a person's support, he or she must first determine the total support provided for that person. Total support includes amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities. Generally, the amount of an item of support is the amount of the expense incurred in providing that item. For lodging, the amount of support is the fair rental value of the lodging. Expenses not directly related to any one member of a household, such as the cost of food for the household, must be divided among the members of the household. Medical insurance premiums the taxpayer pays, including premiums for supplementary Medicare coverage, are included in the support he or she provides. However, medical insurance benefits, including basic and supplementary Medicare benefits, are not part of support. Support Test Example The taxpayer’s mother received $2,400 in Social Security benefits and $300 in interest. She paid $2,000 for lodging and $400 for recreation. She put $300 in a savings account. Even though the taxpayer’s mother received a total of $2,700 ($2,400 + $300), she spent only $2,400 ($2,000 + $400) for her own support. If the taxpayer spent more than $2,400 for her support and no other support was received, the taxpayer has provided more than half of her support. Total Support Example Grace Brown, mother of Mary Miller, lives with Frank and Mary Miller and their two children. Grace gets Social Security benefits of $2,400, which she spends for clothing, transportation, and recreation. Grace has no other income. Frank and Mary's total food expense for the household is $5,200. They pay Grace's medical and drug expenses of $1,200. The fair rental value of the lodging provided for Grace is $1,800 a year, based on the cost of similar rooming facilities. Figure Grace's total support as follows: Fair rental value of lodging - $ 1,800

Lesson 4 - Standard Deduction, Dependents

Clothing, transportation, and recreation - $2,400 Medical expenses - $1,200 Share of food (1/5 of $5,200) - $1,040 Total support - $6,440 The support Frank and Mary provide ($1,800 lodging + $1,200 medical expenses + $1,040 food = $4,040) is more than half of Grace's $6,440 total support. Payments the taxpayer receives for the support of a foster child from a child placement agency are considered support provided by the agency. Similarly, payments the taxpayer receives for the support of a foster child from a state or county are considered support provided by the state or county. If the taxpayer is not in the trade or business of providing foster care and his or her unreimbursed out-of-pocket expenses in caring for a foster child were mainly to benefit an organization qualified to receive deductible charitable contributions, the expenses are deductible as charitable contributions but are not considered support he or she provided. If the taxpayer’s unreimbursed expenses are not deductible as charitable contributions, they may qualify as support he or she provided. If the taxpayer is in the trade or business of providing foster care, his or her unreimbursed expenses are not considered support provided by him or her. A scholarship received by a child who is a student is not taken into account in determining whether the child provided more than half of his or her own support.

Review Question 5 Which of the following statements is false regarding foster care payments and expenses?

A. Payments the taxpayer receives for the support of a foster child from a child placement agency are considered support provided by the agency

B. Payments the taxpayer receives for the support of a foster child from a state or county are considered support provided by the state or county

C. If the taxpayer is not in the trade or business of providing foster care and his or her unreimbursed out-of-pocket expenses in caring for a foster child were mainly to benefit an organization qualified to receive deductible charitable contributions, the expenses are deductible as charitable contributions but are not considered support the taxpayer provided

D. If the taxpayer is in the trade or business of providing foster care, his or her unreimbursed expenses are considered support provided by him or her

See Review Feedback for answer.

Joint Return Test

A taxpayer generally cannot claim a married person as a dependent if he or she files a joint return. The only exception is a taxpayer can claim a person as a dependent who files a joint return if that person and his or her spouse file the joint return only to claim a refund of income tax withheld or estimated tax paid. Example 1 - Child files joint return The taxpayer supported his or her 18-year-old daughter, and she lived with the taxpayer all year while her husband was in the Armed Forces. The couple files a joint return. The taxpayer cannot claim his or her daughter as a dependent. Example 2 - Child files joint return only as claim for refund of withheld tax The taxpayer’s 18-year-old son and his 17-year-old wife had $800 of wages from part-time jobs and no other income. Neither is required to file a tax return. They do not have a child. Taxes were taken out of their pay so they file a joint return only to get a refund of the withheld taxes. The exception to the joint return test applies, so the taxpayer is not disqualified from claiming each of them as a dependent just because they file a joint return. The taxpayer can claim each of them as dependents if all the other tests to do so are met. (98)

Tests to Be a Qualifying Relative Four tests must be met for a person to be a qualifying relative.

1. The person cannot be a qualifying child or the qualifying child of any other taxpayer.

Lesson 4 - Standard Deduction, Dependents

2. The person either: a. Be related to taxpayer in one of the ways listed:

i. Taxpayer’s child, stepchild, foster child, or a descendant of any of them (for example, a grandchild). (A legally adopted child is considered the taxpayer’s child.)

ii. Taxpayer’s brother, sister, half-brother, half-sister, stepbrother, or stepsister. iii. Taxpayer’s father, mother, grandparent, or other direct ancestor, but not foster parent. iv. Taxpayer’s stepfather or stepmother. v. A son or daughter of taxpayer’s brother or sister. vi. A son or daughter of taxpayer’s half-brother or half-sister. vii. A brother or sister of taxpayer’s father or mother. viii. Taxpayer’s son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-

law. b. Must live with the taxpayer all year as a member of the household (and the taxpayer’s relationship must

not violate local law). 3. In 2023, the person's gross income for the year must be less than $4,700 (Tax-exempt income, such as certain

Social Security benefits, is not included in gross income). 4. The taxpayer must provide more than half of the person's total support for the year.

Unlike a qualifying child, a qualifying relative can be any age. There is no age test for a qualifying relative. Also, a child is not a qualifying relative if the child is a qualifying child or the qualifying child of any other taxpayer. Additionally, a cousin meets this test only if he or she lives with the taxpayer all year as a member of his or her household. A cousin is a descendant of a brother or sister of the taxpayer’s father or mother. However, a taxpayer cannot claim housekeepers, maids, or servants if they work for the taxpayer.

Review Question 6 Which of the following tests is not required for a qualifying relative?

A. Relationship test B. Age test C. Gross income test D. Support test

See Review Feedback for answer.

Four tests must be met for a person to be your qualifying relative. The four tests are: 1. Not a qualifying child test, 2. Member of household or relationship test, 3. Gross income test, and 4. Support test.

Not a Qualifying Child Test

A child is not the taxpayer’s qualifying relative if the child is his or her qualifying child or the qualifying child of any other taxpayer. Example 1 The taxpayer’s 22-year-old daughter, who is a student, lives with the taxpayer and meets all the tests to be a qualifying child. She is not a qualifying relative. Example 2 The taxpayer’s 2-year-old son lives with the taxpayer’s parents and meets all the tests to be their qualifying child. He is not the taxpayer’s qualifying relative. Example 3 The taxpayer’s son lives with the taxpayer but is not the taxpayer’s qualifying child because he is 30 years old and does not meet the age test. He may be a qualifying relative if the gross income test and the support test are met. Example 4 The taxpayer’s 13-year-old grandson lived with his mother for 3 months, with his uncle for 4 months, and with the taxpayer for 5 months during the year. He is not the taxpayer’s qualifying child because he does not meet the residency test. He may be a qualifying relative if the gross income test and the support test are met.

Lesson 4 - Standard Deduction, Dependents

A child is not the qualifying child of any other individual and so may qualify as the taxpayer’s qualifying relative if the child's parent (or other person for whom the child is defined as a qualifying child) is not required to file an income tax return and either:

➢ Does not file an income tax return. ➢ Files a return only to get a refund of income tax withheld or estimated tax paid.

The taxpayer may be able to claim his or her child as a dependent even if the child lives in Canada or Mexico. If the child Does not live with the taxpayer, the child does not meet the residency test to be his or her qualifying child. However, the child may still be his or her qualifying relative. If the persons the child does live with are not U.S. citizens and have no U.S. gross income, those persons are not “taxpayers,” so the child is not the qualifying child of any other taxpayer. If the child is not the qualifying child of any other individuals, the child is the taxpayer’s qualifying relative as long as the gross income test and the support test are met. The taxpayer cannot claim as a dependent a child who lives in a foreign country other than Canada or Mexico, unless the child is a U.S. citizen, U.S. resident alien, or U.S. national. There is an exception for certain adopted children who lived with the taxpayer all year.

Member of Household or Relationship Test

To meet this test, a person must either:

➢ Live with the taxpayer all year as a member of his or her household. ➢ Be related to the taxpayer in one of the ways listed below: ➢ The taxpayer’s child, stepchild, or foster child, or a descendant of any of them (for example, his or her grandchild).

(A legally adopted child is considered his or her child.) ➢ The taxpayer’s brother, sister, half-brother, half-sister, stepbrother, or stepsister. ➢ The taxpayer’s father, mother, grandparent, or other direct ancestor, but not foster parent. ➢ The taxpayer’s stepfather or stepmother. ➢ A son or daughter of the taxpayer’s brother or sister. ➢ A son or daughter of the taxpayer’s half-brother or half-sister. ➢ A brother or sister of the taxpayer’s father or mother. ➢ The taxpayer’s son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law

Any of these relationships that were established by marriage are not ended by death or divorce.

Gross Income Test

To meet this test, a person's gross income for 2023 must be less than $4,700. Gross income is all income in the form of money, property, and services that are not exempt from tax. In a manufacturing, merchandising, or mining business, gross income is the total net sales minus the cost of goods sold, plus any miscellaneous income from the business. Gross receipts from rental property are gross income. Do not deduct taxes, repairs, etc., to determine the gross income from rental property. Gross income also includes a partner's share of the gross (not a share of the net) partnership income. Gross income also includes all taxable unemployment compensation and certain scholarship and fellowship grants. Scholarships received by degree candidates and used for tuition, fees, supplies, books, and equipment required for particular courses generally are not included in gross income.

Support Test (To Be a Qualifying Relative)

To meet this test, the taxpayer must generally provide more than half of a person's total support during the calendar year. However, if two or more persons provide support, but no one person provides more than half of a person's total support, see Multiple Support Agreement, below.

The taxpayer figures whether he or she has provided more than half of a person's total support by comparing the amount he or she contributed to that person's support with the entire amount of support that person received from all sources. This includes support the person provided from the person’s own funds. A person's own funds are not support unless they are actually spent for support.

Lesson 4 - Standard Deduction, Dependents

If the taxpayer files a joint return, the person can be related to either him or her or his or her spouse. Also, the person does not need to be related to the spouse who provides support. For example, the taxpayer’s spouse's uncle who receives more than half of his support from the taxpayer may be a qualifying relative, even though he does not live with the taxpayer. However, if the taxpayer and his or her spouse file separate returns, the spouse's uncle can be a qualifying relative only if he lives with the taxpayer all year as a member of his or her household.

Multiple-Support Agreements

Sometimes no one provides more than half of the support of a person. Instead, two or more persons, each of whom would be able to claim the person as a dependent but for the support test, together provide more than half of the person's support. When this happens, the taxpayers can agree that any one of them who individually provides more than 10% of the person's support, but only one, can claim that person as a dependent. Each of the others must sign a statement agreeing not to claim the person as a dependent for that year. The person who claims the person as a dependent must keep these signed statements for his or her records. A multiple support declaration identifying each of the others who agreed not to claim the person as a dependent must be attached to the return of the person claiming the person as a dependent. Form 2120 - Multiple Support Declaration can be used for this purpose.

The taxpayer can claim someone as a dependent under a multiple support agreement for someone related to him or her or for someone who lived with him or her all year as a member of the taxpayer’s household.

Example 1 The taxpayer, her sister, and her two brothers provide the entire support of their mother for the year. The taxpayer provides 45%, her sister 35%, and her two brothers each provide 10%. Either the taxpayer or her sister can claim their mother as a dependent. The other, either the taxpayer or the sister, must sign a statement agreeing not to claim their mother as a dependent. The one who claims the person as a dependent must attach Form 2120, or a similar declaration, to her return and must keep the statement signed by the other for her records. Because neither brother provides more than 10% of the support, neither can claim their mother as a dependent and neither has to sign a statement. Example 2 The taxpayer’s father lives with her and receives 25% of his support from Social Security, 40% from the taxpayer, 24% from his brother (the taxpayer’s uncle), and 11% from a friend. Either the taxpayer or her uncle can claim her father as a dependent if the other signs a statement agreeing not to. The one who claims the father as a dependent must attach Form 2120, or a similar declaration, to his or her return and must keep for his or her records the signed statement from the one agreeing not to claim the father as a dependent.

Children of Divorced or Separated Parents (or Parents Who Live Apart)

In most cases, a child of divorced or separated parents (or parents who live apart) will be a qualifying child of one of the parents. However, if the child does not meet the requirements to be a qualifying child of either parent, the child may be a qualifying relative of one of the parents. In that case, the following rules must be used in applying the support test. A child will be treated as being the qualifying relative of his or her noncustodial parent if all four of the following statements are true: (91)

1. The parents: a. Are divorced or legally separated under a decree of divorce or separate maintenance. b. Are separated under a written separation agreement. c. Lived apart at all times during the last 6 months of the year, whether or not they are or were married.

2. The child received over half of his or her support for the year from the parents (and the rules on multiple support agreements do not apply).

3. The child is in the custody of one or both parents for more than half of the year. 4. Either of the following applies:

a. The custodial parent signs a written declaration, that he or she will not claim the child as a dependent for the year, and the non-custodial parent attaches this written declaration to his or her return (If the decree or agreement went into effect after 1984).

b. A pre-1985 decree of divorce or separate maintenance or written separation agreement that applies to 2023 states that the non-custodial parent can claim the child as a dependent, the decree or agreement was not changed after 1984 to say the non-custodial parent cannot claim the child as a dependent, and the non-custodial parent provides at least $600 for the child's support during the year.

Lesson 4 - Standard Deduction, Dependents

The custodial parent is the parent with whom the child lived for the greater number of nights during the year. The other parent is the noncustodial parent. If the parents divorced or separated during the year and the child lived with both parents before the separation, the custodial parent is the one with whom the child lived for the greater number of nights during the rest of the year. A child is treated as living with a parent for a night if the child sleeps:

➢ At that parent's home, whether or not the parent is present, or ➢ In the company of the parent, when the child does not sleep at a parent's home (for example, the parent and child

are on vacation together).

If the child lived with each parent for an equal number of nights during the year, the custodial parent is the parent with the higher adjusted gross income. The night of December 31 is treated as part of the year in which it begins. For example, the night of December 31, 2023, is treated as part of 2023.

If a child is emancipated under state law, the child is treated as not living with either parent. For example, when a child turned age 18 in May 2023, he or she became emancipated under the law of the state where he or she lives. As a result, he or she is not considered in the custody of his or her parents for more than half of the year. The special rule for children of divorced or separated parents (or parents who live apart) does not apply.

If a child was not with either parent on a particular night (because, for example, the child was staying at a friend's house), the child is treated as living with the parent with whom the child normally would have lived for that night, except for the absence. But if it cannot be determined with which parent the child normally would have lived or if the child would not have lived with either parent that night, the child is treated as not living with either parent that night.

If, due to a parent's nighttime work schedule, a child lives for a greater number of days but not nights with the parent who works at night, that parent is treated as the custodial parent. On a school day, the child is treated as living at the primary residence registered with the school.

If the taxpayer is the custodial parent, he or she can use Form 8332 - Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent to make the written declaration to release a claim to an exemption for a child to the noncustodial parent. Although the exemption amount is zero for tax year 2023, this release allows the noncustodial parent to claim the Child Tax Credit, Additional Child Tax Credit, and Credit for Other

Dependents, if applicable, for the child. The noncustodial parent must attach a copy of the form or statement to his or her tax return. The release can be for 1 year, for a number of specified years (for example, alternate years), or for all future years, as specified in the declaration. Example 1 - Child lived with one parent for a greater number of nights The taxpayer and the child’s other parent are divorced. In 2023, the child lived with the taxpayer 210 nights and with the other parent 155 nights. The taxpayer is the custodial parent. Example 2 - Child is away at camp In 2023, the taxpayer’s daughter lives with each parent for alternate weeks. In the summer, she spends 6 weeks at summer camp. During the time she is at camp, she is treated as living with the taxpayer for 3 weeks and with her other parent, the taxpayer’s ex-spouse, for 3 weeks because this is how long she would have lived with each parent if she had not attended summer camp. Example 3 - Child lived same number of nights with each parent The taxpayer’s son lived with him or her 180 nights during the year and lived the same number of nights with his other parent, the taxpayer’s ex-spouse. The taxpayer’s AGI is $40,000. His or her ex-spouse's AGI is $25,000. The taxpayer is treated as his or her son's custodial parent because he or she has the higher AGI.

Example 4 - Child is at parent’s home but with other parent The taxpayer’s son normally lives with him or her during the week and with his other parent, the taxpayer’s ex-spouse, every other weekend. The taxpayer becomes ill and is hospitalized. The other parent lives in the taxpayer’s home with his or her son for 10 consecutive days while the taxpayer is in the hospital. The taxpayer’s son is treated as living with the taxpayer during this 10-day period because he was living in the taxpayer’s home.

Example 5 - Child emancipated in May When the taxpayer’s son turned age 18 in May 2023, he became emancipated under the law of the state where he lives. As a result, he is not considered in the custody of his parents for more than half of the year. The special rule for children of divorced or separated parents does not apply.

Lesson 4 - Standard Deduction, Dependents

Example 6 - Child emancipated in August The taxpayer’s daughter lives with the taxpayer from January 1, 2023, until May 31, 2023, and lives with her other parent, the taxpayer’s ex-spouse, from June 1, 2023, through the end of the year. She turns 18 and is emancipated under state law on August 1, 2023. Because she is treated as not living with either parent beginning on August 1, she is treated as living with the taxpayer the greater number of nights in 2023. The taxpayer is the custodial parent.

Special Rule for Qualifying Child of More Than One Person

Sometimes, a child meets the relationship, age, residency, support, and joint return tests to be a qualifying child of more than one person. Although the child is a qualifying child of each of these persons, only one person can actually treat the child as a qualifying child to take all of the following tax benefits (provided the person is eligible for each benefit): (86)

➢ The Child Tax Credit or Credit for Other Dependents. ➢ Head of household filing status. ➢ The Credit for Child and Dependent Care Expenses. ➢ The exclusion from income for dependent care benefits. ➢ The Earned Income Tax Credit.

The other person cannot take any of these benefits based on this qualifying child. In other words, the taxpayer and the other person cannot agree to divide these tax benefits. The other person cannot take any of these benefits for a child unless he or she has a different qualifying child. To determine which person can treat the child as a qualifying child to claim these six tax benefits, the following tiebreaker rules apply: (86)

➢ If only one of the persons is the child's parent, the child is treated as the qualifying child of the parent. ➢ If the parents do not file a joint return together but both parents claim the child as a qualifying child, the IRS will

treat the child as the qualifying child of the parent with whom the child lived for the longer period of time during the year. If the child lived with each parent for the same amount of time, the IRS will treat the child as the qualifying child of the parent who had the higher adjusted gross income (AGI) for the year.

➢ If no parent can claim the child as a qualifying child, the child is treated as the qualifying child of the person who had the highest AGI for the year.

➢ If a parent can claim the child as a qualifying child but no parent does so claim the child, the child is treated as the qualifying child of the person who had the highest AGI for the year, but only if that person's AGI is higher than the highest AGI of any of the child's parents who can claim the child. If the child's parents file a joint return with each other, this rule can be applied by dividing the parents' combined AGI equally between the parents.

Subject to these tiebreaker rules, the taxpayer and the other person may be able to choose which one claims the child as a qualifying child.

Example The taxpayer and her 3-year-old daughter, Jill, lived with the taxpayer’s mother all year. The taxpayer is 25 years old, unmarried, and has an AGI of $9,000. The taxpayer’s mother's AGI is $15,000. Jill's father did not live with the taxpayer or her daughter. The taxpayer has not signed Form 8332 (or a similar statement). Jill is a qualifying child of both the taxpayer and her mother because she meets the relationship, age, residency, support, and joint return tests for both. However, only one can claim her. Jill is not a qualifying child of anyone else, including her father. The taxpayer agrees to let her mother claim Jill. This means the taxpayer’s mother can claim Jill as a qualifying child for all of the six tax benefits listed earlier, if she qualifies (and if the taxpayer does not claim Jill as a qualifying child for any of those tax benefits).

Lesson 4 - Standard Deduction, Dependents

• $1,250, or

• The individual's earned income for the year plus $400 (but not more than the regular standard deduction amount, generally $13,850).

In this question, Michael uses the Standard Deduction Worksheet for Dependents to find his standard deduction. He enters $1,250 (because his earned income is less than $750) on line 5 and $13,850 on line 6 because he is single. His standard deduction, on line 7a, is $1,250 (the smaller of $1,250 and $13,850). Only Choice C has the correct amount and is therefore the correct response. Topic - Dependents of Other Taxpayers Source - Publication 501 - Dependents, Standard Deduction, and Filing Information Question 4 - B. 4 Since Mary and Matthew provided more than 50% of the support for all of the children and their 22-year-old child is a full- time student, each child (4) qualifies as a dependent making Choice B the correct response. Mary and Matthew cannot claim themselves as dependents so Choice C and D are incorrect. Topic - Tests to Be a Qualifying Child Source - Publication 501 - Dependents, Standard Deduction, and Filing Information Question 5 - D. If the taxpayer is in the trade or business of providing foster care, his or her unreimbursed expenses are considered support provided by him or her Payments the taxpayer receives for the support of a foster child from a child placement agency are considered support provided by the agency (Choice A). Similarly, payments the taxpayer receives for the support of a foster child from a state or county are considered support provided by the state or county (Choice B). If the taxpayer is not in the trade or business of providing foster care and his or her unreimbursed out-of-pocket expenses in caring for a foster child were mainly to benefit an organization qualified to receive deductible charitable contributions, the expenses are deductible as charitable

Lesson 4 - Standard Deduction, Dependents

contributions but are not considered support he or she provided. If the taxpayer’s unreimbursed expenses are not deductible as charitable contributions, they may qualify as support he or she provided (Choice C). However, if the taxpayer is in the trade or business of providing foster care, his or her unreimbursed expenses are not considered support provided by him or her therefore Choice D is false and the correct response. Topic - Support Test Source - Publication 501 - Dependents, Standard Deduction, and Filing Information Question 6 - B. Age test Four tests must be met for a person to be a qualifying relative.

1. Not a qualifying child test. 2. Member of household or relationship test (Choice A). 3. Gross income test (Choice C). 4. Support test (Choice D).

Unlike a qualifying child, a qualifying relative can be any age. There is no age test for a qualifying relative. Therefore, Choice B, Age test, is not required for a qualifying relative and the correct response. Topic - Tests to Be a Qualifying Relative Source - Publication 501 - Dependents, Standard Deduction, and Filing Information

Income At the conclusion of this lesson you should have a basic knowledge of:

➢ Earned Income. ➢ Unemployment and Other Compensation. ➢ Special Rules for Certain Employees. ➢ Passive Income. ➢ Rental Income. ➢ Separation or Divorce Issues.

The general definition of income in 26 USC Section 61 is that gross income means all income from whatever source derived, including (but not limited to) the following items: (99)

➢ Compensation for services, including fees, commissions, fringe benefits, and similar items. ➢ Gross income derived from businesses. ➢ Gains derived from dealings in property. ➢ Interest. ➢ Rents. ➢ Royalties. ➢ Dividends. ➢ Alimony and separate maintenance payments. ➢ Annuities. ➢ Income from life insurance and endowment contracts. ➢ Pensions. ➢ Income from discharge of indebtedness. ➢ Distributive share of partnership income. ➢ Income in respect to the decedent. ➢ Income from the interest in an estate or trust.

Earned Income Earned income includes all the taxable income and wages the taxpayer gets from working or from certain disability payments. A taxpayer receives earned income by working for someone who pays him or her or owning or running a business or farm. Taxable earned income includes: (100)

➢ Wages, salaries, tips, and other taxable employee pay. ➢ Union strike benefits. ➢ Long-term disability benefits received prior to minimum retirement age. ➢ Net earnings from self-employment if:

o The taxpayer owns or operates a business or a farm. o The taxpayer is a minister or member of a religious order. o The taxpayer is a statutory employee and has income.

Examples of income that are not earned income: (100)

➢ Pay received for work while an inmate in a penal institution. ➢ Interest and dividends. ➢ Retirement income. ➢ Social Security benefits. ➢ Unemployment benefits. ➢ Alimony. ➢ Child support.

Lesson 5 - Income

The most common forms of income reported by the average taxpayer are compensation, dividends, and interest. About 95% of the adjusted gross income of individuals is from these three sources. Income from compensation alone -- salaries, wages and all fringe benefits -- accounts for about 85% of the total adjusted gross income.

Compensation and Wages

Form W-2 – Wage and Tax Statement is used to report to employees the annual amount of salaries and withholdings. In some cases, taxable compensation is not subject to withholding of income taxes and the compensation is not reported on Form W-2. When taxable income is not subject to withholdings, the taxpayer must report the amount on line 8(a-z) of Schedule 1 (Form 1040) unless it fits into one of the categories shown on lines 1 through 7. If the space on line 8 is insufficient to state the nature and source, then the taxpayer must attach a supplementary schedule to Form 1040 to explain the amounts reported. The IRS does not provide a printed form for this purpose.

Compensation Subject to the Tax

All compensation for personal services is subject to the income tax. Compensation means more than just salaries and wages. The term also includes tips, commissions, fees for personal services, overtime pay, vacation pay and every other payment for personal services. Virtually every payment made by an employer to an employee or by a customer for personal services is compensation and is taxable income to the employee/recipient. Taxability of a payment is not affected by what the payment is called. For example, bonuses and performance awards are usually taxable as compensation. The IRS provides the following list of items that do not have to be included as taxable income: (101)

➢ Adoption expense reimbursements for qualifying expenses. ➢ Child support payments. ➢ Gifts, bequests, and inheritances (Subject to limits). ➢ Workers' compensation benefits (some exceptions may apply; see Publication 525 - Taxable and Nontaxable

Income). ➢ Meals and lodging for the convenience of the taxpayer’s employer. ➢ Compensatory damages awarded for physical injury or physical sickness. ➢ Welfare benefits. ➢ Cash rebates from a dealer or manufacturer.

Review Question 1 Which of the following payments are generally taxable?

A. Qualified disaster relief payments B. Veteran Affairs (VA) benefits C. Unemployment compensation D. Payments from a government welfare fund based on need

See Review Feedback for answer.

Foreign Earned Income If the taxpayer is a U.S. citizen or a resident alien of the United States and he or she lives abroad, the taxpayer is taxed on his or her worldwide income. Foreign earned income for this purpose means wages, salaries, professional fees, and other compensation received for personal services the taxpayer performed in a foreign country during the period for which he or she met the tax home test and either the bona fide residence test or the physical presence test. It also includes noncash income (such as a home or car) and allowances or reimbursements. A taxpayer qualifies for the tax benefits available to taxpayers who have foreign earned income if both of the following apply: (102)

➢ The taxpayer meets the tax home test. ➢ The taxpayer meets either the bona fide residence test or the physical presence test.

Lesson 5 - Income

Income from working abroad as an employee of the U.S. Government does not qualify for either of the exclusions or the housing deduction.

To meet the tax home test, the taxpayer’s tax home must be in a foreign country throughout his or her period of bona fide residence or physical presence, whichever applies. For this purpose, the period of physical presence is the 330 full days during which the taxpayer was present in a foreign country, not the 12 consecutive months during which those days occurred. Foreign earned income does not include amounts that are actually a distribution of corporate earnings or profits distribution of corporate earnings or profits rather than a reasonable allowance as compensation for the taxpayer’s personal services. It also does not include the following types of income: (102)

➢ Pay received as a military or civilian employee of the U.S. Government or any of its agencies. ➢ Pay for services conducted in international waters (not a foreign country). ➢ Pay in specific combat zones, as designated by an Executive Order from the President, that is excludable from

income. ➢ Payments received after the end of the tax year following the year in which the services that earned the income

were performed. ➢ The value of meals and lodging that are excluded from income because it was furnished for the convenience of

the employer. ➢ Pension or annuity payments, including social security benefits.

Certain U.S. citizens or resident aliens, specifically contractors or employees of contractors supporting the U.S. Armed Forces in designated combat zones, may now qualify for the foreign earned income exclusion. The Bipartisan Budget Act of 2018 changed the tax home requirement for eligible taxpayers, enabling them to claim the foreign earned income exclusion even if their “abode” is in the United States. The law applies for tax year 2018 and subsequent years. This means that these taxpayers, if eligible, will be able to claim the foreign earned income exclusion on their income tax return for 2023 when they file. Under the exclusion, taxpayers can choose to exclude their foreign earned income from gross income, up to a certain dollar amount. For tax year 2023, that dollar amount limit is $120,000.

Unemployment and Other Compensation

Cafeteria Plans

A cafeteria plan, including a flexible spending arrangement, is a written plan that allows employees to choose between receiving cash or taxable benefits instead of certain qualified benefits for which the law provides an exclusion from wages. If an employee chooses to receive a qualified benefit under the plan, the fact that the employee could have received cash or a taxable benefit instead will not make the qualified benefit taxable. Generally, a cafeteria plan does not include any plan that offers a benefit that defers pay. However, a cafeteria plan can include a qualified 401(k) plan as a benefit. Also, certain life insurance plans maintained by educational institutions can be offered as a benefit even though they defer pay. A cafeteria plan can include the following benefits: (103)

➢ Accident and health benefits (but not Archer medical savings accounts (Archer MSAs) or long-term care

insurance). ➢ Adoption assistance. ➢ Dependent care assistance. ➢ Group-term life insurance coverage (including costs that cannot be excluded from wages). ➢ Health savings accounts (HSAs). Distributions from an HSA may be used to pay eligible long-term care insurance

premiums or qualified long-term care services. A cafeteria plan cannot include the following benefits: (103)

➢ Archer MSAs. ➢ Athletic facilities. ➢ De minimis (minimal) benefits. ➢ Educational assistance.

Lesson 5 - Income

➢ Employee discounts. ➢ Employer-provided cell phones. ➢ Lodging on the business premises. ➢ Meals. ➢ No-additional-cost services. ➢ Transportation (commuting) benefits. ➢ Tuition reduction. ➢ Working condition benefits.

A cafeteria plan also cannot include scholarships or fellowships.

A cafeteria plan may not allow an employee to request salary reduction contributions for a health flexible spending arrangement (FSA) in excess of the annual limit. For 2023, the annual dollar limit on employee contributions to employer- sponsored healthcare flexible spending arrangements (FSA) increases to $3,050. Amounts contributed are not subject to Federal income tax, Social Security tax or Medicare tax. If the plan allows, the employer may also contribute to an employee’s FSA. A cafeteria plan that does not limit health FSA contributions to the dollar limit is not a cafeteria plan and all benefits offered under the plan are includible in the employee's gross income.

Cafeteria plan rules ordinarily require FSA contributions to be used for expenses incurred within the year of contribution, or else they will be forfeited. The rules include limited exceptions that allow plans to either contain an additional 2.5-month grace period on to the end of the plan year for participants to incur expenses that may be reimbursed from the prior year’s contributions or carry up to $610 in 2023 from health FSA contributions over to the next year. (104)

In most cases, if an individual is covered by an accident or health insurance plan through a cafeteria plan, and the amount of the insurance premiums was not included in income, he or she is not considered to have paid the premiums and must include any benefits received in income. If the amount of the premiums was included in income, the individual is considered to have paid the premiums and any benefits received are not taxable. The Affordable Care Act requires employers to report the cost of coverage under an employer-sponsored group health plan. However, there is nothing about the reporting requirement that causes or will cause excludable employer-provided health coverage to become taxable. The purpose of the reporting requirement is to provide employees useful and comparable consumer information on the cost of their health care coverage. For tax purposes, the taxpayer can generally exclude from his or her income any health insurance premiums (including Medicare) paid by his or her employer. The premiums can be for insurance covering the taxpayer, his or her spouse, and any dependents. It does not matter whether the premiums paid for an employer-sponsored group policy or an individual policy. If the taxpayer pays the premiums on his or her health insurance policy and receives a reimbursement from his or her employer for those premiums, the amount of the reimbursement is not taxable income. However, if the taxpayer’s employer simply pays him or her a lump sum that may be used to pay health insurance premiums but is not required to be used for this purpose, that amount is taxable. The deductibility of health insurance premiums follows the rules for deducting medical expenses. Usually, the premiums a taxpayer pays on an individual health insurance policy will not be deductible. However, if the taxpayer itemizes deductions on Schedule A, and his or her unreimbursed medical expenses exceed 7.5% of adjusted gross income (AGI) in any tax year, the taxpayer may be able to take a deduction. He or she can deduct the amount by which his or her unreimbursed medical expenses exceed this 7.5% threshold. Unreimbursed medical expenses include premiums paid for major medical, hospital, surgical, and physician's expense insurance, and amounts paid out-of-pocket for treatment not covered by the taxpayer’s health insurance.

The Consolidated Appropriations Act, 2021 makes permanent the lower threshold of 7.5% for all taxpayers, originally restored for 2017 and 2018 and then extended for 2019 and 2020. (104)

Unemployment Compensation

The term “unemployment compensation” means any amount received under a law of the United States, or of a State, which is in the nature of unemployment compensation. Thus, Section 85 applies only to unemployment compensation

Lesson 5 - Income

paid pursuant to governmental programs and does not apply to amounts paid pursuant to private nongovernmental unemployment compensation plans (which are includible in income without regard to Section 85). Generally, unemployment compensation programs are those designed to protect taxpayers against the loss of income caused by involuntary layoff. Ordinarily, unemployment compensation is paid in cash and on a periodic basis. The amount of the payments is usually computed in accordance with a formula based on the taxpayer's length of prior employment and wages. Such payments, however, may be made in a lump sum or other than in cash or on some other basis. At present, Federal law requires that all unemployment compensation received from governmental units must be reported as income. If unemployment compensation was received during the year, the taxpayer should receive Form 1099-G - Certain Government Payments showing the amount he or she was paid. Any unemployment compensation received must be included in his or her income. (105) Unemployment compensation generally includes the following benefits: (106)

➢ Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund. ➢ State unemployment insurance benefits. ➢ Railroad unemployment compensation benefits. ➢ Disability payments from a government program paid as a substitute for unemployment compensation (Amounts

received as workers' compensation for injuries or illness are not unemployment compensation). ➢ Trade readjustment allowances under the Trade Act of 1974. ➢ Unemployment assistance under the Disaster Relief and Emergency Assistance Act of 1974. ➢ Unemployment assistance under the Airline Deregulation Act of 1974 Program.

The taxpayer must include benefits from regular union dues paid to him or her as an unemployed member of a union in his or her income. However, other rules apply if the taxpayer contributes to a special union fund and the contributions are not deductible. If this applies, only include in income the amount the taxpayer received from the fund that is more than his or her contributions. The taxpayer can choose to have Federal income tax withheld from the unemployment benefits. He or she makes this choice using Form W-4V - Voluntary Withholding Request. If the taxpayer completes the form and gives it to the paying office, they will withhold tax at 10% of the payments. If the taxpayer chooses not to have tax withheld, he or she may have to make estimated tax payments throughout the year. (107)

Review Question 2 Unemployment compensation generally includes which of the following benefits?

A. Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund B. State unemployment insurance benefits C. Railroad unemployment compensation benefits D. All of the above

See Review Feedback for answer.

Sickness and Injury Benefits

In most cases, the taxpayer must report as income any amount he or she receives for personal injury or sickness through an accident or health plan that is paid for by his or her employer. If both the taxpayer and the employer pay for the plan, only the amount the taxpayer receives that is due to the employer's payments is reported as income. However, certain payments may not be taxable. If the taxpayer retired on disability, he or she must include in income any disability pension he or she receives under a plan that is paid for by his or her employer. The taxpayer must report taxable disability payments as wages until he or she reaches minimum retirement age. Minimum retirement age generally is the age at which the taxpayer can first receive a pension or annuity if he or she is not disabled. (108)

The taxpayer may be able to exclude from income amounts he or she receives as a pension, annuity, or similar allowance for personal injury or sickness resulting from active service in one of the following government services: (109)

➢ The armed forces of any country.

Lesson 5 - Income

➢ The National Oceanic and Atmospheric Administration. ➢ The Public Health Service. ➢ The Foreign Service.

The taxpayer should not include the disability payments in his or her income if any of the following conditions apply: (109)

➢ The taxpayer was entitled to receive a disability payment before September 25, 1975. ➢ The taxpayer was a member of a listed government service or its reserve component or was under a binding

written commitment to become a member, on September 24, 1975. ➢ The taxpayer received the disability payments for a combat-related injury. This is a personal injury or sickness

that: o Results directly from armed conflict. o Takes place while the taxpayer was engaged in extra-hazardous service. o Takes place under conditions simulating war, including training exercises such as maneuvers. o Is caused by an instrumentality of war.

➢ The taxpayer would be entitled to receive disability compensation from the Department of Veterans Affairs (VA) if he or she filed an application for it. The exclusion under this condition is equal to the amount the taxpayer would be entitled to receive from the VA.

Workers' Compensation

Amounts in the nature of unemployment compensation also include cash disability payments made pursuant to a governmental program as a substitute for case unemployment payments to an unemployed taxpayer who is ineligible for such payments solely because of the disability. Usually, these disability payments are paid in the same weekly amount and for the same period as the unemployment compensation benefits to which the unemployed taxpayer otherwise would have been entitled. Amounts received under workmen's compensation acts as compensation for personal injuries or sickness are not amounts in the nature of unemployment compensation. Amounts the taxpayer receives as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act. The exemption also applies to his or her survivors. The exemption, however, does not apply to retirement plan benefits the taxpayer receives based on his or her age, length of service, or prior contributions to the plan, even if he or she retired because of an occupational sickness or injury. If part of the taxpayer’s workers' compensation reduces his or her Social Security or equivalent railroad retirement benefits received, that part is considered Social Security (or equivalent railroad retirement) benefits and may be taxable. If the taxpayer returns to work after qualifying for workers' compensation, salary payments he or she receives for performing light duties are taxable as wages.

Reimbursement for Medical Care

A reimbursement for medical care generally is not taxable. However, it may reduce the taxpayer’s medical expenses deduction if he or she receives reimbursement for an expense he or she deducted in an earlier year. If a taxpayer receives an advance reimbursement or loan for future medical expenses from his or her employer without regard to whether he or she suffered a personal injury or sickness or incurred medical expenses, that amount is included in income, whether or not the taxpayer incurs uninsured medical expenses during the year. Reimbursements received under the taxpayer’s employer's plan for expenses incurred before the plan was established are included in income. Amounts a taxpayer receives under a reimbursement plan that provides for the payment of unused reimbursement amounts in cash or other benefits are included in income. However, a qualified HSA distribution from a health flexible spending account or health reimbursement account can be made to a health savings account.

Sick Pay

The IRS defines sick pay as any amount paid under a plan for employees because of an employee’s temporary absence from work due to injury, sickness or disability. The sick pay may be paid by either the employer or by a third party, such as an insurance company. Based on this definition, the IRS classifies Long-Term Disability Insurance (LTD), Short-Term Disability Insurance (STD) and State Disability Insurance (SDI) benefits paid to employees as sick pay. Pay a taxpayer

Lesson 5 - Income

receives from his or her employer while he or she is sick or injured is part of his or her salary or wages. In addition, the taxpayer must include in his or her income sick pay benefits received from any of the following payers: (110)

➢ A welfare fund. ➢ A state sickness or disability fund. ➢ An association of employers or employees. ➢ An insurance company, if his or her employer paid for the plan.

However, if the taxpayer paid the premiums on an accident or health insurance policy, the benefits he or she receives under the policy are not taxable.

Life Insurance and Disability Insurance Proceeds

A taxpayer must report as income any amount he or she receives for disability through an accident or health insurance plan paid for by his or her employer: (111)

➢ If both the taxpayer and the employer have paid the premiums for the plan, only the amount he or she receives for disability that is due to his or her employer’s payments is reported as income.

➢ If the taxpayer pays the entire cost of a health or accident insurance plan, do not include any amounts he or she receives for disability as income on the tax return.

➢ If the taxpayer pays the premiums of a health or accident insurance plan through a cafeteria plan, and the amount of the premium was not included as taxable income to him or her, the premiums are considered paid by the employer, and the disability benefits are fully taxable.

➢ If the amounts are taxable: o The taxpayer can submit a Form W-4S - Request for Federal Income Tax Withholding From Sick Pay to

the insurance company. o Make estimated tax payments by filing Form 1040-ES - Estimated Tax for Individuals.

Amounts a taxpayer receives from an employer while he or she is sick or injured are part of his or her salary or wages.

Taxation of Disability Benefits

Who Pays the Insurance Premium Is the Benefit Taxable? How Much of the Benefit is

Taxable?

Employer pays 100% Yes 100%

Employer pays portion and employee pays balance with post-tax dollars

Yes Percentage of premium paid by

employer

Employer pays portion and employee pays balance with pre-tax dollars

Yes 100%

Employee pays 100% with post-tax dollars

No None

Employee pays 100% with pre-tax dollars

Yes 100%

Table 5-1 - Internal Revenue Code (IRC) Section 105 (2023)

Military and Government Disability Pensions

Certain military and government disability pensions are not taxable. The taxpayer may be able to exclude from income amounts he or she receives as a pension, annuity, or similar allowance for personal injury or sickness resulting from active service in one of the following government services:

➢ The armed forces of any country. ➢ The National Oceanic and Atmospheric Administration. ➢ The Public Health Service. ➢ The Foreign Service.

The taxpayer does not include the disability payments in his or her income if any of the following conditions apply:

1. He or she was entitled to receive a disability payment before September 25, 1975.

Lesson 5 - Income

2. He or she was a member of a listed government service or its reserve component or was under a binding written commitment to become a member, on September 24, 1975.

3. He or she receives the disability payments for a combat-related injury. This is a personal injury or sickness that: a. Results directly from armed conflict, b. Takes place while he or she is engaged in extra-hazardous service, c. Takes place under conditions simulating war, including training exercises such as maneuvers, or d. Is caused by an instrumentality of war.

4. He or she would be entitled to receive disability compensation from the Department of Veterans Affairs (VA) if he or she filed an application for it. The taxpayer’s exclusion under this condition is equal to the amount he or she would be entitled to receive from the VA.

If the taxpayer receives a disability pension based on years of service, in most cases he or she must include it in his or her income. However, if the pension qualifies for the exclusion for a service-connected disability, the taxpayer does not include in income the part of his or her pension that he or she would have received if the pension had been based on a percentage of disability. The taxpayer must include the rest of his or her pension in his or her income. In most cases, under the statute of limitations a claim for credit or refund must be filed within 3 years from the time a return was filed. However, if the taxpayer receives a retroactive service-connected disability rating determination, the statute of limitations is extended by a 1-year period beginning on the date of the determination. This 1-year extended period applies to claims for credit or refund filed after June 17, 2008 and does not apply to any tax year that began more than 5 years before the date of the determination.

Review Question 3 Unemployment compensation generally includes any amount received under an unemployment compensation law of the United States or of a state. Which of the following statements is false?

A. The taxpayer may be liable for estimated taxes if he or she receives unemployment compensation B. Benefits paid to a taxpayer as an unemployed member of a union out of regular union dues are not

included in his or her gross income C. Benefits received from a company-financed fund, to which a taxpayer did not contribute, are taxable

wages D. Payments a taxpayer receives from his or her employer during periods of unemployment, under a

union agreement that guarantees him or her full pay during the year, are taxable as wages

See Review Feedback for answer.

Prizes and Awards

Almost all contest awards and prizes are now taxable compensation. They usually represent a payment for services rendered. For example, if the taxpayer wins a photography contest, he must have taken the time and invested in the supplies necessary to produce the winning photograph. Although he must include the prize income, he is entitled to reduce the amount of the prize by direct costs. The winner of a lucky number drawing or other contest of chance must report this income on line 8(i), Schedule 1 (Form 1040). (112)

Prizes and awards in goods or services must be included in income at their fair market value. Fair market value is the price that property would sell for on the open market.

Prizes awarded in recognition of accomplishments in religious, charitable, scientific, artistic, educational, literary, or civic fields, generally must be included in income. However, do not include the prize in income if: (112)

➢ The taxpayer was selected without any action on his or her part to enter the contest or proceeding. ➢ The taxpayer is not required to perform substantial future services as a condition to receiving the prize or award. ➢ The prize or award is transferred by the payer directly to a governmental unit or tax-exempt charitable organization

as designated by the taxpayer.

Employee Achievement Awards

If an individual receives tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award

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for length of service or safety achievement, he or she generally can exclude its value from income. However, the amount he or she can exclude is limited to the employer's cost and cannot be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards the person receives during the year. The employer can tell the individual whether the award is a qualified plan award. The employer must make the award as part of a meaningful presentation, under conditions and circumstances that do not create a significant likelihood of it being disguised pay. However, the exclusion does not apply to the following awards: (113)

➢ A length-of-service award if the taxpayer received it for less than 5 years of service or if he or she received another length-of-service award during the year or the previous 4 years.

➢ A safety achievement award if the taxpayer is a manager, administrator, clerical employee, or other professional employee or if more than 10% of eligible employees previously received safety achievement awards during the year.

Gambling Income

Winnings or gains arising from gambling, betting, and lotteries are includible in gross income. Even winnings or gains arising from illegal transactions (such as bootlegging, extortion, embezzlement, or fraud) are includible in the taxpayer’s gross income. Income tax is withheld at a flat 24% rate from certain kinds of gambling winnings. Gambling winnings of more than $5,000 from the following sources are subject to income tax withholding: (59)

➢ Any sweepstakes: wagering pool, including payments made to winners of poker tournaments; or lottery. ➢ Any other wager if the proceeds are at least 300 times the amount of the bet.

It does not matter whether winnings are paid in cash, in property, or as an annuity. Winnings not paid in cash are taken into account at their fair market value.

Gambling winnings from bingo, keno, and slot machines generally are not subject to income tax withholding. However, the taxpayer may need to provide the payer with a Social Security number to avoid withholding. If the taxpayer receives gambling winnings not subject to withholding, he or she may need to pay estimated tax. If a payer withholds income tax from a taxpayer’s gambling winnings, he or she should receive a Form W-2G - Certain Gambling Winnings showing the amount he or she won and the amount withheld. The taxpayer should report the tax withheld on his or her 2023 Form 1040, along with all other Federal income tax withheld, as shown on Forms W-2 and 1099. If a taxpayer has any kind of gambling winnings and does not give the payer his or her Social Security number, the payer may have to withhold income tax at a flat 24% rate. This rule also applies to winnings of at least $1,200 from bingo or slot machines or $1,500 from keno, and to certain other gambling winnings of at least $600.

The Tax Cuts and Jobs Act the limitation on wagering losses is modified to provide that all deductions for expenses incurred in carrying out wagering transactions, not just gambling losses, are limited to the extent of gambling winning. The provision reverses the result reached by the Tax Court where the court held that a

taxpayer’s expenses incurred in the conduct of wagers, were not limited to the extent of gambling winnings, and were deductible as ordinary and necessary business expenses in the case of a “professional gambler”. (114)

The taxpayer cannot reduce gambling winnings by gambling losses and report the difference. He or she must report the full amount of winnings as income and claim losses (up to the amount of winnings) as an itemized deduction. Therefore, the taxpayer’s records should show winnings separately from losses. The taxpayer must

keep an accurate diary or similar record of losses and winnings. To deduct losses, the taxpayer must be able to provide receipts, tickets, statements, or other records that show the amount of both winnings and losses. (115)

Tips

When employees receive cash tips of $20 or more in a calendar month, they are required to report to their employer the total amount of tips they received. The employees must give the employer written reports by the tenth of the following month. Employees who receive tips of less than $20 in a calendar month are not required to report their tips but must report these amounts as income on their tax returns and pay taxes.

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Cash tips include tips received directly from customers, tips from other employees under any tip-sharing arrangement, and charged tips (e.g., credit and debit card charges) that are distributed to an employee. Both directly and indirectly tipped employees must report tips received to their employer. Service charges added to a bill or fixed by the employer that the customer must pay, when paid to an employee, will not constitute a tip but rather constitute non-tip wages. These non-tip wages are subject to Social Security tax, Medicare tax, and Federal income tax withholding. In addition, the employer cannot use these non-tip wages when computing the credit available to employers under Section 45B of the Internal Revenue Code, because these amounts are not tips. Common examples of service charges (sometimes called auto-gratuities) in service industries are: (116)

➢ Large Party Charge (restaurant). ➢ Bottle Service Charge (restaurant and night-club). ➢ Room Service Charge (hotel and resort). ➢ Contracted Luggage Assistance Charge (hotel and resort). ➢ Mandated Delivery Charge (pizza or other retail deliveries).

If an individual received tips as a self-employed person, he or she should report these tips as income on Schedule C. (116)

Employers are responsible for withholding the 0.9% Additional Medicare Tax on a tipped individual’s wages paid in excess of $200,000 in a calendar year. An employer is required to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax.

A taxpayer must report all tips he or she received in 2023 on his or her tax return, including both cash tips and noncash tips. Any tips the taxpayer reported to his or her employer for 2023 are included in the wages shown in box 1 of his or her Form W-2. The taxpayer should add to the amount in box 1 only the tips he or she did not report to his or her employer. Generally, an individual must report all tips received during the tax year on the tax return, including both cash tips and noncash tips. If the taxpayer kept a daily tip record and reported tips to an employer as required, the employer will add the following tips to the amount in box 1 of the Form W-2: (117)

➢ Cash and charge tips received that totaled less than $20 for any month. ➢ The value of noncash tips, such as tickets, passes, or other items of value.

If the taxpayer received $20 or more in cash and charge tips in a month from any one job and did not report all of those tips to an employer, he or she must report the Social Security and Medicare taxes on the unreported tips as additional tax on the return. To report these taxes, the individual must file a return even if he or she would not otherwise have to file. The taxpayer must use Form 1040, Form 1040-NR, Form 1040-SS, or 1040-PR (as appropriate) for this purpose. He or she should use Form 4137 - Social Security and Medicare Tax on Unreported Tip Income to figure these taxes. Enter the tax on the return as instructed and attach the completed Form 4137 to the return.

Allocated Tips

Allocated tips are tips that an employer assigned to an individual in addition to the tips he or she reported to the employer for the year. The employer will have done this only if: (117)

1. The taxpayer worked in an establishment (restaurant, cocktail lounge, or similar business) that must allocate tips to employees.

2. The tips the taxpayer reported to the employer were less than his or her share of 8% of food and drink sales.

Allocated tips are shown separately in box 8 of the Form W-2. They are not included in box 1 with wages and reported tips. An employer can use a tip rate lower than 8% (but not lower than 2%) to figure allocated tips only if the IRS approves the lower rate. Either the employer or the employees can request approval of a lower rate by filing a petition with the IRS. The petition must include specific information about the establishment that will justify the lower rate. A user fee must be paid with the petition.

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The employee petition can be filed only with the consent of a majority of the directly tipped employees (waiters, bartenders, and others who receive tips directly from customers). The petition must state the total number of directly tipped employees and the number of employees consenting to the petition. Employees filing the petition must promptly notify the employer, and the employer must promptly give the IRS copies of all Form 8027 - Employer's Annual Information Return of Tip Income and Allocated Tips filed for the establishment for the previous 3 years.

Penalty for Not Reporting Tips

If a taxpayer does not report tips to his or her employer as required, he or she may be subject to a penalty equal to 50% of the Social Security and Medicare taxes or railroad retirement tax owed on the unreported tips. The penalty amount is in addition to the taxes the taxpayer owes. (117)

Royalties

The most common types of royalties are from copyrights and patents. Additional common royalties are from oil, gas, and mineral properties extracted from the taxpayer’s property. Royalties from copyrights on literary, musical, or artistic works, and similar property, or from patents on inventions, are amounts paid to the taxpayer for the right to use his or her work over a specified period of time. Royalties generally are based on the number of units sold, such as the number of books, tickets to a performance, or machines sold. Royalty income from oil, gas, and mineral properties is the amount the taxpayer receives when natural resources are extracted from the property. The royalties are based on units, such as barrels and tons and are paid to the taxpayer by a person or company who leases the property from him or her. Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income and should be reported on Part I of Schedule E - Supplemental Income and Loss. However, if the taxpayer holds an operating oil, gas, or mineral interest or is in business as a self-employed writer, inventor or artist, report his or her income and expenses on Schedule C (Form 1040). (113)

Bartering

Bartering occurs when a taxpayer exchanges goods or services without exchanging money. If the taxpayer barters for someone else’s products or services, he or she will have to report the fair market value of the products or services on his or her tax return. If the taxpayer barters his or her products or services through a barter exchange, the taxpayer should receive a Form 1099-B - Proceeds From Broker and Barter Exchange Transactions. The amount shown in 1099-B, Box 3, Bartering, is the barter transaction’s proceeds and is generally reportable as income included on the tax return. Generally, the taxpayer reports bartering income on Schedule C (Form 1040). (118)

The IRS reminds all taxpayers that the fair market value of property or services received through barter is taxable income. Both parties must report as income the value of the goods and services received in the exchange.

Here are four facts about bartering: (119)

1. Barter exchanges - A barter exchange is an organized marketplace where members barter products or services. Some exchanges operate out of an office and others over the Internet. All barter exchanges are required to issue Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, annually. The exchange must give a copy of the form to its members and file a copy with the IRS.

2. Bartering income - Barter and trade dollars are the same as real dollars for tax reporting purposes. If the taxpayer barters, he or she must report on the tax return the fair market value of the products or services received.

3. Tax implications - Bartering is taxable in the year it occurs. The tax rules may vary based on the type of bartering that takes place. Barterers may owe income taxes, self-employment taxes, employment taxes or excise taxes on their bartering income.

4. Reporting rules - How the taxpayer reports bartering varies depending on which form of bartering takes place. Generally, if he or she is in a trade or business the taxpayer reports bartering income on Schedule C - Profit or Loss from Business. The taxpayer may be able to deduct certain costs incurred to perform the bartering.

Canceled Debts

In most cases, if the taxpayer has cancellation of debt income because his or her debt is canceled, forgiven, or discharged for less than the amount he or she must pay, the amount of the canceled debt is taxable and he or she must report the

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canceled debt on his or her tax return for the year the cancellation occurs. The canceled debt is not taxable, however, if the law specifically allows the taxpayer to exclude it from gross income. In general, the taxpayer must report any taxable amount of a canceled debt as ordinary income from the cancellation of debt on Form 1040 - U.S. Individual Income Tax Return, Form 1040-SR - U.S. Tax Return for Seniors or Form 1040-NR - U.S. Nonresident Alien Income Tax Return as "other income" if the debt is a nonbusiness debt, or on an applicable schedule if the debt is a business debt. If property secured the taxpayer’s debt and the creditor takes that property in full or partial satisfaction of his or her debt, he or she is treated as having sold that property to the creditor. The taxpayer’s tax treatment depends on whether he or she was personally liable for the debt (recourse debt) or not personally liable for the debt (nonrecourse debt). If the taxpayer’s property was subject to a recourse debt, his or her amount realized is the fair market value (FMV) of the property. The taxpayer’s ordinary income from the cancellation of the debt is the amount of the debt in excess of the FMV of the property that the lender forgives. The taxpayer must include this cancellation of debt in his or her income unless an exception or exclusion, discussed below, applies. The difference between the FMV and the taxpayer’s adjusted basis (usually his or her cost) will be gain or loss on the disposition of the property. If the taxpayer’s property was subject to a nonrecourse debt, his or her amount realized is the entire amount of the nonrecourse debt plus the amount of cash and the FMV of any property he or she received. The taxpayer will not have ordinary income resulting from debt cancellation. Amounts that meet the requirements for any of the following exceptions are not cancellation of debt income: (120) Exceptions to Cancellation of Debt Income:

➢ Amounts canceled as gifts, bequests, devises, or inheritances. ➢ Certain qualified student loans canceled under the loan provisions that the loans would be canceled if the taxpayer

works for a certain period of time in certain professions for a broad class of employers. ➢ Certain other education loan repayment or loan forgiveness programs to help provide health services in certain

areas. ➢ Certain student loan discharges after December 31, 2020, and before January 1, 2026. ➢ Amounts of canceled debt that would be deductible if he or she, as a cash basis taxpayer, paid it. ➢ A qualified purchase price reduction given by the seller of property to the buyer. ➢ Any amounts discharged from certain Federal, private, or educational student loans.

Amounts that meet the requirements for any of the following exclusions are not included in income, even though they are cancellation of debt income. Exclusions from gross income:

➢ Debt canceled in a Title 11 bankruptcy case. ➢ Debt canceled to the extent insolvent. ➢ Cancellation of qualified farm indebtedness. ➢ Cancellation of qualified real property business indebtedness. ➢ Cancellation of qualified principal residence indebtedness that is discharged subject to an arrangement that is

entered into and evidenced in writing before January 1, 2026. If the cancellation of debt occurs in a title 11 bankruptcy case, the bankruptcy exclusion takes precedence over the insolvency exclusion. To the extent that the taxpayer is insolvent, the insolvency exclusion takes precedence over qualified farm debt or qualified real property business indebtedness exclusions. Generally, if the taxpayer excludes canceled debt from income under one of the exclusions listed above, he or she must reduce certain tax attributes (certain credits and carryovers, losses and carryovers, basis of assets, etc.) (but not below zero) by the amount excluded. The taxpayer must attach to his or her tax return a Form 982 - Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) to report the amount qualifying for exclusion and any corresponding reduction of those tax attributes. For cancellation of qualified principal residence indebtedness that the taxpayer excludes from income, he or she must only reduce his or her basis in the taxpayer’s principal residence.

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The Bipartisan Budget Act of 2018 retroactively extended the exclusion for qualified principal residence indebtedness that provides tax relief on canceled debt for many homeowners involved in the mortgage foreclosure through 2017. The Consolidated Appropriations Act, 2021 includes an extension of the qualified principal residence indebtedness exclusion through 2025. Typically, when debt is forgiven, the discharged

amount is included in a taxpayer’s gross income. The provision reduces the maximum amount that may be excluded from $2,000,000 to $750,000. The exclusion did not apply if the discharge was due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.

Review Question 4 Which of the following is canceled debt that qualifies for exclusion from gross income?

A. Debt canceled in a Title 11 bankruptcy case B. Amounts specifically excluded from income by law such as gifts or bequests C. Cancellation of certain qualified student loans D. Canceled debt, if paid by a cash basis taxpayer, would be deductible

See Review Feedback for answer.

Bankruptcy

A bankruptcy case is a case under title 11 of the United States Code, but only if the debtor is under the jurisdiction of the court and the cancellation of the debt is granted by the court or occurs as a result of a plan approved by the court. None of the debt canceled in a bankruptcy case is included in the debtor's gross income in the year it was canceled. Instead, certain losses, credits, and basis of property must be reduced by the amount of excluded income (but not below zero). These losses, credits, and basis in property are called tax attributes. Tax attributes include the basis of certain assets and the losses and credit. By reducing the tax attributes, the tax on the canceled debt is partially postponed instead of being entirely forgiven. This prevents an excessive tax benefit from the debt cancellation.

Insolvency

A debtor is insolvent when, and to the extent, the debtor's liabilities exceed the fair market value (FMV) of the assets. Determine the debtor's liabilities and the FMV of the assets immediately before the cancellation of the debtor's debt to determine whether or not the debtor is insolvent and the amount by which the debtor is insolvent. Exclude from the debtor's gross income debt canceled when the debtor is insolvent, but only up to the amount by which the debtor is insolvent. However, the taxpayer must use the amount excluded to reduce certain tax attributes.

Life Insurance Proceeds

Generally, if a taxpayer receives the proceeds under a life insurance contract as a beneficiary due to the death of the insured person, the benefits are not includable in gross income and do not have to be reported. However, any interest received is taxable and needs to be reported just like any other interest received. This means when a beneficiary receives life insurance proceeds after a period of interest accumulation rather than immediately upon the policyholder's death, the beneficiary must pay taxes, not on the entire benefit, but on the interest. Additionally, if the policy was transferred to the taxpayer for cash or other valuable consideration, the exclusion for the proceeds is limited to the sum of the consideration paid, additional premiums paid, and certain other amounts. (121)

Inheritance

Inheritances are not considered income for Federal tax purposes, whether the taxpayer inherits cash, investments or property. However, any subsequent earnings on the inherited assets are taxable, unless they come from a tax-free source. The taxpayer will have to include the interest income from inherited cash and dividends on inherited stocks or mutual funds in his or her reported income, for example:

➢ Any gains when the taxpayer sells inherited investments or property are generally taxable, but he or she can usually also claim losses on these sales.

➢ State taxes on inheritances vary; check the taxpayer state's department of revenue, treasury or taxation for details.

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The taxpayer does not need to report a transaction to the IRS if a taxpayer’s parent transfers the title of his or her home to the taxpayer. However, the parent may be required to report this transaction to the IRS as a taxable gift to the taxpayer. Generally, a taxable gift is any property transferred for less than adequate and full consideration. To determine if the sale of inherited property is taxable, the taxpayer must first determine his or her basis in the property. The basis of property inherited from a decedent is generally one of the following:

➢ The fair market value (FMV) of the property on the date of the decedent's death (whether or not the executor of the estate files an estate tax return (Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return)).

➢ The FMV of the property on the alternate valuation date, but only if the executor of the estate files an estate tax return (Form 706) and elects to use the alternate valuation on that return.

For information on the FMV of inherited property on the date of the decedent’s death, the taxpayer should contact the executor of the decedent’s estate. Also, note that in 2015, Congress passed a new law that, in certain circumstances, requires the recipient’s basis in certain inherited property to be consistent with the value of the property as finally determined for Federal estate tax purposes.

Recovery

A recovery is a return of an amount the taxpayer deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements, and rebates of itemized deductions. The taxpayer also may have recoveries of non-itemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which he or she previously claimed a tax credit. The taxpayer must include a recovery in his or her income in the year he or she received it up to the amount by which the deduction or credit he or she took for the recovered amount reduced the tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from the deduction or credit is considered to have reduced the taxpayer’s tax in the earlier year. Refunds of Federal income taxes are not included in a taxpayer’s income because they are never allowed as a deduction from income. If the taxpayer received a state or local income tax refund (or credit or offset) in 2023, he or she generally must include it in income if he or she deducted the tax in an earlier year. The payer should send Form 1099-G - Certain Government Payments to the taxpayer by January 31, 2023. The IRS also will receive a copy of the Form 1099-G. If the taxpayer files Form 1040, use the State and Local Income Tax Refund Worksheet in the 2023 Form 1040 instructions for Schedule 1, line 1 to figure the amount (if any) to include in his or her income. If the taxpayer could choose to deduct for a tax year either state and local income taxes, or state and local general sales taxes, then the maximum refund that the taxpayer may have to include in income is limited to the excess of the tax he or she chooses to deduct for that year over the tax he or she did not choose to deduct for that year. (113)

If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit and is not reported as income. If the taxpayer receives a refund or other recovery that is for amounts he or she paid in 2 or more separate years, he or she must allocate, on a pro rata basis, the recovered amount

between the years in which he or she paid it. This allocation is necessary to determine the amount of recovery from any earlier years and to determine the amount, if any, of the allowable deduction for this item for the current year.

Repayments

If a taxpayer had to repay an amount that he or she included as income in an earlier year, he or she may be able to deduct the amount repaid from the income for the year in which he or she repaid it. Or, if the amount the taxpayer repaid is more than $3,000, he or she may be able to take a credit against the tax for the year in which he or she repaid it. In most cases, the taxpayer can claim a deduction or credit only if the repayment qualifies as an expense or loss incurred in trade or business or in a for-profit transaction. (113)

Partnerships

A partnership generally is not a taxable entity. The income, gains, losses, deductions, and credits of a partnership are passed through to the partners based on each partner's distributive share of these items. The distributive share of

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partnership income, gains, losses, deductions, or credits generally is based on the partnership agreement. The taxpayer must report his or her distributive share of these items on the tax return whether or not they actually are distributed to him or her. However, the taxpayer’s distributive share of the partnership losses is limited to the adjusted basis of the partnership interest at the end of the partnership year in which the losses took place. (113) An organization formed after 1996 is classified as a partnership for Federal tax purposes if it has two or more members and it is none of the following: (122)

➢ An organization formed under a Federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic.

➢ An organization formed under a state law that refers to it as a joint-stock company or joint-stock association. ➢ An insurance company. ➢ Certain banks. ➢ An organization wholly owned by a state or local government. ➢ An organization specifically required to be taxed as a corporation by the Internal Revenue Code (for example,

certain publicly traded partnerships). ➢ Certain foreign organizations identified in Section 301.7701-2(b)(8) of the regulations. ➢ A tax-exempt organization. ➢ A real estate investment trust. ➢ An organization classified as a trust under Section 301.7701-4 of the regulations or otherwise subject to special

treatment under the Internal Revenue Code. ➢ Any other organization that elects to be classified as a corporation by filing Form 8832 - Entity Classification

Election. An organization formed before 1997 and classified as a partnership under the old rules will generally continue to be classified as a partnership as long as the organization has at least two members and does not elect to be classified as a corporation by filing Form 8832.

Allocation of Personal Service Income

If the income is for personal services performed partly in the United States and partly outside the United States, the taxpayer must make an accurate allocation of income for services performed in the United States. In most cases, other than certain fringe benefits, he or she makes this allocation on a time basis. That is, U.S. source income is the amount that results from multiplying the total amount of pay by the fraction of days in which services were performed in the U.S. This fraction is determined by dividing the number of days services are performed in the United States by the total number of days of service for which the compensation is paid. (123)

S Corporations

In most cases, an S corporation does not pay tax on its income. Instead, the income, losses, deductions, and credits of the corporation are passed through to the shareholders based on each shareholder's pro rata share. The taxpayer must report his or her share of these items on the tax return. In most cases, the items passed through to the taxpayer will increase or decrease the basis of the S corporation stock as appropriate. (113)

Estates and Trusts

An estate or trust, unlike a partnership, may have to pay Federal income tax. If the taxpayer is a beneficiary of an estate or trust, he or she may be taxed on his or her share of its income distributed or required to be distributed to the taxpayer. However, there is never a double tax. Estates and trusts file their returns on Form 1041 - U.S. Income Tax Return for Estates and Trusts and the taxpayer’s share of the income is reported to him or her on Schedule K-1 (Form 1041) - Beneficiary’s Share of Income, Deductions, Credits. The decedent's estate fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic estate that has: (124)

➢ Gross income for the tax year of $600 or more. ➢ A beneficiary who is a nonresident alien.

The trust’s fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic trust taxable under Section 641 that has: (124)

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➢ Any taxable income for the tax year. ➢ Gross income of $600 or more (regardless of taxable income). ➢ A beneficiary who is a nonresident alien.

Scholarships, Fellowships, and Grants

Scholarships, fellowships, and grants are sourced according to the residence of the payer. Those made by entities created or domiciled in the United States are generally treated as income from sources within the United States. Those made by entities created or domiciled in a foreign country are treated as income from foreign sources. A scholarship is generally an amount paid or allowed to a student at an educational institution for the purpose of study. A fellowship is generally an amount paid to an individual for the purpose of research. The amount of a scholarship or fellowship includes the following: (125)

➢ The value of contributed services and accommodations. This includes such services and accommodations as room (lodging), board (meals), laundry service, and similar services or accommodations that are received by an individual as a part of a scholarship or fellowship.

➢ The amount of tuition, matriculation, and other fees that are paid or remitted to the student to aid the student in pursuing study or research.

➢ Any amount received in the nature of a family allowance as a part of a scholarship or fellowship.

If the taxpayer receives a scholarship or fellowship grant, all or part of the amounts received may be tax-free. Qualified scholarship and fellowship grants are treated as tax-free amounts if the following conditions are met: (126)

1. The taxpayer is a candidate for a degree at an educational institution that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities; and

2. Amounts the taxpayer receives as a scholarship or fellowship grant are used for tuition and fees required for enrollment or attendance at the educational institution, or for fees, books, supplies, and equipment required for courses at the educational institution.

Also, a scholarship or fellowship is tax free only to the extent: (126)

1. It does not exceed the taxpayer’s expenses. 2. It is not designated or earmarked for other purposes (such as room and board) and does not require (by its terms)

that it cannot be used for qualified education expenses. 3. It does not represent payment for teaching, research, or other services required as a condition for receiving the

scholarship. The taxpayer is a candidate for a degree if he or she: (126)

1. Attends a primary or secondary school or are pursuing a degree at a college or university, or 2. Attends an educational institution that:

a. Provides a program that is acceptable for full credit toward a bachelor's or higher degree, or offers a program of training to prepare students for gainful employment in a recognized occupation; and

b. Is authorized under Federal or state law to provide such a program and is accredited by a nationally recognized accreditation agency.

An eligible educational institution is one whose main function is the presentation of formal instruction and that typically maintains a regular faculty and curriculum and generally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities. For purposes of tax-free scholarships and fellowships, these are expenses for: (126)

1. Tuition and fees required to enroll at or attend an eligible educational institution. 2. Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the

eligible educational institution. These items must be required of all students in the taxpayer’s course of instruction.

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Qualified education expenses do not include the cost of room and board, travel, research, clerical help, equipment or other expenses that are not required for enrollment in or attendance at an eligible educational institution. A taxpayer must include in gross income amounts used for incidental expenses, such as room and board, travel, and optional equipment, and generally amounts received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant. Generally, the taxpayer cannot exclude from his or her gross income the part of any scholarship or fellowship that represents payment for teaching, research, or other services required as a condition for receiving the scholarship. This applies even if all candidates for a degree must perform the services to receive the degree. Also, when reporting scholarship income on the tax return, a taxpayer will include the amounts on the same line as “Wages, salaries, tips, etc.” However, the taxpayer does not have to treat as payment for services the part of any scholarship or fellowship that represents payment for teaching, research or other services if he or she receives the amount under: (126)

➢ The National Health Service Corps Scholarship Program. ➢ The Armed Forces Health Professions Scholarship and Financial Assistance Program.

Whether the taxpayer must report his or her scholarship or fellowship depends on whether he or she must file a return and whether any part of his or her scholarship or fellowship is taxable. If the taxpayer’s only income is a completely tax-free scholarship or fellowship, he or she does not have to file a tax return and no reporting is necessary. If all or part of the taxpayer’s scholarship or fellowship is taxable and he or she is required to file a tax return, the taxpayer must report the taxable amount whether or not he or she received a Form W-2. If the taxpayer receives an incorrect Form W-2, he or she should ask the payer for a corrected one.

Athletic Scholarships

Athletic scholarships are tax-free only if they meet the requirements discussed above. For example, if the taxpayer’s son or daughter were to receive an athletic scholarship in an amount that paid for tuition and fees, room and board, books and supplies, and miscellaneous expenses, two thirds of the scholarship would be taxable to the student-athlete in the year the funds were received. An athletic scholarship, as with other scholarships, is only tax-free when used to pay for qualified expenses. The same rules apply to any scholarship that the student may receive that is used to pay educational expenses.

Fulbright Grants

A Fulbright grant is generally treated as any other scholarship or fellowship in figuring how much of the grant is tax-free. If the taxpayer receives a Fulbright grant for lecturing or teaching, it is payment for services and is taxable. A special rule applies if the grant was paid in nonconvertible foreign currency. A Fulbright grant is a grant under the Mutual Educational and Cultural Exchange Act of 1961, known as the Fulbright-Hays Act. If the taxpayer receives a supplemental grant under the U.S. Information and Educational Exchange Act of 1948 (Smith-Mundt Act) for study, research, or teaching abroad, it is treated like a Fulbright grant.

Pell Grants and Other Title IV Need-Based Education Grants

These need-based grants are treated as scholarships for purposes of determining their tax treatment. They are tax-free to the extent used for qualified education expenses during the period for which a grant is awarded.

Payment to Service Academy Cadets

An appointment to a United States military academy is not a scholarship or fellowship. Payment the taxpayer receives as a cadet or midshipman at an armed services academy is pay for personal services and will be reported to him or her in box 1 of Form W-2.

Veterans' Benefits

Payments the taxpayer receives for education, training, or subsistence under any law administered by the Department of Veterans Affairs (VA) are tax free. The taxpayer does not include these payments as income on his or her Federal tax return. If the taxpayer qualifies for one or more of the education benefits, he or she may have to reduce the amount of

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education expenses qualifying for a specific benefit by part or all of his or her VA payments. This applies only to the part of the taxpayer’s VA payments that is required to be used for education expenses. Example Stephanie returned to college and is receiving two education benefits under the latest GI Bill. She receives a $1,534 monthly basic housing allowance (BHA) that is directly deposited to her checking account, and $3,840 paid directly to her college for tuition. Neither of these benefits is taxable and Stephanie does not report them on her tax return. She also wants to claim an American Opportunity Tax Credit on her return. She paid $5,000 in qualified education expenses. To figure the amount of credit, Stephanie must first subtract the $3,840 from her qualified education expenses because this payment under the GI Bill was required to be used for education expenses. She does not subtract any amount of the BHA because it was paid to her and its use was not restricted.

Qualified Tuition Reduction

If the taxpayer is allowed to study tuition free or for a reduced rate of tuition, he or she may not have to pay tax on this benefit. This is called a “tuition reduction.” The taxpayer does not have to include a qualified tuition reduction in his or her income. A tuition reduction is qualified only if the taxpayer receives it from, and uses it at, an eligible educational institution. The taxpayer does not have to use the tuition reduction at the eligible educational institution from which he or she received it. In other words, if the taxpayer works for an eligible educational institution and the institution arranges for him or her to take courses at another eligible educational institution without paying any tuition, he or she may not have to include the value of the free courses in his or her income. The rules for determining if a tuition reduction is qualified, and therefore tax free, are different if the education provided is below the graduate level or is graduate education. Also, a taxpayer must include in his or her income any tuition reduction he or she receives that is payment for his or her services. Qualified tuition reductions apply to officers, owners, or highly compensated employees only if benefits are available to employees on a nondiscriminatory basis. This means that the tuition reduction benefits must be available on substantially the same basis to each member of a group of employees. The group must be defined under a reasonable classification set up by the employer. The classification must not discriminate in favor of owners, officers, or highly compensated employees.

Medicaid Waiver Payments

On January 3, 2014, the Internal Revenue Service issued Notice 2014-7, 2014-4 I.R.B. 445. Notice 2014-7 provides guidance on the Federal income tax treatment of certain payments to individual care providers for the care of eligible individuals under a state Medicaid Home and Community-Based Services waiver program described in Section 1915(c) of the Social Security Act (Medicaid Waiver payments). Section 1915(c) enables individuals who otherwise would require care in a hospital, nursing facility, or intermediate care facility to receive care in the individual care provider’s home. The notice provides that the Service will treat these Medicaid waiver payments as difficulty of care payments excludable from gross income under Section 131 of the Internal Revenue Code. Under Section 131, “the provider’s home” means the place where the provider resides and regularly performs the routines of the provider’s private life, such as shared meals and holidays with family. Qualified Medicaid waiver payments are defined as payments made by a state or political subdivision thereof, or an entity that is a certified Medicaid provider, under a Medicaid waiver program to an individual care provider for nonmedical support services provided under a plan of care to an eligible individual (whether related or unrelated) living in the individual care provider’s home. Therefore, if a caregiver lives in the same home of the individual receiving care services, they can exclude these payments from gross income. An example of this is a mother caring for her disabled daughter or an adult son caring for his elderly mother. The individuals do not have to be related; they just need to live together.

State and Local Tax Refunds

Revenue Ruling 2019-11 provides guidance to taxpayers regarding the inclusion in income of recovered state and local taxes in the current year when the taxpayer deducted state and local taxes paid in a prior year, subject to the Section 164(b)(6) limitation. In general, the ruling provides that if a taxpayer received a tax benefit from deducting state or local taxes in a prior tax year and the taxpayer recovers all or a portion of those taxes in the current tax year, the taxpayer must include in gross income the lesser of:

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➢ The difference between the taxpayer's total itemized deductions taken in the prior year and the amount of itemized deductions the taxpayer would have taken in the prior year had the taxpayer paid the proper amount of state and local tax; or

➢ The difference between the taxpayer's itemized deductions taken in the prior year and the standard deduction amount for the prior year, if the taxpayer was not precluded from taking the standard deduction in the prior year.

This holding applies to the recovery of any state or local tax, including state or local income tax and state or local real or personal property tax.

Living Expenses

In the case of an individual whose principal residence is damaged or destroyed by fire, storm, or other casualty, or who is denied access to his principal residence by governmental authorities because of the occurrence or threat of occurrence of such a casualty, gross income does not include amounts received by such individual under an insurance contract which are paid to compensate or reimburse such individual for living expenses incurred for himself and members of his household resulting from the loss of use or occupancy of such residence. A payment of living expenses received from an individual's insurer is excludable from gross income under Section 123 to the extent that the household's actual living expenses incurred for the period of loss of use exceed the household's normal living expenses that would have been incurred for such period. For these purposes, actual living expenses are defined as the reasonable and necessary expenses incurred because of the loss of use or occupancy of the principal residence to maintain the taxpayer and members of their household’s customary standard of living. Generally, expenses such as rent and utilities at the temporary residence, restaurant meals which normally would have been prepared at home and transportation expenses fall under this category. Insurance payments received for additional costs incurred in renting suitable housing and any extraordinary expenses for transportation, food, utilities and miscellaneous items are also excluded from income. Payments received for the loss of rental income or reimbursements for damage or loss of real or personal property do not qualify for the income exclusion. If the taxpayer’s principal residence was used partially for business/rental, the portion of reimbursements attributable to the nonresidential use of temporary replacement property will be included in income. Taxable Payments:

➢ Normal Living Expenses. ➢ Disaster unemployment assistance. ➢ Expenses attributable to business use. ➢ Loss of rental income.

Nontaxable Payments:

➢ Extra expenses for renting, transportation, food, utilities, miscellaneous services incurred while unable to use home because of casualty.

➢ Temporary increase in living expenses.

Settlements and Judgments

The general rule of taxability for amounts received from settlement of lawsuits and other legal remedies is Internal Revenue Code (IRC) Section 61 that states all income is taxable from whatever source derived, unless exempted by another section of the code. IRC Section 104 provides an exclusion from taxable income with respect to lawsuits, settlements and awards. However, the facts and circumstances surrounding each settlement payment must be considered to determine the purpose for which the money was received because not all amounts received from a settlement are exempt from taxes. Awards and settlements can be divided into two distinct groups to determine whether the payments are taxable or non- taxable. The first group includes claims relating to physical injuries, and the second group is for claims relating to non- physical injuries. Within these two groups, the claims usually fall into three categories: (127)

1. Actual damages resulting from physical or non-physical injury. 2. Emotional distress damages arising from the actual physical or non-physical injury. 3. Punitive damages.

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The IRS has consistently held that compensatory damages, including lost wages, received on account of a personal physical injury are excludable from gross income with the exception of punitive damages. Damages received for non- physical injury such as emotional distress, defamation and humiliation, although generally includable in gross income, are not subject to Federal employment taxes. Emotional distress recovery must be on account of (attributed to) personal physical injuries or sickness unless the amount is for reimbursement of actual medical expenses related to emotional distress that was not previously deducted under IRC Section 213. As a result of the amendment in 1996, mental and emotional distress arising from non-physical injuries are only excludible from gross income under IRC Section104(a)(2) only if received on account of physical injury or physical sickness. Punitive damages are not excludable from gross income, with one exception. The exception applies to damages awarded for wrongful death, where under state law, the state statue provides only for punitive damages in wrongful death claims. In these cases, refer to IRC Section 104(c) which allows the exclusion of punitive damages. Employment-related lawsuits may arise from wrongful discharge or failure to honor contract obligations. Damages received to compensate for economic loss, for example lost wages, business income and benefits, are not excludable from gross income unless a personal physical injury caused such loss. Discrimination suits for age, race, gender, religion, or disability can generate compensatory, contractual, and punitive awards, none of which are excludible under IRC Section104(a)(2). As a general rule, dismissal pay, severance pay, or other payments for involuntary termination of employment are wages for federal employment tax purposes.

Special Rules for Certain Employees

Clergy

For income tax purposes, a licensed, commissioned, or ordained minister is generally treated as a common law employee of his or her church, denomination, or sect. If the taxpayer is a minister performing ministerial services, he or she is taxed on wages, offerings, and on any fees received for performing marriages, baptisms, funerals, and masses. (128) Special rules for housing apply to members of the clergy. Under these rules, the taxpayer does not include in income the rental value of a home (including utilities) or a designated housing allowance provided to him or her as part of pay. However, the exclusion cannot be more than the reasonable pay for the taxpayer’s service. (113) If the taxpayer is a member of a religious order who has taken a vow of poverty, how he or she treats earnings that he or she renounces and turns over to the order depends on whether the taxpayer’s services are performed for the order. If the taxpayer is performing the services as an agent of the order in the exercise of duties required by the order, do not include in his or her income the amounts turned over to the order.

If the taxpayer’s order directs him or her to perform services for another agency of the supervising church or an associated institution, the taxpayer is considered to be performing the services as an agent of the order. Any wages he or she earns as an agent of an order that he or she turns over to the order are not included in his or her income.

Example Harold is a member of a church order and has taken a vow of poverty. He renounces any claims to his earnings and turns over to the order any salaries or wages he earns. Harold is a registered nurse, so his order assigns him to work in a hospital that is an associated institution of the church. However, Harold remains under the general direction and control of the order. He is considered to be an agent of the order and any wages he earns at the hospital that he turns over to his order are not included in his income.

Foreign Employer

A U.S. citizen who works in the United States for a foreign government, an international organization, a foreign embassy, or any foreign employer, must include his or her salary in his or her income. The taxpayer is exempt from Social Security

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and Medicare employee taxes if he or she is employed in the United States by an international organization or a foreign government. However, the taxpayer must pay self-employment tax on earnings from services performed in the United States, even though he or she is not self-employed. This rule also applies if the taxpayer is an employee of a qualifying wholly owned instrumentality of a foreign government. (113)

Military

For Federal tax purposes, the U.S. Armed Forces includes officers and enlisted personnel in all regular and reserve units controlled by the Secretaries of Defense, the Army, Marines, Navy and Air Force. The Coast Guard is also included, but not the U.S. Merchant Marine or the American Red Cross. However, these and other support personnel may qualify for certain tax deadline extensions because of their service in a combat zone. (129)

Passive Income Passive income can only be generated by a passive activity. Just because the taxpayer did not work for the income does not mean it is passive. There are only two sources for passive income: (130)

➢ A rental activity. ➢ A business in which the taxpayer does not materially participate.

The following incomes may seem passive, but generally, none are passive income: (130)

➢ Portfolio income, including interest, dividends, royalties, annuities and gains on stocks and bonds. ➢ Lottery winnings. ➢ Salaries, wages, Form 1099-MISC commissions and retirement income. ➢ Guaranteed payments for services. ➢ Income from any activity in which the taxpayer materially participates.

Regardless of whether income is deemed to be passive or non-passive, it must always be reported somewhere on the return, most typically on Schedule E - Supplemental Income and Loss. Form 8582 - Passive Activity Loss Limitations is computational only, figuring the amount of passive loss deductible for the current year. It is not the form used to report income.

Form 8582 is filed by individuals, estates, and trusts who have passive activity deductions (including prior year unallowed losses). However, the taxpayer does not have to file Form 8582 if he or she meets the following exception. The taxpayer actively participated in rental real estate activities and he or she meets all of the following conditions: (131)

➢ Rental real estate activities with active participation were the taxpayer’s only passive activities. ➢ The taxpayer has no prior year unallowed losses from these (or any other passive) activities. ➢ The taxpayer’s total loss from the rental real estate activities was not more than $25,000 ($12,500 if married filing

separately). ➢ If the taxpayer is married filing separately, he or she lived apart from his or her spouse all year. ➢ The taxpayer has no current or prior year unallowed credits from a passive activity. ➢ The taxpayer modified adjusted gross income was not more than $100,000 (not more than $50,000 if married

filing separately). ➢ The taxpayer does not hold any interest in a rental real estate activity as a limited partner or as a beneficiary of

an estate or trust.

For tax year 2023, if a taxpayer actively participated in a passive rental real estate activity, he or she may be able to deduct up to $25,000 of loss from the activity from his or her non-passive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. The taxpayer is not considered to actively participate in a rental real estate activity if at any time during the tax year his or her interest (including his or her spouse's interest) in the activity was less than 10% (by value) of all interests in the

activity. Also, the special allowance is not available if the taxpayer was married, is filing a separate return for the year, and lived with his or her spouse at any time during the year. (131)

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Review Question 5 Which of the following is a source for passive income?

A. Lottery winnings B. Annuities C. Guaranteed payments for services D. Rental activity

See Review Feedback for answer.

Rental Income Generally, cash or the fair market value of property a taxpayer receives for the use of real estate or personal property is taxable to him or her as rental income. Most individuals operate on a cash basis, which means they count their rental income as income when it is actually or constructively received and deduct their expenses as they are paid. Some specific types of income are: (132)

➢ Amounts paid to cancel a lease – If a tenant pays a taxpayer to cancel a lease, this money is also rental income and is reported in the year received.

➢ Advance rent – Generally the taxpayer includes any advance rent paid in income in the year he or she receives it regardless of the period covered or the method of accounting used.

employees or fees charged by independent contractors (groundkeepers, bookkeepers, accountants, attorneys, etc.) for services provided.

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➢ Uncollected rents - unless taxpayer is a cash basis taxpayer and cannot deduct uncollected rents as an expense because he or she has not included those rents in income.

➢ Any day that the unit is available for rent but not actually rented is not a day of rental use.

Review Question 6 Which of the following is not rental income in the year received?

A. Security deposit, equal to one month's rent, to be refunded at the end of the lease if the building passes inspection

B. Payment to cancel the remaining lease C. Repairs paid by the tenant in lieu of rent D. January 2024 rent received December 2023

See Review Feedback for answer.

Separation or Divorce Income Whenever a husband and wife are legally separated or divorced, property and money may change hands. These exchanges fall into one of three categories: child support payments, alimony, or property settlements. The difference between the three is more than a matter of legal terminology; they involve distinct tax consequences.

Child Support

These payments are nontaxable to the recipient and nondeductible by the taxpayer making the payments. If a taxpayer is in arrears in payments for both alimony and child support, payments are first applied to child support. For tax purposes, one can never pay alimony as long as child support is still owed. A recent law now allows the government to divert income tax refunds of taxpayers in arrears on child support payments. In addition, child support payments may now be withheld from the taxpayer's salary checks by employers who are so ordered by the courts. (91)

Alimony

Child support and alimony differ as to basic objectives. After the divorce or legal separation, the wife (or husband) loses the right to participate in the former spouse’s earnings. If many years of marriage have intervened, he or she may have lost marketable job skills, and advanced age could place such a person at a disadvantage in the labor market. Money paid from one spouse to another for day-to-day support of the spouse with fewer financial resources is alimony (sometimes also referred to as "spousal support"). The law allows courts to award alimony or spousal support to one of the former spouses when a married couple divorces. Payments made to a third party are considered alimony. Indirect alimony may include cash payments to a third party to provide a residence for a former spouse (i.e., rent, mortgage, utilities, etc.) medical cost payments or other such expenses incurred by the recipient. Alimony does not include: (133)

➢ Child support. ➢ Noncash property settlements. ➢ Payments that are taxpayer’s spouse's part of community property income. ➢ Payments to keep up the payer's property. ➢ Use of the payer's property.

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Alimony, then, is in the nature of monetary reparations to compensate for the former spouse’s loss of earning power. Consideration of alimony as supplemental compensation is the key to determining its tax treatment. Alimony is taxable to the ex-spouse and deductible by the paying former spouse. The treatment of alimony is the opposite of that for child support. Taxpayers deducting alimony paid must report the amount paid on line 19a of Schedule 1 (Form 1040) and the former spouse’s Social Security number on line 19b of Schedule 1 (Form 1040). This additional information will make it possible for the Internal Revenue Service to determine that amounts being deducted by an ex-spouse are being reported as income by the recipient. (91) An amendment to a divorce decree may change the nature of the taxpayer’s payments. Amendments are not ordinarily retroactive for Federal tax purposes. However, a retroactive amendment to a divorce decree correcting a clerical error to reflect the original intent of the court will generally be effective retroactively for Federal tax purposes. If both alimony and child support payments are called for by the taxpayer’s divorce or separation instrument, and he or she pays less than the total required, the payments apply first to child support and then to alimony.

The Tax Cuts and Jobs Act (TCJA) provides that for any divorce or separation agreement executed after December 31, 2018 or executed before that date but modified after it (if the modification expressly provides that the new amendments apply), alimony and separate maintenance payments are not deductible by the payor- spouse and are not included in the income of the payee-spouse. Instead, income used for alimony payments is

taxed at the rates applicable to the payor-spouse rather than the recipient spouse. The new law does not change the tax treatment of child support payments.

Property Settlements

Generally, there is no recognized gain or loss on the transfer of property between spouses, or between former spouses if the transfer is because of a divorce. A property transfer is incident to a taxpayer’s divorce if the transfer: (91)

➢ Occurs within 1 year after the date the marriage ends. ➢ Is related to the ending of the marriage.

A divorce, for this purpose, includes the ending of a marriage by annulment or due to violations of state laws. A property transfer is related to the ending of a marriage if both of the following conditions apply: (91)

➢ The transfer is made under an original or modified divorce or separation instrument. ➢ The transfer occurs within 6 years after the date the marriage ends.

Unless these conditions are met, the transfer is presumed not to be related to the ending of a marriage. However, this presumption will not apply if the taxpayer can show that the transfer was made to carry out the division of property owned by the taxpayer and his or her spouse at the time the marriage ended. For example, the presumption will not apply if the taxpayer can show that the transfer was made more than 6 years after the end of the marriage because of business or legal factors which prevented earlier transfer of the property and the transfer was made promptly after those factors were resolved. (91)

Review Question 7 A property transfer is incident to a taxpayer’s divorce if the transfer occurs within how many year(s) after the date the marriage ends?

A. One year B. Two years C. Three years D. Four years

See Review Feedback for answer.

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• Adoption expense reimbursements for qualifying expenses.

• Child support payments.

• Gifts, bequests, and inheritances (Subject to limits).

• Workers' compensation benefits.

• Compensatory damages awarded for physical injury or physical sickness.

• Welfare benefits (Choice D).

• Cash rebates from a dealer or manufacturer.

• Qualified disaster relief payments (Choice A).

• VA benefits (Choice B).

Unemployment compensation (Choice C) is not included on this list and is therefore the correct response. Topic - Compensation Subject to the Tax Source - IRS.GOV - What is Taxable and Nontaxable Income? Question 2 - D. All of the above Unemployment compensation generally includes benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund (Choice A), state unemployment insurance benefits (Choice B), railroad unemployment compensation benefits (Choice C), disability payments from a government program paid as a substitute for unemployment compensation, trade readjustment allowances under the Trade Act of 1974, unemployment assistance under the Disaster Relief and Emergency Assistance Act of 1974 and unemployment assistance under the Airline Deregulation Act of 1974 Program. Since Choices A, B, and C are included in unemployment compensation Choice D, All of the above, is the correct response. Topic - Unemployment Compensation Source - IRS.GOV - Topic No. 418 - Unemployment Compensation Question 3 - B. Benefits paid to a taxpayer as an unemployed member of a union out of regular union dues are not included in his or her gross income If the taxpayer chooses not to have tax withheld from unemployment compensation, he or she may have to make estimated tax payments throughout the year (Choice A). Also, benefits received from a company-financed fund, to which a taxpayer did not contribute (Choice C), and payments a taxpayer receives from his or her employer during periods of unemployment, under a union agreement that guarantees him or her full pay during the year (Choice D), are taxable as wages. However, the taxpayer must include benefits from regular union dues paid to him or her as an unemployed member of a union in his or her gross income making Choice B false and the correct response. Topic - Unemployment Compensation Source - IRS.GOV - Topic No. 418 - Unemployment Compensation

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Question 4 - A. Debt canceled in a Title 11 bankruptcy case Canceled debt that qualifies for exception to inclusion in gross income includes amounts canceled as gifts, bequests, devises, or inheritances (Choice B), certain qualified student loans canceled under the loan provisions that the loans would be canceled if the taxpayer works for a certain period of time in certain professions for a broad class of employers (Choice C), and amounts of canceled debt that would be deductible if the taxpayer, as a cash basis taxpayer, paid it (Choice D). Canceled debt that qualifies for exclusion from gross income include debt canceled in a Title 11 bankruptcy case, debt canceled during insolvency, cancellation of qualified farm indebtedness, cancellation of qualified real property business indebtedness and cancellation of qualified principal residence indebtedness. Only Choice A appears in this list and is therefore the correct response. Topic - Canceled Debts Source - IRS.GOV - Topic No. 431 - Canceled Debt – Is It Taxable or Not? Question 5 - D. Rental activity The following incomes may seem passive, but generally, none are passive income:

• Portfolio income, including interest, dividends, royalties, annuities and gains on stocks and bonds (Choice B).

• Lottery winnings (Choice A).

• Salaries, wages, Form 1099-MISC commissions and retirement income.

• Guaranteed payments for services (Choice C).

• Income from any activity in which the taxpayer materially participates. Passive income can only be generated by a passive activity. Just because the taxpayer did not work for the income does not mean it is passive. There are only two sources for passive income; a rental activity (Choice D) or a business in which the taxpayer does not materially participate. Topic - Passive Income Source - Publication 925 - Passive Activity and At-Risk Rules Question 6 - A. Security deposit, equal to one month's rent, to be refunded at the end of the lease if the building passes inspection Some specific types of rental income are:

• Amounts paid to cancel a lease (Choice B).

• Advance rent (Choice D).

• Expenses paid by a tenant (Choice C). However, the taxpayer does not include a security deposit in taxpayer’s income if he or she may be required to return it to the tenant at the end of the lease (Choice A). But if the taxpayer keeps part or all of the security deposit because the tenant did not live up to the terms of the lease, this money is taxable income in the year the determination is made. If the taxpayer keeps the security deposit because the tenant damaged the property, the security deposit is not taxable. If the security deposit is to be used as the tenant's final month's rent, include the money as income when received, rather than when it is applied to the last month's rent. Topic - Rental Income Source - IRS.GOV - Topic No. 414 - Rental Income and Expenses Question 7 - A. One year Generally, there is no recognized gain or loss on the transfer of property between spouses, or between former spouses if the transfer is because of a divorce. A property transfer is incident to a taxpayer’s divorce if the transfer occurs within 1 year after the date the marriage ends and is related to the ending of the marriage. A divorce, for this purpose, includes the ending of a marriage by annulment or due to violations of state laws. Only Choice A has the correct number of years and is therefore the correct response. Topic - Property Settlements Source - Publication 4345 - Settlements - Taxability

Investment Income At the conclusion of this lesson you should have a basic knowledge of:

➢ Dividends. ➢ Interest Subject to the Tax. ➢ Reporting Interest. ➢ Schedule B (Form 1040).

Investment income is generally all income other than salaries, wages, and other amounts received as pay for work actually done. It includes taxable interest, dividends, capital gains (including capital gain distributions) and royalties. Taxable interest includes interest received from bank accounts, loans made to others and other sources. Dividends are distributions of money, stock, or other property paid by a corporation or by a mutual fund. The taxpayer may also receive dividends through a partnership, an estate, a trust, or an association that is taxed as a corporation. However, some amounts received called dividends are actually interest income. Capital gain distributions (also called capital gain dividends) are paid or credited to a taxpayer’s account by mutual funds (or other regulated investment companies) and real estate investment trusts (REITs). They will be shown in box 2a of the Form 1099-DIV received from the mutual fund or REIT. (70)

Dividends

➢ Ordinary dividends. ➢ Capital gain distributions. ➢ Non-dividend distributions.

Most distributions are paid in cash (check). However, distributions can consist of more stock, stock rights, other property or services.

Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as stock options) are distributions by a corporation of rights to acquire the corporation's stock. Generally, stock dividends and stock rights are not taxable to an individual. However, there are some exceptions. If the stock dividends are not taxable, a taxpayer must divide his or her basis for the old stock between the old and new stock. The basis of stock must be adjusted for certain events that occur after purchase. For example, if the taxpayer receives more stock from nontaxable stock dividends or stock splits, he or she must reduce the basis of the original stock. The taxpayer must also reduce the basis when he or she receives non-dividend distributions. These distributions, up to the amount of the basis, are a nontaxable return of capital. Example Bruce bought 100 shares of stock of XYZ Corporation in 2007 for $10 a share. In January 2008 he bought another 200 shares for $11 a share. In July 2008 he gave his son 50 shares. In December 2010 he bought 100 shares for $9 a share. In April 2023 he sold 130 shares. Bruce cannot identify the shares he disposed of, so he must use the stock he acquired first to figure the basis. The shares of stock he gave his son had a basis of $500 (50 × $10). Bruce figures the basis of the 130 shares of stock he sold in 2023 as follows:

➢ 50 shares (50 × $10) balance of stock bought in 2007 - $500.

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➢ 80 shares (80 × $11) stock bought in January 2008 - $880. ➢ Total basis of stock sold in 2023 = $1,380.

Dividends Subject to the Tax

For tax purposes, a dividend is any distribution of property made by a corporation to its stockholders, provided it is paid out of earnings and profits accumulated since March 1, 1913. When a corporation has no profits prior to a distribution, or when all accumulated profits have already been distributed to the stockholders, a distribution is nothing more than a return of the stockholders' capital investment. Such a distribution amounts to a partial liquidation of the corporation, and these distributions must receive treatment different from that given ordinary dividends. In addition, some distributions from certain corporations are taxed as capital gains. The form in which a dividend is received (cash or property) has no effect on its taxation. Most dividends are paid in cash. When a distribution is of some property other than cash, the fair market value of the property at the time of the distribution is the measure of the dividend. Small, closely held corporations frequently make non-cash distributions in order to preserve their working capital. Section 61(a)(7) lists dividends as being included in gross income. They are included in their entirety unless there is a specific exclusion. There is no exclusion for dividends received by an individual from a taxable domestic corporation (provided the dividends are paid out of earnings and profits, which is the assumed case unless other information is provided). An eligible domestic corporation can avoid double taxation (once to the shareholders and again to the corporation) by electing to be treated as an S corporation.

Review Question 1 Tanvir and Aurora Ahmed, who are married, received $10,000 in the current year as dividends from a taxable domestic corporation. In Tanvir and Aurora’s current-year joint return, what amount of these dividends is included in their gross income?

A. $7,000 B. $9,800 C. $9,900 D. $10,000

See Review Feedback for answer.

Ordinary Dividends and Qualified Dividends

Since January 1, 2003, dividends have been split into ordinary dividends and qualified dividends.

Ordinary Dividends

Ordinary dividends received by a taxpayer are included in gross income and continue to be taxed as ordinary income. A taxpayer can assume that any dividend he or she receives on common or preferred stocks is an ordinary dividend, unless the paying corporation on its Form 1099-DIV - Dividends and Distributions states otherwise. The dividend tax on these dividends is the same as an investor's personal income tax bracket. If the

taxpayer is in the 24% tax bracket, for instance, he or she will pay a 24% dividend tax on ordinary (also known as non- qualified) dividends. Ordinary dividends are entered on line 3b, Form 1040, and are usually shown in box 1a of the taxpayers’ Form(s) 1099- DIV. If the total ordinary dividends exceed $1,500 all ordinary dividends must be reported on Part II, Schedule B.

Lesson 6 - Investment Income

Review Question 2 The taxpayer must complete Schedule B (Form 1040), Part II, if the total ordinary dividends exceed what amount?

A. $1,000 B. $1,200 C. $1,500 D. $2,000

See Review Feedback for answer.

Qualified Dividends

Qualified dividends are eligible to be taxed at a lower tax rate than other ordinary income. Generally, qualified dividends are taxed at long-term capital gains rates. For 2023, this means that qualified dividends are subject to the same 0%, 15%, or 20% maximum tax rate that applies to net capital gains. The maximum rate of tax on qualified dividends is:

➢ 0% on any amount that otherwise would be taxed at a 10% or 12% rate. ➢ 15% on any amount that otherwise would be taxed at rates greater than 12% but less than 37%. ➢ 20% on any amount that otherwise would be taxed at a 37% rate.

To qualify for the maximum rate, all of the following requirements must be met:

1. The dividends must have been paid by a U.S. corporation or a qualified foreign corporation. 2. The dividends are not of the type listed below under Dividends that are not Qualified Dividends. 3. The taxpayer must meet the holding period.

Additional 3.8% Federal Net Investment Income Tax (NIIT) applies to individuals on the lesser of net investment income or modified AGI in excess of $200,000 (single) or $250,000 (married/filing jointly and surviving spouses). The tax also applies to any trust or estate on the lesser of undistributed net income or adjusted gross income (AGI) in excess of the dollar amount at which the estate/trust pays income taxes at the highest rate. To help calculate the tax on qualified dividends (and capital gains) the IRS provides a Qualified Dividends and Capital Gain Tax Worksheet.

Review Question 3 Generally, qualified dividends are taxed at what tax rate?

A. Individual tax rate B. Long-term capital gains tax rates C. Corporate tax rates D. None of the above

See Review Feedback for answer.

Holding Period

The taxpayer must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment. When counting the number of days the taxpayer held the stock, include the day he or she disposed of the stock, but not the day he or she acquired it (there are minor exceptions to these requirements). In the case of preferred stock, the taxpayer must have held the stock more than 90 days during the 181- day period that begins 90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days. If the preferred dividends are due to periods totaling less than 367 days, the holding period in the previous paragraph applies.

Dividends that are not Qualified Dividends

The following dividends are not qualified dividends. They are not qualified dividends even if they are shown in box 1b of Form 1099-DIV: (135)

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➢ Capital gain distributions. ➢ Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building and loan

associations, U.S. savings and loan associations, Federal savings and loan associations, and similar financial institutions.

➢ Dividends from a corporation that is a tax-exempt organization or farmer's cooperative during the corporation's tax year in which the dividends were paid or during the corporation's previous tax year.

➢ Dividends paid by a corporation on employer securities held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation.

➢ Dividends on any share of stock to the extent the taxpayer is obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property.

➢ Payments in lieu of dividends. ➢ Payments shown in Form 1099-DIV, box 1b, from a foreign corporation to the extent the taxpayer knows or has

reason to know the payments are not qualified dividends.

How To Report Dividend Income

Generally, the taxpayer should use Form 1040 to report dividend income. Report the total of the ordinary dividends on line 3b of Form 1040. Report qualified dividends on line 3a. If the taxpayer received capital gain distributions, he or she should use Form 1040. If the taxpayer received non-dividend distributions required to be reported as capital gains, he or she must use Form 1040. Use Schedule B - Interest and Ordinary Dividends if the taxpayer had over $1,500 of taxable interest or ordinary dividends. Use Schedule B (Form 1040) if any of the following applies:

➢ The taxpayer had over $1,500 of taxable interest or ordinary dividends. ➢ The taxpayer received interest from a seller-financed mortgage and the buyer used the property as a personal

residence. ➢ The taxpayer has accrued interest from a bond. ➢ The taxpayer is reporting original issue discount (OID) in an amount less than the amount shown on Form 1099-

OID. ➢ The taxpayer is reducing his or her interest income on a bond by the amount of amortizable bond premium. ➢ The taxpayer is claiming the exclusion of interest from series EE or I U.S. savings bonds issued after 1989. ➢ The taxpayer received interest or ordinary dividends as a nominee. ➢ The taxpayer had a financial interest in, or signature authority over, a financial account in a foreign country or he

or she received a distribution from, or were a grantor of, or transferor to, a foreign trust. Part III of the schedule has questions about foreign accounts and trusts.

If the taxpayer owned stock on which he or she received $10 or more in dividends and other distributions, the taxpayer should receive a Form 1099-DIV. Even if the taxpayer does not receive a Form 1099-DIV, he or she must report all taxable dividend income.

Stock Spilt

A stock split occurs when a company creates additional shares, thus reducing the price per share. If the taxpayer owns stock that has split and now owns additional shares, he or she must adjust his or her basis per share or per the lots of the stock he or she owns. If the old shares of stock and the new shares are uniform and identical: (136)

➢ The basis of the old shares must be allocated to the old and new shares. ➢ The per share basis is determined by dividing the adjusted basis of the old stock by the number of shares of old

and new stock. If the old shares were purchased in separate lots for differing amounts of money (a different basis per lot) the adjusted basis of the old stock must be allocated between the old and new stock on a lot-by-lot basis. In a stock split, a corporation issues additional shares to current shareholders, but the total basis does not change. Following a stock split, a taxpayer must reallocate his or her basis between the original shares and the shares newly acquired in the stock split. (136)

➢ Stock splits do not create a taxable event; the taxpayer merely receives more stock evidencing the same ownership interest in the corporation that issued the stock. He or she does not report income until he or she sells the stock.

➢ The taxpayer’s overall basis is not changed as a result of a stock split, but his or her per share basis is changed. The taxpayer will need to adjust his or her basis per share of the stock.

Lesson 6 - Investment Income

Example If the taxpayer owns 100 shares of a corporation with a $15 per share basis, the total basis is $1,500. In a 2-for-1 stock split, every shareholder is issued an additional share of stock for each share the shareholder owns. The taxpayer now owns 200 shares, but his or her total basis is still $1,500. Following the stock split, the taxpayer must reallocate the basis between the original shares and the shares newly acquired in the stock split. The basis per share is now $7.50 ($1,500 divided by 200) for each of the 200 shares.

Review Question 4 Jane purchased 500 shares of stock five years ago for $100 a share. The directors voted a 3 for 1 stock split. After the split, Jane had 1500 shares. What is Jane's basis per share after the split?

A. $33.33 B. $100 C. $200 D. $300

See Review Feedback for answer.

Stock Options

If the taxpayer receives an option to buy stock, he or she may have income when he or she receives the option, when he or she exercises the option, or when he or she disposes of the option or stock received when he or she exercises the option. There are two types of stock options: statutory stock options and non-statutory stock options. Generally, options granted under an employee stock purchase plan (ESPP) or an incentive stock option (ISO) plan are considered statutory stock options. Non-statutory stock options are not granted under an employee stock purchase plan or an ISO plan. If the taxpayer is granted a statutory stock option, he or she generally does not include any amount in his or her gross income when he or she is granted or exercises the option. However, the taxpayer may be subject to Alternative Minimum Tax in the year he or she exercises an ISO. The taxpayer has taxable income or deductible loss when he or she sells the stock received by exercising the option. The taxpayer generally treats this amount as a capital gain or loss. However, if he or she does not meet special holding period requirements, he or she will have to treat income from the sale as ordinary income. If the taxpayer is granted a non-statutory stock option, the amount of income to include and the time to include it depends on whether the fair market value of the option can be readily determined. If an option is actively traded on an established market, the fair market value of the option can be readily determined. Most non-statutory options do not have a readily determinable fair market value. For non-statutory options without a readily determinable fair market value, there is no taxable event when the option is granted but the fair market value of the stock received on exercise, less the amount paid, is included in income when the option is exercised. The taxpayer has taxable income or deductible loss when he or she sells the stock received by exercising the option. The taxpayer generally treats this amount as a capital gain or loss. (137)

Non-Dividend Distributions

A non-dividend distribution is a distribution that is not paid out of the earnings and profits of a corporation or a mutual fund. The taxpayer should receive a Form 1099-DIV or other statement showing the non-dividend distribution. On Form 1099- DIV, a non-dividend distribution will be shown in box 3. If the taxpayer does not receive such a statement, he or she reports the distribution as an ordinary dividend. A non-dividend distribution reduces the basis of the taxpayer’s stock. It is not taxed until his or her basis in the stock is fully recovered. This nontaxable portion is also called a return of capital; it is a return of the taxpayer’s investment in the stock of the company. If the taxpayer buys stock in a corporation in different lots at different times, and he or she cannot definitely identify the shares subject to the non-dividend distribution, reduce the basis of the earliest purchases first. When the basis of the stock has been reduced to zero, report any additional non-dividend distribution the taxpayer receives as a capital gain. Whether he or she reports it as a long-term or short-term capital gain depends on how long he or she has held the stock. Example Francisco bought stock in 2008 for $100. In 2012, he received a non-dividend distribution of $80. He did not include this

Lesson 6 - Investment Income

amount in his income, but he reduced the basis of his stock to $20. Francisco received a non-dividend distribution of $30 in 2023. The first $20 of this amount reduced his basis to zero. He reports the other $10 as a long-term capital gain for 2023. Francisco must report as a long-term capital gain any non-dividend distribution he receives on this stock in later years.

Nontaxable Dividends

Nontaxable dividends are dividends from a mutual fund or some other regulated investment company that are not subject to taxes. These funds are often not taxed because they invest in municipal or other tax-exempt securities. One common type of tax-exempt income is interest earned on municipal bonds, which are bonds issued by states and cities to raise funds for general operations or a specific project. When a taxpayer makes interest income on municipal bonds issued in their state of residence, the profit is exempt from both Federal and State taxes. A mutual fund must primarily invest its capital into tax-exempt investments for its dividends to be classified as nontaxable.

Interest Subject to the Tax Interest is rent on money, paid by the borrower to the lender. With few exceptions, interest is fully taxable to the taxpayer receiving it. Taxable interest includes interest received from bank accounts, loans made to others, and other sources. The major problem connected with interest is the determination of the year when it is included in gross income. To a cash- basis taxpayer, interest is taxable under the doctrine of constructive receipt of income when it is unqualifiedly made subject to the demand of the taxpayer. Under this rule, interest is received when it is credited to the taxpayer's account. Taxable interest income is reported on line 2b, Form 1040. For 2023, if interest or dividend income exceed $1,500, a listing of all sources and amounts would have to be shown on Part I of Schedule B. Otherwise, if the taxpayer had interest income and dividends of $1,500 or less the total amount may be placed directly on the Form 1040, line 2b. Interest income is generally reported to taxpayers on Form 1099-INT- Interest Income, or a similar statement, by banks, savings and loans, and other payers of interest. Form 1099-INT does not have to be attached to the submitted tax return unless it has tax withholding. (134) Certain distributions commonly called dividends are actually interest. A taxpayer must report as interest so-called dividends on deposits or on share accounts in: (138)

➢ Cooperative banks. ➢ Credit unions. ➢ Domestic building and loan associations. ➢ Domestic savings and loan associations. ➢ Federal savings and loan associations. ➢ Mutual savings banks.

U.S. Savings Bonds

Series HH bonds were issued at face value. Interest is paid twice a year by direct deposit to the taxpayer’s bank account. If the taxpayer is a cash method taxpayer, he or she must report interest on these bonds as income in the year received. Series HH bonds were first offered in 1980 and last offered in August 2004. Before 1980, series H bonds were issued. Series H bonds are treated the same as series HH bonds. If the taxpayer is a cash method taxpayer, he or she must report the interest when received. Series H bonds have a maturity period of 30 years. Series HH bonds mature in 20 years. The last series H bonds matured in 2009. Interest on series EE and series I bonds is payable when the taxpayer redeems the bonds. The difference between the purchase price and the redemption value is taxable interest. Series EE bonds were first offered in January 1980 and have a maturity period of 30 years. Series E bonds were issued before July 1980. The original 10-year maturity period of series E bonds has been extended to 40 years for bonds issued before December 1965 and 30 years for bonds issued after November 1965. Paper series EE and series E bonds are issued at a discount. The face value is payable to the taxpayer at maturity. Electronic series EE bonds are issued at their face value. The face value plus accrued interest is payable to the taxpayer at maturity. As of January 1, 2012, paper savings bonds will no longer be sold at financial institutions. Owners of paper

Lesson 6 - Investment Income

series EE bonds can convert them to electronic bonds. These converted bonds do not retain the denomination listed on the paper certificate but are posted at their purchase price (with accrued interest). Series I bonds were first offered in 1998. These are inflation-indexed bonds issued at their face amount with a maturity period of 30 years. The face value plus all accrued interest is payable to the taxpayer at maturity. If the taxpayer uses the cash method of reporting income, he or she can report the interest on series EE, series E, and series I bonds in either of the following ways:

➢ Method 1 - Postpone reporting the interest until the earlier of the year he or she cashes or disposes of the bonds or the year they mature.

➢ Method 2 - Choose to report the increase in redemption value as interest each year. The taxpayer must use the same method for all series EE, series E, and series I bonds he or she owns. If the taxpayer does not choose Method 2 by reporting the increase in redemption value as interest each year, he or she must use Method 1.

If the taxpayer uses an accrual method of accounting, he or she must report interest on U.S. savings bonds each year as it accrues. The taxpayer cannot postpone reporting interest until it is received or until the bonds mature.

Discount on Debt Instruments

A debt instrument, such as a bond, note, debenture, or other evidence of indebtedness, that bears no interest or bears interest at a lower than current market rate will usually be issued at less than its face amount. This discount is, in effect, additional interest income. The following are some types of discounted debt instruments.

➢ U.S. Treasury bonds. ➢ Corporate bonds. ➢ Municipal bonds. ➢ Certificates of deposit. ➢ Notes between individuals. ➢ Stripped bonds and coupons. ➢ Collateralized debt obligations (CDOs).

The discount on these instruments (except municipal bonds) is taxable in most instances. The discount on municipal bonds generally is not taxable.

Gift for Opening Account

If the taxpayer receives noncash gifts or services for making deposits or for opening an account in a savings institution, he or she may have to report the value as interest. For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest. The value is determined by the cost to the financial institution.

Review Question 5 If a taxpayer receives noncash gifts or services for making deposits or for opening an account in a savings institution, for deposits of less than $5,000, gifts or services valued at more than what amount must be reported as interest?

A. $10 B. $20 C. $30 D. $40

See Review Feedback for answer.

Lesson 6 - Investment Income

Interest on Insurance Dividends

Interest on insurance dividends left on deposit with an insurance company that can be withdrawn annually is taxable to an individual in the year it is credited to his or her account. However, if the taxpayer can withdraw it only on the anniversary date of the policy (or other specified date), the interest is taxable in the year that date occurs.

Prepaid Insurance Premiums

Any increase in the value of prepaid insurance premiums, advance premiums, or premium deposit funds is interest if it is applied to the payment of premiums due on insurance policies or made available to the taxpayer for withdraw.

U.S. Obligations

Interest on U.S. obligations, such as U.S. Treasury bills, notes, and bonds, issued by any agency or instrumentality of the United States is taxable for Federal income tax purposes.

Installment Sale Payments

If a contract for the sale or exchange of property provides for deferred payments, it also usually provides for interest payable with the deferred payments. That interest is taxable when the taxpayer receives it. If little or no interest is provided for in a deferred payment contract, part of each payment may be treated as interest.

Other Taxable Interest

Interest a taxpayer receives on tax refunds, accumulated interest on an annuity contract sold before its maturity date and the interest a condemning authority pays to compensate for a delay in payment of an award is taxable income.

Excluded Interest

Interest received on the obligations of a state, a territory, or any political subdivision of a state or territory, such as a city or a county, is excluded fully from Federal income taxation. This exclusion makes an investment in state and local bonds attractive for taxpayers that are in higher tax brackets. However, tax-exempt interest must be reported on line 2a, Form 1040 even though it is not taxed. (138)

Even if interest on the obligation is not subject to income tax, the taxpayer may have to report a capital gain or loss when he or she sells it. Estate, gift, or generation-skipping tax may apply to other dispositions of the obligation.

Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a U.S. possession, or any of their political subdivisions. Political subdivisions include: (139)

➢ Port authorities. ➢ Toll road commissions. ➢ Utility services authorities. ➢ Community redevelopment agencies. ➢ Qualified volunteer fire departments (for certain obligations issued after 1980).

Review Question 6 Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a U.S. possession, or which of their following political subdivisions?

A. Port authorities B. Toll road commissions C. Utility services authorities D. All of the above

See Review Feedback for answer.

Capital Gain Distributions

Capital gain distributions (also called capital gain dividends) are paid to a taxpayer or credited to his or her account by

Lesson 6 - Investment Income

mutual funds (or other regulated investment companies) and real estate investment trusts (REITs). They will be shown in box 2a of the Form 1099-DIV received from the mutual fund or REIT. Report capital gain distributions as long-term capital gains, regardless of how long the taxpayer owned his or her shares in the mutual fund or REIT.

Money Market Funds

Money market funds are offered by nonbank financial institutions such as mutual funds and stock brokerage houses and pay dividends. Generally, amounts a taxpayer receives from money market funds should be reported as dividends, not as interest. Exempt-interest dividends taxpayer receives from a mutual fund or other regulated investment company, including those received from a qualified fund of funds in any tax year beginning after December 22, 2010, are not included in taxable income.

Other Deferred Interest Accounts

If the taxpayer opens a certificate of deposit and other deferred interest account, interest may be paid at fixed intervals of 1 year or less during the term of the account. The taxpayer generally must include this interest in his or her income when he or she actually receives it or is entitled to receive it without paying a substantial penalty. The same is true for accounts that mature in 1 year or less and pay interest in a single payment at maturity.

If the taxpayer withdraws funds from a deferred interest account before maturity, he or she may have to pay a penalty. The taxpayer must report the total amount of interest paid or credited to his or her account during the year, without subtracting the penalty.

The interest a taxpayer pays on money borrowed from a bank or savings institution to meet the minimum deposit required for a certificate of deposit from the institution and the interest he or she earns on the certificate are two separate items. The taxpayer must report the total interest he or she earns on the certificate in his or her income. If the taxpayer itemizes deductions, he or she can deduct the interest he or she pays as investment interest, up to the amount of his or her net investment income.

Tax Exempt Bonds

This is an obligation issued by or on behalf of a governmental issuer for which the interest paid is excluded from the holder's gross income under Section 103. For this purpose, a bond can be in any form of indebtedness under Federal tax law, including a bond, note, loan, or lease-purchase agreement such as a municipal bond. Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a U.S. possession, or any of their political subdivisions. Political subdivisions include: (70)

There are other requirements for tax-exempt bonds. Contact the issuing state or local government agency or see Sections 103 and 141 through 150 of the Internal Revenue Code and the related regulations. Interest on a state or local government obligation may be tax exempt even if the obligation is not a bond. For example, interest on a debt evidenced only by an ordinary written agreement of purchase and sale may be tax exempt. Also, interest paid by an insurer on default by the state or political subdivision may be tax exempt. Interest on Federally guaranteed state or local obligations issued after 1983 is generally taxable. This rule does not apply to interest on obligations guaranteed by the following U.S. Government agencies: (70)

➢ Bonneville Power Authority (if the guarantee was under the Northwest Power Act as in effect on July 18, 1984). ➢ Department of Veterans Affairs. ➢ Federal home loan banks. (The guarantee must be made after July 30, 2008, in connection with the original bond

issue during the period beginning on July 30, 2008 and ending on December 31, 2010 (or a renewal or extension of a guarantee so made) and the bank must meet safety and soundness requirements).

➢ Federal Home Loan Mortgage Corporation. ➢ Federal Housing Administration.

Lesson 6 - Investment Income

➢ Federal National Mortgage Association. ➢ Government National Mortgage Corporation. ➢ Resolution Funding Corporation. ➢ Student Loan Marketing Association.

Individual Retirement Arrangements (IRAs)

Interest earned on an Individual Retirement Arrangement (IRA) is excluded from income until withdrawals are made from the account. This exclusion also applies to interest earned by Keogh retirement plans and other qualified pension or profit- sharing plans.

Education Savings Bond Program

Interest income can be excluded on qualified U.S. Savings Bonds redeemed to pay for qualified higher education expenses. These are expenses for tuition and required fees at an eligible educational institution (such as an accredited college, university, or eligible vocational school) or to a Coverdell education savings account for the taxpayer, his or her spouse, or his or her dependent(s). A qualified U.S. Savings bond is a Series EE or I savings bond that was issued after December 31, 1989, to an individual who has reached age 24 before the date of issuance. The exclusion is subject to a phase-out in the years in which the bonds are cashed and the tuition is paid. The phase-out based on the taxpayer’s modified adjusted gross income (MAGI) for 2023 begins at $91,850 for taxpayers filing single or head of household, and $137,800 for married taxpayers filing jointly or for a qualifying surviving spouse with dependent child. The taxpayer does not qualify for the interest exclusion if MAGI is equal to or more than the upper limit for his or her filing status. In 2023, the exclusion phases out completely at MAGI levels of $167,800 for joint returns and $106,850 for other returns. This exclusion is not available to married individuals who file separate returns. If the total proceeds (interest and principal) from the qualified U.S. savings bonds the taxpayer redeems during the year are not more than his or her adjusted qualified higher educational expenses for the year, he or she may be able to exclude all of the interest. If the proceeds are more than the expenses, the taxpayer may be able to exclude only part of the interest. If the total proceeds (interest and principal) from the qualified U.S. savings bonds the taxpayer redeems during the year are not more than his or her adjusted qualified higher educational expenses for the year, he or she may be able to exclude all of the interest. If the proceeds are more than the expenses, the taxpayer may be able to exclude only part of the interest. To determine the excludable amount, multiply the interest part of the proceeds by a fraction. The numerator of the fraction is the qualified higher educational expenses the taxpayer paid during the year. The denominator of the fraction is the total proceeds the taxpayer received during the year. To figure the interest exclusion when the bonds are redeemed, use Form 8815 - Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989.

Interest Income on Frozen Deposits

Exclude from gross income interest on frozen deposits. A deposit is frozen if, at the end of the year, the taxpayer cannot withdraw any part of the deposit because: (140)

➢ The financial institution is bankrupt or insolvent. ➢ The state where the institution is located has placed limits on withdrawals because other financial institutions in

the state are bankrupt or insolvent.

The amount of interest a taxpayer must exclude is the interest that was credited on the frozen deposits minus the sum of:

➢ The net amount the taxpayer withdrew from these deposits during the year. ➢ The amount the taxpayer could have withdrawn as of the end of the year (not reduced by any penalty for premature

withdrawals of a time deposit).

If the taxpayer receives a Form 1099-INT for interest income on deposits that were frozen at the end of 2023, see frozen deposits under How To Report Interest Income in Chapter 1 of Publication 550, for information about reporting this interest income exclusion on a tax return. The interest a taxpayer excludes is treated as credited to his or her account in the following year. The taxpayer must include it in income in the year he or she can withdraw it.

Lesson 6 - Investment Income

Nonresident Aliens

Nonresident aliens are not taxed on certain kinds of interest income as follows, per Internal Revenue Code subsections 871(h) and (i), provided that such interest income arises from one of the following sources:

➢ A U.S. bank. ➢ A U.S. savings and loan association. ➢ A U.S. credit union. ➢ A U.S. insurance company. ➢ Portfolio Interest.

If the nonresident alien individual uses Form 1040-NR to report his or her income, then such nontaxable interest income shall not be reported anywhere on Form 1040-NR.

A nonresident alien individual should not deliver Form W-9 - Request for Taxpayer Identification Number and Certification to a U.S. bank, U.S. savings and loan association, U.S. credit union, or U.S. insurance company. Instead, he or she should deliver Form W-8BEN - Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding to such institutions in order to put them on notice that he is a nonresident alien and that the interest income accruing to his account at such institutions is not reportable to the IRS, except in the case of U.S. bank accounts held by residents of Canada. Refer to Treasury Regulation 1.6049-8(a).

How To Report Interest Income Most interest that the taxpayer either receives or is credited to his or her account and that can be withdrawn without penalty is taxable income. Examples of taxable interest are interest on bank accounts, money market accounts, certificates of deposit, and deposited insurance dividends. If the taxpayer uses this method, he or she generally reports his or her interest income in the year in which he or she actually or constructively receives it. A taxpayer constructively receives income when it is credited to his or her account or made available to him or her. The taxpayer does not need to have physical possession of it. For example, he or she is considered to receive interest, dividends, or other earnings on any deposit or account in a bank, savings and loan, or similar financial institution, or interest on life insurance policy dividends left to accumulate, when they are credited to his or her account and subject to his or her withdrawal. This is true even if they are not yet entered in the taxpayer’s passbook. The taxpayer constructively receives income on the deposit or account even if he or she must: (140)

➢ Make withdrawals in multiples of even amounts. ➢ Give a notice to withdraw before making the withdrawal. ➢ Withdraw all or part of the account to withdraw the earnings. ➢ Pay a penalty on early withdrawals, unless the interest he or she is to receive on an early withdrawal or redemption

is substantially less than the interest payable at maturity.

If the taxpayer uses an accrual method, he or she reports his or her interest income when he or she earns it, whether or not he or she has received it. Interest is earned over the term of the debt instrument. Generally, the taxpayer reports all taxable interest income on Form 1040, line 2b. The taxpayer uses Schedule B (Form 1040) if any of the following applies:

➢ He or she had over $1,500 of taxable interest or ordinary dividends. ➢ He or she received interest from a seller-financed mortgage and the buyer used the property as a personal

residence. ➢ He or she has accrued interest from a bond. ➢ He or she is reporting original issue discount (OID) in an amount less than the amount shown on Form 1099-OID. ➢ He or she is reducing his or her interest income on a bond by the amount of amortizable bond premium. ➢ He or she is claiming the exclusion of interest from series EE or I U.S. savings bonds issued after 1989. ➢ He or she received interest or ordinary dividends as a nominee. ➢ He or she had a financial interest in, or signature authority over, a financial account in a foreign country or he or

she received a distribution from, or were a grantor of, or transferor to, a foreign trust. Part III of the schedule has questions about foreign accounts and trusts.

Lesson 6 - Investment Income

Reporting Tax-Exempt Interest

Total tax-exempt interest (such as interest or accrued OID on certain state and municipal bonds, including tax-exempt interest on zero coupon municipal bonds) and exempt-interest dividends from a mutual fund as shown in box 8 of Form 1099-INT. Add this amount to any other tax-exempt interest received. Report the total on line 2a of Form 1040. Form 1099-INT, box 9, and Form 1099-DIV, box 11, show the tax-exempt interest subject to the alternative minimum tax on Form 6251. These amounts are already included in the amounts on Form 1099-INT, box 8, and Form 1099-DIV, box 10. Do not add the amounts in Form 1099-INT, box 9 and Form 1099-DIV, box 11 to, or subtract them from, the amounts on Form 1099-INT, box 8, and Form 1099-DIV, box 10.

Form 1099-DIV - Dividends and Distributions

An individual should file Form 1099-DIV - Dividends and Distributions, for each person: (62)

➢ To whom he or she has paid dividends (including capital gain dividends and exempt-interest dividends) and other distributions on stock of $10 or more.

Report of Foreign Bank and Financial Accounts (FBAR)

The Financial Crimes Enforcement Network (FinCEN) distributed a rule that amends the Bank Secrecy Act (BSA) implementing regulations regarding the Report of Foreign Bank and Financial Accounts (FBAR). The FBAR form is utilized to report a financial interest in, or signature or other authority over, one or more financial accounts in foreign countries. A report is not mandatory if the aggregate value of the accounts does not exceed $10,000. Therefore, if a U.S. person who has a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account that exceeds $10,000 at any time during the calendar year, the Bank Secrecy Act may require him or her to report the account yearly to the Internal Revenue Service by filing a Report of Foreign Bank and Financial Accounts (FBAR).

FBARs must be electronically filed through the Bank Secrecy Act (BSA) E-Filing System using the electronic FinCEN Form 114 - Report of Foreign Bank and Financial Accounts (FBAR), which supersedes the now- obsolete paper Treasury Department Form 90-22.1. Starting after December 31, 2015, the due date of FinCEN

Report 114 (relating to Report of Foreign Bank and Financial Accounts) is April 15 with a maximum extension for a 6- month period ending on October 15 and with provision for an extension under rules similar to the rules in Treasury Regulation Section 1.6081–5. For any taxpayer required to file such Form for the first time, any penalty for failure to timely request for, or file, an extension, may be waived by the Secretary. United States persons are required to file an FBAR if both of the following apply: (141)

1. The United States person had a financial interest in or signature authority over at least one financial account located outside of the United States.

2. The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.

United States person includes U.S. citizens; U.S. residents; entities, including but not limited to, corporations, partnerships, or limited liability companies, created or organized in the United States or under the laws of the United States; and trusts or estates formed under the laws of the United States. The Federal tax treatment of an entity does not determine whether the entity has an FBAR filing requirement. For example, an entity that is disregarded for purposes of Title 26 of the United States Code must file an FBAR, if otherwise required to do so. Similarly, a trust for which the trust income, deductions, or credits are taken into account by another person for purposes of Title 26 of the United States Code must file an FBAR, if otherwise required to do so.

Lesson 6 - Investment Income

A financial account contains, but is not limited to, securities, brokerage, savings, demand, checking, deposit, time deposit, or other account maintained with a financial institution (or other person performing the services of a financial institution). A financial account also is comprised of commodity futures or options account, an insurance policy with a cash value (such as a whole life insurance policy), an annuity policy with a cash value, and shares in a mutual fund or similarly pooled fund (i.e., a fund that is available to the general public with a regular net asset value determination and regular redemptions). A foreign financial account is a financial account located outside of the United States. For example, an account maintained with a branch of a United States bank that is physically located outside of the United States is a foreign financial account. An account maintained with a branch of a foreign bank that is physically located in the United States is not a foreign financial account. Exceptions to the FBAR reporting requirements are located in the FBAR instructions. There are filing exceptions for the following United States persons or foreign financial accounts:

➢ Certain foreign financial accounts jointly owned by spouses. ➢ United States persons included in a consolidated FBAR. ➢ Correspondent/nostro accounts. ➢ Foreign financial accounts owned by a governmental entity. ➢ Foreign financial accounts owned by an international financial institution. ➢ IRA owners and beneficiaries. ➢ Participants in and beneficiaries of tax-qualified retirement plans. ➢ Certain individuals with signature authority over but no financial interest in a foreign financial account. ➢ Trust beneficiaries (but only if a U.S. person reports the account on an FBAR filed on behalf of the trust). ➢ Foreign financial accounts maintained on a United States military banking facility.

A U.S. person who has a foreign financial account may have a reporting obligation even though the account produces no taxable income. The reporting obligation is met by answering questions on a tax return about foreign accounts (for example, the questions about foreign accounts on Form 1040 Schedule B) and by filing an FBAR. The FBAR is a calendar year report, which must be filed with the Department of Treasury on or before April 15 of the year following the calendar year reported. Generally, extensions of time to file an FBAR are allowed. The law affords an extension of up to six months to be available to all taxpayers, which coincides with the October 15 extension due date for individual income tax returns. While the due dates for the FBAR and individual income tax returns now coincide, the method of filing FBARs has not changed. FBARs must be filed electronically through the FinCEN BSA E-Filing System. Those required to file an FBAR who fail to properly file a complete and correct FBAR may be subject to civil monetary penalties. For penalties that are assessed in 2023, the IRS may assess an inflation-adjusted civil penalty not to exceed $15,611 per violation for non-willful violations that are not due to reasonable cause. For willful violations, the inflation- adjusted penalty may be the greater of $156,107 or 50% of the balance in the account at the time of the violation, for each violation. Taxpayers with specified foreign financial assets that exceed $50,000 on the last day of the tax year or $75,000 at any time during the tax year (higher threshold amounts apply to married individuals filing jointly and individuals living abroad) must report those assets to the IRS on Form 8938 - Statement of Specified Foreign Financial Assets, which is filed with an income tax return. The new Form 8938 filing requirement is in addition to the FBAR filing requirement.

Review Question 7 Craig, a United States citizen, owns foreign financial accounts X, Y, and Z with maximum account values of $100, $12,000 and $3,000, respectively. None of the accounts produce income. Which of the following is true regarding Craig’s Report of Foreign Bank and Financial Accounts (FBAR) requirement?

A. Craig is not required to file an FBAR because the aggregate value of the accounts is below $20,000 B. Craig is not required to file an FBAR because the accounts do not produce income C. Craig must report foreign financial accounts X, Y, and Z on the FBAR even though accounts X and

Z have maximum account values below $10,000 D. Craig must only report foreign financial account Y on the FBAR because accounts X and Z have

maximum account values below $10,000

See Review Feedback for answer.

Lesson 6 - Investment Income

• 0% on any amount that otherwise would be taxed at a 10% or 12% rate.

• 15% on any amount that otherwise would be taxed at rates greater than 12% but less than 37%.

• 20% on any amount that otherwise would be taxed at a 37% rate. Individual tax rate (Choice A) and corporate tax rates (Choice C) are taxed at different percentages based on income and are incorrect. Topic - Qualified Dividends Source - IRS.GOV - Topic No. 404 - Dividends Question 4 - A. $33.33 A stock split occurs when a company creates additional shares, thus reducing the price per share. If the taxpayer owns stock that has split and now owns additional shares, he or she must adjust his or her basis per share or per the lots of the stock he or she owns. In this question, Jane had 500 shares purchased at $100 a share (or $50,000). She now has 1500 shares with the same total cost ($50,000). $50,000 / 1500 = $33.33. Only Choice A has the correct amount and is therefore the correct answer. Topic - Stock Spilt Source - IRS.GOV - Stocks (Options, Splits, Traders)

Lesson 6 - Investment Income

Question 5 - A. $10 If the taxpayer receives noncash gifts or services for making deposits or for opening an account in a savings institution, he or she may have to report the value as interest. For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest. The value is determined by the cost to the financial institution. Only Choice A has the correct amount and is therefore the correct answer. Topic - Gift for Opening Account Source - Publication 17 - Part Two - Interest Income Question 6 - D. All of the above Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a U.S. possession, or any of their political subdivisions. Political subdivisions include port authorities (Choice A), toll road commissions (Choice B), utility services authorities (Choice C), community redevelopment agencies, and qualified volunteer fire departments (for certain obligations issued after 1980). Since Choices A, B, and C are included in the political subdivisions in which interest on a bond used to finance government operations is not taxable, Choice D, All of the above, is the correct response. Topic - Excluded Interest Source - Publication 550 - Investment Income and Expenses Question 7 - C. Craig must report foreign financial accounts X, Y, and Z on the FBAR even though accounts X and Z have maximum account values below $10,000 A United States person must file an FBAR if that person has a financial interest in or signature authority over any financial account(s) outside of the United States and the aggregate maximum value of the account(s) exceeds $10,000 at any time during the calendar year (making Choices A and D incorrect). Craig must report foreign financial accounts X, Y, and Z on the FBAR even though accounts X and Z have maximum account values below $10,000 (Choice C is therefore true and the correct response). Whether or not an account produces income does not affect the requirement to file an FBAR (making Choice B incorrect). Topic - Report of Foreign Bank and Financial Accounts (FBAR) Source - IRS.GOV - Report of Foreign Bank and Financial Accounts (FBAR)

Capital Gains and Losses, Sale of Personal Residence At the conclusion of this lesson you should have a basic knowledge of:

➢ Capital Gains. ➢ Capital Losses. ➢ Tax on Capital Gains. ➢ Sale of Personal Residence.

Almost everything an individual owns and uses for personal or investment purposes is a capital asset. Examples include a home, personal use items like household furnishings, and stocks or bonds held as investments. When a capital asset is sold, the difference between the basis in the asset and the amount it is sold for is a capital gain or a capital loss. Generally, an asset's basis is its original cost. A person has a capital gain if he or she sells the asset for more than the basis. The person has a capital loss if he or she sells the asset for less than the basis. Losses from the sale of personal-use property, such as a home or car, are not deductible.

Sales and Other Dispositions of Capital Assets

Form 8949 - Sales and Other Dispositions of Capital Assets is an IRS form used by individuals, partnerships, corporations, trusts, and estates to report capital gains and losses from investment. Taxpayers must use the form to report short- and long-term capital gains and losses from sales or investment exchanges. Individuals must us Form 8949 to report: (142)

➢ The sale or exchange of a capital asset not reported on another form or schedule. ➢ Gains from involuntary conversions (other than from casualty or theft) of capital assets not held for business or

profit. ➢ Nonbusiness bad debts. ➢ Worthlessness of a security. ➢ The election to defer capital gain invested in a Qualified Opportunity Fund. ➢ The disposition of interests in Qualified Opportunity Funds.

Along with the list above, corporations can report on Form 8949 the sale of stock of a specified 10%-owned foreign corporation, adjusted for the dividends-received deduction under Section 245A, but only if the sale would otherwise generate a loss. If the taxpayer is filing a joint return, he or she completes as many copies of Form 8949 as he or she needs to report all of his or her and his or her spouse's transactions. The taxpayer and his or her spouse may list the transactions on separate forms or the taxpayer and his or her spouse may combine them. However, the taxpayer must include on his or her Schedule D the totals from all Forms 8949 for both him or herself and his or her spouse. Form 8949 allows the taxpayer and the IRS to reconcile amounts that were reported to him or her and the IRS on Form 1099-B or 1099-S (or substitute statement) with the amounts he or she reports on his or her return. If the taxpayer receives Form 1099-B or 1099-S (or substitute statement), always report the proceeds (sales price) shown on that form (or statement) in column (d) of Form 8949. If Form 1099-B (or substitute statement) shows that the cost or other basis was reported to the IRS, always report the basis shown on that form (or statement) in column (e). If any correction or adjustment to these amounts is needed, make it in column (g). If all Forms 1099-B the taxpayer received (and all substitute statements) show basis was reported to the IRS and if no correction or adjustment is needed, he or she may not need to file Form 8949 as it is not required for certain transactions. The taxpayer may be able to aggregate those transactions and report them directly on either line 1a (for short-term transactions) or line 8a (for long-term transactions) of Schedule D. This option applies only to transactions (other than sales of collectibles) for which:

1. He or she received a Form 1099-B (or substitute statement) that shows basis was reported to the IRS and does not show any adjustments in box 1f or 1g.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

2. The Ordinary box in box 2 is not checked. 3. He or she does not need to make any adjustments to the basis or type of gain or loss (short term or long term)

reported on Form 1099-B (or substitute statement), or to his or her gain or loss. 4. The taxpayer is not electing to defer income due to an investment in a qualified opportunity fund (QOF) and is not

terminating deferral from an investment in a QOF. If the taxpayer chooses to report these transactions directly on Schedule D, he or she does not need to include them on Form 8949 and does not need to attach a statement. Corporations and partnerships use Form 8949 to report: (143)

➢ The sale or exchange of a capital asset not reported on another form or schedule. ➢ Sale of stock of a specified 10%-owned foreign corporation, adjusted for the dividends-received deduction under

Section 245A, but only if the sale would otherwise generate a loss. ➢ Nonbusiness bad debts. ➢ Undistributed long-term capital gains from Form 2439 - Notice to Shareholder of Undistributed Long-Term Capital

Gains. ➢ Worthlessness of a security. ➢ The election to defer capital gain invested in a Qualified Opportunity Fund. ➢ The disposition of interests in Qualified Opportunity Funds.

Electing large partnerships and corporations also use Form 8949 to report their share of gain or (loss) from a partnership, S corporation, estate or trust. The taxpayer completes all necessary pages of Form 8949 before completing line 1, 2, 3, 8, 9, or 10 of Schedule D. He or she uses Schedule D: (142)

➢ To figure the overall gain or loss from transactions reported on Form 8949. ➢ To report certain transactions the taxpayer does not have to report on Form 8949. ➢ To report a gain from Form 2439 or 6252 or Part I of Form 4797. ➢ To report a gain or loss from Form 4684, 6781, or 8824. ➢ To report a gain or loss from a partnership, S corporation, estate, or trust. ➢ To report capital gain distributions not reported directly on Form 1040, line 7 (or effectively connected capital gain

distributions not reported directly on Form 1040-NR, line 7). ➢ To report a capital loss carryover from 2022 to 2023.

Use Form 4797 - Sales of Business Property to report the following: (144)

➢ The sale or exchange of: o Real property used in the taxpayer’s trade or business. o Depreciable and amortizable tangible property used in the taxpayer’s trade or business. o Oil, gas, geothermal, or other mineral property. o Section 126 property.

➢ The involuntary conversion (from other than casualty or theft) of property used in the taxpayer’s trade or business and capital assets held for more than 1 year in connection with a trade or business or a transaction entered into for profit.

➢ The disposition of noncapital assets other than inventory or property held primarily for sale to customers in the ordinary course of a trade or business.

➢ The disposition of capital assets not reported on Schedule D. ➢ The gain or loss (including any related recapture) for partners and S corporation shareholders from certain Section

179 property dispositions by partnerships (other than electing large partnerships) and S corporations. ➢ The computation of recapture amounts under Sections 179 and 280F(b)(2) when the business use of Section 179

or listed property decreases to 50% or less. ➢ Gains or losses treated as ordinary gains or losses if the taxpayer is a trader in securities or commodities and

made a mark-to-market election under Internal Revenue Code Section 475(f).

Use Form 6781 - Gains and Losses From Section 1256 Contracts and Straddles to report any gain or loss on Section 1256 contracts under the mark-to-market rules and gains and losses under Section 1092 from straddle positions.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

A Section 1256 contract is any: (145)

➢ Regulated futures contract. ➢ Foreign currency contract. ➢ Non-equity option. ➢ Dealer equity option. ➢ Dealer securities futures contract.

A Section 1256 contract does not include any interest rate swap, currency swap, basis swap, commodity swap, equity swap, equity index swap, credit default swap, interest rate cap, interest rate floor, or similar agreement.

Use Parts I, II, and III of Form 8824 - Like-Kind Exchanges to report each exchange of business or investment property for property of a like kind. Certain members of the executive branch of the Federal Government and judicial officers of the Federal Government use Part IV to elect to defer gain on conflict-of-interest sales. Judicial officers of the Federal Government are the following: (146)

➢ Chief Justice of the United States. ➢ Associate Justices of the Supreme Court. ➢ Judges of the:

o United States courts of appeals. o United States district courts, including the district courts in Guam, the Northern Mariana Islands, and the

Virgin Islands. o Court of Appeals for the Federal Circuit. o Court of International Trade. o Tax Court. o Court of Federal Claims. o Court of Appeals for Veterans Claims. o United States Court of Appeals for the Armed Forces. o Any court created by Act of Congress, the judges of which are entitled to hold office during good behavior.

See the instructions for the Schedule D the taxpayer is filing for detailed information about the following: (143)

➢ Other forms he or she may have to file. ➢ The definition of capital asset. ➢ Reporting capital gain distributions, undistributed capital gains, the sale of a main home, the sale of capital assets

held for personal use, or the sale of a partnership interest. ➢ Capital losses, nondeductible losses, and losses from wash sales. ➢ Traders in securities. ➢ Short sales. ➢ Gain or loss from options. ➢ Installment sales. ➢ Demutualization of life insurance companies. ➢ Exclusion or rollover of gain from the sale of qualified small business stock. ➢ Any other rollover of gain, such as gain from the sale of publicly traded securities. ➢ Exclusion of gain from the sale of DC Zone assets or qualified community assets. ➢ Certain other items that get special treatment. ➢ Special reporting rules for corporations and partnerships in certain situations.

Basis

Basis is the amount of the investment in property for tax purposes. The basis of property the taxpayer buys is usually its cost. The taxpayer needs to know his or her basis to figure any gain or loss on the sale or other disposition of the property. The basis of property a taxpayer buys is usually its cost. The cost is the amount he or she pays for it in cash, in debt obligation, in other property, or in services. The cost also includes:

➢ Sales tax charged on the purchase. ➢ Freight charges to obtain the property. ➢ Installation and testing charges.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

If the taxpayer buys real property, such as a building and land, certain fees and other expenses he or she pays are part of the cost basis in the property. If the taxpayer agrees to pay real estate taxes on a property that was owed by the seller and the seller does not reimburse him or her, the taxes he or she pays are treated as part of the basis in the property. The taxpayer cannot deduct them as taxes paid. If the taxpayer reimburses the seller for real estate taxes the seller paid for him or her, the taxpayer can usually deduct that amount. Do not include that amount in the basis in the property. The following settlement fees and closing costs for buying the property are part of the basis in the property: (72)

➢ Abstract fees. ➢ Charges for installing utility services. ➢ Legal fees. ➢ Recording fees. ➢ Surveys. ➢ Transfer taxes. ➢ Title insurance. ➢ Any amounts the seller owes that the taxpayer agrees to pay, such as back taxes or interest, recording or

mortgage fees, charges for improvements or repairs, and sales commissions. The following are settlement fees and closing costs a taxpayer cannot include in the basis in the property: (72)

➢ Fire insurance premiums. ➢ Rent or other charges relating to occupancy of the property before closing. ➢ Charges connected with getting or refinancing a loan, such as:

o Points (discount points, loan origination fees), o Mortgage insurance premiums, o Loan assumption fees, o Cost of a credit report, and o Fees for an appraisal required by a lender.

Also, do not include amounts placed in escrow for the future payment of items such as taxes and insurance. If the taxpayer buys buildings and the land on which they stand for a lump sum, he or she allocates the basis of the property among the land and the buildings so he or she can figure the depreciation allowable on the buildings. If the taxpayer buys a tract of land and subdivides it, he or she must determine the basis of each lot. This is necessary because the taxpayer must figure the gain or loss on the sale of each individual lot. As a result, he or she does not recover the entire cost in the tract until he or she has sold all of the lots. To determine the basis of an individual lot, multiply the total cost of the tract by a fraction. The numerator is the fair market value (FMV) of the lot and the denominator is the FMV of the entire tract. If the taxpayer made a mistake in figuring the cost basis of subdivided lots sold in previous years, he or she cannot correct the mistake for years for which the statute of limitations (generally 3 tax years) has expired. The taxpayer figures the basis of any remaining lots by allocating the correct original cost basis of the entire tract among the original lots.

Review Question 1 Will purchases rental property for $150,000. He uses $20,000 cash and obtains a mortgage for $130,000. He pays closing costs of $10,000, which includes $5,000 in points on the mortgage and $5,000 for bank fees and title costs. His initial basis in the property is what amount?

A. $30,000 B. $150,000 C. $155,000 D. $160,000

See Review Feedback for answer.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

Adjusted Basis

Adjusted basis refers to a material change to the recorded initial cost of an asset or security after it has already been owned. Updating the original purchase cost by taking into account any increases or decreases to its value is primarily used to compute the capital gain or loss on a sale for tax purposes. The cost basis of a security, such as shares of stock, can sometimes be adjusted when certain events happen. For example, a dividend paid in the form of additional stock will cause an adjustment in the cost basis of the original shares. The cost basis of the original shares will also be adjusted in the event of a stock split or a capital distribution. Dividends paid by the issuing company in cash do not cause an adjusted basis. To calculate an asset's or security's adjusted basis, simply take its purchase price and then add or subtract any changes to its value.

Casualty Losses

Under the Tax Cuts and Jobs Act (TCJA), if a casualty loss is incurred in a location that is not declared a Federal disaster area, the loss is only deductible to the extent of casualty gains. Generally, Federal disaster area losses related to an individual taxpayer’s personal-use property including homes, household items and vehicles are deductible for Federal income tax purposes. Losses should first be reduced by any reimbursement received or anticipated and any salvage value. The amount of casualty loss is the lesser of the adjusted basis of the property, immediately prior to the disaster, or the decrease in fair market value as a result of the casualty. The decrease in fair market value may be determined by appraisal or cost of repairs. Each casualty loss in a federal disaster area is allowed to the extent it exceeds $100 and 10% of adjusted gross income.

Recordkeeping

Basis is the amount of the investment in property for tax purposes. The basis of property the taxpayer buys is usually its cost. The taxpayer needs to know his or her basis to figure any gain or loss on the sale or other disposition of the property. The taxpayer must keep accurate records that show the basis and, if applicable, adjusted basis of the property. The records should show the purchase price, including commissions; increases to basis, such as the cost of improvements; and decreases to basis, such as depreciation, non-dividend distributions on stock, and stock splits.

Capital Asset

For the most part, everything a taxpayer owns and uses for personal purposes, pleasure, or investment is a capital asset. For example: (147)

➢ Stocks or bonds held in a personal account. ➢ A house owned and used by the taxpayer and his or her family. ➢ Household furnishings. ➢ A car used for pleasure or commuting. ➢ Coin or stamp collections. ➢ Gems and jewelry. ➢ Gold, silver, or any other metal.

Any property the taxpayer owns is a capital asset, except the following noncapital assets: (147)

➢ Stock in trade or other property included in inventory or held mainly for sale to customers. ➢ Accounts or notes receivable for services performed in the ordinary course of the trade or business or as an

employee, or from the sale of stock in trade or other property held mainly for sale to customers. ➢ Depreciable property used in the trade or business, even if it is fully depreciated. ➢ Real estate used in the trade or business. ➢ Copyrights, literary, musical, or artistic compositions, letters or memoranda, or similar property:

o Created by the taxpayer’s personal efforts. o Prepared or produced for the taxpayer (in the case of letters, memoranda, or similar property). o That the taxpayer received from someone who created them or for whom they were created, as mentioned

above, in a way (such as by gift) that entitled him or her to the basis of the previous owner. ➢ U.S. Government publications, including the Congressional Record, that the taxpayer received from the

Government, other than by purchase at the normal sales price, or that he or she received from someone who had received it in a similar way, if the basis is determined by reference to the previous owner's basis.

➢ Certain commodities derived by financial instruments held by a dealer and not connected to the dealer's activities as a dealer.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

➢ Certain hedging transactions entered into in the normal course of the trade or business. ➢ Supplies regularly used in the trade or business.

The taxpayer can elect to treat as capital assets certain musical compositions or copyrights he or she sold or exchanged if:

➢ The taxpayer’s personal efforts created the property. ➢ The taxpayer acquired the property under circumstances (for example, by gift) entitling him or her to the basis of

the person who created the property or for whom it was prepared or produced. The taxpayer must make a separate election for each musical composition (or copyright in a musical work) sold or exchanged during the tax year. He or she must make the election on or before the due date (including extensions) of the income tax return for the tax year of the sale or exchange. The taxpayer must make the election on Form 8949 by treating the sale or exchange as the sale or exchange of a capital asset, according to the Instructions for Form 8949 and Instructions for Schedule D (Form 1040). See Publication 550 - Investment Income and Expenses for details.

Review Question 2 Which of the following is considered a taxpayer’s noncapital assets?

A. Supplies regularly used in the trade or business B. A car used for pleasure or commuting C. Coin or stamp collections D. Gems and jewelry

See Review Feedback for answer.

Capital Improvements

The IRS defines a capital improvement as a home improvement that adds market value to the home, prolongs its useful life or adapts it to new uses. Minor repairs and maintenance jobs like changing door locks, repairing a leak or fixing a broken window do not qualify as capital improvements. In addition to improving the home, a capital improvement increases the cost basis of a structure. That is, expenses incurred upon making the improvements are added to the amount the owner paid to buy or build the property. Augmenting the cost basis, in turn, reduces the size of the taxable capital gain when selling the property. Capital improvements typically increase the market value of a property but may also expand the usefulness of the asset beyond its current state. According to the IRS, to qualify as a capital improvement, it must endure for more than one year upon its completion and be durable or permanent in nature. Although the scale of a capital improvement can vary, both individual homeowners and large-scale property owners make capital improvements. Examples of residential capital improvements include adding or renovating a bedroom, bathroom, or a deck. Other IRS approved projects include adding new built-in appliances, wall-to-wall carpeting or flooring, or improvements to a home's exterior, such as replacing the roof, siding, or storm windows. Installing a fixed swimming pool or driveway may also be qualified capital improvements.

Review Question 3 Paul and Nancy purchased a house to use as rental property. They paid the following amounts: $300,000 cash, assumption of an existing $35,000 mortgage, title search $700, recording fees of $300, points for their new loan of $2,000, and the seller's part of the property taxes of $5,500. The seller did not reimburse them for the property taxes. What is their cost basis in the house?

A. $300,000 B. $335,000 C. $341,500 D. $343,500

See Review Feedback for answer.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

Capital Gains and Losses The Tax Cuts and Jobs Act (TCJA) did not change the capital gains tax. Long-term capital gains are still defined as gains made on assets that the taxpayer held for over a year, while short-term capital gains come from assets he or she held for a year or less. Long-term gains are taxed at rates of 0%, 15%, or 20%, depending on the taxpayer’s tax bracket, while short-term gains are taxed as ordinary income.

The 3.8% Net Investment Income Tax (NIIT) that applies to certain high earners will stay in place, with the exact same income thresholds. This is part of the Affordable Care Act, which Congress has not successfully repealed or replaced, so this tax remains. Under the new provisions in the TCJA the long-term capital gains tax rates of 0%, 15%, and 20% still apply. However, the way they are applied has changed slightly. Under previous tax law, the 0% rate was applied to the two lowest tax brackets, the 15% rate was applied to the next four, and the 20% rate was applied to the top bracket.

Under the Tax Cuts and Jobs Act, the three capital gains income thresholds do not match up perfectly with the tax brackets. Instead, they are applied to maximum taxable income levels, as follows:

2023 Long-Term Capital Gains Rate Income Levels

Rate Single Married Filing

Jointly Head of

Household Married Filing

Separately Estates and

Trusts

0% Up to $44,625 Up to $89,250 Up to $59,750 Up to $44,625 Up to $3,000

15% $44,626-$492,300 $89,251-$553,850 $59,751-$523,050 $44,626-$276,900 $3,001-$14,650

20% Over $492,300 Over $553,850 Over $523,050 Over $276,900 Over $14,650

Table 7-1 - Publication 544 - Sales and Other Dispositions of Assets (2023)

The tax treatment of capital gains and losses depends on how long a taxpayer has owned the capital asset. This is called the taxpayer's holding period. The rule is fairly straightforward. If the taxpayer holds an asset for more than one year, we say that it is a long-term asset. If the taxpayer holds the asset for one year or less, we say that it is a short-term asset. Here are 10 facts from the IRS on capital gains and losses: (148)

1. Almost everything the taxpayer owns and uses for personal purposes, pleasure or investment is a capital asset. Capital assets include the home, household furnishings, and stocks and bonds that the taxpayer holds as investments.

2. A capital gain or loss is the difference between the taxpayer’s basis of an asset and the amount he or she receives when it is sold. The taxpayer’s basis is usually what he or she paid for the asset (a capital gain or loss does not impact the basis of an investment).

3. The taxpayer must include all capital gains in income. 4. The taxpayer may deduct capital losses on the sale of investment property. He or she cannot deduct losses on

the sale of personal-use property. 5. Capital gains and losses are long-term or short-term, depending on how long the taxpayer holds on to the property.

If he or she holds the property more than one year, the capital gain or loss is long-term. If the taxpayer holds it one year or less, the gain or loss is short-term.

6. If the long-term gains exceed the long-term losses, the difference between the two is a net long-term capital gain. If the net long-term capital gain is more than the net short-term capital loss, the taxpayer has a 'net capital gain’.

7. The tax rates that apply to net capital gains are generally lower than the tax rates that apply to other types of income. The maximum capital gains rate for most people in 2023 is 15%. For lower-income individuals, the rate may be 0% on some or all of their net capital gains. For high-income individuals, the rate may be 20% on some or all of their net capital gains. Rates of 25% or 28% can also apply to special types of net capital gains.

8. If the capital losses are greater than the capital gains, the taxpayer can deduct the difference between the two on the tax return. The annual limit on this deduction is $3,000, or $1,500 if married filing separately.

9. If the total net capital loss is more than the limit the taxpayer can deduct, he or she can carry over the losses he or she is not able to deduct to next year’s tax return. The taxpayer will treat those losses as if they occurred that year.

10. Form 8949 - Sales and Other Dispositions of Capital Assets, will help the taxpayer calculate capital gains and losses. He or she will carry over the subtotals from this form to Schedule D, Capital Gains and Losses.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the maximum capital gain rates. The term net capital gain means the amount by which the taxpayer’s net long-term capital gain for the year is more than his or her net short-term capital loss. For 2023, the maximum capital gain rates are 0%, 15%, 20%, 25%, and 28%. If the taxpayer calculates his or her tax using the maximum capital gain rate and the regular tax computation results in a lower tax, the regular tax computation applies.

Mutual Funds

A mutual fund is a regulated investment company that pools funds of investors allowing them to take advantage of a diversity of investments and professional asset management. The taxpayer owns shares in the fund, but the fund owns assets such as shares of stock, corporate bonds, government obligations, etc. One of the ways the fund makes money for the taxpayer is to sell these assets at a gain. If the asset was held by the mutual fund for more than one year, the nature of the income is capital gain, which gets passed on to the taxpayer. These are called capital gain distributions, which are distinguished on Form 1099-DIV from other types of income such as ordinary dividends. Capital gains distributions are taxed as long-term capital gains regardless of how long the taxpayer has owned the shares in the mutual fund.

Property Inherited Before 2010 and after 2010

The basis of property inherited before 2010 and after 2010 is generally the Fair Market Value (FMV) of the property on the date of the decedent's death. However, this can vary if the personal representative of the estate elects to use an alternate valuation date or other acceptable method.

Property Inherited During 2010 (after December 31, 2009, and before January 1, 2011)

Special rules may apply to property inherited from a decedent who died in 2010. Determining the basis of such property can be complex. For more information on the special rules, see Publication 4895 - Tax Treatment of Property Acquired From a Decedent Dying in 2010. Generally, if the taxpayer inherited investment property, his or her capital gain or loss on any later disposition of that property is long-term capital gain or loss. This is true regardless of how long he or she actually held the property.

Determining the Holding Period

To decide if the taxpayer has held property more than one year, he or she must know how to calculate a one-year period. The first day of the period begins the day after the day the taxpayer acquired the asset. The last day of the period includes the day on which the taxpayer disposes of the asset. For example, if the taxpayer bought an asset on June 19, 2022, the first day of the period is June 20. If the taxpayer sells the asset on June 19, 2023, this is a short-term asset. The taxpayer did not have it for more than one year. If the taxpayer sells the asset on June 20, 2023, that is now more than one year, and the asset was held long-term.

If a taxpayer inherits property, he or she is considered to have held the property longer than 1 year, regardless of how long he or she actually held it. For a nontaxable exchange, the taxpayer’s holding period starts the day after date he or she acquired old property.

Review Question 4 Arthur bought his principal residence for $250,000 on May 3, 2022. He sold it on May 3, 2023, for $400,000. What is the amount and character of his gain?

A. Long-term, ordinary gain of $400,000 B. Long-term, capital gain of $150,000 C. Short-term, ordinary gain of $400,000 D. Short-term, capital gain of $150,000

See Review Feedback for answer.

Calculating Capital Gains and Losses – Netting Process

The calculation of capital gains and losses is usually reported on a Schedule D through a so-called netting process. In general, here’s how it is done:

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

1. First net the short-term (assets held one year or less) capital gain property with the short-term capital loss property. This is done by adding together all of the capital transactions involving short-term property gain, with all of the capital transactions involving short-term property losses. Subtract the total amount of short-term capital losses from the total amount of short-term capital gains. This will result in either a net short-term capital loss or a net short-term capital gain. Report it in Part I of Form 8949.

2. Follow the same step as we did above for all long-term capital property transactions. This will result in either a net long-term capital gain or a net long-term capital loss. Report it in Part II of Form 8949.

3. Now, net the total short-term and long-term transactions together. This will result in a net capital gain or a net capital loss. (Schedule D (Form 1040), line 15).

Tax on Capital Gains - Individuals (After May 5, 2003)

The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the maximum capital gain rates. The term net capital gain means the amount by which the net long-term capital gain for the year is more than the net short-term capital loss. In 2023, the tax rate on long-term capital gains is 15% for most taxpayers, while those in the top bracket of pay 20% and those in the 10% or 12% tax brackets pay 0%. (147)

IF net capital gain is from ... Maximum capital gain rate is ...

A collectibles gain includes a work of art, rug, antique, metal (such as gold, silver, and platinum bullion), gem, stamp, coin, or alcoholic beverage held more than 1 year and gain from sale of an interest in a partnership, S corporation, or trust due to unrealized appreciation of collectibles.

28%

An eligible gain on qualified small business stock minus the Section 1202 exclusion. 28%

An unrecaptured Section 1250 gain. 25%

Other gain1 and the regular tax rate that would apply is 37% 20%

Other gain1 and the regular tax rate that would apply is 22%, 24%, 32%, or 35% 15%

Other gain1 and the regular tax rate that would apply is lower than 10% or 12%. 0% 1 Other gain means any gain that is not collectibles gain, gain on qualified small business stock, or un-recaptured Section 1250 gain.

Table 7-2 - IRS Publication 550 - Table 4-4: What is Your Maximum Capital Gain Rate? (2023)

Qualified dividends are the ordinary dividends subject to the same 0%, 15%, or 20% maximum tax rate that applies to net capital gain. Net short-term capital gains are subject to taxation at the ordinary income tax rate. These capital gains rates apply to individuals, and also apply when a taxpayer is computing the income tax under the Alternative Minimum Tax. Again, a capital asset must be held more than 12 months in order for the

realized gain to be classified as a long-term capital gain. To help calculate the tax on Capital Gains (and Qualifying Dividends) the IRS provides a Qualified Dividends and Capital Gain Tax Worksheet. (149)

Holding Period of Stock for Purposes of Claiming a Qualified Dividend

To qualify for lower rates, investors are required to hold the stock from which the dividend is paid for more than 60 days in the 121-day period beginning 60 days before ex-dividend date. In the case of preferred stock, investors must have held the stock more than 90 days during the 181-day period that begins 90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days. If the preferred dividends are due to periods totaling less than 367 days, the holding period in the preceding paragraph applies. (149)

Review Question 5 To qualify for lower capital gain rates, investors are required to hold the stock from which the qualified dividend is paid for more than how many days in the 121-day period beginning 60 days before ex-dividend date?

A. 30 days B. 45 days C. 60 days D. 121 days

See Review Feedback for answer.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

Capital Loss Deduction

If the taxpayer ends up with a net capital loss for the year, not only is it deductible, it must be deducted. This is true even if he or she does not have enough other ordinary income (such as wages, interest, dividends, etc.) to offset the net capital loss. The maximum amount of net capital loss that an individual can deduct is $3,000 per year, or $1,500 if filing status is married filing separately. The taxpayer’s allowable capital loss deduction, figured on Schedule D (Form 1040), is the lesser of: (147)

➢ $3,000 ($1,500 if he or she is married and files a separate return). ➢ His or her total net loss as shown on line 16 of Schedule D (Form 1040).

The taxpayer can use his or her total net loss to reduce his or her income dollar for dollar, up to the $3,000 limit. What if the net capital loss is more than $3,000 for the year? Then the taxpayer may carry the excess amount of the loss over to next year's tax return. The taxpayer will continue this carryover process until all of the net capital losses are finally deducted. When the taxpayer carries over a loss, it retains its original character as either a net long-term or a net short- term loss. A short-term loss carried over to next year is added to short-term losses that may have occurred in that next year. Likewise, long-term losses carried over to next year are added to long-term losses that may have been incurred in that following year. This means that a long-term loss that is carried over to next year must first be used to reduce any long-term gains in that next year. The same is true for carried over short-term losses.

Review Question 6 All of the following statements are true regarding capital gains and losses except:

A. The totals for short-term capital gains and losses and the totals for long-term gains and losses must be figured separately

B. If the total of the taxpayer’s capital gains is more than the total of his or her capital losses, the excess is taxable

C. When a taxpayer carries over any capital loss, its character will be long-term D. The yearly limit on the amount of the capital loss a taxpayer can deduct in excess of capital gains is

$3,000 ($1,500 if he or she is married filing separately)

See Review Feedback for answer.

Worthless Securities

Securities such as stocks, stock rights, bonds, etc., which are capital assets should they become worthless, are considered as a loss dating from the last day of the taxable year in which they became worthless. Thus, monetary losses from worthless securities are subject to the same deduction limitations ($3,000 per year for an individual; $1,500 per year for married filing separately) of capital losses. Also, bad debt losses developed from non-business (personal) transactions are considered short-term capital losses. Worthless securities also include securities that the taxpayer abandoned after March 12, 2008. To abandon a security, the taxpayer must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for it. All the facts and circumstances determine whether the transaction is properly characterized as an abandonment or other type of transaction, such as an actual sale or exchange, contribution to capital, dividend, or gift. If the taxpayer is a cash basis taxpayer and makes payments on a negotiable promissory note that he or she issued for stock that became worthless, the taxpayer can deduct these payments as losses in the years he or she actually makes the payments. Do not deduct them in the year the stock became worthless. If the taxpayer did not claim a loss for a worthless security on his or her original return for the year it becomes worthless, he or she can file a claim for a credit or refund due to the loss. Use Form 1040-X - Amended U.S. Individual Income Tax Return to amend the return for the year the security became worthless. The taxpayer must file it within 7 years from the date the original return for that year had to be filed, or 2 years from the date he or she paid the tax, whichever is later. (Claims not due to worthless securities or bad debts generally must be filed within 3 years from the date a return is filed, or 2 years from the date the tax is paid, whichever is later).

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

Nonbusiness Bad Debt

If someone owes an individual money that he or she cannot collect, the individual may have a bad debt. To deduct a bad debt, the taxpayer must have previously included the amount in income or loaned out cash. If he or she is a cash basis taxpayer, the taxpayer may not take a bad debt deduction for money he or she expected to receive but did not (for example, for money owed for services performed, or rent) because that amount was never included in income. For a bad debt, the individual must show that there was an intention at the time of the transaction to make a loan and not a gift. If he or she lends money to a relative or friend with the understanding that it may not be repaid, it is considered a gift and not a loan. There are two kinds of bad debts: business and nonbusiness. Generally, a business bad debt is one that comes from operating a trade or business. The following are examples of business bad debts (if previously included in income): (150)

➢ Loans to clients and suppliers. ➢ Credit sales to customer. ➢ Business loan guarantees.

A business deducts its bad debts from gross income when figuring its taxable income. Business bad debts may be deducted in part or in full. The taxpayer can claim a business bad debt using either the specific charge-off method or the nonaccrual-experience method. All other bad debts are nonbusiness. Nonbusiness bad debts must be totally worthless to be deductible. An individual cannot deduct a partially worthless nonbusiness bad debt. A debt becomes worthless when the surrounding facts and circumstances indicate there is no reasonable expectation of payment. To show that a debt is worthless, the taxpayer must establish that he or she has taken reasonable steps to collect the debt. It is not necessary to go to court if it can be shown that a judgment from the court would be uncollectible. The individual may take the deduction only in the year the debt becomes worthless. He or she does not have to wait until a debt is due to determine whether it is worthless. A nonbusiness bad debt is reported as a short-term capital loss on Form 8949 - Sales and Other Dispositions of Capital Assets, Part 1, line 1. Enter the name of the debtor and “bad debt statement attached” in column (a). Enter the basis in the bad debt in column (f) and enter zero in column (e). Use a separate line for each bad debt. It is subject to the capital loss limitations. A nonbusiness bad debt deduction requires a separate detailed statement attached to the return. (150)

Review Question 7 Which of the following are examples of business bad debts (if previously included in income)?

A. Loans to clients and suppliers B. Credit sales to customer C. Business loan guarantees D. All of the above

See Review Feedback for answer.

Virtual Currency

Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency (i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance), but it does not have legal tender status in the U.S. Cryptocurrency is a type of virtual currency that utilizes cryptography to validate and secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies. The sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

For Federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. This also means that:

➢ Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.

➢ Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.

➢ The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

➢ A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has a taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency. If the taxpayer’s employer gives him or her virtual currency (such as Bitcoin) as payment for his or her services, the taxpayer must include the fair market value of the currency in his or her income. The fair market value of virtual currency paid as wages is subject to Federal income tax withholding, Federal Insurance Contribution Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2. A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property. For example, a person who in the course of a trade or business makes a payment of fixed and determinable income using virtual currency with a value of $600 or more to a U.S. non-exempt recipient in a taxable year is required to report the payment to the IRS and to the payee. Examples of payments of fixed and determinable income include rent, salaries, wages, premiums, annuities, and compensation. The IRS issued additional detailed guidance to help taxpayers better understand their reporting obligations for specific transactions involving virtual currency. The guidance included Revenue Ruling 2019-24 established the following rules that cryptocurrency is a type of virtual currency that utilizes cryptography to secure transactions that are digitally recorded on a distributed ledger, such as a blockchain. Units of cryptocurrency are generally referred to as coins or tokens. Distributed ledger technology uses independent digital systems to record, share, and synchronize transactions, the details of which are recorded in multiple places at the same time with no central data store or administration functionality. A hard fork is unique to distributed ledger technology and occurs when a cryptocurrency on a distributed ledger undergoes a protocol change resulting in a permanent diversion from the legacy or existing distributed ledger. A hard fork may result in the creation of a new cryptocurrency on a new distributed ledger in addition to the legacy cryptocurrency on the legacy distributed ledger. Following a hard fork, transactions involving the new cryptocurrency are recorded on the new distributed ledger and transactions involving the legacy cryptocurrency continue to be recorded on the legacy distributed ledger. An airdrop is a means of distributing units of a cryptocurrency to the distributed ledger addresses of multiple taxpayers. A hard fork followed by an airdrop results in the distribution of units of the new cryptocurrency to addresses containing the legacy cryptocurrency. However, a hard fork is not always followed by an airdrop. Cryptocurrency from an airdrop generally is received on the date and at the time it is recorded on the distributed ledger. However, a taxpayer may constructively receive cryptocurrency prior to the airdrop being recorded on the distributed ledger. A taxpayer does not have receipt of cryptocurrency when the airdrop is recorded on the distributed ledger if the taxpayer is not able to exercise dominion and control over the cryptocurrency. For example, a taxpayer does not have dominion and control if the address to which the cryptocurrency is airdropped is contained in a wallet managed through a cryptocurrency exchange and the cryptocurrency exchange does not support the newly created cryptocurrency such that the airdropped cryptocurrency is not immediately credited to the taxpayer’s account at the cryptocurrency exchange. If the taxpayer later acquires the ability to transfer, sell, exchange, or otherwise dispose of the cryptocurrency, the taxpayer is treated as receiving the cryptocurrency at that time.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

For example, the taxpayer owns 100 units of Crypto A. Crypto A experiences a hard fork and Crypto B is created. 50 units of Crypto B are airdropped to the taxpayer. The taxpayer must report ordinary income equal to the fair market value of Crypto B. (151)

Sale of Personal Residences

Since 2013, the Affordable Care Act imposed a new 3.8% tax on investment income of taxpayers whose total income exceeds $200,000 ($250,000 if filing a joint return). All or part of the gain (not the entire proceeds) on the sale of a home is subject to the 3.8% tax if the taxpayer’s total income (including the gain on the home sale) exceeds $200,000

(or $250,000 if a joint return is filed). However, if the taxpayer meets the other requirements for exclusion, the gain on sale is reduced by $250,000 (or $500,000 if the taxpayer files a joint return). The exclusion applies in determining the amount of net investment income for purposes of the 3.8% tax. To exclude gain, the taxpayer, in most cases, must have owned and lived in the property as his or her main home for at least 2 years during the 5-year period ending on the date of sale. If he or she sells the land on which the main home is located, but not the house itself, the taxpayer cannot exclude any gain he or she realizes from the sale of the land.

Figuring Gain or Loss

To figure the gain or loss on the sale of the main home, the taxpayer must know the selling price, the amount realized, and the adjusted basis. Subtract the adjusted basis from the amount realized to get the gain or loss.

Selling price −Selling expenses Amount realized −Adjusted basis Gain or loss

The amount the taxpayer realizes from a sale or trade of property is everything he or she receives for the property minus his or her expenses of sale (such as redemption fees, sales commissions, sales charges, or exit fees). Amount realized includes the money the taxpayer receives plus the fair market value of any property or services he or she receives. If the taxpayer finances the buyer's purchase of his or her property and the debt instrument does not provide for adequate stated interest, the unstated interest that the taxpayer must report as ordinary income will reduce the amount realized from the sale. (152)

A taxpayer may exclude from income up to $250,000 of gain ($500,000 on a joint return in most situations) realized on the sale or exchange of a principal residence if all of the following are true: (69)

➢ Meets the ownership test. ➢ Meets the use test. ➢ During the 2-year period ending on the date of the sale, taxpayer did not exclude gain from the sale of another

home.

Ownership and Use

As a general rule, gain may only be excluded if, during the five-year period that ends on the date of the sale or exchange, the individual owned and used the property as a principal residence for periods aggregating two years or more (i.e., a total of 730 days (365 x 2)). Short temporary absences for vacations or seasonal absences are counted as periods of use, even if the individual rents out the property during these periods of absence.

However, an absence of an entire year is not considered a short temporary absence. The ownership and use test may be met during non-concurrent periods, provided that both tests are met during the five-year period that ends on the date of sale. Additionally, if the taxpayer owned and lived in the property as the main home for less than 2 years, he or she can still claim an exclusion in some cases. However, the maximum amount the taxpayer may be able to exclude will be reduced. (69)

If a taxpayer has more than one home, he or she can exclude gain only from the sale of the main home. The taxpayer must include in income the gain from the sale of any other home. If he or she has two homes and lives in each of them, the main home is ordinarily the one he or she lives in most of the time during the year. In addition to the amount of time the taxpayer lives in each home, other factors are relevant in determining which home is the main home.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

Those factors include the following:

➢ The taxpayer’s place of employment. ➢ The location of the taxpayer’s family members' main home. ➢ The taxpayer’s mailing address for bills and correspondence. ➢ The address listed on the taxpayer’s:

o Federal and state tax returns. o Driver's license. o Car registration. o Voter registration card.

➢ The location of the banks the taxpayer uses. ➢ The location of recreational clubs and religious organizations of which the taxpayer is a member.

Married Individuals

The amount of excludable gain is $500,000 for married individuals filing jointly if: (69)

➢ The taxpayer is married and files a joint return for the year. ➢ Either the taxpayer or his or her spouse meets the ownership test. ➢ Both the taxpayer and his or her spouse meet the use test. ➢ During the 2-year period ending on the date of the sale, neither the taxpayer nor his or her spouse excluded gain

from the sale of another home. The exclusion is determined on an individual basis. Thus, if a single individual who is otherwise eligible for an exclusion marries someone who has used the exclusion within the two years prior to the sale, the newly married individual is entitled to a maximum exclusion of $250,000. Once both spouses satisfy the eligibility rules and two years have passed since the exclusion was allowed to either of them, they may exclude up to $500,000 of gain on their joint return.

Review Question 8 For married individuals filing jointly, the maximum amount of excludable gain on the sale of a home is $500,000 if during a period of what length ending on the date of the sale, neither the taxpayer nor his or her spouse excluded gain from the sale of another home?

A. One year B. Two years C. Three years D. Four years

See Review Feedback for answer.

Deceased Spouse

When a spouse dies before the date of sale, the surviving spouse is considered as owning and living in the home for the same period as the deceased spouse. A surviving spouse may qualify to exclude up to $500,000 of any gain from the sale or exchange of his or her main home if all of the following requirements are met: (69)

1. The sale or exchange took place after 2008. 2. The sale or exchange took place no more than 2 years after the date of death of the spouse. 3. The taxpayer has not remarried. 4. The taxpayer and his or her spouse met the use test at the time of the spouse's death. 5. The taxpayer or his or her spouse met the ownership test at the time of the spouse's death. 6. Neither the taxpayer nor his or her spouse excluded gain from the sale of another home during the last 2 years

before the date of death.

Divorced Individuals

When a residence is transferred to an individual incident to a divorce, the time during which the individual’s spouse or former spouse owned the residence is added to the individual’s period of ownership. An individual who owns a residence is deemed

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

to use it as a principal residence during the time the individual’s spouse or former spouse had use of the home under a divorce or separation agreement.

Hardship Relief: Safe Harbors

A taxpayer who fails to meet the ownership and use requirements, or the minimum two-year time period for claiming the full exclusion (e.g.$250,000), may still be eligible for a partial exclusion when the sale of the home is due to: (69)

➢ A change in place of employment. ➢ Health reasons. ➢ Unforeseen circumstances.

According to the IRS, in order for an individual to be eligible for the partial exclusion, the individual’s primary reason for the sale must be related to one of these three reasons. If the individual is able to satisfy one of the safe harbor tests discussed below, then the primary reason for the sale will be treated as having been due to employment, health, or unforeseen circumstances.

Change of Employment

The primary reason test will be satisfied if the individual’s new place of employment is at least 50 miles farther from the residence sold or exchanged than was the former place of employment. If there was no former place of employment, the distance between the individual’s new place of employment and the residence sold or exchanged must be at least 50 miles.

Health Reasons

The primary reason test will be satisfied if the reason for the sale is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury. Obtaining or providing medical or personal care for a qualified individual suffering from a disease, illness, or injury, will also qualify. The term qualified individual is very broad and includes the owner’s spouse, as well as children, siblings, parents, and others. A physician’s recommendation for a change of homes for health reasons also qualifies.

Unforeseen Circumstances

Examples of situations that will be recognized by the IRS as unforeseen circumstances include: (69)

➢ Involuntary conversion of the home. ➢ Natural or man-made disasters or acts of terrorism. ➢ Death. ➢ A period of unemployment that permits the individual to be eligible for unemployment compensation. ➢ Change of employment resulting in the inability to pay the costs of housing and basic living expenses. ➢ Divorce or legal separation. ➢ Multiple births resulting from the same pregnancy. ➢ An event the IRS determines unforeseen (For example, the IRS determined the September 11, 2001 terrorist

attacks to be unforeseen circumstances). A sale of a residence due to the individual’s change in preference or improvement in financial position is not due to an unforeseen circumstance.

Other Tests

If the individual does not satisfy one of the safe harbor tests listed previously, then the IRS will consider all the facts and circumstances when determining the principal reason for the sale. Factors that will be considered include:

➢ The circumstances giving rise to the sale. ➢ The individual’s financial ability to maintain the property. ➢ Material changes that would impact the suitability of the property as the individual’s residence.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

Computing the Reduced Exclusion

When an individual qualifies for hardship relief, the individual may be entitled to a reduced exclusion. The reduced exclusion is computed by multiplying the maximum allowable exclusion (i.e., $250,000 or $500,000) by a fraction. The numerator of the fraction is the shortest of:

➢ The period of time that the individual owned the property as a principal residence during the five-year period ending on the date of sale exchange.

➢ The period of time that individual used the property as a principal residence during the five-year period ending on the date of sale or exchange.

➢ The period between the date of the most recent prior sale or exchange to which the exclusion applied and the date of the current sale or exchange.

The numerator may be expressed in days or months. The denominator of the fraction is either 730 days or 24 months (depending on the measure of time used in the numerator).

Installment Sales

An installment sale is a sale of property where at least one payment is to be received after the tax year in which the sale occurs. The taxpayer is required to report gain on an installment sale under the installment method unless he or she elects out on or before the due date for filing the tax return (including extensions) for the year of the sale. Use Form 6252 - Installment Sale Income to report the sale on the installment method. Also use Form 6252 to report any payment received in 2023 from a sale made in an earlier year that was reported on the installment method. To elect out of the installment method, report the full amount of the gain on Form 8949 on a timely filed return (including extensions) for the year of the sale. If the original return was filed on time, a taxpayer can make the election on an amended return filed no later than 6 months after the due date of the return (excluding extensions). Write “Filed pursuant to Section 301.9100-2” at the top of the amended return. Installment method rules do not apply to sales that result in a loss. A taxpayer cannot use the installment method to report gain from the sale of inventory or stocks and securities traded on an established securities market. Any portion of the gain from the sale of depreciable assets that must be reported as ordinary income under the depreciation recapture rules must be reported in the year of the sale. The total gain on an installment method is generally the amount by which the selling price of the property sold exceeds adjusted basis in that property. The selling price includes the money and the fair market value of property received for the sale of the property, any selling expenses, and existing debt encumbering the property that the buyer assumes. The taxpayer does not include stated interest, unstated interest, any amount refigured or recharacterized as interest, or OID. (153) Under the installment method, a taxpayer includes in income each year only part of the gain he or she receives or is considered to have received. Use Form 6252 - Installment Sale Income to report an installment sale in the year the sale occurs and for each year he or she receives an installment payment.

Gifts and Inheritances

To determine if the sale of inherited property is taxable, the taxpayer must first determine his or her basis in the property. The basis of property inherited from a decedent is generally one of the following:

➢ The fair market value (FMV) of the property on the date of the decedent's death. ➢ The FMV of the property on the alternate valuation date if the executor of the estate chooses to use alternate

valuation.

In general, capital gains or losses from sale of inherited property are treated as long-term. Report the sale on Schedule D (Form 1040) - Capital Gains and Losses, and on Form 8949 - Sales and other Dispositions of Capital Assets if the taxpayer sells the property for more than his or her basis, he or she has a taxable gain. For information on how to report the sale on Schedule D, see Publication 550, Investment Income and Expenses.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

Like-Kind Exchanges

Under the Tax Cuts and Jobs Act (TCJA), for exchanges completed after December 31, 2017, the nonrecognition rules for like-kind exchanges apply only to exchanges of real property not held primarily for sale. Exceptions apply to property disposed of before January 1, 2018, and to property received in an exchange before January 1, 2018. Therefore, as of January 1, 2018, exchanges of personal or intangible property such as machinery,

equipment, vehicles, artwork, collectibles, patents, and other intellectual property generally do not qualify for nonrecognition of gain or loss as like-kind exchanges. However, certain exchanges of mutual ditch, reservoir or irrigation stock are still eligible. Like-kind exchange treatment now applies only to exchanges of real property that is held for use in a trade or business or for investment. Real property, also called real estate, includes land and generally anything built on or attached to it. An exchange of real property held primarily for sale still does not qualify as a like-kind exchange. A transition rule in the new law allows like-kind treatment for some exchanges of personal or intangible property. If the taxpayer disposed of the personal or intangible property on or before December 31, 2017, or received replacement property on or before that date, the exchange may qualify for like-kind exchange treatment. Properties are of like-kind if they are of the same nature or character, even if they differ in grade or quality. Improved real property is generally of like-kind to unimproved real property. For example, an apartment building would generally be of like-kind to unimproved land. However, real property in the United States is not of like-kind to real property outside the U.S. To report a like-kind exchange, taxpayers must file Form 8824 - Like-Kind Exchanges with their tax return for the year the taxpayer transfers property as part of a like-kind exchange. This form helps a taxpayer figure the amount of gain deferred as a result of the like-kind exchange, as well as the basis of the like-kind property received, if cash or property that is not of like kind is involved in the exchange. Form 8824 helps compute the amount of gain the taxpayer must report.

Qualifying Property

To qualify as a like-kind exchange, the taxpayer must hold for business or investment purposes both the real property he or she transfers and the real property he or she receives. The basis of the property he or she receives is the same as the basis of the property he or she gave up. Exchange expenses are generally the closing costs the taxpayer pays. They include such items as brokerage commissions, attorney fees, deed preparation fees, etc. The taxpayer should add them to the basis of the like-kind property received. Generally, if the taxpayer exchanges business or investment real property solely for business or investment real property of a like kind, Section 1031 provides that no gain or loss is recognized. If, as part of the exchange, the taxpayer also receives other (not like-kind) property or money, gain is recognized to the extent of the other property and money received, but a loss is not recognized. Section 1031 does not apply to exchanges of real property held primarily for sale, or exchanges of personal or intangible property. In addition, Section 1031 does not apply to certain exchanges involving tax-exempt use property subject to a lease.

Like-Kind Property

There must be an exchange of like-kind property. Properties are of like kind if they are of the same nature or character, even if they differ in grade or quality. Generally, real properties are like-kind properties, regardless of whether they are improved or unimproved. However, real property in the United States and real property outside the United States are not like-kind properties.

Deferred Exchange

A deferred exchange occurs when the property received in the exchange is received after the transfer of the property given up. For a deferred exchange to qualify as like kind, the taxpayer must comply with the timing requirements for identification and receipt of replacement property. The replacement property for the exchange must be identified within 45 days after the property being given up is transferred. The replacement property must be received within 180 days, or by the due date of the tax return including extensions, whichever is earlier.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

If the taxpayer makes a deferred exchange using a qualified intermediary (QI), the transfer of the property given up and receipt of like-kind property is treated as a like-kind exchange. If the taxpayer fails to meet the timing requirements because of the QI, his or her transaction will not qualify as a deferred exchange and any gain may be taxable in the year he or she transferred the property. However, if the QI defaults on its obligation to acquire and transfer replacement property because of bankruptcy or receivership proceedings and the taxpayer meets certain requirements, he or she may be able to report the gain in the year or years payments are received.

Multi-Asset Exchanges

A multi-asset exchange involves the transfer and receipt of more than one group of like-kind properties. The transfer or receipt of multiple properties within one like-kind group also is a multi-asset exchange. However, an exchange of a single piece of land, a vehicle, and cash for a single piece of land and a vehicle is not a multi-asset exchange because, of the assets transferred, Section 1031 may apply only to the exchange of the land for other land. Special rules apply when figuring the amount of gain recognized and the taxpayer’s basis in properties received in a multi-asset exchange.

Other Nontaxable Exchanges

Partnership Interests

Exchanges of partnership interests do not qualify as nontaxable exchanges of like-kind property. This applies regardless of whether they are general or limited partnership interests or are interests in the same partnership or different partnerships. However, under certain conditions the exchange may be treated as a tax-free contribution of property to a partnership. An interest in a partnership that has a valid election to be excluded from being treated as a partnership for Federal tax purposes is treated as an interest in each of the partnership assets and not as a partnership interest. (154)

U.S. Treasury Notes or Bonds

Treasury notes have maturity periods of more than 1 year, ranging up to 10 years. Maturity periods for Treasury bonds are longer than 10 years. Both generally are issued in denominations of $100 to $1 million and both generally pay interest every 6 months. Generally, a taxpayer reports this interest for the year paid. When the notes or bonds mature, he or she can redeem these securities for face value or use the proceeds from the maturing note or bond to reinvest in another note or bond of the same type and term. If the taxpayer does nothing, the proceeds from the maturing note or bond will be deposited in his or her bank account. Certain issues of U.S. Treasury obligations may be exchanged for certain other issues designated by the Secretary of the Treasury with no gain or loss recognized on the exchange.

Insurance Policies and Annuities

No gain or loss is recognized if the taxpayer makes any of the following exchanges, and if the insured or the annuitant is the same under both contracts: (155)

➢ A life insurance contract for another life insurance contract, or for an endowment or annuity contract, or for a qualified long-term care insurance contract.

➢ An endowment contract for an annuity contract or for another endowment contract providing for regular payments beginning at a date not later than the beginning date under the old contract, or for a qualified long-term insurance contract.

➢ One annuity contract for another annuity contract. ➢ An annuity contract for a qualified long-term care insurance contract. ➢ A qualified long-term care insurance contract for another qualified long-term insurance contract.

In addition, if certain conditions are met, no gain or loss is recognized on the direct transfer of a portion of the cash surrender value of an existing annuity contract for a second contract, regardless of whether the contracts are issued by the same or different companies.

Foreclosures and Repossessions

If the taxpayer does not make payments he or she owes on a loan secured by property, the lender may foreclose on the loan or repossess the property. The foreclosure or repossession is treated as a sale or exchange from which the taxpayer may realize gain or loss. This is true even if the taxpayer voluntarily returns the property to the lender. He or she also may realize ordinary income from cancellation of debt if the loan balance is more than the fair market value of the property.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

The taxpayer figures and reports gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale or exchange. The gain or loss is the difference between his or her adjusted basis in the transferred property and the amount realized. If the taxpayer is not personally liable for repaying the debt (nonrecourse debt) secured by the transferred property, the amount he or she realizes includes the full debt canceled by the transfer. The full canceled debt is included even if the fair market value of the property is less than the canceled debt. (155)

Short Sales

Similar to a foreclosure, any debt that the taxpayer’s lender cancels because of a short sale is taxable only if the terms of the mortgage hold the taxpayer personally liable for the full amount of the loan. Regardless of the tax consequences, the taxpayer’s lender will report the debt cancellation on a Form 1099-C - Cancellation of Debt. Since most mortgage lenders would not agree to a short sale if the value of the home exceeds the outstanding mortgage balance there are generally no capital gains issues.

Bartering

Bartering occurs when the taxpayer exchanges goods or services without exchanging money. An example of bartering is a plumber exchanging plumbing services for the dental services of a dentist. The taxpayer must include in gross income in the year of receipt the fair market value of goods or services received from bartering. A barter exchange is an organization with members who agree with each other (or with the barter exchange) to exchange property or services. The term does not include arrangements that provide solely for the informal exchange of similar services on a noncommercial basis. Income from bartering is taxable in the year it is performed. Bartering may result in liabilities for income tax, self- employment tax, employment tax or excise tax. The taxpayer’s barter activities may result in ordinary business income, capital gains or capital losses, or he or she may have a nondeductible personal loss. Barter dollars or trade dollars are identical to real dollars for tax reporting purposes. If the taxpayer conducts any direct barter, barter for another’s products or services, he or she must report the fair market value of the products or services he or she received on his or her tax return. The rules for reporting barter transactions may vary depending on which form of bartering takes place. Generally, the taxpayer reports this type of business income on Form 1040, Schedule C, or other business returns such as Form 1065 for Partnerships, Form 1120 for Corporations or Form 1120-S for Small Business Corporations. (156)

Involuntary Conversions An involuntary conversion occurs when the taxpayer’s property is destroyed, stolen, condemned, or disposed of under the threat of condemnation and he or she receives other property or money in payment, such as insurance or a condemnation award. Involuntary conversions are also called involuntary exchanges. Gain or loss from an involuntary conversion of the taxpayer’s property is usually recognized for tax purposes unless the property is his or her main home. The taxpayer reports the gain or deducts the loss on his or her tax return for the year he or she realizes it. The taxpayer cannot deduct a loss from an involuntary conversion of property he or she held for personal use unless the loss resulted from a casualty or theft. However, depending on the type of property the taxpayer receives, he or she may not have to report a gain on an involuntary conversion. Generally, the taxpayer does not report the gain if he or she receives property that is similar or related in service or use to the converted property. The taxpayer’s basis for the new property is the same as his or her basis for the converted property. This means that the gain is deferred until a taxable sale or exchange occurs. If the taxpayer receives money or property that is not similar or related in service or use to the involuntarily converted property and he or she buys qualifying replacement property within a certain period of time, he or she can elect to postpone reporting the gain.

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

Review Feedback Review feedback provides both the answers to each question and an explanation or feedback as to how we arrived at each answer at the end of the lesson. Review feedback also contains evaluative feedback explaining why incorrect answers are wrong. You are also provided the course topic from which we derived our answer and the external source material we used for verification. If you are using the online version of the course, Ctrl+click on the topic to find the section from which we arrived at the answer for the question. You can also Ctrl+click on the question number to return to the specific review question. Question 1 - C. $155,000 The original basis in the property includes the original purchase price plus the bank fees and title costs. The points on the mortgage are not added to the basis but rather are amortized over the term of the loan. In this question, Will purchases the rental property for $150,000. He can include the $5,000 for bank fees and title costs. Thus, his initial basis in the property is $155,000 ($150,000 + $5,000). Only Choice C has the correct amount and is therefore the correct response. Topic - Basis Source - IRS.GOV - Topic No. 703 - Basis of Assets Question 2 - A. Supplies regularly used in the trade or business Most property the taxpayer owns and uses for personal purposes, pleasure, or investment is a capital asset. For example, his or her house, furniture, car (Choice B), stocks, coin and stamp collections (Choice C), gems and jewelry (Choice D), and bonds are capital assets. Among other items, supplies regularly used in the trade or business (Choice A) are noncapital assets. Topic - Capital Asset Source - Publication 550 - Investment Income and Expenses Question 3 - C. $341,500 In this question, cost basis in the house includes $335,000 purchase price (cash and mortgages assumed), $1,000 title search and recording fees, $5,500 payment for seller’s portion of the property taxes. Points paid for business property are business expenses that must be amortized over the life of the loan. The value of the points is not added to the cost basis. Thus, the initial basis in the house is $341,500 ($335,000 + $1,000 + $5,500). Only Choice C has the correct amount and is therefore the correct response. Topic - Basis Source - IRS.GOV - Topic No. 703 - Basis of Assets Question 4 - D. Short-term, capital gain of $150,000 Separate a taxpayer’s capital gains and losses according to how long he or she held or owned the property. The holding period for short-term capital gains and losses is 1 year or less. Report these transactions on Part I of Form 8949. The holding period for long-term capital gains and losses is more than 1 year. Report these transactions on Part II of Form 8949. To figure the holding period, begin counting on the day after the taxpayer received the property and include the day he or she disposed of it. In this question, Arthur did not have his residence for more than one year. This is a short-term asset with a capital gain of $150,000 ($400,000 selling price - $250,000 basis). Only Choice D has the correct number of years and is therefore the correct response. Topic - Determining the Holding Period Source - IRS.GOV - Topic No. 409 - Capital Gains and Losses

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

Question 5 - C. 60 days A taxpayer must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex- dividend date (Choice C). The ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment. When counting the number of days a taxpayer held the stock, include the day he or she disposed of the stock, but not the day he or she acquired it. Only Choice C has the correct number of days and is therefore the correct response. Topic - Holding Period of Stock for Purposes of Claiming a Qualified Dividend Source - Publication 550 - Investment Income and Expenses Question 6 - C. When a taxpayer carries over any capital loss, its character will be long-term A short-term loss carried over to next year is added to short-term losses that may have occurred in that next year. Likewise, long-term losses carried over to next year are added to long-term losses that may have been incurred in that following year. This means that a long-term loss that is carried over to next year must first be used to reduce any long-term gains in that next year. The same is true for carried over short-term losses (Choice A). Also, B. If the total of the taxpayer’s capital gains is more than the total of his or her capital losses, the excess is taxable (Choice B). If the taxpayer ends up with a net capital loss for the year, not only is it deductible, it must be deducted. This is true even if he or she does not have enough other ordinary income (such as wages, interest, dividends, etc.) to offset the net capital loss. The maximum amount of net capital loss that an individual can deduct is $3,000 per year, or $1,500 if filing status is married filing separately (Choice D). The taxpayer may carry the excess amount of the loss over to next year's tax return. The taxpayer will continue this carryover process until all of the net capital losses are finally deducted. When the taxpayer carries over a loss, it retains its original character as either a net long-term or a net short-term loss which makes Choice C false and the correct response. Topic - Capital Loss Deduction Source - IRS.GOV - Topic No. 409 - Capital Gains and Losses Question 7 - D. All of the above There are two kinds of bad debts – business and nonbusiness. Generally, a business bad debt is one that comes from operating a trade or business. Loans to clients and suppliers (Choice A), credit sales to customers (Choice B), and business loan guarantees (Choice C) are examples of business bad debts (if previously included in income). Since Choices A, B, and C are examples of business bad debt, Choice D, All of the above, is the correct response. Topic - Nonbusiness Bad Debt Source - IRS.GOV - Topic No. 453 - Bad Debt Deduction Question 8 - B. Two years The amount of excludable gain on the sale of a home is $500,000 for married individuals filing jointly if:

• The taxpayer is married and files a joint return for the year.

• Either the taxpayer or his or her spouse meets the ownership test.

• Both the taxpayer and his or her spouse meet the use test.

• During the 2-year period ending on the date of the sale, neither the taxpayer nor his or her spouse excluded gain from the sale of another home (Choice B).

Only Choice B has the correct number of years and is therefore the correct response. Topic - Married Individuals Source - Publication 523 - Selling Your Home

Sole Proprietor, Small Business Income and Taxation At the conclusion of this lesson you should have a basic knowledge of:

➢ Schedule C. ➢ Business Use of the Home. ➢ Self-Employment Tax. ➢ Figuring Earnings Subject to the Tax.

Sole Proprietor

This section covers topics regarding individuals who are self-employed. By definition, a Sole Proprietor is someone who owns an unincorporated business by him or herself. A small business and a sole proprietorship (also known as the sole trader or simply a proprietorship), are types of business entities that are owned and operated by one individual and in which there is no legal distinction between the owner and the business. The owner thus receives all the profits (subject to taxation) and has responsibility for the losses. All assets as well as debts are owned by the proprietor. In contrast to a partnership, it is a sole proprietorship meaning the business is owned and controlled by one person even though there may be many employees working for him or her. A sole proprietor may use a business or trade name other than their legal name. They have the ability to raise capital either publicly or privately, to limit the personal liability of the officers and managers, and to limit risk to investors. Sole proprietorships also have the least government rules and regulations affecting them. Owners have complete control over all the aspects of his or her business and can take any managerial decisions that he or she wants to take. Raising capital for a proprietorship is more difficult because an unrelated investor has less peace of mind concerning the use and security of his or her investment and the investment is more difficult to formalize as other types of business entities have more documentation. The enterprise may be crippled or terminated if the owner becomes ill. Since the business is the same legal entity as the proprietor, it ceases to exist upon the proprietor's death. Because the enterprise rests exclusively on one person, it often has difficulty raising long-term capital.

Review Question 1 Which of the following statements about a sole proprietorship is correct?

A. A sole proprietor may not use a business or trade name other than their legal name B. Sole proprietorships also have the same government rules and regulations affecting it as other types

of corporations C. A sole proprietorship is a type of business entity that is owned and operated by one individual and in

which there is no legal distinction between the owner and the business D. A sole proprietorship is owned and controlled by one person and there cannot be many employees

working for him or her

See Review Feedback for answer.

Unlimited Liability

The biggest potential downside of operating as a sole proprietorship is the lack of protection from personal liability. Most businesses operate under alternate forms, such as standard Corporations or Limited Liability Corporations (LLC’s) because they provide considerable protection of personal assets in the event of litigation. They also help protect individuals if creditors are seeking to collect business debts, in that they can ordinarily only reach the assets of the business entity. Since a sole proprietorship is not legally distinct from its owner, personal assets may be subject to those claims. If the taxpayer is engaged in a business which has a significant chance of being the subject of litigation, he or she will want to make sure that they carry adequate insurance and will likely wish to choose a business form which shields the taxpayer from personal liability in the event of a lawsuit. By way of example, if the taxpayer is giving piano lessons, he or she probably has a low risk of liability;

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

but if he or she is giving swimming lessons or horseback riding lessons, a small mistake by the taxpayer or a student can result in a significant liability to the business.

Taxation

Another potential downside of a sole proprietorship is that any income to the business is treated as income to the business owner. It is reported on their individual tax return (using Schedule C) and is taxed in the year it is received. With other corporate forms, it may be possible for the business to have its own income (and to file its own income tax return), and it may be possible to defer income to a different tax year. With a sole proprietorship, even the money the taxpayer left in the business bank account is taxed in the year it is earned, even if the business was saving it to pay for business expenses in the coming year. It is important to consider tax consequences when selecting the form of the business. The income earned from a sole proprietorship remains subject to income and self-employment (SE) tax (Medicare and Social Security contributions), and the taxpayer will be responsible to pay those taxes at the end of the year. In most cases, they will also be required to make quarterly payments of estimated tax liability, to both the state and to the Federal government. The sole proprietor may deduct legitimate business expenses when he or she calculates the taxes, as well as report losses from a sole proprietorship on the income tax return.

Husband and Wife Businesses

One of the advantages of a taxpayer operating his or her own business is hiring family members. However, the employment tax requirements for family employees may vary from those that apply to other employees. Generally speaking, when two or more people engage in a business to share profits, it is considered a partnership rather than a sole proprietorship. However, the Small Business and Work Opportunity Tax Act of 2007 changes the treatment of qualified businesses of married couples not treated as partnerships. A qualified business, or dual sole proprietorship, is one involving the conduct of a trade or business that meets the following conditions:

➢ The only members of the joint venture are a husband and wife. ➢ Both spouses materially participate in the trade or business. ➢ They file a joint return for the year. ➢ Both spouses elect to have the provision apply.

All items of income, gain, loss, deduction and credit are divided between the spouses in accordance with their respective interests in the business. Each spouse takes into account his or her respective share of these items as a sole proprietor. Thus, it is anticipated that each spouse would account for his or her respective share on the appropriate form, such as Schedule C. For purposes of determining net earnings from self-employment, each spouse’s share of income or loss from a qualified joint venture is taken into account just as it is for Federal income tax purposes under the provision (i.e., in accordance with their respective interests in the venture). This generally does not increase the total tax on the return, but it does give each spouse credit for Social Security earnings on which retirement benefits are based. However, this may not be true if either spouse exceeds the Social Security tax limitation. For more information on qualified businesses, refer to Election for Husband and Wife Unincorporated Businesses.

Qualified Joint Ventures

If the taxpayer and his or her spouse both participate as the only active members of a jointly owned and operated business and they file a joint return for the tax year, they can make an election to be taxed as a Qualified Joint Venture rather than a Partnership. Requirements for a qualified joint venture:

1. The only members in the joint venture are a husband and wife who file a joint tax return. 2. The trade or business is owned and operated by the spouses as co-owners (and not in the name of a state law

entity such as an LLC or LLP). 3. The husband and wife must each materially participate in the trade or business. 4. Both spouses must elect qualified joint venture status on Form 1040 by dividing the items of income, gain, loss,

deduction, credit and expenses in accordance with their respective interests in such venture and each spouse filing with the Form 1040 a separate Schedule C (Form 1040), or Form 4835 accordingly, and, if required, a separate Schedule SE (Form 1040) to pay self-employment tax.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

There may be tax benefits for choosing this option. In order to make this election all the income, credit, deduction, gain or loss must be divided according to the percentage of equity in the business each spouse owns. For example, a spouse that owns 60% of the venture must account for 60% of the income while the other spouse need only account for 40% of the income. Each spouse must file a separate Schedule C or F and enter their share on each line with respect to income, deduction, loss, etc. They must also file separate Schedule SE’s to pay SE tax when applicable.

Independent Contractor versus Employee

Even though a sole proprietorship is not technically a business entity, owners can hire employees. There is no limit on the number of employees that a sole proprietor can employ. As the employer, a sole proprietor is responsible for filing taxes and proper administration for these hires. Some sole proprietors choose to use independent contractors. There are many reasons for this including less liability for the owner and greater flexibility in scheduling. With an independent contractor, the owner simply pays the agreed upon rate, and there is less bookkeeping involved. At the end of the year, however, the use of independent contractors is reported on tax returns and some insurance documents. People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they provide their services to the general public are generally independent contractors. However, whether they are independent contractors or employees depends on the facts in each case. It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors. Generally, the business owner must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. The business owner does not generally have to withhold or pay any taxes on payments to independent contractors. If the taxpayer is a business owner hiring or contracting with other individuals to provide services, he or she must determine whether the individuals providing services are employees or independent contractors. In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered. The determination can be complex and depends on the facts and circumstances of each case. The determination is based on whether the person for whom the services are performed has the right to control how the worker performs the services. It is not based merely on how the worker is paid, how often the worker is paid, or whether the work is part-time or full-time. Facts that provide evidence of the degree of control and independence fall into three categories:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

2. Financial: Are the business aspects of the worker’s job controlled by the payer (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)?

3. Type of Relationship: Are there written contracts or employee type benefits (i.e., pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no magic or set number of factors that makes the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another. The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

To file his or her annual tax return, the taxpayer will need to use Schedule C to report his or her income or loss from a business he or she operated or a profession he or she practiced as a sole proprietor.

If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status. If the taxpayer classifies an employee as an independent contractor and he or she has no reasonable basis for doing so, the taxpayer may be held liable for employment taxes for that worker. See Internal Revenue Code Section 3509 for more information.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Hobby Income versus Business Income

In order to use Schedule C, the taxpayer must be engaged in a for-profit business. A hobby is defined as an activity done regularly in one's leisure time for pleasure and not principally done with the goal of making a profit. A hobby may, in many instances, result in a profit but what is important is intent. Conversely, a for-profit business may end with a loss but that is not the intent. In order to determine if the activity qualifies as a business, taxpayers should consider the following factors:

➢ Does the time and effort put into the activity indicate an intention to make a profit? ➢ Does the taxpayer depend on income from the activity? ➢ If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up

phase of the business? ➢ Has the taxpayer changed methods of operation to improve profitability? ➢ Does the taxpayer or his or her advisors have the knowledge needed to carry on the activity as a successful

business? ➢ Has the taxpayer made a profit in similar activities in the past? ➢ Does the activity make a profit in some years? ➢ Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?

The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses. The following table summarizes how income and expenses are treated for hobby and for-profit business.

Sole Proprietor Hobby

Report Expenses Schedule C Not Deductible

Report Income Schedule C Line 8(z), Schedule 1 (Form 1040)

Income subject to SE Tax Yes No

Table 8-1 – For-Profit vs. Hobby (2023)

The Tax Cuts and Jobs Act (TCJA) suspended the itemized deduction for hobby expenses, along with all other miscellaneous itemized deductions. The prohibition on deducting these expenses went into effect for 2018 and continues through 2025. This means that the taxpayer will not be able to deduct any expenses he or she earns from

hobbies during these years, but he or she still have to report and pay tax on any income he or she earns from a hobby. The deduction is scheduled to return in 2026.

Schedule C - Profit or Loss From Business Schedule C - Profit or Loss From Business is designed to report the profit (or loss) from a trade or business of a sole proprietor. Nevertheless, a sole proprietor is no different from any other individual. Such an individual may have non- business income (interest, dividends), gains and losses from property transactions, rent income, or even farm income to report. Likewise, this taxpayer must either elect to itemize deductions or use the standard deduction. Small business owners can deduct all ordinary and necessary business expenses incurred in operating the business. This includes such expenses as advertising, depreciation, wages, car and truck expenses, utilities, etc., which are detailed on Schedule C. In short, Schedule C is only the place to start for the sole proprietor. The taxpayer may be subject to state and local taxes and other requirements such as business licenses and fees. Check with state and local governments for more information.

For tax year 2019 and later, the taxpayer will no longer use Schedule C-EZ, but instead will use the Schedule C.

If the taxpayer’s sole proprietorship business has no profit or loss during the full year, it is not necessary to file a Schedule C for that year. However, if the taxpayer’s business is inactive, but he or she receives payments such as insurance that relate to the business, he or she must report those payments on a Schedule C. The taxpayer should use Schedule C (Form 1040) to report income or loss from a business he or she operated or a profession he or she practiced as a sole proprietor. An activity qualifies as a business if:

➢ The taxpayer’s primary purpose for engaging in the activity is for income or profit. ➢ The taxpayer is involved in the activity with continuity and regularity.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Review Question 2 Small business owners can use Schedule C to deduct all ordinary and necessary business expenses incurred in operating his or her business except:

A. Advertising B. Depreciation C. Car and truck expenses D. Amounts spent to restore or replace property

See Review Feedback for answer.

Here are the key parts of Schedule C discussed in detail. Line 1: Gross receipts or sales Except as otherwise provided in the Internal Revenue Code, gross income includes income from whatever source derived. Enter gross receipts from a trade or business on line 1. Include amounts the taxpayer received in a trade or business that were properly shown on Forms 1099-MISC. If the total amounts that were reported in box 7 of Forms 1099-MISC are more than the total the taxpayer is reporting on line 1, attach a statement explaining the difference. Do not include any amount received for the sale of property used in a business or profession on line 1. (157)

Line 2: Returns and Allowances This line is only to be used by accrual-based taxpayers who previously included an amount as income when earned but were never paid. Cash basis taxpayers should never have an amount reported on line 2. Line 4: Cost of Goods Sold If the taxpayer makes or buys goods to sell, he or she can deduct the cost of goods sold from the gross receipts on line 4 of Schedule C. However, to determine these costs, he or she must value the inventory at the beginning and end of each tax year. This applies if the taxpayer is a manufacturer, wholesaler, or retailer or if are engaged in any business that makes, buys, or sells goods to produce income. This does not apply to a personal service business, such as the business of a doctor, lawyer, carpenter, or painter. However, if the taxpayer works in a personal service business and also sells or charges for the materials and supplies normally used in business, this also applies to them. The cost of goods sold is determined in Lines 35-42 on Schedule C. If the taxpayer must account for an inventory in their business, then he or she must generally use an accrual method of accounting for purchases and sales. (158)

Figuring Cost of Goods Sold on Schedule C

Line 35 - Inventory at beginning of year. If different from last year's closing inventory, attach explanation. Line 36 - Purchases less cost of items withdrawn for personal use. Line 37 - Cost of labor. Do not include any amounts paid by the taxpayer to him or herself. Line 38 - Materials and supplies. Line 39 - Other costs. Line 40 - Add lines 35 through 39. Line 41 - Inventory at end of year. Line 42 - Cost of goods sold. Subtract line 41 from line 40. Part III of Schedule C is for businesses to determine their cost of goods sold which is reported on line 4. The following is a summary of Schedule C Part III that explains how this determination is made. Line 35: Inventory at the Beginning of the Year Beginning inventory is the cost of merchandise on hand at the beginning of the year that will be available to sell to customers. If the taxpayer is a manufacturer or producer, it includes the total cost of raw materials, work in process, finished goods, and materials and supplies used in manufacturing the goods. Opening inventory usually will be identical to the closing inventory of the year before. Any difference between these numbers must be explained by the taxpayer in a schedule attached to the return.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Line 36: Purchases Less Cost of Items Withdrawn for Personal Use If the taxpayer is a merchant, use the cost of all merchandise bought for sale. If the taxpayer is a manufacturer or producer, include the cost of all raw materials or parts purchased for manufacture into a finished product. Line 37: Cost of Labor Labor costs are usually an element of cost of goods sold only in a manufacturing or mining business. Small merchandisers (wholesalers, retailers, etc.) usually do not have labor costs that can properly be charged to cost of goods sold and are taken as a business expense deduction. In a manufacturing business, labor costs properly allocable to the cost of goods sold include both the direct and indirect labor used in fabricating the raw material into a finished, saleable product. Line 38: Materials and Supplies Materials and supplies, such as hardware and chemicals, used in manufacturing goods are charged to cost of goods sold. Those that are not used in the manufacturing process are treated as deferred charges and deducted as a business expense. Line 39: Other Costs Examples of other costs incurred in a manufacturing or mining process that can be charged to the cost of goods sold are as follows:

➢ Freight - Freight-in, express-in, and cartage-in on raw materials, supplies used in production, and merchandise purchased for sale are all part of cost of goods sold.

➢ Containers - Containers and packages that are an integral part of the product manufactured are a part of the cost of goods sold. If they are not an integral part of the manufactured product, their costs are shipping or selling expenses.

➢ Overhead expenses - Overhead expenses include expenses such as rent, heat, light, power, insurance, depreciation, taxes, maintenance, labor, and supervision. Overhead expenses that are direct and necessary expenses of the manufacturing operation are included in the cost of goods sold.

Subtract the value of taxpayer’s closing inventory (including, as appropriate, the allocable parts of the cost of raw materials and supplies, direct labor, and overhead expenses) from line 40. Inventory at the end of the year is also known as closing or ending inventory. Ending inventory will usually become the beginning inventory of the next tax year. When the closing inventory (inventory at the end of the year) is subtracted from the cost of goods available for sale, the remainder is the cost of goods sold during the tax year. Report this on line 4 of Schedule C.

Review Question 3 When determining the cost of goods sold for a business, which of the following are included in the calculation?

A. Materials and supplies, such as hardware and chemicals, used in manufacturing goods B. The cost of merchandise on hand at the beginning of the year that will be available to sell to customers C. Overhead expenses such as rent, heat, light, power, insurance, depreciation, taxes, maintenance,

labor, and supervision of a manufacturing operation D. All of the above

See Review Feedback for answer.

Expenses

This section provides an overview of business expenses that can be deducted on Schedule C. A sole proprietor can deduct the costs of operating the business and these costs are known as business expenses. These are costs that do not have to be capitalized or included in the cost of goods sold but can be deducted in the current year. To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in the particular field of business. A necessary expense is one that is helpful and appropriate for the business. An expense does not have to be indispensable to be considered necessary. (158)

If the taxpayer has an expense that is partly for business and partly personal, separate the personal part from the business part. The personal part is not deductible.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Line 8: Advertising Promoting a business through paid advertisements in newspapers, trade magazines, television, radio, or on the internet are all deductible. Include the normal and necessary expenses associated with these promotions. In addition, the cost of business cards, promotional items, flyers and the cost of distributing them, etc. can also be deducted as business expense. Advertising with the intention of influencing political legislation is not deductible. Line 9: Car and Truck Expenses A sole proprietor can deduct the actual expenses of operating a car or truck or take the standard mileage rate. This is true even if the vehicle was used for hire (such as a taxicab). Actual expenses must be used if there were five or more vehicles simultaneously in active use for the business (such as in fleet operations). Actual expenses cannot be used for a leased vehicle if the taxpayer previously used the standard mileage rate for that vehicle. A taxpayer can take the standard mileage rate for 2023 only if he or she: (157)

➢ Owned the vehicle and used the standard mileage rate for the first year it was placed in service. ➢ Leased the vehicle and are using the standard mileage rate for the entire lease period (except the period, if any,

before 1998).

If the taxpayer takes the standard mileage rate, multiply the number of business miles driven by 65.5 cents for 2023 and add to this amount of parking fees and tolls, and enter the total on line 9. Taxpayer should keep a log of business miles driven as well as tolls and parking fees paid. Do not deduct depreciation, rent, or lease payments, or the actual operating expenses. If the taxpayer deducts actual expenses, include on line 9 the business portion of expenses for gasoline, oil, repairs, insurance, tires, license plates, etc., and show depreciation on line 13 and rent or lease payments on line 20a. If the taxpayer owns or leases five or more cars that are used for business at the same time, he or she must use the actual expense method. The taxpayer may also be required to provide additional information by completion of Part IV of Schedule C.

Placing the company logo, displays, or advertisements on a vehicle does not change the use from personal to business use.

Expenses incurred for use of a vehicle to get from the taxpayer’s home to the place of business are treated as personal commuting expenses and are not deductible. If the taxpayer does not have a regular office, mileage driven between home and the first stop is considered to be commuting to work and is not deductible. In addition, mileage driven between the last business stop and their home is also treated as commuting mileage and is not deductible. If the taxpayer qualifies for an office within the home, however, all of their business mileage driven outside of the home is deductible. Additional information that should be maintained and logged in order to deduct expenses for business use of a vehicle includes:

➢ Basis of vehicle. ➢ Date vehicle was placed into service. ➢ Total number of business miles driven for the year. ➢ Total number of commuting miles driven for the year. ➢ Total overall miles driven for the year.

To determine the business use percentage, divide the total number of business miles driven for the year by the total overall miles driven for the year.

Line 10: Commissions and Fees Use line 10 to enter the total commissions and fees for the tax year. The taxpayer does not include commissions or fees that are capitalized or deducted elsewhere on his or her return. Line 11: Contract Labor Use line 11 to report the total of all payments made to independent contractors for services rendered. If the business paid $600 or more to any one individual, Form 1099-MISC must be filed and the independent contractor must receive a copy by January 31.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Examples of entities that do not need to receive Form 1099-MISC include the following:

➢ Payments made to employees as compensation. ➢ Payment made for products as opposed to services. ➢ Payments made to other corporations. ➢ Payments made that are not related to business.

Do not include any payments made to employees for wages, salaries, and commissions on line 11.

Line 12: Depletion Enter the deduction for depletion on this line. Depletion is a measure of the cost recovery of a natural resource as it is extracted and sold. Since the resource will not be replaced the taxpayer can take a deduction to account for this. Natural resources include but are not limited to mines, oil and gas wells, timber, and any exhaustible natural deposit. For additional details, see Chapter 7 of Publication 225. Line 13: Depreciation and Section 179 Expense Depreciation is the annual deduction allowed to recover the cost or other basis of business or investment property having a useful life substantially beyond the tax year. It is also permissible to depreciate improvements made to business property that is being leased. Depreciation starts upon first use of the property in the business or for the production of income. It ends when the property is taken out of service, all the depreciable cost or other basis have been taken, or the property is no longer used in the business or for the production of income. See the Instructions for Form 4562 - Depreciation and Amortization and Publication 946 - How To Depreciate Property to figure the amount to enter on line 13. Line 14: Employee Benefit Programs Deduct contributions to employee benefit programs that are not an incidental part of a pension or profit-sharing plan included on line 19. Examples are accident and health plans, group-term life insurance, and dependent care assistance programs. The sole proprietor cannot deduct contributions made on his or her behalf as a self-employed person to any benefit plan. However, he or she may be able to deduct on Schedule 1 (Form 1040), line 17, the amount paid for health insurance on behalf of the taxpayer, his or her spouse, and dependents, even if the taxpayer does not itemize deductions. See the instructions for Schedule 1 (Form 1040), line 17, for details. The taxpayer can usually deduct insurance premiums in the tax year to which they apply. If he or she uses the cash method of accounting, he or she generally deducts insurance premiums in the tax year he or she actually paid them, even if he or she incurred them in an earlier year. If the taxpayer uses an accrual method of accounting, he or she cannot deduct insurance premiums before the tax year in which he or she incurs a liability for them. In addition, the taxpayer cannot deduct insurance premiums before the tax year in which he or she actually pays them (unless the exception for recurring items applies). Also, the taxpayer cannot deduct expenses in advance, even if he or she pays them in advance. This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. Expenses such as insurance are generally allocable to a period of time. The taxpayer can deduct insurance expenses for the year to which they are allocable.

Line 15: Insurance (other than health) Deduct premiums paid for business insurance on line 15. Not all forms of business insurance are deductible. Refer to the table for some examples of business insurance that can be deducted on line 15.

Deductible Premiums Non-Deductible Premiums

Liability insurance Insurance for loss of earnings

Workers’ compensation insurance Insurance to secure a loan

Malpractice insurance Self-insurance reserve funds

Fire, storm, theft, accident, or similar losses

Credit insurance that covers losses from business bad debts

Table 8-2 - Publication 334 - Insurance (2023)

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Line 16a and 16b: Interest For tax years beginning after 2017, the taxpayer’s business interest expense deduction may be limited. The taxpayer must file Form 8990 - Limitation on Business Interest Expense Under Section 163(j) to deduct any interest expenses of this trade or business unless he or she is a small business taxpayer or meets one of the other filing exceptions listed in the Instructions for Form 8990. If the taxpayer must file Form 8990, he or she

figures the limit on his or her business interest expenses on Form 8990 before completing lines 16a and 16b. The interest the taxpayer cannot deduct this year will carry forward to next year on Form 8990. The tax treatment of interest expense differs depending on its type. For example, home mortgage interest and investment interest are treated differently. Interest allocation rules require the taxpayer to allocate (classify) interest expense so it is deducted (or capitalized) on the correct line of the return and receives the right tax treatment. These rules could affect how much interest the taxpayer is allowed to deduct on Schedule C. If the taxpayer has a mortgage on real property used in the business, enter on line 16a the interest paid for 2023. The exception to this is if the taxpayer used the main home as the primary place of business. Interest paid on a home office in a principal residence is deducted on Form 8829. Report all other business interest paid on line 16b.

Line 17: Legal and Professional Services Include on this line fees charged by accountants and attorneys that are ordinary and necessary expenses directly related to operating a business. Include fees for tax advice related to the business and for preparation of the tax forms related to the business. Also include expenses incurred in resolving asserted tax deficiencies relating to the business.

Line 18: Office Expense The cost of running and operating an office are deductible. Examples include postage such as stamps, certified mail expenses, priority and/or express mail services. Office expenses also include consumable office supplies such as pads of paper, post it notes, file folders, pens, pencils, and receipt books. The supplies needed to operate office equipment such as printing paper, toner, cash register tape, etc. are also deductible office expenses. Line 18 should also be used to deduct office expenses that are not allowable on Form 8829 - Expenses for Business Use of Your Home. Taxpayers not eligible for in home deductions can still deduct expenses such as cleaning, additional insurance for a home office, telephone and internet usage.

Line 19: Pension and Profit-Sharing Plans Enter the deduction for contributions to a pension, profit-sharing, or annuity plan, or plan for the benefit of the employees. If the plan included the taxpayer as a self-employed person, enter contributions made as an employer on his or her behalf on Schedule 1 (Form 1040), line 16, not on Schedule C. In most cases, the sole proprietor must file the applicable form listed below if the business maintains a pension, profit-sharing, or other funded-deferred compensation plan. The filing requirement is not affected by whether or not the plan qualified under the Internal Revenue Code, or whether or not the business claims a deduction for the current tax year. There is a penalty for failure to timely file these forms: (157)

➢ Form 5500-EZ - Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan. File this form if the taxpayer has a one-participant retirement plan that meets certain requirements. A one-participant plan is a plan that covers only the taxpayer (or taxpayer and their spouse).

➢ Form 5500-SF - Short Form Annual Return/Report of Small Employee Benefit Plan. File this form if the taxpayer has a small plan (fewer than 100 participants in most cases) that meets certain requirements.

➢ Form 5500 - Annual Return/Report of Employee Benefit Plan. File this form for a plan that does not meet the requirements for filing Form 5500-EZ or Form 5500-SF.

For plan years beginning on or after January 1, 2009, the Form 5500 and its schedules and the Form 5500-SF must be filed electronically under the computerized ERISA Filing Acceptance System (EFAST2). Check the DOL website at www.efast.dol.gov for additional information about the forms and schedules concerning the EFAST2 processing system, electronic filing, and software. For more details see IRS Publication 560 - Retirement Plans for Small Business. Line 20a and 20b: Rent or Lease If the business rented or leased vehicles, machinery, or equipment, the taxpayer should enter on line 20a the business portion of a rental cost. But if the business leased a vehicle for a term of 30 days or more, it may have to reduce the deduction by an amount called the inclusion amount. See IRS Publication 463 - Travel, Entertainment, Gift and Car Expenses for more information about leasing a car. Enter on line 20b amounts paid to rent or lease other property, such as office space in a building.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Line 21: Repairs and Maintenance Deduct the cost of incidental repairs and maintenance that do not add to the property's value or appreciably prolong its life. Permissible expenses that can be deducted include labor, supplies and any item that do not add value to the asset, prolong the life of the asset, or adapt the asset for use in another capacity. Do not deduct the value of the sole proprietor’s own labor. Do not deduct amounts spent to restore or replace property; they must be capitalized. Line 22: Supplies In most cases, the taxpayer can deduct the cost of materials and supplies only to the extent they were actually consumed and used in the business during the tax year (provided they were not deducted in a prior tax year). However, if a business had incidental materials and supplies on hand for which no inventories or records of use were kept, it can deduct the cost of those actually purchased during the tax year, provided that method clearly reflects income. Acceptable deductions include the cost of books, professional instruments, equipment, etc., if they are normally used within a year. However, if their usefulness extends substantially beyond a year, the taxpayer must generally recover their costs through depreciation. Line 23: Taxes and Licenses Taxes that are directly attributable to a trade or business are deductible. Licenses and fees that are paid to regulatory agencies or government bodies are also deductible. Examples of acceptable deductions that can be taken on line 23 include:

➢ Real estate and personal property taxes on business assets. ➢ State and local sales taxes imposed on the taxpayer as the seller of goods or services. If the taxpayer collected

this tax from the buyer, he or she must also include the amount collected in gross receipts or sales on line 1. ➢ Licenses and regulatory fees for a trade or business paid each year to state or local governments. But some

licenses, such as liquor licenses, may have to be amortized. ➢ Social Security and Medicare taxes paid to match required withholding from the employees' wages. Reduce the

deduction by the amount shown on Form 8846, line 4. ➢ Federal unemployment tax paid. ➢ Federal highway use tax. ➢ Contributions to state unemployment insurance fund or disability benefit fund if the contributions are considered

taxes under state law.

Do not deduct the following on line 23:

➢ Federal income taxes, including taxpayer’s self-employment tax. However, he or she can deduct a portion of the self-employment tax on Schedule 1 (Form 1040), line 15.

➢ Estate and gift taxes. ➢ Taxes assessed to pay for improvements, such as paving and sewers. ➢ Taxes on the taxpayer’s home or personal use property. ➢ State and local sales taxes on property purchased for use in the business. Instead, treat these taxes as part of

the cost of the property. ➢ State and local sales taxes imposed on the buyer that the taxpayer was required to collect and pay over to state

or local governments. These taxes are not included in gross receipts or sales nor are they a deductible expense. However, if the state or local government allowed the business to retain any part of the sales tax collected, these need to be included as income on line 6.

➢ Other taxes and license fees not related to the business. Line 24a and 24b: Travel, meals, and entertainment Enter expenses for lodging and transportation connected with overnight travel for business while away from the tax home on line 24a. In most cases, the tax home is the main place of business, regardless of where the taxpayer maintains the family home. The taxpayer cannot deduct expenses paid or incurred in connection with employment away from home if that period of employment exceeds 1 year. Also, the taxpayer cannot deduct travel expenses for his or her spouse, dependent, or any other individual unless that person is an employee, the travel is for a bona fide business purpose, and the expenses would otherwise be deductible by that person. Under the Tax Cuts and Jobs Act (TCJA), the taxpayer can no longer deduct entertainment expenses. He or she may still deduct 50% of his or her business meal expenses that are not entertainment expenses. Enter the total deductible business meals on line 24b. This includes expenses for meals while traveling away from home for business. Do not include entertainment expenses on line 24b.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Business meal expenses are deductible only if they: (104)

➢ Are directly related to or associated with the active conduct of the trade or business. ➢ Not lavish or extravagant. ➢ Incurred while the sole proprietor or an employee is present at the meal.

The taxpayer cannot deduct any expense paid or incurred for a facility (such as a yacht or hunting lodge) used for any activity usually considered entertainment, amusement, or recreation. Also, they cannot deduct membership dues for any club organized for business, pleasure, recreation, or other social purpose. This includes country clubs, golf and athletic clubs, airline and hotel clubs, and clubs operated to provide meals under conditions favorable to business discussion. But it does not include civic or public service organizations, professional organizations (such as bar and medical associations), business leagues, trade associations, chambers of commerce, boards of trade, and real estate boards. Line 25: Utilities Include on line 25 charges for business use electric, gas, telephone, water, sewer and other ordinary and necessary utility charges. If the taxpayer qualifies to take an office-in-home deduction, the amounts paid for utilities for the home are included on Form 8829. If the taxpayer uses his or her home telephone for business use, the base cost of the first line in to the home is not deductible. However, any long-distance charges are includible on this line. Line 26: Wages Enter the total salaries and wages for the tax year on line 26. Do not include salaries and wages deducted elsewhere on the return or amounts paid to the sole proprietor as these payments are treated as nondeductible owner’s draw. Wages that are attributable to the cost of goods sold should be included in the Cost of Goods Sold section (Part III Schedule C discussed earlier).

If a sole proprietor provided taxable fringe benefits to employees, such as personal use of a car, do not deduct as wages the amount applicable to depreciation and other expenses claimed elsewhere.

Line 27a: Other expenses Line 27a includes all ordinary and necessary business expenses not deducted elsewhere on Schedule C. The type and amount of each expense are listed separately on the lines provided. Line 30: Business use of the Home To determine the deductible amount of business use of a taxpayer’s home, complete and attach Form 8829 - Expenses for Business Use of Your Home.

Business Use of the Home

Form 8829 - Expenses For Business Use of Your Home is used when a taxpayer can claim deductions for the business use of a portion of his or her home. The general rule is that taxpayers who use a part of the home for legitimate business purposes can deduct expenses allocable to that portion of the home used for those business purposes. This is the so-called home office deduction rule. Generally, the taxpayer can deduct business expenses that apply to a part of the home only if that part is exclusively used on a regular basis: (159)

➢ As the principal place of business for any of the trades or businesses. ➢ As a place of business used by patients, clients or customers to meet or deal with the taxpayer in the normal

course of the trade or business. ➢ In connection with the trade or business if it is a separate structure that is not attached to the home.

Exceptions to this rule apply to space used on a regular basis for:

➢ Storage of inventory or product samples. ➢ Certain Daycare facilities.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

A home office qualifies as a principal place of business if the taxpayer meets the following requirements:

➢ The taxpayer uses it exclusively and regularly for administrative or management activities of the trade or business. ➢ The taxpayer has no other fixed location where he or she conducts substantial administrative or management

activities of the trade or business. If the part of the property being used for a home office is not attached to the living area of the home, that is, it is a separate building, then the taxpayer must show that the separate building is used in connection with his trade or business. But it does not have to be the principal place of business.

The key is to be sure that the part of the home being claimed as the home office is used exclusively for the business activity. Thus, if the room in the house doubles as a home office and family room used by the rest of the family for entertainment, it does not qualify as being exclusively used for business. There are two exceptions to the exclusive use rule. The first is where part of the home is used for storing inventory. Then, the taxpayer can deduct the expenses related to using that room if:

➢ The inventory is kept for use in the taxpayer's trade or business. ➢ The trade or business in question is the wholesale or retail of selling of goods. ➢ The home is the only fixed location of the taxpayer's trade or business. ➢ The storage space is used on a regular basis. ➢ The space being used is a separately identifiable space suitable for storage.

The second exception to the exclusive use rule is for homes that are used for providing daycare services. Then the rooms can be used for both business and personal use, but the taxpayer has to allocate out the personal use portion, which is nondeductible. If the taxpayer qualifies for a home office deduction, the taxpayer can deduct both direct and indirect expenses for that office. Direct expenses are those that only benefit the particular room in the house used for business purposes, such as painting or repairing the room. Indirect expenses are those that benefit the entire home, including those parts of the home not being used for business.

Utilities

Business expenses for heat, lights, power, telephone service, and water and sewerage are deductible. However, any part due to personal use is not deductible. Deductions for internet-related expenses include domain registrations fees and webmaster consulting costs. When starting a business, the taxpayer may have to amortize these expenses as start-up costs. A taxpayer is denied a business deduction for basic local telephone service charges on the first line in the residence. Additional charges for long-distance telephone calls, equipment, optional services (such as call waiting or message-taking) or additional telephone lines may be deductible. (160)

Part of the Home Used for Business

To determine what percentage of expenses can be deducted, we must discuss the business-use percentage of the home. Do this by dividing the area used for business by the total area of the home, in square feet. If the rooms in the home are about the same in size, simply divide the number of rooms used for business by the total number of rooms in the home.

Daycare Services

Taxpayers who use their personal residences on a regular basis in the business of providing qualifying day care services do not have to meet the exclusive use test in order to deduct business-related expenses. But the daycare business expenses are available only if the taxpayer has applied for and has been granted a license, or certification, or approval as a daycare center under the provisions of applicable state law.

Depreciation - Business Use of the Home

If the taxpayer owns his or her home and qualifies to deduct expenses for its business use, he or she can claim a deduction for depreciation. Depreciation is an allowance for the wear and tear on the part of the taxpayer’s home used for business.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

The taxpayer cannot depreciate the cost or value of the land. He or she recovers its cost when he or she sells or otherwise disposes of the property. Before the taxpayer figures his or her depreciation deduction, he or she needs to know the following information: (161)

➢ The month and year he or she started using his or her home for business. ➢ The adjusted basis and fair market value of his or her home (excluding land) at the time he or she began using it

for business. ➢ The cost of any improvements before and after he or she began using the property for business. ➢ The percentage of his or her home used for business.

The adjusted basis of the taxpayer’s home is generally its cost, plus the cost of any permanent improvements he or she made to it, minus any casualty losses or depreciation deducted in earlier tax years. A permanent improvement increases the value of property, adds to its life, or gives it a new or different use. Examples of improvements are replacing electric wiring or plumbing, adding a new roof or addition, paneling, or remodeling. The fair market value of the taxpayer’s home is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts. Sales of similar property, on or about the date the taxpayer begins using his or her home for business, may be helpful in determining the property's fair market value. If the taxpayer first used his or her home for business before 2011 but after 1986, see IRS Publication 946 - How To Depreciate Property. If first used prior to 1987, see IRS Publication 534 - Depreciating Property Placed in Service Before 1987. Additional help can be found in Publication 587 - Business Use of Your Home.

Carryover of Non-allowed Expenses to Next Year

There is a limit on the amount of otherwise nondeductible expenses, such as utilities, insurance, and depreciation that the taxpayer can take as a home office deduction. The total amount of deductions, with depreciation taken last, cannot be more than the gross income earned from the business use of the home. The gross income limit is determined by deducting the following from gross income:

➢ The business percentage of expenses that would be deductible by any taxpayer regardless of whether or not he is using the home in a trade or business, such as deductible mortgage interest, real estate taxes and casualty losses.

➢ All other business deductions such as wages and supplies that are not directly related to the use of the home office.

The home office deduction cannot be used to create or increase a loss from the taxpayer's business. The amount of the deduction available is limited to the net income for the year from the business. Any excess loss can only be carried forward and used next year, using the same limitations. Form 8829 is completed to determine the allowable expenses for business use of the home. This figure is entered on the appropriate line on Schedule C.

Simplified Option for Home Office Deduction

Taxpayers may use a simplified option when figuring the deduction for business use of their home. This simplified option does not change the criteria for who may claim a home office deduction. It merely simplifies the calculation and recordkeeping requirements of the allowable deduction. Some key points of the simplified option are: (162)

➢ Standard deduction of $5 per square foot of home used for business (maximum 300 square feet or $1,500). ➢ Allowable home-related itemized deductions claimed in full on Schedule A. (For example: Mortgage interest, real

estate taxes). ➢ No home depreciation deduction or later recapture of depreciation for the years the simplified option is used.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

The taxpayer may choose to use either the simplified method or the regular method for any taxable year. He or she chooses a method by using that method on his or her timely filed, original Federal income tax return for the taxable year. Once the taxpayer has chosen a method for a taxable year, he or she cannot later change to the other method for that same year. If the taxpayer uses the simplified method for one year and uses the regular method for any subsequent year, he or she must calculate the depreciation deduction for the subsequent year using the appropriate

optional depreciation table. This is true regardless of whether the taxpayer used an optional depreciation table for the first year the property was used in business.

Deduction for Qualified Business Income

For tax years beginning after 2017, the taxpayer may be entitled to a deduction of up to 20% of his or her qualified business income from his or her qualified trade or businesses plus 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. The deduction is subject to various limitations, such as limitations based on the type of the taxpayer’s trade or business, his or her taxable income, the amount of W-2 wages paid with respect to the qualified trade or business, and the unadjusted basis of qualified property held by his or her trade or business. The taxpayer will claim this deduction on Form 1040, not on Schedule C. Unlike other deductions, this deduction can be taken in addition to the standard or itemized deductions.

Recordkeeping

If the taxpayer deducts travel, gift, or transportation expenses, he or she must be able to prove (substantiate) certain elements of expense. The taxpayer should keep adequate records to prove his or her expenses or have sufficient evidence that will support his or her own statement. He or she must generally prepare a written record for it to be considered adequate. This is because written evidence is more reliable than oral evidence alone. However, if the taxpayer prepares a record on a computer, it is considered an adequate record. The taxpayer should keep the proof he or she needs in an account book, diary, log, statement of expense, trip sheets, or similar record. He or she should also keep documentary evidence that, together with his or her record, will support each element of an expense. The taxpayer generally must have documentary evidence, such as receipts, canceled checks, or bills, to support his or her expenses.

The taxpayer must generally provide a written statement of the business purpose of an expense. However, the degree of proof varies according to the circumstances in each case. If the business purpose of an expense is clear from the surrounding circumstances, then he or she does not need to give a written explanation.

Information Returns

The taxpayer may have to file information returns for wages paid to employees, certain payments of fees and other nonemployee compensation, interest, rents, royalties, real estate transactions, annuities, and pensions. He or she also may have to file a Form 1099-MISC if he or she sold $5,000 or more of consumer products to a person on a buy-sell, deposit-commission, or other similar basis for resale.

Self-Employment (SE) Tax All individuals engaged in a trade or business in any capacity, other than as employees, are subject to the self-employment tax. Generally, this includes a sole proprietor, a member of a partnership, and one who renders service as an independent contractor. For 2023, the SE tax rate on net earnings is 15.3% (12.4% Social Security tax plus 2.9% Medicare tax).

Self-employment (SE) tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners and is usually calculated on the net profit from Schedule C. If a husband and wife both have separate Schedule C, each spouse must figure their SE tax separately on individual Schedule SE. If a taxpayer has more than one

business and therefore more than one Schedule C, all business income or loss is determined before calculating SE tax. If any of the income from a trade or business, other than a partnership, is community property income under state law, it is included in the earnings subject to SE tax of the spouse carrying on the trade or business.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

A taxpayer must pay SE tax and file Schedule SE if either of the following applies:

➢ Their net earnings from self-employment (excluding church employee income) were $400 or more. ➢ They had church employee income of $108.28 or more except for ministers and members of religious orders.

For a sole proprietor, net income (as reported on Schedule C) must be counted as self-employment income. If net income is less than $400, the self-employment tax does not apply. (163) The Federal Insurance Contributions Act (FICA) tax includes two separate taxes. One is Social Security tax and the other is Medicare tax. Different rates apply for each of these programs. For 2023, the tax rate for Social Security is 6.2% for employees, 6.2% for employers and 12.4% for self-employed people. The Social Security tax applies only to the first $160,200 of wages, for a maximum of $9,932.40 for employees and for employers, and $19,864.80 for self-employed people. The current rate for Medicare is 1.45% for the employer, 1.45% for the employee and 2.9% for self-employed individuals. There is not a wage base limit for Medicare tax. All covered wages are subject to Medicare tax. Federal income tax is a pay-as-you-go tax. The taxpayer must pay it as he or she earns or receives income during the year. An employee usually has income tax withheld from his or her pay. If the taxpayer does not pay his or her tax through withholding, or does not pay enough tax that way, they might have to pay estimated tax. All taxpayers generally have to make estimated tax payments if they expect to owe taxes, including self-employment tax, of $1,000 or more when they file their return.

The self-employment tax is determined by completing Schedule SE Self-Employment. Business Net Profit on Schedule C is transferred to Form 1040 and to Schedule SE. If the taxpayer has to pay SE tax, he or she must file Form 1040 (with Schedule SE attached) even if the taxpayer does not otherwise have to file a Federal income tax return.

Review Question 4 A taxpayer must pay self-employment tax and file Schedule SE if net earnings from self-employment are what amount or more?

A. $400 B. $500 C. $600 D. $800

See Review Feedback for answer.

Figuring Earnings Subject to SE Tax

The Schedule SE was changed. The short form option was removed and a new Part III to calculate an optional deferral of part of self-employment taxes was added. For each section, the taxpayer will need to know what his or her net earnings from self- employment are. Generally, net earnings are simply the net profit from a farm or nonfarm business. There are three methods used to calculate the taxpayer’s net earnings from self-employment:

1. Farm Optional Method - Use the farm optional method only if (a) gross farm income was not more than $9,840, or (b) net farm profits were less than $7,103.

2. Nonfarm Optional Method - Use the nonfarm optional method only for earnings that do not come from farming. The taxpayer may use this method if he or she meets all the following tests:

a. He or she is self-employed on a regular basis. This means that his or her actual net earnings from self- employment were $400 or more in at least 2 of the 3 tax years before the one for which he or she uses this method.

b. He or she has used this method less than 5 years. (There is a 5-year lifetime limit.) The years do not have to be one after another.

c. In 2023, his or her net nonfarm profits within annual limits: i. Less than $7,103, and ii. Less than 72.189% of his or her gross nonfarm income.

3. Maximum Deferral of Self-Employment Tax Payments (regular method) - To figure net earnings using the regular method, multiply the taxpayer’s self-employment earnings by 92.35% (0.9235).

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

The taxpayer may want to use the optional methods when he or she has a loss or a small net profit and any one of the following applies:

➢ He or she wants to receive credit for Social Security benefit coverage. ➢ He or she incurred child or dependent care expenses for which he or she could claim a credit. (An optional method

may increase his or her earned income, which could increase his or her credit.) ➢ He or she is entitled to the Earned Income Tax Credit. (An optional method may increase his or her earned income,

which could increase his or her credit.) ➢ He or she is entitled to the Additional Child Tax Credit. (An optional method may increase his or her earned

income, which could increase his or her credit.)

If the taxpayer uses both optional methods, he or she must add the net earnings figured under each method to arrive at his or her total net earnings from self-employment. The taxpayer can report less than his or her total actual farm and nonfarm net earnings but not less than actual nonfarm net earnings. If he or she uses both optional methods, he or she can report no more than $6,560 as his or her combined net earnings from self-employment in 2023. The taxpayer must use the regular method unless they are eligible to use one or both of the optional methods. Use Publication 334 - Tax Guide for Small Business for general information about the Federal tax laws that apply to small business owners who are sole proprietors and to statutory employees. Publication 334 also has information on business income, expenses, and tax credits.

Review Question 5 Self-employment tax applies to which of the following?

A. Individuals who report only interest and dividend income B. Corporations that report less than $50,000 in gross receipts C. Independent contractors reporting net earnings from self-employment of $100 D. Independent contractors reporting net earnings from self-employment of $400 or more

See Review Feedback for answer.

Income/Loss Included in Net Earnings from Self-Employment

Additional income/loss that should be included in determining the net earnings from self-employment include the following:

1. Fees and other payments received by the taxpayer for services as a director of a corporation. 2. Interest received in the course of any trade or business, such as interest on notes or accounts receivable. 3. Payments for the use of rooms or other space when taxpayer also provided substantial services for the

convenience of tenants. Examples are hotel rooms, boarding houses, tourist camps or homes, trailer parks, parking lots, warehouses, and storage garages.

4. Income from the retail sale of newspapers and magazines if age 18 or older. 5. Income received as a direct seller. Newspaper carriers or distributors of any age are direct sellers if certain

conditions apply. 6. Rental income from a farm if, as landlord, taxpayer materially participated in the production or management of the

production of farm products on this land. This income is farm earnings. To determine whether the taxpayer materially participated in farm management or production, do not consider the activities of any agent who acted for the taxpayer.

7. Income of certain crew members of fishing vessels with crews of normally fewer than 10 people. 8. Fees as a state or local government employee if paid only on a fee basis and the job was not covered under a

Federal-state Social Security coverage agreement. 9. Cash or a payment-in-kind from the Department of Agriculture for participating in a land diversion program.

Income/Loss NOT Included in Net Earnings from Self-Employment

Additional income/loss that should NOT be included in determining the net earnings from self-employment include the following: (164)

1. Salaries, fees, etc., subject to Social Security or Medicare tax that the taxpayer received for performing services as an employee, including services performed as an employee under the railroad retirement system.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

2. Fees received for services performed as a notary public. If the taxpayer had other earnings of $400 or more subject to SE tax, enter “Exempt - Notary” and the amount of the net profit as a notary public from Schedule C or on the dotted line to the left of Schedule SE, line 3. Subtract that amount from the total of lines 1a, 1b, and 2, and enter the result on line 3.

3. Income received as a retired partner under a written partnership plan that provides for lifelong periodic retirement payments if the taxpayer had no other interest in the partnership and did not perform services for it during the year.

4. Income from real estate rentals if the taxpayer did not receive the income in the course of a trade or business as a real estate dealer. Report this income on Schedule E.

5. Income from farm rentals (including rentals paid in crop shares) if, as landlord, taxpayer did not materially participate in the production or management of the production of farm products on the land.

6. Dividends on shares of stock and interest on bonds, notes, etc., if the taxpayer did not receive the income in the course of the trade or business as a dealer in stocks or securities.

7. Payments received from the Conservation Reserve Program if the taxpayer is receiving Social Security benefits for retirement or disability. Deduct these payments on line 1b of Schedule SE.

8. Gain or loss from the sale of a capital asset. 9. Net operating losses from other years.

Self-Employment Tax Deduction

Self-employed individuals who pay Self-employment (SE) tax may take an adjustment to income for a portion of the Social Security tax paid on line 15 of Schedule 1 (Form 1040). The taxpayer can deduct the employer-equivalent portion of the self- employment tax in figuring adjusted gross income. This deduction only affects income tax and not the net earnings from self- employment or self-employment tax.

Review Question 6 Which of the following statements about Self-Employment (SE) tax is correct?

A. It is a Social Security and Medicare tax primarily for individuals who work for themselves B. If a taxpayer has more than one business all business income or loss is determined before calculating

SE tax C. If any of the income from a business is community property income under state law, it is included in

the earnings subject to SE tax of the spouse carrying on the business D. All of the above

See Review Feedback for answer.

Additional Medicare Tax

The taxpayer must file Form 8959 - Additional Medicare Tax if his or her total Medicare wages and tips plus his or her self- employment income (including the Medicare wages and tips and self-employment income of his or her spouse, if married filing jointly) are greater than the threshold amount for the taxpayer’s filing status. Self-employment income includes amounts from Schedule SE – Section A, line 4, or Section B, line 6. Negative amounts should not be considered for the purposes of Form 8959.

Filing Status Threshold Amount

Married filing jointly $250,000

Married filing separate $125,000

Single $200,000

Head of household (with qualifying person) $200,000

Surviving spouse with dependent child $200,000

Note: The Additional Medicare Tax of 0.9% only applies to the wages above the Threshold Amount.

Table 8-3 - Questions and Answers for the Additional Medicare Tax (2023)

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

If the taxpayer has both wages and self-employment income, the threshold amount for applying Additional Medicare Tax on the self-employment income is reduced (but not below zero) by the amount of wages subject to Additional Medicare Tax. Compensation subject to RRTA taxes and wages subject to FICA tax are not combined to determine Additional Medicare Tax liability. The threshold applicable to an individual’s filing status is applied separately to each of these categories of income.

Review Question 7 Bob, a single filer, has $220,000 in self-employment income and $0 in wages. All of the following are true regarding Bob’s Additional Medicare Tax liability except:

A. Bob is liable to pay Additional Medicare Tax on $20,000 B. Bob is liable to pay Additional Medicare Tax on $220,000 C. Bob must file Form 8959 - Additional Medicare Tax D. The Additional Medicare Tax threshold for Bob’s filing status is $200,000

See Review Feedback for answer.

Special Rules and Exceptions

Fishing Crew Member

If the taxpayer is a member of the crew on a boat that catches fish or other water life, the earnings are subject to SE tax if all the following conditions apply: (165)

1. The taxpayer does not get any pay for the work except his or her share of the catch or a share of the proceeds from the sale of the catch, unless the pay meets all the following conditions:

a. The pay is not more than $100 per trip. b. The pay is received only if there is a minimum catch. c. The pay is solely for additional duties (such as mate, engineer, or cook) for which additional cash pay is

traditional in the fishing industry. 2. The taxpayer gets a share of the catch or a share of the proceeds from the sale of the catch. 3. The taxpayer’s share depends on the amount of the catch. 4. The boat's operating crew normally numbers fewer than 10 individuals. (An operating crew is considered as

normally made up of fewer than 10 if the average size of the crew on trips made during the last four calendar quarters is fewer than 10).

Notary Public

Fees the taxpayer receives for services he or she performs as a notary public are reported on Schedule C but are not subject to self-employment tax (see the Instructions for Schedule SE (Form 1040)).

State or Local Government Employee

The taxpayer is subject to SE tax if he or she is an employee of a state or local government, is paid solely on a fee basis, and the services are not covered under a Federal-state Social Security agreement.

U.S. Citizens Employed by Foreign Governments or International Organizations

If the taxpayer was a U.S. citizen employed by a foreign government for services performed in the United States, Puerto Rico, Guam, American Samoa, the Commonwealth of the Northern Mariana Islands, or the U.S. Virgin Islands, they must pay SE tax on income earned. Income from this employment is reported on either Short or Long Schedule SE, line 2. If they performed services elsewhere as an employee of a foreign government or an international organization, those earnings are exempt from SE tax.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

U.S. Citizens or Resident Aliens Living Outside the United States

A self-employed U.S. citizen or resident alien living outside the United States must pay SE tax in most cases. Also, they are not allowed to reduce foreign earnings from self-employment through the foreign earned income exclusion. However, the United States has Social Security agreements with many countries to eliminate dual taxes under two Social Security systems. Under these agreements, the taxpayer must generally pay Social Security and Medicare taxes to only the country they live in. To see which countries have agreements or to learn more, visit the Social Security Administration’s International Programs website at www.socialsecurity.gov/international.

Chapter 11 Bankruptcy Cases

While a debtor in a chapter 11 bankruptcy case, the net profit or loss from self-employment (for example, from Schedule C or Schedule F) will not be included in Form 1040 income. Instead, it will be included on the income tax return (Form 1041) of the bankruptcy estate. However, the taxpayer (not the bankruptcy estate) is responsible for paying SE tax on net earnings from self-employment. Enter on the dotted line to the left of Schedule SE, line 3, Chapter 11 bankruptcy income and the amount of net profit or (loss). Combine that amount with the total of lines 1a, 1b, and 2 (if any) and enter the result on line 3. (164)

Community Income

If any of the income from a business or trade (including farming) is community income, then the income and deductions are reported based on the following: (157)

➢ If only one spouse participates in the business, all of the income from that business is the self-employment earnings of the spouse who carried on the business.

➢ If both spouses participate, the income and deductions are allocated to the spouses based on their distributive shares.

➢ If either or both taxpayer and spouse are partners in a partnership, they should file a partnership return. ➢ If the taxpayer and his or her spouse had community income and file separate returns, attach Schedule SE to the

return of the spouse with the self-employment income. Also, attach Schedule(s) C, or F (showing the spouse's share of community income and expenses) to the return of each spouse.

More Than One Business

If the taxpayer had two or more businesses, the net earnings from self-employment are the combined net earnings or loss from all of the businesses. If the taxpayer had a loss in one business, it reduces the income from another. Even though a separate Schedule C is required for each business or trade, figure the combined SE tax on one Schedule SE.

Income from Farming

Taxpayers who have derived income from farming should use Schedule F, Profit or Loss from Farming, rather than Schedule C to determine net profit from farming activities. Schedule F is similar to Schedule C but contains deduction and income items that are specific to farming that are not found on Schedule C.

Income from Partnerships and Trusts

If the taxpayer was a general or limited partner in a partnership, include on line 1a or line 2 of Schedule SE, whichever applies, the amount of net earnings from self-employment from Schedule K-1 (Form 1065), box 14, code A. General partners should reduce this amount by certain expenses before entering it on Schedule SE. If the taxpayer reduces the amount he or she enters on Schedule SE, he or she must attach an explanation. Limited partners should include only guaranteed payments for services actually rendered to or on behalf of the partnership.

If a partner died and the partnership continued, include in self-employment income the deceased's distributive share of the partnership's ordinary income or loss through the end of the month in which he or she died.

If the taxpayer was married and both he or she and his or her spouse were partners in a partnership, each spouse must report his or her net earnings from self-employment from the partnership. Each spouse must file a separate Schedule SE and report the partnership income or loss on Schedule E (Form 1040), Part II, for income tax purposes. If only one of the taxpayers was a partner in a partnership, the spouse who was the partner must report his or her net earnings from self-employment from the partnership.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Household Employment - Schedule H A taxpayer has a household employee if he or she hired someone to do household work and that worker is the taxpayer’s employee. The worker is the taxpayer’s employee if he or she can control not only what work is done, but how it is done. If the worker is the taxpayer’s employee, it does not matter whether the work is full-time or part-time or that he or she hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether the taxpayer pays the worker on an hourly, daily, or weekly basis, or by the job. Some examples of workers who do household work are:

➢ Babysitters. ➢ Caretakers. ➢ House cleaning workers. ➢ Domestic workers. ➢ Drivers. ➢ Health aides. ➢ Housekeepers. ➢ Maids. ➢ Nannies. ➢ Private nurses. ➢ Yard workers.

The household employment taxes that the taxpayer may have to account for on Schedule H cover the same three taxes that are withheld from all employment wages: the 12.4% Social Security tax, a 2.9% Medicare tax and the 6% Federal unemployment tax, or FUTA. If the taxpayer also pays state unemployment insurance taxes, Schedule H gives him or her credit for the taxes by reducing the FUTA rate. (166) The taxpayer is responsible for paying all of FUTA – employees do not make contributions through withholding. The taxpayer also must pay half of each household employee's Social Security and Medicare tax liability; the employee pays the other half through amounts he or she withholds from her wages. If the taxpayer has to pay these taxes to the Internal Revenue Service, Schedule H calculates the precise amount that he or she should have withheld, as well as the portion he or she owes. (167)

Employment Tax Requirements

If the taxpayer: Then he or she needs to:

Pays cash wages of $2,600 or more in 2023 to any one household employee. The taxpayer does not count wages he or she pays to:

• His or her spouse.

• His or her child under the age of 21.

• His or her parent (exceptions apply).

• Any employee under the age of 18 at any time in 2023 (exceptions apply).

Withhold and pay Social Security and Medicare taxes.

• The taxes are 15.3%1 of cash wages.

• The employee's share is 7.65%1. (The taxpayer can choose to pay it him or herself and not withhold it.)

• The taxpayer’s share is 7.65%

Pays total cash wages of $1,000 or more in any calendar quarter of 2022 or 2023 to household employees.

Pay Federal unemployment tax.

• The tax is 6% of cash wages.

• Wages over $7,000 a year per employee are not taxed.

• The taxpayer may also owe state unemployment tax.

1In addition to withholding Medicare tax at 1.45%, an employer must withhold a 0.9% Additional Medicare Tax from wages he or she

pays to an employee in excess of $200,000 in a calendar year. The employer is required to begin withholding Additional Medicare Tax in the pay period in which he or she pays wages in excess of $200,000 to an employee and continue to withhold it each pay period until the end of the calendar year. Additional Medicare Tax is only imposed on the employee. There is no employer share of Additional Medicare Tax. All wages that are subject to Medicare tax are subject to Additional Medicare Tax withholding if paid in excess of the $200,000 withholding threshold.

Table 8-4 - Publication 926 - Table 1-Do You Need To Pay Employment Taxes? (2023)

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

If a taxpayer paid one person over $2,600 during 2023, withheld Federal income tax during 2023 for any household employee, or paid total cash wages of $1,000 or more in any calendar quarter of 2022 or 2023 to all household employees, he or she is required to fill out a Schedule H - Household Employment Taxes and report the taxes payable on line 9 of Schedule 2 (Form 1040).

To figure the total cash wages the taxpayer paid in 2023 to each household employee, do not include amounts paid to any of the following individuals: (167)

➢ His or her spouse. ➢ His or her child who was under age 21. ➢ His or her parent. (See Exception for parents below.) ➢ His or her employee who was under age 18 at any time during 2023 (If the employee was not a student, see

Exception for employees under age 18 below). Include the cash wages the taxpayer paid his or her parent for work in or around his or her home if both 1 and 2 below apply:

1. The taxpayer’s child who lived with him or her was under age 18 or had a physical or mental condition that required the personal care of an adult for at least 4 continuous weeks during the calendar quarter in which services were performed. A calendar quarter is January through March, April through June, July through September, or October through December.

2. The taxpayer was divorced and not remarried, a widow or widower, or married to and living with a person whose physical or mental condition prevented him or her from caring for the child during that 4-week period.

Include the cash wages the taxpayer paid to a person who was under age 18 and not a student if providing household services was his or her principal occupation.

Cash wages include wages paid by check, money order, etc. Cash wages do not include the value of food, lodging, clothing, or other noncash items the taxpayer gives a household employee.

Farming Taxation - Schedule F Schedule F - Profit or Loss From Farming, is the form that farmers use to report their farm business income and expenses. To a large extent, it is very similar to a self-employed taxpayer's Schedule C. Schedule F farm income includes amounts received from cultivating the land or raising or harvesting any agricultural commodities. This includes income from the operation of stock, dairy, poultry, fish, bees, fruit, or truck farm plantation, ranch, nursery, orchard, or oyster bed operations. It also includes income received in the form of crop shares if the taxpayer materially participates in the production process, operating a nursery or sod farm or raising or harvesting of trees bearing fruit, nuts, or other crops, or ornamental trees, such as evergreen trees, if they are cut within the first 6 years. However, Schedule F specifically does not include:

➢ Gains from the sales of farmland or depreciable farm equipment. ➢ Gains from the sales of livestock held for draft, breeding, sport, or dairy purposes. ➢ Income received by a custom grain harvester who performs harvesting and hauling operations, with his own

equipment and personnel, on farms that the harvester neither owns, rents, nor leases.

Livestock and Produce

When a farmer sells produce or livestock raised on his farm, any money and the fair market value of any property received is ordinary income to the farmer, reported on Schedule F. Being on a cash basis, the income is reported as earned in the year that it is received. In the case of livestock or produce originally bought for the purposes of reselling, the profit on the later sale is the difference between the farmer's basis in the livestock or produce and the amount of money or property received from the sale. Sales of livestock held for draft, breeding, dairy, or sporting purposes are considered livestock held in the farmer's trade or business and is depreciable. Any sales of this type of livestock may result in ordinary gains and losses or in capital gains and losses, depending on the circumstances.

Use of Form 4797

Where livestock is used in the farmer's business and is held for more than one year, two years in the case of horses or cattle,

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

any gain or loss on its sale is reported on Form 4797 - Sales of Business Property. This form would also be used to report the sale of any depreciable farm assets.

Farm Expenses

Ordinary and necessary costs of operating a farm for profit are deductions reported on Part II of Schedule F. Some typical examples of deductible farm expenses are listed in Part II of Schedule F. A main point in dealing with farm expenses is to be sure to allocate out expenses that are properly charged against farm income and those that are really personal living expenses of the farmer.

Self-Employment Tax

There are three ways to figure net earnings from self-employment:

1. The regular method. 2. The nonfarm optional method. 3. The farm optional method.

The taxpayer must use the regular method to the extent he or she does not use one or both of the optional methods. To figure net earnings using the regular method, the taxpayer multiplies his or her self-employment earnings by 92.35% (0.9235). Net earnings figured using the regular method are also called “actual net earnings.” In 2023, the taxpayer uses the farm optional method only for self-employment earnings from a farming business. He or she can use this method if he or she meets either of the following tests:

➢ His or her gross farm income is $9,840 or less. ➢ His or her net farm profits are less than $7,103.

If the taxpayer meets either of the two tests explained above, he or she should use following table to figure his or her net earnings from self-employment under the farm optional method.

IF the taxpayer’s gross farm income is... THEN his or her net earnings are equal to...

$9,840 or less Two-thirds of his or her gross farm income

More than $9,840 $6,560

Table 8-5 - Publication 225 - Farmer’s Tax Guide - Table 12-1 - Figuring Farm Net Earnings (2023)

If the taxpayer’s gross farm income is $9,840 or less and his or her farm net earnings figured under the farm optional method are less than his or her actual farm net earnings, he or she can use the farm optional method to reduce or eliminate his or her Self-employment (SE) tax. The taxpayer’s actual farm net earnings are his or her farm net earnings figured using the regular method. The Nonfarm Optional Method is an optional method available for determining net earnings from nonfarm self-employment, much like the farm optional method. If the taxpayer is also engaged in a nonfarm business, he or she may be able to use this method to figure his or her nonfarm net earnings. The taxpayer can use this method even if he or she does not use the farm optional method for determining his or her farm net earnings and even if he or she has a net loss from his or her nonfarm business. If the taxpayer uses both optional methods, he or she must add the net earnings figured under each method to arrive at his or her total net earnings from self-employment. The taxpayer can report less than his or her total actual farm and nonfarm net earnings but not less than actual nonfarm net earnings. If the taxpayer uses both optional methods, he or she can report no more than $6,560 as his or her combined net earnings from self-employment in 2023.

Credit for Federal Tax on Gasoline and Special Fuels

Federal law places a special excise tax on gasoline and other fuels. The tax is usually added right to the pump price at the time the fuel is purchased. The law gives farmers a special tax credit for gasoline used in off highway operations, such as running a tractor in the field. The credit applies to gas, diesel, and other special fuels, but does not apply to oil. To obtain this credit, the farmer must complete Form 4136 - Credit for Federal Tax Paid on Fuels.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Rent

Income (or Loss), expenses and depreciation pertaining to Rental Real Estate are usually reported on Part I, Schedule E – Supplemental Income and Loss, on Form 1040. Rental income is any payment the taxpayer receives for the use or occupation of property. The taxpayer generally must include in gross income all amounts he or she receives as rent.

Rental Expenses and Improvements

The taxpayer can deduct the cost of repairs that he or she makes to a rental property. The taxpayer cannot deduct the cost of improvements. He or she recovers the costs of improvements by taking depreciation. Separate the costs of repairs and improvements and keep accurate records showing the cost of improvements.

Repairs

A repair keeps the property in good operating condition. It does not materially add to the value of the property or substantially prolong its life. Repairing property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of repairs. The taxpayer can deduct from gross rental income expenses for advertising, cleaning and maintenance, utilities, fire and liability insurance, taxes, interest, commissions for the collection of rent, ordinary and necessary travel and transportation and other expenses.

Improvements

An improvement adds to the value of the property, prolongs its useful life, or adapts it to new uses. Putting a recreation room in an unfinished basement, paneling a den, adding a bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, putting in new cabinets, putting on a new roof, and paving a driveway are examples of improvements. These increases in value must be capitalized and depreciated.

Other Income The following discussion explains how to treat other types of business income a taxpayer may receive.

Restricted Property

Restricted property is property that has certain restrictions that affect its value. If the taxpayer receives restricted stock or other property for services performed, the fair market value of the property in excess of his or her cost is included in income on Schedule C when the restriction is lifted. However, the taxpayer can choose to be taxed in the year he or she receives the property.

Gains and Losses

Do not report on Schedule C a gain or loss from the disposition of property that is neither stock in trade nor held primarily for sale to customers. Instead, the taxpayer must report these gains and losses on other forms.

Promissory Notes

Report promissory notes and other evidence of debt issued to the taxpayer in a sale or exchange of property that is stock in trade or held primarily for sale to customers on Schedule C. In general, the taxpayer reports them at their stated principal amount (minus any unstated interest) when he or she receives them.

Lost Income Payments

If the taxpayer reduces or stops his or her business activities, report on Schedule C any payment he or she receives for the lost income of the business from insurance or other sources. Report it on Schedule C even if the business is inactive when the taxpayer receives the payment.

Damages

The taxpayer must include in gross income compensation he or she receives during the tax year as a result of any of the following injuries connected with his or her business:

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

➢ Patent infringement. ➢ Breach of contract or fiduciary duty. ➢ Antitrust injury.

IRC Section 104(a)(2) excludes from gross income compensatory damages:

1. Received through prosecution of a legal suit or action or through a settlement agreement entered into in lieu of such prosecution.

2. Based on tort or tort-type rights. 3. Paid on account of physical personal injuries or sickness.

IRC Section 104 does not apply to punitive damages, except as allowed by Section 104(c), amounts received as reimbursements for medical expenses previously deducted under Code Section 213, Revenue Ruling 79-247, or payments to businesses. Even if damages are paid as a result of tort or tort-type actions, they must also be received on account of physical personal injuries or sickness to be excluded from a recipient's gross income. If a claim has its origin in a physical personal injury or sickness, then all compensatory damages that flow from that injury or sickness are payments received on account of physical personal injury or sickness. IRC Section 104(a) specifically excludes emotional distress from the definition of physical injury or physical sickness, except where damages are paid for medical care attributable to such distress. This effectively eliminates the exclusion of payments arising out of claims for discrimination, breach of a fiduciary duty, malicious prosecution, defamation, wrongful discharge, intentional or negligent infliction of emotional distress. Damages for physical illnesses arising from emotional distress (e.g., insomnia, headaches, stomach disorders) are generally not excludable because they are considered mere symptoms of the underlying distress. The emotional distress resulting from the tort is not treated as a physical personal injury or sickness. Damages for emotional distress resulting from a physical injury are excluded from gross income.

Economic Injury

The taxpayer may be entitled to a deduction against the income if it compensates him or her for actual economic injury. The deduction is the smaller of the following amounts:

➢ The amount the taxpayer receives or accrues for damages in the tax year reduced by the amount he or she pays or incurs in the tax year to recover that amount.

➢ The taxpayer’s loss from the injury that he or she has not yet deducted.

Punitive Damages

The taxpayer must also include punitive damages in income.

Kickbacks

If the taxpayer receives any kickbacks, he or she should include them in income on Schedule C. However, do not include them if the taxpayer properly treats them as a reduction of a related expense item, a capital expenditure, or cost of goods sold.

Recovery of Items Previously Deducted

If the taxpayer recovers a bad debt or any other item deducted in a previous year, include the recovery in income on Schedule C. However, if all or part of the deduction in earlier years did not reduce his or her tax, the taxpayer can exclude the part that did not reduce the tax. If the taxpayer excludes part of the recovery from income, he or she must include with the return a computation showing how the exclusion was figured. This rule does not apply to depreciation. The taxpayer has to recapture the depreciation deduction. This means he or she includes in income part or all of the depreciation he or she deducted in previous years. In the following situations, the taxpayer must recapture the depreciation deduction.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

This means he or she includes in income part or all of the depreciation he or she deducted in previous years for:

➢ Listed property. ➢ Section 179 property. ➢ Sale or exchange of depreciable property.

If the taxpayer’s business use of listed property falls to 50% or less in a tax year after the tax year, he or she placed the property in service, he or she may have to recapture part of the depreciation deduction. The taxpayer does this by including in income on Schedule C part of the depreciation he or she deducted in previous years. The taxpayer uses Part IV of Form 4797 - Sales of Business Property to figure the amount to include on Schedule C. If the taxpayer takes a Section 179 deduction for an asset and before the end of the asset's recovery period the percentage of business use drops to 50% or less, the taxpayer must recapture part of the Section 179 deduction. The taxpayer does this by including in income on Schedule C part of the deduction he or she took. The taxpayer uses Part IV of Form 4797 - Sales of Business Property to figure the amount to include on Schedule C. If the taxpayer sells or exchanges depreciable property at a gain, he or she may have to treat all or part of the gain due to depreciation as ordinary income. The taxpayer figures the income due to depreciation recapture in Part III of Form 4797 - Sales of Business Property.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Review Feedback Review feedback provides both the answers to each question and an explanation or feedback as to how we arrived at each answer at the end of the lesson. Review feedback also contains evaluative feedback explaining why incorrect answers are wrong. You are also provided the course topic from which we derived our answer and the external source material we used for verification. If you are using the online version of the course, Ctrl+click on the topic to find the section from which we arrived at the answer for the question. You can also Ctrl+click on the question number to return to the specific review question. Question 1 - C. A sole proprietorship is a type of business entity that is owned and operated by one individual and in which there is no legal distinction between the owner and the business A sole proprietorship is a business that is owned and controlled by one person even though there may be many employees working for him or her (Choice D is incorrect). A sole proprietor may use a business or trade name other than their legal name (Choice A is incorrect). They have the ability to raise capital either publicly or privately, to limit the personal liability of the officers and managers, and to limit risk to investors. Also, sole proprietorships also have the least government rules and regulations affecting them (Choice B is incorrect). However, it is true that sole proprietorships (also known as the sole trader or simply a proprietorship) are types of business entities that are owned and operated by one individual and in which there is no legal distinction between the owner and the business (Choice C is correct). Topic - Sole Proprietor Source - IRS.GOV - Sole Proprietorships Question 2 - D. Amounts spent to restore or replace property Small business owners can deduct all ordinary and necessary business expenses incurred in operating the business. This includes such expenses as advertising (Choice A), depreciation (Choice B), wages, car and truck expenses (Choice C), utilities, etc., which are detailed on Schedule C. On line 21 the taxpayer can deduct the cost of incidental repairs and maintenance that do not add to the property's value or appreciably prolong its life. Permissible expenses that can be deducted include labor, supplies and any item that do not add value to the asset, prolong the life of the asset, or adapt the asset for use in another capacity. However, the taxpayer does not deduct the value of the sole proprietor’s own labor. Additionally, he or she does not deduct amounts spent to restore or replace property; they must be capitalized, making Choice D the correct response. Topic - Schedule C - Profit or Loss From Business Source - Instructions for Schedule C Question 3 - D. All of the above Figuring Cost of Goods Sold on Schedule C includes: Line 35 - Inventory at beginning of year (Choice B). Line 36 - Purchases less cost of items withdrawn for personal use. Line 37 - Cost of labor. Do not include any amounts paid by the taxpayer to him or herself. Line 38 - Materials and supplies (Choice A). Line 39 - Other costs (Choice C). Line 40 - Add lines 35 through 39. Line 41 - Inventory at end of year. Line 42 - Cost of goods sold. Subtract line 41 from line 40. Since Choices A, B, and C are included in Figuring Cost of Goods Sold on Schedule C, Choice D, All of the above, is the correct response. Topic - Figuring Cost of Goods Sold on Schedule C Source - Instructions for Schedule C

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

Question 4 - A. $400 Generally, the taxpayer must pay SE tax and file Schedule SE (Form 1040) if net earnings from self-employment were $400 or more. Use Schedule SE to figure net earnings from self-employment. Only Choice A has the correct amount and is therefore the correct response. Topic - Self-Employment (SE) Tax Source - IRS.GOV - Self-Employment Tax (Social Security and Medicare Taxes) Question 5 - D. Independent Contractors reporting net earnings from self-employment of $400 or more A taxpayer must pay SE tax and file Schedule SE if either of the following applies:

• Their net earnings from self-employment (excluding church employee income) were $400 or more.

• They had church employee income of $108.28 or more except for ministers and members of religious orders. For a sole proprietor, net income (as reported on Schedule C) must be counted as self-employment income. If net income is less than $400, the self-employment tax does not apply. Only Choice D has the correct amount and is therefore the correct response. Topic - Figuring Earnings Subject to SE Tax Source - Instructions for Schedule SE Question 6 - D. All of the above Self-employment (SE) tax is a Social Security and Medicare tax primarily for individuals who work for themselves (Choice A). It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners, and is usually calculated on the net profit from Schedule C. If a husband and wife both have separate Schedule Cs, each spouse must figure their SE tax separately on individual Schedule SEs. If a taxpayer has more than one business and therefore more than one Schedule C, all business income or loss is determined before calculating SE tax (Choice B). If any of the income from a trade or business, other than a partnership, is community property income under state law, it is included in the earnings subject to SE tax of the spouse carrying on the trade or business (Choice C). Since Choices A, B, and C are included in Self-employment (SE) tax, Choice D, All of the above, is the correct response. Topic - Self-Employment (SE) Tax Source - IRS.GOV - Self-Employment Tax (Social Security and Medicare Taxes) Question 7 - B. Bob is liable to pay Additional Medicare Tax on $220,000 Bob is only liable to pay Additional Medicare Tax on $20,000 ($220,000 in self-employment income minus the threshold of $200,000 for his filing status). Also, Bob must file Form 8959 - Additional Medicare Tax. Therefore, Choice B is incorrect. Topic - Additional Medicare Tax Source - IRS.GOV - Topic No. 560 - Additional Medicare Tax

Specialized Returns At the conclusion of this lesson you should have a basic knowledge of:

➢ Corporations and S Corporations. ➢ Partnerships and Limited Liability Companies. ➢ Trust and Estate Income Tax. ➢ Tax Exempt Organizations. ➢ Retirement Income Tax. ➢ Farming Income Tax. ➢ Schedule F - Profit or Loss From Farming. ➢ Figuring Earnings Subject to the Tax. ➢ Rental Real Estate. ➢ Reporting Rental Income.

Corporation Filing Information

Rules on income and deductions that apply to individuals also apply, for the most part, to corporations. However, the following are some of the special provisions that apply only to corporations. Generally, for tax years beginning after December 31, 2015, a corporation must file its income tax return by the 15th day of the 4th month after the end of its tax year. A new corporation filing a short-period return must generally file by the 15th day of the 4th month after the short period ends. A corporation that has dissolved must generally file by the 15th day of the 4th month after the date it dissolved.

However, a corporation with a fiscal tax year ending June 30 must file by the 15th day of the 3rd month after the end of its tax year. A corporation with a short tax year ending anytime in June will be treated as if the short period ended June 30 and must file by the 15th day of the 3rd month after the end of its tax year.

If the due date falls on a Saturday, Sunday, or legal holiday, the due date is extended to the next business day.

The rules the taxpayer must use to determine whether a business is taxed as a corporation changed for businesses formed after 1996. A business formed before 1997 and taxed as a corporation under the old rules will generally continue to be taxed as a corporation. The following businesses formed after 1996 are taxed as corporations: (168)

➢ A business formed under a Federal or state law that refers to it as a corporation, body corporate, or body politic. ➢ A business formed under a state law that refers to it as a joint-stock company or joint-stock association. ➢ An insurance company. ➢ Certain banks. ➢ A business wholly owned by a state or local government. ➢ A business specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain

publicly traded partnerships). ➢ Certain foreign businesses. ➢ Any other business that elects to be taxed as a corporation. For example, a limited liability company (LLC) can

elect to be treated as an association taxable as a corporation by filing Form 8832 - Entity Classification Election. For more information about LLCs, see Publication 3402 - Taxation of Limited Liability Companies.

A corporation is a personal service corporation if it meets all of the following requirements: (168)

1. Its principal activity during the “testing period” is performing personal services. Generally, the testing period for any tax year is the prior tax year. If the corporation has just been formed, the testing period begins on the first day of its tax year and ends on the earlier of:

a. The last day of its tax year, or b. The last day of the calendar year in which its tax year begins.

2. Its employee-owners substantially perform the services in (1), above. This requirement is met if more than 20% of the corporation's compensation cost for its activities of performing personal services during the testing period is for personal services performed by employee-owners.

Lesson 9 - Specialized Returns

3. Its employee-owners own more than 10% of the fair market value of its outstanding stock on the last day of the testing period.

Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts. A person is an employee-owner of a personal service corporation if both of the following apply: (168)

1. He or she is an employee of the corporation or performs personal services for, or on behalf of, the corporation (even if he or she is an independent contractor for other purposes) on any day of the testing period.

2. He or she owns any stock in the corporation at any time during the testing period. A corporation is closely held if all of the following apply: (168)

1. It is not a personal service corporation. 2. At any time during the last half of the tax year, more than 50% of the value of its outstanding stock is, directly or

indirectly, owned by or for five or fewer individuals. “Individual” includes certain trusts and private foundations. If the taxpayer transfers property (or money and property) to a corporation in exchange for stock in that corporation (other than nonqualified preferred stock), and immediately afterward he or she is in control of the corporation, the exchange is usually not taxable. This rule applies both to individuals and to groups who transfer property to a corporation. It also applies whether the corporation is being formed or is already operating. It does not apply in the following situations: (168)

➢ The corporation is an investment company. ➢ The taxpayer transfers the property in a bankruptcy or similar proceeding in exchange for stock used to pay

creditors. ➢ The stock is received in exchange for the corporation's debt (other than a security) or for interest on the

corporation's debt (including a security) that accrued while the taxpayer held the debt. Both the corporation and any person involved in a nontaxable exchange of property for stock must attach to their income tax returns a complete statement of all facts pertinent to the exchange.

To be in control of a corporation, the taxpayer or his or her group of transferors must own, immediately after the exchange, at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the outstanding shares of each class of nonvoting stock. The term property does not include services rendered or to be rendered to the issuing corporation. The value of stock received for services is income to the recipient.

Review Question 1 William Hayes transfers property worth $35,000 and renders services valued at $3,000 to a corporation in exchange for stock valued at $38,000. Right after the exchange, he owns 85% of the outstanding stock. What amount of ordinary income must William recognize for the exchange?

A. $0 B. $3,000 C. $35,000 D. $38,000

See Review Feedback for answer.

Income

A corporation should use Form 1120 - U.S. Corporation Income Tax Return to report the income, gains, losses, deductions, credits, and to figure the income tax liability of a corporation. Corporations can generally electronically file (e-file) Form 1120 and certain related forms, schedules, and attachments. For returns filed on or after January 1, 2024, corporations that file 10 or more returns are required to e-file Form 1120. However, in certain instances, these corporations can request a waiver. Unless exempt under Section 501, all domestic corporations (including corporations in bankruptcy) must file an

Lesson 9 - Specialized Returns

income tax return whether or not they have taxable income. Domestic corporations must file Form 1120, unless they are required, or elect to file a special return. Except as otherwise provided in the Internal Revenue Code, gross income includes all income from whatever source derived. Gross income does not include income from qualifying shipping activities if the corporation makes an election under Section 1354 to be taxed on its notional shipping income (as defined in Section 1353) at the highest corporate tax rate (21%). If the election is made, the corporation generally may not claim any loss, deduction, or credit with respect to qualifying shipping activities. A corporation making this election also may elect to defer gain on the disposition of a qualifying vessel. In general, advance payments are reported in the year of receipt. For exceptions to this general rule for corporations that use the accrual method of accounting, see the following: (169)

➢ To report income from long-term contracts, see Section 460. ➢ For rules that allow a limited deferral of advance payments beyond the current tax year, see Section 451(c). Also,

see Regulations Sections 1.451-8(c), (d), and (e). For applicability dates, see Regulations Section 1.451-8(h). ➢ For information on adopting or changing to a permissible method for reporting advance payments for services and

certain goods by an accrual method corporation, see the Instructions for Form 3115. Generally, the installment method cannot be used for dealer dispositions of property. A “dealer disposition” is any disposition of personal property by a person who regularly sells or otherwise disposes of personal property of the same type on the installment plan or real property held for sale to customers in the ordinary course of the taxpayer's trade or business. The restrictions on using the installment method do not apply to the following: (169)

➢ Dispositions of property used or produced in the trade or business of farming. ➢ Certain dispositions of timeshares and residential lots reported under the installment method for which the

corporation elects to pay interest under Section 453(I)(3). Accrual method corporations are not required to accrue certain amounts to be received from the performance of services that, on the basis of their experience, will not be collected, if: (169)

➢ The services are in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting, or

➢ In 2023, the corporation's average annual gross receipts have not exceeded $29 million for any prior 3-tax-year period. For more details, see Regulations Sections 1.448-2(a)(2) and 1.448-1T(f)(2).

This provision does not apply to any amount if interest is required to be paid on the amount or if there is any penalty for failure to timely pay the amount. See Regulations Section 1.448-2 for information on the nonaccrual experience method, including information on safe harbor methods. See Revenue Procedure 2011-46, 2011-42 I.R.B. 518, for information on a book safe harbor method of accounting for corporations that use the nonaccrual experience method of accounting. Corporations that qualify to use the nonaccrual experience method should attach a statement showing total gross receipts, the amount not accrued as a result of the application of Section 448(d)(5), and the net amount accrued.

Property Exchanged for Stock

If the taxpayer transfers property (or money and property) to a corporation in exchange for stock in that corporation (other than nonqualified preferred stock), and immediately afterward his or she is in control of the corporation, the exchange is usually not taxable. This rule applies both to individuals and to groups who transfer property to a corporation. It also applies whether the corporation is being formed or is already operating. It does not apply in the following situations: (169)

➢ The corporation is an investment company. ➢ The taxpayer transfers the property in a bankruptcy or similar proceeding in exchange for stock used to pay

creditors. ➢ The stock is received in exchange for the corporation's debt (other than a security) or for interest on the

corporation's debt (including a security) that accrued while the taxpayer held the debt.

Lesson 9 - Specialized Returns

Both the corporation and any person involved in a nontaxable exchange of property for stock must attach to their income tax returns a complete statement of all facts pertinent to the exchange.

Cost of Goods Sold

Filers of Form 1120, 1120-C, 1120-F, 1120S, 1065 or 1065-B, use Form 1125-A - Cost of Goods Sold to calculate and deduct cost of goods sold. Enter on Form 1120, line 2, the amount from Form 1125-A, line 8.

Interest

Figure the taxable interest on U.S. obligations and on loans, notes, mortgages, bonds, bank deposits, corporate bonds, tax refunds, etc. Do not offset interest expense against interest income. Special rules apply to interest income from certain below-market-rate loans.

Gross Rents

Include the gross amount received for the rental of property. Deduct expenses such as repairs, interest, taxes, and depreciation on the proper lines for deductions. A rental activity held by a closely held corporation or a personal service corporation may be subject to the passive activity loss rules.

Other Income

Examples of other income to report on line 10 include the following:

➢ Recoveries of bad debts deducted in prior years under the specific charge-off method. ➢ The amount included in income from Form 6478 - Alcohol and Cellulosic Biofuel Fuels Credit. ➢ The amount included in income from Form 8864 - Biodiesel and Renewable Diesel Fuels Credit. ➢ Refunds of taxes deducted in prior years to the extent they reduced the amount of tax imposed. See Section 111

and the related regulations. Do not offset current year taxes against tax refunds. ➢ Ordinary income from trade or business activities of a partnership (from Schedule K-1 (Form 1065 or 1065-B)).

Do not offset ordinary losses against ordinary income. Instead, include the losses on line 26. Show the partnership's name, address, and EIN on a separate statement attached to this return. If the amount entered is from more than one partnership, identify the amount from each partnership.

➢ The transferred loss amount identified as “Section 91 Transferred Loss Amount,” which is required to be recognized when substantially all the assets of a foreign branch are transferred to a foreign corporation with respect to which the corporation was a U.S. shareholder immediately after the transfer.

➢ Any LIFO recapture amount under Section 1363(d). The corporation may have to include a LIFO recapture amount in income if it:

1. Used the LIFO inventory method for its last tax year before the first tax year for which it elected to become an S corporation, or

2. Transferred LIFO inventory assets to an S corporation in a nonrecognition transaction in which those assets were transferred basis property.

The LIFO recapture amount is the amount by which the C corporation's inventory under the FIFO method exceeds the inventory amount under the LIFO method at the close of the corporation's last tax year as a C corporation (or for the year of the transfer, if (2) above applies). See the instructions for Schedule J - Income Averaging for Farmers and Fishermen, Part I, line 11.

➢ The ratable portion of any net positive Section 481(a) adjustment. ➢ Part or all of the proceeds received from certain corporate-owned life insurance contracts issued after August 17,

2006. Corporations that own one or more employer-owned life insurance contracts issued after this date must file Form 8925 - Report of Employer-Owned Life Insurance Contracts. See Section 101(j) for details.

Lesson 9 - Specialized Returns

➢ Income from cancellation of debt (COD) from the repurchase of a debt instrument for less than its adjusted issue price.

➢ The corporation's share of the following income from Form 8621 - Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.

1. Ordinary earnings of a qualified electing fund. 2. Gain or loss from marking passive foreign investment company (PFIC) stock to market. 3. Gain or loss from sale or other disposition of Section 1296 stock. 4. Excess distributions from a Section 1291 fund allocated to the current year and pre-PFIC years, if any.

➢ Any payroll tax credit taken by an employer on its 2023 employment tax returns (Forms 941, 943, and 944) for qualified paid sick and qualified paid family leave under FFCRA and ARP (both the nonrefundable and refundable portions). The corporation must include the full amount of the credit for qualified sick and family leave wages in gross income for the tax year that includes the last day of any calendar quarter in which the credit is allowed. (Note: A credit is available only if the leave was taken after March 31, 2020, and before October 1, 2021, and only after the qualified leave wages were paid, which might, under certain circumstances, not occur until a quarter after September 30, 2021, including quarters in 2023).

Uniform Capitalization Rules

The uniform capitalization rules of Section 263A require corporations to capitalize certain costs to inventory or other property. Corporations subject to the Section 263A uniform capitalization rules are required to capitalize:

1. Direct costs of assets produced or acquired for resale, and 2. Certain indirect costs (including taxes) that are properly allocable to property produced or property acquired for

resale.

The corporation cannot deduct the costs required to be capitalized under Section 263A until it sells, uses, or otherwise disposes of the property (to which the costs relate). The corporation recovers these costs through depreciation, amortization, or cost of goods sold.

Costs of Going Into Business

When a company goes into business, it treats all costs it incurs to get its business started as capital expenses. However, a corporation can elect to deduct a limited amount of start-up or organizational costs. Any costs not deducted can be amortized. Start-up costs are costs for creating an active trade or business or investigating the creation or acquisition of an active trade or business. Organizational costs are the direct costs of creating the corporation.

Related Persons

A corporation that uses an accrual method of accounting cannot deduct business expenses and interest owed to a related person who uses the cash method of accounting until the corporation makes the payment and the corresponding amount is includible in the related person's gross income. Determine the relationship, for this rule, as of the end of the tax year for which the expense or interest would otherwise be deductible. If a deduction is denied, the rule will continue to apply even if the corporation's relationship with the person ends before the expense or interest is includible in the gross income of that person. These rules also deny the deduction of losses on the sale or exchange of property between related persons.

Income From Qualifying Shipping Activities

A corporation may make an election to be taxed on its notional shipping income at the highest corporate tax rate. If a corporation makes this election it may exclude income from qualifying shipping activities from gross income. Also, if the election is made, the corporation generally may not claim any loss, deduction, or credit with respect to qualifying shipping activities. A corporation making this election may also elect to defer gain on the disposition of a qualifying vessel.

Election to Expense Qualified Refinery Property

A corporation can make an irrevocable election on its tax return filed by the due date (including extensions) to deduct 50% of the cost of qualified refinery property (defined in Section 179C(c) of the Internal Revenue Code), placed in service before January 1, 2014. The deduction is allowed for the year in which the property is placed in service. A subchapter T cooperative can make an irrevocable election on its return by the due date (including extensions) to allocate this deduction to its owners based on their ownership interest.

Lesson 9 - Specialized Returns

Energy-Efficient Commercial Building Property Deduction

A corporation can claim a deduction for costs associated with energy-efficient commercial building property, placed in service before January 1, 2014. In order to qualify for the deduction: (169)

1. The costs must be associated with depreciable or amortizable property in a Standard 90.1-2001 domestic building; 2. The property must be either a part of the interior lighting system, the heating, cooling, ventilation and hot water

system, or the building envelope (defined in Section 179D(c)(1)(C) of the Internal Revenue Code); and 3. The property must be installed as part of a plan to reduce the total annual energy and power costs of the building

by 50% or more. The deduction is limited to $1.80 per square foot of the building less the total amount of deductions taken for this property in prior tax years. Other rules and limitations apply. The corporation must reduce the basis of any property by any deduction taken. The deduction is subject to recapture if the corporation fails to fully implement an energy savings plan.

Corporate Preference Items

A corporation must make special adjustments to certain items before it takes them into account in determining its taxable income. These items are known as “corporate preference items” and they include the following: (169)

➢ Gain on the disposition of Section 1250 property. ➢ Percentage depletion for iron ore and coal (including lignite). ➢ Amortization of pollution control facilities. ➢ Mineral exploration and development costs.

Dividends-Received Deduction

A corporation can deduct a percentage of certain dividends received during its tax year. This section discusses the general rules that apply. The deduction is figured on Form 1120, Schedule C, or the applicable schedule of the income tax return. Corporations cannot take a deduction for dividends received from the following entities: (169)

➢ A real estate investment trust (REIT). ➢ A corporation exempt from tax under Section 501 or 521 of the Internal Revenue Code either for the tax year of

the distribution or the preceding tax year. ➢ A corporation whose stock was held less than 46 days during the 91-day period beginning 45 days before the

stock became ex-dividend with respect to the dividend. Ex-dividend means the holder has no rights to the dividend. ➢ A corporation whose dividends were received on any share of preferred stock that are attributable to periods

totaling more than 366 days if such stock was held for less than 91 days during the 181-day period that began 90 days before the ex-dividend date.

➢ Any corporation, if the corporation is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property.

Dividends on deposits or withdrawable accounts in domestic building and loan associations, mutual savings banks, cooperative banks, and similar organizations are interest, not dividends. They do not qualify for this deduction. The total deduction for dividends received or accrued is generally limited (in the following order) to: (169)

1. 65% of the difference between taxable income and the 100% deduction allowed for dividends received from affiliated corporations, or by a small business investment company, for dividends received or accrued from 20%- owned corporations, then

2. 80% of the difference between taxable income and the 100% deduction allowed for dividends received from affiliated corporations, or by a small business investment company, for dividends received or accrued from less- than-20%-owned corporations (reducing taxable income by the total dividends received from 20%-owned corporations).

Lesson 9 - Specialized Returns

In figuring the limit, determine taxable income without the following items: (169)

1. The net operating loss deduction. 2. The deduction for income attributable to domestic production activities of specified agricultural or horticultural

cooperatives. 3. The deduction for dividends received. 4. Any adjustment due to the nontaxable part of an extraordinary dividend. 5. Any capital loss carryback to the tax year.

If a corporation has a net operating loss (NOL) for a tax year, the limit of 65% (or 50%) of taxable income does not apply. To determine whether a corporation has an NOL, figure the dividends-received deduction without the 65% (or 50%) of taxable income limit.

Extraordinary Dividends

If a corporation receives an extraordinary dividend on stock held 2 years or less before the dividend announcement date, it generally must reduce its basis in the stock by the nontaxed part of the dividend. The nontaxed part is any dividends- received deduction allowable for the dividends. An extraordinary dividend is any dividend on stock that equals or exceeds a certain percentage of the corporation's adjusted basis in the stock. The percentages are: (169)

➢ 5% for stock preferred as to dividends, or ➢ 10% for other stock.

Treat all dividends received that have ex-dividend dates within an 85-consecutive-day period as one dividend. Treat all dividends received that have ex-dividend dates within a 365-consecutive-day period as extraordinary dividends if the total of the dividends exceeds 20% of the corporation's adjusted basis in the stock.

Below-Market Loans

If a corporation receives a below-market loan and uses the proceeds for its trade or business, it may be able to deduct the forgone interest. A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable Federal rate. A below-market loan generally is treated as an arm's-length transaction in which the borrower is considered as having received both the following: (169)

1. A loan in exchange for a note that requires payment of interest at the applicable Federal rate, and 2. An additional payment in an amount equal to the forgone interest.

Treat the additional payment as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction.

Charitable Contributions

A corporation can claim a limited deduction for charitable contributions made in cash or other property. The contribution is deductible if made to, or for the use of, a qualified organization. A corporation cannot take a deduction if any of the net earnings of an organization receiving contributions benefit any private shareholder or individual. A corporation using the cash method of accounting deducts contributions in the tax year paid. A corporation using an accrual method of accounting can choose to deduct unpaid contributions for the tax year the board of directors authorizes them if it pays them by the due date for filing the corporation’s tax return (not including extensions). Make the choice by reporting the contribution on the corporation's return for the tax year. Attach a declaration stating that the board of directors adopted the resolution during the tax year. The declaration must include the date the resolution was adopted. Figure taxable income for this purpose without the following:

➢ The deduction for charitable contributions. ➢ The dividends-received deduction. ➢ The deduction allowed under Section 249 of the Internal Revenue Code. ➢ The domestic production activities deduction. ➢ Any net operating loss carryback to the tax year. ➢ Any capital loss carryback to the tax year.

Lesson 9 - Specialized Returns

Charitable contributions of a corporation in excess of 10% of its taxable income are disallowed and may be carried forward for five years. However, only the lesser of the following two amounts can be carried over:

➢ The excess of the maximum amount deductible for such succeeding tax year under the 10% limitation over the sum of the contributions made in the year plus all of the excess contributions that were made in tax years before the contribution year (that is, the tax year in which a contribution was made) and that are deductible for the succeeding tax year; or

➢ In the case of the first succeeding tax year, the amount of the excess contribution, and in the case of the second through fifth succeeding tax years, the portion of the excess contribution not deductible between the contribution year and each succeeding tax year.

Notwithstanding any carryover to either the first, second, third, fourth, or fifth year succeeding the tax year, the total deduction for any succeeding tax year, including any carryover, may not exceed the 10% limitation on contributions and gifts.

Capital Losses

A corporation can deduct capital losses only up to the amount of its capital gains. In other words, if a corporation has an excess capital loss, it cannot deduct the loss in the current tax year. Instead, it carries the loss to other tax years and deducts it from any net capital gains that occur in those years. A capital loss is carried to other years in the following order:

➢ 3 years prior to the loss year. ➢ 2 years prior to the loss year. ➢ 1 year prior to the loss year. ➢ Any loss remaining is carried forward for 5 years.

When the corporation carries a net capital loss to another tax year, treat it as a short-term loss. It does not retain its original identity as long-term or short-term. Also, a corporation may not carry a capital loss from, or to, a year for which it is an S corporation. When carrying a capital loss from one year to another, the following rules apply: (169)

➢ When figuring the current year's net capital loss, the taxpayer cannot combine it with a capital loss carried from another year. In other words, he or she can carry capital losses only to years that would otherwise have a total net capital gain.

➢ If the taxpayer carries capital losses from 2 or more years to the same year, he or she deducts the loss from the earliest year first.

➢ The taxpayer cannot use a capital loss carried from another year to produce or increase a net operating loss in the year to which he or she carries it back.

When the taxpayer carries back a capital loss to an earlier tax year, he or she refigures his or her tax for that year. If his or her corrected tax is less than the tax he or she originally owed, he or she uses either Form 1139 - Corporate Application for Tentative Refund, or Form 1120X - Amended U.S. Corporation Income Tax Return, to apply for a refund.

Net Operating Losses

A corporation generally figures and deducts a net operating loss (NOL) the same way an individual, estate, or trust does. For more information on these general rules, including the sequencing rule for when the corporation carries two or more NOLs to the same year. A corporation's NOL generally differs from individual, estate, and trust NOLs in the following ways: (169)

1. A corporation can take different deductions when figuring an NOL. 2. A corporation must make different modifications to its taxable income in the carryback or carryforward year when

figuring how much of the NOL is used and how much is carried over to the next year. 3. A corporation uses different forms when claiming an NOL deduction. 4. A corporation is not subject to Section 461, which limits the amount of losses from the trades or businesses of

noncorporate taxpayers.

Lesson 9 - Specialized Returns

NOL Carryback

Under the Coronavirus Aid, Relief, and Economic Security Act (CARES) a net operating loss (NOL) arising in a tax year beginning in 2018, 2019 or 2020 can be carried back for five years. It also allows for NOLs arising before January 1, 2021 to fully offset income. Taxpayers may elect to irrevocably waive the entire 5-year carryback period with respect to an NOL. Such election must be made by the due date (including extensions)

for filing the taxpayer’s return (i) for the first tax year ending after the date the CARES Act is enacted, with respect to 2018 and 2019 NOLs, and (ii) for the tax year the loss is incurred, with respect to a 2020 NOL. A NOL arising in a tax year beginning after 2020 is not carried back. However, post-2020 NOLs attributable to farming losses may be carried back two years and have an unlimited carryforward. Effective for tax years beginning after 2020, an NOL arising in a tax year beginning after 2017 also only reduces 80% of taxable income in a carryback or carryforward tax year. NOLs arising in tax years ending before 2018 are generally carried back two years and limited to a 20-year carryforward period. Accordingly, the CARES Act temporarily removes limitations put in place by the 2017 Tax Cuts and Jobs Act (TCJA) where, for taxable years beginning after December 31, 2017, NOLs were limited to 80% of taxable income and could not be carried back to reduce income in a prior tax year. Under the CARES Act, losses must be carried back to the earliest year available for offset. As losses will be carried back to pre-2018 tax years, corporate taxpayers may benefit from a tax refund at favorable rates of up to 35%. Taxpayers carrying back an NOL to a year with Section 965 (transition) income from foreign subsidiaries will automatically be treated as having made an IRC Section 965(n) election, which excludes Section 965 income from determining the NOL for that year. As a result, taxpayers will only be able to carry back NOLs to offset non-Section 965 income, which may impact foreign tax credit calculations and subsequent transition tax installments. In the alternative, a taxpayer may affirmatively elect to exclude Section 965 years from the carryback period. For tax years beginning after December 31, 2020, the limitations imposed by TCJA will remain, but deductions for qualified business income under IRC Section 199A and for foreign-derived intangible income (FDII) and global intangible low-taxed income (GILTI) under IRC Section 250 will not be taken into account. The following rules apply: (169)

➢ If a corporation carries back the NOL, it can use either Form 1120X or Form 1139. A corporation can get a refund faster by using Form 1139. It cannot file Form 1139 before filing the return for the corporation's NOL year, but it must file Form 1139 no later than 1 year after the year it sustains the NOL.

➢ If the corporation does not file Form 1139, it must file Form 1120X within 3 years of the due date, plus extensions, for filing the return for the year in which it sustains the NOL.

NOL Carryforward

If a corporation carries forward its NOL, it enters the carryover on Form 1120, Schedule K, line 12. It also enters the deduction for the carryover (but not more than the corporation's taxable income after special deductions) on Form 1120, line 29a, or the applicable line of the corporation's income tax return.

Figuring the NOL Carryover

The CARES Act retroactively suspended the 80% income limitation on use of NOL carryovers for taxable years beginning before January 1, 2021 and allowed 100% of any such taxable income to be offset by the amount of such NOL carryforward. The 80% income limitation is reinstated (with slight modifications) for tax years beginning after December 31, 2021.

If the NOL available for a carryback or carryforward year is greater than 80% of the taxable income for that year the corporation must modify its taxable income to figure how much of the NOL it will use up in that year and how much it can carry over to the next tax year. Its carryover is the excess of the available NOL over its modified taxable income for the carryback or carryforward year. A corporation figures its modified taxable income the same way it figures its taxable income, with the following exceptions:

➢ It can deduct NOLs only from years before the NOL year whose carryover is being figured. ➢ The corporation must figure its deduction for charitable contributions without considering any NOL carrybacks. ➢ It cannot take any domestic activities production deduction.

Lesson 9 - Specialized Returns

➢ It cannot take any deduction for foreign-derived international income. ➢ The modified taxable income for any year cannot be less than zero.

Modified taxable income is used only to figure how much of an NOL the corporation uses up in the carryback or carryforward year and how much it carries to the next year. It is not used to fill out the corporation's tax return or figure its tax. A loss corporation (one with cumulative losses) that has an ownership change is limited on the taxable income it can offset by NOL carryforwards arising before the date of the ownership change. This limit applies to any year ending after the change of ownership. See Section 269 and Sections 381 through 384 of the Internal Revenue Code and the related regulations for more information about the limits on corporate NOL carryovers and corporate ownership changes.

Accumulated Earnings Tax

A corporation can accumulate its earnings for a possible expansion or other bona fide business reasons. However, if a corporation allows earnings to accumulate beyond the reasonable needs of the business, it may be subject to an accumulated earnings tax of 20%. If the accumulated earnings tax applies, interest applies to the tax from the date the corporate return was originally due, without extensions. To determine if the corporation is subject to this tax, first treat an accumulation of $250,000 or less generally as within the reasonable needs of most businesses. Treat an accumulation of $150,000 or less as within the reasonable needs of a business whose principal function is performing services in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts. In determining if the corporation has accumulated earnings and profits beyond its reasonable needs, value the listed and readily marketable securities owned by the corporation and purchased with its earnings and profits at net liquidation value, not at cost. Reasonable needs of the business include the following: (169)

➢ Specific, definite, and feasible plans for use of the earnings accumulation in the business. ➢ The amount necessary to redeem the corporation's stock included in a deceased shareholder's gross estate, if

the amount does not exceed the reasonably anticipated total estate and inheritance taxes and funeral and administration expenses incurred by the shareholder's estate.

The absence of a bona fide business reason for a corporation's accumulated earnings may be indicated by many different circumstances, such as a lack of regular distributions to its shareholders or withdrawals by the shareholders classified as personal loans. However, actual moves to expand the business generally qualify as a bona fide use of the accumulations. The fact that a corporation has an unreasonable accumulation of earnings is sufficient to establish liability for the accumulated earnings tax unless the corporation can show the earnings were not accumulated to allow its individual shareholders to avoid income tax.

Distributions to Shareholders

Common kinds of distributions by a corporation to shareholders are ordinary dividends, capital gain distributions and nontaxable distributions. Most distributions are in money, but they may also be in stock or other property. For this purpose, “property” generally does not include stock in the corporation or rights to acquire this stock. A corporation generally does not recognize a gain or loss on the distributions covered by the rules in this section however some exceptions appear below. The amount of a distribution is generally the amount of any money paid to the shareholder plus the fair market value (FMV) of any property transferred to the shareholder. However, this amount is reduced (but not below zero) by the following liabilities: (169)

➢ Any liability of the corporation the shareholder assumes in connection with the distribution. ➢ Any liability to which the property is subject immediately before, and immediately after, the distribution.

The FMV of any property distributed to a shareholder becomes the shareholder's basis in that property.

A corporation will recognize a gain on the distribution of property to a shareholder if the FMV of the property is more than its adjusted basis. This is generally the same treatment the corporation would receive if the property were sold.

Lesson 9 - Specialized Returns

However, for this purpose, the FMV of the property is the greater of the following amounts: (169)

➢ The actual FMV. ➢ The amount of any liabilities the shareholder assumed in connection with the distribution of the property.

If the property was depreciable or amortizable, the corporation may have to treat all or part of the gain as ordinary income from depreciation recapture. Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as “stock options”) are distributions by a corporation of rights to acquire its stock. Distributions of stock dividends and stock rights are generally tax-free to shareholders. However, if any of the following apply to their distribution, stock and stock rights are treated as property: (169)

1. Any shareholder has the choice to receive cash or other property instead of stock or stock rights. 2. The distribution gives cash or other property to some shareholders and an increase in the percentage interest in

the corporation's assets or earnings and profits (E&P) to other shareholders. 3. The distribution is in convertible preferred stock and has the same result as in (2). 4. The distribution gives preferred stock to some common stock shareholders and gives common stock to other

common stock shareholders. 5. The distribution is on preferred stock. (An increase in the conversion ratio of convertible preferred stock made

solely to take into account a stock dividend, stock split, or similar event that would otherwise result in reducing the conversion right is not a distribution on preferred stock).

The term “stock” includes rights to acquire stock and the term “shareholder” includes a holder of rights or convertible securities.

When to File

Generally, for tax years beginning after December 31, 2015, a corporation must file its income tax return by the 15th day of the 4th month after the end of its tax year. A new corporation filing a short-period return must generally file by the 15th day of the 4th month after the short period ends. A corporation that has dissolved must generally file by the 15th day of the 4th month after the date it dissolved. However, a corporation with a fiscal tax year ending June 30 must file by the 15th day of the 3rd month after the end of its tax year. A corporation with a short tax year ending anytime in June will be treated as if the short period ended June 30 and must file by the 15th day of the 3rd month after the end of its tax year. (168)

Extension of Time to File

File Form 7004 - Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns to request an extension of time to file a corporation’s income tax return. The IRS will grant the extension if the corporation completes the form properly, files it, and pays any tax due by the original due date for the return. Form 7004 does not extend the time for paying the tax due on the return. Interest, and possibly penalties, will be charged on any part of the final tax due not shown as a balance due on Form 7004. The interest is figured from the original due date of the return to the date of payment.

The IRS issued a statement on February 7, 2017 explaining that a new revision of the Instructions for Form 7004 correctly reflects that calendar year C corporations are eligible for an automatic six-month extension of time to file their income tax returns. The statement noted that, although Code Section 6081(b) provides a five- month automatic extension period for calendar year C corporations, the IRS is granting a six-month automatic extension under Code Section 6081(a) instead. The change is reflected in the new revision of the Instructions for Form 7004.

The IRS will no longer send a notification that the extension has been approved. They will notify the corporation only if its request for an extension is disallowed. Properly filing Form 7004 will automatically give the corporation the maximum extension allowed from the due date of its return to file the return. Additionally, The IRS may terminate the automatic extension at any time by mailing a notice of termination to the entity or person that requested the extension. The notice will be mailed at least 10 days before the termination date given in the notice.

Lesson 9 - Specialized Returns

Late Filing of Return

A corporation that does not file its tax return by the due date, including extensions, may be penalized 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax. If the corporation is charged a penalty for late payment of tax (discussed next) for the same period of time, the penalty for late filing is reduced by the amount of the penalty for late payment. A minimum penalty applies for a return that is over 60 days late. The minimum penalty amount may be adjusted for inflation. The penalty will not be imposed if the corporation can show the failure to file on time was due to a reasonable cause.

Late Payment of Tax

A corporation that does not pay the tax when due may be penalized half of 1% of the unpaid tax for each month or part of a month the tax is not paid, up to a maximum of 25% of the unpaid tax. The penalty will not be imposed if the corporation can show that the failure to pay on time was due to a reasonable cause.

Partnership Filing Information The term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not a corporation or a trust or estate. Generally, every domestic partnership must file Form 1065 - U.S. Return of Partnership Income unless it neither receives income nor incurs any expenditures treated as deductions or credits for Federal income tax purposes.

Entities formed as LLCs that are classified as partnerships for Federal income tax purposes have the same filing requirements as domestic partnerships.

A religious or apostolic organization exempt from income tax under Section 501(d) must file Form 1065 to report its taxable income, which must be allocated to its members as a dividend, whether distributed or not. Such an organization must figure its taxable income on an attached statement to Form 1065 in the same manner as a corporation. The organization may use Form 1120 - U.S. Corporation Income Tax Return for this purpose. Enter the organization's taxable income, if any, on line 6a of Schedule K and each member's pro rata share in box 6a of Schedule K-1. Net operating losses are not deductible by the members but may be carried back or forward by the organization under the rules of Section 172. The religious or apostolic organization also must make its annual information return available for public inspection. For this purpose, “annual information return” includes an exact copy of Form 1065 and all accompanying schedules and attached statements, except Schedules K-1. For more details, see Regulations Section 301.6104(d)-1. A qualifying syndicate, pool, joint venture, or similar organization may elect under Section 761(a) not to be treated as a partnership for Federal income tax purposes and will not be required to file Form 1065 except for the year of election. For details, see Section 761(a) and Regulations Section 1.761-2. An electing large partnership (as defined in Section 775) must file Form 1065-B - U.S. Return of Income for Electing Large Partnerships. Real estate mortgage investment conduits (REMICs) must file Form 1066 - U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return. Certain publicly traded partnerships treated as corporations under Section 7704 must file Form 1120. Generally, a foreign partnership that has gross income effectively connected with the conduct of a trade or business within the United States or has gross income derived from sources in the United States must file Form 1065, even if its principal place of business is outside the United States or all its members are foreign persons. A foreign partnership required to file a return generally must report all of its foreign and U.S. source income. A foreign partnership with U.S. source income is not required to file Form 1065 if it qualifies for either of the following two exceptions. For foreign partnerships with U.S. partners a return is not required if: (170)

1. The partnership had no effectively connected income (ECI) during its tax year, 2. The partnership had U.S. source income of $20,000 or less during its tax year,

Lesson 9 - Specialized Returns

3. Less than 1% of any partnership item of income, gain, loss, deduction, or credit was allocable in the aggregate to direct U.S. partners at any time during its tax year, and

4. The partnership is not a withholding foreign partnership as defined in Regulations Section 1.1441-5(c)(2)(i).

For foreign partnerships with no U.S. partners a return is not required if: (170)

1. The partnership had no ECI during its tax year, 2. The partnership had no U.S. partners at any time during its tax year, 3. All required Forms 1042 and 1042-S were filed by the partnership or another withholding agent as required by

Regulations Section 1.1461-1(b) and (c), 4. The tax liability of each partner for amounts reportable under Regulations Sections 1.1461-1(b) and (c) has been

fully satisfied by the withholding of tax at the source, and A foreign partnership filing Form 1065 solely to make an election (such as an election to amortize organization expenses) need only provide its name, address, and employer identification number (EIN) on page one of the form and attach a statement citing “Regulations Section 1.6031(a)-1(b)(5)” and identifying the election being made. A foreign partnership filing Form 1065 solely to make an election must obtain an EIN if it does not already have one.

Passive Activity Limitations

In general, Section 469 limits the amount of losses, deductions, and credits that partners can claim from “passive activities.” The passive activity limitations do not apply to the partnership. Instead, they apply to each partner's share of any income or loss and credit attributable to a passive activity. Because the treatment of each partner's share of partnership income or loss and credit depends on the nature of the activity that generated it, the partnership must report income or loss and credits separately for each activity. Generally, passive activities include activities that involve the conduct of a trade or business if the partner does not materially participate in the activity and all rental activities regardless of the partner's participation. The level of each partner's participation in an activity must be determined by the partner. The passive activity rules provide that losses and credits from passive activities can generally be applied only against income and tax from passive activities. Thus, passive losses and credits cannot be applied against income from salaries, wages, professional fees, or a business in which the partner materially participates; against “portfolio income” or against the tax related to any of these types of income. Special provisions apply to certain activities. First, the passive activity limitations must be applied separately with respect to a net loss from passive activities held through a publicly traded partnership. Second, special rules require that net income from certain activities that would otherwise be treated as passive income must be recharacterized as non-passive income for purposes of the passive activity limitations. To allow each partner to correctly apply the passive activity limitations, the partnership must report income or loss and credits separately for each of the following: (170)

➢ Trade or business activities. ➢ Rental real estate activities. ➢ Rental activities other than real estate. ➢ Portfolio income.

Form 1065 - U.S. Return of Partnership Income

Form 1065 - U.S. Return of Partnership Income is an information return used to report the income, gains, losses, deductions, credits, etc., from the operation of a partnership. A partnership does not pay tax on its income but “passes through” any profits or losses to its partners. Partners must include partnership items on their tax or information returns. Partnerships report only trade or business activity income on lines 1a through 8 of Form 1065. They do not report rental activity income or portfolio income on these lines. Also, they do not include any tax-exempt income on lines 1a through 8. A partnership that receives any tax-exempt income other than interest, or holds any property or engages in any activity that produces tax-exempt income, reports this income on line 18b of Schedule K and in box 18 of Schedule K-1 using code B.

Lesson 9 - Specialized Returns

Partnerships report tax-exempt interest income, including exempt-interest dividends received as a shareholder in a mutual fund or other regulated investment company, on line 18a of Schedule K and in box 18 of Schedule K-1 using code A. Enter on line 1a gross receipts or sales from all trade or business operations, except for amounts that must be reported on lines 4 through 7. In general, advance payments are reported in the year of receipt. To report income from long-term contracts, see Section 460. For special rules for reporting certain advance payments for goods and long-term contracts, see Regulations Section 1.451-5. For permissible methods for reporting advance payments for services and certain goods by an accrual method partnership, see Revenue Procedure 2004-34, 2004-22 I.R.B. 991, as clarified and modified by Revenue Procedure 2011-18, and modified by Revenue Procedure 2011-14. Enter the ordinary income (loss) shown on Schedule K-1 (Form 1065) or Schedule K-1 (Form 1041), or other ordinary income (loss) from a foreign partnership, estate, or trust. Show the partnership's, estate's, or trust's name, address, and EIN on a separate statement attached to this return. If the amount entered is from more than one source, identify the amount from each source. Do not include portfolio income or rental activity income (loss) from other partnerships, estates, or trusts on this line. Instead, report these amounts on Schedules K and K-1, or on line 20a of Form 8825 if the amount is from a rental real estate activity.

Ordinary income (loss) from another partnership that is a publicly traded partnership is not reported on this line. Instead, report the amount separately on line 11 of Schedule K and in box 11 of Schedule K-1 using code F.

Treat shares of other items separately reported on Schedule K-1 issued by the other entity as if the items were realized or incurred by this partnership. If there is a loss from another partnership, the amount of the loss that may be claimed is subject to the at-risk and basis limitations as appropriate.

If the tax year of the partnership does not coincide with the tax year of the other partnership, estate, or trust, include the ordinary income (loss) from the other entity in the tax year in which the other entity's tax year ends.

Other Income (Loss)

Enter any other trade or business income (loss) not included on lines 1a through 6. List the type and amount of income on an attached statement. Examples of other income include the following: (170)

1. Interest income derived in the ordinary course of the partnership's trade or business, such as interest charged on receivable balances.

2. Recoveries of bad debts deducted in prior years under the specific charge-off method. 3. Taxable income from insurance proceeds. 4. The amount included in income from line 7 of Form 6478 - Alcohol and Cellulosic Biofuel Fuels Credit. 5. The amount included in income from line 8 of Form 8864 - Biodiesel and Renewable Diesel Fuels Credit. 6. The recapture amount under Section 280F if the business use of listed property drops to 50% or less. To figure

the recapture amount, complete Part IV of Form 4797. 7. All Section 481 income adjustments resulting from changes in accounting methods. Show the computation of the

Section 481 adjustments on an attached statement. 8. Part or all of the proceeds received from certain employer-owned life insurance contracts issued after August 17,

2006. Partnerships that own one or more employer-owned life insurance contracts issued after that date must file Form 8925, Report of Employer-Owned Life Insurance Contracts. See Section 101(j) for details.

9. The amount of payroll tax credit taken by an employer for qualified paid sick leave and qualified paid family leave under the Families First Coronavirus Response Act (FFCRA) and the American Rescue Plan Act of 2021 (ARP). The partnership must include the full amount (both the refundable and nonrefundable portions) of the credit for qualified sick and family leave wages in its gross income for the tax year that includes the last day of any calendar quarter with respect to which a credit is allowed.

10. The amount of any COBRA premium assistance credit allowed to employers under Section 6432(e), as amended by the ARP.

Do not include items requiring separate computations that must be reported on Schedules K and K-1. See the instructions for Schedules K and K-1. Do not report portfolio or rental activity income (loss) on this line.

Lesson 9 - Specialized Returns

Deductions

The following are some of the special provisions that apply to partnerships. The uniform capitalization rules of Section 263A generally require partnerships to capitalize or include in inventory costs, certain costs incurred in connection with the following: (170)

➢ The production of real property and tangible personal property held in inventory or held for sale in the ordinary course of business.

➢ Real property or personal property (tangible and intangible) acquired for resale. ➢ The production of real property and tangible personal property by a partnership for use in its trade or business or

in an activity engaged in for profit. Tangible personal property produced by a partnership includes a film, sound recording, videotape, book, or similar property. The costs required to be capitalized under Section 263A are not deductible until the property to which the costs relate is sold, used, or otherwise disposed of by the partnership. Section 263A does not apply to the following: (170)

➢ Timber. ➢ Most property produced under a long-term contract. ➢ Certain property produced in a farming business. ➢ Geological and geophysical costs amortized under Section 167(h). ➢ Certain plants bearing fruits and nuts under Section 168(k)(5).

The partnership must report the following costs separately to the partners for purposes of determinations under Section 59(e): (170)

➢ Research and experimental costs under Section 174. ➢ Intangible drilling costs for oil, gas, and geothermal property. ➢ Mining exploration and development costs.

Transactions Between Related Taxpayers

Generally, an accrual basis partnership can deduct business expenses and interest owed to a related party (including any partner) only in the tax year of the partnership that includes the day on which the payment is includible in the income of the related party.

Family Partnership

Members of a family can be partners. However, family members (or any other person) will be recognized as partners only if one of the following requirements is met: (122)

➢ If capital is a material income-producing factor, they acquired their capital interest in a bona fide transaction (even if by gift or purchase from another family member), actually own the partnership interest, and actually control the interest.

➢ If capital is not a material income-producing factor, they joined together in good faith to conduct a business. They agreed that contributions of each entitle them to a share in the profits, and some capital or service has been (or is) provided by each partner.

For purposes of determining a partner's distributive share, an interest purchased by one family member from another family member is considered a gift from the seller. The fair market value of the purchased interest is considered donated capital. For this purpose, members of a family include only spouses, ancestors, and lineal descendants (or a trust for the primary benefit of those persons).

Business Start-Up and Organizational Costs

Generally, a partnership can elect to deduct up to $5,000 of business start-up and organizational costs paid or incurred after October 22, 2004. Any remaining costs must be amortized. The $5,000 deduction is reduced (but not below zero) by the amount the total costs exceed $50,000. If the total costs are $55,000 or more, the deduction is reduced to zero.

Lesson 9 - Specialized Returns

Guaranteed Payments

Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner. This treatment is for purposes of determining gross income and deductible business expenses only. For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. Guaranteed payments are not subject to income tax withholding.

The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense. They are also listed on Schedules K and K-1 of the partnership return. The individual partner reports guaranteed payments on Schedule E (Form 1040) as ordinary income, along with his or her distributive share of the partnership's other ordinary income. Also include on line 10 amounts paid during the tax year for insurance that constitutes medical care for a partner, a partner's spouse, a partner's dependents, or a partner's children under age 27 who are not dependents.

Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenses. Generally, organizational and syndication expenses are not deductible by the partnership. However, a partnership can elect to deduct a portion of its organizational expenses and amortize the remaining expenses. Organizational expenses (if the election is not made) and syndication expenses paid to partners must be reported on the partners' Schedule K-1 as guaranteed payments.

If a partner is to receive a minimum payment from the partnership, the guaranteed payment is the amount by which the minimum payment is more than the partner's distributive share of the partnership income before taking into account the guaranteed payment. Guaranteed payments are included in income in the partner's tax year in which the partnership's tax year ends.

Self-Employed Health Insurance Premiums

Premiums for health insurance paid by a partnership on behalf of a partner, for services as a partner, are treated as guaranteed payments. The partnership can deduct the payments as a business expense, and the partner must include them in gross income. However, if the partnership accounts for insurance paid for a partner as a reduction in distributions to the partner, the partnership cannot deduct the premiums.

A partner who qualifies can deduct 100% of the health insurance premiums paid by the partnership on his or her behalf as an adjustment to income. The partner cannot deduct the premiums for any calendar month, or part of a month, in which the partner is eligible to participate in any subsidized health plan maintained by any employer of the partner, the partner's spouse, the partner's dependents, or any children under age 27 who are not dependents.

Repairs and Maintenance

Enter the costs of incidental repairs and maintenance that do not add to the value of the property or appreciably prolong its life, but only to the extent that such costs relate to a trade or business activity and are not claimed elsewhere on the return. The cost of new buildings, machinery, or permanent improvements that increase the value of the property are not deductible. They are chargeable to capital accounts and may be depreciated or amortized.

Bad Debts

Enter the total debts that became worthless in whole or in part during the year, but only to the extent such debts relate to a trade or business activity. Report deductible nonbusiness bad debts as a short-term capital loss on Form 8949 - Sales and Other Dispositions of Capital Assets.

Taxes and Licenses

Enter taxes and licenses paid or incurred in the trade or business activities of the partnership if not reflected elsewhere on the return. Federal import duties and Federal excise and stamp taxes are deductible only if paid or incurred in carrying on the trade or business of the partnership.

Schedules K-1 - Partners' Distributive Share Items

Although the partnership is not subject to income tax, the partners are liable for tax on their shares of the partnership income, whether or not distributed, and must include their shares on their tax returns. Schedule K-1 (Form 1065) - Partner’s Share of Income, Deductions, Credits, etc., shows each partner's separate share. Attach a copy of each Schedule K-1 to

Lesson 9 - Specialized Returns

the Form 1065 filed with the IRS; keep a copy with a copy of the partnership return as a part of the partnership's records; and furnish a copy to each partner. If a partnership interest is held by a nominee on behalf of another person, the partnership may be required to furnish Schedule K-1 to the nominee. The amount of loss and deduction the taxpayer may claim on his or her tax return may be less than the amount reported on Schedule K-1. It is the partner's responsibility to consider and apply any applicable limitations.

Partnership Distributions

Partnership distributions include the following: (122)

➢ A withdrawal by a partner in anticipation of the current year's earnings. ➢ A distribution of the current year's or prior years' earnings not needed for working capital. ➢ A complete or partial liquidation of a partner's interest. ➢ A distribution to all partners in a complete liquidation of the partnership.

A partnership distribution is not taken into account in determining the partner's distributive share of partnership income or loss. If any gain or loss from the distribution is recognized by the partner, it must be reported on his or her return for the tax year in which the distribution is received. Money or property withdrawn by a partner in anticipation of the current year's earnings is treated as a distribution received on the last day of the partnership's tax year.

Partner's Gain or Loss

A partner generally recognizes gain on a partnership distribution only to the extent any money (and marketable securities treated as money) included in the distribution exceeds the adjusted basis of the partner's interest in the partnership. Any gain recognized is generally treated as capital gain from the sale of the partnership interest on the date of the distribution. If partnership property (other than marketable securities treated as money) is distributed to a partner, he or she generally does not recognize any gain until the sale or other disposition of the property.

Partner's Basis for Distributed Property

Unless there is a complete liquidation of a partner's interest, the basis of property (other than money) distributed to the partner by a partnership is its adjusted basis to the partnership immediately before the distribution. However, the basis of the property to the partner cannot be more than the adjusted basis of his or her interest in the partnership reduced by any money received in the same transaction. (122) Example The adjusted basis of Emily's partnership interest is $30,000. She receives a distribution of property that has an adjusted basis of $20,000 to the partnership and $4,000 in cash. Her basis for the property is $20,000.

When to File

Generally, a domestic partnership must file Form 1065 by the 15th day of the 3rd month following the date its tax year ended as shown at the top of Form 1065. If the due date falls on a Saturday, Sunday, or legal holiday, file by the next day that is not a Saturday, Sunday, or legal holiday.

Extension of Time To File

File Form 7004 - Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns to request an extension of time to file. File Form 7004 by the regular due date of the partnership return. Form 7004 can be electronically filed.

Late Filing of Return

A penalty is assessed against the partnership if it is required to file a partnership return and it (a) fails to file the return by the due date, including extensions, or (b) files a return that fails to show all the information required, unless such failure is due to reasonable cause. In 2023, the penalty is $235 for each month or part of a month (for a maximum of 12 months) the failure continues, multiplied by the total number of persons who were partners in the partnership during any part of the partnership's tax year for which the return is due.

Lesson 9 - Specialized Returns

If the partnership receives a notice about a penalty after it files the return, the partnership may send the IRS an explanation and the Service will determine if the explanation meets reasonable-cause criteria. The taxpayer does not attach an explanation when filing the return.

Failure To Furnish Timely Information

For each failure to furnish Schedule K-1 to a partner when due and each failure to include on Schedule K-1 all the information required to be shown (or the inclusion of incorrect information), a $310 penalty may be imposed for each Schedule K-1 for which a failure occurs. The maximum penalty in 2023 is $3,783,000 for all such failures during a calendar year. If the requirement to report correct information is intentionally disregarded, each $310 penalty is increased to $630 or, if greater, 10% of the aggregate amount of items required to be reported. There is no limit to the amount of the penalty.

S Corporations S corporations are corporations that elect to pass corporate income, losses, deductions and credits through to their shareholders for Federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income. To qualify for S corporation status, the corporation must meet the following requirements:

➢ Be a domestic corporation. ➢ Have only allowable shareholders:

o Including individuals, certain trust, and estates, and o May not include partnerships, corporations or non-resident alien shareholders.

➢ Have no more than 100 shareholders. ➢ Have one class of stock. ➢ Not be an ineligible corporation i.e., certain financial institutions, insurance companies, and domestic international

sales corporations. In order to become an S corporation, the corporation must submit Form 2553 - Election by a Small Business Corporation signed by all the shareholders.

Advantages of an S Corporation

One of the best features of the S corporation is the tax savings for the taxpayer and his or her business. While members of an LLC are subject to employment tax on the entire net income of the business, only the wages of the S corporation shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a "distribution," which is taxed at a lower rate, if at all. Some expenses that shareholder/employees incur can be written off as business expenses. Nevertheless, if such an employee owns 2% or more shares, then benefits like health and life insurance are deemed taxable income. An S corporation designation also allows a business to have an independent life, separate from its shareholders. If a shareholder leaves the company, or sells his or her shares, the S corporation can continue doing business relatively undisturbed. Maintaining the business as a distinct corporate entity defines clear lines between the shareholders and the business that improve the protection of the shareholders. (171)

Disadvantages of an S Corporation

As a separate structure, S corporations require scheduled director and shareholder meetings, minutes from those meetings, adoption and updates to by-laws, stock transfers and records maintenance. A shareholder must receive reasonable compensation. The IRS takes notice of shareholder red flags like low salary/high distribution combinations and may reclassify the taxpayer’s distributions as wages. He or she could pay a higher employment tax because of an audit with these results. A corporation may not carry a capital loss from, or to, a year for which it is an S corporation. In general, an S corporation does not pay a tax on its income. Instead, its income and expenses are passed through to the shareholders, who then report these items on their own income tax returns.

Lesson 9 - Specialized Returns

If the taxpayer is an S corporation shareholder, his or her share of the corporation's current year income or loss and other tax items are taxed to him or her whether or not he or she receives any amount. Generally, those items increase or decrease the basis of the S corporation stock as appropriate. The taxpayer must increase his or her basis in stock of an S corporation by his or her pro rata share of the following items: (172)

➢ All income items of the S corporation, including tax-exempt income, which are separately stated and passed through to the taxpayer as a shareholder.

➢ The non-separately stated income of the S corporation. ➢ The amount of the deduction for depletion (other than oil and gas depletion) that is more than the basis of the

property being depleted. The taxpayer must decrease his or her basis in stock of an S corporation by his or her pro rata share of the following items: (172)

➢ Distributions by the S corporation that were not included in the taxpayer’s income. ➢ All loss and deduction items of the S corporation that are separately stated and passed through to the taxpayer. ➢ Any non-separately stated loss of the S corporation. ➢ Any expense of the S corporation that is not deductible in figuring its taxable income and not properly chargeable

to a capital account. ➢ The amount of the taxpayer’s deduction for depletion of oil and gas wells to the extent the deduction is not more

than his or her share of the adjusted basis of the wells. The basis in the stock cannot be reduced below zero. Generally, S corporation distributions, except dividend distributions, are considered a return of capital and reduce the taxpayer’s basis in the stock of the corporation. The part of any distribution that is more than the basis is treated as a gain from the sale or exchange of property. The corporation's distributions may be in the form of cash or property. (173)

S corporation distributions are not treated as dividends except in certain cases in which the corporation has accumulated earnings and profits from years before it became an S corporation.

The S corporation should send the taxpayer a copy of Schedule K-1 (Form 1120S) - Shareholder’s Share of Income, Deductions, Credits, etc., showing his or her share of the S corporation's income, credits, and deductions for the tax year. The taxpayer must report his or her distributive share of the S corporation's income, gain, loss, deductions, or credits on the appropriate lines and schedules of the Form 1040. The deduction for a taxpayer’s share of losses and deductions shown on Schedule K-1 (Form 1120S) is limited to the adjusted basis of his or her stock and any debt the corporation owes the taxpayer. Any loss or deduction not allowed because of this limit is carried over and treated as a loss or deduction in the next tax year. Rules apply that limit losses from passive activities. The taxpayer’s copy of Schedule K-1 (Form 1120S) and its instructions will explain the limits and tell him or her where on the return to report his or her share of S corporation items from passive activities. If the taxpayer has a passive activity loss from an S corporation, he or she must complete Form 8582 - Passive Activity Loss Limitations to figure the allowable loss to enter on the return.

Review Question 2 In general, an S corporation does not pay a tax on its income. Instead, its income and expenses are passed through to which of the following?

A. Executives B. Shareholders C. Trusts D. Estates

See Review Feedback for answer.

Taxes

Most businesses need to register with the IRS, register with state and local revenue agencies, and obtain a tax ID number

Lesson 9 - Specialized Returns

or permit. All states do not tax S corporations equally. Most recognize them similarly to the Federal government and tax the shareholders accordingly. However, some states (like Massachusetts) tax S corporations on profits above a specified limit. Other states do not recognize the S corporation election and treat the business as a C corporation with all of the tax ramifications. Some states (like New York and New Jersey) tax both the S corporations’ profits and the shareholder's proportional shares of the profits. The taxpayer’s corporation must file the Form 2553 to elect "S" status within two months and 15 days after the beginning of the tax year or any time before the tax year for the status to be in effect.

Built-in Gains Tax

Section 1374 provides for a tax on built-in gains. The built-in gains tax may apply to the following S corporations:

1. An S corporation that was a C corporation before it elected to be an S corporation. 2. An S corporation that acquired an asset with a basis determined (in whole or in part) by reference to its basis (or

the basis of any other property) in the hands of a C corporation (a transferred-basis acquisition). See Section 1374(d)(8).

An S corporation may owe the tax if it has net recognized built-in gains during the applicable recognition period. The Tax Increase Prevention Act (H.R. 5771) extended the reduction of the recognition period for the built-in gains of S corporation. The applicable recognition period is the 5-year period beginning:

1. For an asset held when the S corporation was a C corporation, on the first day of the first tax year for which the corporation is an S corporation; or

2. For an asset with a basis determined by reference to its basis (or the basis of any other property) in the hands of a C corporation, on the date the asset was acquired by the S corporation.

The Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently extended the rule reducing to five years (rather than ten years) the period for which an S corporation must hold its assets following conversion from a C corporation to avoid the tax on built-in gains.

A corporation described in both (1) and (2), above, must figure the built-in gains tax separately for the group of assets it held at the time its S corporation election became effective and for each group of assets it acquired from a C corporation with basis determined (in whole or in part) by reference to the basis of the asset (or any other property) in the hands of the C corporation. For details, see Regulations Section 1.1374-8.

Certain transactions involving the disposal of timber, coal, or domestic iron ore under Section 631 are not subject to the built-in gains tax.

Excess Net Passive Income Tax

S corporations that have previously been a C corporation and have accumulated earnings and profits at the end of the tax year will be assessed a passive income tax if passive investment income for the year exceeds 25% of gross receipts for the year. The tax is assessed at the maximum corporate tax rate of 21%. Recognized built-in gains and losses are not taken into account in determining the amount of passive investment income. Code Section 1362(d) (3(C)(i) defines passive investment income to be income derived from royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities. An exception is made for interest on notes from sales of inventory (Code Section 1362(d) (3(C)(ii)), and for income derived directly from the active and regular conduct of a lending or finance business (Code Section 1362(d) (3(C)(iii)). If passive investment income exceeds 25% of gross receipts for three consecutive years, then the S corporation election is terminated immediately following the third tax year. To avoid the passive income tax, the S corporation can either distribute E&P from C corporation years as an actual or deemed dividend or generate enough operating income so that passive investment income does not exceed 25% of gross receipts for the year. Also, the passive income tax is calculated using the lesser of "excessive net passive income" or taxable income. By reducing taxable income, the S corporation is able to minimize the passive income tax. Keep in mind, however, that the S corporation election will still terminate if passive investment income exceeds 25% of gross receipts for three consecutive years. Any passive income tax paid is a reduction to income that passes to the S corporation shareholders.

Lesson 9 - Specialized Returns

Review Question 3 An S corporation can be subject to which of the following taxes:

A. Built-in gains tax B. Excess net passive income tax C. Both A and B D. None of the above

See Review Feedback for answer.

Return of S Corporation

Every S corporation shall make a return for each taxable year, stating specifically the items of its gross income and the deductions allowable by subtitle A, the names and addresses of all persons owning stock in the corporation at any time during the taxable year, the number of shares of stock owned by each shareholder at all times during the taxable year, the amount of money and other property distributed by the corporation during the taxable year to each shareholder, the date of each such distribution, each shareholder's pro rata share of each item of the corporation for the taxable year, and such other information. Each S corporation required to file a return for any taxable year shall (on or before the day on which the return for such taxable year was filed) furnish to each person who is a shareholder at any time during such taxable year a copy of such information shown on such return as may be required by regulations.

S Corporation Compensation

S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly. Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for the service rendered to the corporation. The instructions to the Form 1120S - U.S. Income Tax Return for an S Corporation state "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation." The key to establishing reasonable compensation is determining what the shareholder-employee did for the S corporation. As such, we need to look to the source of the S corporation's gross receipts. The three major sources are:

1. Services of shareholder, 2. Services of non-shareholder employees, or 3. Capital and equipment.

If the gross receipts and profits come from items 2 and 3, then that should not be associated with the shareholder- employees’ personal services and not be allocated as compensation. On the other hand, if most of the gross receipts and profits are associated with the shareholder’s personal services, then most of the profit distribution should be allocated as compensation. In addition to the shareholder-employee direct generation of gross receipts, the shareholder-employee should also be compensated for administrative work performed for the other income producing employees or assets. For example, a manager may not directly produce gross receipts, but he assists the other employees or assets which are producing the day-to-day gross receipts. Some factors in determining reasonable compensation:

➢ Training and experience. ➢ Duties and responsibilities. ➢ Time and effort devoted to the business.

Lesson 9 - Specialized Returns

➢ Dividend history. ➢ Payments to non-shareholder employees. ➢ Timing and manner of paying bonuses to key people. ➢ What do comparable businesses pay for similar services. ➢ Compensation agreements. ➢ The use of a formula to determine compensation.

Health and accident insurance premiums paid on behalf of greater than two percent of S corporation shareholder- employee are deductible and reportable by the S corporation as wages for income tax withholding purposes on the shareholder-employee’s Form W-2. These benefits are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes. The additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement, issued to the shareholder- employee, but would not be included in Boxes 3 and 5 of Form W-2. A 2% shareholder-employee is eligible for an Adjusted Gross Income (AGI) deduction for amounts paid during the year for medical care premiums if the medical care coverage is established by the S corporation and the shareholder meets the other self-employed medical insurance deduction requirements. If, however, the shareholder or the shareholder’s spouse is eligible to participate in any subsidized health care plan then the shareholder is not entitled to the AGI deduction. A medical plan can be considered established by the S corporation if the S corporation paid or reimbursed the shareholder- employee for premiums and reported:

➢ The premium payment. ➢ Reimbursement as wages on the shareholder-employee’s W-2.

S Corporation Stock and Debt Basis Shareholder Loss Limitations

An S corporation is a corporation with an election in effect. The impact of the election is that the S corporation's items of income, loss and deduction flow to the shareholder and thus taxed on the shareholder's personal return. The two main reasons for electing S corporation status are:

1. Avoid double taxation on distributions. 2. Allow corporate losses to flow through to its owners.

There are three shareholder loss limitations:

1. Stock and Debt Basis Limitations. 2. At Risk Limitations. 3. Passive Activity Loss Limitations.

Each limitation must be met, and in the order presented, before a shareholder is allowed to claim a flow-through loss. The fact that a shareholder receives a K-1 reflecting a loss does not mean that the shareholder is automatically entitled to claim the loss. The amount of a shareholder's stock and debt basis in the S corporation is very important. Unlike a C corporation, each year a shareholder's stock and/or debt basis of an S corporation increases or decreases based upon the S corporation's operations. The S corporation will issue a shareholder a Schedule K-1. It is important to understand that the K-1 reflects the S corporation's items of income, loss and deduction that are allocated to the shareholder for the year. The K-1 shows the amount of non-dividend distribution the shareholder receives; it does not state the taxable amount of a distribution. The taxable amount of a distribution is contingent on the shareholder's stock basis. It is not the corporation's responsibility to track a shareholder's stock and debt basis but rather it is the shareholder's responsibility. If a shareholder receives a non-dividend distribution from an S corporation, the distribution is tax-free to the extent it does not exceed the shareholder's stock basis. Debt basis is not considered when determining the taxability of a distribution.

Lesson 9 - Specialized Returns

If a shareholder is allocated an item of S corporation loss or deduction, the shareholder must first have adequate stock and/or debt basis to claim that loss and/or deduction item. In addition, it is important to remember that, even when the shareholder has adequate stock and/or debt basis to claim the S corporation loss or deduction item, the shareholder must also consider the at-risk and passive activity loss limitations and therefore may not be able to claim the loss and/or deduction item. It is important that a shareholder know his or her stock basis when:

➢ The S corporation allocates a loss and/or deduction item to the shareholder - In order for the shareholder to claim a loss, they need to demonstrate they have adequate stock and/or debt basis.

➢ The S corporation makes a non-dividend distribution to the shareholder - In order for the shareholder to determine whether or not the distribution is non-taxable they need to demonstrate they have adequate stock basis.

➢ The shareholder disposes of their stock - As with any asset, including C corporation stock, when the asset is sold or disposed of, basis needs to be established in order to reflect the proper gain or loss on the disposition.

Since shareholder stock basis in an S corporation changes every year, it must be computed every year. In computing stock basis, the shareholder starts with their initial capital contribution to the S corporation or the initial cost of the stock they purchased (the same as a C corporation). That amount is then increased and/or decreased based on the flow-through amounts from the S corporation. An income item will increase stock basis while a loss, deduction or distribution will decrease stock basis. Some examples of items that increase a taxpayer’s basis include the taxpayer’s pro rata share of the following:

➢ All income items of the S corporation, including tax-exempt income, which are separately stated. ➢ Any non-separately stated income of the S corporation. ➢ The amount of the deduction for depletion (other than oil and gas) that is more than the basis of the property being

depleted.

Only non-dividend distributions reduce stock basis, dividend distributions do not. The corporation is responsible for telling the shareholder the amount of non-dividend and dividend distributions. Box 16D of Schedule K-1 reflects non-dividend distributions. Form 1099-DIV is used to report dividend distributions; dividends are not reported on the shareholder's Schedule K-1.

Additional S Corporation Information

➢ A non-dividend distribution in excess of stock basis is taxed as a capital gain on the shareholder's personal return. Stock held for longer than one year is a long-term capital gain (LTCG).

➢ Non-deductible expenses reduce a shareholder's stock and/or debt basis before loss and deduction items. If non- deductible expenses exceed stock and/or debt basis, they are not suspended and carried forward.

➢ If the current year has different types of loss and deduction items, which exceed stock and/or debt basis, the allowable loss and deduction items must be allocated pro rata based on the size of the particular loss and deduction items.

➢ A shareholder is not allowed to claim loss and deduction items in excess of stock and/or debt basis. Loss and deduction items not allowable in the current year are suspended due to basis limitations.

➢ Suspended losses and deductions due to basis limitations retain their character in subsequent years. Any suspended loss or deduction items in excess of stock and/or debt basis are carried forward indefinitely.

➢ In determining current year allowable losses, current year loss and deduction items are combined with the suspended loss and deduction items carried over from the prior year, though the current year and suspended items should be separately stated on the Form 1040 Schedule E or other appropriate schedule on the return.

➢ A shareholder is only allowed debt basis to the extent he or she has personally lent money to the S corporation. A loan guarantee is not sufficient to allow the shareholder debt basis.

➢ If a shareholder contends he or she has contributed or loaned substantial funds to the S corporation, consideration should be given to whether the shareholder had the financial means to make the contribution or loan.

➢ Part or all of the repayment of a reduced basis debt is taxable to the shareholder. ➢ If a shareholder sells their stock, suspended losses due to basis limitations are lost. Any gain on the sale of the

stock does not increase the shareholder's stock basis. A stock basis computation should be reviewed in the year stock is sold or disposed of.

Termination of Election

Once the election is made, it stays in effect until it is terminated. If the election is terminated, the corporation (or a successor

Lesson 9 - Specialized Returns

corporation) can make another election on Form 2553 - Election by a Small Business Corporation only with IRS consent for any tax year before the 5th tax year after the first tax year in which the termination took effect. See Regulations Section 1.1362-5 for details. An election terminates automatically in any of the following cases: (174)

1. The corporation is no longer a small business corporation as defined in Section 1361(b). This kind of termination of an election is effective as of the day the corporation no longer meets the definition of a small business corporation. Attach to Form 1120S for the final year of the S corporation a statement notifying the IRS of the termination and the date it occurred.

2. The corporation, for each of three consecutive tax years, (a) has accumulated earnings and profits and (b) derives more than 25% of its gross receipts from passive investment income as defined in Section 1362(d)(3)(C). The election terminates on the first day of the first tax year beginning after the third consecutive tax year. The corporation must pay a tax for each year it has excess net passive income. See the line 22a instructions for details on how to figure the tax.

3. The election is revoked. An election can be revoked only with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares of stock (including non- voting stock). The revocation can specify an effective revocation date that is on or after the day the revocation is filed. If no date is specified, the revocation is effective at the start of the tax year if the revocation is made on or before the 15th day of the 3rd month of that tax year. If no date is specified and the revocation is made after the 15th day of the 3rd month of the tax year, the revocation is effective at the start of the next tax year.

To revoke the election, the corporation must file a statement with the appropriate service center listed under Where To File in the Instructions for Form 2553. In the statement, the corporation must notify the IRS that it is revoking its election to be an S corporation. The statement must be signed by each shareholder who consents to the revocation and contain the information required by Regulations Section 1.1362-6(a)(3).

Review Question 4 Which of the following statements regarding the termination of an S corporation election is true?

A. The election may be revoked with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares

B. The election may be revoked by the board of directors of the corporation only if they are not shareholders

C. The election terminates automatically if the corporation derives more than 25% of its gross receipts from passive investment income during the year

D. The election may be revoked by the Internal Revenue Service if there is a history of 10 years of operating losses

See Review Feedback for answer.

Limited Liability Company (LLC) A limited liability company (LLC) is a business entity organized in the United States under state law. Unlike a partnership, all of the members of an LLC have limited personal liability for its debts. An LLC may be classified for Federal income tax purposes as a partnership, corporation, or an entity disregarded as separate from its owner by applying the rules in Regulations Section 301.7701-3. A Limited Liability Company (LLC) is a business structure allowed by state statute. Each state may use different regulations, and the taxpayer should check with his or her state if he or she is interested in starting a Limited Liability Company. Owners of an LLC are called members. Most states do not restrict ownership, and so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single- member” LLCs, those having only one owner. A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check the taxpayer’s state’s requirements and the Federal tax regulations for further information. There are special rules for foreign LLCs.

Lesson 9 - Specialized Returns

Classifications

Depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return (a “disregarded entity”). Specifically, a domestic LLC with at least two members is classified as a partnership for Federal income tax purposes unless it files Form 8832 - Entity Classification Election and affirmatively elects to be treated as a corporation. And an LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes), unless it files Form 8832 and affirmatively elects to be treated as a corporation.

LLCs Classified as Partnerships

If an LLC has at least two members and is classified as a partnership, it generally must file Form 1065 - U.S. Return of Partnership Income. Generally, an LLC classified as a partnership is subject to the same filing and reporting requirements as partnerships. For certain purposes, members of an LLC are treated as limited partners in a limited partnership. For example, LLC members are treated as limited partners for purposes of material participation under the passive activity limitation rules (see Temporary Regulation Section 1.469-5T(e)). See the Instructions for Form 1065 for reporting rules that apply specifically to LLCs. Only a member manager of an LLC can sign the partnership tax return. And only a member manager can represent the LLC as the tax matters partner under the consolidated audit proceedings in Sections 6221 through 6234. A member manager is any owner of an interest in the LLC who, alone or together with others, has the continuing authority to make the management decisions necessary to conduct the business for which the LLC was formed. If there are no elected or designated member managers, each owner is treated as a member manager. If the number of members in an LLC classified as a partnership is reduced to only one member, it becomes an entity disregarded as separate from its owner under Regulations Section 301.7701-3(f)(2). However, if the LLC has made an election to be classified as a corporation and that elective classification is in effect at the time of the change in membership, the default classification as a disregarded entity will not apply. Other tax consequences of a change in membership, such as recognition of gain or loss, are determined by the transactions through which an interest in the LLC is acquired or disposed of. If a partnership that becomes a disregarded entity as a result of a decrease in the number of members makes an election to be classified as a corporation, the applicable deemed transactions discussed under Subsequent Elections, below, apply.

LLCs Classified as Disregarded Entities

If an LLC has only one member and is classified as an entity disregarded as separate from its owner, its income, deductions, gains, losses, and credits are reported on the owner's income tax return. For example, if the owner of the LLC is an individual, the LLC's income and expenses would be reported on the following schedules filed with the owner's Form 1040:

➢ Schedule C - Profit or Loss From Business (Sole Proprietorship). ➢ Schedule E - Supplemental Income and Loss. ➢ Schedule F - Profit or Loss From Farming.

A single-member LLC that is classified as a disregarded entity for income tax purposes is treated as a separate entity for purposes of employment tax and certain excise taxes. For wages paid after January 1, 2009, the single-member LLC is required to use its name and employer identification number (EIN) for reporting and payment of employment taxes. A single-member LLC is also required to use its name and EIN to register for excise tax activities on Form 637; pay and report excise taxes reported on Forms 720, 730, 2290, and 11-C; and claim any refunds, credits, and payments on Form 8849. An individual owner of a single-member LLC classified as a disregarded entity is not an employee of the LLC. Instead, the owner is subject to tax on the net earnings from self-employment of the LLC which is treated in the same manner as a sole proprietorship. If a single-member LLC classified as a disregarded entity for income tax purposes acquires an additional member, it becomes a partnership under Regulations Section 301.7701-3(f)(2). However, if the LLC has made an election to be classified as a corporation and that elective classification is in effect at the time of the change in membership, the default classification as a partnership will not apply.

Lesson 9 - Specialized Returns

Other tax consequences of a change in membership, such as recognition of gain or loss, are determined by the transactions through which an interest in the LLC is acquired or disposed of. If a disregarded entity that becomes a partnership as a result of an increase in the number of members makes an election to be classified as a corporation, the applicable deemed transactions apply. Example Bart, who is not related to Alain, buys 50% of Alain's interest in an LLC that is a disregarded entity for $5,000. Alain does not contribute any portion of the $5,000 to the LLC. Alain and Bart continue to operate the business of the LLC as co- owners of the LLC. The LLC is converted to a partnership when the new member, Bart, buys an interest in the disregarded entity from the owner, Alain. Bart's buying a 50% interest in Alain's ownership interest in the LLC is treated as Bart's buying a 50% interest in each of the LLC's assets, which are treated as owned directly by Alain for Federal income tax purposes. Immediately thereafter, Alain and Bart are treated as contributing their respective interests in those assets to a partnership in exchange for ownership interests in the partnership. Alain recognizes gain or loss from the deemed sale to Bart of the 50% interest in the assets. Neither Alain nor Bart recognizes any gain or loss as a result of the deemed contribution of the assets to the partnership.

LLCs Classified as Corporations

An LLC with either a single member or more than one member can elect to be classified as a corporation rather than be classified as a partnership or disregarded entity under the default rules. The taxpayer should file Form 8832 - Entity Classification Election to elect classification as a C corporation. He or she should file Form 2553 - Election by a Small Business Corporation to elect classification as an S corporation. LLCs electing classification as an S corporation are not required to file Form 8832 to elect classification as a corporation before filing Form 2553. By filing Form 2553, an LLC is deemed to have elected classification as a corporation in addition to the S corporation classification. (175) If the LLC elects to be classified as a corporation by filing Form 8832, a copy of the LLC's Form 8832 must be attached to the Federal income tax return of each direct and indirect owner of the LLC for the tax year of the owner that includes the date on which the election took effect. If the LLC is classified as a corporation, it must file a corporation income tax return. If it is a C corporation, it is taxed on its taxable income and distributions to the members are includible in the members' gross income to the extent of the corporation's earnings and profits (double taxation). If it is an S corporation, the corporation is generally not subject to any income tax and the income, deductions, gains, losses, and credits of the corporation “pass through” to the members. Corporations generally file either: (175)

➢ Form 1120 - U.S. Corporation Income Tax Return. ➢ Form 1120S - U.S. Income Tax Return for an S Corporation.

Effective Date of Election

An LLC that does not want to accept its default Federal tax classification, or that wishes to change its classification, uses Form 8832 - Entity Classification Election to elect how it will be classified for Federal tax purposes. Generally, an election specifying an LLC’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed. An LLC may be eligible for late election relief in certain circumstances. See Form 8832 General Instructions for more information.

Subsequent Elections

An LLC can elect to change its classification. Generally, once an LLC has elected to change its classification, it cannot elect again to change its classification during the 60 months after the effective date of the election. An election by a newly formed LLC that is effective on the date of formation is not considered a change for purposes of this limitation. For more information and exceptions, see Regulations Section 301.7701-3(c) and the Form 8832 instructions. An election to change classification can have significant tax consequences based on the following transactions that are deemed to occur as a result of the election. An election to change classification from a partnership to a corporation will be treated as if the partnership contributed all of its assets and liabilities to the corporation in exchange for stock and the partnership then immediately liquidated by distributing the stock to its partners. An election to change classification from a corporation to a partnership will be treated

Lesson 9 - Specialized Returns

as if the corporation distributed all of its assets and liabilities to its shareholders in liquidation and the shareholders then immediately contributed all of the distributed assets and liabilities to a new partnership. An election to change classification from a corporation to a disregarded entity will be treated as if the corporation distributed all of its assets and liabilities to its single owner in liquidation. An election to change classification from a disregarded entity to a corporation will be treated as if the owner of the disregarded entity contributed all of the assets and liabilities to the corporation in exchange for stock.

Review Question 5 Wanda and Sylvester are members of an LLC. They agree that the LLC should be classified as a corporation but do not want to elect to have the LLC treated as an S corporation. The LLC must file which form?

A. Form 1120 - U.S. Corporation Income Tax Return B. Form 1120S - U.S. Income Tax Return for an S Corporation C. Form 2553 - Election by a Small Business Corporation D. Form 8832 - Entity Classification Election

See Review Feedback for answer.

Trust and Estate Income Tax A trust or a decedent's estate is a separate legal entity for Federal tax purposes. A decedent's estate comes into existence at the time of death of an individual. A trust may be created during an individual's life (inter vivos) or at the time of his or her death under a will (testamentary). If the trust instrument contains certain provisions, then the person creating the trust (the grantor) is treated as the owner of the trust's assets. Such a trust is a grantor type trust. A trust or decedent's estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, there is one major distinction. A trust or decedent's estate is allowed an income distribution deduction for distributions to beneficiaries. To figure this deduction, the fiduciary must complete Schedule B. The income distribution deduction determines the amount of any distributions taxed to the beneficiaries. For this reason, a trust or decedent's estate sometimes is referred to as a “pass-through” entity. The beneficiary, and not the trust or decedent's estate, pays income tax on his or her distributive share of income. Schedule K-1 (Form 1041) is used to notify the beneficiaries of the amounts to be included on their income tax returns. Before preparing Form 1041, the fiduciary must figure the accounting income of the estate or trust under the will or trust instrument and applicable local law to determine the amount, if any, of income that is required to be distributed, because the income distribution deduction is based, in part, on that amount. The fiduciary of a domestic decedent's estate, trust, or bankruptcy estate uses Form 1041 to report: (176)

➢ The income, deductions, gains, losses, etc., of the estate or trust. ➢ The income that is either accumulated or held for future distribution or distributed currently to the beneficiaries. ➢ Any income tax liability of the estate or trust. ➢ Employment taxes on wages paid to household employees.

Decedent's Estate

The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic estate that has: (176)

➢ Gross income for the tax year of $600 or more. ➢ A beneficiary who is a nonresident alien.

An estate is a domestic estate if it is not a foreign estate. A foreign estate is one the income of which is from sources outside the United States that is not effectively connected with the conduct of a U.S. trade or business and is not includible in gross income. If the taxpayer is the fiduciary of a foreign estate, file Form 1040-NR - U.S. Nonresident Alien Income Tax Return, instead of Form 1041.

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Trust

The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic trust taxable under Section 641 that has:

➢ Any taxable income for the tax year. ➢ Gross income of $600 or more (regardless of taxable income). ➢ A beneficiary who is a nonresident alien.

Two or more trusts are treated as one trust if the trusts have substantially the same grantor(s) and substantially the same primary beneficiary(ies) and a principal purpose of such trusts is avoidance of tax. This provision applies only to that portion of the trust that is attributable to contributions to corpus made after March 1, 1984.

A trust is a domestic trust if: (176)

➢ A U.S. court is able to exercise primary supervision over the administration of the trust (court test), and ➢ One or more U.S. persons have the authority to control all substantial decisions of the trust (control test).

See Regulations Section 301.7701-7 for more information on the court and control tests. Also treated as a domestic trust is a trust (other than a trust treated as wholly owned by the grantor) that: (176)

1. Was in existence on August 20, 1996, 2. Was treated as a domestic trust on August 19, 1996, and 3. Elected to continue to be treated as a domestic trust.

A trust that is not a domestic trust is treated as a foreign trust. If the taxpayer is the trustee of a foreign trust, file Form 1040-NR instead of Form 1041. Also, a foreign trust with a U.S. owner generally must file Form 3520-A - Annual Information Return of Foreign Trust With a U.S. Owner. If a domestic trust becomes a foreign trust, it is treated under Section 684 as having transferred all of its assets to a foreign trust, except to the extent a grantor or another person is treated as the owner of the trust when the trust becomes a foreign trust.

Grantor Trusts

A trust is a grantor trust if the grantor retains certain powers or ownership benefits. This can also apply to only a portion of a trust. In general, a grantor trust is ignored for income tax purposes and all of the income, deductions, etc., are treated as belonging directly to the grantor. This also applies to any portion of a trust that is treated as a grantor trust.

If only a portion of the trust is a grantor type trust, indicate both grantor trust and the other type of trust, for example, simple or complex trust, as the type of entities checked in Section A on page 1 of Form 1041.

If the entire trust is a grantor trust, fill in only the entity information of Form 1041. Do not show any dollar amounts on the form itself; show dollar amounts only on an attachment to the form. Do not use Schedule K-1 (Form 1041) as the attachment. If only part of the trust is a grantor type trust, the portion of the income, deductions, etc., that is allocable to the non- grantor part of the trust is reported on Form 1041, under normal reporting rules. The amounts that are allocable directly to the grantor are shown only on an attachment to the form. Do not use Schedule K-1 (Form 1041) as the attachment. However, Schedule K-1 is used to reflect any income distributed from the portion of the trust that is not taxable directly to the grantor or owner. The fiduciary must give the grantor (owner) of the trust a copy of the attachment. On the attachment, show:

➢ The name, identifying number, and address of the person(s) to whom the income is taxable. ➢ The income of the trust that is taxable to the grantor or another person under Sections 671 through 678. Report

the income in the same detail as it would be reported on the grantor's return had it been received directly by the grantor.

➢ Any deductions or credits that apply to this income. Report these deductions and credits in the same detail as they would be reported on the grantor's return had they been received directly by the grantor.

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The income taxable to the grantor or another person under Sections 671 through 678 and the deductions and credits that apply to that income must be reported by that person on their own income tax return.

Special Rule for Certain Revocable Trusts

Section 645 provides that if both the executor (if any) of an estate (the related estate) and the trustee of a qualified revocable trust (QRT) elect the treatment in Section 645, the trust must be treated and taxed as part of the related estate during the election period. This election may be made by a QRT even if no executor is appointed for the related estate. In general, Form 8855 - Election To Treat a Qualified Revocable Trust as Part of an Estate must be filed by the due date for Form 1041 for the first tax year of the related estate. This applies even if the combined related estate and electing trust do not have sufficient income to be required to file Form 1041. However, if the estate is granted an extension of time to file Form 1041 for its first tax year, the due date for Form 8855 is the extended due date. Once made, the election is irrevocable. In general, a QRT is any trust (or part of a trust) that, on the day the decedent died, was treated as owned by the decedent because the decedent held the power to revoke the trust as described in Section 676. An electing trust is a QRT for which a Section 645 election has been made. The election period is the period of time during which an electing trust is treated as part of its related estate. The election period begins on the date of the decedent's death and terminates on the earlier of:

➢ The day on which the electing trust and related estate, if any, distribute all of their assets. ➢ The day before the applicable date.

To determine the applicable date, first determine whether a Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return is required to be filed as a result of the decedent's death. If no Form 706 is required to be filed, the applicable date is 2 years after the date of the decedent's death. If Form 706 is required, the applicable date is the later of 2 years after the date of the decedent's death or 6 months after the final determination of liability for estate tax. For additional information, see Regulations Section 1.645-1(f).

Distributable Net Income (DNI)

The income distribution deduction allowable to estates and trusts for amounts paid, credited, or required to be distributed to beneficiaries is limited to DNI. This amount, which is figured on Schedule B, line 7, is also used to determine how much of an amount paid, credited, or required to be distributed to a beneficiary will be includible in his or her gross income. When completing Form 1041, the taxpayer must take into account any items that are income in respect of a decedent (IRD). In general, IRD is income that a decedent was entitled to receive but that was not properly includible in the decedent's final income tax return under the decedent's method of accounting. IRD includes:

➢ All accrued income of a decedent who reported his or her income on the cash method of accounting. ➢ Income accrued solely because of the decedent's death in the case of a decedent who reported his or her income

on the accrual method of accounting. ➢ Income to which the decedent had a contingent claim at the time of his or her death.

Some examples of IRD for a decedent who kept his or her books on the cash method are:

➢ Deferred salary payments that are payable to the decedent's estate. ➢ Uncollected interest on U.S. savings bonds. ➢ Proceeds from the completed sale of farm produce. ➢ The portion of a lump-sum distribution to the beneficiary of a decedent's IRA that equals the balance in the IRA at

the time of the owner's death. This includes unrealized appreciation and income accrued to that date, less the aggregate amount of the owner's nondeductible contributions to the IRA. Such amounts are included in the beneficiary's gross income in the tax year that the distribution is received.

The IRD has the same character it would have had if the decedent had lived and received such amount.

Lesson 9 - Specialized Returns

The following deductions and credits, when paid by the decedent's estate, are allowed on Form 1041 even though they were not allowable on the decedent's final income tax return:

➢ Business expenses deductible under Section 162. ➢ Interest deductible under Section 163. ➢ Taxes deductible under Section 164. ➢ Percentage depletion allowed under Section 611. ➢ Foreign Tax Credit.

Income required to be distributed currently is income that is required under the terms of the governing instrument and applicable local law to be distributed in the year it is received. The fiduciary must be under a duty to distribute the income currently, even if the actual distribution is not made until after the close of the trust's tax year. A fiduciary is a trustee of a trust, or an executor, executrix, administrator, administratrix, personal representative, or person in possession of property of a decedent's estate.

Misuse of Trusts

For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts. While there are legitimate uses of trusts in tax and estate planning, some highly questionable transactions promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. Such trusts rarely deliver the tax benefits promised and are used primarily as a means of avoiding income tax liability and hiding assets from creditors, including the IRS. IRS personnel have seen an increase in the improper use of private annuity trusts and foreign trusts to shift income and deduct personal expenses. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering a trust arrangement. Promoters of fraudulent trust arrangements use a variety of methods to advertise their schemes. They may include seminars, flyers, and even the Internet. The main selling point of fraudulent trust arrangements is that the paperwork will look like the taxpayer is giving up control of his or her assets and money; when in reality he or she still controls how his or her money and assets are used. A fraudulent trust only has the appearance of a trust. It is typically promoted by the promise of tax benefits or avoidance with no meaningful change in the taxpayer's control over or benefit from the taxpayer's income or assets. Using the name "trust" in association with financial arrangements does not make it a legitimate trust. No matter how carefully written the trust documents are, if the intent is to evade taxes, the trust will be treated as fraudulent. Fraudulent trusts are illegal and are a specific area of concern for IRS Criminal Investigation.

When To File

For calendar year estates and trusts, file Form 1041 - U.S. Income Tax Return for Estates and Trusts and Schedule(s) K- 1 by April 15, 2024. For fiscal year estates and trusts, file Form 1041 by the 15th day of the 4th month following the close of the tax year. For example, an estate that has a tax year that ends on June 30, 2023, must file Form 1041 by October 15, 2023. If the due date falls on a Saturday, Sunday, or legal holiday, file on the next business day. (168)

Extension of Time To File

If more time is needed to file the estate or trust return, use Form 7004 - Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns to apply for an automatic 5½-month extension of time to file.

The taxpayer should file a separate Form 7004 for each return for which he or she is requesting an extension of time to file. This extension will apply only to the specific return identified on Part I, line 1. For consolidated group returns, see the instructions for Part II, line 3 for Form 7004.

The IRS will no longer send a notification that the extension has been approved. They will notify the business entity only if its request for an extension is disallowed. Properly filing Form 7004 will automatically give the business entity the maximum extension allowed from the due date of its return to file the return. Additionally, The IRS may terminate the automatic extension at any time by mailing a notice of termination to the entity or person that requested the extension. The notice will be mailed at least 10 days before the termination date given in the notice.

Lesson 9 - Specialized Returns

Period Covered

File the 2022 return for calendar year 2022 and fiscal years beginning in 2022 and ending in 2023. If the return is for a fiscal year or a short tax year (less than 12 months), fill in the tax year space at the top of the form. The 2022 Form 1041 may also be used for a tax year beginning in 2023 if:

1. The estate or trust has a tax year of less than 12 months that begins and ends in 2023, and 2. The 2022 Form 1041 is not available by the time the estate or trust is required to file its tax return. However, the

estate or trust must show its 2023 tax year on the 2022 Form 1041 and incorporate any tax law changes that are effective for tax years beginning after 2022.

Estimated Tax

Generally, an estate or trust must pay estimated income tax for 2023 if it expects to owe, after subtracting any withholding and credits, at least $1,000 in tax, and it expects the withholding and credits to be less than the smaller of:

1. 90% of the tax shown on the 2023 tax return, or 2. 100% of the tax shown on the 2022 tax return (110% of that amount if the estate's or trust's adjusted gross income

on that return is more than $150,000, and less than ⅔ of gross income for 2022 or 2023 is from farming or fishing). However, if a return was not filed for 2022 or that return did not cover a full 12 months, item 2 does not apply. For this purpose, include household employment taxes in the tax shown on the tax return, but only if either of the following is true:

➢ The estate or trust will have Federal income tax withheld for 2023, or ➢ The estate or trust would be required to make estimated tax payments for 2023 even if it did not include household

employment taxes when figuring estimated tax. In 2023, estimated tax payments are not required from:

1. An estate of a domestic decedent or a domestic trust that had no tax liability for the full 12-month 2022 tax year. 2. A decedent's estate for any tax year ending before the date that is 2 years after the decedent's death. 3. A trust that was treated as owned by the decedent if the trust will receive the residue of the decedent's estate

Section 643(g) Election

Fiduciaries of trusts that pay estimated tax may elect under Section 643(g) to have any portion of their estimated tax payments allocated to any of the beneficiaries. The fiduciary of a decedent's estate may make a Section 643(g) election only for the final year of the estate.

Interest

Interest is charged on taxes not paid by the due date, even if an extension of time to file is granted. Interest is also charged on penalties imposed for failure to file, negligence, fraud, substantial valuation misstatements, substantial understatements of tax, and reportable transaction understatements. Interest is charged on the penalty from the due date of the return (including extensions). The interest charge is figured at a rate determined under Section 6621.

Late Filing of Return

The law provides a penalty of 5% of the tax due for each month, or part of a month, for which a return is not filed up to a maximum of 25% of the tax due (15% for each month, or part of a month, up to a maximum of 75% if the failure to file is fraudulent). In 2023, if the return is more than 60 days late, the minimum penalty is the smaller of $485 or the tax due. The penalty will not be imposed if the taxpayer can show that the failure to file on time was due to reasonable cause. If he or she receives a notice about penalty and interest after he or she files this return, send the IRS an explanation and they will determine if the taxpayer meets reasonable-cause criteria. The taxpayer does not attach an explanation when he or she files Form 1041.

Lesson 9 - Specialized Returns

Late Payment of Tax

Generally, the penalty for not paying tax when due is ½ of 1% of the unpaid amount for each month or part of a month it remains unpaid. The maximum penalty is 25% of the unpaid amount. The penalty applies to any unpaid tax on the return. Any penalty is in addition to interest charges on late payments.

Failure To Provide Information Timely

The taxpayer must provide Schedule K-1 (Form 1041), on or before the day he or she is required to file Form 1041, to each beneficiary who receives a distribution of property or an allocation of an item of the estate. In 2023, for each failure to provide Schedule K-1 to a beneficiary when due and each failure to include on Schedule K-1 all the information required to be shown (or the inclusion of incorrect information), a $310 penalty may be imposed with regard to each Schedule K-1 for which a failure occurs. The maximum penalty is $3,783,000 for all such failures during a calendar year. If the requirement to report information is intentionally disregarded, each $310 penalty is increased to $630 or, if greater, 10% of the aggregate amount of items required to be reported, and the $3,783,000 maximum does not apply. The penalty will not be imposed if the fiduciary can show that not providing information timely was due to reasonable cause and not due to willful neglect.

Underpaid Estimated Tax

If the fiduciary underpaid estimated tax, use Form 2210 - Underpayment of Estimated Tax by Individuals, Estates, and Trusts, to figure any penalty. Enter the amount of any penalty on Form 1041.

Trust Fund Recovery Penalty

This penalty may apply if certain excise, income, Social Security, and Medicare taxes that must be collected or withheld are not collected or withheld, or these taxes are not paid. These taxes are generally reported on Forms 720, 941, 943, 944, or 945. The trust fund recovery penalty may be imposed on all persons who are determined by the IRS to have been responsible for collecting, accounting for, or paying over these taxes, and who acted willfully in not doing so. The penalty is equal to the unpaid trust fund tax. See the Instructions for Form 720, Publication 15 (Circular E), Employer's Tax Guide, or Publication 51 (Circular A), Agricultural Employer's Tax Guide, for more details, including the definition of responsible persons.

Tax Exempt Organizations To be tax-exempt under Section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in Section 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of its activities, and it may not participate in any campaign activity for or against political candidates. Organizations described in Section 501(c)(3) are commonly referred to as charitable organizations. Organizations described in Section 501(c)(3), other than testing for public safety organizations, are eligible to receive tax-deductible contributions in accordance with Code Section 170. The organization must not be organized or operated for the benefit of private interests, and no part of a Section 501(c)(3) organization's net earnings may inure to the benefit of any private shareholder or individual. If the organization engages in an excess benefit transaction with a person having substantial influence over the organization, an excise tax may be imposed on the person and any organization managers agreeing to the transaction. Section 501(c)(3) organizations are restricted in how many political and legislative (lobbying) activities they may conduct. Form 1023 - Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code is used to apply for recognition as a tax-exempt organization under Section 501(c)(3). Organizations that may qualify for exemption under Section 501(c)(3) include corporations, unincorporated associations and trusts. A partnership may not qualify for exemption and therefore may not file Form 1023. Form 1023-EZ - Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code is the streamlined version of Form 1023. Any organization may file Form 1023 to apply for recognition of exemption from Federal income tax under Section 501(c)(3). Only certain organizations are eligible to file Form 1023-EZ. The

Lesson 9 - Specialized Returns

organization must complete the Form 1023-EZ Eligibility Worksheet in the Instructions for Form 1023-EZ to determine if they are eligible to file this form. Form 1023-EZ is filed electronically only on Pay.gov. If the organization is not eligible to file Form 1023-EZ, they can still file Form 1023. Most organizations seeking exemption from Federal income tax under Section 501(c)(3) are required to complete and submit an application. However, the following types of organizations may be considered tax exempt under Section 501(c)(3) even if they do not file Form 1023 or Form 1023-EZ: (177)

➢ Churches, including synagogues, temples, and mosques. ➢ Integrated auxiliaries of churches and conventions or associations of churches. ➢ Any organization that has gross receipts in each taxable year of normally not more than $5,000.

A limited liability company that files Form 1023 is treated as a corporation rather than a partnership. As a corporation, it may file Form 1023. Note, however, that a limited liability company should not file an exemption application if it wants to be treated as a disregarded entity by its tax-exempt parent. The IRS will only recognize a limited liability company under Section 501(c)(3) if all its members are Section 501(c)(3) organizations. A charity's organizing document must limit the organization's purposes to exempt purposes set forth in Section 501(c)(3) and must not expressly empower it to engage, other than as an insubstantial part of its activities, in activities that do not further those purposes. This requirement may be met if the purposes stated in the organizing document are limited by reference to Section 501(c)(3). In addition, an organization's assets must be permanently dedicated to an exempt purpose. This means that if an organization dissolves, its assets must be distributed for an exempt purpose described in Section 501(c)(3), or to the Federal government or to a state or local government for a public purpose. To establish that an organization's assets will be permanently dedicated to an exempt purpose, the organizing document should contain a provision insuring their distribution for an exempt purpose if the organization dissolves. Although reliance may be placed upon state law to establish permanent dedication of assets for exempt purposes, an organization's application can be processed by the IRS more rapidly if its organizing document includes a provision ensuring permanent dedication of assets for exempt purposes. If the organizing document does not contain these provisions, an organization should amend it before submitting its exemption application. State officials can provide more information about how to amend organizing documents. Organizations applying for recognition of exemption under a provision other than Section 501(c)(3) generally use Form 1024 - Application for Recognition of Exemption Under Section 501(a). Even if these organizations are not required to file Form 1024 to be tax-exempt, they may wish to file Form 1024 to receive a determination letter of IRS recognition of their Section 501(c) status in order to obtain certain incidental benefits such as:

➢ Public recognition of tax-exempt status. ➢ Exemption from certain state taxes. ➢ Advance assurance to donors of deductibility of contributions (in certain cases). ➢ Nonprofit mailing privileges.

Generally, Form 1024 is not used to apply for a group exemption letter.

Exempt Organizations - Required Filings

Although they are exempt from income taxation, exempt organizations are generally required to file annual returns of their income and expenses with the Internal Revenue Service. As of 2008, small tax-exempt organizations that previously were not required to file returns because their gross receipts did not exceed a certain threshold may be required to file an annual electronic notice. Some organizations, such as churches and certain church-affiliated organizations, are not required to file annual returns or notices. If an organization has unrelated business income, it must file an unrelated business income tax return. In addition to filing an annual exempt organization return, exempt organizations may be required to file other returns of and pay employment taxes. Some organizations may be required to file certain returns electronically. In addition to required filings, a charity may have other ongoing compliance obligations.

Lesson 9 - Specialized Returns

Unrelated Business Taxable Income (UBTI)

Even though an organization is recognized as tax exempt, it still may be liable for tax on its unrelated business income. For most organizations, unrelated business income is income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization's exemption. An exempt organization that has $1,000 or more of gross income from an unrelated business must file Form 990-T - Exempt Organization Business Income Tax Return. An organization must pay estimated tax if it expects its tax for the year to be $500 or more. The obligation to file Form 990-T is in addition to the obligation to file the annual information return, Form 990, 990-EZ or 990-PF. Each organization must file a separate Form 990-T, except title holding corporations and organizations receiving their earnings that file a consolidated return under Internal Revenue Code Section 1501.

Employment Taxes

If a tax-exempt organization (EO) has employees, the EO is responsible for Federal Income Tax Withholding and Social Security and Medicare taxes. In addition, some EOs are responsible for Federal Unemployment Tax.

Retirement Plans SEP, SIMPLE, and qualified plans offer the employer and his or her employees a tax-favored way to save for retirement. The employer can deduct contributions he or she makes to the plan for his or her employees. If the taxpayer is a sole proprietor, he or she can deduct contributions he or she makes to the plan for him or herself. An employer can also deduct trustees' fees if contributions to the plan do not cover them. Earnings on the contributions are generally tax free until the employer or his or her employees receive distributions from the plan. Under a 401(k) plan, employees can have an employer contribute limited amounts of their before-tax (after-tax, in the case of a qualified Roth contribution program) pay to the plan. These amounts (and the earnings on them) are generally tax free until his or her employees receive distributions from the plan or, in the case of a qualified distribution from a designated Roth account, completely tax free.

Simplified Employee Pension Plans (SEP)

SEPs provide a simplified method for an employer to make contributions to a retirement plan for him or herself and his or her employees. Instead of setting up a profit-sharing or money purchase plan with a trust, the employer can adopt a SEP agreement and make contributions directly to a traditional individual retirement account or a traditional individual retirement annuity (SEP-IRA) set up for him or herself and each eligible employee. Contributions an employer makes for 2023 to a common-law employee's SEP-IRA cannot exceed the lesser of 25% of the employee's compensation or $66,000. Compensation generally does not include the employer’s contributions to the SEP. The SEP plan document will specify how the employer contribution is determined and how it will be allocated to participants. If the employer contributes to a defined contribution plan, annual additions to an account are limited to the lesser of $66,000 or 100% of the participant's compensation in 2023. When the employer figures this limit, he or she must add his or her contributions to all defined contribution plans maintained by him or her. Because a SEP is considered a defined contribution plan for this limit, the employer’s contributions to a SEP must be added to the employer’s contributions to other defined contribution plans he or she maintains. Generally, the employer can deduct the contributions he or she makes each year to each employee's SEP-IRA. If the taxpayer is self-employed, he or she can deduct the contributions he or she makes each year to his or her own SEP-IRA. The most an employer can deduct for his or her contributions to the employer’s or his or her employee's SEP-IRA is the lesser of the following amounts:

1. The employer’s contributions (including any excess contributions carryover). 2. 25% of the compensation (limited to $330,000 per participant) paid to the participants during 2023 from the

business that has the plan, not to exceed $66,000 per participant.

Lesson 9 - Specialized Returns

Savings Incentive Match Plans (SIMPLE)

Generally, if an employer had 100 or fewer employees who received at least $5,000 in compensation last year, he or she can set up a SIMPLE plan. Under a SIMPLE plan, employees can choose to make salary reduction contributions rather than receiving these amounts as part of their regular pay. In addition, the employer will contribute matching or non-elective contributions. The two types of SIMPLE plans are the SIMPLE IRA plan and the SIMPLE 401(k) plan. Contributions are made up of salary reduction contributions and employer contributions. The employer must make either matching contributions or non-elective contributions. No other contributions can be made to the SIMPLE IRA plan. These contributions, which the employer can deduct, must be made timely. The amount the employee chooses to have the employer contribute to a SIMPLE IRA on his or her behalf cannot be more than $15,500 for 2023. These contributions must be expressed as a percentage of the employee's compensation unless the employer permits the employee to express them as a specific dollar amount. The employer cannot place restrictions on the contribution amount (such as limiting the contribution percentage), except to comply with the $15,500 limit. If the employer or an employee participates in any other qualified plan during the year and the employer’s or his or her employee have salary reduction contributions (elective deferrals) under those plans, the salary reduction contributions under a SIMPLE IRA plan also count toward the overall annual limit, $22,500 in 2023, on exclusion of salary reduction contributions and other elective deferrals. A SIMPLE IRA plan can permit participants who are age 50 or over at the end of the calendar year to also make catch-up contributions. The catch-up contribution limit for 2023 for SIMPLE IRA plans is $3,500. Salary reduction contributions are not treated as catch-up contributions for 2023 until they exceed $15,500. However, the catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts:

➢ The catch-up contribution limit. ➢ The excess of the participant's compensation over the salary reduction contributions that are not catch-up

contributions.

The employer is generally required to match each employee's salary reduction contributions on a dollar-for- dollar basis up to 3% of the employee's compensation. This requirement does not apply if the employer makes non-elective contributions.

Instead of matching contributions, the employer can choose to make non-elective contributions of 2% of compensation on behalf of each eligible employee who has at least $5,000 (or some lower amount if the employer selects) of compensation from him or her for the year. If employer makes this choice, he or she must make non-elective contributions whether or not the employee chooses to make salary reduction contributions. Only $330,000 of the employee's compensation can be taken into account to figure the contribution limit in 2023.

If the employer chooses this 2% contribution formula, he or she must notify the employees within a reasonable period of time before the 60-day election period for the calendar year. The employer can deduct SIMPLE IRA contributions in the tax year within which the calendar year for which contributions were made ends. The employer can deduct contributions for a particular tax year if they are made for that tax year and are made by the due date (including extensions) of his or her Federal income tax return for that year.

Qualified Plans

The qualified plan rules are more complex than the SEP plan and SIMPLE plan rules. However, there are advantages to qualified plans, such as increased flexibility in designing plans and increased contribution and deduction limits in some cases. Qualified retirement plans set up by self-employed individuals are sometimes called Keogh or H.R.10 plans. A sole proprietor or a partnership can set up one of these plans. A common-law employee or a partner cannot set up one of these plans. These plans can also be set up and maintained by employers that are corporations. All the rules discussed here apply to corporations except where specifically limited to the self-employed.

There are two basic kinds of qualified plans, defined contribution plans and defined benefit plans, and different rules apply to each. The employer can have more than one qualified plan, but his or her contributions to all the plans must not total more than the overall limits.

Lesson 9 - Specialized Returns

Defined Contribution Plan

A defined contribution plan provides an individual account for each participant in the plan. It provides benefits to a participant largely based on the amount contributed to that participant's account. Benefits are also affected by any income, expenses, gains, losses, and forfeitures of other accounts that may be allocated to an account. A defined contribution plan can be either a profit-sharing plan or a money purchase pension plan. Although it is called a “profit-sharing plan,” the employer does not actually have to make a business profit for the year in order to make a contribution (except for him or herself if he or she is self-employed). A profit-sharing plan can be set up to allow for discretionary employer contributions, meaning the amount contributed each year to the plan is not fixed. An employer may even make no contribution to the plan for a given year. The plan must provide a definite formula for allocating the contribution among the participants and for distributing the accumulated funds to the employees after they reach a certain age, after a fixed number of years, or upon certain other occurrences. In general, the employer can be more flexible in making contributions to a profit-sharing plan than to a money purchase pension plan or a defined benefit plan. Contributions to a money purchase pension plan are fixed and are not based on the employer’s business profits. For example, if the plan requires that contributions be 10% of the participants' compensation without regard to whether the employer has profits (or the self-employed person has earned income), the plan is a money purchase pension plan. This applies even though the compensation of a self-employed individual as a participant is based on earned income derived from business profits.

Defined Benefit Plan

A defined benefit plan is any plan that is not a defined contribution plan. Contributions to a defined benefit plan are based on what is needed to provide definitely determinable benefits to plan participants. Actuarial assumptions and computations are required to figure these contributions. Generally, the taxpayer will need continuing professional help to have a defined benefit plan. A qualified plan is generally funded by the employer’s contributions. However, employees participating in the plan may be permitted to make contributions, and the employer may be permitted to make contributions on his or her own behalf. An employer can make deductible contributions for a tax year up to the due date of his or her return (plus extensions) for that year. The plan must provide that contributions or benefits cannot exceed certain limits. The limits differ depending on whether the plan is a defined contribution plan or a defined benefit plan. For 2023, the annual benefit for a participant under a defined benefit plan cannot exceed the lesser of the following amounts:

➢ 100% of the participant's average compensation for his or her highest 3 consecutive calendar years. ➢ $265,000 in 2023.

For 2023, a defined contribution plan's annual contributions and other additions (excluding earnings) to the account of a participant cannot exceed the lesser of the following amounts:

➢ 100% of the participant's compensation. ➢ $66,000.

Catch-up contributions are not subject to the above limit.

Employees may be permitted to make nondeductible contributions to a plan in addition to an employer’s contributions. Even though these employee contributions are not deductible, the earnings on them are tax free until distributed in later years. Also, these contributions must satisfy the nondiscrimination test of Section 401(m). An employer can usually deduct, subject to limits, contributions he or she makes to a qualified plan, including those made for his or her own retirement. The contributions (and earnings and gains on them) are generally tax free until distributed by the plan. The deduction limit for the contributions to a qualified plan depends on the kind of plan the employer has.

Lesson 9 - Specialized Returns

The deduction for contributions to a defined contribution plan (profit-sharing plan or money purchase pension plan) cannot be more than 25% of the compensation paid (or accrued) during the year to the employer’s eligible employees participating in the plan. If the taxpayer is self-employed, he or she must reduce this limit in figuring the deduction for contributions he or she makes for his or her own account. When figuring the deduction limit, the following rules apply:

➢ Elective deferrals (discussed later) are not subject to the limit. ➢ Compensation includes elective deferrals. ➢ The maximum compensation that can be taken into account for each employee in 2023 is $330,000.

The deduction for contributions to a defined benefit plan is based on actuarial assumptions and computations. Consequently, an actuary must figure the deduction limit.

Prohibited Transactions

Prohibited transactions are transactions between the plan and a disqualified person that are prohibited by law. If the employer is a disqualified person who takes part in a prohibited transaction, he or she must pay a tax. Prohibited transactions generally include the following transactions:

1. A transfer of plan income or assets to or use of them by or for the benefit of, a disqualified person. 2. Any act of a fiduciary by which he or she deals with plan income or assets in his or her own interest. 3. The receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a

transaction that involves plan income or assets. 4. Any of the following acts between the plan and a disqualified person:

a. Selling, exchanging, or leasing property. b. Lending money or extending credit. c. Furnishing goods, services, or facilities.

Certain transactions are exempt from being treated as prohibited transactions. For example, a prohibited transaction does not take place if the employer is a disqualified person and receives any benefit to which he or she is entitled as a plan participant or beneficiary. However, the benefit must be figured and paid under the same terms as for all other participants and beneficiaries. The taxpayer is a disqualified person if he or she is any of the following:

1. A fiduciary of the plan. 2. A person providing services to the plan. 3. An employer, any of whose employees are covered by the plan. 4. An employee organization, any of whose members are covered by the plan. 5. Any direct or indirect owner of 50% or more of any of the following:

a. The combined voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of a corporation that is an employer or employee organization described in (3) or (4).

b. The capital interest or profits interest of a partnership that is an employer or employee organization described in (3) or (4).

c. The beneficial interest of a trust or unincorporated enterprise that is an employer or an employee organization described in (3) or (4).

6. A member of the family of any individual described in (1), (2), (3), or (5). (A member of a family is the spouse, ancestor, lineal descendant, or any spouse of a lineal descendant.)

7. A corporation, partnership, trust, or estate of which (or in which) any direct or indirect owner described in (1) through (5) holds 50% or more of any of the following:

a. The combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation.

b. The capital interest or profits interest of a partnership. c. The beneficial interest of a trust or estate.

8. An officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10% or more shareholder, or highly compensated employee (earning 10% or more of the yearly wages of an employer) of a person described in (3), (4), (5), or (7).

9. A 10% or more (in capital or profits) partner or joint venture of a person described in (3), (4), (5), or (7).

Lesson 9 - Specialized Returns

10. Any disqualified person, as described in (1) through (9) above, who is a disqualified person with respect to any plan to which a Section 501(c)(22) trust is permitted to make payments under Section 4223 of ERISA.

The term “highly compensated employee” means any employee who:

➢ Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or

➢ For the preceding year: o Received compensation from the business of more than $150,000 if the preceding year is 2023, and o If the employer so chooses, was in the top 20% of employees when ranked by compensation for the

preceding year.

The initial tax on a prohibited transaction is 15% of the amount involved for each year (or part of a year) in the taxable period. If the transaction is not corrected within the taxable period, an additional tax of 100% of the amount involved is imposed. Both taxes are payable by any disqualified person who participated in the transaction (other than a fiduciary acting only as such). If more than one person takes part in the transaction, each person can be jointly and severally liable for the entire tax.

Farms The taxpayer is in the business of farming if he or she cultivates, operates, or manages a farm for profit, either as owner or tenant. A farm includes livestock, dairy, poultry, fish, fruit, and truck farms. It also includes plantations, ranches, ranges, and orchards. Gross farm income refers to the monetary and non-monetary income received by farm operators. Its main components include cash receipts from the sale of farm products, government payments, other farm income (such as income from custom work), value of food and fuel produced and consumed on the same farm, rental value of farm dwellings, and change in value of year- end inventories of crops and livestock. Here are 10 things about farm income and expenses that the IRS wants the taxpayer to know. (178)

1. Crop insurance proceeds. Insurance payments from crop damage count as income. They should generally be reported the year they are received.

2. Deductible farm expenses. Farmers can deduct ordinary and necessary expenses as business expenses. An ordinary farming expense is one that is common and accepted in the farming business. A necessary expense is one that is appropriate for that business.

3. Employees and hired help. The taxpayer can deduct reasonable wages paid to the farm’s full and part-time workers. The taxpayer must withhold Social Security, Medicare and income taxes from the employees’ wages.

4. Items purchased for resale. If the taxpayer purchased livestock and other items for resale, he or she may be able to deduct their cost in the year of the sale. This includes freight charges for transporting livestock to the farm.

5. Repayment of loans. The taxpayer can only deduct the interest paid on a loan if the loan proceeds are used for the farming business. He or she cannot deduct interest on a loan used for personal expenses.

6. Weather-related sales. Bad weather may force the taxpayer to sell more livestock or poultry than normal. If so, he or she may be able to postpone reporting a gain from the sale of the additional animals.

7. Net operating losses. If deductible expenses are more than income for the year, the taxpayer may have a net operating loss. He or she can carry that loss over to other years and deduct it. The taxpayer may get a refund of part or all of the income tax paid for past years or may be able to reduce his or her tax in future years.

8. Farm income averaging. The taxpayer may be able to average some or all of the current year's farm income by spreading it out over the past three years. This may lower his or her taxes if the farm income is high in the current year and low in one or more of the past three years. This method does not change the prior year tax. It only uses the prior year information to figure the current year tax.

9. Fuel and road use. The taxpayer may be able to claim a tax credit or refund of Federal excise taxes on fuel used on the farm for farm work.

10. Farmers Tax Guide. More information about farm income and deductions is in Publication 225 - Farmer’s Tax Guide.

Schedule F (Form 1040)

Individuals, trusts, and partnerships report farm income on Schedule F (Form 1040) - Profit or Loss From Farming. Use this schedule to figure the net profit or loss from regular farming operations. Income from farming reported on Schedule F

Lesson 9 - Specialized Returns

includes amounts the taxpayer receives from cultivating, operating, or managing a farm for gain or profit, either as owner or tenant. This includes income from operating a stock, dairy, poultry, fish, fruit, or truck farm and income from operating a plantation, ranch, range, or orchard. It also includes income from the sale of crop shares if the taxpayer materially participates in producing the crop. Income received from operating a nursery, which specializes in growing ornamental plants, is considered to be income from farming. Income reported on Schedule F does not include gains or losses from sales or other dispositions of the following farm assets: (179)

➢ Land. ➢ Depreciable farm equipment. ➢ Buildings and structures. ➢ Livestock held for draft, breeding, sport, or dairy purposes.

Amounts received from the sales of products the taxpayer raised on his or her farm for sale (or bought for resale), such as livestock, produce, or grains, are reported on Schedule F. This includes money and the fair market value of any property or services the taxpayer receives. When he or she sells farm products bought for resale, the profit or loss is the difference between the selling price (money plus the fair market value of any property) and the basis in the item (usually the cost). The taxpayer generally reports these amounts on Schedule F for the year he or she receives payment. Sales of livestock held for draft, breeding, sport, or dairy purposes may result in ordinary or capital gains or losses, depending on the circumstances. In either case, the taxpayer should always report these sales on Form 4797 - Sales of Business Property instead of Schedule F. Animals the taxpayer does not hold primarily for sale are considered business assets of his or her farm.

Accounting Methods

A farmer must use an accounting method that clearly shows his or her income and expenses. He or she must also figure his or her taxable income and file an income tax return for an annual accounting period called a tax year.

Cash Method

Most farmers use the cash method because they find it easier to keep records using the cash method. However, certain farm corporations and partnerships and all tax shelters must use an accrual method of accounting. Under the cash method, include in the taxpayer’s gross income all items of income he or she actually or constructively received during the tax year. Items of income include money received as well as property or services received. If the taxpayer receives property or services, he or she must include the fair market value (FMV) of the property or services in income. Income is constructively received when an amount is credited to the taxpayer’s account or made available to him or her without restriction. The taxpayer does not need to have possession of the income for it to be treated as income for the tax year. If he or she authorizes someone to be his or her agent and receive income for him or her, the taxpayer is considered to have received the income when the agent receives it. Income is not constructively received if the taxpayer’s receipt of the income is subject to substantial restrictions or limitations. The taxpayer cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. He or she must report the income in the year the money or property is received or made available to him or her without restriction.

Review Question 6 Frances Jones, a farmer who uses the cash method of accounting, was entitled to receive a $10,000 payment on a grain contract in December 2023. She was told in December that her payment was available. She requested not to be paid until January 2024. In what year must Frances include this payment in her income?

A. 2022 B. 2023 C. 2024 D. 2025

See Review Feedback for answer.

Lesson 9 - Specialized Returns

Accrual Method

Under an accrual method of accounting, a farmer generally reports income in the year earned and deducts or capitalizes expenses in the year incurred. The purpose of an accrual method of accounting is to correctly match income and expenses. Certain businesses engaged in farming must use an accrual method of accounting for its farm business and for sales and purchases of inventory items. Generally, the taxpayer includes an amount in income for the tax year in which all events that fix his or her right to receive the income have occurred, and he or she can determine the amount with reasonable accuracy. Under this rule, include an amount in income on the earliest of the following dates: (180)

➢ When the taxpayer receives payment. ➢ When the income amount is due to the taxpayer. ➢ When the taxpayer earns the income. ➢ When title passes.

If the taxpayer keeps an inventory, generally he or she must use an accrual method of accounting to determine his or her gross income. An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. Under an accrual method of accounting, the taxpayer generally deducts or capitalizes a business expense when both of the following apply: (180)

1. The all-events test has been met. This test is met when: a. All events have occurred that fix the fact that the taxpayer has a liability. b. The amount of the liability can be determined with reasonable accuracy.

2. Economic performance has occurred.

Generally, the taxpayer cannot deduct or capitalize a business expense until economic performance occurs. If his or her expense is for property or services provided to him or her, or for his or her use of property, economic performance occurs as the property or services are provided or as the property is used. If the taxpayer’s expense is for property or services he or she provides to others, economic performance occurs as he or she provides the property or services. Generally, the following businesses, if engaged in farming, must use an accrual method of accounting: (180)

1. A corporation that has gross receipts of more than $29 million in 2023. 2. A partnership with a corporation as a partner, if that corporation meets the requirements of (1) above. 3. A tax shelter.

Items (1) and (2) above do not apply to an S corporation or a business operating a nursery or sod farm, or the raising or harvesting of trees (other than fruit and nut trees).

Review Question 7 Jane, who is a farmer, uses a calendar tax year and an accrual method of accounting. She entered into a contract with ABC Farm Consulting in 2022. The contract stated that Jane must pay ABC Farm Consulting $2,000 in December 2022. It further stipulates that ABC Farm Consulting will develop a plan for integrating her farm with a larger farm operation based in a neighboring state by March 1, 2023. Jane paid ABC Farm Consulting $2,000 in December 2022. Integration of operations according to the plan began in May 2023 and they completed the integration in December 2023. Jane incurs what amount of cost in 2023?

A. $0 B. $500 C. $1,000 D. $2,000

See Review Feedback for answer.

Lesson 9 - Specialized Returns

Farm Sales and Exchanges If the taxpayer sells, exchanges, or otherwise disposes of his or her property, he or she usually has a gain or a loss. A sale is a transfer of property for money or a mortgage, note, or other promise to pay money. An exchange is a transfer of property for other property or services. Amounts received from the sales of products the taxpayer raised on his or her farm for sale (or bought for resale), such as livestock, produce, or grains, are reported on Schedule F - Profit or Loss From Farming. This includes money and the fair market value of any property or services he or she receives. When the taxpayer sells farm products bought for resale, his or her profit or loss is the difference between the selling price (money plus the fair market value of any property) and the basis in the item (usually the cost). The taxpayer generally reports these amounts on Schedule F for the year he or she receives payment.

Ordinary or Capital Gain or Loss

Generally, the taxpayer will have a capital gain or loss if he or she sells or exchanges a capital asset. He or she may also have a capital gain if his or her Section 1231 transactions result in a net gain. To figure the net capital gain or loss, the taxpayer must classify his or her gains and losses as either ordinary or capital (and his or her capital gains or losses as either short-term or long-term). The net capital gains may be taxed at a lower tax rate than ordinary income. The deduction for a net capital loss may be limited.

Livestock

This part discusses the sale or exchange of livestock used in a farm business. Gain or loss from the sale or exchange of this livestock may qualify as a Section 1231 gain or loss. However, any part of the gain that is ordinary income from the recapture of depreciation is not included as Section 1231 gain. The rules discussed here do not apply to the sale of livestock held primarily for sale to customers. The sale of this livestock is reported on Schedule F. The sale or exchange of livestock used in a farm business qualifies as a Section 1231 transaction if the taxpayer held the livestock for 12 months or more (24 months or more for horses and cattle). For Section 1231 transactions, livestock includes cattle, hogs, horses, mules, donkeys, sheep, goats, fur-bearing animals, and other mammals. Also, for Section 1231 transactions, livestock does not include chickens, turkeys, pigeons, geese, emus, ostriches, rheas, or other birds, fish, frogs, reptiles, etc. If livestock is held primarily for draft, breeding, dairy, or sporting purposes, it is used in a farm business. The purpose for which an animal is held ordinarily is determined by a farmer's actual use of the animal. An animal is not held for draft, breeding, dairy, or sporting purposes merely because it is suitable for that purpose, or because it is held for sale to other persons for use by them for that purpose. However, a draft, breeding, or sporting purpose may be present if an animal is disposed of within a reasonable time after it is prevented from its intended use or made undesirable as a result of an accident, disease, drought, or unfitness of the animal. Example Ben discovers an animal that he intends to use for breeding purposes is sterile. He disposes of it within a reasonable time. This animal was held for breeding purposes. Gain on the sale of raised livestock is generally the gross sales price reduced by any expenses of the sale. Expenses of sale include sales commissions, freight or hauling from a farm to a commission company, and other similar expenses. The basis of the animal sold is zero if the costs of raising it were deducted during the years the animal was being raised.

Rents

The rent a taxpayer receives for the use of his or her farmland is generally rental income, not farm income. However, if the taxpayer materially participates in farming operations on the land, the rent is farm income. If the taxpayer pastures someone else's livestock and takes care of them for a fee, the income is from his or her farming business. The taxpayer must enter it as Other income on Schedule F. If the taxpayer simply rents his or her pasture for a flat cash amount without providing services, report the income as rent on Part I of Schedule E (Form 1040) - Supplemental Income and Loss.

Crop Shares

The taxpayer must include rent he or she receives in the form of crop shares in income in the year he or she converts the

Lesson 9 - Specialized Returns

shares to money or the equivalent of money. It does not matter whether the taxpayer uses the cash method of accounting or an accrual method of accounting. If the taxpayer materially participates in operating a farm from which he or she receives rent in the form of crop shares or livestock, the rental income is included in self-employment income. If the taxpayer does not materially participate in operating the farm, report this income on Form 4835 and carry the net income or loss to Schedule E (Form 1040). The income is not included in self-employment income.

Sales Caused by Weather-Related Conditions

If the taxpayer sells or exchanges more livestock, including poultry, than he or she normally would in a year because of a drought, flood, or other weather-related condition, he or she may be able to postpone reporting the gain from the additional animals until the next year. The taxpayer must meet all the following conditions to qualify: (179)

➢ His or her principal trade or business is farming. ➢ He or she uses the cash method of accounting. ➢ He or she can show that, under his or her usual business practices, he or she would not have sold or exchanged

the additional animals this year except for the weather-related condition. ➢ The weather-related condition caused an area to be designated as eligible for assistance by the Federal

government. Sales or exchanges made before an area became eligible for Federal assistance qualify if the weather-related condition that caused the sale or exchange also caused the area to be designated as eligible for Federal assistance. The designation can be made by the President, the Department of Agriculture (or any of its agencies), or by other Federal departments or agencies. The taxpayer should follow these steps to figure the amount of gain to be postponed for each class of animals:

1. Divide the total income realized from the sale of all livestock in the class during the tax year by the total number of such livestock sold. For this purpose, do not treat any postponed gain from the previous year as income received from the sale of livestock.

2. Multiply the result in (1) by the excess number of such livestock sold solely because of weather-related conditions.

Review Question 8 In 2021, Carmen bought 20 feeder calves for $11,000 for resale. She sold them in 2023 for $21,000. What amount of profit will Carmen report her on 2023 Schedule F?

A. $0 B. $10,000 C. $11,000 D. $21,000

See Review Feedback for answer.

Deductible Expenses The ordinary and necessary costs of operating a farm for profit are deductible business expenses. Schedule F, Part II, lists some common farm expenses that are typically deductible. If the reimbursement is received in the same year that the expense is claimed, reduce the expense by the amount of the reimbursement. If the reimbursement is received in a year after the expense is claimed, include the reimbursement amount in income. Some expenses the taxpayer pays during the tax year may be part personal and part business. These may include expenses for gasoline, oil, fuel, water, rent, electricity, telephone, automobile upkeep, repairs, insurance, interest, and taxes. The taxpayer must allocate these mixed expenses between their business and personal parts. Generally, the personal part of these expenses is not deductible. The business portion of the expenses is deductible on Schedule F.

Prepaid Farm Supplies

Prepaid farm supplies include the following items if paid for during the year:

Lesson 9 - Specialized Returns

➢ Feed, seed, fertilizer, and similar farm supplies not used or consumed during the year, but not including farm supplies that the taxpayer would have consumed during the year if not for a fire, storm, flood, other casualty, disease, or drought.

➢ Poultry (including egg-laying hens and baby chicks) bought for use (or for both use and resale) in the taxpayer’s farm business. However, include only the amount that would be deductible in the following year if he or she had capitalized the cost and deducted it ratably over the lesser of 12 months or the useful life of the poultry.

➢ Poultry bought for resale and not resold during the year.

If the taxpayer uses the cash method of accounting to report his or her income and expenses, the deduction for prepaid farm supplies in the year he or she pays for them may be limited to 50% of the other deductible farm expenses for the year (all Schedule F deductions except prepaid farm supplies). This limit does not apply if the taxpayer meets certain exceptions. If the limit applies, the taxpayer can deduct the excess cost of farm supplies other than poultry in the year he or she uses or consumes the supplies. The excess cost of poultry bought for use (or for both use and resale) in the taxpayer’s farm business is deductible in the year following the year he or she pays for it. The excess cost of poultry bought for resale is deductible in the year he or she sells or otherwise disposes of that poultry.

Conservation Expenses

A taxpayer can deduct conservation expenses only for land he or she or his or her tenant are using, or have used in the past, for farming. These expenses include, but are not limited to, the following:

1. The treatment or movement of earth, such as: a. Leveling. b. Conditioning. c. Grading. d. Terracing. e. Contour furrowing. f. Restoration of soil fertility.

2. The construction, control, and protection of: a. Diversion channels. b. Drainage ditches. c. Irrigation ditches. d. Earthen dams. e. Watercourses, outlets, and ponds.

3. The eradication of brush. 4. The planting of windbreaks.

The taxpayer cannot deduct expenses to drain or fill wetlands, or to prepare land for center pivot irrigation systems, as soil and water conservation expenses. These expenses are added to the basis of the land. The basis of property a taxpayer buys is usually its cost. Cost is the amount he or she pays in cash, debt obligations, other property, or services. The taxpayer’s cost includes amounts he or she pays for sales tax, freight, installation, and testing. The basis of real estate and business assets will include other items. Basis generally does not include interest payments.

Dispositions of Property Used in Farming

When the taxpayer disposes of property used in his or her farm business, the taxable gain or loss is usually treated as ordinary income (which is taxed at the same rates as wages and interest income) or capital gain (which is generally taxed at lower rates) under the rules for Section 1231 transactions. When the taxpayer disposes of depreciable property (Section 1245 property or Section 1250 property) at a gain, he or she may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. Any gain remaining after applying the depreciation recapture rules is a Section 1231 gain, which may be taxed as a capital gain. Gains and losses from property used in farming are reported on Form 4797 - Sales of Business Property.

Lesson 9 - Specialized Returns

Gain or loss on the following transactions is subject to Section 1231 treatment: (179)

➢ Sale or exchange of cattle and horses - The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 24 months or longer.

➢ Sale or exchange of other livestock - This livestock must be held for draft, breeding, dairy, or sporting purposes and held for 12 months or longer. Other livestock includes hogs, mules, sheep, goats, donkeys, and other fur- bearing animals. Other livestock does not include poultry.

➢ Sale or exchange of depreciable personal property - This property must be used in the taxpayer’s business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. Examples of depreciable personal property include farm machinery and trucks. It also includes amortizable Section 197 intangibles.

➢ Sale or exchange of real estate - This property must be used in the taxpayer’s business and held longer than 1 year. Examples are his or her farm or ranch (including barns and sheds).

➢ Sale or exchange of unharvested crops - The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person, and the land must have been held longer than 1 year. The taxpayer cannot keep any right or option to reacquire the land directly or indirectly (other than a right customarily incident to a mortgage or other security transaction). Growing crops sold with a leasehold on the land, even if sold to the same person in a single transaction, are not included.

➢ Distributive share of partnership gains and losses - The taxpayer’s distributive share must be from the sale or exchange of property listed earlier and held longer than 1 year (or for the required period for certain livestock).

➢ Cutting or disposal of timber - The taxpayer must treat the cutting or disposal of timber as a sale. ➢ Condemnation - The condemned property must have been held longer than 1 year. It must be business property

or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. It cannot be property held for personal use.

➢ Casualty or theft - The casualty or theft must have affected business property, property held for the production of rents or royalties, or investment property (such as notes and bonds). The taxpayer must have held the property longer than 1 year. However, if his or her casualty or theft losses are more than his or her casualty or theft gains, neither the gains nor the losses are taken into account in the Section 1231 computation. Section 1231 does not apply to personal casualty gains and losses.

Section 1245 Property

A gain on the disposition of Section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable. Any recognized gain that is more than the part that is ordinary income because of depreciation is a Section 1231 gain. Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property:

1. Personal property (either tangible or intangible). 2. Other tangible property (except buildings and their structural components) used as any of the following. See

Buildings and structural components below: a. An integral part of manufacturing, production, or extraction, or of furnishing transportation,

communications, electricity, gas, water, or sewage disposal services. b. A research facility in any of the activities in (a). c. A facility in any of the activities in (a) above, for the bulk storage of fungible commodities.

3. That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following: a. Amortization of certified pollution control facilities. b. The Section 179 expense deduction. c. Deduction for clean-fuel vehicles and certain refueling property. d. Certain expenditures for childcare facilities. (Repealed by Public Law 101-58, Omnibus Budget

Reconciliation Act of 1990, Section 11801(a)(13) except with regards to deductions made prior to November 5, 1990.)

e. Expenditures to remove architectural and transportation barriers to the handicapped and elderly. f. Certain reforestation expenditures.

4. Single purpose agricultural (livestock) or horticultural structures. 5. Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary

product of petroleum.

Lesson 9 - Specialized Returns

The gain treated as ordinary income on the sale, exchange, or involuntary conversion of Section 1245 property, including a sale and leaseback transaction, is the lesser of the following amounts. The depreciation (which includes any Section 179 deduction claimed) and amortization allowed or allowable on the property. The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property). For any other disposition of Section 1245 property, ordinary income is the lesser of (1) above or the amount by which its fair market value (FMV) is more than its adjusted basis. For details, see chapter 3 of Publication 544. If the taxpayer elects not to use the uniform capitalization rules, he or she must treat any plant he or she produces as Section 1245 property. If the taxpayer has a gain on the property's disposition, he or she must recapture the pre-productive expenses he or she would have capitalized if he or she had not made the election by treating the gain, up to the amount of these expenses, as ordinary income. For Section 1231 transactions, show these expenses as depreciation on Form 4797, Part III, line 22. For plant sales that are reported on Schedule F - Profit or Loss From Farming, this recapture rule does not change the reporting of income because the gain is already ordinary income. The taxpayer can use the farm- price method or the unit-livestock-price method to figure these expenses.

Section 1250 Property

Gain on the disposition of Section 1250 property is treated as ordinary income to the extent of additional depreciation allowed or allowable on the property. Section 1250 property includes all real property that is subject to an allowance for depreciation and that is not and never has been Section 1245 property. It includes a leasehold of land or Section 1250 property subject to an allowance for depreciation. A fee simple interest in land is not included because it is not depreciable. If the taxpayer’s Section 1250 property becomes Section 1245 property because he or she changes its use, the taxpayer can never again treat it as Section 1250 property. If the taxpayer holds Section 1250 property longer than 1 year, the additional depreciation is the actual depreciation adjustments that are more than the depreciation figured using the straight line method. If the taxpayer holds Section 1250 property for 1 year or less, all the depreciation is additional depreciation. The taxpayer will not have additional depreciation if any of the following conditions apply to the property disposed of: (181)

➢ He or she figured depreciation for the property using the straight line method or any other method that does not result in depreciation that is more than the amount figured by the straight line method; he or she held the property longer than 1 year; and, if the property was qualified property, he or she made a timely election not to claim any special depreciation allowance. In addition, if the property was in a renewal community, he or she must not have elected to claim a commercial revitalization deduction for property placed in service before January 1, 2010.

➢ The property was residential low-income rental property he or she held for 16 ⅔ years or longer. For low-income rental housing on which the special 60-month depreciation for rehabilitation expenses was allowed, the 16 ⅔ years start when the rehabilitated property is placed in service.

➢ He or she chose the alternate ACRS method for the property, which was a type of 15-, 18-, or 19-year real property covered by the Section 1250 rules.

➢ The property was residential rental property or nonresidential real property placed in service after 1986 (or after July 31, 1986, if the choice to use MACRS was made); he or she held it longer than 1 year; and, if the property was qualified property, he or she made a timely election not to claim any special depreciation allowance. These properties are depreciated using the straight line method. In addition, if the property was in a renewal community, he or she must not have elected to claim a commercial revitalization deduction.

Additional depreciation includes all depreciation adjustments to the basis of Section 1250 property whether allowed to the taxpayer or another person (as carryover basis property).

Farm Inventory

If the taxpayer is required to keep an inventory, he or she should keep a complete record of his or her inventory as part of his or her farm records. This record should show the actual count or measurement of the inventory. It should also show all factors that enter into its valuation, including quality and weight, if applicable. If the taxpayer is in the hatchery business, and use an accrual method of accounting, he or she must include in inventory eggs in the process of incubation. All harvested and purchased farm products held for sale or for feed or seed, such as grain, hay, silage, concentrates, cotton, tobacco, etc., must be included in inventory.

Lesson 9 - Specialized Returns

Supplies acquired for sale or that become a physical part of items held for sale must be included in inventory. Deduct the cost of supplies in the year used or consumed in operations. Do not include incidental supplies in inventory as these are deductible in the year of purchase.

Livestock held primarily for sale must be included in inventory. Livestock held for draft, breeding, or dairy purposes can either be depreciated or included in inventory. If the taxpayer is in the business of breeding and raising chinchillas, mink, foxes, or other fur-bearing animals, these animals are livestock for inventory purposes. Generally, growing crops are not required to be included in inventory. However, if the crop has a preproductive period of more than 2 years, the taxpayer may have to capitalize (or include in inventory) costs associated with the crop. See Uniform capitalization rules below. The taxpayer’s inventory should include all items held for sale, or for use as feed, seed, etc., whether raised or purchased, that are unsold at the end of the year.

Uniform Capitalization Rules

The following applies if the taxpayer is required to use an accrual method of accounting:

➢ The uniform capitalization rules apply to all costs of raising a plant, even if the preproductive period of raising a plant is 2 years or less.

➢ The costs of animals are subject to the uniform capitalization rules. In a farming business using the cash method of accounting, the uniform capitalization rules do not apply to:

➢ Any animal. ➢ Any plant with a preproductive period of 2 years or less. ➢ Any costs of replanting certain plants lost or damaged due to casualty.

In addition, the taxpayer can elect not to use the uniform capitalization rules for plants with a preproductive period of more than 2 years. If he or she makes this election, special rules apply. This election cannot be made by a corporation, partnership, or tax shelter required to use an accrual method of accounting. This election also does not apply to any costs incurred for the planting, cultivation, maintenance, or development of any citrus or almond grove (or any part thereof) within the first 4 years the trees were planted. If the taxpayer elects not to use the uniform capitalization rules, he or she must use the alternative depreciation system for all property used in any of his or her farming businesses and placed in service in any tax year during which the election is in effect.

Inventory Valuation Methods

The following methods are those generally available for valuing inventory. The method the taxpayer uses must conform to generally accepted accounting principles for similar businesses and must clearly reflect income:

➢ Cost. ➢ Lower of cost or market. ➢ Farm-price method. ➢ Unit-livestock-price method.

If the taxpayer values his or her livestock inventory at cost or the lower of cost or market, he or she does not need IRS approval to change to the unit-livestock-price method. However, if the taxpayer values his or her livestock inventory using the farm-price method, then he or she must obtain permission from the IRS to change to the unit-livestock-price method.

Lesson 9 - Specialized Returns

Review Question 9 During 2023, Sean, a cash method taxpayer, bought fertilizer ($4,000), feed ($1,000), and seed ($500) for use on his farm in the following year. Sean’s total prepaid farm supplies expense for 2023 is $5,500. His other deductible farm expenses totaled $10,000 for 2023. Therefore, Sean’s deduction for prepaid farm supplies cannot be more than what amount for 2023?

A. $0 B. $5,000 C. $5,500 D. $10,000

See Review Feedback for answer.

Depreciation The taxpayer can depreciate most types of tangible property (except land), such as buildings, machinery, equipment, vehicles, certain livestock, and furniture. He or she can also depreciate certain intangible property, such as copyrights, patents, and computer software. To be depreciable, the property must meet all the following requirements:

1. It must be property the taxpayer owns. 2. It must be used in the taxpayer’s business or income-producing activity. 3. It must have a determinable useful life. 4. It must have a useful life that extends substantially beyond the year the taxpayer places it in service.

To claim depreciation on property, the taxpayer must use it in his or her business or income-producing activity. If the taxpayer uses property to produce income (investment use), the income must be taxable. The taxpayer cannot depreciate property that he or she uses solely for personal activities. However, if the taxpayer uses property for business or investment purposes and for personal purposes, he or she can deduct depreciation based only on the percentage of business or investment use. Example If the taxpayer uses his or her car for farm business, he or she can deduct depreciation based on its percentage of use in farming. If he or she also uses it for investment purposes, he or she can depreciate it based on its percentage of investment use. A taxpayer can never depreciate inventory because it is not held for use in his or her business. Inventory is any property the taxpayer holds primarily for sale to customers in the ordinary course of his or her business. Livestock purchased for draft, breeding, or dairy purposes can be depreciated only if they are not kept in an inventory account. Livestock the taxpayer raises usually has no depreciable basis because the costs of raising them are deducted and not added to their basis. Depreciation for livestock begins when the livestock reaches the age of maturity. If the taxpayer bought immature livestock for drafting purposes, depreciation begins when they can be worked. If the taxpayer bought immature livestock for dairy purposes, depreciation begins when they can be milked. If the taxpayer bought immature livestock for breeding purposes, depreciation begins when they can be bred. The taxpayer’s basis for depreciation is his or her initial cost for the immature livestock. If the taxpayer acquires an orchard, grove, or vineyard before the trees or vines have reached the income-producing stage, and they have a preproductive period of more than 2 years, he or she must capitalize the preproductive-period costs under the uniform capitalization rules (unless he or she elects not to use these rules). The depreciation begins when the trees and vines reach the income-producing stage (that is, when they bear fruit, nuts, or grapes in quantities sufficient to commercially warrant harvesting). (179)

Lesson 9 - Specialized Returns

Certain property cannot be depreciated, even if the requirements explained earlier are met. This includes the following:

➢ The taxpayer can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping. Although the taxpayer cannot depreciate land, he or she can depreciate certain costs incurred in preparing land for business use.

➢ Property placed in service and disposed of in the same year. ➢ Equipment used to build capital improvements. The taxpayer must add otherwise allowable depreciation on the

equipment during the period of construction to the basis of the taxpayer’s improvements. ➢ Intangible properties, such as Section 197 intangibles, are properties that do not have a determinable useful life

and generally cannot be depreciated. ➢ Certain term interests.

Disaster Area Losses

Special rules apply to Federally declared disaster area losses. A Federally declared disaster is a disaster that occurred in an area declared by the President to be eligible for Federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. It includes a major disaster or emergency declaration under the act. The taxpayer generally must deduct a casualty loss in the year it occurred. However, if he or she has a deductible loss from a disaster that occurred in an area warranting public or individual assistance (or both), he or she can choose to deduct that loss on his or her return or amended return for the tax year immediately preceding the tax year in which the disaster happened. If the taxpayer makes this choice, the loss is treated as having occurred in the preceding year. Qualified disaster relief payments are not included in the income of individuals to the extent any expenses compensated by these payments are not otherwise compensated for by insurance or other reimbursement. These payments are not subject to income tax, self-employment tax, or employment taxes (Social Security, Medicare, and Federal unemployment taxes). No withholding applies to these payments. Qualified disaster relief payments include payments the taxpayer receives (regardless of the source) for the following expenses:

➢ Reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a Federally declared disaster.

➢ Reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence due to a Federally declared disaster. (A personal residence can be a rented residence or one the taxpayer owns.)

➢ Reasonable and necessary expenses incurred for the repair or replacement of the contents of a personal residence due to a Federally declared disaster.

Qualified disaster relief payments include amounts paid by a Federal, state, or local government in connection with a Federally declared disaster to individuals affected by the disaster. Qualified disaster relief payments do not include:

➢ Payments for expenses otherwise paid for by insurance or other reimbursements, or ➢ Income replacement payments, such as payments of lost wages, lost business income, or unemployment

compensation.

Income Averaging for Farmers

If the taxpayer is engaged in a farming business, he or she may be able to average all or some of his or her farm income by using income tax rates from the 3 prior years (base years) to calculate the tax on that income. This may give the taxpayer a lower tax if his or her current year income is high and his or her taxable income which includes income from farming from one or more of the 3 prior years was low. The term “farming business” is defined in the Instructions for Schedule J - Income Averaging for Farmers and Fishermen. The taxpayer can use income averaging to figure his or her tax for any year in which he or she was engaged in a farming business as an individual, a partner in a partnership, or a shareholder in an S corporation. Services performed as an employee are disregarded in determining whether an individual is engaged in a farming business. However, if the taxpayer is a shareholder of an S corporation engaged in a farming business, he or she may treat compensation received from the corporation that is attributable to the farming business as farm income. The taxpayer does not need to have been engaged in a farming business in any base year. Corporations, partnerships, S corporations, estates, and trusts cannot use income averaging.

Lesson 9 - Specialized Returns

Elected Farm Income (EFI)

EFI is the amount of income from the taxpayer’s farming business that he or she elects to have taxed at base year rates. The taxpayer can designate as EFI any type of income attributable to his or her farming business. However, the taxpayer’s EFI cannot be more than his or her taxable income, and any EFI from a net capital gain attributable to his or her farming business cannot be more than his or her total net capital gain. he taxpayer can elect to use income averaging to compute his or her regular tax liability. However, income averaging is not used to determine his or her regular tax or tentative minimum tax when figuring his or her alternative minimum tax (AMT). Using income averaging may reduce the total tax even if he or she owes AMT. The taxpayer can use income averaging by filing Schedule J (Form 1040) with his or her timely filed (including extensions) return for the year. The taxpayer can also use income averaging on a late return, or use, change, or cancel it on an amended return, if the time for filing a claim for refund has not expired for that election year. The taxpayer generally must file the claim for refund within 3 years from the date he or she filed his or her original return or 2 years from the date he or she paid the tax, whichever is later.

Excise Taxes

The taxpayer may be eligible to claim a credit on his or her income tax return for the Federal excise tax on certain fuels. He or she may also be eligible to claim a quarterly refund of the fuel taxes during the year, instead of waiting to claim a credit on his or her income tax return. Whether the taxpayer can claim a credit or refund depends on whether the fuel was taxed and the purpose (nontaxable use) for which he or she used the fuel. The nontaxable uses of fuel for which a farmer may claim a credit or refund are generally the following:

➢ Use on a farm for farming purposes. ➢ Off-highway business use. ➢ Uses other than as a fuel in a propulsion engine, such as home use.

Farm Employment Taxes

In general, the taxpayer is an employer of farmworkers if his or her employees do any of the following types of work:

➢ Raising or harvesting agricultural or horticultural products on a farm, including raising and feeding of livestock. ➢ Operating, managing, conserving, improving, or maintaining his or her farm and its tools and equipment. ➢ Services performed in salvaging timber, or clearing land of brush and other debris, left by a hurricane (also known

as hurricane labor). ➢ Handling, processing, or packaging any agricultural or horticultural commodity if he or she produced more than

half of the commodity (for a group of up to 20 unincorporated operators, all of the commodity). ➢ Work related to cotton ginning, turpentine, gum resin products, or the operation and maintenance of irrigation

facilities.

Generally, a worker who performs services for the taxpayer is his or her employee if he or she has the right to control what will be done and how it will be done. This is so even when the taxpayer gives the employee freedom of action. What matters is that the taxpayer has the right to control the details of how the services are performed. The taxpayer is responsible for withholding and paying employment taxes for his or her employees. He or she is also required to file employment tax returns. These requirements do not apply to amounts that the taxpayer pays to independent contractors. If the taxpayer employs a family of workers, each worker subject to his or her control (not just the head of the family) is an employee. All cash wages the taxpayer pays to an employee during the year for farmwork are subject to Social Security and Medicare taxes if he or she meets either of the following tests.

➢ The taxpayer pays the employee $150 or more in cash wages (count all wages paid on a time, piecework, or other basis) during the year for farmwork (the $150 test). The $150 test applies separately to each farmworker that he or she employs. If the taxpayer employs a family of workers, each member is treated separately. Do not count wages paid by other employers.

➢ The taxpayer pays cash and noncash wages of $2,500 or more during the year to all his or her employees for farmwork (the $2,500 test).

If the $2,500 test for the group is not met, the $150 test for an employee still applies.

Lesson 9 - Specialized Returns

Annual cash wages of less than $150 the taxpayer pays to a seasonal farmworker are not subject to Social Security and Medicare taxes, even if he or she pays $2,500 or more to all his or her farmworkers. However, these wages count toward the $2,500 test for determining whether other farmworkers' wages are subject to Social Security and Medicare taxes. A seasonal farmworker is a worker who:

➢ Works as a hand-harvest laborer. ➢ Is paid piece rates in an operation usually paid on this basis in the region of employment. ➢ Commutes daily from his or her permanent home to the farm. ➢ Worked in agriculture less than 13 weeks in the preceding calendar year.

Only cash wages paid to farmworkers are subject to Social Security and Medicare taxes. Cash wages include checks, money orders, and any kind of money or cash. Noncash wages include food, lodging, clothing, transportation passes, and other goods and services. Noncash wages paid to farmworkers, including commodity wages, are not subject to Social Security and Medicare taxes. However, they are subject to these taxes if the substance of the transaction is a cash payment. If the cash wages the taxpayer pays to farmworkers are subject to Social Security and Medicare taxes, they are also subject to Federal income tax withholding. Although noncash wages are subject to Federal income tax, the taxpayer should only withhold income tax he or she and the employee agree to do so. The amount to withhold is figured on gross wages without taking out Social Security and Medicare taxes, union dues, insurance, etc.

Special Estimated Tax Rules for Qualified Farmers

If at least two-thirds of the taxpayer’s gross income for 2022 or 2023 is from farming, he or she has only one payment due date for his or her 2023 estimated tax, January 15, 2024. The due dates for the first three payment periods do not apply. For purposes of estimated tax exceptions for farmers, gross income from farming is income from cultivating the soil or raising agricultural commodities. It includes the following amounts: (179)

➢ Income from operating a stock, dairy, poultry, bee, fruit, or truck farm. ➢ Income from a plantation, ranch, nursery, range, orchard, or oyster bed. ➢ Crop shares for the use of the taxpayer’s land. ➢ Gains from sales of draft, breeding, dairy, or sporting livestock. ➢ Gross income from farming is the total of the following amounts from the taxpayer’s tax return. ➢ Gross farm income from Schedule F (Form 1040). ➢ Gross farm rental income from Form 4835. ➢ Gross farm income from Schedule E (Form 1040), Parts II and III. ➢ Gains from the sale of livestock used for draft, breeding, sport, or dairy purposes reported on Form 4797.

Farm income does not include any of the following: (179)

➢ Wages the taxpayer receives as a farm employee. ➢ Income the taxpayer receives from contract grain harvesting and hauling with workers and machines he or she

furnishes. ➢ Gains the taxpayer receives from the sale of farmland and depreciable farm equipment.

The following special estimated tax rules apply if the taxpayer was a qualified farmer for 2023: (179)

➢ The taxpayer does not have to pay estimated tax if he or she files his or her 2023 Form 1040 and pays all the tax due by March 1, 2024.

➢ The taxpayer does not have to pay estimated tax if he or she expects his or her 2023 income tax withholding (including any amount applied to 2023 estimated tax from the 2022 return) to be at least 66⅔% (.6667) of the total tax to be shown on the taxpayer’s 2023 tax return or 100% of the total tax shown on his or her 2022 income tax return.

➢ If the taxpayer must pay estimated tax, he or she is required to make only one estimated tax payment (his or her required annual payment) by January 15, 2024, using special rules to figure the amount of the payment.

Lesson 9 - Specialized Returns

If the taxpayer does not pay all his or her required estimated tax for 2023 by January 15, 2024, or file his or her 2023 return and pay any tax due by March 1, 2024, the taxpayer should use Form 2210-F - Underpayment of Estimated Tax by Farmers and Fishermen to determine if he or she owes a penalty.

Rental Real Estate If the taxpayer owns rental real estate, he or she should be aware of the Federal tax responsibilities. A property that the taxpayer owns and rents to tenants for 15 days or more each year is considered a rental property by the IRS. All rental income must be reported on the tax return, and in general the associated expenses can be deducted from rental income. If the taxpayer uses a dwelling unit as a home and he or she rents it less than 15 days during the year, its primary function is not considered to be a rental and it should not be reported on Schedule E (Form 1040). The taxpayer is not required to report the rental income and rental expenses from this activity. Any expenses related to the home, such as mortgage interest, property taxes, and any qualified casualty loss, will be reported as normally allowed on Schedule A (Form 1040). If the taxpayer is a cash basis taxpayer, he or she should report rental income on the return for the year it was received, regardless of when it was earned. As a cash basis taxpayer, the taxpayer generally deducts rental expenses in the year paid. If the taxpayer uses an accrual method, he or she generally reports income when it is earned, rather than when received and the taxpayer deducts expenses when incurred, rather than when paid. Most individuals use the cash method of accounting. Below are some tips about tax reporting, recordkeeping requirements and information about deductions for rental property to help avoid mistakes.

Rental Income

The taxpayer generally must include in gross income all amounts received as rent. Rental income is any payment received for the use or occupation of property. The taxpayer must report rental income for all properties. In addition to amounts received as normal rent payments, there are other amounts that may be rental income and must be reported on the tax return: (182)

➢ Advance rent is any amount received before the period that it covers. Include advance rent in rental income in the year received regardless of the period covered or the method of accounting used.

➢ Security deposits used as a final payment of rent are considered advance rent. Include it in income when received. Do not include a security deposit in income when the taxpayer receives it if he or she plans to return it to the tenant at the end of the lease. But if the taxpayer keeps part or all of the security deposit during any year because the tenant does not live up to the terms of the lease, include the amount kept in income in that year.

➢ Payment for canceling a lease occurs if the tenant pays the taxpayer to cancel a lease. The amount received is rent. Include the payment in income in the year received regardless of method of accounting.

➢ Expenses paid by tenant occur if the tenant pays any of expenses. The taxpayer must include them in rental income. He or she can deduct the expenses if they are deductible rental expenses. For example, the tenant pays the water and sewage bill for the rental property and deducts it from the normal rent payment. Under the terms of the lease, the tenant does not have to pay this bill. Include the utility bill paid by the tenant and any amount received as a rent payment in rental income.

➢ Property or services received, instead of money, as rent, must be included as the fair market value of the property or services in rental income. For example, the tenant is a painter and offers to paint the rental property instead of paying rent for two months. If the taxpayer accepts the offer, include in the rental income the amount the tenant would have paid for two months’ worth of rent.

➢ Lease with option to buy occurs if the rental agreement gives the tenant the rights to buy the rental property. The payments received under the agreement are generally rental income.

If the taxpayer owns a part interest in rental property, he or she must report his or her part of the rental income from the property. Income (or Loss), expenses and depreciation pertaining to Rental Real Estate or Royalties are usually reported on Part I, Schedule E – Supplemental Income and Loss, on Form 1040. Rental income is any payment the taxpayer receives for the use or occupation of property. The taxpayer generally must include in gross income all amounts he or she receives as rent.

Deductions for Rental Property

If the taxpayer receives rental income from the rental of a dwelling unit, there are certain rental expenses he or she may deduct on the tax return. These expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs.

Lesson 9 - Specialized Returns

The taxpayer can also deduct the ordinary and necessary expenses for managing, conserving, and maintaining the rental property. Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities, and insurance. (182)

Repairs

The taxpayer can deduct the cost of repairs that he or she makes to a rental property. A repair keeps the property in good operating condition. It does not materially add to the value of the property or substantially prolong its life. Repairing property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of repairs. The taxpayer can also deduct the expenses paid by the tenant if they are deductible rental expenses. When the taxpayer includes the fair market value of the property or services in the rental income, he or she can deduct that same amount as a rental expense.

The taxpayer can deduct from gross rental income expenses for advertising, cleaning and maintenance, utilities, fire and liability insurance, taxes, interest, commissions for the collection of rent, ordinary and necessary travel and transportation and other expenses.

Improvements

The taxpayer cannot deduct the cost of improvements. He or she recover the costs of improvements by taking depreciation, explained later. Separate the costs of repairs and improvements, and keep accurate records showing the cost of improvements. An improvement adds to the value of the property, prolongs its useful life, or adapts it to new uses. Putting a recreation room in an unfinished basement, paneling a den, adding a bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, putting in new cabinets, putting on a new roof, and paving a driveway are examples of improvements. These increases in value must be capitalized and depreciated. The taxpayer can recover some or all of improvements by using Form 4562 - Depreciation and Amortization to report depreciation beginning in the year the rental property is first placed in service, and beginning in any year he or she makes an improvement or add furnishings. These expenses must be depreciated over the useful life of the property. Only a percentage of these expenses are deductible in the year they are incurred. (182)

Interest Expense

The taxpayer can deduct mortgage interest he or she pays on his or her rental property. When the taxpayer refinances a rental property for more than the previous outstanding balance, the portion of the interest allocable to loan proceeds not related to rental use generally cannot be deducted as a rental expense.

Local Benefit Taxes

In most cases, the taxpayer cannot deduct charges for local benefits that increase the value of his or her property, such as charges for putting in streets, sidewalks, or water and sewer systems. These charges are nondepreciable capital expenditures and must be added to the basis of his or her property. However, the taxpayer can deduct local benefit taxes that are for maintaining, repairing, or paying interest charges for the benefits.

Local Transportation Expenses

The taxpayer may be able to deduct ordinary and necessary local transportation expenses if he or she incurs them to collect rental income or to manage, conserve, or maintain his or her rental property. Transportation expenses incurred to travel between the taxpayer’s home and a rental property generally constitute nondeductible commuting costs unless he or she uses the home as his or her principal place of business. Generally, if the taxpayer uses his or her personal car, pickup truck, or light van for rental activities, he or she can deduct the expenses using one of two methods: actual expenses or the standard mileage rate.

Reporting Rental Income and Expenses

If the taxpayer rents buildings, rooms or apartments, and provide only heat and light, and trash collection, he or she normally reports rental income and expenses on Form 1040, Schedule E - Supplemental Income and Loss, Part I. List total income, expenses, and depreciation for each rental property. If the rental expenses exceed rental income the taxpayer may report a loss up to $25,000 on the tax return, limited for adjusted gross incomes above $100,000. (182)

Lesson 9 - Specialized Returns

Records

Good records will help the taxpayer monitor the progress of the rental property, prepare financial statements, identify the source of receipts, keep track of deductible expenses, prepare tax returns and support items reported on tax returns. The taxpayer should keep adequate records to prove his or her expenses or have sufficient evidence that will support his or her own statement. The taxpayer must generally prepare a written record for it to be considered adequate. This is because written evidence is more reliable than oral evidence alone. However, if the taxpayer prepares a record on a computer, it is considered an adequate record. The taxpayer generally must have documentary evidence, such as receipts, canceled checks, or bills, to support his or her expenses. Documentary evidence ordinarily will be considered adequate if it shows the amount, date, place, and essential character of the expense. Keep track of any travel expenses incurred for rental property repairs. Separate receipts for minor repairs like plumbing, fixing a broken door or minor repainting from receipts for capital improvements like adding a new roof, remodeling a kitchen or installing insulation. The taxpayer must be able to substantiate certain elements of expenses to deduct them. He or she generally must have documentary evidence, such as receipts, canceled checks or bills, to support expenses. If the taxpayer is audited and cannot provide evidence to support items reported on the tax returns, he or she may be subject to additional taxes and penalties. For example, if the taxpayer cannot substantiate the rental real estate expenses of replacing the door locks, with appropriate records, the IRS may disallow that expense which may mean that the taxpayer incurs additional taxes and penalties. (182)

Renting Part of Property

If a taxpayer rents part of his or her property, he or she must divide certain expenses between the part of the property used for rental purposes and the part of the property used for personal purposes, as though he or she actually had two separate pieces of property. The taxpayer can deduct the expenses related to the part of the property used for rental purposes, such as home mortgage interest, mortgage insurance premiums, and real estate taxes, as rental expenses on Schedule E (Form 1040). The taxpayer can also deduct as rental expenses a portion of other expenses that are normally nondeductible personal expenses, such as expenses for electricity or painting the outside of the house. If an expense is for both rental use and personal use, such as mortgage interest or heat for the entire house, the taxpayer must divide the expense between rental use and personal use. He or she can use any reasonable method for dividing the expense. It may be reasonable to divide the cost of some items (for example, water) based on the number of people using them. The two most common methods for dividing an expense are (1) the number of rooms in his or her home, and (2) the square footage of his or her home.

Lesson 9 - Specialized Returns

Review Feedback Review feedback provides both the answers to each question and an explanation or feedback as to how we arrived at each answer at the end of the lesson. Review feedback also contains evaluative feedback explaining why incorrect answers are wrong. You are also provided the course topic from which we derived our answer and the external source material we used for verification. If you are using the online version of the course, Ctrl+click on the topic to find the section from which we arrived at the answer for the question. You can also Ctrl+click on the question number to return to the specific review question. Question 1 - B. $3,000 If the taxpayer transfers property (or money and property) to a corporation in exchange for stock in that corporation (other than nonqualified preferred stock), and immediately afterward he or she is in control of the corporation, the exchange is usually not taxable. This rule applies both to individuals and to groups who transfer property to a corporation. The term property does not include services rendered or to be rendered to the issuing corporation. The value of stock received for services is income to the recipient. In William’s case, no gain is recognized on the exchange of property. However, he recognizes ordinary income of $3,000 as payment for services he rendered to the corporation. Only Choice B has the correct amount and is therefore the correct response. Topic - Corporation Filing Information Source - Publication 542 - Corporations Question 2 - B. Shareholders S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders (Choice B) for Federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income at the entity level. Topic - Disadvantages of an S Corporation Source - IRS.GOV - S Corporations Question 3 - C. Both A and B Section 1374 provides for a tax on built-in gains. The built-in gains tax may apply to an S corporation that was a C corporation before it elected to be an S corporation or that acquired an asset with a basis determined (in whole or in part) by reference to its basis (or the basis of any other property) in the hands of a C corporation (a transferred-basis acquisition). Also, S corporations that have previously been a C corporation and have accumulated earnings and profits at the end of the tax year will be assessed a passive income tax if passive investment income for the year exceeds 25% of gross receipts for the year. The tax is assessed at the maximum corporate tax rate of 21%. Recognized built-in gains and losses are not taken into account in determining the amount of passive investment income. An S corporation can be subject to built-in gains tax (Choice A) and excess net passive income tax (Choice B) making Choice C the correct response. Topic - Taxes Source - IRS.GOV - S Corporations Question 4 - A. The election may be revoked with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares An election terminates automatically in any of the following cases:

Lesson 9 - Specialized Returns

election terminates on the first day of the first tax year beginning after the third consecutive tax year. The corporation must pay a tax for each year it has excess net passive income. See the line 22a instructions for details on how to figure the tax (Choice C is false).

As shown above, an election can be revoked only with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares of stock (including non-voting stock) making Choice A true and the correct response.

Topic - Termination of Election Source - Instructions for Form 1120-S Question 5 - D. Form 8832 - Entity Classification Election An LLC with either a single member or more than one member can elect to be classified as a corporation rather than be classified as a partnership or disregarded entity under the default rules. The taxpayer should file Form 8832 - Entity Classification Election to elect classification as a C corporation. Only Choice D has the correct form and is therefore the correct response.

Topic - LLCs Classified as Corporations Source - Publication 3402 - Taxation of Limited Liability Companies Question 6 - B. 2023 The taxpayer cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. He or she must report the income in the year the money or property is received or made available to him or her without restriction. Frances must still include this payment in her 2023 income because it was made available to her in 2023. Only Choice B has the correct year and is therefore the correct response.

Topic - Accounting Methods Source - Publication 225 - Farmer's Tax Guide Question 7 - D. $2,000 Generally, the taxpayer cannot deduct or capitalize a business expense until economic performance occurs. If his or her expense is for property or services provided to him or her, or for his or her use of property, economic performance occurs as the property or services are provided or as the property is used. If the taxpayer’s expense is for property or services he or she provides to others, economic performance occurs as he or she provides the property or services. Economic performance for Jane's liability in the contract occurs as the services are provided. Jane incurs the $2,000 cost in 2023. Only Choice D has the correct amount and is therefore the correct response. Topic - Accounting Methods Source - Publication 225 - Farmer's Tax Guide Question 8 - B. $10,000 Amounts received from the sales of products the taxpayer raised on his or her farm for sale (or bought for resale), such as livestock, produce, or grains, are reported on Schedule F - Profit or Loss From Farming. This includes money and the fair market value of any property or services he or she receives. When the taxpayer sells farm products bought for resale, his or her profit or loss is the difference between the selling price (money plus the fair market value of any property) and the basis in the item (usually the cost). The taxpayer generally reports these amounts on Schedule F for the year he or she receives payment. In Carmen’s case, she reports the $21,000 sales price on Schedule F, line 1b, subtracts the $11,000 basis on line 1d, and reports the resulting $10,000 profit on line 1e. Only Choice B has the correct amount and is therefore the correct response. Topic - Farm Sales and Exchanges Source - Publication 225 - Farmer's Tax Guide

Lesson 9 - Specialized Returns

Question 9 - B. $5,000 If the taxpayer uses the cash method of accounting to report his or her income and expenses, his or her deduction for prepaid farm supplies in the year the taxpayer pays for them may be limited to 50% of his or her other deductible farm expenses for the year. Therefore, Sean’s deduction for prepaid farm supplies cannot be more than $5,000 (50% of $10,000) for 2023. The excess prepaid farm supplies expense of $500 ($5,500 − $5,000) is deductible in a later tax year when he uses or consumes the supplies. Only Choice B has the correct amount and is therefore the correct response. Topic - Prepaid Farm Supplies Source - Publication 225 - Farmer's Tax Guide

Depreciation At the conclusion of this lesson you should have a basic knowledge of:

➢ Basis of Property. ➢ Methods of Depreciation. ➢ Section 179 Election.

If property acquired for business is expected to last more than one year, generally a taxpayer cannot deduct the entire cost as a business expense in the year the item was acquired. The cost must be spread over more than one tax year and part of the cost should be deducted each year on Schedule C. This method of deducting the cost of business property is called depreciation. (183)

Review Question 1 Generally, a taxpayer cannot deduct the entire cost as a business expense in the year the item was acquired if property acquired for the business is expected to last more than how long?

A. One year B. Two years C. Three years D. Four years

See Review Feedback for answer.

The taxpayer should use Form 4562 - Depreciation and Amortization to:

➢ Claim his or her deduction for depreciation and amortization. ➢ Make the election under Section 179 to expense certain property. ➢ Provide information on the business/investment use of automobiles and other listed property.

The taxpayer should complete and file Form 4562 if he or she is claiming any of the following:

➢ Depreciation for property placed in service during the tax year. ➢ A Section 179 expense deduction (which may include a carryover from a previous year). ➢ Depreciation on any vehicle or other listed property (regardless of when it was placed in service). ➢ A deduction for any vehicle reported on a form other than Schedule C - Profit or Loss From Business. ➢ Any depreciation on a corporate income tax return other than Form 1120-S - U.S. Income Tax Return for an S-

Corporation. ➢ Amortization of costs that begin during the tax year.

Most types of tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment are depreciable. Likewise, certain intangible property, such as patents, copyrights, and computer software is depreciable. In order for a taxpayer to be allowed a depreciation deduction for a property, the property must meet all the following requirements: (184)

➢ The taxpayer must own the property. Taxpayers may also depreciate any capital improvements for property the taxpayer leases. A taxpayer is considered as owning property even if it is subject to a debt.

➢ A taxpayer must use the property in business or in an income-producing activity. If a taxpayer uses a property for business and for personal purposes, the taxpayer can only deduct depreciation based only on the business use of that property.

➢ The property must have a determinable useful life of more than one year.

Lesson 10 - Depreciation

Review Question 2 Phil bought a new van that he will use only for his courier business. Phil will be making payments on the van over the next 5 years. With regards to depreciation which of the following statements is true?

A. Phil does not own the van and he cannot depreciate it B. Phil owns the van but he cannot depreciate it because it is subject to debt C. Phil owns the van and he can depreciate it D. Phil does not own the van but he can depreciate it

See Review Feedback for answer.

A taxpayer can depreciate leased property only if he or she retains the incidents of ownership in the property. This means the taxpayer bears the burden of exhaustion of the capital investment in the property. Therefore, if he or she leases property from someone to use in his or her trade or business or for the production of income,

the taxpayer generally cannot depreciate its cost because he or she does not retain the incidents of ownership. As mentioned above, the taxpayer can depreciate any capital improvements he or she makes to the property. Even if a taxpayer meets the preceding requirements for a property, a taxpayer cannot depreciate the following property: (184)

➢ Property placed in service and disposed of in same year. ➢ Equipment used to build capital improvements. A taxpayer must add otherwise allowable depreciation on the

equipment during the period of construction to the basis of the improvements. ➢ Certain term interests.

Depreciation begins when a taxpayer places property in service for use in a trade or business or for the production of income. The property ceases to be depreciable when the taxpayer has fully recovered the property’s cost or other basis or when the taxpayer retires it from service, whichever happens first.

A taxpayer cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping. Although the taxpayer cannot depreciate land, he or she can depreciate certain land preparation costs, such as landscaping

costs, incurred in preparing land for business use. These costs must be so closely associated with other depreciable property that the taxpayer can determine a life for them along with the life of the associated property. (185)

Review Question 3 All of the following types of property are depreciable except:

A. Vehicles B. Furniture C. Patents D. Land

See Review Feedback for answer.

If the taxpayer is a tenant-stockholder in a cooperative housing corporation and uses his or her cooperative apartment in his or her business or for the production of income, he or she can depreciate his or her stock in the corporation, even though the corporation owns the apartment. The taxpayer figures his or her depreciation deduction as follows: (186)

1. Figure the depreciation for all the depreciable real property owned by the corporation in which the taxpayer has a proprietary lease or right of tenancy. If he or she bought his or her cooperative stock after its first offering, figure the depreciable basis of this property as follows:

a. Multiply the taxpayer’s cost per share by the total number of outstanding shares, including any shares held by the corporation.

b. Add to the amount figured in (a) any mortgage debt on the property on the date he or she bought the stock.

Lesson 10 - Depreciation

c. Subtract from the amount figured in (b) any mortgage debt that is not for the depreciable real property, such as the part for the land.

2. Subtract from the amount figured in (1) any depreciation for space owned by the corporation that can be rented but cannot be lived in by tenant-stockholders.

3. Divide the number of the taxpayer’s shares of stock by the total number of outstanding shares, including any shares held by the corporation.

4. Multiply the result of (2) by the percentage the taxpayer figured in (3). This is his or her depreciation on the stock. The taxpayer’s depreciation deduction for the year cannot be more than the part of his or her adjusted basis in the stock of the corporation that is allocable to his or her business or income-producing property. The taxpayer must also reduce his or her depreciation deduction if only a portion of the property is used in a business or for the production of income.

Basis of Property

Basis is generally the amount of a taxpayer’s capital investment in a property for tax purposes. Use the basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange or other disposition of the property. In most situations, the basis of an asset the taxpayer purchases is its cost. The cost is the amount he or she pays for it in cash, debt obligations, and other property or services. Cost includes sales tax and other expenses connected with the purchase. The basis in some assets is not determined by cost (such as a gift or an inheritance). If the taxpayer acquired the property from an individual who died in 2010, special rules may apply to the calculation of basis. For more information, refer to Publication 551 - Basis of Assets. (187)

Review Question 4 Basis is generally the amount of a taxpayer’s capital investment in a property for tax purposes. Use the basis to figure all of the following except:

A. Depreciation B. Amortization C. Depletion D. Recovery Period

See Review Feedback for answer.

Cost Basis

The basis of property a taxpayer buys is usually its cost. The cost is the amount paid in cash, debt obligations, other property, or services. The cost also includes amounts the taxpayer pays for the following items: (188)

➢ Sales tax. ➢ Freight. ➢ Installation and testing. ➢ Excise taxes. ➢ Legal and accounting fees (when they must be capitalized). ➢ Revenue stamps. ➢ Recording fees. ➢ Real estate taxes (if assumed for the seller).

The taxpayer may also have to capitalize (add to basis) certain other costs related to buying or producing property.

Lesson 10 - Depreciation

Review Question 5 The cost of a property includes amounts for which of the following items?

A. Sales tax B. Freight C. Excise taxes D. All of the above

See Review Feedback for answer.

The basis of stocks or bonds a taxpayer buys is generally the purchase price plus any costs of purchase, such as commissions and recording or transfer fees. If the taxpayer receives stocks or bonds other than by purchase, the basis is usually determined by the fair market value (FMV) or the previous owner's adjusted basis of the stock. The taxpayer must adjust the basis of stocks for certain events that occur after purchase. See Stocks and Bonds in Publication 550 - Investment Income and Expenses for more information on the basis of stock. (188) Real property, also called real estate, is land and generally anything built on or attached to it. If the taxpayer buys real property, certain fees and other expenses become part of the cost basis in the property. The basis includes the settlement fees and closing costs for buying property. The taxpayer cannot include in the basis the fees and costs for getting a loan on property. A fee for buying property is a cost that must be paid even if the taxpayer bought the property with cash. The following items are some of the settlement fees or closing costs the taxpayer can include in the basis of the property:

➢ Abstract fees (abstract of title fees). ➢ Charges for installing utility services. ➢ Legal fees (including title search and preparation of the sales contract and deed). ➢ Recording fees. ➢ Surveys. ➢ Transfer taxes. ➢ Owner's title insurance. ➢ Any amounts the seller owes that the taxpayer agrees to pay, such as back taxes or interest, recording or

mortgage fees, charges for improvements or repairs, and sales commissions.

Review Question 6 Which of following is a settlement fee or closing cost the taxpayer can include in the basis of the property?

A. Owner's title insurance B. Points (discount points, loan origination fees) C. Mortgage insurance premiums D. Loan assumption fees

See Review Feedback for answer.

Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance. The following items are some settlement fees and closing costs the taxpayer cannot include in the basis of the property:

1. Casualty insurance premiums. 2. Rent for occupancy of the property before closing. 3. Charges for utilities or other services related to occupancy of the property before closing. 4. Charges connected with getting a loan. The following are examples of these charges:

a. Points (discount points, loan origination fees). b. Mortgage insurance premiums. c. Loan assumption fees. d. Cost of a credit report. e. Fees for an appraisal required by a lender.

5. Fees for refinancing a mortgage.

Lesson 10 - Depreciation

If these costs relate to business property, items (1) through (3) are deductible as business expenses. Items (4) and (5) must be capitalized as costs of getting a loan and can be deducted over the period of the loan. If the taxpayer pays points to obtain a loan (including a mortgage, second mortgage, line of credit, or a home equity loan), do not add the points to the basis of the related property. Generally, he or she deducts the points over the term of the loan. If the taxpayer buys property and assumes (or buys subject to) an existing mortgage on the property, his or her basis includes the amount he or she pays for the property plus the amount to be paid on the mortgage.

Review Question 7 Which of following is a settlement fee or closing cost the taxpayer cannot include in the basis of the property?

A. Recording fees B. Surveys C. Transfer taxes D. Mortgage insurance premiums

See Review Feedback for answer.

Basis of Inherited Property

The basis in property a taxpayer inherited from a decedent is generally one of the following: (188)

➢ The FMV of the property at the date of the individual's death. ➢ The FMV on the alternate valuation date if the personal representative for the estate chooses to use alternate

valuation. For information on the alternate valuation date, see the Instructions for Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return.

➢ The value under the special-use valuation method for real property used in farming or a closely held business if chosen for estate tax purposes.

➢ The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a qualified conservation easement. For information on a qualified conservation easement, see the Instructions for Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return.

If a Federal estate tax return does not have to be filed, the basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes.

The above rule does not apply to an appreciated property the taxpayer receives from a decedent if the taxpayer or his or her spouse originally gave the property to the decedent within one year before the decedent's death. The basis in this property is the same as the decedent's adjusted basis in the property immediately before his or her death, rather than the Fair Market Value (FMV). Appreciated property is any property whose FMV on the day it was given to the decedent is more than its adjusted basis. (188)

In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), husbands and wives are each usually considered to own half the community property. When either spouse dies, the total value of the community property, even the part belonging to the surviving spouse, generally becomes the basis of the entire property. For this rule to apply, at least half the value of the community property interest must be includable in the decedent's gross estate, whether or not the estate must file a return. (188)

Special Basis for Property Inherited During 2010 (after Dec. 31, 2009, and before Jan. 1, 2011)

Under the Special Basis for Property Inherited During 2010, the starting point for basis is the lesser of the asset’s fair market value on the date of death or the decedent’s basis. The executor can allocate General Basis and/or Spousal Property Basis Increase to eligible property but not in excess of the amount needed to increase the decedent's adjusted basis to the property's Fair Market Value (FMV) as of the date of the decedent's death. The result is that, for each property, the sum of the decedent’s adjusted basis in that property and the Basis Increase allocated to that property cannot exceed the FMV of that property on the decedent’s date of death. (189) Aggregate Basis Increase is $1,300,000. However, for a decedent who was neither a resident nor citizen of the United States, the Aggregate Basis Increase is $60,000. Spousal Property Basis Increase is $3,000,000. Generally, the executor

Lesson 10 - Depreciation

can allocate Spousal Property Basis Increase only to qualified spousal property that was both acquired from and owned by the decedent. Qualified spousal property means: (189)

➢ Outright transfer property. ➢ Qualified terminable interest property.

Basis of Property Received as a Gift

To figure the basis of property a taxpayer receives as a gift, it is necessary to have:

➢ Adjusted basis to the donor just before it was given to the taxpayer. ➢ The Fair Market Value (FMV) at the time it was given to the taxpayer. ➢ Any gift tax paid on the property.

If the FMV of the property at the time of the gift is less than the donor's adjusted basis, the basis depends on whether the taxpayer has a gain or a loss when he or she disposes of the property. The basis for figuring gain is the same as the donor's adjusted basis plus or minus any required adjustment to basis while holding the property. The basis for figuring loss is its FMV when the taxpayer received the gift plus or minus any required adjustment to basis while holding the property.

Methods of Depreciation

There are three systems involved in the computation of depreciation. The depreciation system that applies to a particular piece of property is determined by the type of property and when the property was placed in service. For tangible property use:

➢ MACRS (Modified Accelerated Cost Recovery System) if placed in service after December 31, 1986. ➢ ACRS (Accelerated Cost Recovery System) if placed in service after December 31, 1980, but before January 1,

1987. ➢ Straight line or an accelerated method of depreciation, such as the declining balance method, if placed in service

before January 1, 1981.

Tangible property is any property that the taxpayer can see and touch. This includes automobiles, buildings, and equipment. The total of all the yearly depreciation deductions cannot be more than the cost or other basis of the property.

Recovery Periods

In 2023, under MACRS, most property used in business (income-producing) activities that is placed in service during the current tax year would fall into one of the following property classifications under GDS:

➢ 3-year property includes: o Any racehorse that is more than two years old at the time. o Any horse (other than a racehorse) that is more than 12 years old at the time it is placed in service. o Any qualified rent-to-own property (as defined in Section 168(i)(14)).

➢ 5-year property includes: o Automobiles. o Light general-purpose trucks. o Office machinery (such as typewriters, calculators, copiers, and duplicating equipment.) o Any semi-conductor manufacturing equipment. o Any qualified technological equipment. o Any Section 1245 property used in connection with research and experimentation. o Certain energy property specified in Section 168(e)(3)(B)(vi). o Appliances, carpets, furniture, etc., used in a rental real estate activity. o Any new machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land

improvement) used in a farming business and placed in service after 2017, in tax years ending after 2017. The original use of the property must begin with the taxpayer after 2017.

➢ 7-year property includes: o Office furniture and fixtures (such as desks, files, and safes). o Railroad track. o Any motorsports entertainment complex property (as defined in Section 168(i) (15)).

Lesson 10 - Depreciation

o Any natural gas gathering line (as defined in Section 168(i)(17)) placed in service after April 11, 2005, the original use of which begins with the taxpayer after April 11, 2005 and is not under self-construction or subject to a binding contract in existence before April 12, 2005. Also, no AMT adjustment is required.

o Any used agricultural machinery and equipment placed in service after 2017, grain bins, cotton ginning assets, or fences used in a farming business (but no other land improvements).

o Any property that does not have a class life and is not otherwise classified. ➢ 10-year property includes:

o Vessels, barges, tugs, and similar water transportation equipment. o Any single-purpose agricultural or horticultural structure (see Section 168(i)(13)). o Any tree or vine bearing fruits or nuts. o Any qualified smart electric meter property. o Any qualified smart electric grid system property.

➢ 15-year property includes: o Any municipal wastewater treatment plant. o Any telephone distribution plant and comparable equipment used for 2-way exchange of voice and data

communications. o Any Section 1250 property that is a retail motor fuels outlet (whether or not food or other convenience items

are sold there). o Initial clearing and grading land improvements for gas utility property. o Certain electric transmission property (that is Section 1245 property) used in the transmission at 69 or more

kilovolts of electricity placed in service after April 11, 2005, the original use of which begins with the taxpayer after April 11, 2005 and is not under self-construction or subject to a binding contract in existence before April 12, 2005.

o Qualified improvement property, as defined in Section 168(e)(6), placed in service by the taxpayer after December 31, 2017.

➢ 20-year property includes: o Farm buildings (other than single purpose agricultural or horticultural structures). o Municipal sewers not classified as 25-year property. o Initial clearing and grading land improvements for electric utility transmission and distribution plants.

➢ 25-year property is water utility property, which is: o Property that is an integral part of the gathering, treatment, or commercial distribution of water, and that,

without regard to this provision, would be 20-year property. o Municipal sewers.

➢ Residential Rental Property is any building or structure, such as a rental home (including a mobile home), if 80% or more of its gross rental income for the tax year is from dwelling units.

➢ Nonresidential Real Property is any real property that is neither residential rental property nor property with a class life of less than 27.5 years.

➢ 50-year property includes any improvements necessary to construct or improve a roadbed or right-of-way for railroad track that qualifies as a railroad grading or tunnel bore under Section 168(e)(4).

Qualified Rent-to-Own Property

Qualified rent-to-own property is property held by a rent-to-own dealer for purposes of being subject to a rent-to-own contract. It is tangible personal property generally used in the home for personal use. It includes computers and peripheral equipment, televisions, videocassette recorders, stereos, camcorders, appliances, furniture, washing machines and dryers, refrigerators, and other similar consumer durable property. Consumer durable property does not include real property, aircraft, boats, motor vehicles, or trailers.

Review Question 8 Using the MACRS GDS method of depreciation, any tree or vine bearing fruits or nuts appears in which property class?

A. 7-year property B. 10-year property C. 15-year property D. 20-year property

See Review Feedback for answer.

Lesson 10 - Depreciation

Depreciation Systems

Use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period is used. Generally, the taxpayer must use GDS unless specifically required by law to use ADS or if he or she elects to use ADS. The General Depreciation System (GDS) is the most commonly used MACRS system as this method provides for greater deduction during the early years of a property’s life.

MACRS provides three depreciation methods under GDS and one depreciation method under ADS: (185)

➢ The regular MACRS 200% declining balance method over a GDS recovery period (listed above). ➢ The 150% declining balance method over a GDS recovery period. ➢ The straight line method over a GDS recovery period. ➢ The straight line method over an ADS recovery period.

For property placed in service before 1999, the taxpayer could have elected the 150% declining balance method using the ADS recovery periods for certain property classes. If the taxpayer made this election, he or she should continue to use the same method and recovery period for that property. (185) Instead of using either the 200% or 150% declining balance methods over the GDS recovery period, the taxpayer can elect to use the straight line method over the GDS recovery period. Make the election by entering “S/L” under column (f) in Part III of Form 4562. Under GDS, property is depreciated over one of the following recovery periods for 2023: (185)

Property Class Recovery Period

3-year property 3 years1

5-year property 5 years

7-year property 7 years

10-year property 10 years

15-year property 15 years2

20-year property 20 years

25-year property 25 years3

Residential rental property 27.5 years

Nonresidential real property 39 years4

Railroad gradings and tunnel bores 50 years 15 years for qualified rent-to-own property placed in service before August 6, 1997. 239 years for property that is a retail motor fuels outlet placed in service before August 20, 1996 (31.5 years if placed in service before May 13,

1993), unless the taxpayer elected to depreciate it over 15 years.

320 years for property placed in service before June 13, 1996, or under a binding contract in effect before June 10, 1996

431.5 years for property placed in service before May 13, 1993 (or before January 1, 1994, if the purchase or construction of the property is under

a binding contract in effect before May 13, 1993, or if construction began before May 13, 1993).

Table 10-1 - IRS Publication 946 - Recovery Periods Under GDS (2023)

The taxpayer can elect to use the Alternative Depreciation System (ADS) even though his or her property may come under GDS. ADS uses the straight line method of depreciation over fixed ADS recovery periods. Make the election by completing line 20 in Part III of Form 4562. The following table shows some of the ADS recovery periods for 2023:

Property ADS Recovery

Period

Rent-to-own property 4 years

Automobiles and light duty trucks 5 years

Computers and peripheral equipment 5 years

High technology telephone station equipment installed on customer premises 5 years

Lesson 10 - Depreciation

High technology medical equipment 5 years

Personal property with no class life 12 years

Natural gas gathering lines 14 years

Single purpose agricultural and horticultural structures 15 years

Any tree or vine bearing fruit or nuts 20 years

Initial clearing and grading land improvements for gas utility property 20 years

Initial clearing and grading land improvements for electric utility transmission and distribution plants

25 years

Electric transmission property used in the transmission at 69 or more kilovolts of electricity 30 years

Natural gas distribution lines 35 years

Nonresidential real property 40 years

Residential rental property 30 years1

Section 1245 real property not listed in Appendix B of Publication 946 40 years

Railroad grading and tunnel bore 50 years 140 years for property placed in service before January 1, 2018.

Table 10-2 - Publication 946 - Recovery Periods Under ADS (2023)

The recovery periods for most property generally are longer under ADS than they are under GDS. The following table shows some of the ADS recovery periods in relation to class life and GDS recovery periods in 2023:

Property Class Life (In years)

GDS Recovery Period

(in years)

ADS Recovery Period

(In years)

Automobiles and taxis 3 5 5

Light general-purpose trucks 4 5 5

Information systems including computers and peripheral equipment

6 5 5

Data Handling Equipment; except computers 6 5 6

Heavy general-purpose Trucks 6 5 6

Buses 9 5 9

Office Furniture, Fixtures and Equipment 10 7 10

Vessels, Barges Tugs and Similar Water Transportation Equipment, except those used in marine construction

18 10 18

Airplanes (airframes and engines) except those used in commercial or contract carrying of passengers of freight, and all Helicopters

6 5 6

Tractor Units for Use Over-the-road 4 3 4

Trailers and Trailer-mounted Containers 6 5 6

Land Improvements 20 15 20

Industrial Steam and Electric Generation and/or Distribution Systems

22 15 22

Table 10-3 - Publication 946 -Table B-1. Table of Class Lives and Recovery Periods (2023)

A taxpayer must use ADS for the following property:

➢ Listed property used 50% or less in a qualified business. ➢ Any tangible property used predominantly outside the United States during the year. ➢ Any tax-exempt use property. ➢ Any tax-exempt bond-financed property. ➢ All property used predominantly in a farming business and placed in service in any tax year during which an

election not to apply the uniform capitalization rules to certain farming costs is in effect. ➢ Any property imported from a foreign country for which an Executive Order is in effect because the country

maintains trade restrictions or engages in other discriminatory acts.

Lesson 10 - Depreciation

If the taxpayer elects to use a different method for one item in a property class, he or she must apply the same method to all property in that class placed in service during the year of the election. However, the taxpayer can make the election on a property-by-property basis for nonresidential real and residential rental property.

Depreciation Conventions

Under MACRS, averaging conventions establish when the recovery period begins and ends. The convention a taxpayer uses determines the number of months for which he or she can claim depreciation in the year the property was placed in service and in the year the property is disposed. Use the mid-month convention for nonresidential real property, residential rental property, and any railroad grading or tunnel bore.

Use the mid-quarter convention if the mid-month convention does not apply and the total depreciable bases of MACRS property placed in service during the last 3 months of the tax year (excluding nonresidential real property, residential rental property, any railroad grading or tunnel bore, property placed in service and disposed of in the same year, and property that is being depreciated under a method other than MACRS) are more than 40% of the total depreciable bases of all MACRS property the taxpayer placed in service during the entire year. Use the half-year convention if neither the mid-quarter convention nor the mid-month convention applies. Under this convention, the taxpayer treats all property placed in service or disposed of during a tax year as placed in service or disposed of at the midpoint of the year. This means that a one-half year of depreciation is allowed for the year the property is placed in service or disposed. (185)

Rental Property

A taxpayer can depreciate rental property if it meets all the following requirements. (72)

1. The taxpayer owns the property. 2. The property is used in a business or income-producing activity (such as rental property). 3. The property has a determinable useful life. 4. The property is expected to last more than one year.

Three factors determine how much depreciation a taxpayer can deduct each year: (72)

1. Basis in the property. 2. The recovery period for the property. 3. The depreciation method used.

A taxpayer cannot simply deduct the mortgage or principal payments, or the cost of furniture, fixtures and equipment, as an expense. The basis of property is usually its cost. The cost is the amount paid for the property in cash, in debt obligation, in other property, or in services. The cost also includes: (72)

➢ Sales tax charged on the purchase. ➢ Freight charges to obtain the property. ➢ Installation and testing charges.

The taxpayer begins to depreciate his or her rental property when he or she places it in service for the production of income. The taxpayer stops depreciating it either when he or she has fully recovered his or her cost or other basis, or when he or she retires it from service, whichever happens first. The taxpayer places property in service in a rental activity when it is ready and available for a specific use in that activity. Even if he or she is not using the property, it is in service when it is ready and available for its specific use. If the taxpayer places property in service in a personal activity, he or she cannot claim depreciation. However, if he or she changes the property's use to business or the production of income, he or she can begin to depreciate it at the time of the change. The taxpayer places the property in service for business or income-producing use on the date of the change.

Lesson 10 - Depreciation

Under MACRS, property that a taxpayer placed in service during 2023 for rental activities generally falls into one of the following classes: (72)

➢ 5-year property - This class includes computers and peripheral equipment, office machinery (typewriters, calculators, copiers, etc.), automobiles, and light trucks. This class also includes appliances, carpeting, and furniture used in a residential rental real estate activity. Depreciation is limited on automobiles and other property used for transportation and property of a type generally used for entertainment, recreation, or amusement.

➢ 7-year property - This class includes office furniture and equipment (desks, file cabinets, etc.). This class also includes any property that does not have a class life and that has not been designated by law as being in any other class.

➢ 15-year property - This class includes roads, fences, and shrubbery (if depreciable). ➢ Residential rental property - This class includes any real property that is a rental building or structure (including

a mobile home) for which 80% or more of the gross rental income for the tax year is from dwelling units. It does not include a unit in a hotel, motel, inn, or other establishment where more than half of the units are used on a transient basis. If the taxpayer lives in any part of the building or structure, the gross rental income includes the fair rental value of the part he or she lives in.

The recovery period of property is the number of years over which the taxpayer recovers its cost or other basis. The recovery periods are generally longer under ADS than GDS. The recovery period of property depends on its property class. Under GDS, the recovery period of an asset is generally the same as its property class. The following table contains some of the MACRS recovery periods for property used in rental activities for 2023.

Type of Property General Depreciation

System Alternative

Depreciation System

Computers and their peripheral equipment 5 years 5 years

Office machinery, such as typewriters, calculators, copiers 5 years 6 years

Automobiles 5 years 5 years

Light trucks 5 years 5 years

Appliances, such as stoves, refrigerators 5 years 9 years

Carpets 5 years 9 years

Furniture used in rental property 5 years 9 years

Office furniture and equipment, such as desks, files 7 years 10 years

Any property that does not have a class life and that has not been designated by law as being in any other class

7 years 12 years

Roads 15 years 20 years

Shrubbery 15 years 20 years

Fences 15 years 20 years

Residential rental property (buildings or structures) and structural components such as furnaces, water pipes, venting, etc.

27.5 years 30 years1

Additions and improvements, such as a new roof

The same recovery period as that of the property to which the addition or improvement is made, determined as if the property was placed in service at the same time as the addition or improvement.

1 40 years for property placed in service before January 1, 2018. However, the ADS recovery period for residential rental property placed in service

before January 1, 2018, is 30 years if the property is held by an electing real property trade or business (as defined in Section 163(j)(7)(B)) and Sections 168(g)(1)(A), (B), (C), (D), or (E) did not apply to the property before January 1, 2018.

Table 10-4 - IRS Publication 527 - Table 2-1 - MACRS Recovery Periods for Property Used in Rental Activities (2023)

For rental properties, MACRS consists of two systems that determine how a taxpayer depreciates property: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). The taxpayer must use GDS unless he or she is specifically required by law to use ADS or he or she elects to use ADS.

Lesson 10 - Depreciation

Figuring MACRS Depreciation

The following information is necessary to calculate the depreciation using MACRS:

➢ Depreciation System: o ADS or GDS. o Property class. o Recovery period.

➢ Date placed in service. ➢ Basis amount. ➢ Depreciation convention. ➢ Depreciation method (200 DB, 150 DB, S/L).

The taxpayer can figure his or her MACRS depreciation in one of two ways:

➢ Actually compute the deduction using the applicable depreciation method and convention over the recovery period.

➢ Use the percentage from the optional MACRS tables. Under GDS, the formula for calculating depreciation on a residential rental property is relatively straightforward:

1. Purchase price less land value plus allowable improvements = cost basis. 2. Cost basis / 27.5 years = annual allowable depreciation.

For example, if the taxpayer’s existing cost basis is $206,000 then divide by the GDS life span of 27.5 years. The taxpayer is able to deduct $7,490.91 per year or 3.6% of the loan amount.

Section 179 Election When it comes to tax planning, there's an old adage that says, "When in doubt, accelerate deductions and postpone income”. This concept is based on the time value of money. When it comes to depreciating property, following this adage can be difficult. Remember, as a general rule, business assets are depreciated over a specified period of years. There is one major exception under the Code. It is the so-called Section 179 Election. Under Section 179 of the Internal Revenue Code, a taxpayer might be able to treat all or part of the cost of certain qualifying property as an expense in the year that the property was acquired. This means that instead of treating a depreciable asset as a capital expenditure, where he or she can only recover the cost of the asset through the general depreciation system, the taxpayer might be able to take an immediate current year's deduction for all or part of the cost of the asset. In common tax jargon, we say that he might be able to expense the asset instead of capitalizing and depreciating the asset.

When Can the Section 179 Election Be Made?

We say that this is an election. By that we mean that the taxpayer has to make a decision during the first year that the asset is placed in service as to whether he or she wants a current year's deduction, or instead wants to depreciate it over a period of years. An asset placed in service under Section 179 means that the decision must be made in the first year that the asset is placed in a condition or state of readiness and availability for a specifically assigned function. Be careful with this concept. For example, let us say that the taxpayer bought a car last year and used it entirely for personal purposes. This year, he or she starts using the car for legitimate business use. Can the taxpayer take a Section 179 deduction for the car this year? No, they cannot. Any Section 179 expense that would have been allowed is only allowed during the first year that the asset was placed in service which, in our example, was last year. However, because the property was not used in a trade or business, or held for production of income last year, the taxpayer could not take the deduction during last year. Although this year may be the first year that the car was placed in business use, that does not matter. Any deduction now available has to be taken through the general depreciation system (GDS).

Lesson 10 - Depreciation

Review Question 9 As a general rule, business assets are depreciated over a specified period of years. What is the one major exception?

A. Tangible Property B. MACRS Depreciation C. Section 179 Election D. General Depreciation System

See Review Feedback for answer.

What Property Can Be Expensed?

Not only is a Section 179 expense deduction available only in the first year that the property is placed in service, it is only available for qualifying property. The asset must be used more than 50% of the time for business in the first year it is placed in service and must have a useful life of more than one year. (190)

Property that may be written off in the tax year of purchase, rather than depreciated over the asset's useful life, includes:

➢ Tangible personal property including: o Machinery and equipment. o Property contained in or attached to a building (other than structural components), such as refrigerators,

grocery store counters, office equipment, printing presses, testing equipment, and signs. o Gasoline storage tanks and pumps at retail service stations. o Livestock, including horses, cattle, hogs, sheep, goats, and mink and other furbearing animals. o Portable air conditioners or heaters placed in service by the taxpayer in tax years beginning after 2015. o Certain property used predominantly to furnish lodging or in connection with the furnishing of lodging

(except as provided in Section 50(b)(2)). ➢ Other tangible property (except most buildings and their structural components) that:

o Is used as an integral part of manufacturing, production, or extraction, or of providing transportation, communications, electricity, gas, water, or sewage disposal services.

o Is a research facility used in connection with any of the activities listed above. o Is a facility used in connection with any of the activities referred to above for the bulk storage of

interchangeable commodities such as grain. ➢ Single purpose livestock or horticultural structures. ➢ Storage facilities, again excluding buildings and their structural components, that are used in connection with the

distribution of petroleum or any primary product of petroleum. ➢ Off-the-shelf computer software. ➢ Qualified Section 179 real property.

Although some of this may seem technical, it is not really very difficult to understand. The vast majority of all tangible personal property can be expensed if it is used in the taxpayer's trade or business in the first year that the property was acquired. This would include, for example, machinery, equipment, and even most livestock. However, some types of property are specifically excluded, and therefore cannot be expensed under Section 179. Some examples of non-qualifying property are:

➢ Property held for investment (Section 212 property). ➢ Land and land improvements do not qualify as Section 179 property. Land improvements include swimming pools,

paved parking areas, wharves, docks, bridges, and fences. ➢ Certain property the taxpayer leases to others (if he or she is a noncorporate lessor). ➢ Property used predominantly outside the United States, except property described in Section 168(g)(4) of the

Internal Revenue Code. ➢ Property used by certain tax-exempt organizations, except property used in connection with the production of

income subject to the tax on unrelated trade or business income.

➢ Property used by governmental units or foreign persons or entities, except property used under a lease with a term of less than 6 months.

Lesson 10 - Depreciation

To qualify for the Section 179 deduction, the taxpayer’s property must have been acquired for use in a trade or business. Property the taxpayer acquires only for the production of income, such as investment property, rental property (if renting property is not his or her trade or business), and property that produces royalties, does not qualify.

When the taxpayer uses property for both business and nonbusiness purposes, he or she can elect the Section 179 deduction only if he or she uses the property more than 50% for business in the year he or she places it in service. If the taxpayer uses the property more than 50% for business, multiply the cost of the property by the percentage of business use. Use the resulting business cost to figure the Section 179 deduction.

To qualify for the Section 179 deduction, the taxpayer’s property must have been acquired by purchase. For example, property acquired by gift or inheritance does not qualify. Property is not considered acquired by purchase in the following situations:

1. It is acquired by one component member of a controlled group from another component member of the same group.

2. Its basis is determined either: a. In whole or in part by its adjusted basis in the hands of the person from whom it was acquired. b. Under the stepped-up basis rules for property acquired from a decedent.

3. It is acquired from a related person.

For this purpose, related persons consist of the taxpayer and a member of his or her family, including only a spouse, child, parent, brother, sister, half-brother, half-sister, ancestor, and lineal descendant.

How Much Can the Taxpayer Deduct?

The taxpayer’s Section 179 deduction is generally the cost of the qualifying property. However, the total amount he or she can elect to deduct under Section 179 is subject to a dollar limit and a business income limit. These limits apply to each taxpayer, not to each business. For a passenger automobile, the total Section 179 deduction and depreciation deduction are limited. If the taxpayer deducts only part of the cost of qualifying property as a Section 179 deduction, he or she can generally depreciate the cost he or she does not deduct.

If the taxpayer buys qualifying property with cash and a trade-in, its cost for purposes of the Section 179 deduction includes only the cash he or she paid.

Section 179 Dollar Limitations

With the passage and signing into law of the Tax Cuts and Jobs Act, the deduction limit for Section 179 is $1,160,000 for tax year 2023. The limit on equipment purchases is $2,890,000 for tax year 2023. In addition, the deduction now includes any of the following improvements to existing nonresidential property (i.e., the improvement must be placed in service after the date the property itself was first placed in service): roofs;

heating, air-conditioning, and ventilation systems; fire protection, alarm, and security systems. Further, the bonus depreciation is 80% for 2023. The bonus depreciation also now includes used equipment. (191) The total cost that can be deducted under Section 179 is also limited to the taxable income earned from the taxpayer's trade or business during the year. Taxable income (including salaries and wages paid to the taxpayer(s) from the business and reported as W-2 income) is figured without regard to any available Section 179 expense deduction. However, the amount of any disallowed deduction in this tax year can be carried over to next tax year and be added to the amount of qualified Section 179 property placed in service in that next tax year. To elect the Section 179 Deduction a taxpayer needs to fill out Part One of IRS Form 4562 - Depreciation and Amortization. Section 179 property is property that the taxpayer acquires by purchase for use in the active conduct of his or her trade or business, and is one of the following:

➢ Qualified Section 179 real property. ➢ Tangible personal property, including cellular telephones, similar telecommunications equipment, and air

conditioning or heating units (for example, portable air conditioners or heaters). Also, tangible personal property may include certain property used mainly to furnish lodging or connection with the furnishing of lodging (except as provided in Section 50(b)(2)).

➢ Other tangible property (except buildings and their structural components) used as: 1. An integral part of manufacturing, production, or extraction or of furnishing transportation,

communications, electricity, gas, water, or sewage disposal services;

Lesson 10 - Depreciation

2. A research facility used in connection with any of the activities in (1) above; or 3. A facility used in connection with any of the activities in (1) above for the bulk storage of fungible

commodities. ➢ Single purpose agricultural (livestock) or horticultural structures. ➢ Storage facilities (except buildings and their structural components) used in connection with distributing petroleum

or any primary product of petroleum. ➢ Off the shelf computer software.

Under special rules for qualified Section 179 real property the taxpayer can elect to treat certain qualified real property placed in service during the tax year as Section 179 property. If the election is made, the term "Section 179 property" will include any qualified real property which is:

➢ Qualified improvement property as described in Section 168(e)(6), and ➢ Any of the following improvements to nonresidential real property placed in service after the date the

nonresidential real property was first placed in service. 1. Roofs. 2. Heating, ventilation, and air-conditioning property. 3. Fire protection and alarm systems. 4. Security systems.

A deduction attributable to qualified Section 179 real property which is disallowed under the trade or business income limitation for 2023 can be carried over to 2024. Thus, the amount of any 2023 disallowed Section 179 expense deduction attributable to qualified Section 179 real property will be reported on line 13 of Form 4562.

Listed Property

Listed property is a specific class of depreciable property that is subject to a special set of tax rules if it is used for business no more than 50% of the time. Listed property generally includes the following:

➢ Passenger automobiles weighing 6,000 pounds or less. ➢ Any other property used for transportation if the nature of the property lends itself to personal use, such as

motorcycles, pick-up trucks, sport utility vehicles, etc. ➢ Any property used for entertainment or recreational purposes (such as photographic, phonographic,

communication, and video recording equipment). ➢ Computers or peripheral equipment placed in service before 2018.

The Tax Cuts and Jobs Act (TCJA) removed computer or peripheral equipment from the definition of listed property. This change applies to property placed in service after December 31, 2017.

Listed property does not include:

➢ Photographic, phonographic, communication, or video equipment used exclusively in a taxpayer's trade or business or at the taxpayer's regular business establishment.

➢ Any computer or peripheral equipment used exclusively at a regular business establishment and owned or leased by the person operating the establishment.

➢ An ambulance, hearse, or vehicle used for transporting persons or property for compensation or hire. ➢ Any truck or van placed in service after July 6, 2003, that is a qualified nonpersonal use vehicle.

The TCJA also changed depreciation limits for passenger vehicles, trucks, and vans (not meeting the guidelines below), that are used more than 50% in a qualified business use and placed in service after December 31, 2017. For passenger automobiles placed in service during calendar year 2023, for which the Section 168(k) bonus first-year depreciation deduction does not apply, the depreciation limit under Section 280F(d)(7) is:

➢ $12,200 for the first year, ➢ $19,500 for the second year,

Lesson 10 - Depreciation

➢ $11,700 for the third year, and ➢ $6,960 for each succeeding taxable year in the recovery period.

For passenger automobiles to which the Section 168(k) bonus first-year depreciation deduction applies and that are acquired after September 27, 2017, and placed in service during calendar year 2023, the depreciation limit under Section 280F(d)(7) is:

➢ $20,200 for the first year, ➢ $19,500 for the second year, ➢ $11,700 for the third year, and ➢ $6,960 for each succeeding taxable year in the recovery period.

Exceptions include the following vehicles:

➢ Taxis, transport vans, and other vehicles used to specifically transport people or property for hire. ➢ Ambulance or hearse used specifically in a taxpayer’s business. ➢ Qualified non-personal use vehicles specifically modified for business (i.e., van without seating behind driver,

permanent shelving installed, and exterior painted with company’s name).

Also, the maximum Section 179 expense deduction for sport utility vehicles (SUV) placed in service in tax years beginning in 2023 is $28,900. Many vehicles that by their nature are not likely to be used for personal purposes qualify for full Section 179 deduction including the following vehicles:

1. Heavy non-SUV vehicles with a cargo area at least six feet in interior length (this area must not be easily accessible from the passenger area).

2. Vehicles that can seat nine-plus passengers behind the driver's seat (i.e.: Hotel / Airport shuttle vans, etc.). 3. Vehicles with a fully enclosed driver's compartment / cargo area, no seating at all behind the driver's seat, and no

part of the body Section protruding more than 30 inches ahead of the leading edge of the windshield. Used Equipment (that is new to the taxpayer) qualifies for Section 179. Under the TCJA, used equipment also qualifies for Bonus Depreciation.

Bonus Depreciation

The Tax Cuts and Jobs Act (TCJA) increased the bonus depreciation percentage from 50% to 100% for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. The bonus depreciation percentage for qualified property that a taxpayer acquired before September 28, 2017, and placed in service before January 1, 2018, remains at 50%. Special rules apply for longer production period property and certain aircraft. The amount of allowable bonus depreciation is then phased down over four years: 80% will be allowed for property placed in service in 2023, 60% in 2024, 40% in 2025, and 20% in 2026. (For certain property with long production periods, the above dates will be pushed out a year). The depreciation deduction generally applies to depreciable business assets with a recovery period of 20 years or less and certain other property. Machinery, equipment, computers, appliances, and furniture generally qualify. The definition of property eligible for bonus depreciation was expanded to include used qualified property acquired and placed in service after September 27, 2017, if all the following factors apply:

➢ The taxpayer or its predecessor did not use the property at any time before acquiring it. ➢ The taxpayer did not acquire the property from a related party. ➢ The taxpayer did not acquire the property from a component member of a controlled group of corporations. ➢ The taxpayer’s basis of the used property is not figured in whole or in part by reference to the adjusted basis of

the property in the hands of the seller or transferor. ➢ The taxpayer’s basis of the used property is not figured under the provision for deciding basis of property acquired

from a decedent. ➢ Also, the cost of the used property eligible for bonus depreciation does not include the basis of property determined

by reference to the basis of other property held at any time by the taxpayer (for example, in a like-kind exchange or involuntary conversion).

Lesson 10 - Depreciation

The TCJA added qualified film, television, and live theatrical productions as types of qualified property that may be eligible for bonus depreciation. This provision applies to property acquired and placed in service after September 27, 2017. Under the TCJA, certain types of property are not eligible for bonus depreciation in any taxable year beginning after December 31, 2017. One such exclusion from qualified property is for property primarily used in the trade or business of the furnishing or sale of:

➢ Electrical energy, water or sewage disposal services, ➢ Gas or steam through a local distribution system, or ➢ Transportation of gas or steam by pipeline.

This exclusion applies if the rates for the furnishing or sale have to be approved by a Federal, state or local government agency, a public service or public utility commission, or an electric cooperative. The TCJA also added an exclusion for any property used in a trade or business that has had floor-plan financing indebtedness if the floor-plan financing interest was taken into account under Section 163(j)(1)(C). Floor-plan financing indebtedness is secured by motor vehicle inventory that in a business that sells or leases motor vehicles to retail customers. As corrected by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, qualified improvement property is treated as 15-year property, and, therefore, bonus depreciation eligible. The change is made as if included in TCJA, and thus is effective for property placed in service after December 31, 2017. Bonus Depreciation is useful to very large businesses spending more than the Section 179 Spending Cap on new capital equipment. Also, businesses with a net loss are still qualified to deduct some of the cost of new equipment and carry- forward the loss. When applying these provisions, Section 179 is generally taken first, followed by Bonus Depreciation - unless the business had no taxable profit, because the unprofitable business is allowed to carry the loss forward to future years.

Unrecovered Basis

There are limits on the amount a taxpayer can deduct for depreciation of his or her car, truck, or van. The Section 179 deduction is treated as depreciation for purposes of the limits. The maximum amount a taxpayer can deduct each year depends on the year he or she puts the car in service. If the depreciation deductions for the taxpayer’s car are reduced, he or she will have unrecovered basis in his or her car at the end of the recovery period. If the taxpayer continues to use his or her car for business, he or she can deduct that unrecovered basis (subject to depreciation limits) after the recovery period ends. Unrecovered basis is the cost or other basis of the passenger automobile reduced by any clean-fuel vehicle deduction, electric vehicle credit, depreciation, and Section 179 deductions that would have been allowable if the taxpayer had used the car 100% for business and investment use and the passenger automobile limits had not applied.

The taxpayer cannot claim a depreciation deduction for listed property other than passenger automobiles after the recovery period ends. There is no unrecovered basis at the end of the recovery period because he or she is considered to have used this property 100% for business and investment purposes during all of the recovery period.

For 5-year property, the taxpayer’s recovery period is 6 calendar years. A part year's depreciation is allowed in the first calendar year, a full year's depreciation is allowed in each of the next 4 calendar years, and a part year's depreciation is allowed in the 6th calendar year. Under MACRS, the taxpayer’s recovery period is the same whether he or she utilizes declining balance or straight line depreciation. The taxpayer determines his or her unrecovered basis in the 7th year after he or she placed the car in service.

If the taxpayer continues to use his or her car for business after the recovery period, he or she is due a depreciation deduction in each succeeding tax year until he or she recovers the basis in the car. The maximum amount the taxpayer can deduct each year is determined by the date he or she placed the car in service and his or her business-use percentage. For example, no deduction is allowed for a year the taxpayer uses a car 100% for personal purposes.

Lesson 10 - Depreciation

Per Revenue Procedure 2011-26 the IRS provides a safe harbor accounting method. This procedure provides guidance with respect to the 100% additional first year depreciation deduction under Section 168(k)(5) of the Code, and the extension of the 50% bonus depreciation deduction for qualified property placed in service in 2010. This procedure defines which property is eligible for the 100% bonus depreciation deduction and provides guidance regarding the time and manner for making certain elections under Sections 168(k)(2) and (5). The procedure also provides a safe harbor method of accounting for passenger automobiles that qualify for the 100% additional first year depreciation deduction and that are subject to first-year limitations under Section 280F. The taxpayer selects the safe harbor method by choosing it to deduct depreciation on a passenger car on the return of the year that follows the placed-in-service year of the car when the cost exceeded the first-year luxury auto limit and the 100% bonus depreciation deduction was claimed.

Capitalization and Repairs In the past, the ability to take an immediate deduction for certain expenditures was somewhat liberal. However, the IRS began to take notice and as a result, the Treasury Department has attempted to produce rules that will tighten this flexibility with Treasury Decision 9636. These new rules are commonly referred to as the “Cap and Repair Regs”. There are two different versions of the regulation:

➢ The temporary cap and repair regulations were issued in 2011. If the taxpayer’s operation elected to implement the temporary regulations, those would apply during the time period from 2011-2013, and new regulations would be effective for taxable years beginning January 1, 2014.

➢ The final cap and repair regulations were issued in September 2013. If the taxpayer’s operation did not elect to implement the temporary regulations, the final regulations will apply and are effective for taxable years beginning January 1, 2014.

Section 162 of the Internal Revenue Code (IRC) allows a taxpayer to deduct all the ordinary and necessary expenses he or she incurs during the taxable year in carrying on his or her trade or business, including the costs of certain materials, supplies, repairs, and maintenance. However, Section 263(a) of the IRC requires the taxpayer to capitalize the costs of acquiring, producing, and improving tangible property, regardless of the size or the cost incurred. The tax law has long required the taxpayer to determine whether expenditures related to tangible property are currently deductible business expenses or non-deductible capital expenditures. Before the issuance of the final tangible property regulations on September 17, 2013, [Treasury Decision 9636 ("final regulations")], the taxpayer’s decisions were guided by decades of often conflicting case law, as well as administrative rulings on specific factual situations. The basic structure and requirements within the temporary regulations remained intact. Although the final regulations have been “simplified” in several key areas, they remain complex overall. The final regulations follow the basic outline of the proposed and temporary regulations, with changes made within each of five main areas:

1. Materials and supplies (Regulation 1.162-3). 2. Repairs and maintenance (Regulation 1.162-4). 3. Capital expenditures (Regulation 1.263(a)-1). 4. Amounts paid for the acquisition or production of tangible property (Regulation 1.263(a)-2). 5. Amounts paid for the improvement of tangible property (Regulation 1.263(a)-3).

The changes emphasized by the IRS include:

1. A revised and simplified de minimis safe harbor under Regulation 1.263(a)-1(f). 2. The extension of the safe harbor for routine maintenance to buildings. 3. An annual election for buildings that cost $1 million or less to deduct up to $10,000 of maintenance costs or, if

less, 2% of the building’s adjusted basis. 4. A new annual election to capitalize repair costs that are capitalized on a taxpayer’s books and records. 5. The refinement of the criteria for defining betterments and restorations to tangible property.

The final regulations apply to anyone who pays or incurs amounts to acquire, produce, or improve tangible real or personal property. These regulations apply to corporations, S corporations, partnerships, LLCs, and individuals filing a Form 1040 with Schedule C, E, or F. The final regulations affect the taxpayer if he or she incurs amounts to acquire, produce or improve tangible real or personal property in carrying on his or her trades or businesses. The rules are most significant

Lesson 10 - Depreciation

for those that regularly incur large capital expenditures, e.g., electric utilities, telecommunications companies, and businesses with substantial real estate holdings. The final regulations are effective for taxable years beginning on or after January 1, 2014.

De Minimis Safe Harbor Election

Effective for taxable years beginning on or after January 1, 2016, the Internal Revenue Service in Notice 2015-82 increased the de minimis safe harbor threshold from $500 to $2,500 per invoice or item for taxpayers without applicable financial statements. In addition, the IRS will provide audit protection to eligible businesses by not challenging the use of the $2,500 threshold for tax years ending before January 1, 2016 if the taxpayer otherwise satisfies the requirements of Treasury Regulation Section 1.263(a)-1(f)(1)(ii). Under the final regulations, the taxpayer may elect to apply a de minimis safe harbor to amounts paid to acquire or produce tangible property to the extent such amounts are deducted by him or her for financial accounting purposes or in keeping his or her books and records. If the taxpayer has an applicable financial statement (AFS), he or she may use this safe harbor to deduct amounts paid for tangible property up to $5,000 per invoice or item. If the taxpayer does not have an AFS, he or she may use the safe harbor to deduct amounts up to $500 (prior to January 1, 2016) per item or invoice.

These limitations are for purposes of determining whether particular expenses qualify under the safe harbor; they are not intended as a ceiling on the amount the taxpayer can deduct as business expenses under the IRC.

Amounts paid for the acquisition or production of tangible property that exceed the safe harbor limitations are not subject to the de minimis safe harbor election. Therefore, the safe harbor does not require the taxpayer to capitalize all amounts paid for tangible property in excess of the applicable limitation. If an amount does not qualify under the de minimis safe harbor, the taxpayer should treat the amount under the normal rules that apply, i.e., currently deductible if paid for incidental materials and supplies or for repair and maintenance. This treatment is proper regardless of whether the amount exceeds the applicable de minimis safe harbor limitation. The de minimis safe harbor is simply an administrative convenience that generally allows the taxpayer to elect to deduct small-dollar expenditures for the acquisition or production of property that otherwise must be capitalized under the general rules. The facts and circumstances analysis for distinguishing capital improvements from deductible repairs are:

➢ For buildings – The unit of property is generally the entire building including its structural components. However, under the final regulations and for these purposes only, the improvement analysis applies to the building structure and each of the key building systems. The key building systems are the plumbing system, electrical system, HVAC system, elevator system, escalator system, fire protection and alarm system, gas distribution system, and the security system. Lessees of portions of buildings apply the analysis to the portion of the building structure and portion of each building system subject to the lease. Lessors of an entire building apply the improvement rules to the entire building structure and each of the key building systems.

➢ For non-buildings – The unit of property is, and the analysis applies to, all components that are functionally interdependent. Components of property are functionally interdependent if the taxpayer cannot place in service one component of property without placing in service another component of property.

➢ For plant property, e.g., manufacturing plant, generation plant, etc. – The unit of property is, and the analysis applies to, each component or group of components within the plant that performs a discrete and major function or operation.

➢ For network assets, e.g., railroad track, oil and gas pipelines, etc. – The taxpayer’s particular facts and circumstances or industry guidance from the Treasury Department and the IRS determines the unit of property and the application of the improvement analysis.

The tax law requires that repairs and improvements to business property must be capitalized under certain conditions. To capitalize means the expenditure is not deducted in full immediately but is depreciated over time. A unit of tangible property is improved only if the amounts paid are:

➢ For a betterment to the unit of property; or ➢ To restore the unit of property; or ➢ To adapt the unit of property to a new or different use.

Lesson 10 - Depreciation

Betterments include material additions (i.e., physical enlargement) to the property, or expenditures that materially increase an asset’s productivity, efficiency, strength, quality, or output. Adaptations are amounts paid to adapt the property to a new or different use. Restorations include replacement of a major component or substantial structural part of the property or returning the property to operating condition when no longer functional. To reduce the difficulty with applying the facts and circumstances analysis to identify the tax treatment of costs and to recognize simpler administration by permitting the taxpayer to follow financial accounting policies for Federal tax purposes, the final regulations include an election to capitalize repair and maintenance expenses as improvements, if he or she treats such costs as capital expenditures for financial accounting purposes. The taxpayer may elect to treat repair and maintenance costs paid during the taxable year as amounts paid to improve property if he or she:

1. Pays these amounts in carrying on a trade or business; and 2. Treats these amounts as capital expenditures on his or her books and records regularly used in computing his or

her income. 3. Makes the election to capitalize for each taxable year in which qualifying amounts are incurred by attaching a

statement to his or her timely filed original Federal tax return including extensions for the taxable year that the amounts are paid.

a. If he or she makes the election to capitalize repair and maintenance expenses, he or she must apply the election to all amounts paid for repair and maintenance that he or she treats as capital expenditures on his or her books and records in that taxable year.

b. An annual election is not a change in method of accounting. Therefore, he or she should not file Form 3115 - Application for Change in Accounting Method to make this election or to stop capitalizing repairs and maintenance costs for a subsequent year.

Structural Components and the Partial Disposition Election

Under Treasury Disposition Regulations Section 1.168(i)-8(d)(2), taxpayers may recognize a disposition on the retirement of a building structural component that is Modified Accelerated Cost Recovery System (MACRS) property. The definition of a disposition for MACRS property now includes a partial disposition. In addition to certain mandatory partial dispositions, the regulations contain a voluntary partial disposition election. The partial disposition election is made by reporting the gain, loss, or other deduction on the taxpayers timely filed, including extensions, original Federal tax return for that taxable year in which the partial disposition occurs. The disposition regulations are especially important as applied to buildings and their structural components that are MACRS property. Taxpayers typically make a number of capitalized improvements over a building’s long life. These improvements often require a significant financial outlay. It is beneficial to recognize dispositions of structural components retired as part of these improvements.

Materials and Supplies Costs

In most cases, the final regulations do not change the general rules for deducting materials and supplies. The final regulations merely incorporate pre-existing precedents on the definition and treatment of materials and supplies and add some safe harbors to provide the taxpayer with additional certainty. The final regulations also provide additional elections and methods for those using rotable spare parts. Materials and supplies are tangible, non-inventory property used and consumed in the taxpayer’s operations including:

➢ Acquired components – Costs of components acquired to maintain, repair, or improve tangible property owned, leased, or serviced by the taxpayer and that is not acquired as part of a larger item of tangible property.

➢ Consumables – Costs of fuel, lubricants, water, and similar items that are reasonably expected to be consumed in 12 months or less, beginning when used in operations.

➢ 12-month property – Costs of tangible property that has an economic useful life of 12 months or less, beginning when the property is used or consumed in the taxpayer’s operations.

➢ $200 property – Costs of tangible property that has an acquisition cost or production cost of $200 or less.

Lesson 10 - Depreciation

As under prior rules, the taxpayer may deduct the costs of incidental and nonincidental materials and supplies in the following manner:

➢ Incidental materials and supplies – If the materials and supplies are incidental, i.e., of minor or secondary importance, carried on hand without keeping a record of consumption, and no beginning and ending inventories are recorded, e.g., pens, paper, staplers, toner, trash baskets, then the taxpayer deducts the materials and supplies costs in the taxable year in which the amounts are paid or incurred, provided taxable income is clearly reflected.

➢ Nonincidental materials and supplies – If the materials and supplies are not incidental, then the taxpayer deducts the materials and supplies costs in the taxable year in which the materials and supplies are first used or consumed in his or her operations. For example, the taxpayer deducts certain expendable spare parts in a trucking business for which records of consumption are kept and inventories are recorded in the taxable year the part is removed from his or her storage area and installed in one of his or her trucks. However, an otherwise deductible material or supply cost could be subject to capitalization under Section 263(a) if he or she uses the material or supply to improve property or under Section 263A if he or she incorporates the material or supply into property he or she produces or acquires for resale.

➢ Application with de minimis safe harbor – If the taxpayer elects to use the de minimis safe harbor and any materials and supplies also qualify for the safe harbor, he or she must deduct amounts paid for these materials or supplies under the safe harbor in the taxable year the amounts are paid or incurred. Such amounts are not treated as amounts paid for materials and supplies and may be deducted as business expenses in the taxable year they are paid or incurred.

Because the final regulations governing the treatment of materials and supplies are based primarily on prior law, if the taxpayer was previously in compliance with the rules he or she generally will still be in compliance and generally no action will be required to continue to apply these rules on a prospective basis. Also, the final regulations governing the treatment of material and supplies apply to amounts paid or incurred in taxable years beginning on or after January 1, 2014. Therefore, for the taxpayer’s first taxable year beginning January 1, 2014, most taxpayers will not have a change in accounting method for his or her materials and supplies. If the taxpayer desires to change his or her method of accounting for materials and supplies in a subsequent taxable year, he or she would file Form 3115 and compute a Section 481(a) adjustment taking into account only amounts paid after January 1, 2014. Nothing in the final regulations under Section 263(a) changes the treatment of any amount that is specifically provided for under any provision of the IRC or the Treasury regulations other than Section 162(a) or Section 212. For example, the final regulations do not eliminate the requirements of Section 263(a), which generally provides that the taxpayer must capitalize the direct and allocable indirect costs of producing real or tangible personal property and acquiring property for resale. Generally, the final regulations apply to taxable years beginning on or after January 1, 2014, or in certain circumstances, apply to costs paid or incurred in taxable years beginning on or after January 1, 2014.

Lesson 10 - Depreciation

Review Feedback Review feedback provides both the answers to each question and an explanation or feedback as to how we arrived at each answer at the end of the lesson. Review feedback also contains evaluative feedback explaining why incorrect answers are wrong. You are also provided the course topic from which we derived our answer and the external source material we used for verification. If you are using the online version of the course, Ctrl+click on the topic to find the section from which we arrived at the answer for the question. You can also Ctrl+click on the question number to return to the specific review question. Question 1 - A. One year In order for a taxpayer to be allowed a depreciation deduction for a property; he or she must own the property, the taxpayer must use the property in business or in an income-producing activity and the property must have a determinable useful life of more than one year. Only Choice A has the correct number of years and is therefore the correct response. Topic - Depreciation Source - IRS.GOV - Topic No. 704 - Depreciation Question 2 - C. Phil owns the van and he can depreciate it To claim depreciation, the taxpayer usually must be the owner of the property. He or she is considered as owning property even if it is subject to a debt making Choice C correct the response as it refers to Phil owning the van and his ability to depreciate it. Topic - Depreciation Source - IRS.GOV - Topic No. 704 - Depreciation Question 3 - D. Land The taxpayer can depreciate most types of tangible property (except land (Choice D)), such as buildings, machinery, vehicles (Choice A), furniture (Choice B), and equipment. He or she also can depreciate certain intangible property, such as patents (Choice C), copyrights, and computer software. Topic - Depreciation Source - IRS.GOV - Topic No. 704 - Depreciation Question 4 - D. Recovery Period Basis is generally the amount of a taxpayer’s capital investment in a property for tax purposes. Use the basis to figure depreciation (Choice A), amortization (Choice B), depletion (Choice C), casualty losses, and any gain or loss on the sale, exchange or other disposition of the property. Choice D, Recovery Period, is not listed and therefore the correct response. Topic - Basis of Property Source - IRS.GOV - Topic No. 703 - Basis of Assets Question 5 - D. All of the above The cost also includes amounts paid for sales tax (Choice A), freight (Choice B), installation and testing, excise taxes (Choice C), legal and accounting fees (when they must be capitalized), revenue stamps, recording fees, and real estate taxes (if assumed for the seller). The taxpayer may also have to capitalize (add to basis) certain other costs related to buying or producing property. Since Choices A, B, and C are included in cost of an asset Choice D, All of the above, is the correct response. Topic - Cost Basis Source - IRS.GOV - Topic No. 703 - Basis of Assets

Lesson 10 - Depreciation

Question 6 - A. Owner's title insurance The following items are some of the settlement fees or closing costs a taxpayer can include in the basis of the property; abstract fees (abstract of title fees), charges for installing utility services, legal fees (including title search and preparation of the sales contract and deed), recording fees surveys, transfer taxes, owner's title insurance (Choice A) and any amounts the seller owes that the taxpayer agrees to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions. Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance. Topic - Cost Basis Source - IRS.GOV - Topic No. 703 - Basis of Assets Question 7 - D. Mortgage insurance premiums Charges connected with getting a loan such as points (discount points, loan origination fees), mortgage insurance premiums (Choice D), loan assumption fees, cost of a credit report and fees for an appraisal required by a lender cannot be included in the basis of the property. Topic - Cost Basis Source - IRS.GOV - Topic No. 703 - Basis of Assets Question 8 - B. 10-year property The 10-year property class under GSD includes vessels, barges, tugs, and similar water transportation equipment, any single purpose agricultural or horticultural structure, any tree or vine bearing fruits or nuts and qualified small electric meter and qualified smart electric grid system placed in service on or after October 3, 2008. Topic - Recovery Periods Source - Publication 946 - How To Depreciate Property Question 9 - C. Section 179 Election As a general rule, business assets are depreciated over a specified period of years (i.e., MACRS, GDS, ADS). There is one major exception under the Code. It is the Section 179 Election (Choice C). Under Section 179 of the Internal Revenue Code, a taxpayer might be able to treat all or part of the cost of certain qualifying property as an expense in the year that the property was acquired. This means that instead of treating a depreciable asset as a capital expenditure, where he or she can only recover the cost of the asset through the general depreciation system, the taxpayer might be able to take an immediate current year's deduction for all or part of the cost of the asset. Topic - Section 179 Election Source - Publication 946 - How To Depreciate Property

Retirement Income At the conclusion of this lesson you should have a basic knowledge of:

➢ Taxation of Social Security Benefits. ➢ Individual Retirement Arrangement (IRA) Contributions. ➢ Individual Retirement Arrangement (IRA) Distributions. ➢ Roth Individual Retirement Arrangements.

Social Security and Medicare Taxes The Federal Insurance Contributions Act (FICA) tax includes two separate taxes. One is Social Security tax, and the other is Medicare tax. Different rates apply for each of these programs. For 2023, the tax rate for Social Security is 6.2% for employees, 6.2% for employers and 12.4% for self-employed people. The Social Security tax applies only to the first $160,200 of wages, for a maximum of $9,932.40 for employees and for employers, and $19,864.80 for self-employed people. The current rate for Medicare is 1.45% for the employer and 1.45% for the employee, or 2.9% total. There is not a wage base limit for Medicare tax. All covered wages are subject to Medicare tax. In 2023, Social Security and Medicare taxes apply to the wages of household workers the taxpayer pays $2,600 or more in cash or an equivalent form of compensation. Social Security and Medicare taxes apply to election workers who are paid $2,200 or more in cash or an equivalent form of compensation. (192)

The 2013 Additional Medicare Tax (imposed by the Patient Protection and Affordable Care Act) requires individuals to pay a supplemental 0.9% tax (in addition to the 1.45% contribution that applies to all wages) on wages in excess of $200,000 ($250,000 if married, filing jointly). (193)

Any excess Social Security tax withheld over these maximums (usually from having two or more employers) is taken in additional paid-in income taxes and is combined with amounts withheld from wages or with estimates. If a joint return is filed, these amounts withheld from each spouse cannot be added together to exceed the maximums. (192)

Taxation of Social Security Benefits

If the only income the taxpayer received during the year was his or her Social Security or the Social Security Equivalent Benefit (SSEB) portion of tier 1 railroad retirement benefits, his or her benefits generally are not taxable and the taxpayer probably does not have to file a return. If the taxpayer has income in addition to his or her benefits, he or she may have to file a return even if none of his or her benefits are taxable. If any portion of the benefits is taxable, the taxpayer should file using Form 1040. The base amounts used to figure the tax on Social Security benefits are: (194)

➢ $25,000 if the taxpayer is single, head of household or surviving spouse. ➢ $25,000 if the taxpayer is married filing separately and lived apart from his or her spouse for all of current year. ➢ $32,000 if the taxpayer is married filing jointly. ➢ $0 if the taxpayer is married filing separately and lived with his or her spouse at any time during the current year.

Lesson 11 - Retirement Income

Review Question 1 Veronica is a 62-year-old, married taxpayer who files married filing separately, and who lives apart from her spouse for an entire taxable year. What is the Veronica’s base amount for computing taxable Social Security benefits?

A. $0 B. $10,000 C. $25,000 D. $32,000

See Review Feedback for answer.

Maximum Taxable Part

Some people have to pay Federal income taxes on their Social Security benefits. This usually happens only if the taxpayer has other substantial income (such as wages, self-employment, interest, dividends and other taxable income that must be reported on his or her tax return) in addition to his or her benefits. No one pays Federal income tax on more than 85% of his or her Social Security benefits based on Internal Revenue Service (IRS) rules. In order to determine the taxability of Social Security benefits, it is first necessary to calculate “combined income” – a measurement of income used specifically for these purposes. Combined income is calculated as the taxpayer’s total income from taxable sources (essentially the net amounts included on the front page of his or her tax return in calculating Adjusted Gross Income), plus any tax-exempt interest (i.e., from municipal bonds) and excluded foreign income, plus one half of his or her Social Security benefits. If this total exceeds $25,000 for individuals ($32,000 for married couples), then 50% of the excess is the amount of Social Security benefits that must be included in income. If provisional income exceeds $34,000 for individuals ($44,000 for married couples), then 85% of the excess amount is included in income. If the taxpayer files a single, Federal tax return and his or her combined income is: (192)

➢ Between $25,000 and $34,000, he or she may have to pay income tax on up to 50% of his or her benefits. ➢ More than $34,000, up to 85% of his or her benefits may be taxable.

If the taxpayer files a joint, Federal tax return and his or her combined income is:

➢ Between $32,000 and $44,000, he or she may have to pay income tax on up to 50% of his or her benefits. ➢ More than $44,000, up to 85% of his or her benefits may be taxable.

If the taxpayer is married and files a separate tax return, he or she probably will pay taxes on his or her benefits. To find out whether any of the taxpayer’s benefits may be taxable, compare the base amount for his or her filing status with his or her combined income which is the total of: (194)

1. One-half of his or her benefits, plus 2. The taxpayer’s adjusted gross, including tax-exempt interest.

When making this comparison, do not reduce the taxpayer’s other income by any exclusions for:

➢ Interest from qualified U.S. savings bonds. ➢ Employer-provided adoption benefits. ➢ Foreign earned income or foreign housing. ➢ Income earned by bona fide residents of American Samoa or Puerto Rico.

Any repayment of benefits the taxpayer made during 2023 must be subtracted from the gross benefits he or she received in 2023. It does not matter whether the repayment was for a benefit the taxpayer received in 2023 or in an earlier year.

Lesson 11 - Retirement Income

Joint Return

If the taxpayer is married and files a joint return for 2023, the taxpayer and his or her spouse must combine incomes and benefits when figuring if the combined benefits are taxable. Even if the taxpayer’s spouse did not receive any benefits, he or she must add the spouse's income to his or hers when figuring if any of the benefits are taxable. The IRS provides a Social Security Benefits Worksheet upon which the taxpayer can calculate taxable Social Security benefits.

Repayments

If the taxpayer received benefits during the year, he or she should receive a Form SSA-1099 - Social Security Benefit Statement or Form RRB-1099 - Payments by the Railroad Retirement Board. These forms show the amounts received and repaid, and taxes withheld for the year. The taxpayer may receive more than one of these forms for the same year. He or she should add the amounts shown on all the Forms SSA-1099 and Forms RRB-1099 he or she receives for the year to determine the total amounts received and repaid, and taxes withheld for that year. Any repayment of benefits the taxpayer made during the current year must be subtracted from the gross benefits he or she received. It does not matter whether the repayment was for a benefit he or she received in the current year or in an earlier year. The taxpayer’s gross benefits are shown in box 3 of Form SSA-1099 or RRB-1099. His or her repayments are shown in box 4. The amount in box 5 shows his or her net benefits for the current (box 3 minus box 4). Use the amount in box 5 to figure whether any of taxpayer’s benefits are taxable.

Canadian Social Security

Under Article XVIII, pensions and annuities from Canadian sources paid to U.S. residents are subject to tax by Canada, but the tax is limited to 15% of the gross amount (if a periodic pension payment) or of the taxable amount (if an annuity). Canadian pensions and annuities paid to U.S. residents may be taxed by the United States, but the amount of any pension included in income for U.S. tax purposes may not be more than the amount that would be included in income in Canada if the recipient were a Canadian resident. If a resident of the United States receives Social Security from Canada, it will only be taxable in the United States as if it was being received as U.S. Social Security except that if it would have been exempt in Canada then it will be exempt from U.S. tax as well.

Pensions and Annuities The pension or annuity payments that a taxpayer receives are fully taxable if he or she has no cost in the contract because any of the following situations: (195)

➢ The taxpayer’s employer did not withhold contributions from his or her salary. ➢ The taxpayer received all of his or her contributions tax free in prior years.

If a taxpayer contributed after-tax dollars to a pension or annuity, the pension payments are partially taxable. He or she will not pay tax on the part of the payment that represents a return of the after-tax amount paid. This amount is the taxpayer’s investment in the contract and includes the amounts his or her employer contributed that were taxable to him or her when contributed. Partly taxable pensions are taxed under either the General Rule or the Simplified Method. If the starting date of the pension or annuity payments is after November 18, 1996, the taxpayer generally must use the Simplified Method to determine how much of the annuity payments are taxable and how much is tax free. Under the Simplified Method, the taxpayer figures the tax-free part of each annuity payment by dividing the cost by the total number of anticipated monthly payments. For an annuity that is payable for the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date and is determined from a table. For any other annuity, this number is the number of monthly annuity payments under the contract. If the taxpayer’s annuity starting date is after 1986, the total amount of annuity income that he or she can exclude over the years as a recovery of the cost cannot exceed his or her total cost. Any unrecovered cost at the taxpayer’s (or the last annuitant's) death is allowed as an itemized deduction on the final return of the decedent.

Lesson 11 - Retirement Income

The taxpayer must use the Simplified Method if the annuity starting date is after November 18, 1996, and he or she meets both of the following conditions: (195)

1. The taxpayer receives his or her pension or annuity payments from any of the following plans: a. A qualified employee plan. b. A qualified employee annuity. c. A tax-sheltered annuity plan (403(b) plan).

2. On the annuity starting date, at least one of the following conditions applies to the taxpayer: a. He or she is under age 75. b. He or she is entitled to less than 5 years of guaranteed payments.

The General Rule is used to figure the tax treatment of various types of pensions and annuities, including nonqualified employee plans. A nonqualified employee plan is an employer's plan that does not meet Internal Revenue Code requirements. It does not qualify for most of the tax benefits of a qualified plan. The taxpayer can use the General Rule if he or she receives pension or annuity payments from:

➢ A nonqualified plan (for example, a private annuity, a purchased commercial annuity, or a nonqualified employee plan),

➢ A qualified plan if: o The annuity starting date is before November 19, 1996 (and after July 1, 1986), and the taxpayer does

not qualify to use, or chooses not to use, the Simplified Method. o The taxpayer is 75 or over and the annuity payments are guaranteed for at least 5 years (regardless of

the annuity starting date). The following are qualified plans:

➢ A qualified employee plan. ➢ A qualified employee annuity. ➢ A tax-sheltered annuity (TSA) plan or contract.

If the taxpayer receives pension or annuity payments before age 59½, he or she may be subject to an additional 10% tax on early distributions unless the distribution qualifies for an exemption. The additional tax does not apply to any part of a distribution that is tax free or to any of the following types of distributions:

➢ Distributions made as a part of a series of substantially equal periodic payments from a qualified plan that begins after the taxpayer’s separation from service.

➢ Distributions made because the taxpayer is totally and permanently disabled. ➢ Distributions made on or after the death of the plan participant or contract holder. ➢ Distributions made from a qualified retirement plan after the taxpayer’s separation from service in or after the year

he or she reached age 55. The taxpayer may choose not to have income tax withheld from the pension or annuity payments (unless they are eligible rollover distributions) or want to specify how much tax is withheld. If so, provide the payer Form W-4P - Withholding Certificate for Pension or Annuity Payments or a similar form provided by the payer. Withholding from periodic payments of a pension or annuity is generally figured the same way as for salaries and wages. If the taxpayer does not submit the withholding certificate, the payer must withhold tax as if the taxpayer is married and claiming three withholding allowances. If the taxpayer does not provide the payer with the correct Social Security number, tax will be withheld as if the taxpayer is single and claiming no withholding allowances, even if the taxpayer submitted a Form W-4P and elected a lower amount. A taxpayer should receive Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., from each person to whom he or she has received a designated distribution or was treated as having made a distribution of $10 or more from profit-sharing or retirement plans, any individual retirement arrangements (IRAs), annuities, pensions, insurance contracts, survivor income benefit plans, permanent and total disability payments under life insurance contracts, charitable gift annuities, etc. (196)

Lesson 11 - Retirement Income

If the taxpayer dies before the total investment in the contract is recovered, and annuity payments cease as a result of his or her death, the un-recovered amount is allowed as a deduction to the owner in his or her last taxable year.

Qualified Domestic Relations Order (QDRO)

The taxpayer may be able to roll over tax free all or part of a distribution from a qualified retirement plan that he or she receives under a QDRO. A QDRO is a judgment, decree or order for a retirement plan to pay child support, alimony or marital property rights to a spouse, former spouse, child or other dependent of a participant. The QDRO must contain certain specific information, such as:

1. The participant and each alternate payee’s name and last known mailing address. 2. The amount or percentage of the participant's benefits to be paid to each alternate payee.

A QDRO may not award an amount or form of benefit that is not available under the plan. A spouse or former spouse who receives QDRO benefits from a retirement plan reports the payments received as if he or she were a plan participant. The spouse or former spouse is allocated a share of the participant's cost (investment in the contract) equal to the cost times a fraction. The numerator of the fraction is the present value of the benefits payable to the spouse or former spouse. The denominator is the present value of all benefits payable to the participant. A QDRO distribution that is paid to a child or other dependent is taxed to the plan participant. An individual may be able to roll over tax-free all or part of a distribution from a qualified retirement plan that he or she received under a QDRO. If a person receiving QDRO payments is either the employee's spouse or former spouse (not as a nonspousal beneficiary), then he or she can roll it over, just as if he or she were the employee receiving a plan distribution and choosing to roll it over. The taxpayer may be able to roll it over tax free into a traditional individual retirement arrangement (IRA) or another qualified retirement plan.

Review Question 2 Partly taxable pensions are taxed under either of which two methods?

A. The General Rule or the Simplified Method B. The General Rule or MACRS C. The Simplified Method or MACRS D. The General Rule or the Multiple Lives Annuity Rule

See Review Feedback for answer.

Individual Retirement Arrangements (IRAs)

Setting Every Community Up for Retirement Enhancement (SECURE) Act

The following are several key provisions included in the SECURE Act: (197)

➢ IRA contributions: Previously, taxpayers were not allowed to contribute to a traditional IRA once they attained the age of 70½. The new law repeals this restriction based on the age of the IRA participant.

➢ Part-time workers: Generally, employers were able to exclude part-time workers (i.e., those working less than 1,000 hours per year) from participating in their 401(k) plans. Now the new law opens up plans to employees who have completed one year of service (with the 1,000-hour rule) or three consecutive years of at least 500 hours of service.

➢ Required minimum distributions: Under long-standing rules, participants in qualified plans and IRAs were obligated to start taking required minimum distributions (RMD) in the year after the year they turned age 70½. The new law pushes back the RMD age to reflect longer life expectancies.

Lesson 11 - Retirement Income

➢ Early withdrawals: The tax law already exempts certain distributions from qualified plans from the usual 10% tax penalty on early withdrawals prior to age 59½. The SECURE Act adds to the list by allowing penalty-free distributions for qualified birth and adoption expenses. Within a year after a birth or adoption, new parents can take up to $5,000 from a 401(k) or IRA or other qualified retirement plan.

The main purpose for a taxpayer to set up an Individual Retirement Arrangement (IRA) is to save for future retirement. The main tax advantage for taxpayers is that any earnings on the deposits remain tax-free until distributions are taken from the IRA, and at retirement age the taxpayer would probably be in a lower tax-bracket. The taxpayer’s basis in traditional IRAs is the total of all nondeductible contributions and nontaxable amounts included in rollovers made to traditional IRAs minus the total of all nontaxable distributions, adjusted if necessary. Here are nine important tips from the IRS about setting aside money for a taxpayer’s retirement in an Individual Retirement Arrangement:

1. The taxpayer must have taxable compensation to contribute to an IRA. This includes income from wages, salaries, tips, commissions, and bonuses. It also includes net income from self-employment. If he or she files a joint return, generally only one spouse needs to have taxable compensation.

2. The taxpayer can contribute to a traditional IRA at any time during the year. He or she must make all contributions by the due date for filing the tax return. This due date does not include extensions. For most people this means the taxpayer must contribute for 2023 by April 15, 2024. If he or she contributes between January 1 and April 15, contact the IRA plan sponsor to make sure they apply it to the right year.

3. For 2023, the most a taxpayer can contribute to an IRA is the smaller of either taxable compensation for the year or $6,500. If the taxpayer was 50 or older at the end of 2023 the maximum amount increases to $7,500.

4. Generally, the taxpayer will not pay income tax on the funds in a traditional IRA until he or she begins taking distributions from it.

5. The taxpayer may be able to deduct some or all of the contributions to a traditional IRA. 6. Use the worksheets in the instructions for Form 1040 to figure the amount of the contributions that can be

deducted. 7. The taxpayer may also qualify for the Savers Credit, formally known as the Retirement Savings Contributions

Credit. The credit can reduce taxes up to $1,000 (up to $2,000 if filing jointly). Use Form 8880 - Credit for Qualified Retirement Savings Contributions, to claim the Saver’s Credit.

8. The taxpayer must file Form 1040 to deduct IRA contribution or to claim the Saver’s Credit. 9. See Publication 590-A - Contributions to Individual Retirement Arrangements (IRAs), for more about IRA

contributions.

Contributions to Traditional IRAs

The Setting Every Community Up for Retirement Enhancement (SECURE) Act eliminates the prohibition on traditional IRA contributions for those age 70½ and older as of January 1, 2020. The only requirement for setting up a traditional IRA is the taxpayer must have received some taxable compensation income during the year. Taxable compensation includes wages, salaries, alimony, tips, commissions and the like. However, the following are not considered compensation income for purposes of setting up or contributing to an IRA: (198)

➢ Earnings and profits from property, such as rental income, interest income, and dividend income. ➢ Pension or annuity income. ➢ Deferred compensation income. ➢ Any other income that is an exclusion from gross income.

An IRA can be set up either in the name of the taxpayer or the taxpayer and his or her spouse, in a so-called spousal IRA. Contributions can be made to a spousal IRA even if the spouse has no compensation income. There are specific limitations on the amount that he or she can contribute to a traditional IRA during the year.

The maximum amount of contribution is limited to the smaller of: (199)

➢ For tax year 2023, $6,500 if the taxpayer is under age 50. If he or she is over 50 years old the catch-up contribution limit is $7,500.

➢ The taxpayer’s compensation income for the tax year.

The IRA contribution limit does not apply to rollover contributions or qualified reservist repayments. (200)

Lesson 11 - Retirement Income

For 2023, the limit on annual contributions to an Individual Retirement Arrangement (IRA) increased to $6,500. The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000.

There are established time frames during which a taxpayer can make an IRA contribution. An IRA contribution can be made at any time during the tax year or by the due date of the tax return for the year in which he or she wants the contribution to apply, not including any extensions in time to file requests. In other words, most taxpayers can make an IRA contribution for 2023 by April 15, 2024. In fact, the taxpayer can even claim an IRA contribution and file his or her tax return before the contribution is actually made, as long as it in fact is made before the due date of the return. However, if contributions to the traditional IRA for a year were less than the limit, the taxpayer cannot contribute more after the due date of his or her return for that year to make up the difference. Line 20 on Schedule 1 (Form 1040) is where the taxpayer claims a deduction for an IRA contribution for the year. The rules for claiming this deduction have become remarkably complicated over the last several years. Specifically, if either the taxpayer or his spouse is covered by an employer provided retirement plan, the amount of available deduction may be reduced or even eliminated. Not only is the amount of available IRA deduction dependent on filing status, but it may also be subject to certain income limitations. The amount of available IRA deduction can be determined by using an IRS supplied IRA worksheet.

Review Question 3 In 2023, to contribute to a traditional IRA, the taxpayer must be under what age at the end of the tax year?

A. 59½ B. 70½ C. 72 D. No age limit

See Review Feedback for answer.

Deductible Phase-Out Range

A taxpayer’s deduction may be limited if he or she (or his or her spouse, if married) is covered by a retirement plan at work and the taxpayer’s income exceeds certain levels. The deductible IRA income 2023 phase-out limits, for individuals who are active participants, are increased as follows:

2023 IRA Deduction Limits - Effect of Modified AGI on Deduction if the Taxpayer is Covered by a Retirement Plan at Work

Filing Status Modified AGI Amount Deduction Amount

Single or Head of Household

$73,000 or less Full Deduction to Contribution Limit

more than $73,000 but less than $83,000

Partial Deduction

$83,000 or more No Deduction

Married filing jointly or Qualifying Surviving Spouse

$116,000 or less Full Deduction to Contribution Limit

more than $116,000 but less than $136,000

Partial Deduction

$136,000 or more No Deduction

Married filing separately

Less than $10,000 Partial Deduction

$10,000 or more No Deduction

If the taxpayer files separately and did not live with his or her spouse at any time during the year, the taxpayer’s IRA deduction is determined under the single filing status.

Table 11-1 - IRA Deduction Limits - Effect of MAGI on Deduction if You Are Covered by a Retirement Plan at Work (2023)

Lesson 11 - Retirement Income

If the taxpayer is not covered by a retirement plan at work, he or she should use the following table to determine if his or her modified AGI affects the amount of his or her deduction. The deduction is limited only if his or her spouse is covered by a retirement plan.

2023 IRA Deduction Limits - Effect of Modified AGI on Deduction if the Taxpayer is not Covered by a Retirement Plan at Work

Filing Status Modified AGI Amount Deduction Amount

Single, Head of Household or Surviving Spouse

Any Amount Full Deduction to Contribution Limit

Married filing jointly or separately with a spouse who is not covered by a plan at work

Any Amount Full Deduction to Contribution Limit

Married filing jointly with a spouse who is covered by a plan at work

$218,000 or less Full Deduction to Contribution Limit

more than $218,000 but less than $228,000

Partial Deduction

$228,000 or more No Deduction

Married filing separately with a spouse who is covered by a plan at work

Less than $10,000 Partial Deduction

$10,000 or more No Deduction

If the taxpayer files separately and did not live with his or her spouse at any time during the year, the taxpayer’s IRA deduction is determined under the single filing status.

Table 11-2 - IRA Deduction Limits - Effect of MAGI on Deduction if You Are NOT Covered by a Retirement Plan at Work (2023)

The taxpayer’s deduction is allowed in full if he or she (and his or her spouse, if married) are not covered by a retirement plan at work.

Kay Bailey Hutchison Spousal IRA Limit

For 2023, if the taxpayer files a joint return and his or her taxable compensation is less than that of his or her spouse, the most that can be contributed for the year to his or her IRA is the smaller of the following two amounts:

1. $6,500 ($7,500 if the taxpayer is age 50 or older). 2. The total compensation includible in the gross income of both the taxpayer and his or her spouse for the year,

reduced by the following two amounts: a. The taxpayer’s spouse's IRA contribution for the year to a traditional IRA. b. Any contributions for the year to a Roth IRA on behalf of the taxpayer’s spouse.

This means that the total combined contributions that can be made for the year to a taxpayer’s IRA and his or her spouse's IRA can be as much as $13,000 ($14,000 if only one person is age 50 or older or $15,000 if both people are age 50 or older).

Nondeductible IRAs

A nondeductible IRA is like a traditional IRA in all respects but one: an individual cannot take a tax deduction for contributions made to the IRA. An individual can set up a Nondeductible IRA if that person is covered by a pension, 401(k) or other retirement plan, and that person's income is above the limits for a Traditional (Deductible) IRA. Although the money that a person puts into the IRA is not tax-deductible, that individual will not be taxed on the investment earnings on their contributions until that person withdraws the money. This allows the individual to accumulate more than if the investment earnings were taxed immediately. If a taxpayer makes a nondeductible contribution, he or she must fill out Form 8606 - Nondeductible IRAs. Use Form 8606 to report: (201)

➢ Nondeductible contributions made to traditional IRAs. ➢ Distributions from traditional, SEP, or SIMPLE IRAs, if the taxpayer has ever made nondeductible contributions

to traditional IRAs. ➢ Conversions from traditional, SEP, or SIMPLE IRAs to Roth IRAs. ➢ Distributions from Roth IRAs.

Lesson 11 - Retirement Income

Penalty for Not Filing Form 8606

If the taxpayer is required to file Form 8606 to report a nondeductible contribution to a traditional IRA for 2023, but does not do so, he or she must pay a $50 penalty, unless he or she can show reasonable cause.

Overstatement Penalty

If the taxpayer overstates the nondeductible contributions for 2023, he or she must pay a $100 penalty, unless he or she can show reasonable cause.

Amending Form 8606

After the taxpayer files the return, he or she can change a nondeductible contribution to a traditional IRA to a deductible contribution or vice versa. The taxpayer also may be able to make a recharacterization. If necessary, complete a new Form 8606 showing the revised information and file it with Form 1040-X - Amended U.S. Individual Income Tax Return.

Recharacterizations

Generally, a taxpayer can recharacterize (correct) an IRA contribution, Roth IRA conversion, or a Roth IRA rollover from a qualified retirement plan by making a trustee-to-trustee transfer from one IRA to another type of IRA. Trustee-to-trustee transfers are made directly between financial institutions or within the same financial institution. The taxpayer generally must make the transfer by the due date of the return (including extensions) and reflect it on the return. However, if the taxpayer filed a timely return without making the transfer, he or she can make the transfer within 6 months of the due date of the return, excluding extensions. If necessary, file an amended return reflecting the transfer. If the taxpayer made a contribution to a Roth IRA and later recharacterized part or all of it in a trustee-to-trustee transfer to a traditional IRA he or she reports the nondeductible traditional IRA portion of the recharacterized contribution, if any, on Form 8606, Part I. The taxpayer does not report the Roth IRA contribution (whether or not he or she recharacterized all or part of it) on Form 8606. He or she attaches a statement to his or her return explaining the recharacterization. If the recharacterization occurred in 2023, include the amount transferred from the Roth IRA on the 2023 Form 1040, 1040-SR, or 1040-NR. If the recharacterization occurs in 2024, report the amount transferred only in the attached statement, and not on the 2023 or 2024 tax return.

Recordkeeping

To verify the nontaxable part of distributions from IRAs, including Roth IRAs, the taxpayer should keep a copy of the following forms and records until all distributions are made: (201)

➢ Page 1 of Form 1040 (or Forms 1040-NR or 1040-T) filed for each year the taxpayer made a nondeductible contribution to a traditional IRA.

➢ Forms 8606 and any supporting statements, attachments, and worksheets for all applicable years. ➢ Forms 5498 or similar statements the taxpayer received each year showing contributions made to a traditional

IRA or Roth IRA. ➢ Forms 5498 or similar statement received showing the value of the taxpayer’s traditional IRAs for each year he or

she received a distribution. ➢ Forms 1099-R or W-2P received for each year the taxpayer received a distribution.

Penalty-Free Withdrawals from IRAs

Generally, if the taxpayer is under the age of 59½, he or she must pay a 10% additional tax (10% in addition to any regular income tax on the amount) on the distribution of any assets (money or other property) from a traditional IRA. Distributions before age 59½ are called early distributions. The 10% additional tax applies to the part of the distribution that is included in gross income. There are certain distributions a taxpayer can receive before age 59½ without paying the early distribution penalty. A taxpayer may not have to pay the additional tax for one of the following situations: (202)

➢ The taxpayer has unreimbursed medical expenses that are more than 7.5% of adjusted gross income. ➢ The distributions are not more than the cost of medical insurance due to a period of unemployment. ➢ The taxpayer is totally and permanently disabled. ➢ The taxpayer is the beneficiary of a deceased IRA owner. ➢ The taxpayer is receiving distributions in the form of an annuity.

Lesson 11 - Retirement Income

➢ The distributions are not more than qualified higher education expenses. ➢ The taxpayer uses the distributions to buy, build, or rebuild a first home. ➢ The distribution is due to an IRS levy of the qualified plan. ➢ The distribution is a qualified reservist distribution.

Penalty-Free Withdrawals from IRAs for Unreimbursed Medical Expenses

The taxpayer does not have to pay the 10% additional tax on distributions that are not more than the amount he or she paid for unreimbursed medical expenses during the year of the distribution minus 7.5% of adjusted gross income for the year of the distribution. The taxpayer can only take into account unreimbursed medical expenses that he or she would be able to include in figuring a deduction for medical expenses on Schedule A (Form 1040). The taxpayer does not have to itemize deductions to take advantage of this exception to the 10% additional tax. (202)

Penalty-Free Withdrawal from IRAs for Medical Insurance Premiums

Certain unemployed persons who make an early distribution to pay for qualifying medical insurance premiums are not subject to the 10% penalty. Eligible unemployed individuals are those who have received Federal or state unemployment compensation for 12 consecutive weeks. Qualifying premiums are deductible premiums for the medical care of the unemployed individual, spouse, and dependents. To be excludable, the distributions must be received in the tax year during which unemployment compensation is received or in the following year. In determining whether the premiums are deductible, the 7.5% medical expense floor is ignored. This exception to the 10% penalty imposed on certain early distribution ceases to apply after the person has been reemployed for 60 days (not necessarily consecutive) after initial unemployment. (202)

Penalty-Free Withdrawals from IRAs for Disability

If the taxpayer becomes disabled before reaching the age 59½, any distributions from a traditional IRA because of the disability are not subject to the 10% additional tax. A taxpayer is considered disabled if he or she can furnish proof that he or she cannot do any substantial gainful activity because of physical or mental condition. A physician must determine that the condition can be expected to result in death or to be of long, continued, and indefinite duration. (202)

Penalty-Free Withdrawals from IRAs for a Beneficiary

If a person dies before reaching age 59½, the assets in a traditional IRA can be distributed to a beneficiary or to an estate without either having to pay the 10% additional tax. However, if the taxpayer inherits a traditional IRA from a deceased spouse and elects to treat it as his or her own, any distribution the taxpayer later receives before he or she reaches age 59½ may be subject to the 10% additional tax. (202)

Penalty-Free Withdrawals from IRAs for an Annuity

The taxpayer can receive distributions from a traditional IRA that are part of a series of substantially equal payments over his or her life (or his or her life expectancy), or over the lives (or the joint life expectancies) of the taxpayer and his or her beneficiary, without having to pay the 10% additional tax, even if the taxpayer receives such distributions before the taxpayer is age 59½. The taxpayer must use an IRS approved distribution method and he or she must take at least one distribution annually for this exception to apply. The required minimum distribution method, when used for this purpose, results in the exact amount required to be distributed, not the minimum amount.

There are two other IRS-approved distribution methods that the taxpayer can use. They are generally referred to as the fixed amortization method and the fixed annuitization method. These two methods are not fully discussed in this publication because they are more complex and generally require professional assistance. (202)

Example: Bob, age 50, is the owner of an IRA from which he would like to start taking distributions beginning in 2023. He would like to avoid the additional 10% tax imposed on early distributions by taking advantage of the substantially-equal-periodic-payment exception: (203)

➢ Bob’s IRA account balance is $400,000 as of December 31, 2022 (the last valuation prior to the first distribution). ➢ 120% of the applicable Federal mid-term rate is assumed to be 2.98%, and this will be the interest rate Bob uses

under the amortization and annuitization methods. ➢ Bob will determine distributions over his own life expectancy only.

Lesson 11 - Retirement Income

Penalty-Free Withdrawals from IRAs for Qualified Higher Educational Expenses

Penalty-free distributions from IRAs may be made for qualified educational purposes. The penalty-free withdrawal is available for qualified higher education expenses including tuition, fees, supplies, and equipment required for enrollment or attendance at a post-secondary educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance. (204) This penalty-free withdrawal (up to the amount of the IRA) is available to the taxpayer, the taxpayer's spouse, or any child or stepchild or grandchild of taxpayer or the taxpayer's spouse. When determining the amount of the distribution that is not subject to the 10% additional tax, include qualified higher education expenses paid with any of the following funds: (204)

➢ Payment for services, such as wages. ➢ A loan. ➢ A gift. ➢ An inheritance given to either the student or the individual making the withdrawal. ➢ A withdrawal from personal savings (including savings from a qualified tuition program).

Do not include expenses paid with any of the following funds: (204)

➢ Tax-free distributions from a Coverdell education savings account. ➢ Tax-free part of scholarships and fellowships. ➢ Pell grants. ➢ Employer-provided educational assistance. ➢ Veterans' educational assistance. ➢ Any other tax-free payment (other than a gift or inheritance) received as educational assistance.

In addition, if the student is at least a half-time student, room and board are qualified education expenses. The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts:

➢ The allowance for room and board, as determined by the eligible educational institution, which was included in the cost of attendance (for Federal financial aid purposes) for a particular academic period and living arrangement of the student.

➢ The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

The taxpayer may need to contact the eligible educational institution for qualified room and board costs.

Penalty-Free Withdrawal from IRAs for First-time Homebuyer Expenses

The 10% early distribution penalty will not be charged if the taxpayer uses the money from his or her IRA for qualified expenses associated with buying a principal residence. A maximum of $10,000 during the individual’s lifetime may be withdrawn without a penalty for this purpose. Qualified expenses include acquisition costs, settlement charges and closing costs. The principal residence may be for the individual or the individual’s spouse, child, grandchild, or ancestor of the individual or the individual’s spouse. In order to be considered a first-time homebuyer, the individual (and spouse, if married) must not have had an ownership interest in a principal residence during the two-year period ending on the date that the new home is acquired. (202)

Penalty-Free Withdrawal from IRAs for Qualified Reservist Distributions

A qualified reservist distribution is not subject to the additional tax on early distributions if the following requirements are met:

➢ The taxpayer was ordered or called to active duty after September 11, 2001. ➢ The taxpayer was ordered or called to active duty for a period of more than 179 days or for an indefinite period

because he or she is a member of a reserve component. ➢ The distribution is from an IRA or from amounts attributable to elective deferrals under a Section 401(k) or 403(b)

plan or a similar arrangement. ➢ The distribution was made no earlier than the date of the order or call to active duty and no later than the close of

the active-duty period.

Lesson 11 - Retirement Income

The term reserve component includes the: (202)

➢ Army National Guard of the United States. ➢ Army Reserve. ➢ Naval Reserve. ➢ Marine Corps Reserve. ➢ Air National Guard of the United States. ➢ Air Force Reserve. ➢ Coast Guard Reserve. ➢ Reserve Corps of the Public Health Service.

Penalty-Free Withdrawal from IRAs for Qualified Birth and Adoption Expenses

As part of the spending bill Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The SECURE Act represents a major overhaul of the rules for retirement plans and IRAs and is generally effective on January 1, 2020. The SECURE Act allows penalty-free distributions for qualified birth and adoption expenses. Within a year after a birth or adoption, new parents can take up to $5,000 from a 401(k) or IRA or other qualified retirement plan.

Penalty-Free Withdrawal from IRAs for Qualified Public Safety Employees

A qualified public safety employee distribution is not subject to the additional tax on early distributions if the employee separates from service during or after the year the employee reaches age 55 (age 50 for public safety employees of a state, or political subdivision of a state, in a governmental defined benefit plan). Effective for distributions after December 31, 2015, the exception for public safety employees who are age 50 or over is expanded to include specified Federal law enforcement officers, customs and border protection officers, Federal firefighters, and air traffic controllers. Also, the restriction that only defined benefit plans qualify for the exemption is eliminated. Thus, an exemption is allowed for distributions from defined contribution plans or other types of governmental plans, such as the TSP. Additionally, the exception for public safety employees includes distributions to firefighters at age 50 or with 25 years of service under the plan. (204)

Review Question 4 Certain unemployed persons who take an early IRA distribution to pay for qualifying medical insurance premiums are not subject to the 10% early distribution penalty. Eligible unemployed individuals are those who have received Federal or state unemployment compensation for how many consecutive weeks?

A. 10 weeks B. 12 weeks C. 15 weeks D. 18 weeks

See Review Feedback for answer.

Roth IRAs

Contributions to a Roth IRA are never deductible. The advantage of the Roth IRA is that the buildup within the IRA (e.g., interest, dividends, and/or price appreciation) may be free from Federal income tax when the individual withdraws money from the account. In general, a Roth IRA is subject to the same rules that apply to a traditional IRA.

For tax year 2023, the Roth IRA allows individuals under the age of 50 to make a maximum annual nondeductible contribution of up to $6,500 ($7,500 if age 50 or older). However, no more than $6,500 ($7,500 if age 50 or older) can be contributed to all of an individual's IRAs, whether they are traditional (deductible) or Roth (not deductible). Basically, a Roth IRA is an IRA that is subject to the rules that apply to a traditional IRA with the following exceptions: (196)

➢ The taxpayer cannot deduct contributions to a Roth IRA. ➢ The taxpayer can leave amounts in the Roth IRA as long as he or she lives.

Lesson 11 - Retirement Income

➢ The account or annuity must be designated as a Roth IRA when it is set up. ➢ Distributions for any of the following purposes are not taxable if:

o 5 year holding period has been met. o Made on or after age 59½. o Made to an individual's beneficiary or estate at death. o Made when the individual becomes disabled. o Made for a qualified purpose, such as first-time home buyer expenses, subject to a $10,000 lifetime cap.

There are several restrictions that the taxpayer should be aware of. One restriction is that a payment or distribution is not a qualified distribution if it is made less than 5 tax years from the first tax year in which the individual made a contribution to a Roth IRA. Another restriction is that a rollover from a deductible IRA to a Roth IRA will be taxable. (205) The following table shows whether a taxpayer’s contribution to a Roth IRA is affected by the amount of his or her modified AGI as computed for Roth IRA purpose.

Amount of Roth IRA Contributions That a Taxpayer Can Make For 2023

Filing Status Modified AGI Amount Contribution Amount

Single, Head of Household or Married Filing Separately (taxpayer did not live with his or her spouse at any time during the year)

$138,000 or less Up to Contribution Limit

$138,000 - $153,000 Reduced Amount

$153,000 or more $0

Married filing jointly or Qualifying Surviving Spouse

$218,000 or less Up to Contribution Limit

$218,000 - $228,000 Reduced Amount

$228,000 or more $0

Married filing separately (taxpayer lived with his or her spouse at any time during the year)

Less than $10,000 Reduced Amount

$10,000 or more $0

Table 11-3 - Amount of Roth IRA Contributions (2023)

If the amount the taxpayer can contribute must be reduced, figure his or her reduced contribution limit as follows:

1. Start with his or her modified AGI. 2. Subtract from the amount in (1):

a. $218,000 if filing a joint return or surviving spouse, b. $0 if married filing a separate return, and the taxpayer lived with his or her spouse at any time during the

year, or c. $138,000 for all other individuals.

3. Divide the result in (2) by $15,000 ($10,000 if filing a joint return, surviving spouse, or married filing a separate return and the taxpayer lived with his or her spouse at any time during the year).

4. Multiply the maximum contribution limit (before reduction by this adjustment and before reduction for any contributions to traditional IRAs) by the result in (3).

5. Subtract the result in (4) from the maximum contribution limit before this reduction. 6. The result is the taxpayer’s reduced contribution limit.

Review Question 5 If a calendar-year taxpayer makes a conversion contribution to a Roth IRA on February 25, 2024, and makes a regular contribution for 2023 on the same date, the 5-year period for the conversion begins January 1, 2024, while the 5-year period for the regular contribution begins on what date?

A. January 1, 2023 B. January 1, 2024 C. February 25, 2024 D. March 25, 2024

See Review Feedback for answer.

Lesson 11 - Retirement Income

Designated Roth Accounts - In-Plan Rollovers to Designated Roth Accounts

A plan with a designated Roth program may allow participants to transfer eligible rollover distributions to a designated Roth account from another account in the same plan. The Roth contribution program must be in place before a plan can offer in-plan Roth rollovers. A Roth program cannot be set up solely to accept in-plan rollovers - it must also accept elective deferrals from participants. Not all pre-tax plan balances can be transferred to a designated Roth account. To be eligible for an in-plan rollover, the amount must be eligible for distribution to the participant under the terms of the plan and must be otherwise eligible for rollover (an eligible rollover distribution). In general, an eligible rollover distribution is a distribution that is not: (206)

➢ A required minimum distribution. ➢ A corrective distribution of excess contributions or deferrals. ➢ A hardship distribution. ➢ A loan treated as a distribution. ➢ A distribution that is one of a series of substantially equal payments made at least annually over a lifetime or 10

years. ➢ Dividends on employer securities. ➢ The cost of life insurance coverage.

The value of the distribution less the participant’s basis, if any (the taxable amount of the distribution) must be included in the participant’s gross income. For a typical rollover of money from a pre-tax 401(k) account, the entire amount of the rollover, including earnings, will be taxable. The additional 10% early withdrawal tax does not apply to an in-plan Roth rollover. However, there are special rules that could make the rollover subject to this tax if it is withdrawn from the designated Roth account within five years.

20% mandatory withholding does not apply to an in-plan Roth direct rollover. However, if the taxpayer receives his or her distribution in cash, 20% withholding will apply even if the amount is rolled over to a designated Roth account within 60 days. (206)

IRA Catch-Up Amounts

A taxpayer who will be at least age 50 by the end of the tax year is able to make an additional contribution to a traditional IRA (or Roth IRA). For tax year 2023, the maximum annual amount of the catch-up contribution is $1,000, so the total contribution maximum is $7,500. In future years, the maximum catch-up amount will remain at $1,000.

Review Question 6 In 2023, Andrea, a non-working spouse, files a joint return with Jed, who is not covered by a pension plan at work. Their AGI is $50,000 and Jed plans to contribute $3,000 to a traditional IRA account. Andrea, who is 51, wishes to contribute to an IRA account. What is the maximum amount she can contribute?

A. $5,000 B. $6,500 C. $7,500 D. $8,000

See Review Feedback for answer.

SIMPLE IRA

A SIMPLE IRA plan (Savings Incentive Match Plan for Employees) allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan. SIMPLE IRA plans can provide a significant source of income at retirement by allowing employers and employees to set aside money in retirement accounts. SIMPLE IRA plans do not have the start-up and operating costs of a conventional retirement plan.

Lesson 11 - Retirement Income

The amount the employee contributes to a SIMPLE IRA cannot exceed $15,500 in 2023. If an employee participates in any other employer plan during the year and has elective salary reductions under those plans, the total amount of the salary reduction contributions that an employee can make to all the plans he or she participates in is limited to $22,500 in 2023. SIMPLE IRA contributions include: (207)

➢ Salary reduction contributions. ➢ Employer contributions:

o Matching contributions. o Nonelective contributions.

No other contributions can be made to a SIMPLE IRA plan. The following are specifics regarding a SIMPLE IRA: (207)

➢ Available to any small business – generally with 100 or fewer employees. ➢ Easily established by adopting Form 5304-SIMPLE, Form 5305-SIMPLE, a SIMPLE IRA prototype or an

individually designed plan document. ➢ Employer cannot have any other retirement plan. ➢ No filing requirement for the employer.

The following are specifics regarding contributions to a SIMPLE IRA: (207)

➢ Employer is required to contribute each year either a: o Matching contribution up to 3% of compensation. o 2% non-elective contribution for each eligible employee.

▪ Under the non-elective contribution formula, even if an eligible employee does not contribute to his or her SIMPLE IRA, that employee must still receive an employer contribution to his or her SIMPLE IRA equal to 2% of his or her compensation.

➢ Employees may elect to contribute. ➢ Employee is always 100% vested in (or, has ownership of) all SIMPLE IRA money.

Employers must deposit employees’ salary reduction contributions to the SIMPLE IRA within 30 days after the end of the month in which the employee would have received them in cash. They must make matching contributions or nonelective contributions by the due date (including extensions) of their Federal income tax return for the year.

SIMPLE Plan Catch-Up Amounts

A SIMPLE IRA or a SIMPLE 401(k) plan may permit catch-up contributions up to $3,500 in 2023 for individuals aged 50 or over. Salary reduction contributions in a SIMPLE IRA plan are not treated as catch-up contributions for 2023 until they exceed $15,500.

Catch-Up Contributions

Individuals who are age 50 or over at the end of the calendar year can make annual catch-up contributions. Catch-up contributions up to $7,500 in 2023 may be permitted by these plans: (208)

➢ 401(k) (other than a SIMPLE 401(k)). ➢ 403(b). ➢ SARSEP. ➢ Governmental 457(b).

Elective deferrals are not treated as catch-up contributions until they exceed the $22,500 limit in 2023, the ADP test limit of Section 401(k)(3) or the plan limit (if any). A participant can make catch-up contributions for a year up to the lesser of the following amounts:

➢ The catch-up contribution dollar limit. ➢ The excess of the participant's compensation over the elective deferral contributions that are not catch-up

contributions.

Plan participants must make catch-up contributions to a retirement plan via elective deferrals. Catch-up contributions must be made before the end of the plan year.

Lesson 11 - Retirement Income

Lump-Sum Distributions

A lump-sum distribution is the distribution or payment, within one tax year, of a plan participant's entire balance from all of the employer's qualified pension, profit-sharing, or stock bonus plans. All of the participant's accounts under the employer's qualified pension, profit-sharing, or stock bonus plans must be distributed in order to be a lump-sum distribution. If a taxpayer received a lump-sum distribution from a qualified retirement plan or a qualified retirement annuity and he or she was born before January 2, 1936, he or she may be able to elect optional methods of figuring the tax on the distribution. These optional methods can be elected only once after 1986 for any eligible plan participant. Additionally, a lump-sum distribution is a distribution that was paid: (209)

➢ Because of the plan participant's death. ➢ After the participant reaches age 59½. ➢ Because the participant, if an employee, separates from service. ➢ After the participant, if a self-employed individual, becomes totally and permanently disabled.

A distribution from a nonqualified plan (such as a privately purchased commercial annuity or a Section 457 deferred compensation plan of a state or local government or tax-exempt organization) cannot qualify as a lump-sum distribution. The participant's entire balance from a plan does not include certain forfeited amounts. It also does not include any deductible voluntary employee contributions allowed by the plan after 1981 and before 1987. The taxpayer should receive a Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., from the payer of the lump-sum distribution showing his or her taxable distribution and the amount eligible for capital gain treatment. If the taxpayer does not receive Form 1099-R by January 31st of the year following the year of the distribution, he or she should contact the payer of the lump-sum distribution. The part from active participation in the plan before 1974 may qualify as capital gain subject to a 20% tax rate. The part from participation after 1973 (and any part from participation before 1974 that the taxpayer does not report as capital gain) is ordinary income. He or she may be able to use the 10-year tax option to figure tax on the ordinary income part. Use Form 4972 - Tax on Lump-Sum Distributions to figure the separate tax on a lump-sum distribution using the optional methods. The tax figured on Form 4972 is added to the regular tax figured on the taxpayer’s other income. This may result in a smaller tax than he or she would pay by including the taxable amount of the distribution as ordinary income in figuring the regular tax.

Review Question 7 A lump-sum distribution is the distribution or payment, within how many tax year(s), of a plan participant's entire balance from an employer's qualified pension?

A. One year B. Two years C. Three years D. Four years

See Review Feedback for answer.

Rollovers

An IRA rollover occurs when the taxpayer withdraws cash or other assets from one eligible retirement plan and contributes all or part of it, within 60 days, to another eligible retirement plan. This rollover transaction is not taxable, but it is reportable on the Federal tax return. A taxpayer can roll over most distributions from an eligible retirement plan except for: (210)

➢ The nontaxable part of a distribution, such as an after-tax contribution to a retirement plan (in certain situations after-tax contributions can be rolled over).

➢ A distribution that is one of a series of payments made for a life (or life expectancy), or the joint lives (or joint life expectancies) of the taxpayer and his or her beneficiary or made for a specified period of 10 years or more.

➢ A required minimum distribution.

Lesson 11 - Retirement Income

➢ A hardship distribution. ➢ Dividends on employer securities. ➢ The cost of life insurance coverage.

If an eligible rollover distribution is paid, the taxpayer has 60 days from the date he or she received it to roll it over to another eligible retirement plan. Any taxable eligible rollover distribution paid from an employer-sponsored retirement plan to an individual is subject to a mandatory income tax withholding of 20%, even if he or she intends to roll it over later. If the taxpayer does roll it over and wants to defer tax on the entire taxable portion, he or she will have to add funds from other sources equal to the amount withheld. The taxpayer can choose to have the payer transfer a distribution directly to another eligible retirement plan or to an IRA. Under this direct rollover option, the 20% mandatory withholding does not apply.

In Revenue Procedure 2016-47, effective August 2016, the IRS has created a new “self-certification” procedure that allows someone who misses the 60-day deadline for rollovers to avoid the expense and delay of obtaining a private letter ruling. Instead, a taxpayer submits a model IRS letter to the new retirement account custodian, checking in that letter one of 11 acceptable excuses for missing the deadline.

A self-certification is not a waiver by the IRS of the 60-day rollover requirement. However, a taxpayer may report the contribution as a valid rollover unless later informed otherwise by the IRS. The IRS, in the course of an examination, may consider whether a taxpayer’s contribution meets the requirements for a waiver. The taxpayer must have missed the 60-day deadline because of his or her inability to complete a rollover due to one or more of the following reasons:

➢ An error was committed by the financial institution receiving the contribution or making the distribution to which the contribution relates.

➢ The distribution, having been made in the form of a check, was misplaced and never cashed. ➢ The distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an

eligible retirement plan. ➢ The taxpayer’s principal residence was severely damaged. ➢ A member of the taxpayer’s family died. ➢ The taxpayer or a member of the taxpayer’s family was seriously ill. ➢ The taxpayer was incarcerated. ➢ Restrictions were imposed by a foreign country. ➢ A postal error occurred. ➢ The distribution was made on account of a levy under Section 6331 and the proceeds of the levy have been

returned to the taxpayer. ➢ The party making the distribution to which the rollover relates delayed providing information that the receiving plan

or IRA required to complete the rollover despite the taxpayer’s reasonable efforts to obtain the information.

While the reasons are comprehensive, they only apply if the taxpayer was initially eligible to complete a 60-day rollover. As a result of a 2014 U.S. Tax Court decision, taxpayers may only perform one 60-day IRA rollover every 12 months, no matter how many IRAs they have. The contribution must be made to the plan or IRA as soon as practicable after the reason or reasons listed above no longer prevent the taxpayer from making the contribution. This requirement is deemed to be satisfied if the contribution is made within 30 days after the reason or reasons no longer prevent the taxpayer from making the contribution.

One reason the IRS will not allow is that the taxpayer was using his or her retirement money as a short-term loan for some non-retirement purpose, such as a down payment on a house, and missed the 60-day deadline because of a complication or delay.

IRA One-Rollover-Per-Year Rule

As of January 1, 2015, a taxpayer can make only one rollover from a traditional IRA to another (or the same) traditional IRA in any 12-month period, regardless of the number of IRAs he or she owns. The limit will apply by aggregating all of an individual’s IRAs, including SEP and SIMPLE IRAs as well as traditional and Roth IRAs,

effectively treating them as one IRA for purposes of the limit. However, trustee-to-trustee transfers between IRAs and rollovers from traditional to Roth IRAs ("conversions") are not limited.

Lesson 11 - Retirement Income

If the taxpayer receives a distribution from an IRA of previously untaxed amounts:

1. He or she must include the amounts in gross income if he or she made an IRA-to-IRA rollover in the preceding 12 months, and

2. He or she may be subject to the 10% early withdrawal tax on the amounts he or she includes in gross income. Additionally, if the taxpayer pays the distributed amounts into another (or the same) IRA, the amounts may be:

1. Treated as an excess contribution, and 2. Taxed at 6% per year as long as they remain in the IRA.

The one-per year limit does not apply to:

➢ Rollovers from traditional IRAs to Roth IRAs (conversions). ➢ Trustee-to-trustee transfers to another IRA. ➢ IRA-to-plan rollovers. ➢ Plan-to-IRA rollovers. ➢ Plan-to-plan rollovers.

Partial Rollovers

If the taxpayer withdraws assets from a traditional IRA, he or she can roll over part of the withdrawal tax free and keep the rest of it. The amount the taxpayer keeps will generally be taxable (except for the part that is a return of nondeductible contributions). The amount he or she keeps may be subject to the 10% additional tax on early distributions.

Direct Rollovers

The taxpayer’s employer's qualified plan must give him or her the option to have any part of an eligible rollover distribution paid directly to a traditional IRA. The plan is not required to give the taxpayer this option if his or her eligible rollover distributions are expected to total less than $200 for the year. If he or she chooses the direct rollover option, no tax is withheld from any part of the designated distribution that is directly paid to the trustee of the traditional IRA. If any part is paid to the taxpayer, the payer must withhold 20% of that part's taxable amount.

SEPIRA Deduction

A Simplified Employee Pension Plan (SEP) plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. A business of any size, even self-employed, can establish a SEP. An employee eligible to participate in an SEP is an individual (including a self-employed individual) who meets all the following requirements:

➢ Has reached age 21. ➢ Has worked for the employer in at least 3 of the last 5 years. ➢ Received at least $750 in compensation from the employer during 2023.

An employer can use less restrictive participation requirements than those listed, but not more restrictive ones. An employer can exclude the following employees from a SEP:

➢ Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and the employer.

➢ Nonresident alien employees who do not have U.S. wages, salaries, or other personal services compensation from the employer.

Contributions an employer can make for 2023 to an employee's SEP-IRA cannot exceed the lesser of: (211)

1. 25% of the compensation, limited to $330,000 per participant, paid to the participants during 2023 from the business that has the plan.

2. $66,000 per participant.

An employee cannot contribute to SEPs because SEPs only permit employer contributions. SEPs do not include a salary reduction arrangement.

Lesson 11 - Retirement Income

Participants in Salary Reduction Simplified Employee Pension (SARSEP) plans established before 1997 were entitled to elective deferral contributions. For these plans, a participant’s elective deferral contributions are further limited to $22,500 in 2023 or 100% of their compensation, whichever is less. Catch-up contributions are not subject to this limit.

Qualified Retirement Plans

There are two broad categories of qualified retirement plans, a defined benefit plan and a defined contribution plan. Defined benefit plans include employer contributed pension and annuity plans that provide a specific retirement benefit to employees. The benefit is usually in the form of a monthly retirement pension that is based on the employee’s wages and years of service with the employer. An employer’s annual contributions to the plan are based on actuarial assumptions and are not allocated to individual accounts maintained for employees. Defined contribution plans include contributions by the employee and/or the employer to the employee’s individual account under the plan. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans. A separate account must be provided for each employee covered by the plan and the employee’s retirement benefit will be based solely on contributions to the account, as well as its investment gains and earnings. The amount for self-employed SEP, SIMPLE, and qualified plans is typically entered on line 16, Schedule 1 (Form 1040). (212)

Charitable Donations from IRAs

The Protecting Americans from Tax Hikes Act of 2015 made permanent the tax exemption of distributions from individual retirement accounts for charitable purposes. Individuals age 70½ or over can exclude up to $100,000 from gross income for donations paid directly to a qualified charity from their IRA. Key points about qualified charitable distributions (QCD) include:

➢ Married individuals filing a joint return could exclude up to $100,000 donated from each spouse’s own IRA ($200,000 total) in 2023.

➢ The donation satisfies any IRA required minimum distributions for the year. ➢ The amount excluded from gross income is not deductible. ➢ Donations from an inherited IRA are eligible if the beneficiary is at least age 70½. ➢ Donations from a SEP or SIMPLE IRA are not eligible. ➢ Donations from a Roth IRA are eligible.

The SECURE Act preserved the ability to make qualified charitable distributions (QCDs) at age 70½ even though the required minimum distribution age was increased to age 73 in 2023. Qualified charitable distributions can satisfy all or part the amount of the taxpayer’s required minimum distribution (RMD) from his or her IRA. IRA owners reported charitable donations from an IRA on Form 1040.

The SECURE 2.0 Act contains an expansion of the rules for qualified charitable donations (QCDs). Section 307 indicates that the annual IRA QCD limit of $100,000 will be indexed for inflation, effective for tax years after 2023. The bill did not indicate any change to the current QCD age and QCDs continue to be ineligible for a donation to donor-advised fund sponsors, private foundations, or supporting organizations. Section 307 also

includes a one-time election for a QCD to a split-interest entity. This indicates an ability for donors to make a QCD of up to $50,000 to fund one of either a Charitable Remainder Unitrust (CRUT), Charitable Remainder Annuity Trust (CRAT) or Charitable Gift Annuity (CGA). In addition, the limit has been raised on the amount of IRA or company plan funds that can be used to purchase a QLAC (qualified longevity annuity contact), A QLAC is a deferred annuity that extends RMDs until payments start. The new limit is $200,000 (indexed in future years).

Required Minimum Distributions (RMD)

In 2023, a taxpayer cannot keep retirement funds in his or her account indefinitely. The taxpayer generally has to start taking withdrawals from his or her IRA or retirement plan account when he or she reaches age 73. Roth IRAs do not require withdrawals until after the death of the owner. These minimum distribution rules apply to: (213)

➢ Traditional IRAs. ➢ SEP IRAs. ➢ SIMPLE IRAs.

Lesson 11 - Retirement Income

➢ 401(k) plans. ➢ 403(b) plans. ➢ 457(b) plans. ➢ Profit sharing plans. ➢ Other defined contribution plans.

The required minimum distribution is the minimum amount a taxpayer must withdraw from his or her account each year. The taxpayer can withdraw more than the minimum required amount. His or her withdrawals will be included in his or her taxable income except for any part that was taxed before (the taxpayer’s basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts). The required minimum distribution for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s Uniform Lifetime Table. A separate table is used if the sole beneficiary is the owner’s spouse who is ten or more years younger than the owner. The beginning date for the first required minimum distribution for IRAs (including SEP and SIMPLE IRAs) is April 1 of the year following the calendar year in which the taxpayer reaches age 73. The beginning date for the first required minimum distribution for 401(k), profit-sharing, 403(b), or other defined contribution plan is generally, April 1 following the later of the calendar year in which the taxpayer reaches age 73 or retires.

The plan’s terms may allow the taxpayer to wait until the year he or she actually retires to take his or her first RMD (unless he or she is a 5% owner). Alternatively, a plan may require the taxpayer to begin receiving distributions by April 1 of the year after he or she reaches age 73, even if he or she has not retired. If the taxpayer

owns 5% or more of the business sponsoring the plan, then he or she must begin receiving distributions by April 1 of the year after the calendar year in which he or she reaches age 73. For each subsequent year after the taxpayer’s required beginning date, he or she must withdraw his or her RMD by December 31. If the taxpayer does not take any distributions, or if the distributions are not large enough, he or she may have to pay a 50% excise tax on the amount not distributed as required. To report the excise tax, the taxpayer may have to file Form 5329 - Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. For the year of the account owner’s death, use the RMD the account owner would have received. For the year following the owner’s death, the RMD will depend on the identity of the designated beneficiary. The account balance is divided by this life expectancy to determine the RMD.

Spouses who are the sole designated beneficiary can: (213)

➢ Treat an IRA as their own. ➢ Base RMDs on their own current age. ➢ Base RMDs on the decedent’s age at death, reducing the distribution period by one each year. Withdraw the

entire account balance by the end of the 5th year following the account owner’s death, if the account owner died before the required beginning date.

If the account owner died before the required beginning date, the surviving spouse can wait until the owner would have turned 73 to begin receiving RMDs. Individual beneficiaries other than a spouse can: (213)

➢ Withdraw the entire account balance by the end of the 5th year following the account owner’s death, if the account owner died before the required beginning date.

o Calculate RMDs using the distribution period from the Single Life Table based on: o If the owner died after RMDs began, the longer of the:

▪ Beneficiary’s remaining life expectancy determined in the year following the year of the owner’s death reduced by one for each subsequent year.

▪ Owner’s remaining life expectancy at death, reduced by one for each subsequent year. If the account owner died before RMDs began, the beneficiary’s age at year-end following the year of the owner’s death, reducing the distribution period by one for each subsequent year.

Lesson 11 - Retirement Income

The SECURE 2.0 Act pushes back the beginning date for required minimum distributions from qualified plans. Individuals turning age 72 during 2023 or later will start their RMD at age 73. For those reaching age 74 after December 31, 2032, their start date is age 75.

Additional Tax on Excess Accumulation in Qualified Retirement Plans (Including IRAs)

A taxpayer owes this tax if he or she does not receive the required minimum distribution from his or her qualified retirement plan, including an IRA or an eligible Section 457 deferred compensation plan. For 2023 and subsequent years, the additional tax is 25% of the excess accumulation, which is the difference between the amount that was required to be distributed and the amount that was actually distributed. The tax is due for the tax year that includes the last day by which the minimum required distribution must be taken.

The SECURE 2.0 Act specified that if required minimum distributions are not taken, the excise tax penalty is reduced to 25% for taxable years beginning in 2023. The penalty is further reduced to 10% if correction is made within two years after the end of the taxable year in which the distribution was missed.

The excess accumulation penalty is calculated on Form 5329 - Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts (under the section labeled “Additional Tax on Excess Accumulation in Qualified Retirement Plans (Including IRAs)” and reported in the ‘other taxes’ section of the individual’s tax return (Form 1040). If the taxpayer files Form 5329, he or she must file Form 1040. The IRS can waive the penalty, if the owner or beneficiary can show ‘reasonable cause’ for not taking the required minimum distribution (RMD) or demonstrate that the shortfall was due to ‘reasonable error’. Taxpayers who feel that they qualify for a waiver should File Form 5329 and attach a letter of explanation to the IRS. The letter should explain why the RMD deadline was missed, or why less than the RMD amount was withdrawn. The taxpayer must also show that have steps have been taken to remedy the RMD short fall, such as including a copy of the account statement showing that the RMD has since been taken from the account. An individual who applies for the waiver should not pay the penalty unless the IRS informs him or her that the waiver-request was denied. If the taxpayer is unable to take required distributions because he or she has a traditional IRA invested in a contract issued by an insurance company that is in state insurer delinquency proceedings, the 50% excise tax does not apply if the conditions and requirements of Revenue Procedure 92-10 are satisfied. To qualify for exemption from the tax, the assets in the taxpayer’s traditional IRA must include an affected investment.

Lesson 11 - Retirement Income

• $25,000 if the taxpayer is single, head of household or surviving spouse.

• $25,000 if the taxpayer is married filing separately and lived apart from his or her spouse for all of current year (Choice C).

• $32,000 if the taxpayer is married filing jointly (Choice D).

• $0 if the taxpayer is married filing separately and lived with his or her spouse at any time during the current year (Choice A).

How much of the benefits are taxable depends on the total amount of the taxpayer’s benefits and other income. Generally, the higher the income amount, the greater the taxable portion of the taxpayer’s benefits. Only Choice C has the correct amount and is therefore the correct response. Topic - Taxation of Social Security Benefits Source - IRS.GOV - Social Security Income Question 2 - A. The General Rule or the Simplified Method Partly taxable pensions are taxed under either the General Rule or the Simplified Method (Choice A). The Modified Accelerated Cost Recovery System (MACRS) is used to recover the basis of most business and investment property placed in service after 1986 and multiple-lives annuities are annuities payable for the lives of more than one annuitant (Choices B and C). Multiple Lives Annuity Rule refer to annuities involving a multiple lives evaluation using special mortality laws (Choice D). Topic - Pensions and Annuities Source - IRS.GOV - Topic No. 410 - Pensions and Annuities Question 3 - D. No age limit For 2020 and later, there is no age limit on making regular contributions to traditional or Roth IRAs. The Setting Every Community Up for Retirement Enhancement (SECURE) Act eliminated the prohibition on traditional IRA contributions for those age 70½ and older (Choice D). Generally, the amounts an individual withdraws from an IRA or retirement plan before reaching age 59½ are called ”early” or ”premature” distributions. Individuals must pay an additional 10% early withdrawal tax unless an exception applies (Choice A). A taxpayer must take his or her first required minimum distribution (RMD) for the year in which he or she turns age 73 (Choice C). Topic - Contributions to Traditional IRAs Source - IRS.GOV - Retirement Topics - IRA Contribution Limits Question 4 - B. 12 weeks Certain unemployed persons who make an early distribution to pay for qualifying medical insurance premiums are not subject to the 10% early distribution penalty. Eligible unemployed individuals are those who have received Federal or state unemployment compensation for 12 consecutive weeks. Qualifying premiums are deductible premiums for the medical care of the unemployed individual, spouse, and dependents. Only Choice B has the correct number of weeks and is therefore the correct response. Topic - Penalty-Free Withdrawal from IRAs for Medical Insurance Premiums Source - IRS.GOV - Retirement Topics - Exceptions to Tax on Early Distributions

Lesson 11 - Retirement Income

Question 5 - A. January 1, 2023 The 5-year period used for determining whether the 10% early distribution tax applies to a distribution from a conversion or rollover contribution to a Roth IRA is separately determined for each conversion and rollover and is not necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution. In this example, if a calendar-year taxpayer makes a conversion contribution on February 25, 2024 and makes a regular contribution for 2023 on the same date, the 5-year period for the conversion begins January 1, 2024, while the 5-year period for the regular contribution begins on January 1, 2023. Only Choice A has the correct date and is therefore the correct response. Topic - Roth IRAs Source - IRS.GOV - Roth IRAs Question 6 - C. $7,500 Because Andrea is over age 50 and otherwise qualifies to make a contribution, she can contribute up to $7,500 to her traditional IRA for 2023 ($6,500 regular contribution plus $1,000 catch-up contribution). Only Choice C has the correct amount and is therefore the correct response. Topic - IRA Catch-Up Amounts Source - IRS.GOV - Retirement Topics - Catch-Up Contributions Question 7 - A. One year A lump-sum distribution is the distribution or payment in one tax year of a plan participant's entire balance from all of the employer's qualified plans of one kind (for example, pension, profit-sharing, or stock bonus plans). Only Choice A has the correct number of years and is therefore the correct response. Topic - Lump-Sum Distributions Source - IRS.GOV - Topic No. 412 - Lump-Sum Distributions

Exclusions, Deductions, Expenses, Employee Compensation At the conclusion of this lesson you should have a basic knowledge of:

➢ Deductions for Adjusted Gross Income. ➢ Education Saving Accounts. ➢ Health Savings Accounts. ➢ Other Expenses. ➢ Fringe Benefits.

Exclusions

Many items that are commonly thought of as income are excluded from taxation because of Congressional action; they are called exclusions. The distinction between increases in wealth that are not income, such as gifts, and those that are exclusions has no effect on the amount of tax paid by each taxpayer. Both types are subtracted from the taxpayer's total increase in wealth for a taxable year to arrive at the taxpayer's gross income. However, the distinction can be important because some exclusions must be reported on Form 1040.

For now, keep in mind that excludable and nontaxable mean about the same thing. These exclusions (and exemptions) should not be confused with deductions from Gross Income (such as Health savings account deduction) or from Adjusted Gross Income (such as Standard Deduction or any Itemized Deduction), which must be shown on an individual’s income tax return. Generally, an exclusion does not have to be posted on a tax return.

It is important to note that most of the exclusions which deal with employer-employee relations are tax-free only if the benefits are provided on a nondiscriminatory basis to all employees. That is, the plans must not favor highly compensated employees or owner-employees. These nondiscrimination rules apply to group term life

insurance plans, accident and health plans, legal assistance plans, educational assistance plans, and dependent care assistance plans, to mention only a few.

Exclusions Related to Illness

There are four primary groups of exclusions relating to illness: (214)

1. Payments made by an employer to a Health Savings Account and other tax-favored health plans on behalf of the employee to provide health and accident coverage for the employee and his or her family. This covers not only medical expenses, but also disability insurance.

2. Amounts which are received by an employee under an accident and health plan which reimburse him or her for amounts spent for medical services.

3. Amounts which are received by an employee directly from his or her employer which reimburse him or her for amounts spent for medical services.

4. Amounts which represent restitution for a permanent loss of, or loss of use of, a member or function of the body, or for permanent disfigurement of the taxpayer, his or her spouse, or a dependent.

Compensation received under the following special provisions is also excluded:

➢ Workers’ compensation. ➢ Damages for personal injury, such as for injuries the taxpayer received in an auto accident while traveling on

personal time. ➢ Medical pensions and allowances resulting from injuries or illnesses while in the armed forces. ➢ Payments made to government employees for injuries received during terrorist attacks outside the U.S. ➢ Compensatory damages received for physical injury or physical sickness, whether paid in a lump sum or in

periodic payments.

Lesson 12 - Exclusions, Employee Compensation, Deductions

Review Question 1 Which of the following special provision compensations are excluded from income?

A. Disability benefits received for loss of income B. Damages for personal injury C. Medical pensions D. All of the above

See Review Feedback for answer.

Exclusions Related to Death

The following exclusions relate to the death of the taxpayer: (113)

➢ Premiums paid by an employer for group-term life insurance, up to $50,000 face amount for each employee. Policies of this type provide only temporary coverage and do not have a cash surrender or loan value. When the face amount of the policy is greater than $50,000, then the premium applicable to the excess is taxable income to the employee.

➢ Amounts received by beneficiaries of life insurance contracts because of the death of the insured are, with minor exceptions, excluded from income. So are amounts received under a life insurance contract from a terminally ill taxpayer.

Exclusions Related to Age

Our tax laws reflect a continuing concern about the social and economic needs of the aged. Prior to 1983, the entire amount of Social Security benefits and Railroad Retirement benefits received could be excluded. In 1993, as part of Omnibus Budget Reconciliation Act, the Social Security taxation provision was modified to add a secondary set of thresholds and a higher taxable percentage for beneficiaries who exceeded the secondary thresholds. (215)

Generally, if Social Security benefits were the only income for the tax year, the benefits are not taxable. However, if the taxpayer received income from other sources, up to 50% of the retirement benefit will be taxable if the total of one-half of the benefits and adjusted gross income is more than the following base amount for his or her filing status.

The base amounts are: (216)

➢ $25,000 if the taxpayer is single, head of household, or qualifying surviving spouse. ➢ $25,000 if the taxpayer is married filing separately and lived apart from his or her spouse for all of the current year. ➢ $32,000 if the taxpayer is married filing jointly. ➢ $0 if the taxpayer is married filing separately and lived with his or her spouse at any time during the current year.

Additionally, up to 85% of the retirement benefit will be taxable if one-half of the Social Security benefit plus adjusted gross income exceeds the following secondary base amount for filing status: (216)

➢ $44,000 for married couples filing jointly. ➢ $34,000 for single, head of household, qualifying surviving spouse with a dependent child, or married individuals

filing separately who did not live with their spouses at any time during the year. ➢ $0 for married persons filing separately who lived together during the year.

Annual Gift Tax Exclusion

In 2023, a taxpayer can give $17,000 per person, to any number of people, and none of the gifts will be taxable. A separate annual exclusion applies to each person and the exclusion is subject to cost-of-living increases. The exclusion applies to the transfer by gift of any property. The taxpayer makes a gift if he or she gives property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. The basis of property received as a gift is the donor's carry-over basis (adjusted basis). If a taxpayer sells something at less than its full value or if he or she makes an interest-free or reduced-interest loan, it may be a gift.

Lesson 12 - Exclusions, Employee Compensation, Deductions

In addition to the annual exclusion, a taxpayer also can give the following without triggering the gift tax: (217)

➢ Charitable gifts. ➢ Gifts to a spouse. ➢ Gifts to a political organization for its use. ➢ Gifts of educational expenses. These are unlimited as long as the taxpayer makes a direct payment to the

educational institution for tuition only. ➢ Gifts of medical expenses. These, too, are unlimited as long as they are paid directly to the medical facility.

If the taxpayer or his or her spouse made a gift to a third party, the gift can be considered as made one-half by the taxpayer and one-half by his or her spouse. This is known as gift splitting. Both of the spouses must agree to split the gift. If they do, each can take the annual exclusion for his or her part of the gift. For gifts made in 2023, gift splitting allows married couples to give up to $34,000 to a person without making a taxable gift. If the taxpayers split a gift they made, both must file a gift tax return to show that the taxpayer and his or her spouse agree to use gift splitting. Form 709 must be filed even if half of the split gift is less than the annual exclusion.

Exclusions and Intergovernmental Relations

The Federal tax law specifically excludes interest received from any city, state, territory, or any political subdivision, or the District of Columbia. These rules also exclude amounts received from any possession of the United States. This exclusion is one of the most widely used tax-planning tools at present. Welfare payments by state and other governmental units remain excluded from taxation. (218)

Exclusions Related to Education

Institutions for higher learning very often grant scholarships and fellowships to outstanding students, and to good students who need assistance to pursue their program of study. A fellowship or scholarship grant qualifies for an exclusion if the person receiving it is a candidate for a degree, and if the payments are made for tuition, books, fees, supplies and equipment. Amounts received for meals and lodging or other expenses must be included by the taxpayer as income. The amounts received may not represent compensation for past, present, or future services of any kind. If the student is required to perform duties such as teaching classes or grading papers, and these chores are not required of all candidates for the degree, then the exclusion does not apply. (219)

Exclusion Related to Foreign-Earned Income

As mentioned previously, every citizen of the United States is subject to the income tax, even if they are residents of a foreign country receiving income from foreign sources. Special provisions are available, however, so that these taxpayers are not taxed heavier than citizens residing in the United States because of the foreign taxes they must pay and the higher cost of living in the foreign country.

To qualify for the Foreign Earned Income Exclusion, however, U.S. citizens must establish that they are bona fide residents of a foreign country, or resident aliens who are present in a foreign country at least 330 days out of any consecutive 12-month period. Single taxpayers meeting the above qualifications may exclude up to $120,000 for tax year 2023, up from $112,000 for 2022. If married and both individuals work abroad and both meet either the bona fide residence test or the physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $240,000 for the 2023 tax year. The taxpayer can also choose to exclude from income a foreign housing amount. If he or she chooses to exclude a foreign housing amount, the taxpayer must figure the foreign housing exclusion before the foreign earned income exclusion. The foreign earned income exclusion is limited to the foreign earned income minus the foreign housing exclusion. The foreign housing exclusion applies only to amounts considered paid for with employer provided funds and is the total of the housing expenses for the year minus the base housing amount. The taxpayer’s housing amount is the total of his or her housing expenses for the year minus the base housing amount. The computation of the base housing amount (line 32 of Form 2555 - Foreign Earned Income) is tied to the maximum foreign earned income exclusion. The amount is 16% of the exclusion amount (computed on a daily basis), multiplied by the number of days in the taxpayer’s qualifying period that fall within his or her tax year. (220)

Lesson 12 - Exclusions, Employee Compensation, Deductions

Review Question 2 Priscilla’s qualifying period in relation to the Foreign Housing Exclusion and Deduction includes all of 2023. During the year, she spent $20,756 for her housing. This amount is below the limit for the location in which she incurred the expenses. What is Priscilla’s qualified housing amount for 2023?

A. $0 B. $1,556 C. $17,920 D. $19,200

See Review Feedback for answer.

Deductions for Adjusted Gross Income Adjusted Gross Income is defined as gross income minus adjustments to income. These adjustments are deductions for adjusted gross income, or what many professional tax preparers call "above the line deductions”. Some common adjustments to income include:

➢ 50% of Self-employment tax. ➢ 100% of Self-employment health insurance premiums. ➢ Penalties on early withdrawal of savings. ➢ Alimony paid. ➢ Student loan interest paid up to $2,500. ➢ Jury duty income repaid to employer.

Teachers’ Classroom Expenses

In 2023, if the taxpayer is an eligible educator, he or she can deduct up to $300 ($600 if married filing jointly and both spouses are educators, but not more than $300 each) of any unreimbursed expenses (otherwise deductible as a trade or business expense). Qualified expenses are amounts the taxpayer paid or incurred for books, supplies, computer equipment (including related software and services), other equipment, and supplementary materials that he or she uses in the classroom. For courses in health and physical education, expenses for supplies are qualified expenses only if related to athletics. This deduction is for expenses paid or incurred during the tax year.

Under the COVID-related Tax Relief Act of 2020, which was enacted as part of the Consolidated Appropriations Act, 2021, unreimbursed expenses paid or incurred after March 12, 2020, by eligible educators for protective items to stop the spread of COVID-19 qualify for the educator expense deduction. (104)

Armed Forces Reservists

If a member of a reserve component of the Armed Forces of the United States travels more than 100 miles away from home in connection with the performance of services as a member of the reserves, the reservist can deduct travel expenses as an adjustment to gross income rather than as a miscellaneous itemized deduction. The amount of expenses such a taxpayer can deduct as an adjustment to gross income is limited to the Federal per diem rate (for lodging, meals, and incidental expenses) and the standard mileage rate (for car expenses) plus any parking fees, ferry fees, and tolls. Any expenses in excess of these amounts can be claimed only as a miscellaneous itemized deduction subject to the 2% limit. If the taxpayer has reserve-related travel that takes him or her more than 100 miles from home, he or she should first complete Form 2106 - Employee Business Expenses or Form 2106-EZ - Unreimbursed Employee Business Expenses. Then include his or her expenses for reserve travel over 100 miles from home, up to the Federal rate, from Form 2106, line 10 in the total on Schedule 1 (Form 1040), line 12. (221)

Performing Artists

If a taxpayer is a performing artist, such a taxpayer may qualify to deduct his or her employee business expenses as an adjustment to gross income rather than as a miscellaneous itemized deduction. This adjustment is arrived at using Form 2106 or 2106-EZ and is posted on Schedule 1 (Form 1040), line 12.

Lesson 12 - Exclusions, Employee Compensation, Deductions

To qualify, the performing artist must meet all of the following requirements: (221)

1. During the tax year, he or she performed services in the performing arts as an employee for at least two employers. 2. The artist received at least $200 each from any two of these employers. 3. Such a taxpayer’s related performing-arts business expenses are more than 10% of the taxpayer’s gross income

from the performance of those services. 4. Such a taxpayer’s adjusted gross income is not more than $16,000 before deducting these business expenses.

Officials Paid on a Fee Basis

Certain fee-basis officials can claim their employee business expenses whether or not they itemize their other deductions on Schedule A (Form 1040). Fee-basis officials are persons who are employed by a state or local government and who are paid in whole or in part on a fee basis. Such taxpayers can deduct their business expenses in performing services in that job as an adjustment to gross income (rather than as a miscellaneous itemized deduction). Claim this adjustment on Schedule 1 (Form 1040), line 12. (222)

Coverdell Education Savings Accounts (CESA) The American Taxpayer Relief Act made permanent the $2,000 total contributions per year for the beneficiary of a Coverdell ESA. Low and middle-income taxpayers may open up a Coverdell Education Savings Account (CESA) for qualified higher education as well as elementary and secondary education expenses (i.e., grades kindergarten through 12). The school may be public, private or religious. Contributions to a Coverdell ESA are not deductible but amounts deposited in the account grow tax free until distributed. A Coverdell ESA is a tax-exempt trust. The requirements to establish a CESA are: (223)

1. When the account is established, the designated beneficiary must be under the age of 18 or a special needs beneficiary.

2. Except in the case of rollover contributions, annual contributions may not exceed $2,000. 3. The account must be designated as a Coverdell ESA when it is created. 4. The document creating and governing the account must be in writing and must meet certain requirements. 5. Contributions must be in cash. 6. The trustee must be a bank or other qualified person. 7. No portion of the trust’s assets may be invested in life insurance contracts. 8. Trust assets must not be commingled with other property, except in a common trust or investment fund. 9. Upon death of the beneficiary, any balance in the fund must be distributed to the beneficiary’s estate within 30

days of death. Qualified High Education Expenses are related to enrollment or attendance at an eligible post-secondary school. To be qualified some expenses must be required by the school and some must be incurred by students who are enrolled at least half time. (224)

➢ The following expenses must be required for enrollment or attendance of a designated beneficiary at an eligible postsecondary school:

o Tuition and fees. o Books, supplies, and equipment.

➢ Expenses for special needs services needed by a special needs beneficiary must be incurred in connection with enrollment or attendance at an eligible postsecondary school.

➢ Expenses for room and board must be incurred by students who are enrolled at least half-time. ➢ The expense for room and board qualifies only to the extent that it is not more than the greater of the following

two amounts: o The allowance for room and board, as determined by the school, that was included in the cost of

attendance (for Federal financial aid purposes) for a particular academic period and living arrangement of the student.

o The actual amount charged if the student is residing in housing owned or operated by the school. Qualified Elementary and Secondary Education Expenses are expenses related to enrollment or attendance at an eligible elementary or secondary school. As shown in the following list, to be qualified, some of the expenses must be required or provided by the school. There are special rules for computer-related expenses. (224)

Lesson 12 - Exclusions, Employee Compensation, Deductions

The following expenses must be incurred by a designated beneficiary in connection with enrollment or attendance at an eligible elementary or secondary school: (224)

➢ Tuition and fees. ➢ Books, supplies, and equipment. ➢ Academic tutoring. ➢ Special needs services for a special needs beneficiary.

The following expenses must be required or provided by an eligible elementary or secondary school in connection with attendance or enrollment at the school: (224)

➢ Room and board. ➢ Uniforms. ➢ Transportation. ➢ Supplementary items and services (including extended day programs).

The purchase of computer technology, equipment, or internet access and related services is a qualified elementary and secondary education expense if it is to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in elementary or secondary school. (This does not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature). The maximum annual contribution that could be made to a CESA is $2,000 per beneficiary; and the annual contribution is phased out for joint filers with modified adjusted gross income at or above $190,000 and less than $220,000 (at or above $95,000 and less than $110,000 for single filers). (224)

Contributions to a Coverdell ESA are not deductible but amounts deposited in the account grow tax free until distributed. The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution.

CESA Distributions

Amounts remaining in the account must be distributed within 30 days after the beneficiary reaches age 30 or 30 days after the death of the beneficiary. One way of avoiding taking an unwanted distribution is to take advantage of the rollover provision for Coverdell ESAs. Distributed amounts are not subject to Federal income taxes if they are rolled over to another ESA for the benefit of the same beneficiary or a member of the beneficiary's family that is under the age of 30 including: (224)

➢ Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them. ➢ Brother, sister, stepbrother, or stepsister. ➢ Father or mother or ancestor of either. ➢ Stepfather or stepmother. ➢ Son or daughter of a brother or sister. ➢ Brother or sister of father or mother. ➢ Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. ➢ The spouse of any individual listed above. ➢ First cousin.

The age limit does not apply to beneficiaries with special needs.

CESA Coordination with Other Education Benefits

The American opportunity or Lifetime learning credit can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used for both benefits. Qualified expenses will first be reduced for tax-exempt scholarships or fellowship grants and any other tax-free educational benefits. Expenses will then be reduced for amounts taken into account in determining the American opportunity and Lifetime learning credits. Where a student receives distributions from both a CESA and a qualified tuition program that together exceed these remaining expenses, the expenses must be allocated between the distributions.

Lesson 12 - Exclusions, Employee Compensation, Deductions

Generally, contributions to CESAs are treated as gifts to the beneficiaries. Distributions from CESAs are excludable from gross income to the extent that the distribution does not exceed the qualified higher education expenses incurred by the beneficiary during the year in which the distribution is made. Qualified distributions, with the exception of room and board, are tax exempt regardless of whether the beneficiary attends an eligible educational institution on a full-time, half-time, or less than half-time basis. Room and board expenses constitute qualified higher education expenses only if the student is enrolled at an eligible institution on at least a half-time basis. Distributions are deemed paid from both contributions (which are always tax free) and earning (which may be excludable). The amount of contributions distributed is determined by multiplying the distribution by the ratio that the aggregate amount of contributions bears to the total balance of the account at the time the distribution is made. If aggregate distributions exceed expenses during the tax year, qualified education expenses are deemed to be paid from a pro rata share of both principal and interest. To calculate, the portion of earnings excludable from income is based on the ratio that the qualified higher education expenses bear to the total amount of the distribution. The remaining portion of earnings is included in the income of the distributee. The tax imposed on any taxpayer who receives a payment or distribution from a CESA that is includible in gross income will be increased by an additional 10% penalty. Qualified higher education expenses include tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution fall under the definition of qualified education expenses. The term also generally includes the room and board expenses. Also, for students residing in housing owned or operated by an eligible educational institution, the term will be expanded to cover, if greater, the actual room and board expenses charged by the institution. Room and board expenses are considered qualified higher education costs only if the designated beneficiary is enrolled in a degree, certificate, or other program leading to a recognized educational credential at an eligible educational institution and the student carries at least one-half the normal full-time workload for the course of study pursued. Furthermore, funds from a CESA may be used to pay for elementary and secondary education expenses, including tutoring, computer equipment, room and board, uniforms, and extended day program costs. An eligible educational institution is generally an accredited postsecondary educational institution providing credit towards a bachelor’s degree, an associate’s degree, a graduate-level or professional degree, or another recognized postsecondary credential. Generally, proprietary and postsecondary vocational institutions are eligible educational institutions. (224)

Section 529 Plan

A Qualified Tuition Program (QTP) is also called a Section 529 plan. If the program is established and maintained by a state, or agency or instrumentality of a state, the program may allow either prepaying or contributing to an account for paying a beneficiary's qualified higher education expenses at an eligible educational institution. Eligible educational institutions can also establish and maintain QTPs but only to allow prepaying a beneficiary's qualified higher education expenses. Contributions to a QTP on behalf of any beneficiary cannot be more than the amount necessary to provide for the qualified higher education expenses of the beneficiary. Contact the program’s trustee or administrator to determine the program’s contribution limit. Contributions made to a QTP are not deductible on the taxpayer’s Federal tax return. The benefits of establishing a QTP are that earnings accumulate tax free while in the account, and no tax is due on a distribution that is used to pay qualified higher education expenses. The beneficiary generally does not have to include in income any of the earnings from a QTP unless the amount distributed is greater than the beneficiary's qualified higher education expenses. The important differences between a Coverdell ESA and a 529 plan include: (225)

➢ 529 plans do not have age limits on beneficiaries, while Coverdell ESAs must be used, or rolled over to another beneficiary, by age 30.

➢ Contribution limits for Coverdell ESAs are much lower than 529 plans. While the annual contributions are almost limitless for 529 plans, Coverdell contributions are limited to $2,000 per year.

➢ Coverdell ESAs can offer taxpayers a much broader range of investment options when compared to state run 529 plans.

➢ Coverdell ESAs offer greater flexibility when using the funds for qualified education expenses. For example, the account can be used to pay for expenses of qualified elementary and secondary schools.

Lesson 12 - Exclusions, Employee Compensation, Deductions

The Setting Every Community Up for Retirement Enhancement (SECURE) Act expands Section 529 education savings accounts to cover costs associated with registered apprenticeships; homeschooling; up to $10,000 of qualified student loan repayments (including those for siblings); and private elementary, secondary, or religious schools as of January 1, 2020.

Qualified Student Loan

Generally, personal interest the taxpayer pays, other than certain mortgage interest, is not deductible on his or her tax return. However, in 2023, if the taxpayer’s modified adjusted gross income (MAGI) is less than $90,000 ($185,000 if filing a joint return) there is a special deduction allowed for paying interest on a student loan (also known as an education loan) used for higher education. For most taxpayers, MAGI is the adjusted gross income as figured on their Federal income tax return before subtracting any deduction for student loan interest. This deduction can reduce the amount of the taxpayer’s income subject to tax by up to $2,500. A qualified student loan is any loan an individual took out to pay the qualified higher education expenses for his or herself, for his or her spouse, or any for any person who was the taxpayer’s dependent when the student loan was taken out (usually for a son or daughter). The loan must be for an eligible student and pay for qualified higher education expenses. An eligible student is a person who:

1. Was enrolled in a degree, certificate, or other program (including a program of study abroad that was approved for credit by the institution at which the student was enrolled) leading to a recognized educational credential at an eligible educational institution, and

2. Carried at least half the normal full-time workload for the course of study he or she was pursuing. For purposes of the student loan interest deduction, these expenses are the total costs of attending an eligible educational institution, including graduate school. They include amounts paid for the following items: (226)

➢ Tuition and fees. ➢ Room and board. ➢ Books, supplies and equipment. ➢ Other necessary expenses (such as transportation).

The cost of room and board qualifies only to the extent that it is not more than the greater of:

➢ The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for Federal financial aid purposes) for a particular academic period and living arrangement of the student.

➢ The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

In addition to simple interest on the loan, if all other requirements are met, the items following types of interest can be student loan interest:

➢ Loan origination fee - In general, this is a one-time fee charged by the lender when a loan is made. To be deductible as interest, a loan origination fee must be for the use of money rather than for property or services (such as commitment fees or processing costs) provided by the lender. A loan origination fee treated as interest accrues over the life of the loan.

➢ Capitalized interest - This is unpaid interest on a student loan that is added by the lender to the outstanding principal balance of the loan. Capitalized interest is treated as interest for tax purposes and is deductible as payments of principal are made on the loan. No deduction for capitalized interest is allowed in a year in which no loan payments were made.

➢ Interest on revolving lines of credit - This interest, which includes interest on credit card debt, is student loan interest if the borrower uses the line of credit (credit card) only to pay qualified education expenses.

➢ Interest on refinanced and consolidated student loans - This includes interest on a loan used solely to refinance a qualified student loan of the same borrower. It also includes a single consolidation loan used solely to refinance two or more qualified student loans of the same borrower. (If the taxpayer refinances a qualified student loan for more than his or her original loan and he or she uses the additional amount for any purpose other than qualified education expenses, he or she deducts any interest paid on the refinanced loan.)

Lesson 12 - Exclusions, Employee Compensation, Deductions

Qualified education expenses must be reduced by certain non-taxable benefits such as employer-provided educational assistance, excludable U.S. Series EE and I savings bond interest (from Form 8815 - Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989), nontaxable qualified state tuition program earnings, nontaxable earnings from Coverdell education savings accounts, and any scholarship, educational assistance allowance, etc. Furthermore, a loan is not a qualified student loan if any of the proceeds were used for other purposes or the loan was from either a related person or a person who borrowed the proceeds under a qualified employer plan or a contract purchased under such a plan. (227)

Health Savings Account Deduction

Health Savings Accounts

Individuals and employees, through an employer’s cafeteria plan, can establish Health Savings Accounts (HSA) to reimburse them for qualified medical expenses paid during the year. For 2023, these accounts allow taxpayers with high deductible health insurance to make pre-tax contributions for self-coverage of up to $3,850 each year ($7,750 for family coverage) to cover health care costs. Amounts are excluded from gross income if paid or distributed from an HSA that is used exclusively to pay the qualified medical expenses of the account beneficiary or dependent. Other distributions are included in income and subject to an additional 20% tax unless made after the participant reaches age 65, dies or becomes disabled. Qualified medical expenses are the same expenses that qualify for the medical expenses deduction. An exception is that premiums for long-term care and coverage during periods of unemployment, whether through COBRA or not, also qualify. (228)

In order for an individual to be eligible for an HSA, on the first day of each month, the individual must be covered by a high deductible health plan and not covered by any other health plan that is not a high deductible health plan. Individual eligibility for an HSA is determined on a monthly basis. For 2023, a high deductible health plan is defined as a plan that has at least a $1,500 annual deductible for self-only coverage and a $3,000 deductible

for family coverage. In addition, annual out-of-pocket expenses paid under the plan must be limited to $7,500 for individuals and $15,000 for families. Out-of-pocket expenses include deductibles, co-payments and other amounts (does not include premiums) that must be paid for plan benefits. (229) Contributions to HSAs are deductible in determining adjusted gross income. The taxpayer’s maximum contribution is reduced by any employer contributions to his or her HSA, any contributions made to his or her Archer MSA, and any qualified HSA funding distributions. Excess contributions are subject to a 6% excise tax and are includible in gross income. Additionally, contributions by an employer that exceed the annual HSA limits are taxable as income to the employee. Taxpayers use Form 8889 - Health Saving Accounts (HSAs) to calculate their HSA deductions and any taxable distributions. Individuals who reach age 55 by the end of the tax year can increase their annual contributions by $1,000. Contributions, however, cannot be made after the participant attains age 65 and is eligible for Medicare. However, distributions for qualified medical expenses continue to be excludable from gross income and premiums for health insurance other than for a Medicare supplemental policy are considered qualified medical expenses. (228)

HSAs vs. MSAs

HSAs differ from MSAs in several ways. MSAs are limited to individuals working for small employers (generally 50 employees or fewer), or who are self-employed, while there is no such limitation for HSAs. Archer MSA’s generally cannot be established after 2007, although eligible individuals can still make MSA contributions, and receive distributions. HSAs are available for a wider range of high deductible plans than are MSAs. (230) In addition, contributions for MSAs must be made by the self-employed individual or the taxpayer’s employer, while contributions to HSAs may be made by the taxpayer, their family or their employer. Contributions to HSAs may be made even if the individual on whose behalf it is made has no compensation, or if the contribution exceeds the individual’s compensation.

Lesson 12 - Exclusions, Employee Compensation, Deductions

Other Deductions

Miscellaneous Itemized Deductions

Under the Tax Cuts and Jobs Act, the deduction for miscellaneous itemized deductions that are subject to the 2% floor is suspended. Therefore, no miscellaneous itemized deductions may be claimed by an individual on Schedule A of Form 1040 for tax years 2018 through 2025. These deductions include unreimbursed job expenses, tax preparation fees and investment fees and expenses.

Home Mortgage Interest Deduction

The Tax Cuts and Jobs Act (TCJA) retains the Home Mortgage Interest Deduction for new mortgages for principal and second residences, but reduces the interest deduction to a $750,000 mortgage from the current $1,000,000 cap. For mortgages taken out before December 15, 2017, the limit will remain $1,000,000.

However, the Tax Cuts and Jobs Act (TCJA) suspends from 2018 until 2026 the deduction for interest paid on home equity loans and lines of credit, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan. Under the TCJA, for example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not. As under prior law, the loan must be secured by the taxpayer’s main home or second home (known as a qualified residence), not exceed the cost of the home and meet other requirements. The TCJA imposes a lower dollar limit on mortgages qualifying for the home mortgage interest deduction. As of 2018, taxpayers may only deduct interest on $750,000 of qualified residence loans. The limit is $375,000 for a married taxpayer filing a separate return. These are down from the prior limits of $1 million, or $500,000 for a married taxpayer filing a separate return. The limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home. Under Temporary Regulations Section 1.163-10T(o)(5), taxpayers can irrevocably elect to treat debt as not secured by a qualified residence. The effect of this election is that the general tracing rules of Temporary Regulations Section 1.163-8T apply to determine the tax treatment of the interest expense. The election does not have to be made in the year the debt is incurred; instead, it can be made in that year or any subsequent year the debt is outstanding. However, once made, the election is binding on all future years (as to that debt) unless the IRS consents to revoke the election. The election is made by attaching a properly completed statement to the return for the year of the election. The rules for deducting interest vary, depending on whether the loan proceeds are used for personal, investment, or business activities. Interest expense can fall into any of the following categories:

➢ Personal interest, which is not deductible. ➢ Investment interest (interest on debt that is for property held for investment), for which the yearly deduction is

limited to “net investment income.” ➢ Residence interest (interest on a home mortgage), which is generally deductible as an itemized deduction. ➢ Passive activity interest (interest on debt that is for business or income-producing activities in which the taxpayer

does not “materially participate”), which is generally deductible only if income from passive activities exceeds expenses from those activities.

➢ Trade or business interest (interest on debt that is for activities in which the taxpayer does materially participate), which he or she can generally deduct in full.

Because of the variety of limits imposed on interest deductions, the IRS provides special rules to allocate interest expense among the categories. These tracing rules are generally based on the use of the loan proceeds. Under the tracing rules, interest expense is allocated in the same way as the debt on which the interest is paid. The debt, in turn, is allocated by tracing payouts of the debt proceeds to specific expenditures. The property that secures the loan generally will not affect the way the interest is treated. It's the use of the proceeds that counts.

Lesson 12 - Exclusions, Employee Compensation, Deductions

Self-Employment Tax Deduction

The taxpayer can deduct the employer-equivalent portion of self-employment tax in figuring adjusted gross income. This deduction only affects the income tax. It does not affect either net earnings from self-employment or self-employment tax. A taxpayer can claim 50% of what he or she paid in self-employment tax as an income tax deduction. See the Form 1040 and Schedule SE instructions for calculating and claiming the deduction. (192)

Self-Employed Health Insurance Deduction

Self-employed persons may deduct from gross income 100% of amounts paid during the year for health insurance for themselves, spouses, and dependents. The deduction is limited to the taxpayer’s net earned income derived from the trade or business for which the insurance plan was established, minus the deductions for 50% of the self-employment tax and/or the deduction for contributions to Keogh, self-employed SEP or SIMPLE plans. Amounts eligible for the deduction do not include amounts paid during any month, or part of a month, that the self-employed individuals were able to participate in a subsidized health plan maintained by a previous employer or their spouses’ employers. (231)

Qualified Moving Expenses Deduction

The Tax Cuts and Jobs Act provides that for tax years beginning after December 31, 2017 until January 1, 2026, the deduction for moving expenses is suspended, except for members of the Armed Forces on active duty who move pursuant to a military order and incident to a permanent change of station. (103)

Review Question 3 Beth's employer transferred her from Boston, Massachusetts, to Buffalo, New York. On her way to Buffalo, Beth drove into Canada to visit the Toronto Zoo. Beth's excursion into Canada cost her an additional $50 in gas and $200 for a hotel room. What amount can Beth deduct as moving expenses for the sightseeing excursion?

A. $0 B. $50 C. $200 D. $250

See Review Feedback for answer.

If taxpayer is a member of the Armed Forces on active duty and, due to a military order, he or she moves because of a permanent change of station he or she can deduct the reasonable unreimbursed expenses of moving him or herself and members of his or her household. A member of the taxpayer’s household is anyone who has both his or her former home and his or her new home as his or her main home. It does not include a tenant or employee unless the taxpayer can claim that person as a dependent on his or her tax return. The taxpayer can deduct expenses (if not reimbursed or furnished in kind) for: (232)

➢ Moving household goods and personal effects. ➢ Travel.

The taxpayer can deduct the expenses of moving his or her household goods and personal effects, including expenses for hauling a trailer, packing, crating, in-transit storage, and insurance. He or she cannot deduct expenses for moving furniture or other goods he or she bought on the way from his or her old home to his or her new home. The taxpayer can include only the cost of storing and insuring his or her household goods and personal effects within any period of 30 consecutive days after the day these goods and effects are moved from his or her former home and before they are delivered to his or her new home. The taxpayer can deduct the expenses of traveling (including lodging within certain limitations, but not meals) from his or her old home to his or her new home, including car expenses and air fare.

Lesson 12 - Exclusions, Employee Compensation, Deductions

The taxpayer can deduct as car expenses either:

➢ His or her actual out-of-pocket expenses, such as the amount he or she pays for gas and oil for your car, if he or she keeps an accurate record of each expense.

➢ The standard mileage rate of 22 cents per mile between in 2023. The taxpayer can add parking fees and tolls to the amount claimed under either method. He or she cannot deduct any part of general repairs, general maintenance, insurance, or depreciation for his or her car. He or she cannot deduct any expenses for meals. He or she cannot deduct the cost of unnecessary side trips or lavish and extravagant lodging. Also, the taxpayer does not deduct any expenses for moving services that were provided by the government. Also, he or she does not deduct any expenses that were reimbursed by an allowance he or she did not include in income. The taxpayer cannot deduct the following items as moving expenses:

➢ Any part of the purchase price of his or her new home. ➢ Car tags. ➢ Driver's license. ➢ Expenses of buying or selling a home (including closing costs, mortgage fees, and points). ➢ Expenses of entering into or breaking a lease. ➢ Home improvements to help sell his or her home. ➢ Loss on the sale of his or her home. ➢ Losses from disposing of memberships in clubs. ➢ Mortgage penalties. ➢ Real estate taxes. ➢ Refitting of carpet and draperies. ➢ Return trips to his or her former residence. ➢ Security deposits (including any given up due to the move). ➢ Storage charges except those incurred in transit and for foreign moves.

Review Question 4 For members of the Armed Forces on active duty, which of the following expenses are not deductible as moving expenses?

A. Transportation of household goods B. Transportation of personal effects C. Lodging D. Meals

See Review Feedback for answer.

Penalty on Early Withdrawal of Savings

Interest that was previously earned on a time savings account or deposit with a savings institution and that is later forfeited because of premature withdrawals is deductible from gross income in the year when the interest is forfeited. The taxpayer can deduct the entire penalty even if it is more than the interest income. The deduction for this penalty is taken on line 18 of Schedule 1 (Form 1040). (138)

Alimony

Lesson 12 - Exclusions, Employee Compensation, Deductions

taxed at the rates applicable to the payor-spouse rather than the recipient spouse. The new law does not change the tax treatment of child support payments. Alimony is defined as a payment to or for a spouse or former spouse under a written divorce or separation decree. The following never qualify as being alimony: (91)

➢ Child support. The key to this problem is that true alimony is a deduction to the payer and is included in the income of the payee. Child support, on the other hand, is never deductible by the payer, and is excluded from the income of the payee.

➢ Non-cash property settlements. The concept is that there was property obtained during the marriage of the parties. This is called marital property.

➢ In a divorce, when there is a splitting of the marital property between the parties, each is theoretically only getting what they had a property right to receive. There are no tax consequences to a party who receives property pursuant to a divorce property settlement agreement.

➢ Use of property. For example, the taxpayer’s former spouse lives rent-free in a home the taxpayer owns, and the taxpayer must pay the mortgage, real estate taxes, insurance, repairs, and utilities for the home. Because the taxpayer owns the home and the debts are his or hers, the taxpayer’s payments for the mortgage, real estate taxes, insurance, and repairs are not alimony. Neither is the value of the taxpayer’s former spouse's use of the home.

➢ Payments to keep up the payer's property. For example, say that the decree says that a former spouse can live rent free in an apartment that the taxpayer owns. The taxpayer still has to make the mortgage payments and the like. These payments will not be considered alimony.

➢ Voluntary payments. If the decree says a taxpayer is to pay $1,000 a month, and he or she pays $1,200, the additional $200 payment is a voluntary payment and is NOT deductible as alimony.

If the taxpayer must pay all the mortgage payments (principal and interest) on a jointly owned home, and they otherwise qualify as alimony, he or she can deduct one-half of the total payments as alimony. If the taxpayer itemizes deductions and the home is a qualified home, he or she can claim one-half of the interest in figuring the deductible interest. The taxpayer’s spouse must report one-half of the payments as alimony received. If the taxpayer’s spouse itemizes deductions and the home is a qualified home, he or she can claim one-half of the interest on the mortgage in figuring deductible interest.

If the taxpayer paid amounts that are considered taxable alimony or separate maintenance, he or she may deduct from income the amount of alimony or separate maintenance he or she paid whether or not he or she itemizes his or her deductions. Deduct alimony or separate maintenance payments on Form 1040 - U.S. Individual Income Tax Return or Form 1040-SR - U.S. Tax Return for Seniors (attach Schedule 1 (Form 1040) - Additional Income and

Adjustments to Income). The taxpayer must enter the Social Security number (SSN) or individual taxpayer identification number (ITIN) of the spouse or former spouse receiving the payments or his or her deduction may be disallowed, and he or she may have to pay a $50 penalty.

Review Question 5 Under Christopher’s divorce decree executed on April 3, 2018, he must pay his former spouse's medical and dental expenses of $500. If the payments otherwise qualify, what amount can Christopher deduct as alimony on his return?

A. $0 B. $50 C. $250 D. $500

See Review Feedback for answer.

Lesson 12 - Exclusions, Employee Compensation, Deductions

Child Support

A payment that is specifically designated as child support or treated as specifically designated as child support under a divorce or separation instrument is not alimony. The amount of child support may vary over time. Child support payments are not deductible by the payer and are not taxable to the payee. A payment will be treated as specifically designated as child support to the extent that the payment is reduced either: (91)

➢ On the happening of a contingency relating to the child, or ➢ At a time that can be clearly associated with the contingency.

A payment may be treated as specifically designated as child support even if other separate payments are specifically designated as child support. If both alimony and child support payments are called for by the taxpayer’s divorce or separation instrument, and he or she pays less than the total required, the payments apply first to child support and then to alimony.

Property Settlements

Generally, no gain or loss is recognized on a transfer of property from the taxpayer to (or in trust for the benefit of): (91)

➢ His or her spouse. ➢ His or her former spouse, but only if the transfer is incident to their divorce.

This rule applies even if the transfer was in exchange for cash, the release of marital rights, the assumption of liabilities, or other consideration. This rule does not apply in the following situations:

➢ The taxpayer’s spouse or former spouse is a nonresident alien. ➢ Certain transfers in trust. ➢ Certain stock redemptions under a divorce or separation instrument or a valid written agreement that are taxable

under applicable tax law, as discussed in Regulations Section 1.1041-2. The term property includes all property whether real or personal, tangible or intangible, or separate or community. It includes property acquired after the end of the marriage and transferred to the taxpayer’s former spouse. It does not include services.

Tuition and Fees Deduction

The Consolidated Appropriations Act, 2021, repeals the Tuition and Fees Deduction, effective with tax years that began in 2021. This is a permanent repeal, so the Tuition and Fees Deduction will not return in the next tax extenders bill. Instead, the phase-out limits on the Lifetime Learning Credit are increased to $80,000 ($160,000 for married filing jointly). (104)

Combat Zone Exclusion

If the taxpayer is a member of the U.S. Armed Forces who serves in a combat zone, he or she can exclude certain pay from income. This pay is generally referred to as combat pay. The taxpayer does not actually need to show the exclusion on the tax return because income that qualifies for the combat zone exclusion is not included in the wages reported on his or her Form W-2. The month for which the taxpayer received the pay must be a month in which he or she either served in a combat zone or was hospitalized as a result of wounds, disease, or injury incurred while serving in the combat zone. The taxpayer does not have to receive the excluded pay while he or she is in a combat zone, is hospitalized, or in the same year the taxpayer served in a combat zone. If the taxpayer is an enlisted member, warrant officer, or commissioned warrant officer, he or she can exclude the following amounts from income: (95)

➢ Active duty pay earned in any month he or she served in a combat zone. ➢ Imminent danger/hostile fire pay. ➢ A reenlistment bonus if the voluntary extension or reenlistment occurs in a month, he or she served in a combat

zone.

Lesson 12 - Exclusions, Employee Compensation, Deductions

➢ Pay for accrued leave earned in any month he or she served in a combat zone. The Department of Defense must determine that the unused leave was earned during that period.

➢ Pay received for duties as a member of the Armed Forces in clubs, messes, post and station theaters, and other non-appropriated fund activities. The pay must be earned in a month he or she served in a combat zone.

➢ Awards for suggestions, inventions, or scientific achievements he or she is entitled to because of a submission he or she made in a month he or she served in a combat zone.

➢ Student loan repayments. If the entire year of service required to earn the repayment was performed in a combat zone, the entire repayment made because of that year of service is excluded. If only part of that year of service was performed in a combat zone, only part of the repayment qualifies for exclusion. For example, if the individual served in a combat zone for 5 months, 5/12 of the repayment qualifies for exclusion.

Retirement pay and pensions do not qualify for the combat zone exclusion.

The Bipartisan Budget Act of 2018, enacted in February, changed the tax home requirement for eligible taxpayers, enabling them to claim the foreign earned income exclusion even if their “abode” is in the United States. The new law applies for tax year 2018 and subsequent years. This means that these taxpayers, if eligible, will be able to claim the foreign earned income exclusion on their income tax return for 2023 when they file.

Under the exclusion, taxpayers can choose to exclude their foreign earned income from gross income, up to a certain dollar amount.

Employee Educational Assistance Plans

If a taxpayer receives educational assistance benefits from his or her employer under an educational assistance program, he or she can exclude up to $5,250 of those benefits each year. This means the taxpayer’s employer should not include the benefits with his or her wages, tips, and other compensation shown in box 1 of his or her Form W-2. If the taxpayer’s employer pays more than $5,250 for educational benefits for him or her during the year, the taxpayer must generally pay tax on the amount over $5,250. His or her employer should include in his or her wages (Form W-2, box 1) the amount that the taxpayer must include in income. Tax-free educational assistance benefits include payments for tuition, fees and similar expenses, textbooks, supplies, and equipment. The payments may be for either undergraduate or graduate-level courses. The payments do not have to be for work-related courses. Educational assistance benefits do not include payments for the following items: (226)

➢ Meals, lodging, or transportation. ➢ Tools or supplies (other than textbooks) that the taxpayer can keep after completing the course of instruction. ➢ Courses involving sports, games, or hobbies unless they:

o Have a reasonable relationship to the business of the taxpayer’s employer, or o Are required as part of a degree program.

If the benefits over $5,250 also qualify as a working condition fringe benefit, the taxpayer’s employer does not have to include them in his or her wages. A working condition fringe benefit is a benefit which, had the taxpayer paid for it, he or she could deduct as an employee business expense. The taxpayer cannot use any of the tax-free education expenses paid for by his or her employer as the basis for any other deduction or credit, including the American Opportunity Tax Credit and Lifetime Learning Credit. (54)

Other Employee Compensation

Foreign Earned Income

If the taxpayer is a U.S. citizen or a resident alien of the United States and he or she lives abroad, the taxpayer is taxed on his or her worldwide income. Foreign earned income for this purpose means wages, salaries, professional fees, and other compensation received for personal services the taxpayer performed in a foreign country during the period for which he or she met the tax home test and either the bona fide residence test or the physical presence test. It also includes noncash income (such as a home or car) and allowances or reimbursements. A taxpayer qualifies for the tax benefits available to taxpayers who have foreign earned income if both of the following apply: (102)

➢ The taxpayer meets the tax home test. ➢ The taxpayer meets either the bona fide residence test or the physical presence test.

Lesson 12 - Exclusions, Employee Compensation, Deductions

Income from working abroad as an employee of the U.S. Government does not qualify for either of the exclusions or the housing deduction.

income. ➢ Payments received after the end of the tax year following the year in which the services that earned the income

were performed. ➢ The value of meals and lodging that are excluded from income because it was furnished for the convenience of

the employer. ➢ Pension or annuity payments, including social security benefits.

Review Question 6 A taxpayer qualifies for the tax benefits available to taxpayers who have foreign earned income if which of the following apply?

A. The taxpayer meets the tax home test B. The taxpayer meets the bona fide residence test C. The taxpayer meets the physical presence test D. All of the above

See Review Feedback for answer.

Cafeteria Plans

A cafeteria plan is a separate written plan maintained by an employer for employees that meets the specific requirements of and regulations of Section 125 of the Internal Revenue Code. It provides participants an opportunity to receive certain benefits on a pretax basis. Participants in a cafeteria plan must be permitted to choose among at least one taxable benefit (such as cash) and one qualified benefit. A qualified benefit is a benefit that does not defer compensation and is excludable from an employee’s gross income under a specific provision of the Code, without being subject to the principles of constructive receipt. Qualified benefits include the following: (233)

➢ Accident and health benefits (but not Archer medical savings accounts or long-term care insurance). ➢ Adoption assistance. ➢ Dependent care assistance. ➢ Group-term life insurance coverage. ➢ Health savings accounts, including distributions to pay long-term care services.

The written plan must specifically describe all benefits and establish rules for eligibility and elections.

Lesson 12 - Exclusions, Employee Compensation, Deductions

A Section 125 plan is the only means by which an employer can provide employees a choice between taxable and nontaxable benefits without the choice causing the benefits to become taxable. A plan providing only a choice between taxable benefits is not a Section 125 plan.

Bargain Purchases

A bargain purchase is a purchase of an item for less than its fair market value (FMV). If, as compensation for services, the taxpayer buys goods or other property at less than FMV, include the difference between the purchase price and the property's FMV in his or her income. The individual’s basis in the property is its FMV (the purchase price plus the amount included in income). (234)

If the difference between the purchase price and the FMV is a qualified employee discount, do not include the difference in income. This exclusion applies to a price reduction an employer gives an employee on property or services he or she provides to customers in the ordinary course of the line of business in which the employee performs substantial services. However, it does not apply to discounts on real property or discounts on personal property of a kind commonly held for investment (such as stocks or bonds). For this exclusion, any of the following individuals can be treated as employees:

➢ A current employee. ➢ A former employee who retired or left on disability. ➢ A widow or widower of an individual who died while an employee. ➢ A widow or widower of an employee who retired or left on disability. ➢ A leased employee who has provided services on a substantially full-time basis for at least a year if the services

are performed under primary direction or control. ➢ A partner who performs services for a partnership.

An employer can generally exclude the value of an employee discount he or she provides an employee from the employee's wages, up to the following limits:

➢ For a discount on services, 20% of the price charged nonemployee customers for the service. ➢ For a discount on merchandise or other property, gross profit percentage times the price charged nonemployee

customers for the property.

The employer determines gross profit percentage in the line of business based on all property provided to customers (including employee customers) and the experience during the tax year immediately before the tax year in which the discount is available. To figure gross profit percentage, subtract the total cost of the property from the total sales price of the property and divide the result by the total sales price of the property. An employer cannot exclude from the wages of a highly compensated employee any part of the value of a discount that is not available on the same terms to one of the following groups:

➢ All of the employees. ➢ A group of employees defined under a reasonable classification the employer set up that does not favor highly

compensated employees.

For this exclusion, a highly compensated employee for 2023 is an employee who meets either of the following tests:

➢ The employee was a 5% owner at any time during the year or the preceding year. ➢ The employee received more than $150,000 in pay for the preceding year (can be ignored if the employee was

not also in the top 20% of employees when ranked by pay for the preceding year).

Working Condition Benefits

This exclusion applies to property and services the employer provides to an employee so that the employee can perform his or her job. It applies to the extent the cost of the property or services would be allowable as a business expense or depreciation expense deduction to the employee if he or she had paid for it. The employee must meet any substantiation requirements that apply to the deduction. Examples of working condition benefits include an employee's use of a company car for business, an employer-provided cell phone provided primarily for noncompensatory business purposes, and job-related education provided to an employee.

Lesson 12 - Exclusions, Employee Compensation, Deductions

This exclusion also applies to a cash payment the employer provides for an employee's expenses for a specific or prearranged business activity if such expenses would otherwise be allowable as a business expense or depreciation expense deduction to the employee. The employer must require the employee to verify that the payment is actually used for those expenses and to return any unused part of the payment.

Review Question 7 Barbara works as an engineer and her employer provides her with a $200 subscription to an engineering trade magazine. What amount of the cost of the subscription is included in Barbara’s income?

A. $0 B. $50 C. $100 D. $200

See Review Feedback for answer.

Personal Use of Company Car

One of the fringe benefits left untaxed until 1984 was the personal use of a company car. Under current regulations, there are various methods available for employers to use in determining the amount which must be included in an employee's gross income when he or she uses a company car for personal benefit. However, regardless of the method chosen by the employer, the employee is bound to that method. (103) If an employer provides a car for an employee's use, the amount the employer can exclude as a working condition benefit is the amount that would be allowable as a deductible business expense if the employee paid for its use. If the employee uses the car for both business and personal use, the value of the working condition benefit is the part determined to be for business use of the vehicle. However, instead of excluding the value of the working condition benefit, the employer can include the entire annual lease value of the car in the employee's wages. The employee can then claim any deductible business expense for the car as an itemized deduction on his or her personal income tax return. This option is available only if the employer uses the lease value rule to value the benefit.

All of an employee's use of a qualified non-personal use vehicle is a working condition benefit. A qualified non-personal use vehicle is any vehicle the employee is not likely to use more than minimally for personal purposes because of its design. Qualified non-personal use vehicles generally include all of the following vehicles. (103)

➢ Clearly marked, through painted insignia or words, police, fire, and public safety vehicles. ➢ Unmarked vehicles used by law enforcement officers if the use is officially authorized. ➢ An ambulance or hearse used for its specific purpose. ➢ Any vehicle designed to carry cargo with a loaded gross vehicle weight over 14,000 pounds. ➢ Delivery trucks with seating for the driver only, or the driver plus a folding jump seat. ➢ A passenger bus with a capacity of at least 20 passengers used for its specific purpose. ➢ School buses. ➢ Tractors and other special-purpose farm vehicles. ➢ Bucket trucks, cement mixers, combines, cranes and derricks, dump trucks (including garbage trucks), flatbed

trucks, forklifts, qualified moving vans, qualified specialized utility repair trucks, and refrigerated trucks.

Using a company car for business purposes is not considered a fringe benefit, while personal use is a taxable fringe benefit. Personal use of a company car includes commuting to and from work, running errands or allowing a family member who is not a company employee to use the vehicle.

Fringe Benefits

Any fringe benefit provided by an employer is taxable and must be included in the recipient's pay unless the law specifically excludes it. The following non-cash benefits qualify for exclusion for all or part of their value from an employee's gross income:

➢ No-additional-cost services (e.g., free stand-by flights by airlines to their employees).

Lesson 12 - Exclusions, Employee Compensation, Deductions

➢ Qualified employee discounts (e.g., reduced sales prices of products and services sold by the employer). ➢ Working condition fringe benefits (e.g., use of company car for business purposes). ➢ De minimis fringe benefits (e.g., use of copying machine for personal purposes). ➢ Qualified transportation fringe benefits (e.g., transportation in a commuter highway vehicle, transit passes, and

qualified parking). ➢ Qualified retirement planning services. ➢ On-premises athletic facilities provided and operated by the employer.

These benefits may be extended to retired and disabled former employees, to widows and widowers of deceased employees, and to spouses and dependent children of employees. Applicable nondiscrimination conditions must be met.

No-Additional-Cost Services

The no-additional-cost services exclusion applies to a service the employer provides to an employee if it does not cause the employer to incur any substantial additional costs. The service must be offered to customers in the ordinary course of the line of business in which the employee performs substantial services. No-additional-cost services are excess capacity services, such as airline, bus, or train tickets; hotel rooms; or telephone services provided free, at a reduced price, or through a cash rebate to employees working in those lines of business. Services that are not eligible for treatment as no-additional-cost services are non-excess capacity services, such as the facilitation by a stock brokerage firm of the purchase of stock by employees. These services may however be eligible for a qualified employee discount of up to 20% of the value of the service provided. (235) To determine whether the employer incurs substantial additional costs to provide a service to an employee, count any lost revenue as a cost. The employer does not reduce the costs they incur by any amount the employee pays for the service. The employer is considered to incur substantial additional costs if they or their employees spend a substantial amount of time in providing the service, even if the time spent would otherwise be idle or if the services are provided outside normal business hours.

COBRA Premium Assistance

The American Rescue Plan provides a temporary 100% reduction in the premium that individuals would have to pay when they elect Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) continuation health coverage following a reduction in hours or an involuntary termination of employment. The new law provides a corresponding tax credit for the entities that maintain group health plans, such as employers, multiemployer plans, and insurers. The 100% reduction in the premium and the credit are also available with respect to continuation coverage provided for those events under comparable State laws, sometimes referred to as "mini-COBRA." Under Section 139I, the premium assistance is excluded from an individual’s gross income. The employer, plan, or insurer claims a tax credit in the amount of assistance provided in each calendar quarter against the Medicare taxes due for that quarter or as a refundable overpayment and increases its gross income by the amount of the credit in the tax year that includes the last day of any calendar quarter with respect to which the credit is allowed. The 100% reduction in the premium and the credit are also available with respect to continuation coverage provided for those events under comparable State laws, sometimes referred to as "mini-COBRA." However, coverage with a premium greater than the premium for the coverage that the individual was enrolled in at the time of the qualifying event is not eligible for the COBRA premium assistance.

De Minimis (Minimal) Benefits

An employer can exclude the value of a de minimis benefit they provide to an employee from the employee's wages. A de minimis benefit is any property or service the employer provides to an employee that has so little value (taking into account how frequently the employer provides similar benefits to the employees) that accounting for it would be unreasonable or administratively impracticable. Cash and cash equivalent fringe benefits (for example, gift certificates, gift cards, and the use of a charge card or credit card), no matter how little, are never excludable as a de minimis benefit. However, meal money and local transportation fare, if provided on an occasional basis and because of overtime work, may be excluded. Examples of de minimis benefits include the following:

➢ Personal use of an employer-provided cell phone provided primarily for noncompensatory business purposes. ➢ Occasional personal use of a company copying machine if the employer sufficiently controls its use so that at least

85% of its use is for business purposes.

Lesson 12 - Exclusions, Employee Compensation, Deductions

➢ Holiday or birthday gifts, other than cash, with a low fair market value. Also, flowers or fruit or similar items provided to employees under special circumstances (for example, on account of illness, a family crisis, or outstanding performance).

➢ Group-term life insurance payable on the death of an employee's spouse or dependent if the face amount is not more than $2,000.

➢ Certain meals. ➢ Occasional parties or picnics for employees and their guests. ➢ Occasional tickets for theater or sporting events. ➢ Certain transportation fare.

Some examples of benefits that are not excludable as de minimis fringe benefits are season tickets to sporting or theatrical events; the commuting use of an employer-provided automobile or other vehicle more than 1 day a month; membership in a private country club or athletic facility, regardless of the frequency with which the employee uses the facility; and use of employer-owned or leased facilities (such as an apartment, hunting lodge, boat, etc.) for a weekend. If a benefit provided to an employee does not qualify as de minimis then generally the entire benefit must be included in income.

Transportation Fringe Benefits

This exclusion applies to the following benefits: (103)

➢ A ride in a commuter highway vehicle between the employee's home and workplace. ➢ A transit pass. ➢ Qualified parking.

The exclusion applies whether the employee provides only one or a combination of these benefits to his or her employees.

Qualified transportation benefits can be provided directly by the employer or through a bona fide reimbursement arrangement. However, cash reimbursements for transit passes qualify only if a voucher or a similar item that the employee can exchange only for a transit pass is not readily available for direct distribution by the employer to his or her employee. A voucher is readily available for direct distribution only if an employee can obtain it from a voucher provider that does not impose fare media charges or other restrictions that effectively prevent the employer from obtaining vouchers. Generally, the employer can exclude qualified transportation fringe benefits from an employee's wages even if he or she provides them in place of pay.

In tax year 2023, employers can generally exclude a maximum of $300 per month from the employee's wages for combined commuter highway vehicle transportation and transit passes. A qualifying vehicle must seat at least six adults (excluding the driver), and at least 80% of its mileage use must be reasonably expected to be for employees' commuting purposes and for trips when the vehicle is at least one-half full (excluding the driver). In tax year 2023, employers can generally exclude up to $300 per month from the employee's wages for the value of qualified parking. The parking must be provided on or near the business premises of the employer or on or near a location from which the employee commutes to work by mass transit, in a commuter highway vehicle, or by carpool. The exclusion does not apply to parking on or near property used by the employee for residential purposes.

The Tax Cuts and Jobs Act included the suspension of the Qualified Bicycle Commuting Reimbursement Exclusion beginning after December 31, 2017, and before January 1, 2026.

The exclusion for these types of transportation fringe benefits also applies if an employer reimburses an employee's expenses for transit passes, van pooling, or qualified parking. Furthermore, employers may provide the employee a choice of one or more qualified transportation benefits or the cash equivalent without loss of the exclusion. The amount is includable if the cash option is chosen. With respect to mass transit passes, employers must provide vouchers and not make cash reimbursements unless vouchers are not readily available for direct distribution by the employer to its employees. If the value of a benefit for any month is more than its limit, the employer includes in the employee's wages the amount over the limit minus any amount the employee paid for the benefit. The employer cannot exclude the excess from the employee's wages as a de minimis transportation benefit. (103)

Employer-Provided Child or Dependent Care Services

Internal Revenue Code Section 129 allows employers to provide dependent care assistance benefits for their employees on a tax-free basis. When the taxpayer chooses to participate in a dependent care assistance program through his or her

Lesson 12 - Exclusions, Employee Compensation, Deductions

employer, the employer has to report that value in box 10 of the taxpayer’s Form W-2. This type of plan is a voluntary agreement to reduce his or her salary in return for an employer-provided fringe benefit.

The value of child or dependent care services provided by an employer pursuant to a written plan generally is not includable in the employee's gross income. To qualify for dependent care assistance, the dependent must be: (236)

➢ A qualifying child who is the taxpayer’s dependent and who was under age 13 when the care was provided. ➢ A spouse who was not physically or mentally able to care for him or herself and lived with the taxpayer for more

than half the year. ➢ A person who was not physically or mentally able to care for him or herself, lived with the taxpayer for more than

half the year, and either: o Was the taxpayer’s dependent. o Would have been the taxpayer’s dependent except that:

▪ He or she received gross income of $4,700 or more. ▪ He or she filed a joint return. ▪ The taxpayer, or taxpayer’s spouse if filing jointly, could be claimed as a dependent on someone

else's 2023 return.

The plan generally must not discriminate in favor of employees who are highly compensated. However, if a plan would qualify as a dependent care assistance program except for the fact that it fails to meet discrimination, eligibility, or other requirements, then despite the failure the plan may still be treated as a dependent care assistance program in the case of employees who are not highly compensated.

The amount a taxpayer can exclude or deduct is limited to the smallest of: (236)

➢ The total amount of dependent care benefits the taxpayer received during the year. ➢ The total amount of qualified expenses the taxpayer incurred during the year. ➢ Taxpayer’s earned income. ➢ Taxpayer’s spouse's earned income. ➢ For 2023, the maximum amount is $5,000. For married employees filing separate returns, the maximum amount

is $2,500.

A taxpayer can choose to include his or her nontaxable combat pay in earned income when figuring the exclusion or deduction, even if he or she chooses not to include it in earned income for the Earned Income Tax Credit or the Credit for Child and Dependent Care Expenses.

Insolvency

A taxpayer is insolvent when his or her total liabilities exceed his or her total assets. The forgiven debt may be excluded as income under the "insolvency" exclusion. Normally, a taxpayer is not required to include forgiven debts in income to the extent that the taxpayer is insolvent. The forgiven debt may also qualify for exclusion if the debt was discharged in a Title 11 bankruptcy proceeding or if the debt is qualified farm indebtedness or qualified real property business indebtedness. To show that the taxpayer is excluding canceled debt from income under the insolvency exclusion, he or she attaches Form 982 to his or her Federal income tax return and checks the box on line 1b. On line 2, include the smaller of the amount of the debt canceled or the amount by which he or she was insolvent immediately before the cancellation. The taxpayer can use the Insolvency Worksheet in Publication 4681 to help calculate the extent that he or she was insolvent immediately before the cancellation. He or she must also reduce his or her tax attributes in Part II of Form 982.

Bankruptcy

Debt canceled in a title 11 bankruptcy case is not included in the taxpayer’s income. A title 11 bankruptcy case is a case under title 11 of the United States Code (including all chapters in title 11 such as chapters 7, 11, and 13). The taxpayer must be a debtor under the jurisdiction of the court and the cancellation of the debt must be granted by the court or occur as a result of a plan approved by the court.

Retirement Planning Services

An employer may exclude from an employee's wages the value of any retirement planning advice or information the employer provides to an employee or his or her spouse if the employer maintains a qualified retirement plan. A qualified retirement plan includes a plan, contract, pension, or account described in Section 219(g)(5) of the Internal Revenue

Lesson 12 - Exclusions, Employee Compensation, Deductions

Code. In addition to employer plan advice and information, the services provided may include general advice and information on retirement. However, the exclusion does not apply to services for tax preparation, accounting, legal, or brokerage services. The employer cannot exclude from the wages of a highly compensated employee retirement planning services that are not available on the same terms to each member of a group of employees normally provided education and information about the employer's qualified retirement plan.

Review Question 8 An employer may exclude from an employee's wages the value of any retirement planning advice or information the employer provides to an employee or his or her spouse if the employer maintains a qualified retirement plan. The services provided may include all of the following except:

A. Information on retirement B. Information about a pension C. Tax preparation services D. General advice about retirement

See Review Feedback for answer.

Meals on the Business Premises

An employer can exclude the value of meals they furnish to an employee from the employee's wages if the meals meet the following tests:

➢ The meals are furnished on the employer’s business premises. ➢ The meals are furnished for the employer’s convenience.

If the employer allows the employee to choose to receive additional pay instead of meals, then the meals, if chosen, are not excluded. The exclusion also does not apply to cash allowances for meals.

Meals the employer furnishes to a restaurant or other food service employee during, or immediately before or after, the employee's working hours are furnished for the employer’s convenience. For example, if a waitress works during the breakfast and lunch periods, the employer can exclude from her wages the value of the breakfast and lunch the employer furnishes in the restaurant for each day she works. However, if the employer also allows the employee to have meals on their business premises without charge on the employee’s days off, the employer cannot exclude the value of those meals from the employee’s wages.

Athletic Facilities

An employer can exclude the value of an employee's use of an on-premises gym or other athletic facility they operate from an employee's wages if substantially all use of the facility during the calendar year is by their employees, their spouses, and their dependent children. For this purpose, an employee's dependent child is a child or stepchild who is the employee's dependent or who, if both parents are deceased, has not attained the age of 25. The exclusion does not apply to any athletic facility if access to the facility is made available to the general public through the sale of memberships, the rental of the facility, or a similar arrangement.

Adoption Assistance

An adoption assistance program allows eligible employees to exclude from taxable income expenses paid or reimbursed by their employers on their behalf for qualifying adoption expenses. Provided all requirements are met, an individual may take advantage of both the adoption credit and the income exclusion; however, the maximum dollar limit cannot be exceeded. In most cases, employer-provided adoption benefits are amounts the taxpayer’s employer paid directly to either him or her or a third party for qualified adoption expenses under a qualified adoption assistance program. Employer- provided adoption benefits should be shown in box 12 of the taxpayer’s Form W-2. His or her salary may have been reduced to pay these benefits. The taxpayer may also be able to exclude amounts not shown in box 12 of his or her Form W-2 if all of the following apply:

➢ The taxpayer adopted a child with special needs. ➢ The adoption became final in 2023. ➢ The taxpayer’s employer had a written qualified adoption assistance program.

Lesson 12 - Exclusions, Employee Compensation, Deductions

Review Feedback Review feedback provides both the answers to each question and an explanation or feedback as to how we arrived at each answer at the end of the lesson. Review feedback also contains evaluative feedback explaining why incorrect answers are wrong. You are also provided the course topic from which we derived our answer and the external source material we used for verification. If you are using the online version of the course, Ctrl+click on the topic to find the section from which we arrived at the answer for the question. You can also Ctrl+click on the question number to return to the specific review question. Question 1 - D. All of the above Many amounts received as compensation for sickness or injury are not taxable. These include compensatory damages received for physical injury or physical sickness (Choice B), benefits received under an accident or health insurance policy, disability benefits received for loss of income (Choice A) or earning capacity as a result of injuries under a no-fault car insurance policy, compensation received for permanent loss or loss of use of a part or function of the body, reimbursement for medical care and medical pensions and allowances resulting from injuries or illnesses while in the armed forces (Choice C). Since Choices A, B, and C are included in the special provision compensations that are excluded from income Choice D, All of the above, is the correct response. Topic - Exclusions Related to Illness Source - Publication 525 - Taxable and Nontaxable Income Question 2 - B. $1,556 For 2023, the maximum foreign earned income exclusion is $120,000 per year; 16% of this amount is $19,200 for a full 365 days, or $52.60 per day. Since Priscilla’s qualifying period includes all of 2023 and is below the limit for the location in which she incurred the expenses her housing amount is $20,756 minus $19,200, or $1,556. Only Choice B has the correct amount and is therefore the correct response. Topic - Exclusion Related to Foreign-Earned Income Source - IRS.GOV - Foreign Earned Income Exclusion Question 3 - A. $0 The Tax Cuts and Jobs Act (TCAJ) suspends the exclusion for qualified moving expense reimbursements from the taxpayer’s employee's income for tax years beginning after 2017 and before 2026. However, the exclusion is still available in the case of a member of the U.S. Armed Forces on active duty who moves because of a permanent change of station. The exclusion applies only to reimbursement of moving expenses that the member could deduct if he or she had paid or incurred them without reimbursement. Because Beth is not a member of the U.S. Armed Forces on active duty who moves because of a permanent change of station she can no longer deduct moving expenses. Only Choice A has the correct amount and is therefore the correct response. Topic - Qualified Moving Expenses Deduction Source - Instructions for Form 3903 Question 4 - D. Meals Members of the Armed Forces on active duty are still able to deduct their moving expenses. The deduction is computed on Form 3903 - Moving Expenses and reported on line 14, Schedule 1 (Form 1040). Deductible moving expenses are limited to the cost of transportation of household goods (Choice A) and personal effects (Choice B) and travel (including lodging (Choice C) but not meals (Choice D)) to the new residence. Topic - Qualified Moving Expenses Deduction Source - Instructions for Form 3903 Question 5 - D. $500 The Tax Cuts and Jobs Act (TCJA) provides that for any divorce or separation agreement executed after December 31, 2018 or executed before that date but modified after it (if the modification expressly provides that the new amendments apply), alimony and separate maintenance payments are not deductible by the payor-spouse and are not included in the income of the payee-spouse.

Lesson 12 - Exclusions, Employee Compensation, Deductions

In this question the agreement was effective April 3, 2018. Therefore, cash payments, checks, or money orders to a third party on behalf of the taxpayer’s spouse under the terms of his or her divorce or separation instrument can be alimony, if they otherwise qualify. These include payments for medical expenses, housing costs (rent, utilities, etc.), taxes, tuition, etc. The payments are treated as received by the taxpayer’s spouse and then paid to the third party. Chris can deduct the expenses as alimony on his return. His former spouse must report them as alimony received and can include them in figuring deductible medical expenses. Only Choice D has the correct amount and is therefore the correct response. Topic - Alimony Source - IRS.GOV - Topic No. 452 - Alimony and Separate Maintenance Question 6 - D. All of the above A taxpayer qualifies for the tax benefits available to taxpayers who have foreign earned income if he or she meets the tax home test (Choice A) and he or she meets either the bona fide residence test (Choice B) or the physical presence test (Choice C). Since Choices A, B, and C are included qualifications for the tax benefits available to taxpayers who have foreign earned income Choice D, All of the above, is the correct response. Topic - Foreign Earned Income Source - Publication 54 - Tax Guide for U.S. Citizens and Resident Aliens Abroad Question 7 - A. $0 If the taxpayer’s employer provides him or her with a product or service and the cost of it would have been allowable as a business or depreciation deduction if the taxpayer paid for it him or herself, the cost is not included in the taxpayer’s income. Examples of working condition benefits include an employee's use of a company car for business, an employer- provided cell phone provided primarily for noncompensatory business purposes, and job-related education provided to an employee such as subscriptions to professional journals or magazines. Therefore, Barbara would not t have to any of the $200 in her income and Choice A is the correct response. Topic - Working Condition Benefits Source - Publication 15-B - Employer's Tax Guide to Fringe Benefits Question 8 - C. Tax preparation services An employer may exclude from an employee's wages the value of any retirement planning advice or information the employer provides to an employee or his or her spouse if the employer maintains a qualified retirement plan. A qualified retirement plan includes a plan, contract, pension, or account described in Section 219(g)(5) of the Internal Revenue Code. In addition to employer plan advice and information, the services provided may include general advice and information on retirement. However, the exclusion does not apply to services for tax preparation, accounting, legal, or brokerage services. Topic - Retirement Planning Services Source - Publication 15-B - Employer's Tax Guide to Fringe Benefits

Itemized Deductions At the conclusion of this lesson you should have a basic knowledge of:

➢ Deducting Taxes. ➢ Deducting Interest. ➢ Deducting Contributions. ➢ Deducting Losses. ➢ Deducting Job Expenses. ➢ Other Itemized Deductions.

There are certain personal expenses which Congress has allowed as deductions. These are called itemized expenses, or often called Schedule A deductions, as this is the form that is attached to the return to claim the itemized deductions.

Schedule A Categories

Category Line(s)

Medical and Dental Expenses 1-4

Taxes Paid 5-7

Interest Paid 8-10

Gifts to Charity 11-14

Casualty and Theft Losses 15

Other Itemized Deductions 16

Table 13-1 - Schedule A (Form 1040) (2023)

Changes to Itemized Deductions

Under the Tax Cuts and Jobs Act (TCJA), the medical expense deduction remained in place with a lower floor of 7.5% for tax years 2017 (retroactively) and 2018 for all taxpayers regardless of age. The Consolidated Appropriations Act, 2021 makes permanent the lower threshold of 7.5% for all taxpayers, originally restored for 2017 and 2018 and then extended for 2019 and 2020. (104)

The deduction for state and local income, property, and sales taxes (SALT) is capped at $10,000. The SALT deduction is a substantial reduction from the former rule allowing all property taxes, plus all state and local income or sales taxes, to be claimed as an itemized deduction.

After passage of the TCJA, cash contributions to public charities are generally limited to 60% of a taxpayer’s adjusted gross income (AGI) for tax years 2022 to 2025. No deduction is allowed for donations in exchange for college athletic event seating rights. The cents-per-mile rate for driving for charitable purposes has not been changed; it remains at 14 cents per mile.

Also, the casualty loss deduction is repealed, except for losses in Federally declared disasters. Miscellaneous itemized deductions subject to the 2% of adjusted gross income (AGI) floor, such as unreimbursed employee business expenses and tax preparation fees, are repealed.

The TCJA reduced the maximum amount of mortgage debt to acquire a first or second residence for which the taxpayer can claim itemized interest expense deductions from $1 million (or $500,000 if he or she uses married filing separate status) to $750,000 (or $375,000 if he or she uses married filing separate status). However, this change did not affect home acquisition mortgages taken out under binding contracts in effect before December 16, 2017 as long as the home purchase closed before April 1, 2018.

The previous-law of $1,000,000/$500,000 limits continue to apply to home acquisition mortgages that were taken out under the previous-law rules and are then refinanced after this year (as long as the refinanced loan principal does not exceed the old loan balance at the time of the refinancing). The TCJA also eliminated the previous-law rule that allowed

Lesson 13 - Itemized Deductions

interest deductions on up to $100,000 of home-equity loan balances and lines of credit, unless they are used to buy, build, or substantially improve the taxpayer’s home that secures the loan.

Limit on Itemized Deductions

The Tax Cuts and Jobs Act repeals the phase-out of itemized deductions for high-income taxpayers. This suspension of the overall limitation on itemized deductions will apply to any taxable year beginning after December 31, 2017, and before January 1, 2026.

Making the Election Between Using the Standard Deduction or Itemized Deductions

Each year the taxpayer must decide whether the standard deduction amount or the total of allowed itemized deductions provides him or her with the lowest tax liability. This election is made each year and does not depend on what was done in past years. The taxpayer is entitled to select the most favorable alternative each year.

If the taxpayer elects to itemize deductions even though the total is less than the amount of the Standard Deduction to which the taxpayer is entitled, the taxpayer must check the box on line 18, Schedule A, Form 1040.

Also, some taxpayers are not eligible for the standard deduction. A taxpayer’s standard deduction is zero and he or she should itemize any deductions he or she has if:

➢ His or her filing status is married filing separately, and his or her spouse itemizes deductions on their return. ➢ He or she is filing a tax return for a short tax year because of a change in his or her annual accounting period. ➢ He or she is a nonresident or dual-status alien during the year. He or she is considered a dual-status alien if he

or she was both a nonresident and resident alien during the year. If the taxpayer was a nonresident alien who is married to a U.S. citizen or resident alien at the end of the year, he or she can choose to be treated as a U.S. resident. If he or she makes this choice, he or she can take the standard deduction.

Medical Expenses If the taxpayer paid for medical or dental expenses in 2023, he or she may be able to get a tax deduction for costs not covered by insurance. Here are seven facts from the IRS about claiming the medical and dental expense deduction: (237)

1. The taxpayer can only claim medical and dental expenses for costs not covered by insurance if he or she itemizes deductions on the tax return. The taxpayer cannot claim medical and dental expenses if he or she takes the standard deduction.

2. The taxpayer can deduct medical and dental expenses that are more than 7.5% of adjusted gross income. 3. The taxpayer can include medical and dental costs paid in 2023, even if he or she received the services in a

previous year. Keep good records to show the amount paid. 4. The taxpayer may include most medical or dental costs paid for him or herself, his or her spouse and his or her

dependents. Some exceptions and special rules apply. 5. The taxpayer can normally claim the costs of diagnosing, treating, easing, or preventing disease. The costs of

prescription drugs and insulin qualify. The cost of medical, dental and some long-term care insurance also qualify. 6. The taxpayer may be able to claim the cost of travel to obtain medical care. That includes the cost of public

transportation or an ambulance as well as tolls and parking fees. If he or she uses his or her car for medical travel, the taxpayer can deduct the actual costs, including gas and oil. Instead of deducting the actual costs, the taxpayer can deduct the standard mileage rate for medical travel.

7. Funds from Health Savings Accounts or Flexible Spending Arrangements used to pay for medical or dental costs are usually tax-free. Therefore, the taxpayer cannot deduct expenses paid with funds from those plans.

Medical expenses are defined as expenditures to prevent, cure, or improve a physical or mental defect or illness.

Lesson 13 - Itemized Deductions

These expenses include but are not limited to the following items: (238)

➢ Amount paid to physicians, surgeons, dentists, optometrists, chiropractors, chiropodists, podiatrists, osteopaths, psychiatrists, psychologists, and Christian Science practitioners.

➢ Hospital and clinic charges for in-patient board and lodging, X-rays, therapy treatments, laboratory, nursing care, surgery, obstetrics, treatment for alcoholism, etc.

➢ Cost and maintenance of certain appliances and medical aids such as false teeth, hearing aids, seeing eye dogs, orthopedic braces, artificial limbs, arch supports, eyeglasses, crutches, wheelchairs, truss belts, etc.

➢ Prescription medicines and insulin. ➢ Certain transportation costs incurred for the purpose of securing medical treatment. Personal use of automobile

for medical transportation can be deducted at a standard rate per mile. ➢ Premiums paid for hospitalization insurance. ➢ Certain capital expenditures made to a taxpayer's home for medical reasons. ➢ Cost of special training for the handicapped (such as for the blind to learn the Braille system or the deaf to learn

lip-reading). ➢ Expenses incurred to remove structural barriers in the home of a physically handicapped person. ➢ Lodging costs essential to medical care provided by a physician in a licensed hospital.

A taxpayer cannot include in medical expenses the cost of dancing lessons, swimming lessons, etc., even if they are recommended by a doctor, if they are only for the improvement of general health. For a complete list of medical expenses that are includible and are not includible see Publication 502 - Medical and Dental Expenses.

Expenses that fall into any of these categories are said to be deductible. In some cases, however, certain percentage limitations may apply to reduce the amount of the deduction. Medical expenses for elective cosmetic surgery are not deductible. The relationship between deductions and limitations is expressed in the following formula: Medical expenses that qualify as deductions less applicable limitations equal medical expenses that result in an itemized deduction.

Rules for Deduction of Medical Expenses

The Consolidated Appropriations Act, 2021 makes permanent the lower threshold of 7.5% for all taxpayers. Therefore, a taxpayer can deduct only the part of his or her medical and dental expenses that exceed 7.5% of his or her adjusted gross income (AGI). However, the current cost of medical insurance is so high that many

families can exceed this limitation. Not only is the entire amount of medical or health insurance added with other medical expenses, but all prescription drugs and insulin are included. (238)

Medical care expenses include the insurance premiums the taxpayer paid for policies that cover medical care or for a qualified long-term care insurance policy covering qualified long-term care services. If the taxpayer is an employee, medical expenses do not include that portion of his or her premiums treated as paid by the employer under its sponsored group accident or health policy or qualified long-term care insurance policy. Further, medical expenses do not include the premiums that the taxpayer paid under his or her employer-sponsored policy under a premium conversion policy. If the taxpayer is self-employed and has a net profit for the year, he or she may be able to deduct (as an adjustment to income) the premiums paid on a health insurance policy covering medical care including a qualified long-term care insurance policy for him or herself and their spouse and dependents. The taxpayer cannot take this deduction for any month in which he or she was eligible to participate in any subsidized health plan maintained by an employer, a former employer, his or her spouse's employer, or a former spouse's employer. If the taxpayer does not claim 100% of the self-employed health insurance deduction, he or she can include the remaining premiums with other medical expenses as an itemized deduction on Schedule A (Form 1040). The taxpayer may not deduct insurance premiums paid by an employer-sponsored health insurance plan (cafeteria plan) unless the premiums are included in Box 1 of Form W-2. (239)

Lesson 13 - Itemized Deductions

Review Question 1 Denise has insurance policies that cover her hospital and doctors' bills but not her nursing bills. The insurance she receives for the hospital and doctors' bills is more than their charges. In figuring her medical deduction which of the following is true?

A. Denise is not required to include the total amount the total amount of insurance she received because the policies do not cover some of her medical expenses

B. Denise must reduce the total amount she spent for medical care by the total amount of insurance she received, even if the policies does not cover some of her medical expenses

C. Denise is only required to include the total amount the total amount of insurance she received if the expenses exceed 80% of her adjusted gross income (AGI)

D. Denise must reduce the total amount she spent for medical care by the total amount of insurance she received only if the reimbursements do not include Medicare

See Review Feedback for answer.

Qualified Long-Term Care Insurance Premiums

The definition of medical care was expanded to include the amounts paid for qualified long-term care services and eligible long-term premiums paid under approved long-term care insurance policies. Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, rehabilitative services, and maintenance and personal care services that are: (111)

1. Required by a chronically ill individual. 2. Provided pursuant to a plan of care prescribed by a licensed health care practitioner.

A qualified long-term care insurance contract is an insurance contract that provides only coverage of qualified long-term care services. The contract must: (111)

1. Be guaranteed renewable. 2. Not provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed. 3. Provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the

contract, and dividends under the contract must be used only to reduce future premiums or increase future benefits.

4. Generally, not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer, or the contract makes per diem or other periodic payments without regard to expenses.

The amount of qualified long-term care insurance premiums a taxpayer can include is limited. He or she can include the following as medical expenses on Schedule A (Form 1040) by age (at of the close of the tax year) of the taxpayer:

Age Group 2023 Eligible Premium Amount

Age 40 and under $480

Ages 41 through 50 $890

Ages 51 through 60 $1,790

Ages 61 through 70 $4,770

Age 71 and over $5,960

Note: The limit on premiums is for each person.

Table 13-2 - Publication 502 - Medical and Dental Expenses (2023)

Lesson 13 - Itemized Deductions

Review Question 2 In 2023, what is maximum amount of qualified long-term care insurance premiums a 35-year-old taxpayer is allowed to include as medical expenses on Schedule A (Form 1040)?

A. $0 B. $480 C. $890 D. $1,790

See Review Feedback for answer.

Transportation

Include in medical expenses amounts paid for transportation primarily for, and essential to, medical care. A taxpayer can include: (240)

➢ Bus, taxi, train, or plane fares, or ambulance service. ➢ Transportation expenses of a parent who must go with a child who needs medical care. ➢ Transportation expenses of a nurse or other person who can give injections, medications, or other treatment

required by a patient who is traveling to get medical care and who is unable to travel alone. ➢ Transportation expenses for regular visits to see a mentally ill dependent, if these visits are recommended as a

part of treatment.

The taxpayer can take into account out-of-pocket expenses, such as the cost of gas and oil, when he or she utilizes his or her car for medical reasons. The taxpayer cannot include depreciation, insurance, general repair, or maintenance expenses. If the taxpayer does not want to use his or her actual automobile expenses for 2023, he or she can use the standard medical mileage rate of 22 cents per mile. The taxpayer can also include parking fees and tolls. He or she can add these fees and tolls to his or her medical expenses whether he or she uses actual automobile expenses or use the standard mileage rate.

Taxes The itemized deduction for taxes may vary from state to state and even from city to city. Much depends upon the nature of the tax imposed, and there is little uniformity in state and local taxation. Any general rules, therefore, may be subject to qualifications that depend on state and local circumstances. But general rules are a good place to start, since they provide a basis for further investigation of the taxpayer’s own state and local taxes. To deduct any tax the following two tests must be met: (241)

1. The tax must be imposed on the taxpayer. 2. The taxpayer must pay the tax during the tax year.

Another useful rule is that Federal taxes are never deductible, but some state and local taxes are allowed. The rule is only valid as to deductions claimed on the Federal income tax return. Many states permit the deductions of some Federal taxes against the state income tax.

Business Taxes

Fees and charges that are expenses of a trade or business or of producing income can be deducted. (158)

➢ Income taxes - The taxpayer can deduct on Schedule C a state tax on gross income (as distinguished from net income) directly attributable to a business. The taxpayer can deduct other state and local income taxes on Schedule A (Form 1040) if he or she itemizes deductions. Do not deduct Federal income tax.

➢ Employment taxes - The taxpayer can deduct the Social Security, Medicare, and Federal unemployment (FUTA) taxes paid out of his or her own funds as an employer. The taxpayer can also deduct payments made as an employer to a state unemployment compensation fund or to a state disability benefit fund. Deduct these payments as taxes.

Lesson 13 - Itemized Deductions

➢ Self-employment tax - The taxpayer can deduct the employer-equivalent portion of self-employment tax on line 15 of Schedule 1 (Form 1040).

➢ Personal property tax - The taxpayer can deduct on Schedule C any tax imposed by a state or local government on personal property used in a business. The taxpayer can also deduct registration fees for the right to use property within a state or local area.

➢ Real estate taxes - The taxpayer can deduct on Schedule C the real estate taxes he or she paid on a business property. Deductible real estate taxes are any state, local, or foreign taxes on real estate levied for the general public welfare. The taxing authority must base the taxes on the assessed value of the real estate and charge them uniformly against all property under its jurisdiction.

➢ Excise taxes - The taxpayer can deduct on Schedule C all excise taxes that are ordinary and necessary expenses of carrying on a business.

Taxes on gasoline, diesel fuel, and other motor fuels the taxpayer uses in a business are usually included as part of the cost of the fuel. Do not deduct these taxes as a separate item. The taxpayer may be entitled to a credit or refund for Federal excise tax he or she paid on fuels used for certain purposes.

Federal Unemployment Tax Act (FUTA)

The Federal unemployment tax is part of the Federal and state program under the Federal Unemployment Tax Act (FUTA) that pays unemployment compensation to workers who lose their jobs. Most employers may owe both the Federal unemployment tax (the FUTA tax) and a state unemployment tax. Or, the employer may owe only the FUTA tax or only the state unemployment tax. To find out whether the employer will owe state unemployment tax, contact the employer’s state's unemployment tax agency. For a list of state unemployment tax agencies, visit the U.S. Department of Labor's website. The employer should also find out if he or she needs to pay or collect other state employment taxes or carry workers' compensation insurance. The FUTA tax is 6.0% of the employee's FUTA wages. The tax applies to the first $7,000 paid to each employee as wages during the year. However, the employer may be able to take a credit of up to 5.4% against the FUTA tax, resulting in a net tax rate of 0.6%. The employer’s credit for 2023 is limited unless he or she pays all the required contributions for 2023 to his or her state unemployment fund by April 15, 2024. The credit the employer can take for any contributions for 2023 that he or she pays after April 15, 2024, is limited to 90% of the credit that would have been allowable if the contributions were paid by April 15, 2024.

The 5.4% credit is reduced for wages paid in a credit reduction state. Also, the employer does not withhold the FUTA tax from his or her employee's wages. The employer must pay it from his or her own funds.

The employer figures the FUTA tax on the FUTA wages he or she pays. If the employer pays cash wages to all of his or her household employees totaling $1,000 or more in any calendar quarter of 2022 or 2023, the first $7,000 of cash wages he or she pays to each household employee in 2023 is FUTA wages. (A calendar quarter is January through March, April through June, July through September, or October through December.) If his or her employee's cash wages reach $7,000 during the year, the employer does not figure the FUTA tax on any wages he or she pays that employee during the rest of the year. The employer does not count wages he or she pays to any of the following individuals as FUTA wages: (166)

➢ His or her spouse. ➢ His or her child who is under the age of 21. ➢ His or her parent.

Federal Insurance Contributions Act (FICA)

The 2023 Combined (Employee and Corporate) FICA tax is 7.65% each for the employee and employer on the first $160,200 plus 2.9% on earnings greater than $160,200. The result for most American wage earners is a total FICA tax of 15.3% (Social Security plus Medicare). Self-employed individuals are responsible for the entire FICA tax rate of 15.3% (12.4% Social Security plus 2.9% Medicare). The tax rate and the overall tax obligation have remained the same as 2022.

Additional Medicare Tax

In 2014 the IRS added an Additional Medicare Tax of 0.9% if an individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceeds the threshold amount for the individual’s filing status:

Lesson 13 - Itemized Deductions

Filing Status Threshold Amount

Married filing jointly $250,000

Married filing separate $125,000

Single $200,000

Head of household (with qualifying person) $200,000

Qualifying surviving spouse with dependent child $200,000

Note: The Additional Medicare Tax of 0.9% only applies to the wages above the Threshold Amount.

Table 13-3 - Questions and Answers for the Additional Medicare Tax (2023)

Additional Medicare Tax withholding applies only to compensation paid to an employee that is in excess of these thresholds in a calendar year. These thresholds are not inflation-adjusted, and thus they apply to more employees each year. The Additional Medicare Tax raises the wage earner’s portion on compensation above the threshold amounts to 2.3%. The employer-paid portion of the Medicare tax on these amounts remains at 1.45%.

Compensation subject to RRTA taxes and wages subject to FICA tax are not combined to determine Additional Medicare Tax liability. The threshold applicable to an individual’s filing status is applied separately to each of these categories of income.

State, Local and Foreign Income Taxes

Under the Tax Cuts and Jobs Act (TCJA), state, local and foreign property taxes, and state and local sales taxes, are fully deductible only paid or accrued in carrying on a trade or business or an activity relating to the expenses for the production of income. Therefore, taxpayers may only fully claim deductions for these taxes that are currently deductible when figuring income on Schedule C, Schedule E or Schedule F.

However, a taxpayer may claim an itemized deduction of up to $10,000 ($5,000 for a married, filing separately taxpayer) for the aggregate of state and local property taxes not paid or accrued in carrying on a trade or business activity and state and local income, war profits and excess profits taxes (or sales taxes rather than income taxes) paid or accrued during the year. Foreign real property taxes may not be deducted under this exception. There are four types of deductible nonbusiness taxes:

➢ State, local, and foreign income taxes. ➢ State and local general sales taxes. ➢ State and local real estate taxes. ➢ State and local personal property taxes.

Under the TCJA, a taxpayer who makes payments or transfers property to an entity eligible to receive tax deductible contributions must reduce their charitable deduction by the amount of any state or local tax credit the taxpayer receives or expects to receive.

For example, if a state grants a 70% state tax credit and the taxpayer pays $1,000 to an eligible entity, the taxpayer receives a $700 state tax credit. The taxpayer must reduce the $1,000 contribution by the $700 state tax credit, leaving an allowable contribution deduction of $300 on the taxpayer’s Federal income tax return. The regulations also apply to payments made by trusts or decedents’ estates in determining the amount of their contribution deduction.

State and Local General Sales Taxes

State and local income taxes withheld from the taxpayer’s wages during the year appear on his or her Form W-2 - Wage and Tax Statement. The taxpayer can elect to deduct state and local general sales taxes instead of state and local income taxes, but he or she cannot deduct both. If the taxpayer elects to deduct state and local general sales taxes, he or she can use either his or her actual expenses or the optional sales tax tables. The following amounts are also deductible:

➢ Any estimated taxes the taxpayer paid to state or local governments during the year, and ➢ Any prior year's state or local income tax the taxpayer paid during the year.

Generally, the taxpayer can take either a deduction or a tax credit for foreign income taxes imposed on him or her by a foreign country or a United States possession.

Lesson 13 - Itemized Deductions

State and Local Real Estate Taxes

Deductible real estate taxes are generally any state or local taxes on real property levied for the general public welfare. The charge must be uniform against all real property in the jurisdiction at a like rate. There are popular loan programs that finance energy saving improvements through government-approved programs. The taxpayer signs up for a home energy system loan and use the proceeds to make energy improvements to his or her home. In some programs, the loan is secured by a lien on his or her home and appears as a special assessment or special tax on his or her real estate property tax bill over the period of the loan. The payments on these loans may appear to be deductible real estate taxes; however, they are not deductible real estate taxes. Assessments or taxes associated with a specific improvement benefitting one home are not deductible. However, the interest portion of the taxpayer’s payment may be deductible as home mortgage interest. Many states and counties also impose local benefit taxes for improvements to property, such as assessments for streets, sidewalks, and sewer lines. The taxpayer cannot deduct these taxes. However, he or she can increase the cost basis of his or her property by the amount of the assessment. If a portion of the taxpayer’s monthly mortgage payment goes into an escrow account, and periodically the lender pays his or her real estate taxes out of the account to the local government, the taxpayer does not deduct the amount paid into the escrow account. Only deduct the amount actually paid out of the escrow account during the year to the taxing authority.

State and Local Personal Property Taxes

Deductible personal property taxes are those based only on the value of personal property such as a boat or car. Personal property tax is deductible if it is a state or local tax that is: (242)

➢ Charged on personal property. ➢ Based only on the value of the personal property. ➢ Charged on a yearly basis, even if it is collected more or less than once a year.

Some taxes and fees the taxpayer cannot deduct on Schedule A include Federal income taxes, Social Security taxes, transfer taxes (or stamp taxes) on the sale of property, homeowner's association fees, estate and inheritance taxes, and service charges for water, sewer, or trash collection.

Nondeductible Taxes

The following taxes are not deductible for Federal income tax purposes: (241)

➢ Federal and state gift taxes. ➢ Federal and state death taxes. ➢ Federal income taxes. ➢ Federal excise taxes on telephone calls, airline tickets, gasoline, tobacco, wine, whiskey, etc. ➢ Federal stamp taxes on the sale of securities or real estate and the issuance of bonds and stock. ➢ Employment taxes including Medicare, Federal Social Security, and railroad retirement taxes (other than one-half

self-employment tax paid by a self-employed taxpayer). ➢ State excise taxes. ➢ State sales taxes. ➢ State occupational taxes. ➢ Per capita taxes. ➢ State license fees, including dog license, auto tags, hunting and fishing licenses, marriage license, and safety

inspection charges for automobiles. ➢ State and local gasoline taxes. ➢ Fines and penalties. ➢ Estate, inheritance, legacy, or succession taxes (except when the estate tax is a miscellaneous deduction that is

not subject to the 2%-of-adjusted-gross-income limit).

Excise Taxes

Lesson 13 - Itemized Deductions

by trucks. Excise Tax has several general excise tax programs. One of the major components of the excise program is motor fuel. (243)

Recently, the Supreme Court ruled that the Professional and Amateur Sports Protection Act was unconstitutional. As a result, each state may decide whether to allow sports wagering. Sports wagering, like wagering in general, is subject to Federal excise taxes, regardless of whether the activity is allowed by the state. Also, as of July 1, 2010, indoor tanning services will be subject to a 10% excise tax under the Affordable Care Act.

Under the Tax Cut and Jobs Act (TCJA), certain payments made by an aircraft owner (or, in certain cases, a lessee) related to the management of private aircraft are exempt from the excise taxes imposed on taxable transportation by air.

Foreign Income Taxes

U.S. citizens and residents who lived or worked abroad may need to file a Federal income tax return. If the taxpayer is living or working outside the United States, he or she generally must file and pay taxes in the same way as people living in the U.S. This includes people with dual citizenship. Here are seven tips taxpayers with foreign income should know:

1. Report Worldwide Income - The law requires U.S. citizens and resident aliens to report any worldwide income. This includes income from foreign trusts, and foreign bank and securities accounts.

2. File Required Tax Forms - In most cases, affected taxpayers need to file Schedule B - Interest and Ordinary Dividends with their tax returns. Some taxpayers may need to file additional forms. For example, some may need to file Form 8938 - Statement of Specified Foreign Financial Assets, while others may need to electronically file Financial Crimes Enforcement Network (FinCEN) Form 114 - Report of Foreign Bank and Financial Accounts (FBAR) to the Internal Revenue Service.

3. Consider the Automatic Extension - U.S. citizens and resident aliens living abroad on April 15, 2024, may qualify for an automatic two-month extension to file their 2023 Federal income tax returns. The extension of time to file until June 15, 2024 also applies to those serving in the military outside the U.S. Taxpayers must attach a statement to their returns explaining why they qualify for the extension.

4. Review the Foreign Earned Income Exclusion - Many Americans who live and work abroad qualify for the foreign earned income exclusion. This means taxpayers who qualify will not pay taxes on up to $120,000 of their wages and other foreign earned income they received in 2023.

5. Do Not Overlook Credits and Deductions - Taxpayers may be able to take either a credit or a deduction for income taxes paid to a foreign country. This benefit reduces the taxes these taxpayers pay in situations where both the U.S. and another country tax the same income.

6. Use IRS Free File - Traditional IRS Free File provides free online tax preparation and filing options on IRS partner sites. IRS partners are online tax preparation companies that develop and deliver this service at no cost to qualifying taxpayers. In 2023, only taxpayers whose adjusted gross income (or AGI) is $79,000 or less qualify for any IRS Free File partner offers.

7. Get Tax Help Outside the U.S. - Taxpayers living abroad can get IRS help in four U.S. embassies and consulates. IRS staff at these offices can help with tax filing issues and answer questions about IRS notices and tax bills. The offices also have tax forms and publications. To find the nearest foreign IRS office, visit the IRS.gov website. At the bottom of the home page click on the link labeled ‘Contact Your Local IRS Office.’ Then click on ‘International’.

Generally, a taxpayer can take either a deduction or a credit for income taxes imposed by a foreign country or a U.S. possession. Also, a taxpayer can change his or her choice for each year's taxes. However, a deduction or credit cannot be taken for foreign income taxes paid on income that is exempt from U.S. tax under the foreign earned income exclusion or the foreign housing exclusion. If a taxpayer claimed an itemized deduction for a

given year for qualified foreign taxes, he or she can choose instead to claim a foreign tax credit that will result in a refund for that year by filing an amended return on Form 1040-X within 10 years from the original due date of his or her return. The 10-year period also applies to calculation corrections of his or her previously claimed foreign tax credit. See Publication 54 - Tax Guide for U.S. Citizens and Resident Aliens Abroad for additional details. (244)

Additional Taxes on Qualified Retirement Plans (including IRAs and MSAs)

In general, if a taxpayer takes a distribution from an IRA and/or MSA before they have reached age 59½ (including an involuntary cashout), not only is the distribution included in their income, but they are also subject to a special penalty tax for

Lesson 13 - Itemized Deductions

the early withdrawal from their qualified retirement plan. The amount of the penalty is equal to 10% of the amount of the early distribution, and is reported on Form 5329 - Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. (245)

Estate Tax

If the taxpayer inherited property from a decedent, except those who died in 2010, the basis in property he or she inherits from a decedent is generally one of the following: (246)

➢ The Fair Market Value (FMV) of the property at the date of the decedent's death. ➢ The FMV on the alternate valuation date if the personal representative for the estate elects to use alternate

valuation. ➢ The value under the special-use valuation method for real property used in farming or a closely held business if

elected for estate tax purposes. ➢ The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a

qualified conservation easement. If a Federal estate tax return does not have to be filed, the basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes. The Estate Tax is a tax on the right to transfer property at the time of a person’s death. It consists of an accounting of everything he or she owns or has certain interests in on the date of death. The fair market value of these items is used, not necessarily what the taxpayer paid for them or what their values were when acquired. The total of all of these items is the gross estate. The gross estate includes the value of all property to the extent of the decedent’s interest in the property at the time of death. Unpaid interest that has accrued on savings from the date of the last interest payment to the date of death is included in the gross estate. Outstanding dividends declared to shareholders of record on or before the date of death are included in the gross estate. The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets. A taxpayer’s gross estate also includes the following: (217)

➢ Life insurance proceeds payable to the estate or, if the taxpayer owned the policy, to his or her heirs. ➢ The value of certain annuities payable to the estate or the heirs. ➢ The value of certain property transferred within 3 years before the decedent’s death.

Once the taxpayer has accounted for the Gross Estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at the taxable estate. These deductions may include mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The value of some operating business interests or farms may be reduced for estates that qualify. (247) The allowable deductions used in determining the taxable estate include: (217)

➢ Funeral expenses paid out of the estate. ➢ Debts owed at the time of death. ➢ The marital deduction (generally, the value of the property that passes from the estate to the surviving spouse). ➢ The charitable deduction (generally, the value of the property that passes from the estate to the United States,

any state, a political subdivision of a state, the District of Columbia, or to a qualifying charity for exclusively charitable purposes).

➢ The state death tax deduction (generally any estate, inheritance, legacy, or succession taxes paid as the result of the decedent's death to any state or the District of Columbia).

The generation-skipping transfer tax is imposed as a separate tax, in addition to the gift and estate taxes, on generation-skipping transfers that are taxable distributions or terminations with respect to a generation skipping trust or direct skips. See Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return.

Lesson 13 - Itemized Deductions

The unified credit applies to both the gift tax and the estate tax and it equals the tax on the applicable exclusion amount. A taxpayer must subtract the unified credit from any gift or estate tax that he or she owes. Any unified credit the taxpayer uses against gift tax in one year reduces the amount of credit that he or she can use against gift or estate taxes in a later year. (217) As of 2011, the amount of unified credit available to a person will equal the tax on the basic exclusion amount plus the tax on any deceased spousal unused exclusion (DSUE) amount. The DSUE is only available if an election was made on the deceased spouse's Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return. The applicable exclusion amount consists of the basic exclusion amount ($12,920,000 in 2023) and, in the case of a surviving spouse, any unused exclusion amount of the last deceased spouse (who died after December 31, 2010). The executor of the predeceased spouse's estate must have elected on a timely and complete Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return to allow the donor to use the predeceased spouse's unused exclusion amount.

Estates of decedents who die during 2023 have a basic exclusion amount of $12,920,000, up from a total of $12,060,000 for estates of decedents who died in 2022.

Most relatively simple estates (cash, publicly traded securities, small amounts of other easily valued assets, and no special deductions or elections, or jointly held property) do not require the filing of an estate tax return. A filing is required for estates with combined gross assets and prior taxable gifts exceeding the following amounts:

Decedents dying in: Estate Tax Exemption Amount Tax Rate

2021 $11,700,000 40%

2022 $12,060,000 40%

2023 $12,920,000 40%

Table 13-4 - IRS Estate and Gift Tax (2023)

Gift Tax

The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not. The gift tax applies to the transfer by gift of any property. The taxpayer makes a gift if he or she gives property (including money), or the use of, or income from property, without expecting to receive something of at least equal value in return. The basis of property received as a gift is the donor's carry-over basis (adjusted basis). If a taxpayer sells something at less than its full value or if he or she makes an interest-free or reduced-interest loan, it may be a gift. (248) The annual gift exclusion for 2023 increases to $17,000. For gifts made to spouses who are not U.S. citizens, the annual exclusion has increased to $175,000 for 2023. The top rate for gifts and generation-skipping transfers remains at 40%. The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts:

➢ Gifts, excluding gifts of future interest, which are not more than the annual exclusion for the calendar year. For 2023, a taxpayer generally can give gifts valued up to $17,000 per person, to any number of people, and none of the gifts will be taxable.

➢ Tuition or medical expenses paid directly to an educational or medical institution for someone else. ➢ Gifts to the taxpayer’s spouse. ➢ Gifts to a political organization for its use. ➢ Gifts to charities.

If the taxpayer or his or her spouse makes a gift to a third party, the gift can be considered as made one-half by the taxpayer and one-half by the spouse. This is known as gift splitting. Both the taxpayer and the spouse must agree to split the gift. For 2023, gift splitting allows married couples to give up to $34,000 to a person without making a taxable gift. (217)

Lesson 13 - Itemized Deductions

Use Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return to report the following: (249)

1. Transfers subject to the Federal gift and certain generation-skipping transfer (GST) taxes and to figure the tax due, if any, on those transfers, and

2. Allocation of the lifetime GST exemption to property transferred during the transferor's lifetime. (For more details, Regulations Section 26.2632-1).

In general, if the taxpayer is a citizen or resident of the United States, he or she must file a gift tax return (whether or not any tax is ultimately due) in the following situations: (249)

➢ If he or she gave gifts to someone in 2023 totaling more than $17,000 (other than to his or her spouse), he or she probably must file Form 709.

➢ Certain gifts, called future interests, are not subject to the $17,000 annual exclusion and the taxpayer must file Form 709 even if the gift was under $17,000.

➢ A husband and wife may not file a joint gift tax return. Each individual is responsible for his or her own Form 709. ➢ The taxpayer must file a gift tax return to split gifts with his or her spouse (regardless of their amount). ➢ If a gift is of community property, it is considered made one-half by each spouse. For example, a gift of $100,000

of community property is considered a gift of $50,000 made by each spouse, and each spouse must file a gift tax return.

➢ Likewise, each spouse must file a gift tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety.

➢ Only individuals are required to file gift tax returns. If a trust, estate, partnership, or corporation makes a gift, the individual beneficiaries, partners, or stockholders are considered donors and may be liable for the gift and GST taxes.

➢ The donor is responsible for paying the gift tax. However, if the donor does not pay the tax, the person receiving the gift may have to pay the tax.

➢ If a donor dies before filing a return, the donor's executor must file the return. If the taxpayer meets all of the following requirements, he or she is not required to file Form 709: (249)

1. He or she made no gifts during the year to his or her spouse. 2. He or she did not give more than $17,000 to any one person. 3. All the gifts he or she made were of present interests.

If the only gifts a taxpayer made during the year are deductible as gifts to charities, he or she does not need to file a return as long as he or she transferred the entire interest in the property to qualifying charities. If the taxpayer transferred only a partial interest or transferred part of the interest to someone other than a charity, he or she must still file a return and report all of his or her gifts to charities.

Unreported Social Security and Medicare Tax

Use Form 4137 - Social Security and Medicare Tax on Unreported Tip Income only to figure the Social Security and Medicare tax owed on tips the taxpayer did not report to an employer, including any allocated tips shown on the Form(s) W-2 that he or she must report as income. Use Form 8919 - Uncollected Social Security and Medicare Tax on Wages to figure and report the taxpayer’s share of the uncollected Social Security and Medicare taxes due on his or her compensation if the taxpayer was an employee but was treated as an independent contractor by his or her employer. An Individual can file Form SS-8 - Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding if he or she wants the IRS to determine whether the taxpayer is an independent contractor or an employee. Complete a separate line for each firm. If the taxpayer worked as an employee for more than five firms in 2023, attach additional Form(s) 8919 with lines 1 through 5 completed. Complete lines 6 through 13 on only one Form 8919. The line 6 amount on that Form 8919 should be the combined totals of all lines 1 through 5 of all the Forms 8919. (250)

Tax for Certain Children Who Have Unearned Income (Kiddie Tax)

The exemption from the Kiddie Tax for 2023 will be $2,500. The first $1,250 of a child’s unearned income is tax-free, and the next $1,250 is subject to the child’s tax rate. Any additional earnings above $2,500 are taxed at the child's parents' marginal tax rate. Families who have unearned income that is subject to the Kiddie Tax must file IRS Form 8615 with their

Lesson 13 - Itemized Deductions

Federal tax return. A separate tax return must be filed for children who have unearned income that is greater than $12,500 or any amount of earned income. If a child’s unearned income is less than $12,500 and greater than $1,250, the child’s unearned income can be included on their parents’ income tax return. Unearned income includes taxable interest, ordinary dividends, capital gains (including capital gain distributions), rents, royalties, etc. It also includes taxable Social Security benefits, pension and annuity income, taxable scholarship and fellowship grants not reported on Form W-2, unemployment compensation, alimony, and income (other than earned income) received as the beneficiary of a trust. Nontaxable unearned income, such as tax-exempt interest and the nontaxable part of Social Security and pension payments, is not included in gross income. A child’s capital losses are taken into account in figuring the child’s unearned income. Capital losses are first applied against capital gains. If the capital losses are more than the capital gains, the difference (up to $3,000) is subtracted from the child’s interest, dividends, and other unearned income. Any difference over $3,000 is carried to the next year. A child’s unearned income includes all income produced by property belonging to the child. This is true even if the property was transferred to the child, regardless of when the property was transferred or purchased or who transferred it. A child’s unearned income includes income produced by property given as a gift to the child. This includes gifts to the child from grandparents or any other person and gifts made under the Uniform Gift to Minors Act.

Kiddie Tax

Tax Bracket Tax

$0 to $1,250 0%

Earned income > $1,250 Child’s tax rate

Unearned income > $1,250 ≤ $2,500 Child’s tax rate

Unearned income > $2,500 Generally, the parent’s highest marginal tax rate

Table 13-5 - Publication 929 - Tax for Certain Children Who Have Unearned Income (2023)

The exemption from the Kiddie Tax for 2023 is $2,500. A parent will be able to elect to include a child’s income on the parent’s return for 2023 if the child’s income is more than $1,250 and less than $12,500. The alternative minimum tax (AMT) exemption for 2023 for a child subject to the kiddie tax will be the lesser of (1) $8,800 plus the child’s earned income, or (2) $81,300. Form 8615 - Tax for Certain Children Who Have Unearned Income must be filed for anyone who meets all of the following conditions:

1. The taxpayer had more than $2,500 of unearned income. 2. The taxpayer is required to file a tax return. 3. The taxpayer was either:

a. Under age 18 at the end of 2023, b. Age 18 at the end of 2023 and did not have earned income that was more than half of his or her support,

or c. A full-time student at least age 19 and under age 24 at the end of 2023 and did not have earned income

that was more than half of his or her support. 4. At least one of the taxpayer’s parents was alive at the end of 2023. 5. The taxpayer did not file a joint return for 2023.

These rules apply if the taxpayer was legally adopted and a stepchild. These rules also apply whether or not the taxpayer is a dependent. These rules do not apply if neither of taxpayer’s parents were living at the end of the year.

Net Investment Income Tax (NIIT)

The Net Investment Income Tax (NIIT) is imposed by Section 1411 of the Internal Revenue Code (IRC) and took effect on January 1, 2013. The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts. In general, investment income includes, but is not limited to interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer. (251)

Lesson 13 - Itemized Deductions

The amount subject to the 3.8% tax is the lesser of the taxpayer’s net investment income or the amount by which modified adjusted gross (MAGI) exceeds the applicable threshold. Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds:

Filing Status Threshold Amount*

Married filing jointly $250,000

Married filing separately $125,000

Single $200,000

Head of household (with qualifying person) $200,000

Qualifying surviving spouse with dependent child $250,000

*Taxpayers should be aware that these threshold amounts are not indexed for inflation.

Table 13-6 - IRS.GOV Net Investment Income Tax FAQs (2023)

If an individual is exempt from Medicare taxes, he or she still may be subject to the Net Investment Income Tax if he or she has Net Investment Income and also has modified adjusted gross income over the applicable thresholds.

Review Question 3 Hugo is a single taxpayer with $175,000 in salary and $100,000 in capital gains. His modified adjusted gross income is $275,000 while his net investment income is $100,000. Hugo’s modified adjusted gross income exceeds the net investment income tax threshold by $75,000. What amount does Hugo owe for the net investment income tax?

A. $0 B. $2,850 C. $3,800 D. $5,225

See Review Feedback for answer.

Deduction for Qualified Business Income For tax years beginning after 2017, the taxpayer may be entitled to a deduction of up to 20% of his or her qualified business income from his or her qualified trade or businesses plus 20% of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income. The deduction is subject to various limitations, such as limitations based on the type of the taxpayer’s trade or business, his or her taxable income, the amount of W-2 wages paid with respect to the qualified trade or business, and the unadjusted basis of qualified property held by his or her trade or business. The taxpayer will claim this deduction on Form 1040, not on Schedule C. Unlike other deductions, this deduction can be taken in addition to the standard or itemized deductions. The provision is actually comprised of three separate deductions. The first deduction is the "20% pass-through deduction." In its most simple terms, Section 199A grants an individual business owner (as well as some trusts and estates) a deduction equal to 20% of the taxpayer's qualified business income. In 2023, for business owners with taxable income in excess of $232,100 ($464,200 in the case of taxpayers married filing jointly), however, no deduction is allowed against income earned in a "specified service trade or business." In addition, at these same income levels, the deduction against income earned in an eligible business is limited to the greater of: (252)

➢ 50% of the taxpayer's share of the W-2 wages with respect to the qualified trade or business, or ➢ The sum of 25% of the taxpayer's share of the W-2 wages with respect to the qualified trade or business, plus 2.5%

of the taxpayer's share of the unadjusted basis immediately after acquisition of all qualified property. Once this deduction is computed and limited, as appropriate, it is added to the second deduction for 20% of the taxpayer's qualified REIT dividends and publicly traded partnership (PTP) income for the year.

Lesson 13 - Itemized Deductions

These two deductions are truly separate and distinct. For example, if a taxpayer has a net loss from his or her flow-through businesses, it does not preclude the taxpayer's ability to claim a deduction of 20% of REIT dividends and PTP income. Likewise, if a taxpayer's sum of REIT dividends and PTP income is a loss, it does not reduce the taxpayer's pass-through deduction. After each separate deduction is computed, they are added together and then subjected to an overall limitation, equal to 20% of the excess of:

➢ The taxpayer's taxable income for the year (before considering the Section 199A deduction), over ➢ The sum of net capital gain (as defined in Section 1(h)). This includes qualified dividend income taxed at capital gains

rates, as well as any unrecaptured Section 1250 gain taxed at 25% and any collectibles gain taxed at 28%. The third deduction applies only to specified agricultural and horticultural cooperatives.

Specified Service Trades or Businesses (SSTB)

A taxpayer must be engaged in a “qualified trade or business” in order to claim the Section 199A deduction. Section 199A defines a qualified trade or business by exclusion; every trade or business is a qualified business other than: (252)

➢ The trade or business of performing services as an employee, and ➢ A specified service trade or business.

The first prohibition prevents an employee from claiming a 20% deduction against his or her wage income.

Qualified Business Income

Once a taxpayer has established that he or she is engaged in a Section 162 trade or business, the taxpayer must determine the “qualified business income (QBI)” for each separate qualified trade or business. QBI is defined as the net amount of qualified items of income, gain, deduction and loss with respect to a qualified trade or business that is effectively connected with the conduct of a business within the United States. As a result, QBI does not include certain investment- related income, including the following:

➢ Any item of short-term capital gain, short-term capital loss, long-term capital gain, long-term capital loss, or any item treated as capital gain or loss.

➢ Dividend income, income equivalent to a dividend, or payment in lieu of a dividend described in Section 954(c)(1)(G).

➢ Any interest income other than interest income properly allocable to a trade or business. ➢ Net gain from foreign currency transactions and commodities transactions. ➢ Income from notional principal contracts. ➢ Any amount received from an annuity which is not received in connection with the trade or business. ➢ Any deduction or loss properly allocable to the items described above.

Additionally, the Section 199A deduction does not reduce a partner or shareholder’s basis in the partnership interest or stock. The deduction does not reduce net earnings from self-employment or net investment income tax. The same Section 199A deduction for regular tax purposes is allowed for AMT purposes. The threshold for the accuracy related penalty under Section 6662 for anyone claiming the Section 199A deduction is reduced so that it applies to any understatement that exceeds the greater of $5,000 or 5% of the tax required to be shown on the return (it is normally 10%). (252)

Figuring the Deduction

The taxpayer should use Form 8995 - Qualified Business Income Deduction Simplified Computation to figure his or her qualified business income (QBI) deduction. Individual taxpayers and some trusts and estates may be entitled to a deduction up to 20% of their net QBI from a trade or business, including income from a pass-through entity, but not from a C corporation, plus 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. However, the taxpayer’s total QBI deduction is limited to 20% of his or her taxable income, calculated before the QBI deduction, minus net capital gain. The taxpayer can use Form 8995 or Form 8995-A, as applicable, to figure his or her qualified business income (QBI) deduction. He or she includes the following schedules as appropriate:

➢ Schedule A (Form 8995-A), Specified Service Trades or Businesses (SSTB). ➢ Schedule B (Form 8995-A), Aggregation of Business Operations.

Lesson 13 - Itemized Deductions

➢ Schedule C (Form 8995-A), Loss Netting and Carryforward. ➢ Schedule D (Form 8995-A), Special Rules for Patrons of Agricultural or Horticultural Cooperatives.

Depending on the taxpayer’s taxable income, his or her QBI component may also be limited based on the type of trade or business, W-2 wages paid by that business, and unadjusted basis immediately after acquisition (UBIA) of qualified property held by the business.

Disclosure Requirements

A pass-through entity is required to allocate and disclose QBI, W-2 wages, and UBIA of property. If any one item is not allocated, that item is presumed to be zero. There is no exception for pass-through entities that know that all of its owners have taxable income below the thresholds. In addition, a pass-through entity is required to disclose whether it has multiple trades or businesses, and if any of those businesses are a specified service trade or business (SSTB).

Charitable Contributions A taxpayer can only deduct gifts he or she gives to qualified charities. Gifts of money include those made in cash or by check, electronic funds transfer, credit card and payroll deduction. The taxpayer must have a bank record or a written statement from the charity to deduct any gift of money on his or her tax return. This is true regardless of the amount of the gift. The statement must show the name of the charity and the date and amount of the contribution. Bank records include canceled checks, or bank, credit union and credit card statements. If the taxpayer gives by payroll deductions, he or she should retain a pay stub, a Form W-2 wage statement or another document from his or her employer. It must show the total amount withheld for charity, along with the pledge card showing the name of the charity. Household items include furniture, furnishings, electronics, appliances, and linens. If the taxpayer donates clothing and household items to charity, they generally must be in at least good used condition to claim a tax deduction. If he or she claims a deduction of over $500 for an item, it does not have to meet this standard if the taxpayer includes a qualified appraisal of the item with his or her tax return. The taxpayer must get an acknowledgment from a charity for each deductible donation (either money or property) of $250 or more. Additional rules apply to the statement for gifts of that amount. This statement is in addition to the records required for deducting cash gifts. However, one statement with all of the required information may meet both requirements. Under the Tax Cuts and Jobs Act no charitable deduction is allowed for any payment to an institution of higher education in exchange for which the payor receives the right to purchase tickets or seating at an athletic event. The law also repeals the donee-reporting exemption from the contemporaneous written acknowledgment requirement for tax years beginning after December 31, 2017. The taxpayer can deduct contributions in the year he or she makes them. If the taxpayer charges his or her gift to a credit card before the end of the year it will count for 2023. This is true even if he or she does not pay the credit card bill until 2024. Also, a check will count for 2023 as long as the taxpayer mails it in 2023. Use the following lists for a quick check of whether the taxpayer can deduct a contribution. (253)

Examples of Charitable Contributions

Deductible As Charitable Contributions

Not Deductible As Charitable Contributions

Money or property the taxpayer gives to:

• Churches, synagogues, temples, mosques, and other religious organizations.

• Federal, state, and local governments, if the taxpayer’s contribution is solely for public purposes (for example, a gift to reduce the public debt or maintain a public park).

• Nonprofit schools and hospitals.

• The Salvation Army, American Red Cross, CARE, Goodwill Industries, United Way, Boy Scouts of America, Girl Scouts of America, Boys and Girls Clubs of America, etc.

• War veterans' groups.

Money or property the taxpayer gives to:

• Civic leagues, social and sports clubs, labor unions, and chambers of commerce.

• Foreign organizations (except certain Canadian, Israeli, and Mexican charities).

• Groups that are run for personal profit.

• Groups whose purpose is to lobby for law changes.

• Homeowners' associations.

• Individuals.

• Political groups or candidates for public office.

Lesson 13 - Itemized Deductions

Expenses paid for a student living with the taxpayer, sponsored by a qualified organization.

Cost of raffle, bingo, or lottery tickets.

Out-of-pocket expenses when the taxpayer serves a qualified organization as a volunteer.

Dues, fees, or bills paid to country clubs, lodges, fraternal orders, or similar groups.

Tuition

Value of the taxpayer’s time or services

Value of blood given to a blood bank

Table 13-7 - Publication 526 - Table 1 - Examples of Charitable Contributions - A Quick Check (2023)

To be qualified, an organization must be set up and operated exclusively for charitable, religious, educational, scientific, or literary purposes, or for the prevention of cruelty to children or animals. Typical organizations that meet these tests are nonprofit schools and hospitals, churches, the Salvation Army, the Y.M.C.A. and Y.W.C.A., the American Red Cross, the Boy Scouts and Girl Scouts of America, the Disabled American Veterans, CARE, the American Heart Association, the American Cancer Society, the United Cerebral Palsy Association, the Multiple Sclerosis National Society, Lincoln College, The Civil War Preservation Trust, The Abraham Lincoln Association, and The Civil War Round Table. To be deductible, charitable contributions must be made to qualified organizations. Payments to individuals, a political organization or a political candidate are never deductible. To determine if the organization that the taxpayer contributed to qualifies as a charitable organization for income tax deductions, review Exempt Organizations Select Check on the IRS.gov website. Qualified organizations generally include nonprofit groups whose purpose is:

➢ Religious. ➢ Charitable. ➢ Educational. ➢ Scientific. ➢ Literary. ➢ Preventing cruelty to children or animals.

If the contribution entitles an individual to merchandise, goods, or services, including admission to a charity ball, banquet, theatrical performance, or sporting event, he or she can deduct only the amount that exceeds the fair market value of the benefit received.

Contribution Percentage Limitations

After passage of the TCJA, cash contributions to public charities were generally limited to 60% of a taxpayer’s adjusted gross income (AGI) for tax years 2022 to 2025. The taxpayer may be liable for a penalty if he or she overstates the value or adjusted basis of contributed property. The penalty is 20% of the amount by which the taxpayer underpaid his or her tax because of the overstatement, if: (104)

1. The value or adjusted basis claimed on the taxpayer's return is 150% or more of the correct amount, and 2. He or she underpaid his or her tax by more than $5,000 because of the overstatement.

The penalty is 40%, rather than 20%, if:

1. The value or adjusted basis claimed on the taxpayer's return is 200% or more of the correct amount, and 2. He or she underpaid his or her tax by more than $5,000 because of the overstatement.

Written Substantiation Required

Charitable contributions of $250 or more must be substantiated by a written acknowledgment from the donee or receiving organization. Generally, the acknowledgment must include the amount of cash and a description of non-cash contributions, together with a description and good faith estimate of the value of any goods or services received for the contributions. Contributions made by payroll deduction may be substantiated with an employer-provided document, such as a paystub or Form W-2. Appraisal fees incurred by a taxpayer in determining the fair market value of donated property are not to be treated as part of the charitable contribution.

Lesson 13 - Itemized Deductions

If the taxpayer made the contribution by phone or text message, a telephone bill showing the name of the donee organization, the date of the contribution, and the amount of the contribution will satisfy the recordkeeping requirement. Therefore, for example, if the taxpayer made a $10 charitable contribution by text message that was charged to his or her telephone or wireless account, a bill from the taxpayer’s telecommunications company containing this information satisfies the recordkeeping requirement. (253)

Noncash Deductions Over $500

A taxpayer is required to attach Form 8283 - Noncash Charitable Contributions if the taxpayer claims a deduction over $500 for all non-cash charitable contributions. Generally, the taxpayer cannot take a deduction for clothing or household items donated unless the clothing or household items are in good used condition or better. However, he or she can take a deduction for $500 or more for a contribution of an item of clothing or household item (such as an appliance or furniture) that is not in good used condition or better if he or she includes a qualified appraisal of it with the return.

vehicle - such as a car, boat, or airplane - if his or her deduction for the qualified vehicle is limited to the gross proceeds from its sale and he or she obtained a contemporaneous written acknowledgment. (253)

Charitable Donation of Vehicles

Effective since tax year 2005, a taxpayer contributing a qualified vehicle valued at over $500 to a charity must meet new more stringent substantiation requirements. The taxpayer must obtain from the charity a Form 1098-C Contributions of Motor Vehicles, Boats, and Airplanes or a contemporaneous written statement that names the taxpayer, contains the taxpayer’s Social Security number and the vehicle’s identification number.

This statement must be attached to the donor’s tax return. If the vehicle is sold, the gross proceeds are the taxpayer’s charitable contribution for the vehicle. If the charity retains the vehicle for their use or to make a substantial improvement, the statement must state this fact with the estimated amount of time the charity will use the vehicle. The taxpayer will then be allowed to claim the fair market value of the qualified vehicle as a charitable donation. Qualified vehicles are defined as motor vehicles manufactured for use on public roads and highways, boats, and aircraft.

Review Question 4 A taxpayer contributing a qualified vehicle valued at over $500 must obtain from the charity what form?

A. Form W-2 B. Form 1099-DIV C. Form 1099-INT D. Form 1098-C

See Review Feedback for answer.

Contributions From Which the Taxpayer Benefits

If the taxpayer receives a benefit as a result of making a contribution to a qualified organization, he or she can deduct only the amount of his or her contribution that is more than the value of the benefit he or she receives. If the taxpayer pays more than fair market value to a qualified organization for goods or services, the excess may be a charitable contribution. For the excess amount to qualify, he or she must pay it with the intent to make a charitable contribution. Additionally, If the taxpayer receives or expect to receive a financial or economic benefit as a result of making a contribution to a qualified organization, he or she cannot deduct the part of the contribution that represents the value of the benefit he or she receives. Under the Tax Cuts and Jobs Act, no deduction is allowed for amounts paid in exchange for college or university athletic event seating rights.

If the taxpayer makes a payment or transfers property to or for the use of a qualified organization and receives or expects to receive a state or local tax credit in return, then the amount treated as a charitable contribution deduction is reduced by the amount of the state or local tax credit he or she receives or expects to receive in consideration for his or her payment or transfer, but an exception may apply. If an exception does not apply, the taxpayer must reduce his or her charitable contribution deduction even if he or she cannot claim the state tax credit in the year.

Lesson 13 - Itemized Deductions

If the state or local tax credit the taxpayer receives or expects to receive does not exceed 15% of his or her payment amount or 15% of the fair market value of the transferred property, then his or her charitable contribution deduction is not reduced.

Review Question 5 Matt pays $300 a year for membership in a university's athletic scholarship program. The only benefit of membership is that he has the right to buy one season ticket for a seat in a designated area of the stadium at the university's home football games. What amount can Matt deduct as a charitable contribution?

A. $0 B. $60 C. $240 D. $300

See Review Feedback for answer.

Contributions of Property

If the taxpayer contributes property to a qualified organization, the amount of his or her charitable contribution is generally the fair market value (FMV) of the property at the time of the contribution. If the taxpayer contributes property with a fair market value that is less than his or her basis in it, his or her deduction is limited to its fair market value. The taxpayer cannot claim a deduction for the difference between the property's basis and its fair market value.

The amount the taxpayer can deduct for a contribution of ordinary income property is its fair market value minus the amount that would be ordinary income or short-term capital gain if he or she sold the property for its fair market value. Generally, this rule limits the deduction to his or her basis in the property.

Value of Services

A taxpayer may deduct certain out of pocket costs that a taxpayer incurs in the giving of services to a qualified charity. For example, in tax year 2023, a taxpayer can deduct the cost of special uniforms, telephone expenses, car expenses, either using the actual mileage method or the standard mileage rate of 14 cents per mile, and other travel expenses as long as there is no significant element of personal recreation or pleasure involved in the travel. Gifts to Charity are claimed on Lines 11-14, Schedule A, Form 1040. However, the taxpayer cannot deduct the value of his or her time or services that includes blood donations to the American Red Cross or to blood banks and the value of income lost while he or she works as an unpaid volunteer for a qualified organization. (253)

Qualified Charitable Distributions (QCD)

The Protecting Americans from Tax Hikes Act of 2015 made permanent the tax exemption of distributions from individual retirement accounts for charitable purposes. A qualified charitable distribution (QCD) is a distribution made directly by the trustee of the taxpayer’s individual retirement arrangement (IRA), other than a SEP or SIMPLE IRA, to certain qualified organizations. The taxpayer must have been at least age 70½ when the distribution was made. In 2023, the taxpayer’s total QCDs for the year cannot be more than $100,000 but it can count as a required minimum distribution (RMD). If all the requirements are met, a QCD is nontaxable, but the taxpayer cannot claim a charitable contribution deduction for a QCD. Also, the distribution does not apply to a Roth IRA, which has tax-free withdrawals and no required distributions.

Review Question 6 The Protecting Americans from Tax Hikes Act of 2015 made permanent the tax exemption of distributions from individual retirement accounts for charitable purposes. Individuals age 70½ or over can exclude up to what amount from gross income for donations paid directly to a qualified charity from their IRA?

A. $10,000 B. $20,000 C. $50,000 D. $100,000

See Review Feedback for answer.

Lesson 13 - Itemized Deductions

Casualty and Theft Losses A casualty is defined as the complete or partial destruction of property from a sudden, unexpected, or unusual cause. Under the TCJA, casualty and theft losses are generally only deductible to the extent they are attributable to a “Federally declared disaster”. There is a limited exception for taxpayers who have personal casualty gains, whereby losses not attributable to a disaster may be used to offset such gains, but not below zero. For the purposes of this provision, a “Federally declared disaster” is one that has been determined by the President to warrant Federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. However, personal casualty losses resulting from federally declared disasters that occurred in 2016, as well as certain 2017 disasters, including Hurricane Harvey and Tropical Storm Harvey, Hurricane Irma, Hurricane Maria, and the California wildfires, may be claimed as a qualified disaster loss. This special relief provided is a result of provisions contained in the Disaster Relief and Airport and Airway Extension Act of 2017, the Tax Reform Act of 2017, and the Bipartisan Budget Act of 2018. These provisions include the following:

➢ The $100 limitation per casualty has been increased to $500 for net qualified disaster losses. ➢ The 10% of adjusted gross income limit does not apply to net qualified disaster losses.

The taxpayer can claim his or her standard deduction increased by his or her net qualified disaster loss instead of itemizing deductions on Schedule A.

Review Question 7 A casualty is defined as the complete or partial destruction of property from a sudden, unexpected, or unusual cause. Under the Tax Cuts and Jobs Act (TCJA), casualty and theft losses are generally only deductible to the extent they are attributable to which of the following?

A. Federally declared disaster B. Red Cross disaster relief C. State declared disaster D. County declared disaster

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Interest Interest expense probably leads all other personal deductions from adjusted gross income in placing taxpayers in a position to itemize. Interest on home mortgages is the largest single deduction for most taxpayers. As mortgages run for longer and longer periods of time and as down payments on the purchase of homes decrease, interest charges increase. Mortgage points are also generally deductible as interest, but only if paid on loans used to purchase a principal residence of the taxpayer. To be deductible, interest must actually be owed by the taxpayer claiming the expense. The purpose for which the interest is paid is very important. In addition to excluding interest on funds borrowed to purchase tax-free securities, consumer interest was removed from the list of deductible expenses. Since 1991, no personal consumer interest deduction is allowed. Excluded is interest on credit cards, auto loans and insurance policies. Interest on indebtedness incurred in a trade or business is deductible, as is mortgage interest on the taxpayer's first and second residence, subject to certain limitations. Investment interest is interest paid on money a person borrowed that is allocable to property held for investment. It does not include any interest allocable to passive activities or to securities that generate tax-exempt income. Complete and attach Form 4952 - Investment Interest Expense Deduction to figure the deduction.

Lesson 13 - Itemized Deductions

Deductible Home Mortgage Interest

debt, that is, debt acquired on or before December 15, 2017, would remain subject to the $1 million limitation, as the new law is not applied retroactively.

Review Question 8 Under the Tax Cuts and Jobs Act (TCJA), mortgage interest on loans used to acquire a principal residence and/or a second home remains deductible, but only on debt up to what amount?

A. $100,000 B. $250,000 C. $500,000 D. $750,000

See Review Feedback for answer.

Additionally, mortgage refinances after 2017 will be considered incurred on the date of the original mortgage so long as the refinanced debt does not exceed the original debt. This will afford taxpayers with existing debt the option to refinance without being encumbered by the new limitations. Also, for the eight tax years beginning after December 31, 2017 and before January 1, 2026 the deduction for interest paid on home equity loans and lines of credit is suspended, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan. Mortgage interest is any interest that a person pays on a loan that is secured by his or her principal residence. Secured debt, for purposes of the mortgage interest deduction, means that there is a signed written document:

1. That makes ownership in a qualified home security, or collateral for the mortgage debt. 2. That, in case of default on the loan, the home could be taken by the creditor to satisfy the debt. 3. That is recorded or otherwise protected under state or local law.

This includes a mortgage, a second mortgage, a line of credit loan, or a home equity loan. In most cases, the entire amount of interest paid on a mortgage is deductible as an itemized deduction on Schedule A. However, there are some limitations. We will consider only those rules for mortgages taken out after October 13, 1987. First, the home mortgage must be on a qualified home. The qualified home is where the taxpayer lives most of the time. It can be a house, cooperative apartment, condominium, mobile home, house trailer, or houseboat that has sleeping, cooking, and toilet facilities. (254) A second home can include any other residence the taxpayer owns and treats as a second home. The taxpayer does not have to use the home during the year. However, if he or she rents it to others, the taxpayer must also use it as a home during the year for more than the greater of 14 days or 10% of the number of days it is rented, for the interest to qualify as qualified residence interest. Qualified residence interest and points are generally reported on Form 1098 - Mortgage Interest Statement by the financial institution to which the taxpayer made the payments. The following mortgages yield qualified residence interest and the taxpayer can deduct all of the interest on these mortgages: (254)

➢ A mortgage taken out on or before October 13, 1987 (grandfathered debt). ➢ A mortgage taken out after October 13, 1987, to buy, build, or improve a home (called home acquisition debt) up

to a total of $1 million for this debt plus any grandfathered debt. The limit is $500,000 if the taxpayer is married filing separately.

➢ Home equity debt other than home acquisition debt taken out after October 13, 1987, up to a total of $100,000. The limit is $50,000 if married filing separately. Home equity debt other than home acquisition debt is further limited to the home's fair market value reduced by the grandfathered debt and home acquisition debt.

The taxpayer may be able to take a credit against Federal income tax if he or she was issued a mortgage credit certificate by a state or local government for low-income housing. Use Form 8396 - Mortgage Interest Credit to figure the amount.

Lesson 13 - Itemized Deductions

However, the taxpayer may be subject to a limit (phase-out) on some of the itemized deductions including mortgage interest.

Review Question 9 For the purposes of deductible mortgage interest, if the taxpayer rents a second home to others, he or she must use the home during the year for more than the greater of how many days or 10% of the number of days it is rented, for the interest to qualify as qualified residence interest?

A. 5 days B. 10 days C. 14 days D. 15 days

See Review Feedback for answer.

Home Equity Loans

Under the Tax Cuts and Jobs Act (TCJA), for the eight tax years beginning after December 31, 2017 and before January 1, 2026, the deduction for interest paid on home equity loans and lines of credit is suspended, unless they are used to buy, build, or substantially improve the taxpayer’s home that secures the loan. If qualified, the general limitation is that a home equity loan cannot be more than the fair market value of the home minus the amount of acquisition debt remaining on the home at the time of the home equity loan. Further, the maximum dollar limitation on a home equity debt is $100,000 or less, $50,000 if married filing separately, and totaling no more than the fair market value of the home. The taxpayer reports the amount of mortgage interest paid on either line 8a of Schedule A (Form 1040). (255) If the mortgage interest was paid to a financial institution, it is reported on line 8a, and if to a private person, on line 8b of Schedule A. If the taxpayer paid more than $600 in mortgage interest during the year, the taxpayer should receive a Form 1098 - Mortgage Interest Statement telling the taxpayer exactly how much mortgage interest the taxpayer had paid during the year. If the taxpayer paid mortgage interest and did not receive a Form 1098, report the amount of interest on Line 8b of Schedule A. (256)

Points

The term “points” is used to describe certain charges paid to obtain a home mortgage. Points are prepaid interest and may be deductible as home mortgage interest, if the taxpayer itemizes deductions on Form 1040, Schedule A. If the taxpayer can deduct all of the interest on the mortgage, he or she may be able to deduct all of the points paid on the mortgage. If the acquisition debt exceeds $1,000,000 ($500,000 if married filing separately) or the home equity debt exceeds $100,000 ($50,000 if married filing separately), the taxpayer cannot deduct all the interest on his or her mortgage and he or she cannot deduct all the points. The taxpayer can deduct the points in full in the year they are paid, if all the following requirements are met: (257)

1. The loan is secured by the taxpayer’s main home (the main home is the one he or she lives in most of the time). 2. Paying points is an established business practice in the taxpayer’s area. 3. The points paid were not more than the amount generally charged in that area. 4. The taxpayer uses the cash method of accounting. This means the taxpayer reports income in the year received

and deducts expenses in the year paid. 5. The points were not paid for items that usually are separately stated on the settlement sheet such as appraisal

fees, inspection fees, title fees, attorney fees, or property taxes. 6. The funds the taxpayer provided at or before closing, plus any points the seller paid, were at least as much as the

points charged. The taxpayer cannot have borrowed the funds from a lender or mortgage broker in order to pay the points.

7. The taxpayer uses the loan to buy or build a main home. 8. The points were computed as a percentage of the principal amount of the mortgage. 9. The amount is clearly shown as points on the settlement statement.

Lesson 13 - Itemized Deductions

The taxpayer can also fully deduct (in the year paid) points paid on a loan to improve the main home if the above tests one through six are met. Points that do not meet these requirements may be deductible over the life of the loan. Points paid for refinancing generally can only be deducted over the life of the new mortgage. However, if the taxpayer uses part of the refinanced mortgage proceeds to improve the main home, and he or she meets the first six requirements stated above, the taxpayer can fully deduct the part of the points related to the improvement in the year paid with their own funds. The taxpayer can deduct the rest of the points over the life of the loan. Points charged for specific services, such as preparation costs for a mortgage note, appraisal fees, or notary fees are not interest and cannot be deducted. Points paid by the seller of a home cannot be deducted as interest on the seller's return, but they are a selling expense which will reduce the amount of gain realized. Points paid by the seller may be deducted by the buyer, provided the buyer subtracts the amount from the basis or cost of the residence. Points the taxpayer pays on loans secured by a second home can be deducted only over the life of the loan. (257)

Mortgage Insurance Premiums Deduction

The Consolidated Appropriations Act, 2021 extended the deduction for mortgage insurance premiums through 2021 and it therefore expired on December 31, 2021. (104)

Cancelled Home Mortgage Debt

The Consolidated Appropriations Act, 2021 includes an extension of the qualified principal residence indebtedness exclusion through 2025. Typically, when debt is forgiven, the discharged amount is included in a taxpayer’s gross income. The provision reduces the maximum amount that may be excluded from $2,000,000 to $750,000. Generally, indebtedness must be the result of acquisition, construction, or substantial improvement of primary residence. Many short sales and mortgage modifications include debt forgiveness that falls under the qualified principal residence indebtedness exclusion.

Other Miscellaneous Deductions

Miscellaneous Itemized Deductions

does not affect small business owners or self-employed persons, who would still be able to declare business expenses on IRS Form 1040, Schedule C - Profit or Loss from Business.

Review Question 10 Under the Tax Cuts and Jobs Act (TCJA), which of the following are examples of employee expenses that do not qualify as itemized deductions?

A. Union dues B. Legal fees C. Subscriptions to trade journals D. All of the above

See Review Feedback for answer.

Deductions Subject to the 2% Limit

Under the Tax Cuts and Jobs Act the deduction for miscellaneous itemized deductions that are subject to the 2% of adjusted gross income (AGI) floor is suspended. Therefore, no miscellaneous itemized deductions may be claimed by a taxpayer on Schedule A for tax years 2018 through 2025. Suspended miscellaneous deductions subject to the 2% floor include unreimbursed employee expenses for:

Lesson 13 - Itemized Deductions

➢ Dues to a chamber of commerce if membership helps the taxpayer do his or her job. ➢ Dues to professional societies. ➢ Educator expenses. ➢ Home office or part of the taxpayer’s home used regularly and exclusively in his or her work. ➢ Job search expenses in the taxpayer’s present occupation. ➢ Laboratory breakage fees. ➢ Legal fees related to the taxpayer’s job. ➢ Licenses and regulatory fees. ➢ Malpractice insurance premiums. ➢ Medical examinations required by an employer. ➢ Occupational taxes. ➢ Passport for a business trip. ➢ Repayment of an income aid payment received under an employer's plan. ➢ Research expenses of a college professor. ➢ Rural mail carriers' vehicle expenses. ➢ Subscriptions to professional journals and trade magazines related to the taxpayer’s work. ➢ Tools and supplies used in the taxpayer’s work. ➢ Travel, transportation, meals, entertainment, gifts, and local lodging related to the taxpayer’s work. ➢ Union dues and expenses. ➢ Work clothes and uniforms if required and not suitable for everyday use. ➢ Work-related education.

Also qualifying as miscellaneous expenses are the expenses that taxpayers incur for tax preparation and other tax-related services such as tax counsel fees and appraisal fees.

Other suspended miscellaneous deductions subject to the 2% include: (114)

➢ Appraisal fees for a casualty loss or charitable contribution. ➢ Casualty and theft losses from property used in performing services as an employee. ➢ Clerical help and office rent in caring for investments. ➢ Depreciation on home computers used for investments. ➢ Excess deductions (including administrative expenses) allowed a beneficiary on termination of an estate or trust. ➢ Fees to collect interest and dividends. ➢ Hobby expenses, but generally not more than hobby income. ➢ Indirect miscellaneous deductions from pass-through entities. ➢ Investment fees and expenses. ➢ Legal fees related to producing or collecting taxable income or getting tax advice. ➢ Loss on deposits in an insolvent or bankrupt financial institution. ➢ Loss on traditional IRAs or Roth IRAs when all amounts have been distributed to the taxpayer. ➢ Repayments of income. ➢ Repayments of social security benefits. ➢ Safe deposit box rental, except for storing jewelry and other personal effects. ➢ Service charges on dividend reinvestment plans. ➢ Tax advice fees. ➢ Trustee's fees for the taxpayer’s IRA, if separately billed and paid.

Other miscellaneous itemized deductions subject to the 2% floor include:

➢ Repayments of income received under a claim of right (only subject to the 2% floor if less than $3,000). ➢ Repayments of Social Security benefits. ➢ The share of deductible investment expenses from pass-through entities.

Moving Expense Deduction Suspended Except in Limited Situations

For 2018 through 2025, employers must include moving expense reimbursements in employees’ wages. The Tax Cuts and Jobs Act (TCJA) suspends the exclusion for qualified moving expense reimbursements. However, members of the U.S. Armed Forces can still exclude qualified moving expense reimbursements from their income if:

➢ They are on active duty.

Lesson 13 - Itemized Deductions

➢ They move pursuant to a military order and incident to a permanent change of station. ➢ The move expenses would qualify as a deduction if the employee did not get a reimbursement.

Deductions Not Subject to the 2% Limit

The taxpayer can deduct the items listed below as miscellaneous itemized deductions. They are not subject to the 2% limit. The taxpayer reports these items on Schedule A (Form 1040) or Schedule A (Form 1040-NR).

➢ Amortizable premium on taxable bonds. ➢ Casualty and theft losses from income-producing property. ➢ Federal estate tax on income in respect of a decedent. ➢ Gambling losses up to the amount of gambling winnings. ➢ Impairment-related work expenses of persons with disabilities. ➢ Loss from other activities from Schedule K-1 (Form 1065-B), box 2. ➢ An ordinary loss attributable to a contingent payment debt instrument or an inflation-indexed debt instrument (for

example, a Treasury Inflation-Protected Security). ➢ Repayments of more than $3,000 under a claim of right. ➢ Unrecovered investment in an annuity.

Review Question 11 Which of the following can a taxpayer list as a miscellaneous deduction on Schedule A (Form 1040)?

A. Broker's commissions B. Investment-related seminars C. Amortizable premium on taxable bonds D. Lobbying expenses

See Review Feedback for answer.

Gambling Losses Up to the Amount of Gambling Winnings

Historically, gambling losses have only been deductible to the extent of gambling winnings. However, a 2011 tax court ruling in Mayo vs. Commissioner (136 TC 181) allowed taxpayers engaged in the trade or business of gambling to exclude certain non-wagering expenses (i.e., travel, meals, entry fees, etc.) from “gambling losses” and report them on Schedule C. The Tax Cuts and Jobs Act (TCJA) provides that for tax years beginning after December 31, 2017 until January 1, 2026, the limitation on wagering losses is modified to provide that all deductions for expenses incurred in carrying out wagering transactions, not just gambling losses, are limited to the extent of gambling winnings. The provision thus reverses the result reached by the Tax Court where the court held that a taxpayer’s expenses incurred in the conduct of the trade or business of gambling, other than the cost of wagers, were not limited to the extent of gambling winnings, and were thus deductible as ordinary and necessary business expenses in the case of the “professional gambler.” The taxpayer must report the full amount of gambling winnings for the year on Schedule 1 (Form 1040), line 8(b). He or she deducts gambling losses for the year on Schedule A (Form 1040), line 16. The taxpayer cannot deduct gambling losses that are more than winnings. Generally, nonresident aliens cannot deduct gambling losses on Schedule A (Form 1040-NR). The taxpayer cannot reduce gambling winnings by gambling losses and report the difference. He or she must report the full amount of winnings as income and claim losses (up to the amount of winnings) as an itemized deduction. Therefore, the taxpayer’s records should show winnings separately from losses. The taxpayer must keep an accurate diary or similar record of losses and winnings. The diary should contain at least the following information: (114)

➢ The date and type of the specific wager or wagering activity. ➢ The name and address or location of the gambling establishment. ➢ The names of other persons present with the taxpayer at the gambling establishment. ➢ The amount(s) the taxpayer won or lost.

Lesson 13 - Itemized Deductions

In addition to the diary, the taxpayer should also have other documentation. He or she can generally prove winnings and losses through Form W-2G - Certain Gambling Winnings, Form 5754 - Statement by Person(s) Receiving Gambling Winnings, wagering tickets, canceled checks, substitute checks, credit records, bank withdrawals, and statements of actual winnings or payment slips provided to the taxpayer by the gambling establishment.

Casualty and Theft Losses of Income-Producing Property

The taxpayer can deduct a casualty or theft loss as a miscellaneous itemized deduction not subject to the 2% limit if the damaged or stolen property was income-producing property (property held for investment, such as stocks, notes, bonds, gold, silver, vacant lots, and works of art). First report the loss in Section B of Form 4684 - Casualties and Thefts. The taxpayer may also have to include the loss on Form 4797 - Sales of Business Property if he or she is otherwise required to file that form. To figure the deduction, add all casualty or theft losses from this type of property included on Form 4684, lines 32 and 38b, or Form 4797, line 18a. (114)

Federal Estate Tax on Income in Respect of a Decedent

The taxpayer can deduct the Federal estate tax attributable to income in respect of a decedent that he or she as a beneficiary include in his or her gross income. Income in respect of the decedent is gross income that the decedent would have received had death not occurred and that was not properly includible in the decedent's final income tax return. (114)

Amortizable Premium on Taxable Bonds

In general, if the amount the taxpayer pays for a bond is greater than its stated principal amount, the excess is bond premium. The taxpayer can elect to amortize the premium on taxable bonds. The amortization of the premium is generally an offset to interest income on the bond rather than a separate deduction item. (114)

➢ Pre-1998 election to amortize bond premium - Generally, if the taxpayer first elected to amortize bond premium before 1998, the above treatment of the premium does not apply to bonds acquired before 1988.

➢ Bonds acquired after October 22, 1986, and before 1988 - The amortization of the premium on these bonds is investment interest expense subject to the investment interest limit, unless the taxpayer choses to treat it as an offset to interest income on the bond.

➢ Bonds acquired before October 23, 1986 - The amortization of the premium on these bonds is a miscellaneous itemized deduction not subject to the 2% limit.

On certain bonds (such as bonds that pay a variable rate of interest or that provide for an interest-free period), the amount of bond premium allocable to a period may exceed the amount of stated interest allocable to the period. If this occurs, treat the excess as a miscellaneous itemized deduction that is not subject to the 2% limit. However, the amount deductible is limited to the amount by which the total interest inclusions on the bond in prior periods exceed the total amount the taxpayer treated as a bond premium deduction on the bond in prior periods. If any of the excess bond premium cannot be deducted because of the limit, this amount is carried forward to the next period and is treated as bond premium allocable to that period. (114)

Repayments Under Claim of Right

Under the Tax Cuts and Jobs Act (TCJA), for tax years beginning after December 31, 2017 until January 1, 2026, the deduction for miscellaneous itemized deductions that are subject to the 2% floor is suspended. Therefore, no miscellaneous itemized deductions may be claimed by an individual on Schedule A of Form 1040 for tax years 2018 through 2025. Consequently, if the amount the taxpayer repaid was $3,000 or less, the taxpayer will no longer deduct it as a miscellaneous itemized deduction on Schedule A (Form 1040) as repayments of income received under a claim of right as repayments are subject to the 2% floor if less than $3,000. If the taxpayer had to repay more than $3,000 that he or she included in his or her income in an earlier year because at the time he or she thought they had an unrestricted right to it, the taxpayer may be able to deduct the amount he or she repaid or take a credit against the tax in the year that they repaid it. When a repayment occurs, the taxpayer may:

➢ Reduce his or her income in the current year. ➢ Deduct the amount repaid as a miscellaneous deduction on Schedule A, Form 1040 in the year in which it is

repaid. ➢ Take a refundable credit against tax on Form 1040 for the year that repayment occurs.

Lesson 13 - Itemized Deductions

The prior year return cannot be amended. The taxpayer can use the method (deduction or credit) that results in less tax. The taxpayer generally deducts the repayment on the same form or schedule on which he or she previously reported it as income. Whether the repayment is deemed a reduction in income, a miscellaneous itemized deduction, or a tax credit depends upon the amount of the repayment and the type of income that was included in the previous year. If the amount repaid was $3,000 or less, a Claim of Right under IRC Section 1341 does not apply.

When determining whether the amount the taxpayer repaid was more or less than $3,000, consider the total amount being repaid on the return. Each instance of repayment is not considered separately. (114)

Unrecovered Investment in Annuity

A retiree who contributed to the cost of an annuity can exclude from income a part of each payment received as a tax-free return of the retiree's investment. If the retiree dies before the entire investment is recovered tax free, any unrecovered investment can be deducted on the retiree's final income tax return. If the taxpayer receives annuity payments from a nonqualified retirement plan, he or she must use the General Rule. Under the General Rule, the taxpayer figures the taxable and tax-free parts of his or her annuity payments using life expectancy tables that the IRS issues. (114)

Impairment-Related Work Expenses

If the taxpayer has a physical or mental disability that limits him or her being employed, or substantially limits one or more of his or her major life activities, such as performing manual tasks, walking, speaking, breathing, learning, and working, the taxpayer can deduct the impairment-related work expenses. Impairment-related work expenses are ordinary and necessary business expenses for attendant care services at the taxpayer’s place of work and other expenses in connection with the taxpayer’s place of work that are necessary for him or her to be able to work. If the taxpayer is self-employed, he or she should enter his or her impairment-related work expenses on the appropriate form (Schedule C, E, or F) that he or she used to report his or her business income and expenses. (114)

Review Question 12 Albert is blind. He must use a reader to do his work. He uses the reader both during his regular working hours at his place of work and outside his regular working hours away from his place of work. The reader's services are only for his work and Albert incurs a total of $3,000 during the year in expenses for the reader. What amount of his expense for the reader can Albert deduct as impairment-related work expenses on his income tax return?

A. $0 B. $1,000 C. $2,000 D. $3,000

See Review Feedback for answer.

Total Itemized Deductions

After completing all of the sections that apply to a given taxpayer, enter the total on line 17 of Schedule A (Form 1040). This is the total of all itemized deductions. If the taxpayer elects to itemize for state tax or other purposes even though the itemized deductions are less than the standard deduction, check the box on line 18.

Review Question 13 In 2023, the total amount of itemized deductions allowed is reduced by $0.03 for each dollar of adjusted gross income (AGI) in excess of what amount for married taxpayers filing a joint return and surviving spouses?

A. $125,000 B. $287,650 C. $313,800 D. No Overall Limitation

See Review Feedback for answer.

Lesson 13 - Itemized Deductions

• Age 40 or under – $480 (Choice B).

• Age 41 to 50 – $890 (Choice C).

• Age 51 to 60 – $1,790 (Choice D).

• Age 61 to 70 – $4,770.

• Age 71 or over – $5,960. Only Choice B has the correct amount and is therefore the correct response. Topic - Qualified Long-Term Care Insurance Premiums Source - Publication 502 - Medical and Dental Expenses Question 3 - B. $2,850 The tax applies on the lesser of modified adjusted gross income (MAGI) over the threshold or net investment income, so it applies to the $75,000 of MAGI over the threshold amount of $200,000 for a single taxpayer. Hugo owes the IRS $2,850 ($75,000 X 3.8%) for the tax. Only Choice B has the correct amount and is therefore the correct response. Topic - Net Investment Income Tax (NIIT) Source - IRS.GOV - Questions and Answers on the Net Investment Income Tax

Lesson 13 - Itemized Deductions

Question 4 - D. Form 1098-C Effective since tax year 2005, a taxpayer contributing a qualified vehicle valued at over $500 to a charity must meet new more stringent substantiation requirements. The taxpayer must obtain from the charity a Form 1098-C - Contributions of Motor Vehicles, Boats, and Airplanes (Choice D) or a contemporaneous written statement that names the taxpayer, contains the taxpayer’s Social Security number and the vehicle’s identification number. This statement must be attached to the donor’s tax return. Form W-2 (Choice A) shows important information about the income the taxpayer earned from his or her employer, amount of taxes withheld from his or her paycheck, benefits provided and other information for the year. Form 1099-DIV (Choice B) is used by banks and other financial institutions to report dividends and other distributions to taxpayers and to the IRS. Form 1099-INT (Choice C) is an IRS income tax form used by taxpayers to report interest income received. Topic - Charitable Donation of Vehicles Source - IRS.GOV - Topic No. 506 - Charitable Contributions Question 5 - A. $0 Under the Tax Cuts and Jobs Act no charitable deduction would be allowed for any payment to an institution of higher education in exchange for which the payor receives the right to purchase tickets or seating at an athletic event. In this case, Matt cannot deduct any ($0) as a charitable contribution. Only Choice A has the correct amount and is therefore the correct response. Topic - Contributions From Which the Taxpayer Benefits Source - IRS.GOV - Topic No. 506 - Charitable Contributions Question 6 - D. $100,000 The Protecting Americans from Tax Hikes Act of 2015 made permanent the tax exemption of distributions from individual retirement accounts for charitable purposes. Individuals age 70½ or over can exclude up to $100,000 from gross income for donations paid directly to a qualified charity from their IRA. Only Choice D has the correct amount and is therefore the correct response. Topic - Qualified Charitable Distributions (QCD) Source - IRS.GOV - IRA FAQs - Distributions (Withdrawals) Question 7 - A. Federally declared disaster A casualty is defined as the complete or partial destruction of property from a sudden, unexpected, or unusual cause. Under the TCJA, casualty and theft losses are generally only deductible to the extent they are attributable to a “Federally declared disaster” (Choice A). There is a limited exception for taxpayers who have personal casualty gains, whereby losses not attributable to a disaster may be used to offset such gains, but not below zero. For the purposes of this provision, a “Federally declared disaster” is one that has been determined by the President to warrant Federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. Topic - Casualty and Theft Losses Source - IRS.GOV - Topic No. 515 - Casualty, Disaster, and Theft Losses Question 8 - D. $750,000 Under the Tax Cuts and Jobs Act (TCJA), mortgage interest on loans used to acquire a principal residence and/or a second home remains deductible, but only on debt up to $750,000. This represents an unfavorable decrease of $250,000 since the limitation was $1 million under prior tax law. Taxpayers with existing acquisition debt, that is, debt acquired on or before December 15, 2017, would remain subject to the $1 million limitation, as the new law is not applied retroactively. Only Choice D has the correct amount and is therefore the correct response. Topic - Deductible Home Mortgage Interest Source - IRS.GOV - Topic No. 505 - Interest Expense

Lesson 13 - Itemized Deductions

Question 9 - C. 14 days A second home can include any other residence the taxpayer owns and treats as a second home. The taxpayer does not have to use the home during the year. However, if he or she rents it to others, the taxpayer must also use it as a home during the year for more than the greater of 14 days or 10% of the number of days it is rented, for the interest to qualify as qualified residence interest. Only Choice C has the correct number of days and is therefore the correct response. Topic - Deductible Home Mortgage Interest Source - IRS.GOV - Topic No. 505 - Interest Expense Question 10 - D. All of the above Under the Tax Cuts and Jobs Act (TCJA) the provisions (which took effect beginning with the 2018 tax year) dramatically affect employees who incur unreimbursed expenses related to their job (such as home office expenses, union dues (Choice A), work-related education, job searches, legal fees (Choice B), subscriptions to trade journals (Choice C), etc.), it does not affect small business owners or self-employed persons, who would still be able to declare business expenses on IRS Form 1040, Schedule C - Profit or Loss from Business. Since Choices A, B, and C are examples of employee expenses that do not qualify as itemized deductions Choice D, All of the above, is the correct response. Topic - Miscellaneous Itemized Deductions Source - Publication 529 - Miscellaneous Deductions Question 11 - C. Amortizable premium on taxable bonds Line 16 of Schedule A (Form 1040) allows the taxpayer to list certain other deductions that are miscellaneous deductions but are not subject to the 2% AGI rule. Common deductions taken here include amortizable premium on taxable bonds (Choice C), casualty and theft losses from income-producing property, Federal estate tax on income in respect of a decedent, gambling losses up to the amount of gambling winnings, impairment-related work expenses of persons with disabilities, loss from other activities from Schedule K-1 (Form 1065-B), an ordinary loss attributable to a contingent payment debt instrument or an inflation-indexed debt instrument (for example, a Treasury Inflation-Protected Security)., repayments of more than $3,000 under a claim of right and unrecovered investment in an annuity. Only Choice C is listed among the items not subject to the 2% AGI rule and is therefore the correct response. Topic - Deductions Not Subject to the 2% Limit Source - Publication 529 - Miscellaneous Deductions Question 12 - D. $3,000 If the taxpayer has a physical or mental disability that limits him or her being employed, or substantially limits one or more of his or her major life activities, such as performing manual tasks, walking, speaking, breathing, learning, and working, the taxpayer can deduct the impairment-related work expenses. Impairment-related work expenses are ordinary and necessary business expenses for attendant care services at the taxpayer’s place of work and other expenses in connection with the taxpayer’s place of work that are necessary for him or her to be able to work. In this case, Albert can deduct the $3,000 expense for the reader as impairment-related work expenses on his income tax return. Therefore, Choice D is correct. All other choices have incorrect amounts. Topic - Impairment-Related Work Expenses Source - Publication 529 - Miscellaneous Deductions Question 13 - D. No Overall Limitation The Tax Cuts and Jobs Act repeals the phase-out of itemized deductions for high-income taxpayers. This suspension of the overall limitation on itemized deductions will apply to any taxable year beginning after December 31, 2017, and before January 1, 2026. Only Choice C has the correct amount and is therefore the correct response. Topic - Total Itemized Deductions Source - Publication 529 - Miscellaneous Deductions

Credits At the conclusion of this lesson you should have a basic knowledge of:

➢ Earned Income Tax Credit. ➢ Child and Dependent Care Credit. ➢ Child Tax Credit. ➢ Additional Child Tax Credit. ➢ Credits for Higher Education. ➢ Affordable Care Act Tax Credits. ➢ Adoption Credit. ➢ Other Tax Credits.

A tax credit reduces the amount of tax for which a taxpayer is liable. Unlike a deduction, which reduces the amount of income subject to tax, a tax credit directly reduces tax liability. This means that a $500 tax credit actually takes $500 off the taxpayer’s tax balance due. A tax deduction, on the other hand, reduces his or her taxable income and is equal to the percentage of his or her marginal tax bracket.

Nonrefundable Tax Credits

Most of the tax credits are referred to as nonrefundable credits. A nonrefundable credit is subtracted from the taxpayer’s income tax liability, up to the total amount he or she owes. But unlike a refundable tax credit, a nonrefundable credit cannot reduce his or her tax balance beyond zero. Any unused portion of a nonrefundable tax credit will expire in the year the credit is claimed and cannot be carried over. Examples of nonrefundable tax credits include:

➢ Adoption Credit. ➢ Education credits. ➢ Credit for the Elderly or Disabled. ➢ Foreign Income Tax Credit. ➢ Residential Clean Energy Credit. ➢ Credit to Holders of Tax Credit Bonds. ➢ Mortgage Interest Credit. ➢ Retirement Savings Contributions Credit (Saver's Credit).

Refundable Tax Credits

A refundable tax credit is a tax credit that can reduce tax liability below zero. It is possible to receive a tax refund from this type of credit. Refundable tax credits include:

➢ Earned Income Tax Credit (EITC). ➢ Excess Social Security Credit. ➢ Additional Child Tax Credit (Refundable up to $1,600 in 2023). ➢ Child and Dependent Care Credit. ➢ Premium Tax Credit. ➢ American Opportunity Tax Credit (up to $1,000 is refundable). ➢ Credit for Tax on Undistributed Capital Gain.

Eight Tax Benefits for Parents

Taxpayer’s children may help qualify the taxpayer for valuable tax benefits, such as certain credits and deductions. If the taxpayer is a parent, here are eight benefits he or she can use when filing taxes this year:

Lesson 14 - Credits

1. Dependents - In most cases, a taxpayer can claim a child as a dependent even if the child was born anytime in 2023. For more information, see IRS Publication 501 - Dependents, Standard Deduction and Filing Information.

2. Child Tax Credit – The taxpayer may be able to claim the Child Tax Credit for each of his or her children that were under age 17 at the end of 2023. If the taxpayer does not benefit from the full amount of the Child Tax Credit, he or she may be eligible for the Credit for Other Dependents (ODC). For more information, see the instructions for Schedule 8812 - Child Tax Credit.

3. Child and Dependent Care Credit – The taxpayer may be able to claim this credit if he or she paid someone to care for his or her child or children under age 13, so that he or she could work or look for work. See IRS Publication 503 - Child and Dependent Care Expenses.

4. Earned Income Tax Credit - If the taxpayer worked but earned less than $63,398 in 2023, he or she may qualify for EITC. If the taxpayer has qualifying children, he or she may get up to $7,430 in 2023 back when he or she files a return and claims it. See Publication 596 - Earned Income Tax Credit.

5. Adoption Credit – The taxpayer may be able to take a tax credit for certain expenses he or she incurred to adopt a child. For details about this credit, see the instructions for IRS Form 8839 - Qualified Adoption Expenses.

6. Higher education credits - If the taxpayer paid higher education costs for him or herself or another student who is an immediate family member, he or she may qualify for either the American Opportunity Tax Credit or the Lifetime Learning Credit. Both credits may reduce the amount of tax owed. See IRS Publication 970 - Tax Benefits for Education.

7. Student loan interest – The taxpayer may be able to deduct interest he or she paid on a qualified student loan, even if the taxpayer does not itemize his or her deductions. For more information, see IRS Publication 970 - Tax Benefits for Education.

8. Self-employed health insurance deduction - If the taxpayer was self-employed and paid for health insurance, he or she may be able to deduct premiums paid to cover a child. It applies to children under age 27 at the end of the year, even if the child is not the taxpayer’s dependent.

Here are five credits the IRS wants the taxpayer to consider before filing the Federal income tax return: (258)

1. The Earned Income Tax Credit (EITC) is a refundable credit for people who work and do not earn a lot of money. The maximum credit for 2023 returns is $7,430 for workers with three or more children. Eligibility is determined based on earnings, filing status and eligible children. Workers without children may be eligible for a smaller credit. If the taxpayer worked and earned less than $63,398 in 2023, use the EITC Assistant tool on IRS.gov to see if he or she qualifies. For more information, see Publication 596 - Earned Income Tax Credit.

2. The Child and Dependent Care Credit is for expenses the taxpayer paid for the care of qualifying children under age 13, or for a disabled spouse or dependent. The care must enable the taxpayer to work or look for work. For more information, see Publication 503 - Child and Dependent Care Expenses.

3. The Child Tax Credit may apply to the taxpayer if he or she has a qualifying child under age 17 in 2023. The credit may help reduce the Federal income tax by up to $2,000 for each qualifying child claimed on the return. The taxpayer may be required to file Schedule 8812 - Child Tax Credit with the tax return to claim the credit. See the Instructions for Schedule 8812 for more information.

4. The Retirement Savings Contributions Credit (Saver’s Credit) helps low-to-moderate income workers save for retirement. The taxpayer may qualify if his or her income is below a certain limit and he or she contributes to an IRA or a retirement plan at work. The credit is in addition to any other tax savings that apply to retirement plans. For more information, see Publication 590-A - Contributions to Individual Retirement Arrangements (IRAs).

5. The American Opportunity Tax Credit (AOTC) helps offset some of the costs that the taxpayer pays for higher education. The AOTC applies to the first four years of post-secondary education. The maximum credit is $2,500 per eligible student. 40% of the credit, up to $1,000, is refundable. The taxpayer must file Form 8863 - Education Credits to claim it if he or she qualifies. For more information, see Publication 970 - Tax Benefits for Education.

Review Question 1 Which of the following is a refundable tax credit?

A. Adoption Credit B. Foreign Income Tax Credit C. Retirement Savings Contributions Credit (Saver's Credit) D. Earned Income Tax Credit

See Review Feedback for answer.

Lesson 14 - Credits

Earned Income Tax Credit The Earned Income Tax Credit (EITC) is a benefit for working people with low to moderate income. To qualify, the taxpayer must meet certain requirements and file a tax return, even if he or she does not owe any tax or is not required to file. EITC reduces the amount of tax the taxpayer owes and may give him or her a refund.

Due Diligence Requirements

The due diligence requirement was originally designed to reduce errors on returns claiming the Earned Income Tax Credit (EITC). Legislation in 2015 expanded the due diligence requirements to include the Child Tax Credit (CTC), Additional Child Tax Credit (ACTC), and American Opportunity Tax Credit (AOTC). Under the Tax Cuts and Jobs Act (TCJA), the due diligence requirement now also applies to individual income tax returns claiming the head of household (HOH) filing status and Credit for Other Dependents (ODC). Form 8867 - Paid Preparer’s Due Diligence Checklist has been modified to account for these changes. In addition, Form 8867 has been streamlined. Completing the form is not a substitute for actually performing the necessary due diligence and completing all required forms and schedules when preparing the return. The IRS created Form 8867 to help preparers meet the requirement by obtaining eligibility information from their clients. Preparers have been required to keep copies of the form, or comparable documentation, which is subject to review by the IRS. To help ensure compliance with the law and that eligible taxpayers receive the right credit amount, the new regulations require preparers, effective January 1, 2012, to file the Form 8867 with each return claiming the EITC. Further details can be found in Treasury Decision 9570, published in the Federal Register. (259)

The paid tax return preparer due diligence penalty under IRC Section 6695(h) is now indexed for inflation. Therefore, the penalty for failure to meet the due diligence requirements with respect to returns and claims for refund filed in 2023 is $600 per credit per return.

To meet the due diligence requirements a paid tax return preparer must complete the four following steps:

1. Completion of Eligibility Checklist - Prepare form 8867, the paid preparer Earned Income Tax Credit Checklist. The paid tax return preparer must ask and explain to his or her clients all the questions in Part I and all the questions that apply in Part II and III. He or she must personally answer the due diligence questions in Part IV.

2. Computation of the Credit - Complete the EITC worksheet, which is available in most tax preparation software programs.

3. Knowledge - For the knowledge requirement, the paid tax return preparer must not know or have reason to know that the information used to compute the EITC is incorrect. If there is any doubt, he or she must ask his or her client additional questions. A knowledgeable tax return preparer should be able to conclude if the information given seems incorrect, inconsistent or incomplete.

4. Record Retention - The paid tax return preparer must keep the 8867, the EITC worksheet and a record of how he or she received the information used to prepare the return for three years from June 30 following the date he or she presented the return to his or her client to sign. The paid tax return preparer can keep these records in either paper or electronic format. It is a good idea to keep a back-up of these records at an off-site, secure location.

Completing the Form 8867

Form 8867 covers the HOH filing status, EITC, the AOTC, and the CTC/ACTC/ODC. A tax preparer should only complete columns corresponding to credits actually claimed on the taxpayer’s return that he or she prepared. Only paid tax return preparers should complete Form 8867. Form 8867 is divided into questions that relate to all four topics and has questions that are specifically related to HOH filing status only, EITC only, CTC/ACTC/ODC only, and the AOTC only.

Due Diligence Questions for Returns Claiming EITC

A paid tax return preparer must exercise due diligence to determine whether a taxpayer meets all of the eligibility requirements for the EITC. Although Lines 9a, 9b and 9c only ask three specific questions about EITC eligibility related to claiming a qualifying child, the tax preparer’s client must meet all of the eligibility requirements for claiming the EITC. Therefore, the tax preparer’s client cannot claim the EITC if all of the eligibility requirements for the EITC are not satisfied, even if the tax preparer answers “yes” to 9a, 9b and 9c.

Lesson 14 - Credits

Credit Eligibility Certification

The tax preparer must certify that all of the answers on Form 8867 are, to the best of his or her knowledge, true, correct and complete. Failure to meet due diligence requirements with respect to claiming the EITC, the AOTC, and the CTC/ACTC/ODC could result in a $600 penalty for each failure in 2023. For example, if a paid tax return preparer prepares a return claiming the EITC, the AOTC, and the CTC and he or she failed to meet the due diligence requirements for all of these credits, the tax preparer could be subject to a penalty of $1,800.

Document Retention

To meet the due diligence requirements for the HOH filing status, EITC, the AOTC, and the CTC/ACTC/ODC, you must keep all of the following records: (260)

1. A copy of Form 8867. 2. The applicable worksheet(s) or your own worksheet(s) for any credits claimed specified in Due Diligence

Requirements. 3. Copies of any taxpayer documents you may have relied upon to determine eligibility for and the amount of the

credit(s). 4. A record of how, when, and from whom the information used to prepare Form 8867 and worksheet(s) was

obtained. 5. A record of any additional questions you may have asked to determine eligibility for and amount of the credits,

and the taxpayer’s answers. You must keep those records for three years from the latest of the following dates: (260)

➢ The due date of the tax return (not including extensions). ➢ The date the return was filed (if you are a signing tax return preparer electronically filing the return). ➢ The date the return was presented to the taxpayer for signature (if you are a signing tax return preparer not ➢ electronically filing the return). ➢ The date you submitted to the signing tax return preparer is the part of the return for which you were responsible

(if you are a nonsigning tax return preparer). These records may be kept on paper or electronically in the manner described in Revenue Procedure 97-22 (or later update). (260)

Consequences of Filing EITC Returns Incorrectly

People who come to you, a tax return preparer, expect you to know the tax law and prepare an accurate return. Also, if you are paid and prepare EITC claims, you must meet EITC due diligence requirements. If the IRS examines your client's return and denies all or a part of EITC, your client: (261)

➢ Must pay back the amount in error with interest. ➢ May need to file the Form 8862 - Information to Claim Earned Income Tax Credit after Disallowance. ➢ May be banned from claiming EITC for the next two years if the IRS finds the error is because of reckless or

intentional disregard of the rules. ➢ May be banned from claiming EITC for the next ten years if the IRS finds the error is because of fraud.

In 2023, if the IRS examines the EITC claims you prepared and finds you did not meet all four due diligence requirements, you can get: (261)

➢ A $600 penalty for each failure to comply with EITC due diligence requirements. The penalty amounts are covered

in IRC Section 6695(g). (The IRS adjusted the penalty for taxable year returns beginning in 2015 for cost of living.) ➢ A minimum penalty of $1,000 if you prepare a client return and IRS finds any part of the amount of taxes owed is

due to an unreasonable position (For reference see IRC Section 6694(a)). ➢ A minimum penalty of $5,000 if you prepare a client return and IRS finds any part of the amount of taxes owed is

due to your reckless or intentional disregard of rules or regulations (For reference see IRC Section 6694(b)).

Lesson 14 - Credits

The IRS can also penalize an employer or employing firm if an employee fails to comply with the EITC due diligence requirements.

However, there are only specific circumstances when an employer is subject to the due diligence penalty: (262)

➢ Management participated in or, prior to the time the return was filed, knew of the failure to comply with the due diligence requirements.

➢ The firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements.

➢ The firm establishes appropriate compliance procedures but disregards those procedures through willfulness, recklessness, or gross indifference, including ignoring facts that would lead a person of reasonable prudence and competence to investigate or figure out the employee was not complying.

Form 8862 - Information to Claim Earned Income Tax Credit after Disallowance

If the taxpayer’s EITC any year after 1996 was denied or reduced for any reason other than a math or clerical error, he or she must attach a completed Form 8862 - Information to Claim Earned Income Tax Credit after Disallowance to his or her next tax return to claim the EITC. The taxpayer does not file Form 8862 if either (1) or (2) below is true:

1. After the taxpayer’s EITC was reduced or disallowed in the earlier year: a. He or she filed Form 8862 in a later year and his or her EITC for that later year was allowed, and b. His or her EITC has not been reduced or disallowed again for any reason other than a math or clerical

error. 2. The taxpayer is taking the EITC without a qualifying child for 2023 and the only reason his or her EITC was

reduced or disallowed in the earlier year was because the IRS determined that a child listed on Schedule EIC was not his or her qualifying child.

In either of these cases, the taxpayer can take the EITC without filing Form 8862 if he or she meets all the EITC eligibility requirements.

General Qualifications

Low- and moderate-income workers may be eligible for the Earned Income Tax Credit (EITC). Use Publication 596 - Earned Income Tax Credit (EITC) to determine eligibility. To qualify for the credit adjusted gross income (AGI) must be below a certain amount and the taxpayer must: (263)

➢ Have a valid Social Security Number (if the taxpayer is filing a joint return, his or her spouse also must have a valid Social Security Number).

➢ Have earned income from employment or from self-employment. ➢ Have a filing status other than married filing separately. ➢ Be a U.S. citizen or resident alien all year, or a nonresident alien married to a U.S. citizen or resident alien and

filing a joint return. ➢ Not be a qualifying child of another person (if the taxpayer is filing a joint return, his or her spouse also cannot be

a qualifying child of another person). ➢ Not have investment income over a certain amount. ➢ Not file Form 2555 - Foreign Earned Income (related to foreign earned income). ➢ Have a qualifying child who meets four tests (the Age, Relationship, Residency and Joint Return tests) OR:

o Be age 25 but under 65 at the end of the year. o Live in the United States for more than half the year. o Not qualify as a dependent of another person.

If the taxpayer qualifies, the amount of EITC will depend on filing status, whether the taxpayer has children, the number of children, and the amount of wages and income for the tax year. When EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit.

Lesson 14 - Credits

Earned Income Tax Credit (EITC) Limitations For tax year 2023, the maximum Earned Income Tax Credit (EITC) for low and moderate-income workers and working families rises to $7,430, up from $6,935 in 2022. The EITC is a refundable tax credit for certain people who work and have earned income under $63,398. The credit varies by family size, filing status and other factors, with the maximum credit going to joint filers with three or more qualifying children.

Income Qualification Item Number of Qualifying Children

None One Two Three or More

Earned Income Base Amount $7,840 $11,750 $16,510 $16,510

Maximum Amount of Credit $600 $3,995 $6,604 $7,430

Threshold Phaseout Amount (Single, Surviving Spouse, Head of Household)

$9,800 $21,560 $21,560 $21,560

Completed Phaseout Amount (Single, Surviving Spouse, Head of Household)

$17,640 $46,560 $52,918 $56,838

Threshold Phaseout Amount (Married Filing Jointly)

$16,370 $28,120 $28,120 $28,120

Completed Phaseout Amount (Married Filing Jointly)

$24,210 $53,120 $59,478 $63,398

Table 14-1 - EITC Income Limits, Maximum Credit Amounts and Tax Law Updates (2023)

Disqualified Income

The American Rescue Plan (ARP) increased the maximum amount of investment income a taxpayer can have and still get the credit to $11,000 for 2023. Disqualified income includes an individual’s capital gain net income and net passive income in addition to interest, dividends, tax-exempt interest and non-business rents or royalties. Use Publication 596 - Earned Income Tax Credit (EITC) to determine eligibility. (264)

Qualifying Child

The Earned Income Tax Credit adopts the uniform definition of a qualifying child as enacted by the Working Families Tax Relief Act of 2004. For purposes of claiming the Earned Income Tax Credit, a qualifying child is defined without regard to the support test. A qualifying child must meet a relationship, residency, and age test. Additionally, the taxpayer claiming the qualifying child must satisfy an identification requirement. The qualifying child must have one of the following relationships with the taxpayer to satisfy the relationship test: (265)

➢ A son, daughter, stepchild, or a descendant of such child. ➢ A brother or sister (including by half-blood), a stepsibling or a descendant of such individual. ➢ An adopted child. ➢ An eligible foster child that has been placed by an authorized agency.

A qualifying child does not include a child who is married unless the taxpayer is entitled to claim them as a dependent.

For the residency test, the child must have the same principal place of abode, which must be located within the United States, for more than one-half of the year. For the age test, the child must be either under the age of 19 at the end of the calendar year, or a full-time student under the age of 24 at the end of the calendar year, or permanently and totally disabled at any time during the tax year. Finally, to satisfy the identification test, the taxpayer must specify the name and age of each qualifying child as well as the taxpayer identification number of a qualifying child on their return. The rules for determining among several taxpayers who may claim a child as a qualifying child for purposes of the Earned Income Tax Credit have been simplified. In the event

Lesson 14 - Credits

that two or more taxpayers claim the same child(ren) in the same calendar year, the child(ren) will be the qualifying child(ren) for the parents first and then for a taxpayer, other than the parents, with the highest adjusted gross income (AGI). If both qualifying child’s parents seek to claim the credit, but do not file jointly, then the parent who is claiming the child as a dependent may claim the child as an eligible child for Earned Income Tax Credit determination. For more information on whether a child qualifies for the EITC, see Publication 596 - Chapter 2, Rules If You Have a Qualifying Child.

No Qualifying Child

An individual who does not have a qualifying child may be eligible for this credit if:

1. The principal residence of such individual is in the United States for more than one-half of the tax year. 2. The individual (or the spouse of the individual) is at least age 25 and under age 65 before the close of the tax

year. 3. The individual is not claimed as a dependent by another. 4. The individual is not a qualifying child of another taxpayer.

Restrictions on Claiming the Credit

The credit is denied to taxpayers who are not eligible to work in the United States. A nonresident alien (unless married to a U.S. citizen and filing a joint return) usually cannot claim an Earned Income Tax Credit.

Filing Requirements

For 2022 and beyond, the American Rescue Plan (ARP) provides that a married individual can claim the EITC on a married, filing separate or head of household return (when permitted), as long as a qualifying child lives with the individual for more than six months during the year in question and the taxpayer either:

➢ Does not have the same principal place of abode as the spouse for the last six months of the year, or ➢ Has a separation instrument (a court decree or agreement other than a divorce decree) and does not live in the

same household with the spouse as of the end of the year.

Earned Income

The credit is based on earned income, which includes all wages, salaries, tips, and other employee compensation, plus the amount of the taxpayer’s net earnings from self-employment (determined with regard to the deduction for one-half of self-employment taxes). Earned income is determined without regard to community property laws. Earned income does not include: (266)

➢ Interest and dividends. ➢ Welfare benefits. ➢ Veterans’ benefits. ➢ Pensions or annuities. ➢ Alimony and child support. ➢ Social Security benefits. ➢ Workers’ compensation. ➢ Unemployment compensation. ➢ Taxable scholarships or fellowships that are not reported on Form W-2.

How To Claim the Credit

Taxpayers should use Form 1040, Schedule EITC, to determine whether they are eligible for the credit. The IRS publishes the Earned Income Tax Credit (EITC) Table at the beginning of each year's tax season. Claim the Earned Income Tax Credit on line 27 of Form 1040.

As a reminder, paid preparers must complete Form 8867 - Paid Preparer’s Due Diligence Checklist when filing Federal income tax returns or claims for refund involving the EITC. Paid preparers must meet due diligence requirements in determining the taxpayer's eligibility for, and the amount of, the EITC. Failure to do so could result in a $600 penalty for each failure in 2023.

Lesson 14 - Credits

Review Question 2 When determining earned income, which of the following qualifies for the Earned Income Tax Credit (EITC)?

A. Wages B. Welfare benefits C. Veterans’ benefits D. Interest and Dividends

See Review Feedback for answer.

Child and Dependent Care Credit If a taxpayer paid someone to care for a child, spouse, or dependent in 2023, he or she may be able to claim the Child and Dependent Care Credit on the Federal income tax return. Below are 10 things the IRS wants taxpayers to know about claiming a credit for child and dependent care expenses: (267)

1. The care must have been provided for one or more qualifying persons. A qualifying person is the taxpayer’s dependent under the age of 13 when the care was provided. Additionally, the taxpayer’s spouse and certain other individuals who are physically or mentally incapable of self-care may also be qualifying persons. The taxpayer must identify each qualifying person on the tax return.

2. The care must have been provided so the taxpayer – and his or her spouse if married filing jointly – could work or look for work.

3. If the taxpayer and his or her spouse file jointly, they must have earned income from wages, salaries, tips, other taxable employee compensation or net earnings from self-employment. One spouse may be considered as having earned income if they were a full-time student or were physically or mentally unable to care for themselves.

4. The payments for care cannot be paid to the taxpayer’s spouse, to the parent of the qualifying person, to someone the taxpayer can claim as a dependent on the return, or to a child who will not be age 19 or older by the end of the year even if he or she is not a dependent. The taxpayer must identify the care provider(s) on the tax return.

5. The taxpayer’s filing status must be single, married filing jointly, head of household or qualifying surviving spouse with a dependent child.

6. The qualifying person must have lived with the taxpayer for more than half of 2023. There are exceptions for the birth or death of a qualifying person, or a child of divorced or separated parents.

7. In 2023, the credit can be up to 35% of qualifying expenses, depending upon adjusted gross income. 8. In 2023, the taxpayer may use up to $3,000 of expenses paid in a year for one qualifying individual or $6,000 for

two or more qualifying individuals to figure the credit. 9. The qualifying expenses must be reduced by the amount of any dependent care benefits provided by the

taxpayer’s employer that he or she deducts or excludes from income. 10. If the taxpayer pays someone to come to the home and care for the dependent or spouse, he or she may be a

household employer and may have to withhold and pay Social Security and Medicare tax and pay Federal unemployment tax. See Publication 926 - Household Employer's Tax Guide.

Even if the taxpayer cannot claim his or her child as a dependent, the dependent is treated as the taxpayer’s qualifying person if: (267)

1. The child was under age 13 or was not physically or mentally able to care for him or herself. 2. The child received over half of his or her support during the calendar year from one or both parents who are

divorced or legally separated under a decree of divorce or separate maintenance, are separated under a written separation agreement, or lived apart at all times during the last 6 months of the calendar year.

3. The child was in the custody of one or both parents for more than half the year. 4. The taxpayer was the child's custodial parent.

The custodial parent is the parent with whom the child lived for the greater number of nights in 2023. If the child was with each parent for an equal number of nights, the custodial parent is the parent with the higher adjusted gross income. The noncustodial parent cannot treat the child as a qualifying person even if that parent is entitled to claim the child as a dependent under the special rules for a child of divorced or separated parents.

Lesson 14 - Credits

In the case of a child of divorced or separated parents living apart, only the custodial parent may claim the credit. The qualifying person must reside with the taxpayer for more than half the year to qualify for the Child and Dependent Care Credit and must be unable to care for themselves for more than half of the year. In determining whether a person is a qualifying person, treat someone who was born or who died during the tax year as having lived with the taxpayer for the entire tax year only if the taxpayer's home was the person's home the entire time he or she was alive. A spouse is never a dependent of the other spouse; but can qualify for the Child and Dependent Care Credit provided the conditions are met. One requirement for a spouse that is incapable of self-care is that the spouse must have the same principal place of abode as the taxpayer for more than half of the year.

Work-Related Expenses

Child and dependent care expenses must be work-related to qualify for the credit. Expenses are considered work-related only if both of the following are true: (267)

1. They allow the taxpayer (and his or her spouse if filing jointly) to work or look for work. 2. They are for a qualifying person's care.

To be work-related, the taxpayer’s expenses must allow him or her to work or look for work. If he or she is married, generally both the taxpayer and his or her spouse must work or look for work. One spouse is treated as working during any month he or she is a full-time student or is not physically or mentally able to care for him or herself. The taxpayer’s work can be for others or in his or her own business or partnership. It can be either full time or part time. Work also includes actively looking for work. However, if the taxpayer does not find a job and has no earned income for the year, he or she cannot take this credit. Also, an expense is not considered work-related merely because the taxpayer had it while he or she was working. The purpose of the expense must be to allow the taxpayer to work. Whether the taxpayer’s expenses allow him or her to work or look for work depends on the facts. For example, Glen works during the day and his spouse works at night and sleeps during the day. He pays for care of their 5-year-old child during the hours when he is working, and his spouse is sleeping. In this case, Glen’s expenses are considered work-related. If the taxpayer works part-time, he or she generally must figure his or her expenses for each day. However, if the taxpayer has to pay for care weekly, monthly, or in another way that includes both days worked and days not worked, he or she can figure his or her credit including the expenses he or she paid for days he or she did not work. Any day when the taxpayer works at least 1 hour is a day of work. If the taxpayer works or actively looks for work during only part of the period covered by the expenses, then he or she must figure his or her expenses for each day.

Qualifying Individual

A qualifying individual for the Child and Dependent Care Credit is: (267)

➢ The taxpayer’s dependent qualifying child who is under age 13 when the care is provided. ➢ The taxpayer’s spouse who is physically or mentally incapable of self-care and lived with the taxpayer for more than

half the year. ➢ A person who is physically or mentally incapable of self-care, lived with the taxpayer for more than half the year and

either: o Is his or her dependent, or o Could have been his or her dependent except that:

▪ He or she received gross income of $4,700 or more, ▪ He or she filed a joint return, or ▪ The taxpayer, or his or her spouse if filing jointly, could be claimed as a dependent on someone else's

2023 return. An individual is physically or mentally incapable of self-care if, as a result of a physical or mental defect, the individual is incapable of caring for his or her hygiene or nutritional needs or requires the full-time attention of another person for the individual's own safety or the safety of others.

Amount of Credit

The Child and Dependent Care Credit may be worth up to $1,050 or 35% of $3,000 of eligible expenses in 2023. For two or more qualifying dependents, the taxpayer can claim up to 35% of $6,000 (or $2,100) of eligible expenses. For higher

Lesson 14 - Credits

income earners, the credit percentage is reduced, but not below 20%, regardless of the amount of adjusted gross income. A taxpayer’s child and dependent care expenses must be for the care of one or more qualifying persons.

If the taxpayer received dependent care benefits that he or she excluded or deducted from his or her income, the taxpayer must subtract that amount from the dollar limit that applies to him or her.

To determine the amount of the taxpayer’s credit, multiply his or her work-related expenses (after applying the earned income and dollar limits) by a percentage. This percentage depends on the taxpayer’s adjusted gross income (AGI) shown on Form 1040, 1040-SR, or 1040-NR, line 11. Dependent care benefits include: (267)

1. Amounts the taxpayer’s employer paid directly to either him or her or the care provider for the care of the taxpayer’s qualifying person while he or she works.

2. The fair market value of care in a daycare facility provided or sponsored by the taxpayer’s employer. 3. Pre-tax contributions the taxpayer made under a dependent care flexible spending arrangement.

Qualifying employment-related expenses are considered in determining the credit only to the extent of earned income: wages, salary, remuneration for personal services, net self-employment income, etc. For married taxpayers, expenses are limited to the earned income of the lower-earning spouse. Generally, if one spouse is not working, no credit is allowed. However, if the non-working spouse is physically or mentally incapable of caring for him or herself or is a full-time student at an educational institution for at least five calendar months during the year, the law assumes an earned income, for each month of disability or school attendance, of $250 if there is one qualifying child or dependent or of $500 if there are two or more. Taxpayers must provide each dependent’s taxpayer identification number and the identifying number of the service provider in order to claim the credit. The Child and Dependent Care Expenses are computed on Form 2441 - Child and Dependent Care Expenses.

Review Question 3 Jerry and Heather are married, both are employed, and they have three children all under the age of 9. The two youngest children are in preschool and the oldest child is in grade school. They claim their children as dependents and file a joint return. Their adjusted gross income (AGI) is $37,000. Heather earned $30,000 and Jerry earned $7,000. During the year, they paid $2,500 each for the two children to attend preschool. They also paid Jerry's mother $4,000 to watch the oldest child after school. How much of their childcare payments are eligible to calculate the Child and Dependent Care Credit on their return?

A. $4,000 B. $5,000 C. $6,000 D. $6,500

See Review Feedback for answer.

Child Tax Credit Under the Tax Cuts and Jobs Act (TCJA), the amount of the Child Tax Credit (CTC) is increased to $2,000 per qualifying child; The income levels at which the credit phases out were increased to $400,000 for married taxpayers filing jointly ($200,000 for all other taxpayers) (not indexed for inflation). A $500 nonrefundable Credit for Other Dependents (ODC) is provided for certain non-child dependents. The portion of the Child Tax Credit that is refundable after 2017 and before 2026 is still referred to as the Additional Child Tax Credit (ACTC) but is limited to $1,600 per qualifying child in 2023, and this amount is indexed for inflation, up to the $2,000 base credit amount. The earned income threshold for the refundable portion of the credit was decreased from $3,000 to $2,500.

Lesson 14 - Credits

Spouses and dependents residing outside the United States who use ITINs, a tax processing number issued by the IRS, should review the information on IRS.gov/ITIN to determine whether they need to renew an ITIN before filing a tax return next year. Here are some important facts from the IRS about the Child Tax Credit and how it may benefit a taxpayer’s family. (268)

1. Amount - With the Child Tax Credit, a taxpayer may be able to reduce his or her Federal income tax by up to $2,000 for each qualifying child under the age of 17.

2. Qualification - A qualifying child for this credit is someone who meets the qualifying criteria of six tests: age, relationship, support, dependent, citizenship, and residence.

3. Age Test - To qualify, a child must have been under age 17 – age 16 or younger – at the end of 2023. 4. Relationship Test - To claim a child for purposes of the Child Tax Credit, they must either be the taxpayer’s son,

daughter, stepchild, foster child, brother, sister, stepbrother, stepsister or a descendant of any of these individuals, which includes a grandchild, niece or nephew. An adopted child is always treated as a taxpayer’s own child. An adopted child includes a child lawfully placed with him or her for legal adoption.

5. Support Test - In order to claim a child for this credit, the child must not have provided more than half of their own support.

6. Dependent Test - The taxpayer must claim the child as a dependent on his or her Federal income tax return. 7. Citizenship Test - To meet the citizenship test, the child must be a U.S. citizen, U.S. national, or U.S. resident

alien and the taxpayer must provide a valid Social Security number (SSN) for the child by the tax return due date. 8. Residence Test - The child must have lived with the taxpayer for more than half of 2023. There are some

exceptions to the residence test, which can be found in the Instructions for Schedule 8812. To claim the Child Tax Credit, the taxpayer must file Form 1040. Each child must have a Social Security number before the due date of his or her 2023 return (including extensions) to be claimed as a qualifying child for the Child Tax Credit or Additional Child Tax Credit.

Qualifying Child

A qualifying child for purposes of the Child Tax Credit is a child who: (269)

➢ Is a son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, or a descendant of any of them (for example, a grandchild, niece, or nephew).

➢ Was under age 17 at the end of 2023. ➢ Did not provide over half of his or her own support for 2023. ➢ Lived with the taxpayer for more than half of 2023. ➢ Is claimed as a dependent on the return. ➢ Does not file a joint return for the year (or files it only as a claim for refund). ➢ Was a U.S. citizen, a U.S. national, or a U.S. resident alien.

The taxpayer’s child must have a Social Security Number issued by the Social Security Administration (SSA) before the due date of the taxpayer’s tax return (including extensions) to be claimed as a qualifying child for the Child Tax Credit or Additional Child Tax Credit. Children with an Individual Taxpayer Identification Number (ITIN) cannot be claimed for either credit.

If the taxpayer’s child’s immigration status has changed so that his or her child is now a U.S. citizen or permanent resident, but the child’s Social Security card still has the words “Not valid for employment” on it, the taxpayer should ask the SSA for a new Social Security card without those words.

If the taxpayer’s child does not have a valid SSN, his or her child may still qualify him or her for the Credit for Other Dependents (ODC). This is a non-refundable credit of up to $500 per qualifying person. If the taxpayer’s dependent child lived with him or her in the United States and has an Individual Taxpayer Identification Number (ITIN), but not an SSN, issued by the due date of his or her 2023 tax return (including extensions), he or she may be able to claim the Credit for Other Dependents for that child. Spouses and dependents residing outside the United States who use ITINs, a tax processing number issued by the IRS, should review the information on IRS.gov/ITIN to determine whether they need to renew an ITIN before filing a tax return next year.

Lesson 14 - Credits

Limitation of Child Tax Credit

The Child Tax Credit is limited if the taxpayer’s modified adjusted gross income (MAGI) is above a certain amount. The amount at which this phase-out begins varies depending on the filing status. Phase-out means that the credit is reduced as the taxpayer’s income increases. In this case, the reduction is $50 for each $1,000 by which the taxpayer’s MAGI exceeds the threshold amount.

For married taxpayers filing a joint return, the phase-out begins at $400,000. For all other taxpayers, including married taxpayers filing a separate return, the phase-out begins at $200,000. The credit is completely phased out for married taxpayers when MAGI reaches $440,000 and $240,000 for all other taxpayers.

2023 Child Tax Credit Phase-out Amounts

Full Credit Partial Credit No Credit

Single Up to $200,000 $200,001 - $240,000 Over $240,000

Married Filing Jointly Up to $400,000 $400,001 - $440,000 Over $440,000

Head of Household Up to $200,000 $200,001 - $240,000 Over $240,000

Married Filing Separately Up to $200,000 $200,001 - $240,000 Over $240,000

Table 14-2 - Tax Cuts and Jobs Act (2023)

Credit for Other Dependents (ODC)

The Tax Cuts and Jobs Act provides a $500 Credit for Other Dependents (such as elderly or disabled dependents or children over 17). This credit is to provide some relief to those families who will lose the now defunct personal exemption and are not eligible for the expanded Child Tax Credit (CTC). Both the CTC and ODC can be claimed for eligible dependents for 2023. Like the CTC, this $500 “non-child” credit is subject to income eligibility thresholds and will phase out for taxpayers with adjusted gross incomes (AGI) above $200,000 (single) and $400,000 (married).

Additional Child Tax Credit

Under the Tax Cuts and Jobs Act, the portion of the Child Tax Credit that is refundable after 2017 and before 2026 is still referred to as the Additional Child Tax Credit (ACTC) but is limited to $1,600 per qualifying child in 2023. This amount is indexed for inflation up to the $2,000 base credit amount. The earned income threshold for the refundable portion of the credit is decreased from $3,000 to $2,500. The Additional Child Tax Credit is a refundable tax credit for people who have a qualifying child and did not receive the full amount of the Child Tax Credit. The Additional Child Tax Credit is equal to the lesser of: (270)

➢ The unclaimed portion of the nonrefundable Child Tax Credit amount. ➢ 15% of the person’s earned income over $2,500. ➢ For taxpayers with three or more qualifying children, the excess of the taxpayer’s Social Security taxes for the tax

year over his or her Earned Income Tax Credit for the year. Any refund the taxpayer receives as a result of taking the Additional Child Tax Credit cannot be counted as income when determining if the taxpayer or anyone else is eligible for benefits or assistance, or how much the taxpayer or anyone else can receive, under any Federal program or under any state or local program financed in whole or in part with Federal funds. These programs include Temporary Assistance for Needy Families (TANF), Medicaid, Supplemental Security Income (SSI), and Supplemental Nutrition Assistance Program (food stamps). In addition, when determining eligibility, the refund cannot be counted as a resource for at least 12 months after the taxpayer receives it. An individual should check with his or her local benefits coordinator to find out if his or her refund will affect his or her benefits. For more information on the Additional Child Tax Credit, see Schedule 8812 - Child Tax Credit.

Lesson 14 - Credits

Credits and Deductions for Higher Education Tuition and Related Expenses

Student Loan Interest Deduction A taxpayer may be able to deduct student loan interest even if he or she does not itemize deductions on Schedule A (Form 1040). Student loan interest is interest the taxpayer paid during the year on a qualified student loan. It includes both required and voluntarily pre-paid interest payments. Interest paid during the tax year on any qualified education loan is deductible from gross income in arriving at adjusted gross income on Form 1040. The debt must be incurred by the taxpayer solely to pay qualified higher education expenses. The original loan and all refinancing of the loan are treated as one loan for this purpose. The maximum deductible amount of interest for tax year 2023 is $2,500.

For 2023, the amount of the student loan interest deduction is phased out (gradually reduced) if the taxpayer’s filing status is married filing jointly and modified adjusted gross income (MAGI) is between $155,000 and $185,000. The taxpayer cannot take the deduction if MAGI is $185,000 or more. If the taxpayer’s filing status is married filing separately, he or she does not qualify for the deduction. For all other filing statuses, the student

loan interest deduction is phased out if MAGI is between $75,000 and $90,000. The taxpayer cannot take a deduction if modified AGI is $90,000 or more. The IRS provides a Student Loan Interest Deduction worksheet. For more information, see Publication 970 -Tax Benefits for Education. For purposes of the student loan interest deduction, these expenses are the total costs of attending an eligible educational institution, including graduate school. They include amounts paid for the following items:

➢ Tuition and fees. ➢ Room and board. ➢ Books, supplies, and equipment. ➢ Other necessary expenses (such as transportation).

The cost of room and board qualifies only to the extent that it is not more than the greater of:

➢ The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

Loan Origination Fee

In general, a loan origination fee is a one-time fee charged by the lender when a loan is made. To be deductible as interest, a loan origination fee must be for the use of money rather than for property or services (such as commitment fees or processing costs) provided by the lender. A loan origination fee is treated as interest accrues over the term of the loan. Loan origination fees were not required to be reported on Form 1098-E - Student Loan Interest Statement for loans made before September 1, 2004. If loan origination fees are not included in the amount reported on the taxpayer’s Form 1098- E, he or she can use any reasonable method to allocate the loan origination fees over the term of the loan. One acceptable method allocates equal portions of the loan origination fee to each payment required under the terms of the loan. A method that results in the double deduction of the same portion of a loan origination fee would not be reasonable.

Voluntary Interest Payments

These are payments made on a qualified student loan during a period when interest payments are not required, such as when the borrower has been granted a deferment or the loan has not yet entered repayment status.

Lesson 14 - Credits

Capitalized Interest

This is unpaid interest on a student loan that is added by the lender to the outstanding principal balance of the loan. Capitalized interest is treated as interest for tax purposes and is deductible as payments of principal are made on the loan. No deduction for capitalized interest is allowed in a year in which no loan payments were made.

Discharge of Debt Income for Student Loans

Certain student loans provide that all or part of the debt incurred to attend a qualified educational institution will be canceled if the person who received the loan works for a certain period of time in certain professions for any of a broad class of employers. If the taxpayer’s student loan is canceled as the result of this type of provision, the cancellation of this debt is not included in his or her gross income. To qualify for this treatment, the loan must have been made by: (271)

1. The Federal government, a state or local government, or an instrumentality, agency, or subdivision of one of those governments, or

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: a. Under an agreement with an entity described in (1) or (2) that provided the funds to the institution to make

the loan, or b. As part of a program of the institution designed to encourage students to serve in occupations or areas with

unmet needs and under which the services provided are for or under the direction of a governmental unit or a tax-exempt Section 501(c)(3) organization.

A loan to refinance a qualified student loan also will qualify if it was made by an educational institution or a tax-exempt Section 501(a) organization under its program designed as described in (3)(b).

The American Rescue Plan (ARP) adds a temporary exception to the general rule for student loans. From 2021 to 2025, forgiven student loan debt is not subject to Federal income tax. The provision applies to student loans provided by the Federal government, state governments, and eligible educational institutions, as well as certain private education loans as defined in the Truth in Lending Act. (272)

Tuition and Fees Deduction

American Opportunity Tax Credit (AOTC)

Due Diligence Requirements

Due to changes in the tax law, the paid tax return preparer Earned Income Tax Credit (EITC) due diligence requirements have been expanded to also cover the American Opportunity Tax Credit (AOTC), the Child Tax Credit (CTC) and/or the Additional Child Tax Credit (ACTC). Form 8867 - Paid Preparer’s Due Diligence Checklist has been modified to account for these changes. In addition, Form 8867 has been streamlined. Completing the form is not a substitute for actually performing the necessary due diligence and completing all required forms and schedules when preparing the return. A paid tax return preparer must exercise due diligence to determine whether a taxpayer meets all of the eligibility requirements for the AOTC. Although line 11 of Form 8867 only asks about substantiation of qualified tuition and related expenses, the tax preparer’s client must meet all of the eligibility requirements for claiming the AOTC. Therefore, the tax preparer’s client cannot claim the AOTC if all of the eligibility requirements for the AOTC are not satisfied, even if the tax preparer answers “yes” on line 11.

Lesson 14 - Credits

The American Opportunity Tax Credit expanded and renamed the already-existing Hope Scholarship Credit. The maximum amount of the American Opportunity Tax Credit (AOTC) is $2,500 per student $2,500 of the cost of tuition, fees and course materials paid during the taxable year. Also, 40% of the credit (up to $1,000) is refundable. This means the taxpayer can get the credit even if he or she owes no tax. The credit can be claimed

for expenses for the first four years of post-secondary education. The Protecting Americans from Tax Hikes Act of 2015 made the AOTC provisions permanent. The amount of the American Opportunity Tax Credit is comprised of:

➢ 100% of the first $2,000 in qualifying education expenses, plus ➢ 25% of the next $2,000 in qualifying expenses.

Thus, the taxpayer’s maximum credit could be $2,500 based on $4,000 in qualifying expenses. Generally, 40% of the AOTC is now a refundable credit for most taxpayers, which means that the taxpayer can receive up to $1,000 even if he or she owes no taxes. The term qualified tuition and related expenses has been expanded to include expenditures for course materials. For this purpose, the term “course materials” means books, supplies, and equipment needed for a course of study whether or not the materials must be purchased from the educational institution as a condition of enrollment or attendance. For more information, see Chapter 2 of Publication 970 – Tax Benefits for Education. (226) Generally, the taxpayer can claim the American Opportunity Tax Credit if all three of the following requirements are met:

1. He or she pays qualified education expenses of higher education. 2. He or she pays the education expenses for an eligible student. 3. The eligible student is either him or herself, his or her spouse, or a dependent for whom he or she claims as a

dependent on his or her tax return.

Qualified Education Expenses

For purposes of the American Opportunity Tax Credit, qualified education expenses are tuition and certain related expenses required for enrollment or attendance at an eligible educational institution. Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. However, expenses for books, supplies, and equipment needed for a course of study are included in qualified education expenses whether or not the materials are purchased from the educational institution. Qualified education expenses do not include amounts paid for:

➢ Insurance. ➢ Medical expenses (including student health fees). ➢ Room and board. ➢ Transportation. ➢ Similar personal, living, or family expenses.

This is true even if the amount must be paid to the institution as a condition of enrollment or attendance.

Limitations for the American Opportunity Tax Credit

The taxpayer cannot claim the American Opportunity Tax Credit for 2023 if any of the following apply:

➢ His or her filing status is married filing separately. ➢ He or she is claimed as a dependent on another person's tax return, such as his or her parent's return. ➢ His or her modified adjusted gross income (MAGI) is $90,000 or more ($180,000 or more if married filing jointly). ➢ He or she (or his or her spouse) was a nonresident alien for any part of 2023 and the nonresident alien did not

elect to be treated as a resident alien for tax purposes. ➢ He or she was not issued an SSN (or an ITIN) by the due date of his or her 2023 return (including extensions).

Generally, a taxpayer whose modified adjusted gross income is $80,000 or less ($160,000 or less for joint filers) can claim the credit for the qualified expenses of an eligible student. The credit is reduced if a taxpayer’s modified adjusted gross income exceeds those amounts. A taxpayer whose modified adjusted gross income is greater than $90,000 ($180,000 for joint filers) cannot claim the credit.

Lesson 14 - Credits

Lifetime Learning Credit The Lifetime Learning Credit is a tax credit for any person who takes college classes. It provides a tax credit of 20% of tuition expenses, with a maximum of $2,000 in tax credits on the first $10,000 of college tuition expenses. The taxpayer can claim the Lifetime Learning Credit on the tax return if the taxpayer, his or her spouse, or his or her dependents are enrolled at an eligible educational institution and the taxpayer was responsible for paying college expenses. Unlike the American Opportunity Tax Credit, the student need not be in the first four years of undergraduate classes. Even if the student took only one class, he or she may take advantage of the Lifetime Learning Credit. (273)

Income Limitations on Lifetime Learning Credit

The Consolidated Appropriations Act, 2021 changes the income phaseouts for the Lifetime Learning Tax Credit (LLTC) to be the same as the income phaseouts for the American Opportunity Tax Credit (AOTC). Therefore, the amount of the taxpayer’s credit for 2023 is gradually reduced (phased out) if his or her modified adjusted gross income (MAGI) is between $80,000 and $90,000 ($160,000 and $180,000 if he or she files a joint return).

The taxpayer cannot claim a credit if his or her MAGI is $90,000 or more ($180,000 or more if he or she files a joint return). The new income phaseouts will not be adjusted for inflation. (104)

If a taxpayer is eligible to claim the Lifetime Learning Credit and the American Opportunity Tax Credit for the same student in the same year, he or she can choose to claim either credit, but not both.

Eligible Educational Institutions

All accredited colleges and universities are eligible educational institutions. Additionally, vocational schools and other post- secondary institutions are also eligible. Basically, if the institution is eligible to participate in Federal student aid programs through the U.S. Department of Education, then the taxpayer may use tuition paid to the school for claiming the Lifetime Learning Credit.

Qualifying Expenses

Qualifying expenses include amounts paid for tuition and any required fees such as registration and student body fees. Student-activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution for enrollment or attendance. Qualified education expenses do not include amounts paid for: (273)

➢ Insurance. ➢ Medical expenses (including student health fees). ➢ Room and board. ➢ Transportation ➢ Similar personal, living, or family expenses.

This is true even if the amount must be paid to the institution as a condition of enrollment or attendance. Also, qualified education expenses generally do not include expenses that relate to any course of instruction or other education that involves sports, games or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student's degree program, these expenses can qualify. The taxpayer must be responsible for paying the college tuition and fees. The taxpayer also needs to reduce qualifying expenses when figuring the tax credit by the amount of financial assistance received from grants, scholarships, or reimbursements from an employer. The taxpayer does not need to reduce qualifying expenses, however, if he or she paid for college tuition using borrowed funds, including student loans, or by using gifts from family members.

Who Can Claim the Education Credits?

If the taxpayer’s son or daughter is going to college and the taxpayer claims him or her as a dependent, then the taxpayer can claim the education credits on the tax return. If the taxpayer’s son or daughter is no longer a dependent, then he or she should claim any education credits on his or her own tax return. If the taxpayer pays the college expenses for someone who is not a dependent, he or she cannot claim the tax credit.

Lesson 14 - Credits

Coordination with Other Provisions

Taxpayers may now elect not to claim a tax credit should the taxpayer desire to take full advantage of the exclusion available for distributions from Coverdell educational saving accounts and/or qualified tuition plans. Thus, eligible educational expenses are first reduced by excludable scholarships or fellowships, veterans’ educational assistance allowance, employer-provided educational assistance that is excludable from income, and any other educational assistance other than gifts, bequests, devises, or inheritances that is excludable from gross income. Taxpayers are then permitted to elect to claim either the AOTC or the Lifetime Learning Credit for a student in any tax year. The expenses used to claim an educational credit reduce the amount of eligible expenses available to exclude distributions from educational savings accounts or qualified tuition plans. Since any excess distributions from an educational savings account or a qualified tuition plan over the eligible educational expenses is includible in gross income and subject to a 10% additional tax, waiving the claiming of an educational credit may result in a lower tax liability. However, taxpayers should be aware that the 10% additional tax for excess distributions from educational savings accounts or qualified tuition plans is waived if the excess is caused by the claiming of an educational credit. Taxpayers who receive distributions in excess of eligible expense from both an educational savings account and a qualified tuition plan in the same year must allocate the expenses between the two distributions. Finally, only after eligible expenses are reduced by an educational credit and distributions from educational savings accounts or qualified tuition plans, may the remaining expenses be used to determine the exclusion amount for Series EE United States Savings Bonds. The 10% additional tax does not apply to distributions: (274)

➢ Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary.

➢ Made because the designated beneficiary is disabled. A person is considered to be disabled if he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition. A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration.

➢ Included in income because the designated beneficiary received: o A tax-free scholarship or fellowship. o Veterans' educational assistance. o Employer-provided educational assistance. o Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational

assistance. ➢ Made on account of the attendance of the designated beneficiary at a U.S. military academy (such as the USNA

at Annapolis). This exception applies only to the extent that the amount of the distribution does not exceed the costs of advanced education (as defined in Section 2005(d)(3) of title 10 of the U.S. Code) attributable to such attendance.

➢ Included in income only because the qualified education expenses were taken into account in determining the American Opportunity or Lifetime Learning Credit.

Both the AOTC and the Lifetime Learning Credit (Education Credits) are supported by attaching Form 8863 – Education Credits, and entered on line 3 of Schedule 3 (Form 1040).

Credit Recapture

If any tax-free educational assistance for the qualified education expenses paid in 2023, or any refund of a taxpayer’s qualified education expenses paid in 2023, is received after he or she files the 2023 income tax return, the taxpayer must recapture (repay) any excess credit. The taxpayer does this by refiguring the amount of the adjusted qualified education expenses for 2023 by reducing the expenses by the amount of the refund or tax-free educational assistance. He or she then refigures the education credit(s) for 2023 and figure the amount by which the 2023 tax liability would have increased if he or she had claimed the refigured credit(s). The taxpayer should include that amount as an additional tax for the year the refund or tax-free assistance was received.

Lesson 14 - Credits

Review Question 4 A student must take at least how many classes in order to take advantage of the Lifetime Learning Credit?

A. One class B. Two classes C. Three classes D. Four classes

See Review Feedback for answer.

Affordable Care Act Tax Credits

Also, despite the repeal of the individual mandate penalty, employers and individuals must continue to comply with all other ACA provisions. The tax reform bill does not impact any other ACA provisions, including the Patient-Centered Outcomes Research Institute (PCORI) fees and the health insurance provider’s fee. In addition, the employer shared responsibility (pay or play) rules and related Section 6055 and Section 6056 reporting requirements are still in place. The taxpayer may be eligible to claim the Premium Tax Credit if he or she, his or her spouse (if filing jointly), and his or her dependents enrolled in health insurance through the Health Insurance Marketplace. Advance payments of the Premium Tax Credit may have been made to a health insurer to help pay for the insurance coverage of the taxpayer, his or her spouse (if filing jointly), or his or her dependents. If advance payments of the Premium Tax Credit were made, the taxpayer must file a 2023 income tax return and Form 8962 - Premium Tax Credit (PTC). If the taxpayer, his or her spouse (if filing jointly), or his or her dependents enrolled in health insurance through the Health Insurance Marketplace, the taxpayer should have received Form 1095-A - Health Insurance Marketplace Statement. If the taxpayer receives Form(s) 1095-A, he or she should save it. Form(s) 1095-A will help the taxpayer figure his or her Premium Tax Credit. If the taxpayer did not receive a Form 1095-A, he or she should contact the Marketplace.

Premium Tax Credit

Individuals and families may be eligible for the refundable Premium Tax Credit (PTC) to help them afford health insurance coverage purchased through an Affordable Insurance Exchange. Exchanges will operate in every state and the District of Columbia. This tax credit can help make the cost of purchasing health insurance coverage more affordable for individuals and families with low to moderate incomes. Additionally, the Premium Tax Credit is refundable so taxpayers who have little or no income tax liability can still benefit. The credit also can be paid in advance to a taxpayer’s insurance company to help cover the cost of premiums. In general, the taxpayer may be eligible for the credit if he or she meets all of the following: (275)

1. Purchases coverage through the Marketplace. 2. Has household income that falls within a certain range. 3. Is not able to get affordable coverage through an eligible employer plan that provides minimum value. 4. Is not eligible for coverage through a government program, like Medicaid, Medicare, CHIP or TRICARE. 5. Files a joint return, if married. 6. Cannot be claimed as a dependent by another person.

The Inflation Reduction Act expands the availability of the Premium Tax Credit (PTC) to eligible individuals whose income is above 400% of the Federal Poverty Level (FPL) through the end of 2025. Previously, the PTC was only available to individuals whose annual income is between 100% and 400% of the FPL .

The Act does not change the sliding scale nature of the PTC. But, through the end of 2025, it reduces the premium percentage at all income levels (above 100% FPL). Those with incomes from 100% to 150% FPL are eligible for no-

Lesson 14 - Credits

premium coverage (i.e., he or she contributes no income towards premiums for a silver benchmark plan). The premium contribution increases as income increases but is ultimately capped at no more than 8.5% of income for those with higher incomes (including those with income above 400% FPL). Unlike the current ACA, these levels are not indexed to increase annually, meaning the percentages (e.g., 0% to 8.5%) will remain the same through the end of 2025.

There is no upper income limit on the PTC, meaning that all middle- and upper-income taxpayers who purchase their own coverage can access the PTC if their premiums exceed 8.5% of their overall household income. For purposes of the Premium Tax Credit, the taxpayer’s household income is his or her modified adjusted gross income plus that of every other individual in his or her family for whom he or she can properly claim a as a dependent and who is required to file a Federal income tax return. Modified adjusted gross income is the adjusted gross income on the taxpayer’s Federal income tax return plus any excluded foreign income,

nontaxable Social Security benefits (including tier 1 railroad retirement benefits), and tax-exempt interest received or accrued during the taxable year. It does not include Supplemental Security Income (SSI). If the taxpayer is eligible for the credit, he or she can choose to either:

➢ Claim It Now - have all or some of the credit paid in advance directly to his or her insurance company to lower what he or she pays out-of-pocket for his or her monthly premiums during 2023. Then when the taxpayer files his or her tax return, he or she will subtract the total advance credit payments he or she received during the year from the amount of the Premium Tax Credit calculated on his or her tax return. If the Premium Tax Credit computed on the return is more than the advance payments made on the taxpayer’s behalf during the year, the difference will increase his or her refund or lower the amount of tax he or she owes. If the advance credit payments are more than the Premium Tax Credit, the difference will increase the amount the taxpayer owes and result in either a smaller refund or a balance due.

➢ Claim It Later - wait to claim the full amount of the Premium Tax Credit when he or she files his or her 2023 tax return in 2024. This will either increase the taxpayer’s refund or lower his or her balance due.

Whether the taxpayer chooses to claim the Premium Tax Credit now at the Marketplace or claim it later, he or she must file a Federal income tax return. To claim the credit, the taxpayer must get insurance through the Marketplace. During enrollment through the Marketplace, using information the taxpayer provides about his or her projected income and family composition for 2023, the Marketplace will estimate the amount of the Premium Tax Credit he or she will be able to claim for the 2023 tax year that he or she will file in 2024. The taxpayer will then decide whether he or she wants to have all, some or none of the estimated credit paid in advance directly to his or her insurance company.

The taxpayer should report income and family size changes to the Marketplace throughout the year. Reporting changes, increases or decreases, will help the taxpayer get the proper type and amount of financial assistance and will help him or her avoid getting too much or too little in advance. For example, if the taxpayer does not report income or family size changes to the Marketplace when they happen in 2023, the advance payments

may not match his or her actual qualified credit amount on his or her Federal tax return that he or she will file in 2024. This might result in a smaller refund or balance due. If the taxpayer or a family member enrolled in health insurance through the Marketplace and advance payments of the Premium Tax Credit were made to his or her insurance company to reduce his or her monthly premium payment, the taxpayer must attach Form 8962 - Premium Tax Credit (PTC) to his or her income tax return to reconcile (compare) the advance payments with his or her Premium Tax Credit for the year. The Marketplace is required to send Form 1095-A by January 31, 2024, listing the advance payments and other information the taxpayer needs to complete Form 8962. The taxpayer will need Form 1095-A from the Marketplace in order to complete Form 8962 and to claim the credit and to reconcile his or her advance credit payments. The taxpayer should include Form 8962 with his or her 1040 or 1040-NR. (Do not include Form 1095-A). If the taxpayer chooses to claim the Premium Tax Credit now, when he or she files his or her 2023 tax return in 2024, he or she will subtract the total advance payments he or she received during the year from the amount of the Premium Tax Credit calculated on his or her tax return. If the Premium Tax Credit computed on the return is more than the advance credit paid on the taxpayer’s behalf during the year, the difference will increase his or her refund or lower the amount of tax he or she owes. If the advance credit payments are more than the Premium Tax Credit, the difference will increase the amount the taxpayer owes and result in either a smaller refund or a balance due.

Lesson 14 - Credits

If the taxpayer chooses to claim the Premium Tax Credit later, he or she will claim the full amount of the Premium Tax Credit when he or she files his or her 2023 tax return in 2024. This will either increase his or her refund or lower his or her balance due. The taxpayer should use Form 8962 - Premium Tax Credit (PTC) to figure the amount of his or her Premium Tax Credit and to reconcile any advance payments of the Premium Tax Credit. (276)

Health Coverage Tax Credit (HCTC)

The Health Coverage Tax Credit (HCTC) was extended one year as part of the Consolidated Appropriations Act, 2021 and expired on December 31, 2021.

Small Business Health Care Tax Credit

The Small Business Health Care Tax Credit helps small businesses and small tax-exempt organizations afford the cost of covering their employees and is specifically targeted for those with low- and moderate-income workers. The credit is designed to encourage small employers to provide health insurance coverage for the first time or maintain coverage they already have. In general, the credit is available to small employers that pay at least half the cost of single coverage for their employees. In 2023, the Small Business Health Care Tax Credit benefits employers that: (277)

➢ Have fewer than 25 full-time equivalent employees. ➢ Pay average annual wages of less than $62,000 a year. ➢ Pay at least half of employee health insurance premiums.

To be eligible for this credit, the taxpayer must have purchased coverage through the Small Business Health Options Program, also known as the SHOP marketplace. For tax years beginning in 2014 or later, there are changes to the credit: (277)

➢ The maximum credit increases to 50% of premiums paid for small business employers and 35% of premiums paid for small tax-exempt employers.

➢ To be eligible for the credit, a small employer must pay premiums on behalf of employees enrolled in a qualified health plan offered through a Small Business Health Options Program (SHOP) Marketplace or qualify for an exception to this requirement.

➢ The credit is available to eligible employers for two consecutive taxable years. Even if the taxpayer is a small business employer who did not owe tax during the year, he or she can carry the credit back or forward to other tax years. Also, since the amount of the health insurance premium payments is more than the total credit, eligible small businesses can still claim a business expense deduction for the premiums in excess of the credit. The credit is refundable, so even if the taxpayer has no taxable income, he or she may be eligible to receive the credit as a refund so long as it does not exceed his or her income tax withholding and Medicare tax liability. Refund payments issued to small tax-exempt employers claiming the refundable portion of credit are subject to sequestration. The taxpayer must use Form 8941 - Credit for Small Employer Health Insurance Premiums to calculate the credit. Under the Small Business Health Care Tax Credit, if the taxpayer had more than 10 full-time equivalent employees (FTE) and average annual wages of more than $30,700, the FTE and average annual wage limitations will separately reduce the taxpayer’s credit. This may reduce the taxpayer’s credit to zero even if they had fewer than 25 FTEs and average annual wages of less than $62,000 in 2023.

Adoption Credit The maximum credit and the exclusion for employer-provided benefits are both $15,950 per eligible child in 2023. This amount begins to phase out if the taxpayer has modified adjusted gross income (MAGI) in excess of $239,230 and is completely phased out for modified adjusted gross income (MAGI) of $279,230 or more. Qualified adoption expenses are reasonable and necessary expenses directly related to, and whose principal purpose is for, the legal adoption of an eligible child. These expenses include:

➢ Adoption fees. ➢ Court costs. ➢ Attorney fees.

Lesson 14 - Credits

➢ Travel expenses (including meals and lodging) while away from home. ➢ Re-adoption expenses to adopt a foreign child.

Qualified adoption expenses do not include expenses:

➢ For which the taxpayer received funds under any state, local, or Federal program. ➢ That violate state or Federal law. ➢ For carrying out a surrogate parenting arrangement. ➢ For the adoption of the taxpayer’s spouse's child. ➢ Reimbursed by the taxpayer’s employer or otherwise. ➢ Allowed as a credit or deduction under any other provision of Federal income tax law.

An eligible child is an individual who has not attained the age of 18 at the time of the adoption or who is physically or mentally incapable of caring for him or herself. Generally, the credit and exclusion are allowable whether the adoption is domestic or foreign. A domestic adoption is the adoption of a U.S. child (an eligible child who is a citizen or resident of the U.S. or its possessions before the adoption effort began). A foreign adoption is the adoption of an eligible child who was not a citizen or resident of the U.S. or its possessions before the adoption effort began. The tax years for which the taxpayer can claim the credit depend on when the expenses are paid, whether the adoption is domestic or foreign, and whether the adoption has been finalized. In domestic adoptions, qualified adoption expenses paid before the year the adoption becomes final are allowable for the tax year following the year of payment (and the credit is allowable even if the adoption is never finalized). For a foreign adoption, however, the credit and exclusion are allowable only if the adoption is finalized. Qualified adoption expenses paid before and during the year of finality of a foreign adoption are allowable for the year of finality. Once an adoption becomes final, expenses paid during or after the year of finality are allowable for the year of payment, whether the adoption is foreign or domestic. (278)

Special Needs Child

In the case of an adoption of a U.S. child that a state has determined has special needs, the taxpayer may be eligible for the maximum amount of credit or exclusion for the year of finality, even if he or she paid no qualified adoption expenses. A child is considered special needs for purposes of the adoption credit if all of the following conditions are met: (278)

1. The child was a U.S. citizen or resident when the adoption effort began. 2. A state determines that the child cannot or should not be returned to his or her parent's home. 3. A state determines that the child probably will not be adopted unless assistance is provided to the adoptive family.

The adoption credit’s definition of children with special needs is narrower than the definitions of special needs for other purposes. For purposes of the adoption credit, foreign children are not considered special needs. Additionally, many U.S. children who have disabilities are not considered special needs for the purposes of the adoption credit. Generally, special needs adoptions are the adoptions of children whom the state's child welfare agency considers difficult to place for adoption, and most foster care adoptions are special needs adoptions, but few other adoptions are special needs adoptions.

The taxpayer should use Form 8839 - Qualified Adoption Expenses to figure his or her Adoption Credit and any employer-provided adoption benefits he or she can exclude from his or her income on Form 1040, 1040-SR, or 1040-NR. (279)

Review Question 5 Which of the following expenses are qualified adoption expenses?

A. Necessary adoption fees B. Court costs C. Attorney fees D. All of the above

See Review Feedback for answer.

Lesson 14 - Credits

Credit for the Elderly or the Permanently and Totally Disabled The Elderly and Disabled Tax Credit is a nonrefundable credit for low-income taxpayers over age 65 or those who are retired on permanent and total disability and received taxable disability income during the tax year. To qualify for the elderly and disabled tax credit, individual taxpayers must have income less than $17,500 ($25,000 for married filing jointly) and nontaxable income (nontaxable Social Security, pension, annuities, or disability income) of less than $5,000 ($7,500 for married filing jointly). The tax credit can be as high as $500. The tax credit for the elderly or the permanently and totally disabled applies to citizens or residents who are a U.S. citizen or resident alien, and either of the following applies: (280)

➢ The taxpayer was age 65 or older at the end of 2023, or ➢ The taxpayer was under age 65 at the end of 2023 and he or she meets all of the following:

1. He or she was permanently and totally disabled on the date he or she retired. 2. He or she received taxable disability income for 2023. 3. On January 1, 2023, he or she had not reached mandatory retirement age (the age when his or her

employer's retirement program would have required him or her to retire). Married taxpayers must file a joint return to claim the credit unless the spouses live apart throughout the tax year. The credit is computed on Schedule R - Credit for the Elderly or the Disabled Form 1040. The credit for the elderly or the disabled is entered on line 6d of Schedule 3 (Form 1040). The 2023 initial credits amounts are shown below. For individuals age 65 or older, the initial amount of allowable credit varies with filing status, as follows:

2023 Initial Credit Amounts

IF the taxpayer’s filing status is… THEN enter on line 10 of

Schedule R…

Single, Head of Household, or Surviving Spouse and by the end of 2023

the taxpayer was:

• 65 or older $5,000

• under 65 and retired on permanent and total disability1 $5,000

Married filing a joint return and by the end of 2023:

• both of taxpayers were 65 or older $7,500

• both of the taxpayers were under 65 and one of them retired on permanent and total disability1

$5,000

• both of the taxpayers were under 65 and both of them retired on permanent and total disability2

$7,500

• one of the taxpayers was 65 or older, and the other was under 65 and retired on permanent and total disability3

$7,500

• one of the taxpayers was 65 or older, and the other was under 65 and not retired on permanent and total disability

$5,000

Married filing a separate return and the taxpayer did not live with his or her spouse at any time during the year and, by the end of 2023, he or she was:

• 65 or older $3,750

• under 65 and retired on permanent and total disability1 $3,750 1 Amount cannot be more than the taxable disability income. 2 Amount cannot be more than the taxpayer’s combined taxable disability income. 3 Amount is $5,000 plus the taxable disability income of the spouse under age 65, but not more than $7,500.

Table 14-3 - Publication 524 – Table 2 – Initial Amount (2023)

This initial amount is then reduced by amounts received as pension, annuity or disability benefits that are excludable from gross income and are payable under the Social Security Act, the Railroad Retirement Act of 1974, or a Veterans Administration program. No reduction is made for pension, annuity or disability benefits for personal injuries or sickness. The maximum amount determined above is further reduced by one-half of the excess of the adjusted gross income over the following levels, based on filing status. The 2023 adjusted gross income (AGI) limits are shown below.

Lesson 14 - Credits

2023 Adjusted Gross Income (AGI) Limits

If the taxpayer’s filing status is… THEN, even if he or she qualifies, he or she cannot take the credit if...

His or her adjusted gross income (AGI)* is equal to or more than…

OR the total of his or her nontaxable social security and other nontaxable pension(s), annuities, or disability income is equal to or more than...

Single, head of household, or qualifying surviving spouse

$17,500 $5,000

Individuals, joint return one spouse is a qualified individual

$20,000 $5,000

Married Individuals, joint return, both spouses are qualified individuals

$25,000 $7,500

Married filing separately and the taxpayer lived apart from his or her spouse for all of 2023

$12,500 $3,750

* AGI is the amount on Form 1040.

Table 14-4 - Publication 524 – Table 1 – Income Limits (2023)

For permanently and totally disabled individuals under age 65, the applicable initial amount noted may not exceed the amount of disability income. A person is permanently and totally disabled if he or she cannot engage in any substantial gainful activity because of a physical or mental condition and a physician determines that the disability has lasted or can be expected to last continuously for at least a year or can lead to death. Substantial gainful activity

is the performance of significant duties over a reasonable period of time while working for pay or profit, or in work generally done for pay or profit. Full-time work (or part-time work done at the employer's convenience) in a competitive work situation for at least the minimum wage conclusively shows that the taxpayer is able to engage in substantial gainful activity. Substantial gainful activity is not work a taxpayer does to take care of him or herself or his or her home. It is not unpaid work on hobbies, institutional therapy or training, school attendance, clubs, social programs, and similar activities. However, doing this kind of work may show that the taxpayer is able to engage in substantial gainful activity. The fact that the taxpayer has not worked for some time is not, of itself, conclusive evidence that he or she cannot engage in substantial gainful activity.

Retirement Savings Contribution Credit (Saver’s Credit) For 2023, taxpayers with a low to moderate income may be able to claim a nonrefundable Saver’s Credit if he or she, or his or her spouse if filing jointly, made: (281)

➢ Contributions (other than rollover contributions) to a traditional or Roth IRA. ➢ Elective deferrals to a 401(k), 403(b), governmental 457, SEP, or SIMPLE plan. ➢ Voluntary employee contributions to a qualified retirement plan as defined in Section 4974(c) (including the

Federal Thrift Savings Plan). ➢ Contributions to a Section 501(c)(18)(D) plan.

A taxpayer can claim the credit for 50%, 20% or 10% of the first $2,000 ($4,000 if married filing jointly) contributed during the year to a retirement account. Therefore, the maximum credit amounts that can be claimed are $1,000, $400 or $200 per person. The maximum credit a married couple filing jointly can claim together is $2,000. The applicable percentage is determined by the taxpayer’s filing status and adjusted gross income (AGI). The credit may be used against the taxpayer’s regular and alternative minimum tax liability.

For 2023, the maximum applicable percentage is 50%, which is completely phased out when AGI exceeds $73,000 for joint filers, $54,750 for head of household filers, and $36,500 for single and married filing separately filers. The applicable percentage is the percentage as determined in accordance with the following table: (282)

Lesson 14 - Credits

2023 Saver’s Credit AGI Thresholds

Joint Return Head of Household Single or Married, Filing Separately

Credit Rate

Over Not Over Over Not Over Over Not Over

$0 $43,500 $0 $32,625 $0 $21,750 50%

$43,500 $47,500 $32,625 $35,625 $21,750 $23,750 20%

$47,500 $73,000 $35,625 $54,750 $23,750 $36,500 10%

$73,000 ----- $54,750 ------ $36,500 ---- 0%

Table 14-5 - Retirement Savings Contributions Credit (Saver’s Credit) (2023)

To be eligible for the credit, the individual making the contribution to a qualified retirement savings plan must be at least 18 years of age as of the close of the tax year, must not be claimed as a dependent on someone else’s tax return, and must not be a full-time student. A person enrolled as a full-time student during any part of 5 calendar months during the year is considered a student. The Saver’s Credit can be taken for the taxpayer’s contributions to a traditional or Roth IRA; his or her 401(k), SIMPLE IRA, SARSEP, 403(b), 501(c)(18) or governmental 457(b) plan; and his or her voluntary after-tax employee contributions to his or her qualified retirement and 403(b) plans. Rollover contributions (money that the taxpayer moved from another retirement plan or IRA) are not eligible for the Saver’s Credit. Also, the taxpayer’s eligible contributions may be reduced by any recent distributions he or she received from a retirement plan or IRA. Form 8880 – Credit for Qualified Retirement Savings Contributions is used to figure the dollar amount of this credit, which is claimed on line 4 of Schedule 3 (Form 1040).

Review Question 6 What type of contribution is excluded from the Credit for Qualified Retirement Savings Contributions?

A. Rollover contribution B. Traditional IRA contribution C. Roth IRA contribution D. 401(k) contribution

See Review Feedback for answer.

Other Tax Credits

Foreign Tax Credit (FTC)

The Foreign Tax Credit is intended to relieve the taxpayer of a double tax burden when his or her foreign source income is taxed by both the United States and the foreign country. In most cases, if the foreign tax rate is higher than the U.S. rate, there will be no U.S. tax on the foreign income. If the foreign tax rate is lower than the U.S. rate, U.S. tax on the foreign income will be limited to the difference between the rates. The foreign tax credit can only reduce U.S. taxes on foreign source income; it cannot reduce U.S. taxes on U.S. source income. Although no one rule covers all situations, in most cases it is better to take a credit for qualified foreign taxes than to deduct them as an itemized deduction. This is because:

1. A credit reduces the taxpayer’s actual U.S. income tax on a dollar-for-dollar basis, while a deduction reduces only his or her income subject to tax.

2. The taxpayer can choose to take the foreign tax credit even if he or she does not itemize his or her deductions. The taxpayer then is allowed the standard deduction in addition to the credit.

3. If the taxpayer chooses to take the Foreign Tax Credit, and the taxes paid or accrued exceed the credit limit for the tax year, he or she may be able to carry over or carry back the excess to another tax year.

A taxpayer may either deduct foreign income taxes paid or accrued as an itemized deduction on Schedule A of Form 1040 or may apply them as a credit against his or her U.S. income tax liability. The Foreign Tax Credit (FTC) is claimed on Form 1116 – Foreign Tax Credit unless the total foreign taxes paid are less than $300 for single filers ($600 for married filing jointly). The credit may be claimed directly on Form 1040 if all filing requirements are satisfied. (283)

Lesson 14 - Credits

Generally, the following four tests must be met for any foreign tax to qualify for the credit: (284)

➢ The tax must be imposed on the taxpayer. ➢ The taxpayer must have paid or accrued the tax. ➢ The tax must be the legal and actual foreign tax liability. ➢ The tax must be an income tax (or a tax in lieu of an income tax).

The taxpayer can claim a foreign tax credit only for foreign taxes on income, war profits, excess profits or certain other taxes. In addition, there is a limit on the amount of the credit that the taxpayer can claim. The taxpayer figures this limit and the credit on Form 1116 - Foreign Tax Credit. The credit is the amount of foreign tax he or she paid or accrued or, if smaller, the limit. The limitation is the proportion of the taxpayer’s tentative U.S. income tax (before the Foreign Tax Credit) that taxpayer’s foreign source taxable income bears to his or her worldwide taxable income for the year. The maximum amount of tax that may be credited is computed using the following formula:

FTC = U.S. income tax X Foreign source taxable income Worldwide taxable income

The limit must be applied separately to nonbusiness interest income and all other income. Also, the amount used for taxable income in the numerator and the denominator is regular taxable income with adjustments.

If the taxpayer has foreign taxes available for credit but cannot use them because of the limit, he or she may be able to carry them back 1 tax year and forward to the next 10 tax years.

The taxpayer will not be subject to the above limit and will be able to claim the credit without using Form 1116 if the following requirements are met:

➢ Only foreign source gross income for the tax year is passive category income. For purposes of this rule, high taxed income and export financing interest are also passive category income.

➢ Qualified foreign taxes for the tax year are not more than $300 ($600 if married filing a joint return). ➢ All of gross foreign income and the foreign taxes are reported to the taxpayer on a payee statement (such as a

Form 1099-DIV or 1099-INT). ➢ The taxpayer elects the exemption from foreign tax credit limit for the tax year.

If the taxpayer makes this election, he or she cannot carry back or carry over any unused foreign tax to or from the current tax year.

Mortgage Interest Credit

The taxpayer can claim the Mortgage Interest Credit only if he or she was issued a qualified Mortgage Credit Certificate (MCC) by a state or local governmental unit or agency under a qualified mortgage credit certificate program. The home to which the certificate relates must be the taxpayer’s main home and also must be located in the jurisdiction of the governmental unit that issued the certificate. If the interest on the mortgage was paid to a related person, the taxpayer cannot claim the credit. Also, if two or more persons (other than a married couple filing a joint return) hold an interest in the home to which the MCC relates, the credit must be divided based on the interest held by each person. The taxpayer may have an unused credit to carry forward to the next 3 tax years or until used, whichever comes first. The current year credit is used first and then the prior year credits, beginning with the earliest prior year. If the taxpayer is subject to the $2,000 credit limit because the certificate credit rate is more than 20%, no amount over the $2,000 limit (or his or her prorated share of the $2,000 if he or she must allocate the credit) may be carried forward for use in a later year. For more information, see Form 8396 - Mortgage Interest Credit.

Credit for Excess Social Security Tax or Railroad Retirement Tax Withheld

Most employers must withhold Social Security tax from a taxpayer’s wages. If he or she works for a railroad employer, that employer must withhold tier 1 railroad retirement (RRTA) tax and tier 2 RRTA tax. If a taxpayer worked for more than one employer during 2023 and had more than $9,932.40 in Social Security and Tier 1 RRTA tax withheld, he or she should claim the excess on the appropriate line of Form 1040 or Form 1040-NR. If an employee had total wages and

Lesson 14 - Credits

compensation over the wage base limit in Tier 2 RRTA tax withheld from more than one employer, the employee should claim a refund on Form 843 - Claim for Refund and Request for Abatement. If the taxpayer overpaid the tax, he or she may claim a credit for the overpayment on line 11 of Schedule 3 (Form 1040). The IRS will issue a full reimbursement of the overpayment, as long as the taxpayer does not owe any income tax. If the taxpayer does owe current year or previous year taxes, the IRS applies the overpayment to that amount first, then issues any balance to the taxpayer. If only one employer withheld too much Social Security or RRTA tax, the taxpayer cannot claim the excess as a credit against his or her income tax. The taxpayer’s employer should make an adjustment of the excess. If the employer does not make an adjustment, the taxpayer can use Form 843 - Claim for Refund and Request for Abatement, to claim a refund.

Review Question 7 The taxpayer cannot claim the excess as a credit against his or her income tax if how many employer(s) withheld too much Social Security or RRTA tax?

A. One B. Two C. Three D. Four

See Review Feedback for answer.

New Clean Vehicle Credit

The taxpayer may qualify for a credit up to $7,500 under Internal Revenue Code Section 30D if he or she buys a new, qualified plug-in EV or fuel cell electric vehicle (FCV). The Inflation Reduction Act of 2022 changed the rules for this credit for vehicles purchased from 2023 to 2032.

In 2024, consumers who buy or lease a new or used electric or plug-in vehicle will be able to receive an electric vehicle tax credit at the time of purchase. The near-instant credits of $7,500 for an eligible new vehicle and $4,000 for a qualifying used vehicle will be available to those who meet the credit’s income parameters. Those

who receive the credit despite being over the income limit would need to repay the amount when filing their taxes. For new vehicles, the adjusted gross income limit is $300,000 for married couples and $150,000 for individuals. The credit is available to individuals and their businesses. To qualify, the taxpayer must:

➢ Buy it for his or her own use, not for resales ➢ Use it primarily in the U.S.

In addition, the taxpayer’s modified adjusted gross income (AGI) may not exceed:

➢ $300,000 for married couples filing jointly. ➢ $225,000 for heads of households. ➢ $150,000 for all other filers.

The taxpayer can use his or her modified AGI from the year he or she takes delivery of the vehicle or the year before, whichever is less. If the taxpayer’s modified AGI is below the threshold in 1 of the two years, he or she can claim the credit. However, the credit is nonrefundable, so the taxpayer cannot get back more on the credit than he or she owes in taxes. Also, the taxpayer cannot apply any excess credit to future tax years. The amount of the credit depends on when the taxpayer placed the vehicle in service (took delivery), regardless of purchase date. (285) For vehicles placed in service January 1 to April 17, 2023:

➢ $2,500 base amount. ➢ Plus $417 for a vehicle with at least 7 kilowatt hours of battery capacity. ➢ Plus $417 for each kilowatt hour of battery capacity beyond 5 kilowatt hours. ➢ Up to $7,500 total.

Lesson 14 - Credits

In general, the minimum credit will be $3,751 ($2,500 + 3 times $417), the credit amount for a vehicle with the minimum 7 kilowatt hours of battery capacity. For vehicles placed in service April 18, 2023 and after: Vehicles will have to meet all of the same criteria listed above, plus meet new critical mineral and battery component requirements for a credit up to:

➢ $3,750 if the vehicle meets the critical minerals requirement only. ➢ $3,750 if the vehicle meets the battery components requirement only. ➢ $7,500 if the vehicle meets both.

A vehicle that does not meet either requirement will not be eligible for a credit. To qualify, a vehicle must:

➢ Have a battery capacity of at least 7 kilowatt hours. ➢ Have a gross vehicle weight rating of less than 14,000 pounds. ➢ Be made by a qualified manufacturer.

o FCVs do not need to be made by a qualified manufacturer to be eligible. ➢ Undergo final assembly in North America. ➢ Meet critical mineral and battery component requirements (as of April 18, 2023).

The sale qualifies only if:

➢ The taxpayer buys the vehicle new. ➢ The seller reports required information to him or her at the time of sale and to the IRS.

o Sellers are required to report the taxpayer’s name and taxpayer identification number to the IRS for him or her to be eligible to claim the credit.

In addition, the vehicle's manufacturer suggested retail price (MSRP) cannot exceed:

➢ $80,000 for vans, sport utility vehicles and pickup trucks. ➢ $55,000 for other vehicles.

MSRP is the retail price of the automobile suggested by the manufacturer, including manufacturer installed options, accessories and trim but excluding destination fees. It is not necessarily the price the taxpayer pays. The taxpayer can find the vehicle's weight, battery capacity, final assembly location (listed as “final assembly point”) and VIN on the vehicle's window sticker. To claim the credit, the taxpayer should file Form 8936 - Qualified Plug-in Electric Drive Motor Vehicle Credit (Including Qualified Two-Wheeled Plug-in Electric Vehicles and New Clean Vehicles) with his or her tax return. The taxpayer will need to include the vehicle identification number (VIN) on the form. (286)

Used Clean Vehicle Credit

As of January 1, 2023, if the taxpayer buys a qualified used electric vehicle (EV) or fuel cell vehicle (FCV) from a licensed dealer for $25,000 or less, he or she may be eligible for a used clean vehicle tax credit (also referred to as a previously owned clean vehicle credit). The credit equals 30% of the sale price up to a maximum credit of $4,000. The credit is nonrefundable, so the taxpayer cannot get back more on the credit than he or she owes in taxes. Also, the taxpayer cannot apply any excess credit to future tax years. Purchases made before 2023 do not qualify. To qualify, the taxpayer must:

➢ Be an individual who bought the vehicle for use and not for resale. ➢ Not be the original owner. ➢ Not be claimed as a dependent on another person’s tax return. ➢ Not have claimed another used clean vehicle credit in the 3 years before the purchase date.

Lesson 14 - Credits

In addition, the taxpayer’s modified adjusted gross income (AGI) may not exceed:

➢ $150,000 for married filing jointly or a surviving spouse. ➢ $112,500 for heads of households. ➢ $75,000 for all other filers.

The taxpayer can use his or her modified AGI from the year he or she takes delivery of the vehicle or the year before, whichever is less. If the taxpayer’s income is below the threshold for 1 of the two years, he or she can claim the credit. To qualify, a vehicle must meet all of these requirements:

➢ Have a sale price of $25,000 or less. ➢ Have a model year at least 2 years earlier than the calendar year when he or she buys it. For example, a vehicle

purchased in 2023 would need a model year of 2021 or older. ➢ Not have already been transferred after August 16, 2022, to a qualified buyer. ➢ Have a gross vehicle weight rating of less than 14,000 pounds. ➢ Be an eligible FCV or plug-in EV with a battery capacity of least 7 kilowatt hours. ➢ Be for use primarily in the United States.

The taxpayer should complete Form 8936 - Qualified Plug-in Electric Drive Motor Vehicle Credit (Including Qualified Two- Wheeled Plug-in Electric Vehicles and New Clean Vehicles) and file it with his or her tax return for the year he or she took possession of the vehicle to claim the used clean vehicle credit. The taxpayer will need to include the vehicle identification number (VIN) on the form. (287)

Commercial Clean Vehicle Credit

Businesses and tax-exempt organizations that buy a qualified commercial clean vehicle may qualify for a clean vehicle tax credit of up to $40,000 under Internal Revenue Code (IRC) 45W. (288) The credit equals the lesser of:

➢ 15% of the taxpayer’s basis in the vehicle (30% if the vehicle is not powered by gas or diesel). ➢ The incremental cost of the vehicle.

The maximum credit is $7,500 for qualified vehicles with gross vehicle weight ratings (GVWRs) of under 14,000 pounds and $40,000 for all other vehicles. There is no limit on the number of credits the taxpayer’s business can claim. For businesses, the credits are nonrefundable, so the taxpayer cannot get back more on the credit than he or she owes in taxes. A 45W credit can be carried over as a general business credit. To qualify, a vehicle must be subject to a depreciation allowance, with an exception for vehicles placed in service by a tax-exempt organization and not subject to a lease. The vehicle must also:

➢ Be made by a qualified manufacturer as defined in IRC 30D(d)(1)(C). See our index of qualified manufacturers. ➢ Be for use in the taxpayer’s business, not for resale. ➢ Be for use primarily in the United States. ➢ Not have been allowed a credit under sections 30D or 45W.

In addition, the vehicle must either be:

➢ Treated as a motor vehicle for purposes of title II of the Clean Air Act and manufactured primarily for use on public roads (not including a vehicle operated exclusively on a rail or rails); or

➢ Mobile machinery as defined in IRC 4053(8) (including vehicles that are not designed to perform a function of transporting a load over a public highway).

Lesson 14 - Credits

The vehicle or machinery must also either be:

➢ A plug-in electric vehicle that draws significant propulsion from an electric motor with a battery capacity of at least: o 7 kilowatt hours if the gross vehicle weight rating (GVWR) is under 14,000 pounds o 15 kilowatt hours if the GVWR is 14,000 pounds or more; or

➢ A fuel cell motor vehicle that satisfies the requirements of IRC 30B(b)(3)(A) and (B).

Energy Efficient Home Improvement Credit

The Nonbusiness Energy Property Credit expired at the end of 2021. However, the Inflation Reduction Act revives the credit and gives it a new name, the Energy Efficient Home Improvement Credit.

If the taxpayer makes qualified energy-efficient improvements to his or her home after January 1, 2023, he or she may qualify for a tax credit up to $3,200. The taxpayer can claim the credit for improvements made through 2032. As of January 1, 2023, the credit equals 30% of certain qualified expenses, including:

➢ Qualified energy efficiency improvements installed during the year. ➢ Residential energy property expenses. ➢ Home energy audits.

There are limits on the allowable annual credit and on the amount of credit for certain types of qualified expenses. The credit is allowed for qualifying property placed in service on or after January 1, 2023, and before January 1, 2033. The maximum credit the taxpayer can claim each year is:

➢ $1,200 for energy property costs and certain energy efficient home improvements, with limits on doors ($250 per door and $500 total), windows ($600) and home energy audits ($150).

➢ $2,000 per year for qualified heat pumps, biomass stoves or biomass boilers. The credit has no lifetime dollar limit. The taxpayer can claim the maximum annual credit every year that he or she makes eligible improvements until 2033. However, the credit is nonrefundable, so the taxpayer cannot get back more on the credit than he or she owes in taxes. Also, the taxpayer cannot apply any excess credit to future tax years. The taxpayer should file Form 5695 - Residential Energy Credits with his or her tax return to claim the credit. He or she must claim the credit for the tax year when the property is installed, not merely purchased. (289)

Residential Clean Energy Credit

The Residential Clean Energy Credit equals 30% of the costs of new, qualified clean energy property for the taxpayer’s home installed anytime from 2022 through 2032. The credit percentage rate phases down to 26% for property placed in service in 2033 and 22% for property placed in service in 2034. The taxpayer may be able to take the credit if he or she made energy saving improvements to his or her home located in the United States.

The credit is nonrefundable, so the credit amount the taxpayer receives cannot exceed the amount he or she owes in tax. The taxpayer can carry forward any excess unused credit, though, and apply it to reduce the tax he or she owes in future years. The taxpayer does not include interest paid including loan origination fees. The credit has no annual or lifetime dollar limit except for credit limits for fuel cell property. The taxpayer can claim the annual credit every year that he or she installs eligible property until the credit begins to phase out in 2033. The taxpayer may claim the Residential Clean Energy Credit for improvements to his or her main home, whether he or she owns or rents it. The main home is generally where the taxpayer lives most of the time. The credit applies to new or existing homes located in the United States.

The taxpayer cannot claim the credit if he or she is a landlord or other property owner who does not live in the home.

Lesson 14 - Credits

Qualified expenses include the costs of new clean energy property including:

➢ Solar electric panels. ➢ Solar water heaters. ➢ Wind turbines. ➢ Geothermal heat pumps. ➢ Fuel cells. ➢ Battery storage technology (beginning in 2023).

Starting in 2023, it no longer applies to biomass furnaces and water heaters, but it will apply to battery storage technology with a capacity of at least three kilowatt hours. Also, used (previously owned) clean energy property is not eligible. Qualified expenses may include labor costs for onsite preparation, assembly or original installation of the property and for piping or wiring to connect it to the home. Traditional building components that primarily serve a roofing or structural function generally do not qualify. For example, roof trusses and traditional shingles that support solar panels do not qualify, but solar roofing tiles and solar shingles do because they generate clean energy. (290)

Alternative Fuel Refueling Property Tax Credit

If the taxpayer installs qualified vehicle refueling and recharging property in his or her home or business, he or she may qualify for the Alternative Fuel Refueling Property Tax Credit. The credit was extended and modified by the Inflation Reduction Act. The credit allowed is based on the placed-in-service date for the qualifying property.

To qualify for the credit, refueling property must be used to store or dispense clean-burning fuel. In addition, the following requirements must be met to qualify for the credit:

➢ The refueling property is placed in service during the tax year. ➢ The original use of the property began with the taxpayer. ➢ The property is used primarily inside the United States. ➢ If the property is not business or investment use property, it must be installed on property used as a main home.

As of January 1, 2023, the Inflation Reduction Act expands qualified property to include:

➢ Charging stations for 2- and 3-wheeled vehicles (for use on public roads). ➢ Bidirectional charging equipment (vehicle-to-grid or V2G).

As of 2023, qualifying property is limited to property placed in service within low-income communities or non-urban census tracts. As of January 1, 2023, the credit for qualified refueling property subject to depreciation equals 6% with a maximum credit of $100,000 for each single item of property. Businesses meeting prevailing wage and apprenticeship requirements may be eligible for a 30% credit with the same $100,000 limit. For qualifying property not subject to depreciation, the credit equals 30% of the cost with a maximum amount of $1,000 per item. For property placed in service before January 1, 2023 (including personal property), the credit is 30% of the cost of qualified refueling property with a maximum total credit allowed of $30,000 for depreciable property and $1,000 for all other property. (291)

General Business Credit

Form 3800 - General Business Credit is used to accumulate all of the business tax credits the taxpayer is applying for in a specific tax year, to come up with a total tax credit amount for his or her business tax return. It allows the taxpayer to calculate the total amount of tax credits for which he or she is eligible for a specific tax year, including any tax carrybacks and carry forwards (tax credits which he or she carries back or carries forward from other tax years). For each credit, the taxpayer should attach a statement showing the tax year the credit originated, the amount of the credit reported on the original return, and the amount of credit allowed for that year. Also state whether the total carryforward amount was changed from the originally reported amount and identify the type of credit(s) involved.

Lesson 14 - Credits

Some of the business tax credits that are included in the General Business Credit:

➢ Work Opportunity Tax Credit (Form 5884). ➢ Credit for Increasing Research Activities (Form 6765). ➢ Disabled Access Credit (Form 8826). ➢ Renewable Electricity Production Credit (Form 8835). ➢ Empowerment Zone Employment Credit (Form 8844). ➢ New Markets Credit (Form 8874). ➢ Credit for Small Employer Pension Plan Startup Costs (Form 8881, Part I). ➢ Credit for Employer-provided Childcare Facilities and Services (Form 8882). ➢ Military Spouse Retirement Plan Eligibility Credit (Form 8881, Part III).

General business credits are reported in a specific order, depending on which credits are used in the tax year:

1. First, any carry forwards from past years are used, earliest first. 2. Then, the general business credit earned during that year is calculated. 3. Finally, any carrybacks to that year from future years.

If the taxpayer’s general business tax credits are larger than his or her tax liability for the year, then the credits are used in a specific order.

Work Opportunity Tax Credit

The Work Opportunity Tax Credit (WOTC) is a Federal tax credit available to employers for hiring and employing individuals from certain targeted groups who have faced significant barriers to employment. The WOTC is available for wages paid to certain individuals who begin work on or before December 31, 2025. The WOTC may be claimed by any employer that hires and pays or incurs wages to certain individuals who are certified by a designated local agency (sometimes referred to as a state workforce agency) as being a member of one of 10 targeted groups. In general, the WOTC is equal to 40% of up to $6,000 of wages paid to, or incurred on behalf of, an individual who:

➢ Is in their first year of employment; ➢ Is certified as being a member of a targeted group; and ➢ Performs at least 400 hours of services for that employer.

Thus, the maximum tax credit is generally $2,400. A 25% rate applies to wages for individuals who perform fewer than 400 but at least 120 hours of service for the employer. Up to $24,000 in wages may be taken into account in determining the WOTC for certain qualified veterans. An employer cannot claim the WOTC for employees who are rehired. In general, taxable employers may carry the current year’s unused WOTC back one year and then forward 20 years. (104) The credit is limited to the amount of the business income tax liability or Social Security tax owed. A taxable business may apply the credit against its business income tax liability. In general, taxable employers may carry the current year's unused WOTC back one year and then forward up to 20 years. For qualified tax-exempt organizations, the credit is limited to the amount of employer Social Security tax owed on the total taxable Social Security wages and tips reported by the organization for the employment tax period for which the credit is claimed. On or before the day that an offer of employment is made, the employer and the job applicant must complete Form 8850 - Pre-Screening Notice and Certification Request for the Work Opportunity Credit. The employer has 28 calendar days from the new employee’s start date to submit Form 8850 to the designated local agency located in the state in which the business is located (where the employee works). Additional forms may be required by the DOL to obtain certification. Following receipt of a certification from the designated local agency that the employee is a member of one of the 10 targeted groups, taxable employers file Form 5884 - Work Opportunity Credit and tax-exempt employers file Form 5884- C - Work Opportunity Credit for Qualified Tax-Exempt Organizations Hiring Qualified Veterans to claim the WOTC. Newly hired individuals from the following targeted groups might qualify the taxpayer for this tax credit:

➢ A long-term family assistance recipient. ➢ A qualified recipient of Temporary Assistance for Needy Families (TANF). ➢ A qualified veteran. ➢ A qualified ex-felon. ➢ A designated community resident. ➢ A vocational rehabilitation referral.

Lesson 14 - Credits

➢ A qualified summer youth employee. ➢ A qualified Supplemental Nutrition Assistance Program (SNAP) benefits (food stamps) recipient. ➢ A qualified Supplemental Security Income (SSI) recipient. ➢ A qualified long-term unemployment recipient.

The credit is limited to the amount of the business income tax liability or social security tax owed. A taxable business may apply the credit against its business income tax liability, and the normal carry-back and carry-forward rules apply. See the instructions for Form 3800 - General Business Credit for more details.

For qualified tax-exempt organizations, the credit is limited to the amount of employer Social Security tax owed on wages paid to all employees for the period the credit is claimed.

Qualified tax-exempt organizations will claim the credit on Form 5884-C - Work Opportunity Credit for Qualified Tax- Exempt Organizations Hiring Qualified Veterans as a credit against the employer’s share of Social Security tax. The credit will not affect the employer’s Social Security tax liability reported on the organization’s employment tax return.

Fuel Excise Tax Credit

Owners, operators, and tenants of farms and certain other persons may be eligible to claim a credit of excise taxes on fuel used in the trade or business of farming, when used on a farm in the United States for farming purposes. The taxpayer can claim the following taxes as a credit on his or her income tax return:

➢ Tax on gasoline and aviation gasoline he or she used on a farm for farming purposes. ➢ Tax on fuels (including undyed diesel fuel or undyed kerosene) he or she used for nontaxable uses if the total for

the tax year is less than $750. ➢ Tax on fuel he or she did not include in any claim for refund previously filed for any quarter of the tax year.

The taxpayer may be eligible to claim a credit or refund for the excise tax on fuel used in an off-highway business use. This is any use of fuel in a trade or business or in an income-producing activity. The use must not be in a highway vehicle registered or required to be registered for use on public highways. Off-highway business use generally does not include any use in a recreational motorboat. Off-highway business use includes the use of fuels in a trade or business in any of the following ways:

➢ In stationary machines such as generators, compressors, power saws, and similar equipment. ➢ For cleaning. ➢ In forklift trucks, bulldozers, and earthmovers.

Off-highway nonbusiness (taxable) use of fuel includes use in minibikes, snowmobiles, power lawn mowers, chain saws, and other yard equipment. The taxpayer makes a claim for a fuel tax credit on Form 4136 - Credit for Federal Tax Paid on Fuels and attaches it to his or her income tax return. The taxpayer does not claim a credit for any excise tax for which he or she has filed a refund claim. The taxpayer includes any credit of excise taxes on fuels in his or her gross income if he or she claimed the total cost of the fuel (including the excise taxes) as an expense deduction that reduced his or her income tax liability. If the taxpayer uses the cash method and he or she claims a credit on his or her income tax return, he or she includes the credit amount in gross income for the tax year in which he or she files Form 4136. If the taxpayer uses an accrual method, include the amount of credit or refund in gross income for the tax year in which he or she used the fuels. It does not matter whether the taxpayer filed for a quarterly refund or claimed the entire amount as a credit.

Credit For Increasing Research Activities (Research Credit)

The taxpayer should use Form 6765 - Credit for Increasing Research Activities to figure and claim the Credit for Increasing Research Activities (Research Credit), to elect the reduced credit under Section 280C, and to elect to claim a certain amount of the credit as a payroll tax credit against the employer portion of Social Security taxes. The Research Credit is generally allowed for expenses paid or incurred for qualified research. Qualified research means research for which expenses may be treated as Section 174 expenses. This research must be undertaken for discovering information that is technological in nature, and its application must be intended for use in developing a new or improved

Lesson 14 - Credits

business component of the taxpayer. In addition, substantially all of the activities of the research must be elements of a process of experimentation relating to a new or improved function, performance, reliability, or quality. All of the research activities must be applied separately with respect to each business component of the taxpayer. The Research Credit generally is not allowed for the following types of activities:

➢ Research conducted after the beginning of commercial production. ➢ Research adapting an existing product or process to a particular customer’s need. ➢ Duplication of an existing product or process. ➢ Surveys or studies. ➢ Research relating to certain internal-use computer software. ➢ Research conducted outside the United States, Puerto Rico, or a U.S. possession. ➢ Research in the social sciences, arts, or humanities. ➢ Research funded by another person (or governmental entity).

If the taxpayer incurs qualified clinical testing expenses relating to drugs for certain rare diseases, he or she can elect to claim the Orphan Drug Credit for these expenses instead of the Research Credit.

Retirement Plans Startup Costs Tax Credit

Eligible employers may be able to claim a tax credit of up to $5,000, for three years, for the ordinary and necessary costs of starting a SEP, SIMPLE IRA or qualified plan (like a 401(k) plan.) A tax credit reduces the amount of taxes the taxpayer may owe on a dollar-for-dollar basis. If he or she qualifies, the taxpayer may claim the credit using Form 8881 - Credit for Small Employer Pension Plan Startup Costs. The taxpayer qualifies to claim this credit if:

1. He or she had 100 or fewer employees who received at least $5,000 in compensation from him or her for the preceding year.

2. He or she had at least one plan participant who was a non-highly compensated employee (NHCE). 3. In the three tax years before the first year he or she is eligible for the credit, his or her employees were not

substantially the same employees who received contributions or accrued benefits in another plan sponsored by him or her, a member of a controlled group that includes his or her, or a predecessor of either.

The credit is 50% of the taxpayer’s eligible startup costs, up to the greater of:

➢ $500; or ➢ The lesser of:

o $250 multiplied by the number of NHCEs who are eligible to participate in the plan, or o $5,000.

The taxpayer can claim the credit for each of the first 3 years of the plan and may choose to start claiming the credit in the tax year before the tax year in which the plan becomes effective. He or she cannot both deduct the startup costs and claim the credit for the same expenses. The taxpayer is not required to claim the allowable credit. An eligible employer that adds an auto-enrollment feature to their plan can claim a tax credit of $500 per year for a 3-year taxable period beginning with the first taxable year the employer includes the auto-enrollment feature.

Military Spouse Retirement Plan Eligibility Credit for Small Employers

Effective January 1, 2023, small employers may qualify for a tax credit of up to $500 for each non-highly-compensated military spouse, for up to three years per spouse if they offer special plan benefits to military spouses. The SECURE 2.0 Act provides small employers a tax credit with respect to their defined contribution plans if they:

1. Make military spouses immediately eligible for plan participation within two months of hire. 2. Upon plan eligibility, make the military spouse eligible for any matching or non-elective contribution that they would

have been eligible for otherwise at two years of service. 3. Make the military spouse 100% immediately vested in all employer contributions.

The tax credit equals the sum of $200 per military spouse and 100% of all employer contributions (up to $300) made on behalf of the military spouse, for a maximum tax credit of $500. This credit applies for three years with respect to each military spouse – and does not apply to highly compensated employees. An employer may rely on an employee’s certification that such employee’s spouse is a member of the uniformed services.

Lesson 14 - Credits

• Adoption Credit (Choice A).

• Education credits.

• Credit for the Elderly or Disabled.

• Foreign Income Tax Credit (Choice B).

• Retirement Savings Contributions Credit (Saver's Credit) (Choice C).

Some examples of refundable tax credits include:

• Child Tax Credit.

• Child and Dependent Care Credit.

• Earned Income Tax Credit (EITC) (Choice D). Only Choice D is listed among the refundable tax credits and is therefore the correct response. Topic - Refundable Tax Credits Source - IRS.GOV - Credits and Deductions for Individuals Question 2 - A. Wages Earned income generally means wages (Choice A), salaries, tips, other taxable employee pay, and net earnings from self- employment. Employee pay is earned income only if it is taxable. Nontaxable employee pay, such as certain dependent care benefits and adoption benefits, is not earned income. Other examples of items that are not earned income include interest and dividends (Choice D), pensions and annuities, Social Security, and railroad retirement benefits (including disability benefits), alimony and child support, welfare benefits (Choice B), workers' compensation benefits, unemployment compensation (insurance), nontaxable foster care payments, and veterans' benefits (Choice D), including VA rehabilitation payments. Only Choice A is listed among earned income and is therefore the correct response. Topic - Earned Income Source - IRS.GOV - Earned Income Tax Credit (EITC) Question 3 - C. $6,000 A taxpayer may include up to $6,000 of expenses paid for the care of two or more qualifying persons to figure the child and dependent care credit, provided the amount of expenses claimed does not exceed the gross earnings of the lower earning taxpayer. A taxpayer should combine the total qualifying expenses for all qualifying persons. In this case combine the amounts paid for the two preschool children of $5,000 and the amount paid for after school care of $4,000. However, the total of $9,000 exceeds the maximum of $6,000 therefore they may only use $6,000 of the childcare expenses to calculate the child and dependent care credit. Only Choice C has the correct amount and is therefore the correct response. Topic - Amount of Credit Source - IRS.GOV - Topic No. 602 - Child and Dependent Care Credit

Lesson 14 - Credits

Question 4 - A. One class Unlike the American Opportunity Tax Credit, the student need not be in the first four years of undergraduate classes. Even if the student took only one class, he or she may take advantage of the Lifetime Learning Credit. Only Choice A has the correct number of classes and is therefore the correct response. Topic - Lifetime Learning Credit Source - IRS.GOV - Lifetime Learning Credit Question 5 - D. All of the above Qualified adoption expenses are reasonable and necessary expenses directly related to the legal adoption of the child who is under 18 years old, or physically or mentally incapable of caring for him or herself. These expenses may include adoption fees (Choice A), court costs (Choice B), attorney fees (Choice C), and travel expenses. Since Choices A, B, and C are examples of qualified adoption expenses Choice D, All of the above, is the correct response. Topic - Adoption Credit Source - IRS.GOV - Topic No. 607 - Adoption Credit and Adoption Assistance Programs Question 6 - A. Rollover contribution For tax year 2023, taxpayers with a low to moderate income may be able to claim a nonrefundable Saver’s Credit if he or she, or his or her spouse if filing jointly, made:

• Contributions (other than rollover contributions) to a traditional (Choice B) or Roth IRA (Choice C).

• Elective deferrals to a 401(k) (Choice D), 403(b), governmental 457, SEP, or SIMPLE plan.

• Voluntary employee contributions to a qualified retirement plan as defined in Section 4974(c) (including the Federal Thrift Savings Plan).

• Contributions to a Section 501(c)(18)(D) plan. Choice A, Rollover contribution, is not listed among the qualified contributions and is therefore the correct response. Topic - Retirement Savings Contribution Credit (Saver’s Credit) Source - IRS.GOV - Retirement Savings Contributions Credit (Saver’s Credit) Question 7 - A. One If one employer withheld too much Social Security or RRTA tax, the taxpayer cannot claim the excess as a credit against his or her income tax. The taxpayer’s employer should make an adjustment of the excess. If the employer does not make an adjustment, the taxpayer can use Form 843 - Claim for Refund and Request for Abatement, to claim a refund. Only Choice A has the correct number of employers and is therefore the correct response. Topic - Credit for Excess Social Security Tax or Railroad Retirement Tax Withheld Source - IRS.GOV - Topic No. 608 - Excess Social Security and RRTA Tax Withheld

Additional Taxes At the conclusion of this lesson you should have a basic knowledge of:

➢ Alternative Minimum Tax. ➢ Affordable Care Act Taxes. ➢ Kiddie Tax. ➢ Estate Tax. ➢ Gift Tax. ➢ Household Employment Tax.

Alternative Minimum Tax Alternative Minimum Tax (AMT) rules have been devised to ensure that at least a minimum amount of income tax is paid by higher-income taxpayers who reap large tax savings by making generous use of certain tax deductions, losses and credits. Without AMT some of these taxpayers might be able to escape income taxation entirely. In essence, the AMT functions as a recapture mechanism, reclaiming some of the tax breaks primarily available to higher-income taxpayers, and represents an attempt to maintain tax equity.

The Tax Cuts and Jobs Act (TCJA), enacted in December 2017, substantially changed the AMT. About 5 million taxpayers were expected to pay the AMT under the old law, but only 200,000 are expected to pay the AMT in 2023. So few taxpayers will owe the AMT that the IRS says it will remove its online AMT Assistant tax tool. Three key changes in the TCJA returned the AMT to being primarily a millionaire’s tax.

First, the AMT exemption was increased substantially. For taxpayers who are married filing jointly, the exemption is $126,500 in 2023. It is $81,300 for singles and heads of household, and the exemption is $63,250 for married taxpayers filing separately. Second, the income levels at which the exemptions phase out are much higher. They are $1,156,300 for married couples filing jointly and $578,150 for other taxpayers in 2023. Third, many of the tax breaks that triggered the AMT for middle class taxpayers have been changed. Middle income taxpayers frequently were subject to the AMT when they had high levels of personal and dependent exemptions, deductions for miscellaneous itemized expenses, home equity mortgage interest, and state and local tax deductions. The personal exemptions are eliminated (though dependent exemptions remain), as are miscellaneous itemized expenses and the home equity interest deduction. The state and local tax deduction is limited to $10,000 per tax return. Collectively, they are replaced by a much higher standard deduction. The taxpayer should use Form 6251 - Alternative Minimum Tax to figure the amount, if any, of his or her alternative minimum tax (AMT). The AMT is a separate tax that is imposed in addition to the taxpayer’s regular tax. It applies to taxpayers who have certain types of income that receive favorable treatment, or who qualify for certain deductions, under the tax law. These tax benefits can significantly reduce the regular tax of some taxpayers with higher economic incomes. The AMT sets a limit on the amount these benefits can be used to reduce total tax. The taxpayer also uses Form 6251 to figure his or her tentative minimum tax (Form 6251, line 9).

New Starting Point for AMTI Calculation

Instead of starting with the amount of the taxpayer’s regular tax adjusted gross income (AGI) reduced by any itemized deductions, the taxpayer will start his or her alternative minimum taxable income (AMTI) calculation with his or her taxable income for regular tax unless it is zero. In that case, the taxpayer will start from regular tax AGI reduced by his or her itemized deductions (or standard deduction) and qualified business income deduction. If the taxpayer is not itemizing his or her deductions, his or her standard deduction amount will be added back to AMTI on a later line (because the taxpayer cannot reduce AMTI by the standard deduction).

Lesson 15 - Additional Taxes

Review Question 1 Steve’s regular income tax is $40,000. When he calculates his tax using the alternative minimum tax (AMT) rules, he comes up with $53,000. Therefore, Steve must pay what amount of AMT in addition to the $40,000 of regular income tax?

A. $0 B. $6,500 C. $10,000 D. $13,000

See Review Feedback for answer.

Amount Excluded from Minimum Taxation

A specified amount of AMTI, Alternative Minimum Taxable Income, is exempt from alternative minimum taxation. The amount varies according to the taxpayer’s filing status and the tax year at hand. The exemption is subtracted from the taxpayer’s AMTI to determine the amount of his or her AMTI that is subject to tax at the AMT rates. For 2023 returns, the AMT exemption amounts are: (292)

➢ $126,500 for married individuals filing a joint return and surviving spouses. ➢ $81,300 for a single individual (who is not a surviving spouse) and head of household. ➢ $63,250 for married individuals filing separate returns.

AMT Exemption for Certain Children

For children under age 24 the AMT exemption amount is limited to the amount of earned income plus $8,800 in 2023 if any of the following conditions apply: (293)

➢ The taxpayer was under age 18 at the end of 2023. ➢ The taxpayer was age 18 at the end of 2023 and did not have earned income that was more than half of his or

her support. ➢ The taxpayer was a full-time student over age 18 and under age 24 at the end of 2023 and did not have earned

income that was more than half of his or her support.

Ordinarily, single individuals can subtract a $81,300 exemption amount from their AMT taxable income. However, a child who files Form 8615 - Tax for Certain Children Who Have Unearned Income has a limited exemption amount. The child's exemption amount for 2023 is limited to the child's earned income plus $8,800.

Review Question 2 When all conditions are met for certain children under age 24, the AMT exemption amount is limited to the amount of earned income plus what amount in 2023?

A. $5,950 B. $6,350 C. $7,000 D. $8,800

See Review Feedback for answer.

AMT Exemption Phase-out

The taxpayer’s exemption phases out if his or her AMTI exceeds the thresholds indicated below. More specifically, the exemption is reduced by 25% of the amount by which his or her AMTI exceeds the applicable threshold for his or her filing status.

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The AMTI exemption phase-out thresholds for 2023 begin at: (292)

➢ $1,156,300, for married individuals filing a joint return, and surviving spouses. ➢ $578,150, for unmarried individuals (other than surviving spouses).

AMT is computed at rates of 26% and 28%. In 2023, the 26% rate applies to the first $220,700 ($110,350, in the case of married individuals filing separately) of AMT income in excess of the applicable exemption amount. The 28% rate applies to any additional AMT income. However, special rates apply to net long-term capital gain and qualified dividends. After subtracting the exemption amount from the taxpayer’s AMTI, multiply the remainder by the applicable AMT rate of 26% or 28%. Generally, the resulting figure is his or her tentative minimum tax (TMT). Compare the taxpayer’s TMT with his or her regular income tax. If the regular tax is higher, the taxpayer does not owe any AMT. But if the regular tax is lower, the difference between the two taxes is the amount of AMT he or she must pay in addition to his or her regular tax (if any).

Review Question 3 What is the maximum amount of AMT income that married individuals filing a joint return can earn before their AMT exemption begins to phase out by 25 cents for each $1 above the threshold amount in 2023?

A. $110,350 B. $220,700 C. $578,150 D. $1,156,300

See Review Feedback for answer.

Credit for Prior Year Alternative Minimum Tax

If a taxpayer is not liable for AMT this year, but he or she paid AMT in one or more previous years, he or she may be eligible to take a special minimum tax credit against his or her regular tax this year. Any AMT paid was considered a future credit that could be carried forward indefinitely to offset future regular income tax, subject to limitations. The AMT is caused by two types of adjustments and preferences - deferral items and exclusion items. Deferral items (for example, depreciation) generally do not cause a permanent difference in taxable income over time. Exclusion items (for example, the standard deduction), on the other hand, do cause a permanent difference. The minimum tax credit is allowed only for the AMT caused by deferral items. The taxpayer should use Form 8801 - Credit for Prior Year Minimum Tax - Individuals, Estates, and Trusts if he or she is an individual, estate, or trust to figure the current year nonrefundable credit, if any, for alternative minimum tax (AMT) he or she incurred in prior tax years and to figure any credit carryforward to 2023. Complete Form 8801 if the taxpayer is an individual, estate, or trust that for 2023 had:

➢ An AMT liability and adjustments or preferences other than exclusion items. ➢ A credit carryforward to 2023 (on 2022 Form 8801, line 26). ➢ An unallowed qualified electric vehicle credit.

Preferences and Adjustments

Positive and negative AMT adjustments are added or subtracted from regular taxable income to determine the "taxable income after AMT adjustments". Tax preference items are then added to get the taxpayer’s AMTI. The following is a list of AMT adjustments:

➢ Standard deduction. ➢ Certain itemized deductions. ➢ Mortgage interest. ➢ Taxes. ➢ Medical expenses. ➢ Miscellaneous deductions. ➢ Investment interest.

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➢ MACRS depreciation. ➢ Basis adjustment affects AMT gain or loss. ➢ Incentive stock options (ISO). ➢ Mining exploration and development costs. ➢ Circulation costs. ➢ Long-term contracts. ➢ Research and experimental procedures. ➢ Passive tax-shelter farm losses. ➢ Passive losses from non-farming activities.

Certain tax preference items must be added back into taxable income after AMT adjustments to determine the AMTI. These primary items include the following AMT preference items:

➢ Tax-exempt interest on private-activity municipal bonds. ➢ Percentage Depletion / Excess intangible drilling costs (IDC). ➢ Depreciation (ACRS/MACRS). ➢ Exercise of an Incentive Stock Option (Bargain Element).

Exclusion Items versus Deferral Items

Tax preference and adjustments to AMT are broken down into two categories: exclusion items and deferral items. Exclusion items are adjustments that cause a permanent difference in income for regular tax versus AMT purposes. They include the following AMT adjustments/preferences that are exclusion items:

➢ Standard deduction. ➢ Itemized deduction. ➢ Percentage depletion. ➢ Tax-exempt interest. ➢ Exclusion of gain from qualified small business stock.

Deferral items (for example, depreciation) do not cause a permanent difference in taxable income over time. AMT adjustments/preference that are deferral items are any adjustment/preference item that is not an exclusion item from the list above.

Alternative Minimum Taxable Income (AMTI)

The AMT is calculated based on the alternative minimum taxable income (AMTI) that includes all of the income under the regular tax system plus some income that is tax exempt under the regular tax system. The following common items are not deductible under the AMT system:

➢ State and local taxes. ➢ Miscellaneous itemized deductions.

The only way to determine AMT liability is to calculate taxable income using standard procedures and then using the AMT procedures on Form 6251 - Alternative Minimum Tax for Individuals. The end result of the AMT calculation is a tentative AMT tax from which the regular tax is subtracted. If the result is positive, then this AMT tax is added to the regular tax on Form 1040; if the result is negative, then there is no AMT. Example Don’s regular income tax is $50,000. When he calculates his tax using the AMT rules, he comes up with $62,000. Therefore, Don must pay $12,000 of AMT in addition to the $50,000 of regular income tax.

Affordable Care Act Tax Provisions

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eliminated the individual mandate penalty for the 2019 tax year and beyond. As a result, as of the 2019 tax year, individuals will no longer be penalized for failing to obtain acceptable health insurance coverage for themselves and their family members. Also, despite the repeal of the individual mandate penalty, employers and individuals must continue to comply with all other ACA provisions. The tax reform bill does not impact any other ACA provisions, including the Patient-Centered Outcomes Research Institute (PCORI) fees and the health insurance provider’s fee. In addition, the employer shared responsibility (pay or play) rules and related Section 6055 and Section 6056 reporting requirements are still in place. The taxpayer may be eligible to claim the Premium Tax Credit if he or she, his or her spouse (if filing jointly), and his or her dependents enrolled in health insurance through the Health Insurance Marketplace. Advance payments of the Premium Tax Credit may have been made to a health insurer to help pay for the insurance coverage of the taxpayer, his or her spouse (if filing jointly), or his or her dependents. If advance payments of the Premium Tax Credit were made, the taxpayer must file a 2023 income tax return and Form 8962 - Premium Tax Credit (PTC). If the taxpayer, his or her spouse (if filing jointly), or his or her dependents enrolled in health insurance through the Health Insurance Marketplace, the taxpayer should have received Form 1095-A - Health Insurance Marketplace Statement. If the taxpayer receives Form(s) 1095-A, he or she should save it. Form(s) 1095-A will help the taxpayer figure his or her Premium Tax Credit. If the taxpayer did not receive a Form 1095-A, he or she should contact the Marketplace.

Medical Device Excise Tax

The Further Consolidated Appropriations Act included the repeal of the excise tax on medical devices. The repeal of the excise tax on medical devices began on January 1, 2020.

Cadillac Tax

The Further Consolidated Appropriations Act included the repeal of the so-called “Cadillac” tax on health insurance benefits. The repeal of the Cadillac tax began on January 1, 2020.

Health Coverage for Older Children

Health coverage for an employee's children under 27 years of age is now generally tax-free to the employee. This expanded health care tax benefit applies to various workplace and retiree health plans. These changes immediately allow employers with cafeteria plans (plans that allow employees to choose from a menu of tax-free benefit options and cash or taxable benefits) to permit employees to begin making pre-tax contributions to pay for this expanded benefit. This also applies to self-employed individuals who qualify for the self-employed health insurance deduction on their Federal income tax return. (276)

Review Question 4 Health coverage for an employee's child under how many years of age is now generally tax-free to the employee?

A. 16 years B. 18 years C. 21 years D. 27 years

See Review Feedback for answer.

Net Investment Income Tax

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Filing Status Threshold Amount*

Married filing jointly $250,000

Married filing separately $125,000

Single $200,000

Head of household (with qualifying person) $200,000

Qualifying surviving spouse with dependent child $250,000

*Taxpayers should be aware that these threshold amounts are not indexed for inflation. These amounts will stay the same from year to year unless

Congress specifically changes these amounts through new legislation.

Table 15-1 - IRS.GOV Net Investment Income Tax FAQs (2023)

Nonresident Aliens (NRAs) are not subject to the Net Investment Income Tax. If an NRA is married to a U.S. citizen or resident and has made, or is planning to make, an election under IRC Section 6013(g) to be treated as a resident alien for purposes of filing as Married Filing Jointly, the proposed regulations provide these couples special rules and a corresponding IRC Section 6013(g) election for the NIIT. Estates and Trusts will be subject to the Net Investment Income Tax if they have undistributed Net Investment Income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year. Generally, the threshold amount for the upcoming year is updated by the IRS each fall in a revenue procedure. For tax year 2023, the highest regular income tax bracket for trusts and estates (37%) begins with taxable income in excess of $13,850. The taxpayer should be aware that there are special computational rules for certain unique types of trusts, such as Charitable Remainder Trusts and Electing Small Business Trusts. The following trusts are not subject to the Net Investment Income Tax:

1. Trusts that are exempt from income taxes imposed by Subtitle A of the Internal Revenue Code (e.g., charitable trusts and qualified retirement plan trusts exempt from tax under IRC Section 501, and Charitable Remainder Trusts exempt from tax under IRC Section 664).

2. A trust in which all of the unexpired interests are devoted to one or more of the purposes described in IRC Section 170(c)(2)(B).

3. Trusts that are classified as grantor trusts under IRC Sections 671-679. 4. Trusts that are not classified as trusts for Federal income tax purposes (e.g., Real Estate Investment Trusts and

Common Trust Funds). In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer (within the meaning of IRC Section 469). To the extent that gains are not otherwise offset by capital losses, the following gains are common examples of items taken into account in computing Net Investment Income:

➢ Gains from the sale of stocks, bonds, and mutual funds. ➢ Capital gain distributions from mutual funds. ➢ Gain from the sale of investment real estate (including gain from the sale of a second home that is not a primary

residence). ➢ Gains from the sale of interests in partnerships and S corporations (to the extent the taxpayer was a passive

owner). The Net Investment Income Tax will not be applicable to any amount of gain that is excluded from gross income for regular income tax purposes. The pre-existing statutory exclusion in IRC Section 121 exempts the first $250,000 ($500,000 in the

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case of a married couple) of gain recognized on the sale of a principal residence from gross income for regular income tax purposes and, therefore, from the NIIT. Wages, unemployment compensation; operating income from a non-passive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income, Alaska Permanent Fund Dividends and distributions from certain Qualified Plans are some common types of income that are not investment income. In order to arrive at Net Investment Income, Gross Investment Income is reduced by deductions that are properly allocable to items of Gross Investment Income. Examples of properly allocable deductions include investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in Net Investment Income. Taxpayers will determine any applicable Medicare tax on the new Form 8960 - Net Investment Income Tax - Individuals, Estates and Trusts, when they file their income tax return. Taxpayers whose AGI may exceed the threshold amounts and who have investment income may need to adjust their withholding or make estimated tax payments to ensure the new Medicare tax on investment income does not prompt a balance due when filing taxes next year.

Additional Medicare Tax

Effective January 2013, Additional Medicare Tax applies to an individual’s Medicare wages that surpass a threshold amount based on the taxpayer’s filing status. All wages that are currently subject to Medicare Tax are subject to Additional Medicare Tax if they are paid in excess of the applicable threshold for an individual’s filing status. Employers are responsible for withholding the 0.9% Additional Medicare Tax on an individual’s wages paid in excess of $200,000 in a calendar year. An employer is obligated to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax. (226) An individual is responsible for Additional Medicare Tax if the individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) surpass the threshold amount for the individual’s filing status.

Filing Status Threshold Amount

Married filing jointly $250,000

Married filing separately $125,000

Single $200,000

Head of household (with qualifying person) $200,000

Surviving spouse with dependent child $200,000

Table 15-2 - Questions and Answers for the Additional Medicare Tax (2023)

The Additional Medicare Tax statute mandates an employer to withhold Additional Medicare Tax on wages it pays to an employee in excess of $200,000 in a calendar year. An employer has this withholding obligation even though an employee may not be liable for Additional Medicare Tax because, for example, the employee’s wages together with that of his or her spouse do not exceed the $250,000 threshold for joint return filers. Any withheld Additional Medicare Tax will be credited against the total tax liability shown on the individual’s income tax return (Form 1040). An employee who foresees liability for Additional Medicare Tax may ask that his or her employer withhold an additional amount of income tax withholding on Form W-4 - Employee's Withholding Certificate. This additional income tax withholding will be applied against all taxes shown on the individual’s income tax return (Form 1040), including any Additional Medicare Tax liability.

American Health Benefit Exchanges

The Affordable Care Act (ACA) required that health insurance exchanges were established in every state by January 1, 2014. The central purpose of these new Marketplaces is to enable low- and moderate-income individuals, and small employers to obtain affordable health coverage. Individuals and small business will be able to purchase private health insurance through a variety of insurance Marketplace models throughout the United States. This document reflects information and guidance issued through statute, rule or communications from the Federal government concerning the activities and options as they relate to the development of health insurance marketplaces. Plans provided through an exchange must provide essential health benefits, limit cost sharing and provide specified accrual benefits.

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Tax-Exempt 501(c)(29) Qualified Nonprofit Health Insurance Issuers

The Affordable Care Act requires the Department of Health and Human Services (HHS) to establish the Consumer Operated and Oriented Plan program (CO-OP program). It also provides for tax exemption for recipients of CO-OP program grants and loans that meet additional requirements under Section 501(c)(29). (295)

Retiree Drug Subsidies

Under 26 USC Section 139A of the Internal Revenue Code, certain special subsidy payments for retiree drug coverage made under the Social Security Act are not included in the gross income of plan sponsors. Plan sponsors receive these retiree drug subsidy payments based on the allowable retiree costs for certain qualified retiree prescription drug plans. For taxable years beginning on or after January 1, 2013, new statutory rules affect the ability of plan sponsors to deduct costs that are reimbursed through these subsidies. (295) Generally, taxpayers may not deduct costs that are reimbursed, for which they have a right of reimbursement, or that relate to income on which the taxpayers were not taxed (excluded income). However, for taxable years beginning on or before December 31, 2012, 26 USC Section 139A provides an exception that allows plan sponsors to disregard the excluded income for purposes of determining the deductibility of their costs for the plan year for which they received the subsidy. This exception generally results in a greater deductible amount than if the exception did not apply. For taxable years beginning after December 31, 2012, 26 USC Section 139A has been amended to remove the language that allows plan sponsors to disregard the excluded income for purposes of determining whether a deduction is allowable for subsidized costs. Accordingly, plan sponsors may continue to exclude the RDS payments from gross income but will be subject to the normal rules disallowing a deduction for expenses for which the sponsors are reimbursed, have a right of reimbursement, or relate to excluded income. (296)

Online Resources

The IRS has launched an Affordable Care Act Tax Provisions website at irs.gov/aca to educate individuals and businesses on how the health care law may affect them. The new home page has three sections, which explain the tax benefits and responsibilities for individuals and families, employers, and other organizations, with links and information for each group. The site provides information about tax provisions that are in effect now and those that went into effect in 2014 and beyond. Topics include the Premium Tax Credit for individuals, new benefits and responsibilities for employers, and tax provisions for insurers, tax-exempt organizations and certain other business types. Visitors to the site will find information about the law and its provisions, legal guidance, the latest news, frequently asked questions and links to additional resources.

Several other Federal agencies have a role in implementing the health care law, including the Department of Health and Human Services, which has primary responsibility. To help locate additional online resources from the Department of Health and Human Services, the Department of Labor and the Small Business Administration, the IRS has issued a new Web-based flyer - Publication 5093 - Healthcare Law Online Resources.

Other Taxes

Estate Tax

If the taxpayer inherited property from a decedent, except those who died in 2010, the basis in property he or she inherits from a decedent is generally one of the following: (246)

➢ The Fair Market Value (FMV) of the property at the date of the decedent's death. ➢ The FMV on the alternate valuation date if the personal representative for the estate elects to use alternate

valuation. ➢ The value under the special-use valuation method for real property used in farming or a closely held business if

elected for estate tax purposes. ➢ The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a

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The Estate Tax is a tax on the right to transfer property at the time of a person’s death. It consists of an accounting of everything he or she owns or has certain interests in on the date of death. The fair market value of these items is used, not necessarily what the taxpayer paid for them or what their values were when acquired. The total of all of these items is the gross estate. The gross estate includes the value of all property to the extent of the decedent’s interest in the property at the time of death. Unpaid interest that has accrued on savings from the date of the last interest payment to the date of death is included in the gross estate. Outstanding dividends declared to shareholders of record on or before the date of death are included in the gross estate. The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets. (247) A taxpayer’s gross estate also includes the following: (217)

The allowable deductions used in determining the taxable estate include: (217)

any state, a political subdivision of a state, the District of Columbia, or to a qualifying charity for exclusively charitable purposes).

➢ The state death tax deduction (generally any estate, inheritance, legacy, or succession taxes paid as the result of the decedent's death to any state or the District of Columbia).

After the net amount is computed, the value of lifetime taxable gifts (beginning with gifts made in 1977) is added to this number and the tax is computed. The tax is then reduced by the available unified credit. The unified credit applies to both the gift tax and the estate tax and it equals the tax on the applicable exclusion amount. A taxpayer must subtract the unified credit from any gift or estate tax that he or she owes. Any unified credit the taxpayer uses against gift tax in one year reduces the amount of credit that he or she can use against gift or estate taxes in a later year. (217) As of 2011, the amount of unified credit available to a person will equal the tax on the basic exclusion amount plus the tax on any deceased spousal unused exclusion (DSUE) amount. The DSUE is only available if an election was made on the deceased spouse's Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return. The applicable exclusion amount consists of the basic exclusion amount ($12,920,000 in 2023) and, in the case of a surviving spouse, any unused exclusion amount of the last deceased spouse (who died after December 31, 2010). The executor of the predeceased spouse's estate must have elected on a timely and complete Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return to allow the donor to use the predeceased spouse's unused exclusion amount.

Estates of decedents who die during 2023 have a basic exclusion amount of $12,920,000, up from a total of $12,060,000 for estates of decedents who died in 2022.

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Decedents dying in: Estate Tax Exemption Amount Tax Rate

2021 $11,700,000 40%

2022 $12,060,000 40%

2023 $12,920,000 40%

Table 15-3 - IRS Estate and Gift Tax (2023)

Review Question 5 Estates of decedents who die during 2023 have a basic exclusion amount of what amount?

A. $5,000,000 B. $12,920,000 C. $15,500,000 D. $15,580,000

See Review Feedback for answer.

Gift Tax

The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not. The gift tax applies to the transfer by gift of any property. The taxpayer makes a gift if he or she gives property (including money), or the use of, or income from property, without expecting to receive something of at least equal value in return. The basis of property received as a gift is the donor's carry-over basis (adjusted basis). If a taxpayer sells something at less than its full value or if he or she makes an interest-free or reduced-interest loan, it may be a gift. (248) The annual gift exclusion for 2023 increases to $17,000. For gifts made to spouses who are not U.S. citizens, the annual exclusion has increased to $175,000 for 2023. The top rate for gifts and generation-skipping transfers is 40%. The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts:

➢ Gifts, excluding gifts of future interest, that are not more than the annual exclusion for the calendar year. For 2023, a taxpayer generally can give gifts valued up to $17,000 per person, to any number of people, and none of the gifts will be taxable.

Use Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return to report the following: (249)

1. Transfers subject to the Federal gift and certain generation-skipping transfer (GST) taxes and to figure the tax due, if any, on those transfers, and

2. Allocation of the lifetime GST exemption to property transferred during the transferor's lifetime. (For more details, Regulations Section 26.2632-1).

In general, if the taxpayer is a citizen or resident of the United States, he or she must file a gift tax return (whether or not any tax is ultimately due) in the following situations: (249)

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➢ If he or she gave gifts to someone in 2023 totaling more than $17,000 (other than to his or her spouse), he or she probably must file Form 709.

➢ Certain gifts, called future interests, are not subject to the $17,000 annual exclusion and the taxpayer must file Form 709 even if the gift was under $17,000.

of community property is considered a gift of $50,000 made by each spouse, and each spouse must file a gift tax return.

➢ Likewise, each spouse must file a gift tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety.

➢ The donor is responsible for paying the gift tax. However, if the donor does not pay the tax, the person receiving the gift may have to pay the tax.

➢ If a donor dies before filing a return, the donor's executor must file the return. If the taxpayer meets all of the following requirements, he or she is not required to file Form 709: (249)

1. He or she made no gifts during the year to his or her spouse. 2. He or she did not give more than $17,000 to any one person. 3. All the gifts he or she made were of present interests.

Unreported Social Security and Medicare Tax

Tax for Certain Children Who Have Unearned Income (Kiddie Tax)

The Tax Cuts and Jobs Act changed the Kiddie Tax, which taxes a child’s unearned income at the tax rates of the child’s parents. Starting in 2018, however, the Kiddie Tax was based on the much higher tax rates for estates and trusts. This significantly increased the tax rates that apply to the taxable portion of college grants, scholarships and fellowships and to military survivor benefits of Gold Star families. It also caused low- and middle-income children to be taxed at much higher rates than their parents. The Setting Every Community Up for Retirement Enhancement (SECURE) Act repeals the change to the Kiddie Tax, reverting to the rules that were in effect before 2018. This change is effective for tax years that begin after December 31, 2019.

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Kiddie Tax

Tax Bracket Tax

$0 to $1,250 0%

Earned income > $1,250 Child’s tax rate

Unearned income > $1,250 ≤ $2,500 Child’s tax rate

Unearned income > $2,500 Generally, the parent’s highest marginal tax rate

Table 15-4 - Publication 929 - Tax for Certain Children Who Have Unearned Income (2023)

1. The taxpayer had more than $2,500 of unearned income. 2. The taxpayer is required to file a tax return. 3. The taxpayer was either:

a. Under age 18 at the end of 2023, b. Age 18 at the end of 2023 and did not have earned income that was more than half of his or her support,

or c. A full-time student at least age 19 and under age 24 at the end of 2023 and did not have earned income

that was more than half of his or her support. 4. At least one of the taxpayer’s parents was alive at the end of 2023. 5. The taxpayer did not file a joint return for 2023.

The taxpayer’s child’s unearned income includes all income produced by property belonging to his or her child. This is true even if the property was transferred to his or her child, regardless of when the property was transferred or purchased or who transferred it.

Household Employment Taxes A taxpayer has a household employee if he or she hired someone to do household work and that worker is the taxpayer’s employee. The worker is the taxpayer’s employee if he or she can control not only what work is done, but how it is done. If the worker is the taxpayer’s employee, it does not matter whether the work is full-time or part-time or that he or she hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether the taxpayer pays the worker on an hourly, daily, or weekly basis, or by the job. Some examples of workers who do household work are:

➢ Babysitters. ➢ Caretakers. ➢ House cleaning workers. ➢ Domestic workers. ➢ Drivers. ➢ Health aides. ➢ Housekeepers. ➢ Maids. ➢ Nannies. ➢ Private nurses. ➢ Yard workers.

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Employment Tax Requirements

If the taxpayer: Then he or she needs to:

Pays cash wages of $2,600 or more in 2023 to any one household employee. The taxpayer does not count wages he or she pays to:

• His or her spouse.

• His or her child under the age of 21.

• His or her parent (exceptions apply).

• Any employee under the age of 18 at any time in 2023 (exceptions apply).

Withhold and pay Social Security and Medicare taxes.

• The taxes are 15.3%1 of cash wages.

• The employee's share is 7.65%1. (The taxpayer can choose to pay it him or herself and not withhold it.)

• The taxpayer’s share is 7.65%

Pays total cash wages of $1,000 or more in any calendar quarter of 2022 or 2023 to household employees.

Pay Federal unemployment tax.

• The tax is 6% of cash wages.

• Wages over $7,000 a year per employee are not taxed.

• The taxpayer may also owe state unemployment tax.

1In addition to withholding Medicare tax at 1.45%, an employer must withhold a 0.9% Additional Medicare Tax from wages he or she

Table 15-5 - Publication 926 - Table 1-Do You Need To Pay Employment Taxes? (2023)

Review Question 6 If a taxpayer paid cash wages to household employees totaling more than $1,000 in any calendar quarter during the calendar year or the prior year, he or she generally must pay Federal unemployment tax (FUTA) tax on cash wages of up to what amount paid to each household employee?

A. $7,000 B. $8,000 C. $9,000 D. $9,500

See Review Feedback for answer.

Social Security and Medicare Taxes (Federal Insurance Contributions Act – FICA)

If your client pays a household employee cash wages of more than the amount specified by law in a tax year ($2,600 for 2023), he or she generally must withhold Social Security and Medicare taxes from all cash wages paid to that employee. (Cash wages include wages paid by check, money order, etc.) Unless the taxpayer prefers to pay the employee's share of Social Security and Medicare taxes from his or her own funds, the taxpayer should withhold 7.65% from each payment of cash wages made.

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In addition, Additional Medicare Tax applies to an individual’s Medicare wages that exceed a threshold amount based on the taxpayer’s filing status. Employers are responsible for withholding the 0.9% Additional Medicare Tax on an individual’s wages paid in excess of $200,000 in a calendar year. An employer is required to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax.

The specified dollar amounts and percentages can be found Publication 926 - Household Employer's Tax Guide. The taxpayer should pay the amount he or she withholds to the IRS with an additional 7.65% for his or her share of the taxes. If the taxpayer pays the employee's share of Social Security and Medicare taxes from his or her own funds, the amounts the taxpayer pays for the employee counts as wages for purposes of the employees' income tax. However, they are not counted as Social Security and Medicare wages or as wages for Federal unemployment tax.

Do not withhold or pay Social Security and Medicare taxes from wages the taxpayer pays to: (298)

➢ His or her spouse. ➢ His or her child who is under age 21. ➢ His or her parent, unless an exception is met. ➢ An employee who is under age 18 at any time during the year, unless performing household work is the employee's

principal occupation. If the employee is a student, providing household work is not considered to be his or her principal occupation.

Federal Income Tax Withholding

The taxpayer is not required to withhold Federal income tax from wages he or she pays to a household employee. However, if the employee asks the taxpayer to withhold Federal income tax and he or she agrees, the taxpayer will need a completed Form W-4 - Employee's Withholding Certificate from the employee. See Publication 15 - (Circular E) - Employer's Tax Guide, which has tax withholding tables that are updated each year. (298)

Form W-2 - Wage and Tax Statement

If the taxpayer must withhold and pay Social Security and Medicare taxes, or if the taxpayer withholds Federal income tax, he or she will need to complete Form W-2 - Wage and Tax Statement for each employee. The taxpayer will also need a Form W- 3 - Transmittal of Wage and Tax Statement. To complete Form W-2 the taxpayer will need an employer identification number (EIN) and the employees' Social Security numbers. If the taxpayer does not already have an (EIN), he or she can apply for one using the online EIN application on the IRS website. (298)

Federal Unemployment Tax Act (FUTA)

If the taxpayer paid cash wages to household employees totaling more than $1,000 in any calendar quarter during the calendar year or the prior year, he or she generally must pay Federal unemployment tax (FUTA) tax on the first $7,000 of cash wages paid to each household employee. However, do not count wages paid to his or her spouse, his or her child who is under the age of 21, or his or her parent. The amounts the taxpayer pays to these individuals are also not considered wages subject to FUTA tax. Generally, the taxpayer can take a credit against the FUTA tax liability for amounts paid into state unemployment funds. A state that has not repaid money it borrowed from the Federal government to pay unemployment benefits is a "credit reduction state." If the taxpayer paid wages that are subject to the unemployment compensation laws of a credit reduction state, the FUTA tax credit may be reduced. See the instructions for Form 1040, Schedule H - Household Employment Taxes, or the IRS.gov website for more information. (298)

The FUTA tax is 6.0% of an employee's FUTA wages. However, the taxpayer may be able to take a credit of up to 5.4% against the FUTA tax, resulting in a net tax rate of 0.6%. The taxpayer’s credit for 2023 is limited unless he or she pays all the required contributions for 2023 to his or her state unemployment fund by April 15, 2024. The credit

the taxpayer can take for any contributions for 2023 that he or she pays after April 15, 2024, is limited to 90% of the credit that would have been allowable if the contributions were paid by April 15, 2024.

Schedule H - Household Employment Taxes

If the taxpayer pays wages subject to FICA tax, FUTA tax, or if he or she withholds Federal income tax from and employee's wages, he or she will need to file a Form 1040, Schedule H - Household Employment Taxes. Attach Schedule H to the individual income tax return. If the taxpayer is not required to file a return, he or she must still file Schedule H to report household employment taxes.

Lesson 15 - Additional Taxes

However, a sole proprietor who must file Form 940 - Employer's Annual Federal Unemployment (FUTA) and Form 941 - Employer's QUARTERLY Federal Tax Return or Form 944 - Employer's ANNUAL Federal Tax Return, for business employees, or Form 943 - Employer's Annual Federal Tax Return for Agricultural Employees, for farm employees, may report household employee tax information on these forms instead of on Schedule H. If the taxpayer chooses to report the wages for a household employee on the forms shown above, be sure to pay any taxes due by the date required based on the form, making Federal tax deposits if required. Additional information is available in the instructions for the form.

Estimated Tax Payments

If your client files Form 1040, Schedule H, he or she can avoid owing taxes with the return if he or she pays enough tax before filing the return to cover both the employment taxes for the household employee and the income tax. If the taxpayer is employed, he or she can ask the employer to withhold more Federal income tax from wages during the year. The taxpayer can also make estimated tax payments to the IRS during the year using Form 1040-ES - Estimated Tax for Individuals.

Voluntary Classification Settlement Program (VCSP) The Voluntary Classification Settlement Program (VCSP) is a voluntary program that provides an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from Federal employment taxes. To participate in this voluntary program, the taxpayer must meet certain eligibility requirements and apply to participate in the VCSP by filing Form 8952 - Application for Voluntary Classification Settlement Program and enter into a closing agreement with the IRS. The VCSP allows eligible taxpayers to obtain relief similar to that currently available through the Classification Settlement Program for taxpayers under examination. The VCSP, originally released in Announcement 2011-64, has been modified in Announcement 2012-45 to: (299)

➢ Permit a taxpayer under IRS audit, other than an employment tax audit, to be eligible to participate in the VCSP. ➢ Clarify the current eligibility requirement that a taxpayer who is a member of an affiliated group within the meaning

of Section 1504(a) is not eligible to participate in the VCSP if any member of the affiliated group is under employment tax audit.

➢ Clarify that a taxpayer is not eligible to participate if the taxpayer is contesting in court the classification of the class or classes of workers from a previous audit by the IRS or Department of Labor.

➢ Eliminate the requirement that a taxpayer agrees to extend the period of limitations on assessment of employment taxes as part of the VCSP closing agreement with the IRS.

VCSP Agreements

A taxpayer participating in the VCSP will agree to prospectively treat the class or classes of workers as employees for future tax periods. In exchange, the taxpayer will: (299)

➢ Pay 10% of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of Section 3509(a) of the Internal Revenue Code. See Instructions to Form 8952 for more information.

➢ Not be liable for any interest and penalties on the amount. ➢ Not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified

under the VCSP for prior years.

Applying for VCSP

To participate in the VCSP, a taxpayer must apply using Form 8952 - Application for Voluntary Classification Settlement Program. The application should be filed at least 60 days prior to the date the taxpayer wants to begin treating its workers as employees. The IRS will make every effort to process Form 8952 with sufficient time to allow for the voluntary reclassification on the requested date. Along with the application, the taxpayer may provide the name of a contact or an authorized representative with a valid Power of Attorney (Form 2848). However, the taxpayer, and not the taxpayer's representative, is required to sign Form 8952. The IRS will contact the taxpayer or authorized representative to complete the process after reviewing the application and verifying the taxpayer’s eligibility. Eligible taxpayers accepted into the VCSP will enter into a closing agreement with the IRS to finalize the terms of the VCSP and will simultaneously make full and complete payment of any amount due under the closing agreement.

Lesson 15 - Additional Taxes

Review Feedback Review feedback provides both the answers to each question and an explanation or feedback as to how we arrived at each answer at the end of the lesson. Review feedback also contains evaluative feedback explaining why incorrect answers are wrong. You are also provided the course topic from which we derived our answer and the external source material we used for verification. If you are using the online version of the course, Ctrl+click on the topic to find the section from which we arrived at the answer for the question. You can also Ctrl+click on the question number to return to the specific review question. Question 1 - D. $13,000 After subtracting the exemption amount from the taxpayer’s AMTI, multiply the remainder by the applicable AMT rate of 26% or 28%. Generally, the resulting figure is his or her tentative minimum tax (TMT). Compare the taxpayer’s TMT with his or her regular income tax. If the regular tax is higher, the taxpayer does not owe any AMT. But if the regular tax is lower, the difference between the two taxes is the amount of AMT he or she must pay in addition to his or her regular tax (if any). In this question, Steve’s regular income tax is $40,000. When he calculates his tax using the alternative minimum tax (AMT) rules, he comes up with $53,000. Therefore, Steve must pay $13,000 ($53,000 - $40,000) of AMT in addition to the $40,000 of regular income tax. Only Choice D has the correct amount and is therefore the correct response. Topic - Alternative Minimum Tax Source - IRS.GOV - Topic No. 556 - Alternative Minimum Tax Question 2 - D. $8,800 Ordinarily, single individuals can subtract a $81,300 exemption amount from their AMT taxable income. However, a child who files Form 8615 has a limited exemption amount. The child's exemption amount for 2023 is limited to the child's earned income plus $8,800. Only Choice D has the correct amount and is therefore the correct response. Topic - AMT Exemption for Certain Children Source - IRS.GOV - Topic No. 556 - Alternative Minimum Tax Question 3 - D. $1,156,300 Under the Tax Cuts and Jobs Act (TCJA), the Alternative Minimum Tax (AMT) exemption has increased to $81,300 ($126,500 if married filing jointly or surviving spouse; $63,250 if married filing separately) in 2023. Also, the amount used to determine the phaseout of the taxpayer’s exemption has increased to $578,150 ($1,156,300 if married filing jointly). Only Choice D has the correct amount and is therefore the correct response. Topic - AMT Exemption Phase-out Source - IRS.GOV - Topic No. 556 - Alternative Minimum Tax Question 4 - D. 27 years Health coverage for an employee's children under 27 years of age is now generally tax-free to the employee. This expanded health care tax benefit applies to various workplace and retiree health plans. These changes immediately allow employers with cafeteria plans (plans that allow employees to choose from a menu of tax-free benefit options and cash or taxable benefits) to permit employees to begin making pre-tax contributions to pay for this expanded benefit. This also applies to self-employed individuals who qualify for the self-employed health insurance deduction on their Federal income tax return. Only Choice D has the correct number of years and is therefore the correct response. Topic - Health Coverage for Older Children Source - IRS.GOV - Topic No. 763 - The Affordable Care Act Question 5 - B. $12,920,000 Estates of decedents who die during 2023 have a basic exclusion amount of $12,920,000, up from a total of $12,060,000 for estates of decedents who died in 2022. Only Choice B has the correct amount and is therefore the correct response. Topic - Estate Tax Source - IRS.GOV - Estate Tax

Lesson 15 - Additional Taxes

Question 6 - A. $7,000 If a taxpayer paid cash wages to household employees totaling more than $1,000 in any calendar quarter during the calendar year or the prior year, he or she generally must pay Federal unemployment tax (FUTA) tax on the first $7,000 of cash wages paid to each household employee. However, do not count wages paid to his or her spouse, his or her child who is under the age of 21, or his or her parent. The amounts the taxpayer pays to these individuals are also not considered wages subject to FUTA tax. Generally, the taxpayer can take a credit against the FUTA tax liability for amounts paid into state unemployment funds. Only Choice A has the correct amount and is therefore the correct response. Topic - Household Employment Taxes Source - IRS.GOV - Topic No. 756 - Employment Taxes for Household Employees

Penalties At the conclusion of this lesson you should have a basic knowledge of:

➢ Taxpayer Civil Penalties. ➢ Taxpayer Criminal Penalties.

Civil Penalties Federal law provides Civil Penalties for failure to file income tax returns or pay income taxes as required. The failure-to-file penalty is generally more than the failure-to-pay penalty. So, the taxpayer should still file the tax return on time and pay as much as he or she can then explore other payment options. The IRS will work with the taxpayer. The following are examples of penalties a taxpayer may face for failing to file or filing late. (300)

Failure to File Generally, April 15 is the deadline for most people to file their individual income tax returns and pay any tax owed. During its processing, the IRS checks for mathematical accuracy on the taxpayer’s return. When processing is complete, if the taxpayer owes any tax, penalty, or interest, he or she will receive a bill. Generally, interest accrues on any unpaid tax from the due date of the return until the date of payment in full. The interest rate is determined quarterly and is the Federal short-term rate plus 3%. Interest compounds daily.

Filing Late

A late filing penalty is usually charged if the taxpayer’s return is filed after the due date (including extensions). The penalty is usually 5% of the amount due for each month or part of a month his or her return is late. The maximum penalty is 25%. If the taxpayer’s return is more than 60 days late, the minimum penalty is $485 (for tax returns required to be filed in 2023) or the balance of the tax due on his or her return, whichever is smaller. The taxpayer

might not owe the penalty if he or she a reasonable explanation for filing late. The taxpayer should attach a statement to his or her return fully explaining his or her reason for filing late. (301)

The Setting Every Community Up for Retirement Enhancement (SECURE) Act increased the failure to file penalty for tax returns due after the end of 2019. The new penalty is adjusted for inflation after tax year 2021.

Paying Late

If the taxpayer files a return but does not t pay all tax owed on time, he or she will generally have to pay a late payment penalty. The failure to pay penalty is usually ½ of 1% of any tax, or part of a month, up to a maximum of 25% of the amount of tax that remains unpaid from the due date of the return until the tax is paid in full. The ½ of 1% rate increases to 1% if the tax remains unpaid 10 days after the IRS issues a notice of intent to levy property. This penalty does not apply during the automatic 6- month extension of time to file period if he or she paid at least 90% of his or her actual tax liability on or before the due date of his or her return and pay the balance when he or she files the return. If the taxpayer files his or her return by its due date and requests an installment agreement, the ½ of 1% rate decreases to ¼ of 1% for any month in which an installment agreement is in effect. Be aware that the IRS applies payments to the tax first, then any penalty, then to interest. Any penalty amount that appears on the taxpayer’s bill is generally the total amount of the penalty up to the date of the notice, not the penalty amount charged each month. If a notice of intent to levy is issued, the rate will increase to 1% at the start of the first month beginning at least 10 days after the day that the notice is issued. If a notice and demand for immediate payment is issued, the rate will increase to 1% at the start of the first month beginning after the day that the notice and demand is issued.

Lesson 16 - Penalties

The late payment penalty is usually ½ of 1% of any tax (other than estimated tax) not paid by the filing due date. It is charged for each month or part of a month the tax is unpaid. The maximum penalty is 25%. (302)

Review Question 1 If a taxpayer files a return by the due date (including extensions) but does not make a full payment, what is usually the late payment penalty for unpaid taxes?

A. ½ of 1% for each month, but not more than 25% B. 1% for each month, but not more than 30% C. 2% for each month, but not more than 40% D. 3% for each month, but not more than 50%

See Review Feedback for answer.

Failure to File and Failure to Pay

If a combination of the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5% failure-to-file penalty is reduced by the failure-to-pay penalty. However, if the return is filed more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $485 or 100% of the unpaid tax in 2023.

A taxpayer will not have to pay a penalty if the taxpayer shows he or she failed to file or pay on time because of reasonable cause and not because of willful neglect. The taxpayer must also show that he or she acted in good faith. (303)

Estimated Tax-Related Penalties

Employees have taxes withheld from their paychecks by their employer. When a taxpayer has income that is not subject to withholding, he or she may have to make estimated tax payments during the year. This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes, and awards. The taxpayer may also have to pay estimated tax if the amount being withheld from his or her salary, pension, or other income is not enough to pay the tax liability.

Estimated tax payments are used to pay income tax and self-employment tax, as well as other taxes and amounts reported on the tax return. If the taxpayer does not pay enough through withholding or estimated tax payments, he or she may have to pay a penalty. If the taxpayer does not pay enough by the due date of each payment period, he or she may be charged a penalty even if the taxpayer is due a refund when he or she files the tax return. (304)

Accuracy The two most common accuracy related penalties are the substantial understatement penalty and the negligence or disregard of the rules or regulations penalty. However, the taxpayer may have to pay an accuracy-related penalty if he or she underpays his or her tax because:

➢ He or she shows negligence or disregard of the rules or regulations. ➢ He or she substantially understates his or her income tax. ➢ He or she claims tax benefits for a transaction that lacks economic substance. ➢ He or she fails to disclose a foreign financial asset.

The penalty is equal to 20% of the underpayment. The penalty is 40% of any portion of the underpayment that is attributable to an undisclosed noneconomic substance transaction or an undisclosed foreign financial asset transaction. The penalty will not be figured on any part of an underpayment on which the fraud penalty is charged. The term “negligence” includes a failure to make a reasonable attempt to comply with the tax law or to exercise ordinary and reasonable care in preparing a return. Negligence also includes failure to keep adequate books and records. The taxpayer will not have to pay a negligence penalty if he or she has a reasonable basis for a position he or she took. The term “disregard” includes any careless, reckless, or intentional disregard. (305)

Lesson 16 - Penalties

Substantial Understatement

The understatement is substantial if it is more than 10% of the correct tax or $5,000. To properly disclose the position, complete and attach IRS Form 8275 - Disclosure Statement to the tax return and disclose all relevant facts. As of December 31, 2015, if the taxpayer fails to report a substantial amount of income, then the IRS has 6 years (instead of 3 years) to create an audit assessment. In this case, the taxpayer must have failed to report 25% or more of his or her total income. (305)

The taxpayer may avoid the substantial understatement penalty if he or she has substantial authority for his or her tax treatment of the item or through adequate disclosure. To avoid the substantial understatement penalty by adequate disclosure, the taxpayer must properly disclose the position on the tax return and there must at least be a reasonable basis for the position. To properly disclose the position, the taxpayer completes and attaches IRS Form 8275 - Disclosure Statement to his or her tax return and discloses all relevant facts. A reasonable basis is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper. The position must be more than just merely arguable or merely a colorable claim. The position must be reasonably based on authority supporting the position.

Negligence or Disregard of the Rules

Negligence includes (but is not limited to) any failure to: (305)

➢ Make a reasonable attempt to comply with the internal revenue laws. ➢ Exercise ordinary and reasonable care in preparation of a tax return. ➢ Keep adequate books and records or to substantiate items properly.

This penalty may be asserted if the taxpayer carelessly, recklessly or intentionally disregards IRS rules and regulations - by taking a position on his or her return with little or no effort to determine whether the position is correct or knowingly taking a position that is incorrect. The taxpayer will not have to pay a negligence penalty if there was a reasonable cause for a position he or she took and he or she acted in good faith. Negligence includes any failure to make reasonable attempts to comply with the tax code. The understatement of tax is considered substantial if the taxpayer understates his or her income by more than 10% or $5,000.

Fraud Generally, the civil fraud tax penalty is applicable to any and all civil tax enforcement actions when certain elements are present. These elements include a material misrepresentation and knowledge of the fact that what was being purported as true was, in fact, false. The IRS can usually distinguish when an error is the result of negligence or the willful evasion of the tax law. Tax auditors look for common types of suspicious and fraudulent activity, such as:

➢ Overstatement of deductions and exemptions. ➢ Falsification of documents. ➢ Concealment or transfer of income. ➢ Keeping two sets of financial ledgers. ➢ Falsifying personal expenses as business expenses. ➢ Using a false Social Security number. ➢ Claiming an exemption for a nonexistent dependent, such as a child. ➢ Willfully underreporting income.

If a taxpayer’s failure to file is due to fraud, the penalty is imposed at the rate of 15% for each month, up to 75% of the portion of any underpayment that is attributable to fraud. If a taxpayer’s underpayment is due to fraud, a penalty of 75% of the underpayment due to fraud will be added to the tax. (305)

Joint Return

The fraud penalty on a joint return does not apply to a spouse unless some part of the underpayment is due to the fraud of that spouse. Negligence or ignorance of the law does not constitute fraud.

Lesson 16 - Penalties

Review Question 2 If a taxpayer’s failure to file is due to fraud, what is the penalty imposed?

A. 10% for each month, up to 50% B. 15% for each month, up to 75% C. 20% for each month, up to 80% D. 25% for each month, up to 85%

See Review Feedback for answer.

Failure to Supply Social Security Number (SSN)

If the taxpayer does not include his or her SSN or the SSN of another person where required on a return, statement, or other document, he or she will be subject to a penalty of $50 for each failure. The taxpayer will also be subject to a penalty of $50 if he or she does not give his or her SSN to another person when it is required on a return, statement, or other document.

Frivolous Tax Return

A taxpayer may have to pay a penalty of $5,000 if he or she files a frivolous return. A frivolous return is one that does not include enough information to figure the correct tax or that contains information clearly showing that the tax reported is substantially incorrect. A taxpayer will have to pay the penalty if he or she filed this kind of return because of a frivolous position on the taxpayer’s part or a desire to delay or interfere with the administration of Federal income tax laws. This includes altering or striking out the preprinted language above the space provided for the taxpayer’s signature. (305)

Dishonored Payments

At times, taxpayers will call the IRS because they received a Letter 608C - Dishonored Check Penalty Explained, stating that their payment was dishonored and returned from a financial institution unpaid. When this letter is sent out to the taxpayer, the check is determined to be unpaid and the IRS will not resubmit it for payment. The IRS does not submit checks or other commercial payment instruments a second time for payment. When a check or other commercial payment instrument is not paid, however, the clearinghouse does frequently resubmit it to the bank. The clearinghouse, not the IRS, determines whether or not to resubmit a payment so the IRS does not know if the payment instrument will be submitted a second time or not by the clearinghouse. It is up to the taxpayer to decide whether to wait and see if the clearinghouse resubmits it to the bank, or whether he or she should make an additional payment. If the taxpayer’s check or other commercial payment instrument is resubmitted and there are sufficient funds in his or her bank account to cover it, the check will be paid and not returned to the IRS, so the taxpayer will not be charged the dishonored check penalty. If the payment is honored after the due date, however, the taxpayer may be charged interest and a penalty for the late payment. The IRS will notify the taxpayer if a balance becomes due on his or her account. When a check or other commercial payment instrument the IRS receives for payment of taxes does not clear the bank, a penalty of 2% of the amount of the check or other commercial payment instrument generally applies. However, if the amount of the check or other commercial payment instrument is less than $1,250, the penalty is $25 or the amount of the check or other commercial payment instrument, whichever is less. Thus, if the amount of the check or other commercial payment instrument is between $25 and $1,250, the penalty is $25. The IRS can abate (remove) this penalty in certain circumstances. The taxpayer may request penalty abatement by explaining why the payment was dishonored. The taxpayer must make this request in writing and should only do it after he or she has received the Letter 608C notifying him or her of a penalty assessment. A dishonored check penalty is not assessed on checks or other payment instruments for which the taxpayer placed a stop payment order. If he or she is assessed a penalty, the taxpayer should send a copy of the stop payment request along with his or her penalty relief request to the service center address listed on his or her Letter 608C. (305)

Lesson 16 - Penalties

Review Question 3 If a taxpayer’s check used to pay taxes is returned for insufficient funds (bounces), the IRS may impose a penalty. If the check amount is more than $1,250 the penalty is what percentage of the amount of the check?

A. 2% B. 5% C. 7.5% D. 10%

See Review Feedback for answer.

Criminal Prosecution A taxpayer may be subject to Criminal Prosecution (brought to trial) for actions such as:

➢ Tax evasion. ➢ Willful failure to file a return, supply information, or pay any tax due. ➢ Fraud and false statements. ➢ Preparing and filing a fraudulent return.

Identity Theft

Identity theft occurs when someone uses a taxpayer’s personal information such as his or her name, Social Security Number (SSN), or other identifying information, without his or her permission, to commit fraud or other crimes. An identity thief may use the taxpayer’s SSN to get a job or may file a tax return using his or her SSN to receive a refund. To reduce his or her risk of identity theft, a taxpayer should:

1. Protect his or her SSN. 2. Ensure his or her employer is protecting his or her SSN. 3. Be careful when choosing a tax preparer.

If an individual’s tax records are affected by identity theft and he or she receives a notice from the IRS, the individual responds right away to the name and phone number printed on the IRS notice or letter.

Abusive Tax Schemes

Investors of abusive tax schemes that try to escape their legal tax responsibilities are still liable for taxes, interest, and civil penalties. Violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty or criminal prosecution. Civil fraud can include a penalty of up to 75% of the underpayment of tax attributable to fraud, in addition to the taxes owed. Criminal convictions of promoters and investors of abusive tax schemes may result in fines up to $250,000 and up to five years in prison. (306)

Common Abusive Tax Schemes

Tax evasion using foreign jurisdictions is accomplished using many different methods. Some can be as simple as taking unreported cash receipts and personally traveling to a tax haven country and depositing the cash into a bank account. Others are more elaborate involving numerous domestic and foreign trusts, partnerships, nominees, etc. The following schemes are not all-inclusive, but just a sample of abusive tax schemes. (307)

Abusive Foreign Trust Schemes

The foreign trust schemes usually start off as a series of domestic trusts layered upon one another. This set up is used to give the appearance that the taxpayer has turned his/her business and assets over to a trust and is no longer in control of the business or its assets. Once transferred to the domestic trust, the income and expenses are passed to one or more foreign trusts, typically in tax haven countries. As an example, a taxpayer's business is split into two trusts. One trust would be the business trust that is in charge of the daily operations. The other trust is an equipment trust formed to hold the business's equipment that is leased back to the business trust at inflated rates to nullify any income reported on the business trust tax return (Form 1041). Next the income from the equipment trust is distributed to foreign trust-one, again,

Lesson 16 - Penalties

which nullifies any tax due on the equipment trust tax return. Foreign trust-one then distributes all or most of its income to foreign trust-two. Since all of foreign trust-two's income is foreign based there is no filing requirement. Once the assets are in foreign trust-two, a bank account is opened either under the trust name or an International Business Corporation (IBC). The trust documentation and business records of this scheme all make it appear that the taxpayer is no longer in control of his/her business or its assets. The reality is that nothing ever changed. The taxpayer still exercises full control over his or her business and assets. There can be many different variations to the scheme. (307)

International Business Corporations (IBC)

The taxpayer establishes an IBC with the exact name as that of his/her business. The IBC also has a bank account in the foreign country. As the taxpayer receives checks from customers, he sends them to the bank in the foreign country. The foreign bank then uses its correspondent account to process the checks so that it would never appear to the customer, upon reviewing the canceled check, that the payment was sent offshore. Once the checks clear, the taxpayer's IBC account is credited for the check payments. Here the taxpayer has, again, transferred the unreported income offshore to a tax haven jurisdiction. (307)

False Billing Schemes

A taxpayer sets up an International Business Corporation (IBC) in a tax haven country with a nominee as the owner (usually the promoter). A bank account is then opened under the IBC. On the bank's records the taxpayer would be listed as a signatory on the account. The promoter then issues invoices to the taxpayer's business for goods allegedly purchased by the taxpayer. The taxpayer then sends payment to the IBC that gets deposited into the joint account held by the IBC and taxpayer. The taxpayer takes a business deduction for the payment to the IBC thereby reducing his or her taxable income and has safely placed the unreported income into the foreign bank account. (307)

Review Question 4 A taxpayer may be subject to criminal prosecution (brought to trial) for which of the following actions?

A. Tax evasion B. Willful failure to file a return C. Fraud and false statements D. All of the above

See Review Feedback for answer.

Fixing America’s Surface Transportation (FAST) Act

The Fixing America’s Surface Transportation (FAST) Act was signed into law in December 2015. The purpose of the FAST Act was to provide long-term funding for transportation projects, including new highways. Also included in the bill was a new tax law that requires the Department of State to deny a passport (or renewal of a passport) to a seriously delinquent taxpayer or revoke any passport previously issued to a seriously delinquent taxpayer. For purposes of the law, a “seriously delinquent tax debt” is defined as “an unpaid, legally enforceable Federal tax liability” when a debt greater than $59,000 for 2023, including interest and penalties, has been assessed and a notice of lien or a notice of levy has been filed. The $59,000 limit is adjusted each year for inflation and cost of living. The limit is not per year but cumulative meaning that it is the total tax debt that matters. There are some exceptions under the law. Tax debt which is being paid on time as part of an installment agreement or under an Offer In Compromise does not count. It also does not include any tax debt for which a Collection Due Process hearing is timely requested in connection with a levy or a debt where the collection has been suspended due to an innocent spouse claim. If the taxpayer is seriously delinquent under the law, the IRS is required to notify him or her in writing at the time that it certifies the debt to the State Department. The State Department will then hold his or her passport application or renewal for 90 days to allow the taxpayer to resolve any errors, make full payment, or enter into a satisfactory payment plan. There is no grace period for resolving the debt before the State Department revokes an existing passport. To get off the list, the taxpayer must prove that the debt is fully satisfied, is legally unenforceable or is not seriously delinquent tax debt under the statute.

Lesson 16 - Penalties

Erroneous Claim For Refund Or Credit

Section 6676 imposes a penalty on a taxpayer who files a claim for refund or credit of income tax in an amount that is determined to be excessive. The Section 6676 penalty is equal to 20% of the excessive amount, the amount by which the claim for refund or credit exceeds the amount allowable for the tax year at issue. The penalty can be waived if the taxpayer demonstrates reasonable cause.

Information Return Penalties

Information returns, including Form W-2 and W-3, Form 1099-MISC and Form 1099-NEC, are an important piece of year- end planning. If these forms are not filed correctly, there can be substantial penalties. These penalties include late filing or missed deadlines, incorrect submission of information or missing information. Beginning with the 2016 tax year employers must send Copy A of Forms W-2 and W-3 to the Social Security Administration by January 31 of the following year for both paper and electronic forms. Employers must furnish Copy B and any other applicable copies of information returns to the employee by January 31 of the following year. The amount of the penalty is based on when the taxpayer files the correct information return. In 2023, the penalty is as follows:

➢ $60 per information return if correctly filed within 30 days (by March 30 if the due date is February 28); maximum penalty $630,500 per year ($220,500 for small businesses).

➢ $120 per information return if correctly filed more than 30 days after the due date but by August 1; maximum penalty $1,891,500 per year ($630,500 for small businesses).

➢ $310 per information return if filed after August 1 or taxpayer does not file required information returns; maximum penalty $3,783,000 per year ($1,261,000 for small businesses).

Penalties for not filing correct information returns (Code Section 6721) may apply if the taxpayer:

➢ Does not file a correct information return by the due date and a reasonable cause is not shown. ➢ Files on paper when he or she was required to file electronically. ➢ Does not report a Taxpayer Identification Number (TIN). ➢ Reports an incorrect TIN. ➢ Does not file paper forms that are machine readable.

Penalties for not providing correct payee statements (Code Section 6722) may apply if:

➢ The taxpayer does not provide a correct payee statement by the applicable date and a reasonable cause is not shown.

➢ All required information is not shown on the statement. ➢ Incorrect information is included on the statement.

In 2023, if any failure to file a correct information return is due to intentional disregard of the filing or correct information requirements, the penalty is at least $630 per information return with no maximum penalty.

Failure to Deposit Penalty

The Failure to Deposit Penalty applies to employers that do not make employment tax deposits:

➢ On time. ➢ In the right amount. ➢ In the right way.

Employer-paid taxes include Federal income tax, Social Security and Medicare taxes and Federal Unemployment Tax. Employers must send employment tax deposits to the IRS on a monthly or semi-weekly schedule. The amount of the Failure to Deposit Penalty based on the number of calendar days the deposit is late, starting from its due date. The penalty amounts do not add up. For example, if the deposit is more than 15 calendar days late, the IRS does not add a 10% penalty to the earlier 2% and 5% late penalties. Instead, in this example, the new total penalty would be 10%.

Lesson 16 - Penalties

Number of Days The Deposit is Late Amount of the Penalty

1-5 calendar days 2% of the unpaid deposit

6-15 calendar days 5% of the unpaid deposit

More than 15 calendar days 10% of the unpaid deposit

More than 10 calendar days after the date of the first notice or letter (for example, CP220 Notice) or the day the taxpayer gets a notice or letter for immediate payment (for example, CP504J Notice)

15% of the unpaid deposit

Table 16-1 - Failure to Deposit Penalty (2023)

The IRS charges interest on penalties. The date from which the IRS begins to charge interest varies by the type of penalty. Interest increases the amount the taxpayer owes until he or she pays the balance in full.

Lesson 16 - Penalties

2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders At the conclusion of this lesson you should have a basic knowledge of:

➢ Tax Law Administration. ➢ Provisions of the Tax Cuts and Jobs Act (TCJA). ➢ Provisions of the Further Consolidated Appropriations Act. ➢ Recent Federal Tax Law Reminders.

Administration This course has taught you most of the up-to-date rules that you will need to know to prepare a client's return. However, every year Congress changes the tax laws, and part of being a tax professional is knowing where to look to find these changes. In its role in administering the tax laws enacted by the Congress, the IRS must take the specifics of these laws and translate them into detailed regulations, rules and procedures. The Office of Chief Counsel fills this crucial role by producing several different kinds of documents and publications that provide guidance to taxpayers, firms and charitable groups.

The Internal Revenue Code

The first place that any tax professional looks for answers is the Internal Revenue Code, or simply, "the Code." These are the tax laws as passed by Congress. The first real tax Code became law in 1939. It was rewritten fifteen years later in 1954, again in 1986, again in 1997, once more in 2001, in both 2003 and 2004, and, recently, in 2017. In addition, every year Congress passes new tax laws, or amendments, which then become part of the existing Internal Revenue Code. Although the Code is the first place to look, it is not the only place to look. When you cannot find the answer in “the Code”, you then turn to the Regulations.

Treasury Regulations

Treasury Regulations, which most tax professionals simply call "the Regs," are the IRS's interpretation of the Internal Revenue Code. Unfortunately, the Code is not always as clear as most tax practitioners would prefer. It is not uncommon for someone to look something up in the Code, and still not find the answer. At this point you turn to the Regs. They will often give, not only an explanation of the part of the Code that you may not

understand, but also examples of how the IRS sees the Code in various situations. Like the Code itself, the Regulations have the force of the law.

Revenue Rulings

Every year, the IRS issues numerous so-called Revenue Rulings. Just as the Regs are an interpretation of the Code, the Revenue Rulings are the IRS's interpretation of the Regs and the Code in very specific, factual situations. For example, they often start out with a hypothetical taxpayer problem. After going over the facts of the problem, the Ruling will then tell what the IRS thinks is the law used to solve the problem, and the conclusion that the IRS has come to regarding the hypothetical taxpayer. Revenue Rulings do not have the same force of law as the Code or Regulations. They are only the IRS's opinion about a given tax situation. However, they are quite useful in that they will tell taxpayers who might have the same or similar tax problem as the hypothetical taxpayer how the IRS will deal with that problem.

Court Decisions

Sooner or later, a taxpayer is going to disagree with the IRS. For example, the taxpayer may interpret the Code or Regs to say that he is allowed to take a particular deduction on his tax return. The IRS, on the other hand, may interpret the same Code section or Regulation to say that the taxpayer cannot. If the taxpayer and the IRS cannot settle the argument between themselves, the case may end up in a court of law.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

There are various courts to which taxpayers can go to resolve a dispute with the IRS, including the United States Tax Court (if tax is unpaid), the local Federal District Court (if tax is paid), and the U.S. Court of Claims (if tax is paid). When these courts decide an IRS-taxpayer dispute, they give the reasons for their decisions in writing. These decisions are then published and made available to all taxpayers. If after looking at the Code, the Regs and Revenue Rulings, you still cannot find the answer to a question, there is a good chance that some court published an opinion on the same or similar questions. You may want to look at that case for guidance.

Revenue Procedure

A revenue procedure is an official statement of a procedure that affects the rights or duties of taxpayers or other members of the public under the Internal Revenue Code, related statutes, tax treaties and regulations and that should be a matter of public knowledge. It is also published in the Internal Revenue Bulletin. While a revenue ruling generally states an IRS position, a revenue procedure provides return filing or other instructions concerning an IRS position. For example, a revenue procedure might specify how those entitled to deduct certain automobile expenses should compute them by applying a certain mileage rate in lieu of calculating actual operating expenses. (308)

Private Letter Ruling

A private letter ruling, or PLR, is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer's specific set of facts. A PLR is issued to establish with certainty the Federal tax consequences of a particular transaction before the transaction is consummated or before the taxpayer's return is filed. A PLR is issued in response to a written request submitted by a taxpayer and is binding on the IRS if the taxpayer fully and accurately described the proposed transaction in the request and carries out the transaction as described. A PLR may not be relied on as precedent by other taxpayers or IRS personnel. PLRs are generally made public after all information has been removed that could identify the taxpayer to whom it was issued. (308)

Technical Advice Memorandum

A technical advice memorandum, or TAM, is guidance furnished by the Office of Chief Counsel upon the request of an IRS director or an area director or appeals, in response to technical or procedural questions that develop during a proceeding. A request for a TAM generally stems from an examination of a taxpayer's return, a consideration of a taxpayer's claim for a refund or credit, or any other matter involving a specific taxpayer under the jurisdiction of the territory manager or the area director, appeals. Technical Advice Memoranda are issued only on closed transactions and provide the interpretation of proper application of tax laws, tax treaties, regulations, revenue rulings or other precedents. The advice rendered represents a final determination of the position of the IRS, but only with respect to the specific issue in the specific case in which the advice is issued. Technical Advice Memoranda are generally made public after all information has been removed that could identify the taxpayer whose circumstances triggered a specific memorandum. (308)

Notice

A notice is a public pronouncement that may contain guidance that involves substantive interpretations of the Internal Revenue Code or other provisions of the law. For example, notices can be used to relate what regulations will say in situations where the regulations may not be published in the immediate future. (308)

Announcement

An announcement is a public pronouncement that has only immediate or short-term value. For example, announcements can be used to summarize the law or regulations without making any substantive interpretation; to state what regulations will say when they are certain to be published in the immediate future; or to notify taxpayers of the existence of an approaching deadline. (308)

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Inflation Reduction Act

Major Tax Provisions

The Inflation Reduction Act includes the following major changes: Individual Income Taxes The extension to 2028 (two-year extension) of the excess business loss limitation, which limits the ability of noncorporate taxpayers to deduct business losses exceeding an indexed-for-inflation amount. For 2023, the amount is $289,000 ($578,000 for joint returns). The extension of the excess business loss limitation was inserted into the Act in lieu of any extension to the $10,000 limitation on state and local tax deductions (the “SALT Cap”). Extends the expanded health insurance Premium Tax Credits provided in the American Rescue Plan Act (ARPA), including allowing higher-income households to qualify for the credits and boosting the subsidy for lower-income households, through the end of 2025. Corporate and International Taxes Imposes a 15% minimum tax on certain corporations with average financial statement income exceeding $1 billion. The corporate alternative minimum tax (CAMT) is based in part on financial statement income, or “book income,” and targets corporations reporting substantial financial statement income but paying little or no U.S. income tax because of available deductions and credits. Creates a 1% excise tax on the value of stock repurchases during the taxable year, net of new issuances of stock, effective for repurchases after December 31, 2022. Excluded from the tax are stock contributed to retirement accounts, pensions, and employee-stock ownership plans (ESOPs).

High-Efficiency Electric Home Rebates

Although not a tax credit, the High-Efficiency Electric Home Rebate Program is designed help American families with home improvement. The program, which was added by the Inflation Reduction Act, will provide rebates to low- and middle- income families who purchase energy-efficient electric appliances. To qualify for a rebate, the taxpayer’s family's total annual income must be less than 150% of the median income where he or she lives. Qualifying taxpayers can get rebates as high as:

➢ $840 for a stove, cooktop, range, oven, or heat pump clothes dryer. ➢ $1,750 for a heat pump water heater. ➢ $8,000 for a heat pump for space heating or cooling.

Rebates for non-appliance upgrades will also be available up to the following amounts:

➢ $1,600 for insulation, air sealing, and ventilation. ➢ $2,500 for electric wiring. ➢ $4,000 for an electric load service center upgrade.

A rebate cannot exceed 50% of the cost of a qualified electrification project if the taxpayer's annual income is between 80% and 150% of the area median income. Each qualifying taxpayer will also be limited to no more than $14,000 in total rebates under the program. The funds will be available through September 30, 2031.

Enhanced Premium Tax Credit Extension

The Affordable Care Act (ACA) included enhanced a Premium Tax Credit (PTC) to help individuals and families with incomes between 100% and 400% of the Federal Poverty Line (FPL) purchase health insurance on the Marketplace. As part of the American Rescue Plan Act (ARPA) of 2021, the Premium Tax Credit was opened up to far more taxpayers via a temporary extension for individuals with incomes above 400% of the FPL and a more generous subsidy for those below 400%. For 2021 and 2022, ARPA also expanded the ACA requirement that a health plan premium not be more than 8.5% of an individual’s income to those with incomes above 400% of the FPL. These tax credits were originally set to expire on January 1, 2023. The new provision within the Inflation Reduction Act extends them through 2025.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

American Rescue Plan (ARP)

Student Loan Debt

The American Rescue Plan Act of 2021 modified the treatment of student loan forgiveness for discharges in 2021 through 2025. Generally, if the taxpayer is responsible for making loan payments, and the loan is canceled or repaid by someone else, he or she must include the amount that was canceled or paid on his or her behalf in his or her gross income for tax purposes. However, in certain circumstances, the taxpayer may be able to exclude this amount from gross income if the loan was one of the following: (272)

➢ A loan for postsecondary educational expenses. ➢ A private education loan. ➢ A loan from an educational organization described in Section 170(b)(1)(A)(ii). ➢ A loan from an organization exempt from tax under Section 501(a) to refinance a student loan.

Although the Federal tax code generally treats forgiven debt as taxable income, the American Rescue Plan includes a measure that exempts canceled student debt from taxation through 2025. The result is that student loan forgiveness would not result in the forgiveness being subject to Federal income tax.

Changes Expanding Earned Income Tax Credit (EITC) for Future Years

Changes expanding the EITC for future years include:

➢ Singles and couples who have Social Security numbers can claim the credit, even if their children do not have SSNs. In this instance, they would get the smaller credit available to childless workers. In the past, these filers did not qualify for the credit.

➢ More workers and working families who also have investment income can get the credit. In 2023, the limit on investment income is increased to $11,000.

➢ Married but Separated spouses can choose to be treated as not married for EITC purposes. To qualify, the spouse claiming the credit cannot file jointly with the other spouse, cannot have the same principal residence as the other spouse for at least six months out of the year and must have a qualifying child living with them for more than half the year.

Employee Retention Credit

The Taxpayer Certainty and Disaster Tax Relief Act of 2020, enacted December 27, 2020, made a number of changes to the Employee Retention Credit (ERC) previously made available under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). As a result of the new legislation, eligible employers can now claim a refundable tax credit against the employer share of Social Security tax equal to 70% of the qualified wages they pay to employees after December 31, 2020, through September 30, 2021. Qualified wages are limited to $10,000 per employee per calendar quarter in 2021. Thus, the maximum ERC amount available is $7,000 per employee per calendar quarter. The credit is applied against the employer’s share of payroll taxes, and to the extent the credit exceeded the employer’s share of payroll taxes, the IRS refunds the difference to the employer. Employers can access the ERC for 2021 prior to filing their employment tax returns by reducing employment tax deposits. Small employers (i.e., employers with an average of 500 or fewer full-time employees in 2019) may request advance payment of the credit (subject to certain limits) on Form 7200 - Advance of Employer Credits Due To COVID-19. With the passage of the Infrastructure Investment and Jobs Act, the expiration of the Employee Retention Credit was accelerated from December 31, 2021 to September 30, 2021. Only recovery startup businesses remained eligible to claim the credit until December 31, 2021. A taxpayer can continue to claim the ERC because the original program allowed businesses to claim this credit for 3 years. This means he or she can claim 2020 expenses until April 15, 2024, and 2021 expenses by April 15, 2025. There is one exception: recovery startup businesses had a January 1, 2022, deadline under the Infrastructure Investment and Jobs Act.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Tax Cuts and Jobs Act (TCJA) The Tax Cuts and Jobs Act (TCJA) is designed to cut taxes on individuals and businesses, and to stimulate the economy and create jobs. The tax cuts are projected to be nearly $1.5 trillion. The long-term impact on the deficit is unclear as the measure adds to the deficit in the short term but could reduce it in the long term if predictions of economic growth are realized. With respect to individuals, among other items the TCJA:

➢ Changed the seven existing tax brackets. ➢ Increased the standard deduction. ➢ Repealed the deduction for personal exemptions. ➢ Increased the Child Tax Credit. ➢ Repealed the overall limitation on certain itemized deductions. ➢ Limited the mortgage interest deduction. ➢ Limited the deduction for state and local income or sales taxes.

The Tax Cuts and Jobs Act tax provisions for individuals, including the new tax rates, began January 1, 2018, and will expire at the end of 2025. At that time, unless Congress extends the legislation, the law will go back to the way it was prior to the new legislation. (309)

Setting Every Community Up for Retirement Enhancement (SECURE) Act As part of the spending bill Congress passed the Setting Every Community Up for Retirement Enhancement (SECURE) Act. The SECURE Act represents a major overhaul of the rules for retirement plans and IRAs and is generally effective as of January 1, 2020. The following are several key provisions included in the SECURE Act: (197)

➢ Expansion of Section 529 Plans: The legislation expands Section 529 education savings accounts to cover costs associated with registered apprenticeships; homeschooling; up to $10,000 of qualified student loan repayments (including those for siblings); and private elementary, secondary, or religious schools.

Tax Forms

Form 1099-NEC

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Beginning with the 2020 tax year, the IRS requires business taxpayers to report nonemployee compensation on the new Form 1099-NEC instead of on Form 1099-MISC. Businesses need to use this form if they made payments totaling $600 or more to a nonemployee, such as an independent contractor. In general, a business must report payments it makes if it meets the following four conditions:

1. The payment is made to someone who is not an employee. 2. The payment is made for services in the course of trade or business. 3. The payment is made to an individual, partnership, estate, or corporation. 4. The payment total is at least $600 for the year.

Additionally, businesses will need to file Form 1099-NEC

➢ When they pay an individual at least $10 in royalties, or ➢ If the business has withheld any federal income tax under the backup withholding rules regardless of the amount

of payments for the year to the nonemployee.

Nonemployee compensation can include:

Generally, payers need to file these forms by January 31 and have no automatic 30-day extensions to file unless the business meets certain hardship conditions.

Form 1040-NR Revision

Form 1040-NR has been revised to more closely follow the format of Forms 1040 and 1040-SR. As of 2020, Form 1040- NR will use Schedules 1, 2, and 3.

Individual and Capital Gains Tax Rates

Tax Rate Schedules for 2023

Unmarried Individuals (other than Qualifying Surviving Spouses and Heads of Households)

If Taxable Income Is: The Tax Is:

Not over $11,000 10% of the taxable income

Over $11,000 but not over $44,725 $1,100 plus 12% of the excess over $11,000

Over $44,725 but not over $95,375 $5,147 plus 22% of the excess over $44,725

Over $95,375 but not over $182,100 $16,290 plus 24% of the excess over $95,375

Over $182,100 but not over $231,250 $37,104 plus 32% of the excess over $182,100

Over $231,250 not over $578,125 $52,832 plus 35% of the excess over $231,250

Over $578,125 $174,238.25 plus 37% of the excess over $578,125

Table 17-1 - Revenue Procedure 2022-38 (2023)

Married Individuals Filing Joint Returns and Qualifying Surviving Spouses

If Taxable Income Is: The Tax Is:

Not over $22,000 10% of the taxable income

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Over $22,000 but not over $89,450 $2,200 plus 12% of the excess over $22,000

Over $89,450 but not over $190,750 $10,294 plus 22% of the excess over $89,450

Over $190,750 but not over $364,200 $32,580 plus 24% of the excess over $190,750

Over $364,200 but not over $462,500 $74,208 plus 32% of the excess over $364,200

Over $462,500 but not over $693,750 $105,664 plus 35% of the excess over $462,500

Over $693,750 $186,601.50 plus 37% of the excess over $693,750

Table 17-2 - Revenue Procedure 2022-38 (2023)

Married Individuals Filing Separate Returns

If Taxable Income Is: The Tax Is:

Not over $11,000 10% of the taxable income

Over $11,000 but not over $44,725 $1,100 plus 12% of the excess over $11,000

Over $44,725 but not over $95,375 $5,147 plus 22% of the excess over $44,725

Over $95,375 but not over $182,100 $16,290 plus 24% of the excess over $95,375

Over $182,100 but not over $231,250 $37,104 plus 32% of the excess over $182,100

Over $231,250 not over $346,875 $52,832 plus 35% of the excess over $231,250

Over $346,875 $93,300.75 plus 37% of the excess over $346,875

Table 17-3 - Revenue Procedure 2022-38 (2023)

Heads of Households

If Taxable Income Is: The Tax Is:

Not over $15,700 10% of the taxable income

Over $15,700 but not over $59,850 $1,570 plus 12% of the excess over $15,700

Over $59,850 but not over $95,350 $6,868 plus 22% of the excess over $59,850

Over $95,350 but not over $182,100 $14,678 plus 24% of the excess over $95,350

Over $182,100 but not over $231,250 $35,498 plus 32% of the excess over $182,100

Over $231,250 not over $578,100 $51,226 plus 35% of the excess over $231,250

Over $578,100 $172,623.50 plus 37% of the excess over $578,100

Table 17-4 - Revenue Procedure 2022-38 (2023)

Estates and Trusts

If Taxable Income Is: The Tax Is:

Not over $2,900 10% of the taxable income

Over $2,900 but not over $10,550 $290 plus 24% of the excess over $2,900

Over $10,550 but not over $14,450 $2,126 plus 35% of the excess over $10,550

Over $14,450 $3,491 plus 37% of the excess over $14,450

Table 17-5 - Revenue Procedure 2022-38 (2023)

Capital Gains Tax Rates

The TCJA generally retains the prior law maximum rates on net capital gains and qualified dividends. The breakpoints between the zero and 15% rates and the 15% and 20% rates are the same amounts as the breakpoints under prior law, except that the breakpoints are indexed using new inflation adjustment factors. Long-term capital gains are still defined as gains made on assets that the taxpayer held for over a year, while short-term capital gains come from assets he or she held for a year or less. Long-term gains are taxed at rates of 0%, 15%, or 20%, depending on the taxpayer’s tax bracket, while short-term gains are taxed as ordinary income.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Long Term Capital Gains and Qualified Dividends

Tax Bracket Short-term Long-term

10%, 12% brackets Ordinary rate 0%

22%, 24%, 32%, 35% brackets Ordinary rate 15%

37% bracket Ordinary rate 20%

Table 17-6 - Revenue Procedure 2022-38 (2023)

The way long-term capital gains rates are applied has changed slightly. Under previous tax law, the 0% rate was applied to the two lowest tax brackets, the 15% rate was applied to the next four, and the 20% rate was applied to the top bracket. Under the Tax Cuts and Jobs Act, the capital gains income thresholds do not match up perfectly with the tax brackets. Instead, they are applied to maximum taxable income levels, as follows:

2023 Long-Term Capital Gains Rate Income Levels

Rate Single Married Filing

Jointly Head of

Household Married Filing

Separately Estates and

Trusts

0% Up to $44,625 Up to $89,250 Up to $59,750 Up to $44,625 Up to $3,000

15% $44,626-$492,300 $89,251-$553,850 $59,751-$523,050 $44,626-$276,900 $3,001-$14,650

20% Over $492,300 Over $553,850 Over $523,050 Over $276,900 Over $14,650

Table 17-7 - Publication 544 - Sales and Other Dispositions of Assets (2023)

An additional 3.8% Federal Net Investment Income Tax (NIIT) applies to individuals on the lesser of net investment income or modified adjusted gross income (MAGI) in excess of $200,000 (single) or $250,000 (married/filing jointly and surviving spouses). The tax also applies to any trust or estate on the lesser of undistributed net income or AGI in excess of the dollar amount at which the estate/trust pays income taxes at the highest rate.

Standard Deduction and Filing Requirements

Standard Deduction

In 2023, the standard deduction amounts increased to $13,850 for individuals, to $20,800 for heads of household, and to $27,700 for married couples filing jointly and qualifying surviving spouses. (311)

Standard Deductions - 2023 Tax Year

Filing Status Standard Deduction Amount

Single $13,850

Married Filing Jointly $27,700

Married Filing Separately $13,850

Heads of Household $20,800

Surviving Spouse $27,700

Table 17-8 - Revenue Procedure 2022-38 (2023)

For 2023, the additional standard deduction for married taxpayers 65 or over or blind will be $1,500. For a single taxpayer or head of household who is 65 or over or blind, the additional standard deduction for 2023 will be $1,850. For 2023, the standard deduction amount for an individual who may be claimed as a dependent by another taxpayer cannot exceed the greater of $1,250 or the sum of $400 and the individual’s earned income.

Elderly and/or Blind Taxpayers

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

the person's standard deduction (based on their filing status), plus the additional amount. Additional standard deduction amounts for 2023 are $1,850 for single or head of household or $1,500 for married filing jointly, married filing separately, or qualifying surviving spouse. For example, if the taxpayer is married, filing a joint return and both he and his wife are 68 years of age, what would their standard deduction amount come to for 2023? When completing his or her income tax return, the taxpayer would check off the box for him as being 65 or older, as well as the same box for his spouse. Two boxes are checked, and looking at the married filing joint return section, we see that their available standard deduction would be $30,700. If one was also blind, the standard deduction for 2023 would be $32,200 having three boxes checked. Partial blindness qualifies, with a certified statement from an eye doctor (ophthalmologist or optometrist) attesting that the vision in the taxpayer’s better eye is 20/200 or worse after being corrected with glasses or contact lenses or that the taxpayer’s field of vision is not more than 20 degrees. If the taxpayer’s eye condition is not likely to improve beyond these limits, the statement should include this fact. The taxpayer should keep the statement with his or her records. If the taxpayer is blind on the last day of the year, he or she is entitled to the higher standard deduction.

Standard Deduction Chart for People Age 65 or Older or Blind

Filing Status Number from the boxes checked on

Page 1 of Form 1040 Standard Deduction for 2023

Single 1 2

$15,700 $17,550

Married filing jointly or surviving spouse

1 2 3 4

$29,200 $30,700 $32,200 $33,700

Married filing separately

1 2 3 4

$15,350 $16,850 $18,350 $19,850

Head of household 1 2

$22,650 $24,500

Table 17-9 - Publication 501 - Table 7 – Standard Deduction Chart for People who are 65 or Older or Who are Blind (2023)

For an individual taxpayer, he or she will be required to file a tax return if his or her gross income for the taxable year is more than the standard deduction. For a married taxpayer, he or she will be required to file a tax return if his or her gross income, when combined with his or her spouse’s gross income, is more than the standard deduction for a joint return, provided that the taxpayer and his or her spouse lived in the same home; his or her spouse does not file a separate tax return; and neither the taxpayer nor his or her spouse is a dependent of another taxpayer who has income other than earned income in excess of $500 (indexed for inflation).

Review Question 1 Under the Tax Cuts and Jobs Act, for 2023 the additional standard deduction amount for married taxpayers age 65 and older or the blind is what amount?

A. $1,050 B. $1,500 C. $1,750 D. $1,850

See Review Feedback for answer.

Filing Requirements

An individual must file a Federal income tax return if he or she is a citizen or resident of the United States, or a resident of Puerto Rico, and he or she meets the filing requirements for any of the following categories that apply to him or her:

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

➢ Individuals in general. (There are special rules for surviving spouses, executors, administrators, legal representatives, U.S. citizens and residents living outside the United States, residents of Puerto Rico, and individuals with income from U.S. possessions.)

➢ Dependents. ➢ Certain children under age 19 or full-time students. ➢ Self-employed persons. ➢ Aliens.

An individual files only one Federal income tax return for the year regardless of how many jobs he or she had, how many Forms W-2 he or she received, or how many states he or she lived in during the year. An individual does not file more than one original return for the same year, even if he or she has not gotten his or her refund or has not heard from the IRS since he or she filed. The filing requirements apply even if the taxpayer does not owe tax. Also, age, occupation, and mental or physical conditions have no influence on who is subject to the tax. A minor must pay the tax on his or her income just like any adult, including the President of the United States. Persons institutionalized because of mental incapacity are still subject to the tax. However, not every person has to file an annual tax return with the Internal Revenue Service (IRS). Taxpayers have to file a tax return only if their gross income exceeds the total of their standard deduction. The amount varies depending on the taxpayer's filing status and, for tax year 2023, the minimum income requirements are:

Filing Status Minimum Income Requirements

Single individual $13,850

Single individual 65 or older $15,700

Married couple, filing jointly $27,700

Married couple, one spouse 65 or older $29,200

Married couple, both 65 or older $30,700

Head of household $20,800

Head of household 65 or over $22,650

Surviving spouse $27,700

Surviving spouse 65 or older $29,200

Married, filing separately, any age $5

Table 17-10 - Publication 17 - Filing Requirements for Most Taxpayers (2023)

Regardless of a taxpayer’s gross income, he or she is generally required to file an income tax return if any of the following items apply:

favored account) or health savings account. ➢ The taxpayer owes Social Security and Medicare taxes on unreported tip income. ➢ The taxpayer had net self-employment income of $400 or more. ➢ The taxpayer earned $108.28 or more from a tax-exempt church or church-controlled organization. ➢ The taxpayer received distributions from a Medical Savings Account (MSA) or a Health Savings Account (HSA).

There are a number of reasons why a taxpayer may want to file a tax return even if he or she does not meet the minimum income requirements:

Credit. ➢ If the taxpayer adopted a qualifying child, he or she must file to claim the Adoption Tax Credit.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

➢ If the taxpayer overpaid estimated tax or applied a prior year overpayment to this year, he or she must file to receive the refund.

Personal Exemption Under the Tax Cuts and Jobs Act, for tax years beginning after December 31, 2017 until January 1, 2026, the deduction for personal exemptions is effectively suspended by reducing the exemption amount to zero. A number of corresponding changes are made throughout the Tax Code where specific provisions contain references to the personal exemption amount and, in each of these instances, the dollar amount to be used is $4,700 in 2023, as adjusted by inflation. Since there will be no personal exemption amounts, the taxpayer will figure whether he or she needs to file a return either:

➢ For individual taxpayers, he or she will be required to file a tax return if his or her gross income for the taxable year is more than the standard deduction.

In 2026, taxpayers can claim personal and dependent exemptions again.

Income The taxpayer can receive income in the form of money, property, or services. Generally, an amount included in the taxpayer’s income is taxable unless it is specifically exempted by law. Income that is taxable must be reported on the taxpayer’s income tax return and is subject to tax. Income that is nontaxable may have to be shown on his or her tax return but is not taxable. Generally, the taxpayer must include in gross income everything he or she receives in payment for personal services. In addition to wages, salaries, commissions, fees, and tips, this includes other forms of compensation such as fringe benefits and stock options. The taxpayer should receive a Form W-2 - Wage and Tax Statement from his or her employer showing the pay he or she received for his or her services. The taxpayer is generally taxed on income that is available to him or her, regardless of whether it is actually in his or her possession. A valid check that the taxpayer received or that was made available to him or her before the end of the tax year is considered income constructively received in that year, even if he or she does not cash the check or deposit it to his or her account until the next year. For example, if the postal service tries to deliver a check to the taxpayer on the last day of the tax year but he or she is not at home to receive it, the taxpayer must include the amount in his or her income for that tax year. If the check was mailed so that it could not possibly reach the taxpayer until after the end of the tax year, and he or she could not otherwise get the funds before the end of the year, the taxpayer includes the amount in his or her income for the next year. Income received by an agent for the taxpayer is income he or she constructively received in the year the agent received it. If the taxpayer agrees by contract that a third party is to receive income for him or her, he or she must include the amount in his or her income when the party receives it. Prepaid income, such as compensation for future services, is generally included in the taxpayer’s income in the year he or she receives it. However, if the taxpayer uses an accrual method of accounting, he or she can defer prepaid income he or she receives for services to be performed before the end of the next tax year. In this case, the taxpayer includes the payment in his or her income as he or she earns it by performing the services.

Adjustments to Income

Changes to Above-the-line Deductions

The Tax Cuts and Jobs Act (TCJA) changed certain above-the-line deductions. The alimony deduction is repealed. The

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change applies to any divorce or separation instrument executed or modified after December 31, 2018 (the modification must expressly state that the new rule applies). Also, the deduction for moving expenses is also repealed, except for members of the military. The domestic production activities deduction (DPAD) is also repealed. The educator expenses deduction, student loan interest deduction, health savings account (HSA) deduction, IRA deduction and deductions for self-employed taxpayers all stay the same.

Review Question 2 Under the Tax Cuts and Jobs Act all of the following above-the-line deductions are unchanged except:

A. Student Loan Interest Deduction B. Educator Expenses Deduction C. Alimony Deduction D. IRA Deduction

See Review Feedback for answer.

Alimony Deduction and Exclusion Repealed

Payments incident to divorce generally fall into one of two categories: alimony or property settlements. In general, alimony is a division of income, and property settlements are a division of marital property. A property settlement is not a taxable event and does not give rise to any gain or loss. In contrast, alimony and separate maintenance payments were deductible above-the-line by the payor spouse and includible in income by the recipient spouse. As an above-the-line deduction, alimony was subtracted directly from the payor’s gross income without being limited by the payor’s adjusted gross income (AGI). The Tax Cuts and Jobs Act (TCJA) provides that for any divorce or separation agreement executed after December 31, 2018 or executed before that date but modified after it (if the modification expressly provides that the new amendments apply), alimony and separate maintenance payments are not deductible by the payor-spouse and are not included in the income of the payee-spouse. Instead, income used for alimony payments is taxed at the rates applicable to the payor- spouse rather than the recipient spouse. The new law does not change the tax treatment of child support payments.

Moving Expense Deduction Suspended Except in Limited Situations

When taxpayers made a work-related move, they were able to deduct qualified “moving expenses” paid or incurred during the tax year in connection with commencement of work at a new job. The deduction was available to both employees and self-employed taxpayers. Under the old law, taxpayers could claim a deduction for moving expenses incurred in connection with starting a new job if the new workplace was at least 50 miles farther from a taxpayer’s former residence than the former place of work. The Tax Cuts and Jobs Act (TCJA) provides that for tax years beginning after December 31, 2017 until January 1, 2026, the deduction for moving expenses is suspended, except for members of the Armed Forces (or their spouse or dependents) on active duty who move pursuant to a military order and incident to a permanent change of station.

Recharacterization of Roth IRA Contributions

If a taxpayer makes a contribution to an individual retirement account (IRA) (traditional or Roth) for a tax year, the individual is allowed to recharacterize the contribution as a contribution to the other type of IRA (traditional or Roth) by making a trustee-to-trustee transfer to the other type of IRA before the due date for the individual’s income tax return for that year. In the case of a recharacterization, the contribution will be treated as having been made to the transferee IRA (and not the original, transferor IRA) as of the date of the original contribution. Both regular contributions and conversion contributions to a Roth IRA can be recharacterized as having been made to a traditional IRA. For tax years beginning after December 31, 2017, the Tax Cuts and Jobs Act (TCJA) repeals the special rule that allows IRA contributions to one type of IRA (either traditional or Roth) to be recharacterized as a contribution to the other type of IRA. For example, a conversion contribution establishing a Roth IRA during a tax year can no longer be recharacterized as a contribution to a traditional IRA which in effect results in unwinding the conversion.

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Schedule C Provisions

Elimination of Entertainment Expenses

Ordinary and necessary business expenses are generally deductible, whereas personal consumption expenses are not. Under previous law an entertainment event, such as attendance at a professional sports event, can constitute a deductible business expense rather than an item of personal consumption if the expenditure is business-oriented and it is ordinary and necessary in nature. The Tax Cuts and Jobs Act (TCJA) provides that effective for amounts incurred or paid after December 31, 2017, no deduction will be allowed for:

➢ An activity generally considered to be entertainment, amusement or recreation. ➢ Membership dues paid to any club organized for business, pleasure, recreation or other social purposes. ➢ A facility or any portion of a facility used in connection with entertainment, amusement or recreation.

Therefore, the TCJA repeals the exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to the active conduct of the taxpayer’s trade or business. The new law also repeals the related rule applying a 50% limit to such deductions. Taxpayers may still generally deduct 50% of the food and beverage expenses associated with operating their trade or business. For example, employers may deduct expenses incurred to provide meals consumed by employees on work travel. For amounts incurred and paid after December 31, 2017 until December 31, 2025, the new law expands the 50% limit on the deductibility of business meals to include expenses associated with meals provided for the convenience of the employer on the employer’s business premises or provided on or near the employer’s business premises through an employer-operated facility that meets certain requirements.

Section 179 Deduction

Essentially, Section 179 of the IRS tax code allows businesses to deduct the full purchase price of qualifying equipment and or software purchased or financed during the tax year. That means that if the taxpayer buys (or leases) a piece of qualifying equipment, he or she can deduct the full purchase price from his or her gross income. The deduction is an incentive created by the U.S. government to encourage businesses to buy equipment and invest in themselves.

heating, air-conditioning, and ventilation systems; fire protection, alarm, and security systems. Further, the bonus depreciation is 80% for 2023. The bonus depreciation also now includes used equipment. The total cost that can be deducted under Section 179 is also limited to the taxable income earned from the taxpayer's trade or business during the year. Taxable income (including salaries and wages paid to the taxpayer(s) from the business and reported as W-2 income) is figured without regard to any available Section 179 expense deduction. However, the amount of any disallowed deduction in this tax year can be carried over to next tax year and be added to the amount of qualified Section 179 property placed in service in that next tax year. To elect the Section 179 Deduction a taxpayer needs to fill out Part One of IRS Form 4562 - Depreciation and Amortization. The definition of property eligible for the Section 179 Deduction includes:

➢ Computers. ➢ Computer off-the-shelf software. ➢ Office furniture. ➢ Office equipment. ➢ Equipment (machines, etc.) purchased for business use. ➢ Tangible personal property used in business. ➢ Business Vehicles with a gross vehicle weight in excess of 6,000lbs (Section 179 Vehicle Deductions).

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➢ Property attached to the taxpayer’s building that is not a structural component of the building (i.e.: a printing press, large manufacturing tools and equipment).

➢ Partial Business Use (equipment that is purchased for business use and personal use: generally, the taxpayer’s deduction will be based on the percentage of time he or she uses the equipment).

➢ Improvements to existing nonresidential property. The TCJA also expanded the definition of Section 179 property to allow the taxpayer to elect to include the following improvements made to nonresidential real property after the date when the property was first placed in service:

➢ Qualified improvement property, which means any improvement to a building’s interior. However, improvements do not qualify if they are attributable to:

o the enlargement of the building, o any elevator or escalator, or o the internal structural framework of the building.

➢ Roofs, HVAC, fire protection systems, alarm systems and security systems. These changes apply to property placed in service in taxable years beginning after December 31, 2017.

Off-the-shelf computer software put in service during the tax year is qualifying property for purposes of the Section 179 deduction. This includes computer software that is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially modified. It is any program designed to cause a computer to perform a desired function. However, a database or similar item is not considered computer software unless it is in the public domain and is incidental to the operation of otherwise qualifying software.

The Tax Cuts and Jobs Act (TCJA) removed computer or peripheral equipment from the definition of listed property. This change applies to property placed in service after December 31, 2017.

Review Question 3 Regarding the Tax Cuts and Jobs Act, within the specified dollar limits of Section 179, for 2023 a business can deduct what amount of the purchase price of financed or leased equipment and off-the-shelf software that was placed into service in the same tax year that the deduction is being taken and qualifies for the deduction?

A. 25% of the purchase price B. 50% of the purchase price C. 75% of the purchase price D. 100% of the purchase price

See Review Feedback for answer.

➢ $12,200 for the first year, ➢ $19,500 for the second year, ➢ $11,700 for the third year, and ➢ $6,960 for each succeeding taxable year in the recovery period.

➢ $20,200 for the first year, ➢ $19,500 for the second year,

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➢ $11,700 for the third year, and ➢ $6,960 for each succeeding taxable year in the recovery period.

Exceptions include the following vehicles:

permanent shelving installed, and exterior painted with company’s name). Also, the maximum Section 179 expense deduction for sport utility vehicles (SUV) placed in service in tax years beginning in 2023 is $28,900. Many vehicles that by their nature are not likely to be used for personal purposes qualify for full Section 179 deduction including the following vehicles:

1. Heavy non-SUV vehicles with a cargo area at least six feet in interior length (this area must not be easily accessible from the passenger area.).

part of the body Section protruding more than 30 inches ahead of the leading edge of the windshield. Some of the property and equipment that does not qualify for the Section 179 Deduction is:

➢ Property used outside the United States generally does not qualify for the Section 179 Deduction. ➢ Property that is used to furnish lodging is generally not qualified for the Section 179 Deduction. ➢ Real Property does not qualify for the Section 179 Deduction. Real Property is typically defined as land, buildings,

permanent structures and the components of the permanent structures (including improvements). Other examples of property that would not qualify for the Section 179 Deduction include paved parking areas and fences.

➢ Property acquired by gift or inheritance, as well as property purchased from related parties does not qualify for the Section 179 Deduction (No, a taxpayer cannot sell equipment to him or herself and qualify for Section 179).

➢ Any property that is not considered to be personal property may not qualify for the Section 179 Deduction. Used Equipment (that is new to the taxpayer) qualifies for Section 179. Under the TCJA, used equipment also qualifies for Bonus Depreciation.

Bonus Depreciation

Under the Tax Cuts and Jobs Act, the bonus depreciation increases from 50% to 100%. This provision is retroactive to September 27, 2017 and was good through 2022. The bonus depreciation also now includes used equipment and is not subject to any spending limits or income-based phaseout threshold. Bonus Depreciation is useful to very large businesses spending more than the Section 179 Spending Cap on new capital equipment. Also, businesses with a net loss are still qualified to deduct some of the cost of new equipment and carry- forward the loss. When applying these provisions, Section 179 is generally taken first, followed by Bonus Depreciation - unless the business had no taxable profit, because the unprofitable business is allowed to carry the loss forward to future years. This deduction is gradually phased down for the next five years to:

➢ 80% for qualifying property placed in service after December 31, 2022, and before January 1, 2024. ➢ 60% for qualifying property placed in service after December 31, 2023, and before January 1, 2025. ➢ 40% for qualifying property placed in service after December 31, 2024, and before January 1, 2026. ➢ 20% for qualifying property placed in service after December 31, 2025, and before January 1, 2027.

To qualify for bonus depreciation, property that is classified as “listed property” under the tax code must be used more than 50% of the time for business. Another change brought by the Tax Cuts and Jobs Act is that computers are no longer classified as listed property. As a result, on the taxpayer’s 2023 filing, he or she can use bonus depreciation to deduct computers used less than 50% of the time for business.

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Itemized Deductions - Schedule A Every deduction indicated on Schedule A of the taxpayer’s individual income tax return has been modified to some extent under the Tax Cuts and Jobs Act (TCJA). Accordingly, if the taxpayer has historically itemized deductions, the changes discussed below will, to some degree, have an impact on his or her taxable income in the coming years. Unless otherwise noted, these changes are in effect for tax years beginning after December 31, 2017 and before January 1, 2026.

Changes to Deduction for Medical and Dental Expenses

The Consolidated Appropriations Act, 2021 makes permanent the lower threshold of 7.5% for all taxpayers.

State and Local Tax Deduction and Limit

Under pre-TCJA tax law, taxpayers were entitled to a deduction equal to the state and local taxes (SALT) paid during the year. The deduction consisted of the following types of taxes paid:

➢ State, local, and/or foreign real property taxes. ➢ State and local personal property taxes (i.e., cars, boats). ➢ State, local, and/or foreign income taxes.

Under previous tax law the taxpayer could claim an itemized deduction for an unlimited amount of personal state and local income and property taxes. He or she could also choose to forego any deduction for state and local income taxes and instead deduct state and local general sales taxes. The Tax Cuts and Jobs Act limits the taxpayer’s deduction for state and local income and property taxes to a combined total of $10,000 ($5,000 if he or she uses married filing separate status). Foreign real property taxes can no longer be deducted. However, the taxpayer can still choose to deduct state and local sales taxes instead of state and local income taxes. The new law provides that for tax years beginning after December 31, 2017 until January 1, 2026, state, local, and foreign property taxes, and state and local sales taxes, are fully deductible only when paid or accrued in carrying on a trade or business or an activity relating to expenses for the production of income. Therefore, taxpayers may only fully claim deductions for state, local and foreign property taxes, and sales taxes that are presently deductible in computing income on an individual’s Schedule C, Schedule E, or Schedule F on the individual’s tax return. For example, an individual taxpayer may only deduct property taxes if these taxes were imposed on residential rental property which qualifies as a business asset. In response to this new limitation, some state legislatures are considering or have adopted legislative proposals that would allow taxpayers to make transfers to funds controlled by state or local governments, or other transferees specified by the state, in exchange for credits against the state or local taxes that the taxpayer is required to pay. The aim of these proposals is to allow taxpayers to characterize such transfers as fully deductible charitable contributions for Federal income tax purposes, while using the same transfers to satisfy state or local tax liabilities. Despite these state efforts to circumvent the new statutory limitation on state and local tax deductions, taxpayers should be mindful that Federal law controls the proper characterization of payments for Federal income tax purposes.

Home Mortgage Interest Deduction Changes

Under the Tax Cuts and Jobs Act (TCJA), mortgage interest on loans used to acquire a principal residence and/or a second home remains deductible, but only on debt up to $750,000. This represents an unfavorable decrease of $250,000 since the limitation was $1 million under prior tax law. Taxpayers with existing acquisition debt, that is, debt acquired on or before December 15, 2017, would remain subject to the $1 million limitation, as the new law is not applied retroactively. Additionally, mortgage refinances after 2017 will be considered incurred on the date of the original mortgage so long as the refinanced debt does not exceed the original debt. This will afford taxpayers with existing debt the option to refinance without being encumbered by the new limitations. Also, for the eight tax years beginning after December 31, 2017 and before January 1, 2026 the deduction for interest

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paid on home equity loans and lines of credit is suspended, unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.

Charitable Contribution Changes

After passage of the TCJA, cash contributions to public charities were generally limited to 60% of a taxpayer’s adjusted gross income (AGI) for tax years 2022 to 2025. Also, under the Tax Cuts and Jobs Act (TCJA) no charitable deduction would be allowed for any payment to an institution of higher education in exchange for which the payor receives the right to purchase tickets or seating at an athletic event. The TCJA also repeals the donee-reporting exemption from the contemporaneous written acknowledgment requirement for tax years beginning after December 31, 2017. A taxpayer can only deduct gifts he or she gives to qualified charities. Gifts of money include those made in cash or by check, electronic funds transfer, credit card and payroll deduction. The taxpayer must have a bank record or a written statement from the charity to deduct any gift of money on his or her tax return. This is true regardless of the amount of the gift. The statement must show the name of the charity and the date and amount of the contribution. Bank records include canceled checks, or bank, credit union and credit card statements. If the taxpayer gives by payroll deductions, he or she should retain a pay stub, a Form W-2 wage statement or another document from his or her employer. It must show the total amount withheld for charity, along with the pledge card showing the name of the charity. Household items include furniture, furnishings, electronics, appliances, and linens. If the taxpayer donates clothing and household items to charity, they generally must be in at least good used condition to claim a tax deduction. If he or she claims a deduction of over $500 for an item, it does not have to meet this standard if the taxpayer includes a qualified appraisal of the item with his or her tax return. The taxpayer must get an acknowledgment from a charity for each deductible donation (either money or property) of $250 or more. Additional rules apply to the statement for gifts of that amount. This statement is in addition to the records required for deducting cash gifts. However, one statement with all of the required information may meet both requirements.

Noncash contributions over $5,000 must be substantiated with a contemporaneous written acknowledgement, with a qualified appraisal prepared by a qualified appraiser, and a completed Form 8283, Section B, which is filed with the return claiming the deduction. However, the taxpayer does not need a written appraisal for a qualified vehicle - such as a car, boat, or airplane - if his or her deduction for the qualified vehicle is limited to the gross proceeds from its sale and he or she obtained a contemporaneous written acknowledgment.

The taxpayer can deduct contributions in the year he or she makes them. If the taxpayer charges his or her gift to a credit card before the end of the year it will count for 2023. This is true even if he or she does not pay the credit card bill until 2024. Also, a check will count for 2023 as long as the taxpayer mails it in 2023. Use the following lists for a quick check of whether the taxpayer can deduct a contribution. (312)

Examples of Charitable Contributions

Deductible As Charitable Contributions

Not Deductible As Charitable Contributions

Money or property the taxpayer gives to:

• Churches, synagogues, temples, mosques, and other religious organizations.

• Federal, state, and local governments, if the taxpayer’s contribution is solely for public purposes (for example, a gift to reduce the public debt or maintain a public park).

• Nonprofit schools and hospitals.

• The Salvation Army, American Red Cross, CARE, Goodwill Industries, United Way, Boy Scouts of America, Girl Scouts of America, Boys and Girls Clubs of America, etc.

• War veterans' groups.

Money or property the taxpayer gives to:

• Civic leagues, social and sports clubs, labor unions, and chambers of commerce.

• Foreign organizations (except certain Canadian, Israeli, and Mexican charities).

• Groups that are run for personal profit.

• Groups whose purpose is to lobby for law changes.

• Homeowners' associations.

• Individuals.

• Political groups or candidates for public office.

• Donations in exchange for college athletic event seating rights.

Expenses paid for a student living with the taxpayer, sponsored by a qualified organization.

Cost of raffle, bingo, or lottery tickets.

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Out-of-pocket expenses when the taxpayer serves a qualified organization as a volunteer.

Dues, fees, or bills paid to country clubs, lodges, fraternal orders, or similar groups.

Tuition

Value of the taxpayer’s time or services

Value of blood given to a blood bank

Table 17-11 - Publication 526 - Table 1 - Examples of Charitable Contributions - A Quick Check (2023)

Casualty and Theft Loss Deduction

A casualty is defined as the complete or partial destruction of property from a sudden, unexpected, or unusual cause. Under the TCJA, casualty and theft losses are generally only deductible to the extent they are attributable to a “Federally declared disaster”. There is a limited exception for taxpayers who have personal casualty gains, whereby losses not attributable to a disaster may be used to offset such gains, but not below zero. For the purposes of this provision, a “Federally declared disaster” is one that has been determined by the President to warrant Federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. Additionally, the TCJA retroactively provides relief to taxpayers who incurred a disaster loss in tax years 2016 and 2017 by raising the $100-per-casualty limitation to $500 and waiving the 10% of AGI floor.

Miscellaneous Itemized Deductions

Under the Tax Cuts and Jobs Act (TCJA) the provisions (which took effect beginning with the 2018 tax year) dramatically affect employees who incur unreimbursed expenses related to their job (such as home office expenses, union dues, work- related education, job searches, legal fees, subscriptions to trade journals, etc.), it does not affect small business owners or self-employed persons, who would still be able to declare business expenses on IRS Form 1040, Schedule C (Profit or Loss from Business).

Deductions Subject to the 2% Limit

Suspended miscellaneous deductions subject to the 2% floor include unreimbursed employee expenses for:

➢ Business bad debt of an employee. ➢ Business liability insurance premiums. ➢ Damages paid to a former employer for breach of an employment contract. ➢ Depreciation on a computer the taxpayer’s employer requires him or her to use in his or her work. ➢ Dues to a chamber of commerce if membership helps the taxpayer do his or her job. ➢ Dues to professional societies. ➢ Educator expenses. ➢ Home office or part of the taxpayer’s home used regularly and exclusively in his or her work. ➢ Job search expenses in the taxpayer’s present occupation. ➢ Laboratory breakage fees. ➢ Legal fees related to the taxpayer’s job. ➢ Licenses and regulatory fees. ➢ Malpractice insurance premiums. ➢ Medical examinations required by an employer. ➢ Occupational taxes. ➢ Passport for a business trip. ➢ Repayment of an income aid payment received under an employer's plan. ➢ Research expenses of a college professor. ➢ Rural mail carriers' vehicle expenses. ➢ Subscriptions to professional journals and trade magazines related to the taxpayer’s work. ➢ Tools and supplies used in the taxpayer’s work. ➢ Travel, transportation, meals, entertainment, gifts, and local lodging related to the taxpayer’s work. ➢ Union dues and expenses. ➢ Work clothes and uniforms if required and not suitable for everyday use. ➢ Work-related education.

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Also qualifying as miscellaneous expenses are the expenses that taxpayers incur for tax preparation and other tax-related services such as tax counsel fees and appraisal fees.

Other suspended miscellaneous deductions subject to the 2% include: (114)

➢ Appraisal fees for a casualty loss or charitable contribution. ➢ Casualty and theft losses from property used in performing services as an employee. ➢ Clerical help and office rent in caring for investments. ➢ Depreciation on home computers used for investments. ➢ Excess deductions (including administrative expenses) allowed a beneficiary on termination of an estate or trust. ➢ Fees to collect interest and dividends. ➢ Hobby expenses, but generally not more than hobby income. ➢ Indirect miscellaneous deductions from pass-through entities. ➢ Investment fees and expenses. ➢ Legal fees related to producing or collecting taxable income or getting tax advice. ➢ Loss on deposits in an insolvent or bankrupt financial institution. ➢ Loss on traditional IRAs or Roth IRAs when all amounts have been distributed to the taxpayer. ➢ Repayments of income. ➢ Repayments of Social Security benefits. ➢ Safe deposit box rental, except for storing jewelry and other personal effects. ➢ Service charges on dividend reinvestment plans. ➢ Tax advice fees. ➢ Trustee's fees for the taxpayer’s IRA, if separately billed and paid. ➢ Repayments of income received under a claim of right (only subject to the 2% floor if less than $3,000). ➢ The share of deductible investment expenses from pass-through entities.

Deductions Not Subject to the 2% Limit

➢ Gambling losses up to the amount of gambling winnings. ➢ Casualty and theft losses from income-producing property. ➢ Loss from other activities from Schedule K-1 (Form 1065-B). ➢ Federal estate tax on income in respect of a decedent. ➢ Amortizable premium on taxable bonds. ➢ An ordinary loss attributable to a contingent payment debt instrument or an inflation-indexed debt instrument (for

example, a Treasury Inflation-Protected Security). ➢ Repayment of amounts under a claim of right if over $3,000. ➢ Unrecovered investment in an annuity. ➢ Impairment-related work expenses of persons with disabilities.

Review Question 4 Under the Tax Cuts and Jobs Act miscellaneous deductions which exceed 2% of the taxpayer’s adjusted gross income (AGI) will be eliminated. This includes deductions for which of the following?

A. Impairment-related work expenses of persons with disabilities B. Amortizable premium on taxable bonds C. Federal estate tax on income in respect of a decedent D. Tax preparation expenses

See Review Feedback for answer.

Gambling Losses Up to the Amount of Gambling Winnings

The taxpayer must report the full amount of his or her gambling winnings for the year on his or her Schedule 1 (Form 1040). He or she deducts his or her gambling losses for the year on his or her Schedule A (Form 1040). Gambling losses

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include the actual cost of wagers plus expenses incurred in connection with the conduct of the gambling activity, such as travel to and from a casino. The taxpayer cannot deduct gambling losses that are more than his or her winnings. Generally, nonresident aliens cannot deduct gambling losses on his or her Schedule A (Form 1040-NR).

The taxpayer cannot reduce his or her gambling winnings by his or her gambling losses and report the difference. The taxpayer must report the full amount of his or her winnings as income and claim his or her losses (up to the amount of winnings) as an itemized deduction. Therefore, the taxpayer’s records should show his or her winnings separately from his or her losses.

Changes to the Deduction for Gambling Losses

Estate Tax Deduction

Income that the decedent had a right to receive is included in the decedent's gross estate and is subject to estate tax. This income in respect of a decedent is also taxed when received by the recipient (estate or beneficiary). However, an income tax deduction is allowed to the recipient for the estate tax paid on the income. The deduction for estate tax paid can only be claimed for the same tax year in which the income in respect of a decedent must be included in the recipient's income. (This also is true for income in respect of a prior decedent.) Individuals can claim this deduction only as an itemized deduction on line 16 of Schedule A (Form 1040). This deduction is not subject to the 2% limit on miscellaneous itemized deductions. Estates can claim the deduction on line 19 of Form 1041. For the alternative minimum tax computation, the deduction is not included as an itemized deduction that is an adjustment to taxable income. If income in respect of a decedent is capital gain income, the taxpayer must reduce the gain, but not below zero, by any deduction for estate tax paid on such gain. This applies in figuring the following: (313)

➢ The maximum tax on net capital gain (including qualified dividends). ➢ The exclusion for gain on small business stock under Section 1202. ➢ The limitation on capital losses.

To figure a recipient's estate tax deduction, determine:

➢ The estate tax that qualifies for the deduction, and ➢ The recipient's part of the deductible tax.

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The estate tax is the tax on the taxable estate, reduced by any credits allowed. The estate tax qualifying for the deduction is the part of the net value of all the items in the estate that represent income in respect of a decedent. Net value is the excess of the items of income in respect of a decedent over the items of expenses in respect of a decedent. The deductible estate tax is the difference between the actual estate tax and the estate tax determined without including net value.

Basic Exclusion from Estate Tax

Although initial tax plan discussions considered complete elimination of taxes on estates, the Tax Cuts and Jobs Act keeps the Federal estate tax in place, but it doubles the threshold at which that tax applies. For an estate of any decedent dying during calendar year 2023, the basic exclusion from estate tax amount is $12,920,000 ($25,840,000 for married couples), up from a total of $12,060,000 for estates of decedents who died in 2022. The American Taxpayer Relief Act of 2012 permanently increased the top gift and estate tax rate from 35% to 40%. The annual exclusion for gifts increases to $17,000.

Decedents dying in: Estate Tax Exemption Amount Tax Rate

2021 $11,700,000 40%

2022 $12,060,000 40%

2023 $12,920,000 40%

Table 17-12 - Estate Tax Exemption Amounts (2023)

Also, the portability of the deceased spousal unused exclusion (DSUE) amount, which, if elected, allows the estate exclusion amount ($12,920,000 in 2023) to pass from a deceased spouse to the surviving spouse was unchanged. A deceased spousal unused exclusion amount is available to a surviving spouse only if an election is made on a timely filed estate tax return (including extensions) of the predeceased spouse on which such amount is computed, regardless of whether the estate of the predeceased spouse otherwise is required to file an estate tax return.

Federal Estate Tax on Income in Respect of a Decedent

The taxpayer can deduct the Federal estate tax attributable to income in respect of a decedent that he or she as a beneficiary includes in his or her gross income. Income in respect of the decedent is gross income that the decedent would have received had death not occurred and that was not properly includible in the decedent's final income tax return. The TCJA does not change the IRC Section 67(e) deductions estates and trusts may take in connection with expenses for the administration of a trust or estate that would not have been incurred if the property were not held as such. These deductions include trustee commissions, attorney fees, appraisals, and trust accountings; it appears that they should still be permitted as deductions. The deduction for federal estate tax paid (income in respect of a decedent) under IRC Section 691(c) also continues to be deductible. Income in respect of a decedent must be included in the income of one of the following: (313)

➢ The decedent's estate, if the estate receives it. ➢ The beneficiary, if the right to income is passed directly to the beneficiary and the beneficiary receives it. ➢ Any person to whom the estate properly distributes the right to receive it.

Amortizable Premium on Taxable Bonds

In general, if the amount the taxpayer pays for a bond is greater than its stated principal amount, the excess is bond premium. He or she can elect to amortize the premium on taxable bonds. The amortization of the premium is generally an offset to interest income on the bond rather than a separate deduction item. For bonds issued after September 27, 1985, the taxpayer must amortize bond premium using a constant yield method on the basis of the bond's yield to maturity, determined by using the bond's basis and compounding at the close of each accrual period. Pre-1998 election to amortize bond premium. Generally, if the taxpayer first elected to amortize bond premium before 1998, the above treatment of the premium does not apply to bonds he or she acquired before 1988. Bonds acquired after October 22, 1986, and before 1988. The amortization of the premium on these bonds is investment interest expense subject to the investment interest limit, unless the taxpayer chooses to treat it as an offset to interest income on the bond.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Bonds acquired before October 23, 1986. The amortization of the premium on these bonds is a miscellaneous itemized deduction not subject to the 2% limit. Deduction for excess premium. On certain bonds (such as bonds that pay a variable rate of interest or that provide for an interest-free period), the amount of bond premium allocable to a period may exceed the amount of stated interest allocable to the period. If this occurs, treat the excess as a miscellaneous itemized deduction that is not subject to the 2% limit. However, the amount deductible is limited to the amount by which taxpayer’s total interest inclusions on the bond in prior periods exceed the total amount he or she treated as a bond premium deduction on the bond in prior periods. If any of the excess bond premium cannot be deducted because of the limit, this amount is carried forward to the next period and is treated as bond premium allocable to that period. Pre-1998 choice to amortize bond premium. If the taxpayer made the choice to amortize the premium on taxable bonds before 1998, he or she can deduct the bond premium amortization that is more than his or her interest income only for bonds acquired during 1998 and later years.

Claim of Right - Section 1341

A Claim of Right is basically the case where a taxpayer reported income as being taxable in one year, but then has to repay it back in a future tax year. Previously, if the taxpayer had to repay an amount that he or she included in his or her income in an earlier year, he or she may be able to deduct the amount repaid from his or her income for the year in which he or she repaid it. Or, if the amount he or she repaid is more than $3,000, the taxpayer may be able to take a credit against his or her tax for the year in which he or she repaid it. Generally, the taxpayer can claim a deduction or credit only if the repayment qualifies as an expense or loss incurred in his or her trade or business or in a for-profit transaction. The type of deduction the taxpayer is allowed in the year of repayment depends on the type of income he or she included in the earlier year. The taxpayer generally deducts the repayment on the same form or schedule on which he or she previously reported it as income. For example, if the taxpayer reported it as self-employment income, deduct it as a business expense on Schedule C (Form 1040) or Schedule F (Form 1040). If the taxpayer reported it as a capital gain, deduct it as a capital loss as explained in the Instructions for Schedule D (Form 1040). If the taxpayer reported it as wages, unemployment compensation, or other nonbusiness income, deduct it as a miscellaneous itemized deduction on Schedule A (Form 1040).

However, under the Tax Cuts and Jobs Act (TCJA), for tax years beginning after December 31, 2017 until January 1, 2026, the deduction for miscellaneous itemized deductions that are subject to the 2% floor is suspended. Therefore, no miscellaneous itemized deductions may be claimed by an individual on Schedule A of Form 1040 for tax years 2018 through 2025. Consequently, if the amount the taxpayer repaid was $3,000 or

less, the taxpayer will not long deduct it as a miscellaneous itemized deduction on Schedule A (Form 1040). Repayments of income received under a claim of right as repayments are subject to the 2% floor if less than $3,000. If the amount the taxpayer repaid was more than $3,000, he or she can deduct the repayment. However, he or she can choose instead to take a tax credit for the year of repayment if he or she included the income under a claim of right. This means that at the time the taxpayer included the income, it appeared that he or she had an unrestricted right to it. If the taxpayer qualifies for this choice, he or she should figure his or her tax under both methods and compare the results. The taxpayer can use the method (deduction or credit) that results in less tax.

When determining whether the amount the taxpayer repaid was more or less than $3,000, consider the total amount being repaid on the return. Each instance of repayment is not considered separately.

Impairment-Related Work Expenses

If the taxpayer has a physical or mental disability that limits him or her being employed, or substantially limits one or more of his or her major life activities, such as performing manual tasks, walking, speaking, breathing, learning, and working, he or she can deduct his or her impairment-related work expenses. If a taxpayer takes a business deduction for these impairment-related work expenses, they are not subject to the 7.5% limit that applies to medical expenses in 2023. Impairment-related expenses are those ordinary and necessary business expenses that are: (314)

1. Necessary for the taxpayer to do his or her work satisfactorily. 2. For goods and services not required or used, other than incidentally, in his or her personal activities. 3. Not specifically covered under other income tax laws.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Impairment-related work expenses are ordinary and necessary business expenses for attendant care services at the taxpayer’s place of work and other expenses in connection with his or her place of work that are necessary for him or her to be able to work. If the taxpayer is self-employed, he or she should enter his or her impairment-related work expenses on the appropriate Form (Schedule C, E, or F) that he or she used to report his or her business income and expenses.

Unrecovered Investment in Annuity

A retiree who contributed to the cost of an annuity can exclude from income a part of each payment received as a tax-free return of the retiree's investment. If the retiree dies before the entire investment is recovered tax free, any unrecovered investment can be deducted on the retiree's final income tax return. If the taxpayer has a cost to recover from his or her pension or annuity plan, he or she can exclude part of each annuity payment from income as a recovery of his or her cost. This tax-free part of the payment is figured when the taxpayer’s annuity starts and remains the same each year, even if the amount of the payment changes. The rest of each payment is taxable. The taxpayer figures the tax-free part of the payment using one of the following methods: (74)

➢ Simplified Method. The taxpayer generally must use this method if his or her annuity is paid under a qualified plan (a qualified employee plan, a qualified employee annuity, or a tax-sheltered annuity plan or contract). He or she cannot use this method if his or her annuity is paid under a nonqualified plan.

➢ General Rule. The taxpayer must use this method if his or her annuity is paid under a nonqualified plan. He or she generally cannot use this method if his or her annuity is paid under a qualified plan.

The taxpayer determines which method to use when he or she first begins receiving his or her annuity, and he or she continues using it each year that he or she recovers part of his or her cost. If the taxpayer had more than one partly taxable pension or annuity, he or she figures the tax-free part and the taxable part of each separately. If the taxpayer’s annuity is paid under a qualified plan and his or her annuity starting date is after July 1, 1986, and before November 19, 1996, he or she could have chosen to use either the Simplified Method or the General Rule. If the taxpayer’s annuity starting date is before July 2, 1986, he or she uses the General Rule unless his or her annuity qualified for the Three-Year Rule. If the taxpayer used the Three-Year Rule (which was repealed for annuities starting after July 1, 1986), his or her annuity payments are generally now fully taxable. The taxpayer’s annuity starting date determines the total amount of annuity payments that he or she can exclude from income over the years. Once the taxpayer’s annuity starting date is determined, it does not change. If the taxpayer calculates the taxable portion of his or her annuity payments using the simplified method worksheet, the annuity starting date determines the recovery period for his or her cost. That recovery period begins on the taxpayer’s annuity starting date and is not affected by the date he or she first completes the worksheet. If the taxpayer’s annuity starting date is after 1986, the total amount of annuity income that he or she can exclude over the years as a recovery of the cost cannot exceed his or her total cost. Any unrecovered cost at the taxpayer’s (or the last annuitant's) death is allowed as a miscellaneous itemized deduction on the final return of the decedent. This deduction is not subject to the 2%-of-adjusted-gross-income limit. If the taxpayer’s annuity starting date is before 1987, he or she can continue to take his or her monthly exclusion for as long as he or she receives his or her annuity. If the taxpayer choses a joint and survivor annuity, his or her survivor can continue to take the survivor's exclusion figured as of the annuity starting date. The total exclusion may be more than the taxpayer’s cost.

Itemized Deduction Phase-Out

Taxpayers are generally given the option to either claim a standard deduction or itemize deductions. Under the old law, the total amount of most otherwise allowable itemized deductions was limited for certain higher-income taxpayers. For taxpayers who exceed the threshold, the otherwise allowable amount of itemized deductions was reduced by 3% of the amount of the taxpayers’ adjusted gross income (AGI) exceeding the threshold. The total reduction could not be greater than 80% of all itemized deductions, and certain itemized deductions were exempt from this Pease limitation. The Tax Cuts and Jobs Act repeals the phase-out of itemized deductions for high-income taxpayers. This suspension of the overall limitation on itemized deductions will apply to any taxable year beginning after December 31, 2017, and before January 1, 2026.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Credits

Child Tax Credit (CTC)

Under the Tax Cuts and Jobs Act (TCJA), the amount of the Child Tax Credit (CTC) is increased to $2,000 per qualifying child; The income levels at which the credit phases out were increased to $400,000 for married taxpayers filing jointly ($200,000 for all other taxpayers) (not indexed for inflation). A $500 nonrefundable Credit for Other Dependents (ODC) is provided for certain non-child dependents. The portion of the Child Tax Credit that is refundable after 2017 and before 2026 is still referred to as the Additional Child Tax Credit (ACTC) but is limited to $1,600 per qualifying child in 2023, and this amount is indexed for inflation, up to the $2,000 base credit amount. The earned income threshold for the refundable portion of the credit was decreased from $3,000 to $2,500. The taxpayer’s child must have a Social Security Number issued by the Social Security Administration (SSA) before the due date of the taxpayer’s tax return (including extensions) to be claimed as a qualifying child for the Child Tax Credit or Additional Child Tax Credit. Children with an Individual Taxpayer Identification Number (ITIN) cannot be claimed for either credit. If the taxpayer’s child’s immigration status has changed so that his or her child is now a U.S. citizen or permanent resident, but the child’s Social Security card still has the words “Not valid for employment” on it, the taxpayer should ask the SSA for a new Social Security card without those words. If the taxpayer’s child does not have a valid SSN, his or her child may still qualify him or her for the Credit for Other Dependents (ODC). This is a non-refundable credit of up to $500 per qualifying person. If the taxpayer’s dependent child lived with him or her in the United States and has an Individual Taxpayer Identification Number (ITIN), but not an SSN, issued by the due date of his or her 2020 tax return (including extensions), he or she may be able to claim the Credit for Other Dependents (ODC) for that child.

1. Amount - With the Child Tax Credit, a taxpayer may be able to reduce his or her Federal income tax by up to $2,000 for each qualifying child under the age of 17.

2. Qualification - A qualifying child for this credit is someone who meets the qualifying criteria of six tests: age, relationship, support, dependent, citizenship, and residence.

5. Support Test - In order to claim a child for this credit, the child must not have provided more than half of their own support.

exceptions to the residence test, which can be found in the Instructions for Schedule 8812. The Child Tax Credit is limited if the taxpayer’s modified adjusted gross income (MAGI) is above a certain amount. The amount at which this phase-out begins varies depending on the filing status. Phase-out means that the credit is reduced as the taxpayer’s income increases. In this case, the reduction is $50 for each $1,000 by which the taxpayer’s MAGI exceeds the threshold amount. For married taxpayers filing a joint return, the phase-out begins at $400,000. For all other taxpayers, including married taxpayers filing a separate return, the phase-out begins at $200,000. The credit is completely phased out for married taxpayers when MAGI reaches $440,000 and $240,000 for all other taxpayers.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

2023 Child Tax Credit Phase-out Amounts

Full Credit Partial Credit No Credit

Single 0 - $200,000 $200,001 - $240,000 $240,001 +

Married Filing Jointly 0 - $400,000 $400,001 - $440,000 $440,001 +

Head of Household 0 - $200,000 $200,001 - $240,000 $240,001 +

Married Filing Separately 0 - $200,000 $200,001 - $240,000 $240,001 +

Table 17-13 - Tax Cuts and Jobs Act (2023)

Review Question 5 The portion of the Child Tax Credit that is refundable after 2017 and before 2026 is still referred to as the Additional Child Tax Credit (ACTC) but is limited to what amount per qualifying child in 2023?

A. $1,600 B. $2,000 C. $3,000 D. $3,600

See Review Feedback for answer.

Credit for Other Dependents (ODC)

thresholds and will phase out for taxpayers with adjusted gross incomes (AGI) above $200,000 (single) and $400,000 (married).

Earned Income Tax Credit (EITC)

Under the Tax Cuts and Jobs Act (TCJA), to reduce waste, fraud, and abuse, a taxpayer is required to provide a work- eligible Social Security Number (SSN) in order to claim the refundable Earned Income Tax Credit. In addition, with respect to the Earned Income Tax Credit, taxpayers are required to properly reflect any net earnings from self-employment in their claims for the credit and employers would be required to provide additional information on their payroll tax returns. The IRS also is granted additional authority with respect to the substantiation of earned income amounts.

Overview Topics

Alternative Minimum Tax (AMT) Exemption Amount

Following the passage of the Tax Cuts and Jobs Act, the tax rates for the alternative minimum tax (AMT) are retained, but the exemption amounts are increased. A specified amount of Alternative Minimum Taxable Income (AMTI) is exempt from alternative minimum taxation. The amount varies according to the taxpayer’s filing status and the tax year at hand. The exemption is subtracted from the taxpayer’s AMTI to determine the amount of his or her AMTI that is subject to tax at the AMT rates. For 2023, the exemption amounts increase to $126,500 for joint filers, $63,250 for married filing separately, $81,300 for individual filers and $28,400 for estates and trusts. The alternative minimum tax (AMT) exemption amounts are permanently adjusted for inflation. For taxable years beginning in 2023, the excess taxable income above which the 28% tax rate applies is:

➢ Married Individuals Filing Separate Returns - $110,350. ➢ Joint Returns, Unmarried Individuals (other than qualifying surviving spouses), and Estates and Trusts - $220,700.

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Additionally, the taxpayer’s exemption phases out if his or her AMTI exceeds the thresholds indicated below. More specifically, the exemption is reduced by 25% of the amount by which his or her AMTI exceeds the applicable threshold for his or her filing status. For 2023, the phase-out threshold for the exemption increases to $1,156,300 for joint filers, $578,150 for individual filers and $94,600 for estates and trusts.

Filing Status Threshold Phase-out

Amount Complete Phase-out

Amount

Joint Returns or Surviving Spouses $1,156,300 $1,662,300

Unmarried Individuals (other than Surviving Spouses) $578,150 $903,350

Married Individuals Filing Separate Returns $578,150 $831,150

Estates and Trusts $94,600 $208,200

Table 17-14 - Instructions for Form 6251 (2023)

The AMT exemption for 2023 for a child subject to the kiddie tax will be the lesser of (1) $8,800 (up from $8,200 for 2022) plus the child’s earned income, or (2) $81,300 (up from $75,900 for 2022). If the taxpayer is not liable for AMT this year, but he or she paid AMT in one or more previous years, he or she may be eligible to take a special minimum tax credit against his or her regular tax this year. If eligible, the taxpayer should complete and attach Form 8801 - Credit for Prior Year Minimum Tax - Individuals, Estates, and Trusts, to claim the minimum tax credit. (315)

Pass-Through Entities

Most American businesses are organized as “pass-through” companies in which the income from the business is “passed through” to the business owner's individual tax return. S corporations, LLCs, partnerships and sole proprietorships are all examples of pass-through businesses. Under the Tax Cuts and Jobs Act these entities will be taxed at their individual tax rates less a 20% deduction for qualified business income (QBI), subject to certain wage limits and exceptions. Qualified business income includes domestic income from a trade or business. Employee wages, capital gain, interest and dividend income are excluded. The deduction, referred to as the Section 199A deduction or the deduction for qualified business income, is available for tax years beginning after December 31, 2017. Eligible taxpayers can claim it on their 2023 Federal income tax return they file in 2024. The deduction is generally available to eligible taxpayers whose 2023 taxable incomes fall below $364,200 for joint returns and $182,100 for all other taxpayers. It is generally equal to the lesser of 20% of their qualified business income plus 20% of their qualified real estate investment trust dividends and qualified publicly traded partnership income or 20% of taxable income minus net capital gains. The deduction would be disallowed for businesses offering "professional services", such as law firms, doctor's offices and investment offices, above certain threshold amounts. The W-2 wage limit does not apply in the case of a taxpayer with taxable income not exceeding $364,200 for married individuals filing jointly ($182,100 for single and head-of-household). The application of the W-2 wage limit is phased in for individuals with taxable income exceeding these thresholds, over the next $100,000 of taxable income for married individuals filing jointly ($50,000 for other individuals). (252)

The 20% deduction is not allowed in computing adjusted gross income (AGI), but rather is allowed as a deduction reducing taxable income.

Tax on a Child's Investment and Other Unearned Income (Kiddie Tax)

The Tax Cuts and Jobs Act changed the Kiddie Tax, which taxes a child’s unearned income at the tax rates of the child’s parents. Starting in 2018, however, the Kiddie Tax was based on the much higher tax rates for estates and trusts. The Setting Every Community Up for Retirement Enhancement (SECURE) Act repeals the change to the Kiddie Tax, reverting to the rules that were in effect before 2018. This change is effective for tax years that begin after December 31, 2019.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Section 529 Plans

A Section 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. The Tax Cuts and Jobs Act expanded these plans in two ways:

➢ Tax-free distributions up to $10,000 can be made for tuition at elementary and secondary schools, whether public, private, or religious.

➢ Rollovers of funds from 529 plans to ABLE accounts, special savings accounts for the benefit of a qualified disabled individual, can be made on a tax-free basis.

Previously, 529 plans could be used only to cover costs for college. The new law expands the qualified use of 529 accounts by allowing withdrawals for public, private or religious schools. Home schooling families are also allowed to use 529 funds towards educational expenses. If the taxpayer plans to take advantage of this expanded ruling, note the limit of $10,000 per year, per child. While not new in this tax bill, higher-income earners may want to note that 529 plan contributions are not subject to any income limits. While other tax-advantaged savings accounts like IRAs and Roth IRAs restrict higher-income families from contributing, 529 plans can be used regardless of the taxpayer’s income level. With the flexibility provided by the new law, parents not currently setting aside money for education may want to reconsider earmarking some savings toward a 529 plan.

Achieving a Better Life Experience (ABLE) Accounts

The new legislation also supports funding of Achieving a Better Life Experience (ABLE) accounts designed for use by people with disabilities. Under the new law, the taxpayer can roll over the Section 529 plan assets to an ABLE account. Both accounts must have the same beneficiary or a member of the same family, and the taxpayer can roll over up to the annual gift exclusion amount, which is $17,000 in 2023. Now families will have more flexibility in planning for special needs, where predicting the level of future needs can be a challenge. Also, beneficiaries who work and earn income will now be able to make contributions into their ABLE accounts in excess of the annual maximum contribution limit. Lastly, individuals who are able to take advantage of contributing earned income to their ABLE account may be able to take advantage of the Saver’s Credit.

Discharge of Certain Student Loan Indebtedness

Income from discharge of indebtedness (also called cancellation of debt) is included in the general definition of gross income. The concept of discharge of indebtedness income is that a taxpayer has realized an accession to income, to the extent that he has been released from indebtedness, because assets previously offset by the liability arising from the indebtedness have been freed. Essentially, the taxpayer has earned money by not having to pay money. Therefore, based on these principles, taxpayers who have a commercial, private lender or employer discharge part or all of their debt must include the amount that was discharged in income as cancellation of debt (COD) income unless an exception or exclusion applies. Students whose loans are forgiven (in whole or in part) because they worked in a designated profession for any of a broad class of employers generally need not include the discharged debt in income. The Tax Cuts and Jobs Act (TCJA) provides that effective January 1, 2018 and until January 1, 2026, student loan discharges will be excluded from gross income even if the student loans were discharged because of the student’s death or total and permanent disability.

Net Operating Loss (NOL)

Most taxpayers no longer have the option to carryback a net operating loss (NOL). For most taxpayers, NOLs arising in tax years ending after 2020 can only be carried forward. The 2-year carryback rule in effect before 2018, generally, does

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

not apply to NOLs arising in tax years ending after December 31, 2017. The CARES Act provided for a special 5-year carryback for taxable years beginning in 2018, 2019 and 2020. Exceptions apply to certain farming losses and NOLs of insurance companies other than a life insurance company. Also, for losses arising in taxable years beginning after December 31, 2020, the net operating loss deduction is limited to 80% of the excess (if any) of taxable income (determined without regard to the qualified business income deduction (QBID) and Section 250 deduction over the total NOLD from NOLs arising in taxable years beginning before January 1, 2018.

Review Question 6 In 2023, a calendar-year taxpayer has a $95,000 net operating loss (NOL). In 2023, the taxpayer has taxable income of $100,000. What amount of the unused NOL can be carried back to a previous tax year?

A. $0 B. $500 C. $1,000 D. $5,000

See Review Feedback for answer.

Affordable Care Act (ACA) Provisions

The Tax Cuts and Jobs Act (TCJA) made significant changes to the Federal tax code. The bill does not impact the majority of the Affordable Care Act (ACA) tax provisions. However, it does reduce the ACA’s individual shared responsibility (or individual mandate) penalty to zero, effective beginning in 2019. This action effectively eliminates the individual mandate penalty for the 2019 tax year and beyond. As a result, beginning with the 2019 tax year, individuals will no longer be penalized for failing to obtain acceptable health insurance coverage for themselves and their family members. The taxpayer may be eligible to claim the Premium Tax Credit if he or she, his or her spouse (if filing jointly), and his or her dependents enrolled in health insurance through the Health Insurance Marketplace. Advance payments of the Premium Tax Credit may have been made to a health insurer to help pay for the insurance coverage of the taxpayer, his or her spouse (if filing jointly), or his or her dependents. If advance payments of the Premium Tax Credit were made, the taxpayer must file a 2023 income tax return and Form 8962 - Premium Tax Credit (PTC). If the taxpayer, his or her spouse (if filing jointly), or his or her dependents enrolled in health insurance through the Health Insurance Marketplace, the taxpayer should have received Form 1095-A - Health Insurance Marketplace Statement. If the taxpayer receives Form(s) 1095-A, he or she should save it. Form(s) 1095-A will help the taxpayer figure his or her Premium Tax Credit. If the taxpayer did not receive a Form 1095-A, he or she should contact the Marketplace.

Employee Achievement Awards

If an individual receives tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award for length of service or safety achievement, he or she generally can exclude its value from income. However, the amount he or she can exclude is limited to the employer's cost and cannot be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards the person receives during the year. The employer can tell the individual whether the award is a qualified plan award. The employer must make the award as part of a meaningful presentation, under conditions and circumstances that do not create a significant likelihood of it being disguised pay. However, the exclusion does not apply to the following awards: (316)

➢ A length-of-service award if the taxpayer received it for less than 5 years of service or if he or she received another length-of-service award during the year or the previous 4 years.

For amounts paid or incurred after December 31, 2017, the Tax Cuts and Jobs Act revises the definition of “tangible personal property” to provide that “tangible personal property” does not include cash, cash equivalents, gift cards, gift coupons, gift certificates (other than arrangements conferring only the right to select and receive tangible personal property from a limited array of such items pre-selected or pre-arranged by the employer) or

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

vacations, meals, lodging, tickets to the theater or sporting events, stocks, bonds other securities or similar items. No inference is intended that this is a change from present law and guidance.

Qualified Moving Expense Reimbursements

Qualified moving expense reimbursements are defined as any amount received either directly or indirectly by an employee from an employer as payment for, or a reimbursement of expenses that would be deductible as moving expenses if directly paid or incurred by the employee. An employee may exclude qualified moving expense reimbursements from his or her gross income for income tax purposes and from his or her wages for employment tax purposes. For tax years beginning after December 31, 2017 until January 1, 2026, the exclusion for qualified moving expense reimbursements is suspended, except for members of the Armed Forces on active duty (and their spouses and dependents) who move pursuant to a military order and incident to a permanent change of station.

Exclusion for Qualified Transportation Fringe Benefits

An employee may exclude from his or her gross income up to $20 per month in qualified bicycle commuting reimbursements. Qualified reimbursements are any amount received from an employer during a 15-month period beginning with the first day of the calendar year as payment for reasonable expenses during a calendar year. Reasonable expenses are those incurred in a calendar year for the purchase of a bicycle and bicycle improvements, repair and storage, if the bicycle is regularly used for travel between the employee’s residence and place of employment. Amounts that are excludable from gross income for income tax purposes are also excluded from wages for employment tax purposes. For tax years beginning after December 31, 2017 until January 1, 2026, the exclusion from gross income and wages for qualified bicycle commuting reimbursements is suspended.

Review Question 7 For tax years beginning after December 31, 2017 until January 1, 2026, the exclusion from gross income and wages for which of the following is suspended?

A. Commuter highway vehicle transportation B. Qualified bicycle commuting reimbursements C. Qualified parking D. Transit passes

See Review Feedback for answer.

Real Property Depreciation

The Tax Cuts and Jobs Act (TCJA) shortens the write-off period for residential property under the alternative depreciation system (ADS) from 39 years to 30 years. Nonresidential property remains at 40 years. The ADS depreciation system requires use of the straight-line method over a longer life. Under the new law, the ADS system is required if a real estate business opts out of the new 30% interest expense limitation.

Like-Kind Exchanges

In a like-kind exchange, a taxpayer generally does not recognize a taxable gain or loss on an exchange of like-kind properties provided both the relinquished property and the replacement property are held for productive use in a business or for investment purposes, and no cash(boot) is received in the exchange. For those exchanges completed after December 31, 2017, the Tax Cuts and Jobs Act (TCJA) limits tax-free exchanges to exchanges of real property that is not held primarily for sale. Therefore, as previously allowed, exchanges of personal property and intangible property can no longer qualify as tax-free like-kind exchanges.

Exclusions from Definition of Capital Asset

Almost everything the taxpayer owns and uses for personal purposes, pleasure, or investment is a capital asset. Examples of capital assets include stocks and bonds, a home owned and occupied by the taxpayer and his or her family, household furnishings, a car used for pleasure or commuting, and coin or stamp collections.

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Previously certain assets were specifically excluded from the definition of a capital asset, including inventory property, depreciable property, and certain self-created intangibles (for example, copyrights, musical compositions). The Tax Cuts and Jobs Act (TCJA) provides that, effective for dispositions beginning on January 1, 2018, the definition of “capital asset” is amended to exclude the following self-created property: patents, inventions, models or designs (whether or not patented), and secret formulas or processes, which are held either by the taxpayer who created the property or by a taxpayer with a substituted or transferred basis from the taxpayer who created the property or for whom the property was created.

Modification of the Limitation on Cash Method of Accounting

Under previous law, limitations applied to corporations and partnerships with corporate partners, whereby these taxpayers were prohibited from using the cash method of accounting for tax purposes unless their average annual gross receipts were $5 million or less. Under the Tax Cuts and Jobs Act (TCJA), for tax years beginning after December 31, 2017, the threshold was increased to $29 million for 2023 (indexed for inflation), regardless of the type of entity or the industry of the taxpayer. Any change in accounting method made pursuant to this provision is considered an accounting method change allowing the taxpayer to recognize ratably taxable income resulting from the method change over a four-year period. Losses would be recognized immediately.

Exemption from Uniform Capitalization (UNICAP) Requirements

Previously, a taxpayer was required to either include in inventory or capitalize certain direct costs, and an allocable portion of indirect costs related to real or tangible personal property either produced by the taxpayer or acquired by the taxpayer for resale. Resellers of personal property were exempt from this capitalization requirement if their average annual gross receipts were $10 million or less. Under the Tax Cuts and Jobs Act (TCJA), for tax years beginning after December 31, 2017, the $10 million threshold is increased to $29 million for 2023 (indexed for inflation), regardless of entity structure or industry. Any change in accounting method made pursuant to this provision is considered an accounting method change, allowing the taxpayer to recognize ratably the taxable income resulting from the method change over a four-year period. Losses would be recognized immediately.

Exemption from Inventories

Under previous law, generally, taxpayers with inventory were required to use the accrual method of accounting. Some exceptions to this rule were:

1. Businesses with inventory that had average annual gross receipts of $1 million or less. 2. Certain businesses with average annual gross receipts of $10 million or less that treated the inventory as non-

incidental materials and supplies, therefore not being required to follow the accrual method. In 2023, under the Tax Cuts and Jobs Act (TCJA), for the tax years beginning after December 31, 2017, taxpayers with average annual gross receipts of $29 million or less (indexed for inflation) are not required to account for inventory and have the option to either:

➢ Treat the inventory as non-incidental materials and supplies. ➢ Conform to the taxpayer’s method of accounting reflected in the taxpayer’s applicable financial statements. ➢ If the taxpayer does not have applicable financial statements, the taxpayer conforms to the books and records

prepared in accordance with the taxpayer’s accounting procedures. Any change in accounting method made pursuant to this provision is considered an accounting method change, allowing the taxpayer to recognize ratably the taxable income resulting from the method change over a four-year period. Losses would be recognized immediately.

Business Interest Expense

The Tax Cuts and Jobs Act (TCJA) introduced rules that potentially limit the deductibility of business interest expense. Previously, these amounts were fully deductible (except for some limitations on payments of interest by corporations to foreign related parties). As enacted by the TCJA, net interest expense is now limited to 30% of a taxpayer’s Adjusted Taxable Income. The rule applies to taxpayers with average gross receipts over $29 million in the 2023 tax year. This

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

permanent rule (no sunset provision) appears to include an aggregation of gross receipts among taxpayers under common control. Thus, in 2023, entities below the $29 million threshold may still be subject to this limitation based on other entity ownership of its owners. Net interest expense for limitation purposes is defined as interest expense less business interest income. Business interest income is a narrow category, and excludes, for example, bank account interest earned on the deposit of working capital. This limitation does not include investment interest expense (incurred to buy stocks, bonds, etc.), or interest expense on debt financed distributions from partnerships, which needs to be traced at the taxpayer level (though the limitation might be applied there, depending on how the taxpayer uses the distributed funds). The limitation also does not apply to capitalized interest (typically incurred during a construction period). The taxpayer may have expenses that are for both tax-exempt and taxable income. If he or she cannot specifically identify what part of the expenses is for each type of income, he or she can divide the expenses, using reasonable proportions based on facts and circumstances. The taxpayer must attach a statement to his or her return showing how he or she divided the expenses and stating that each deduction claimed is not based on tax-exempt income. One accepted method for dividing expenses is to do it in the same proportion that each type of income is to the total income. If the expenses relate in part to capital gains and losses, include the gains, but not the losses, in figuring this proportion. To find the part of the expenses that is for the tax-exempt income, divide the taxpayer’s tax-exempt income by the total income and multiply his or her expenses by the result.

Paid Preparer’s Due Diligence Checklist

The Tax Cuts and Jobs Act (TCJA) expands a paid preparer’s due diligence and record keeping requirements under IRC Section 6695(g) to include determining a client’s eligibility to file as head of household (HOH). The TCJA imposes a $600 penalty for each failure in 2023. Due diligence requirements for head of household eligibility will be included on Form 8867 along with the Paid Preparer’s Due Diligence Checklist for the Earned

Income Credit (EITC), the Child Tax Credit (CTC)/Additional Child Tax Credit (ACTC), and/or the American Opportunity Tax Credit (AOTC).

A tax return preparer has complied with the due diligence requirements set forth in Treasury Regulations for the HOH filing status, the EITC, the CTC/ACTC, or the AOTC claimed on a return or claim for refund if he or she: (260)

1. Meets the knowledge requirement by interviewing the taxpayer, asking adequate questions, contemporaneously documenting the questions and the taxpayer’s responses in his or her notes, reviewing adequate information to determine if the taxpayer is eligible to claim the credit(s) and in what amount(s).

2. Completes Form 8867 truthfully and accurately and completes the actions described on Form 8867 for each credit claimed for which he or she is the paid tax return preparer.

3. Submits Form 8867 in the manner required. 4. Keeps all five of the following records for three years from the latest of the required dates:

a. A copy of Form 8867. b. The applicable worksheet(s) or his or her own worksheet(s) for any credits. c. Copies of any documents provided by the taxpayer on which he or she relied to determine eligibility for,

and the amount of, the credit(s). d. A record of how, when, and from whom the information used to prepare Form 8867 and worksheet(s) was

obtained. e. A record of any additional questions he or she may have asked to determine eligibility for, and amount of,

the credits, and the taxpayer’s answers.

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The tax return preparer must keep those records for three years from the latest of the following dates: (260)

➢ The due date of the tax return (not including extensions). ➢ The date the return was filed (if he or she is a signing tax return preparer electronically filing the return). ➢ The date the return was presented to the taxpayer for signature (if he or she is a signing tax return preparer not

electronically filing the return). ➢ The date he or she submitted to the signing tax return preparer is the part of the return for which he or she was

responsible (if he or she is a nonsigning tax return preparer). These records may be kept on paper or electronically in the manner described in Revenue Procedure 97-22 (or later update). A paid tax return preparer is required to exercise due diligence when preparing any client’s return or claim for refund. As part of exercising due diligence, the tax preparer must interview the client, ask adequate questions, and obtain appropriate and sufficient information to determine correct reporting of income, claiming of tax benefits (such as deductions and credits), and compliance with the tax laws. A paid tax return preparer must meet specific due diligence requirements set forth in Treasury Regulations when he or she prepares returns and claims for refund involving the HOH filing status, the EITC, the AOTC and/or the CTC/ACTC. To meet these due diligence requirements, the tax preparer may need to ask additional questions and obtain additional information to determine eligibility for and the amount of the EITC, AOTC, and CTC/ACTC.

Review Question 8 Due to changes in the tax law, the paid tax return preparer Earned Income Tax Credit (EITC) due diligence requirements have been expanded to cover all of the follow credits except:

A. American Opportunity Tax Credit B. Child Tax Credit C. Additional Child Tax Credit D. Adoption Credit

See Review Feedback for answer.

Reminders

Annual Filing Season Program (AFSP)

The IRS is offering a voluntary Annual Filing Season Program (AFSP) to return preparers. The AFSP is intended to recognize and encourage the voluntary efforts of non-credentialed tax return preparers to increase their knowledge and improve their filing season competency through continuing education. To obtain the voluntary certification, credentialed tax preparers (CPA, attorney, enrolled agent, etc.) or tax return preparers who have successfully completed a national or state test (RTRP, CTEC, OBTP, DLLR, Part 1 of the SEE, etc.) would need to have an active Preparer Tax Identification Number (PTIN) and complete 15 credit hours of continuing professional education annually through an IRS approved provider. Non-credentialed/non-exempt or unenrolled tax preparers must complete an 18-hour course consisting of 2 hours of Ethics and Professional Conduct, 10 hours of Federal taxation and 6 hours of Annual Federal Tax Refresher (AFTR) course that includes a 100-question comprehension test with a 3-hour time limit. Unenrolled return preparers can elect to voluntarily take continuing professional education each year in preparation for the filing season and receive an Annual Filing Season Program – Record of Completion. The program is important for a number of reasons. It encourages unregulated return preparers who do not have to meet continuing professional education requirements to stay up to date on tax laws and changes. It helps lessen the risk to taxpayers from preparers who have no education in Federal tax law or filing requirements. And it allows preparers without professional credentials to stand out from the competition by giving them a recognizable record of completion that they can show to their clients.

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Preparers who complete the AFSP will also be included in a public directory that will be added to IRS.gov each year for taxpayers to use in searching for qualified tax return preparers. The Directory of Federal Tax Return Preparers with Credentials and Select Qualifications will only include attorneys, certified public accountants (CPAs), enrolled agents, enrolled retirement plan agents (ERPAs), enrolled actuaries and individuals who have received an Annual Filing Season Program – Record of Completion. Also, as of 2016, there were changes to the representation rights of return preparers. Attorneys, CPAs, and enrolled agents will continue to be the only tax professionals with unlimited representation rights, meaning they can represent their clients on any matters including audits, payment/collection issues, and appeals. AFSP participants will have limited representation rights, meaning they can represent clients whose returns they prepared and signed, but only before revenue agents, customer service representatives, and similar IRS employees, including the Taxpayer Advocate Service. PTIN holders without an AFSP – Record of Completion or other professional credential will only be permitted to prepare tax returns. They will not be allowed to represent clients before the IRS. Established state-based return preparer program participants with current testing requirements such as return preparers who are active members of the Maryland State Board of Individual Tax Preparers, the Oregon Board of Tax Practitioners and/or the California Tax Education Council are exempt from taking the Annual Federal Tax Refresher (AFTR) course. For example, the IRS has exempted California Registered Tax Preparers (CRTP) from having to take the Annual Federal Tax Refresher (AFTR) course and passing the course’s competency examination to obtain a Record of Completion because they have already demonstrated their competency by passing a 60-hour qualifying education course and annually maintaining their continuing professional education. These exempt groups are still required to meet other program requirements, including 15 CPE credits (10 Federal Tax Law, 3 Federal Tax Law Updates, and 2 Ethics). Return preparers who can obtain the AFSP – Record of Completion without taking the AFTR course are:

➢ Anyone who passed the Registered Tax Return Preparer test administered by the IRS between November 2011 and January 2013.

➢ Established state-based return preparer program participants currently with testing requirements: Return preparers who are active registrants of the Oregon Board of Tax Practitioners, California Tax Education Council, and/or Maryland State Board of Individual Tax Preparers.

➢ SEE Part I Test-Passers: Tax practitioners who have passed the Special Enrollment Exam Part I within the past two years as of the first day of the upcoming filing season.

➢ VITA volunteers: Quality reviewers and instructors with active PTINs. ➢ Other accredited tax-focused credential-holders: The Accreditation Council for Accountancy and Taxation’s

Accredited Business Accountant/Advisor (ABA) and Accredited Tax Preparer (ATP) programs.

California Tax Education Council (CTEC) education requirements will meet the IRS requirements. Therefore, a CRTP in good standing will have already met all of the IRS requirements of the new program and will have a simplified process to obtain a Record of Completion. Also, a CRTP was granted the authority to represent, before the IRS, clients whose returns the CRTP prepared, as long as the CRTP is properly registered with CTEC for both the year the tax return was prepared as well as the year the review takes place.

Preparer Tax Identification Number (PTIN)

On January 18, 2013, the United States District Court for the District of Columbia enjoined the Internal Revenue Service from enforcing the regulatory requirements for registered tax return preparers. In accordance with this order, tax return preparers covered by this program are not required to complete competency testing or secure continuing education. The ruling does not affect the regulatory practice requirements for CPAs, attorneys, enrolled agents, enrolled retirement plan agents or enrolled actuaries or the continuing professional education requirements of individual states. On February 1, 2013, the court modified its order to clarify that the order does not affect the requirement for all paid tax return preparers to obtain a preparer tax identification number (PTIN). IRS regulations still require all paid tax return preparers (including attorneys, CPAs, and enrolled agents) to apply for a Preparer Tax Identification Number (PTIN) before preparing any future Federal tax returns. On June 1, 2017, the United States District court for the District of Columbia upheld the Internal Revenue Service’s authority to require the use of a Preparer Tax Identification Number (PTIN) but enjoined the IRS from charging a user fee for the issuance and renewal of PTINs. The PTIN application process may be completed online. Form W-12 - IRS Paid Preparer Tax Identification Number Application and Renewal is available for paper applications and renewals, but takes four to six weeks to process. A tax preparer must renew his or her PTIN every year during the renewal season. The

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renewal season generally runs from mid-October to December 31. The renewal process can be completed online and only takes a few moments. Failure to have and use a valid PTIN may result in penalties. All enrolled agents, regardless of whether they prepare returns, must have a PTIN in order to maintain their status.

Electronic Filing Identification Number (EFIN)

The IRS assigns an EFIN to identify firms that have completed the IRS e-file Application to become an Authorized IRS e- file Provider. After the provider completes the application and passes a suitability check, the IRS sends an acceptance letter, including the EFIN, to the provider. Providers need the EFIN to electronically file tax returns. The firm owns the EFIN. The principals of the firm use either their Social Security Number or Employer Identification Number to apply for an EFIN. On their application, the firm's “Doing Business As” name and business address should be used, not a personal address. Authorized IRS e-file Providers do not have to reapply each year as long as they continue to e-file returns. However, if a Provider does not e-file returns for two consecutive years, the IRS will notify the Provider of removal from the IRS active Provider list. The IRS may reactivate a Provider if the Provider replies within sixty days and requests reactivation. Otherwise, the Provider will have to complete and submit a new application. Providers must update their application information within 30 days of the date of any changes to the information on their current application. Make all changes using the IRS e-file Application. See Changes to Your IRS e-file Application. The EFIN is not transferable, and neither is the password. Even if an Authorized IRS e-file Provider transfers his or her business by sale, gift or other disposition, he or she may not transfer his or her EFIN. The Provider must protect his or her EFINS, Electronic Transmitter Identification Numbers (ETINs) and passwords from unauthorized use.

Identity Theft

Identity theft occurs when another person uses the taxpayer’s personal information such as his or her name, Social Security number (SSN) or other identifying information, without the taxpayer’s permission, to commit fraud or other crimes. Usually, an identity thief utilizes a legitimate taxpayer’s identity to fraudulently file a tax return and claim a refund. Generally, the identity thief will use a stolen SSN to file a forged tax return and try to get a fraudulent refund early in the filing season. The taxpayer may not be aware that an identity theft has happened to him or her until he or she files a return later in the filing season and discovers that two returns have been filed using the same SSN. The taxpayer should be alert to possible identity theft if he or she gets an IRS notice or letter stating: (317)

➢ More than one tax return for the taxpayer was filed. ➢ The taxpayer has a balance due; refund offset or has had collection actions taken against him or her for a year

he or she did not file a tax return. ➢ IRS records indicate the taxpayer received wages from an employer unknown to him or her.

If the taxpayer receives a notice from the IRS, respond immediately. If he or she believes someone may have used his or her SSN fraudulently, the taxpayer should notify the IRS immediately by responding to the name and number printed on the notice or letter. The taxpayer will need to fill out the Form 14039 - Identity Theft Affidavit.

Identity Protection Personal Identification Number (IP PIN)

➢ Reported to the IRS they have been victims of identity theft. ➢ Given the IRS information that verifies their identity. ➢ Had an identity theft indicator applied to their account.

The IP PIN helps to prevent the misuse of a taxpayer's Social Security number or Taxpayer Identification Number on income tax returns. New IP PINs are issued every year. An IP PIN should be used only for the tax year it was issued. IP PINs for 2023 tax returns generally will be sent in December 2022. A new IP PIN will be issued every year for three years after the identity theft incident. If the taxpayer is filing a joint return and both

taxpayers receive an IP PIN, only the taxpayer whose Social Security number (SSN) appears first on the tax return should enter his or her IP PIN.

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Individual Taxpayer Identification Numbers (ITIN)

In January of 2013, the IRS implemented new procedures that affect the Individual Taxpayer Identification Number (ITIN) application process. The information below highlights improvements to the ITIN program: (318)

➢ If the taxpayer is applying directly to the IRS for an ITIN, they will only accept original identification documents or

certified copies of these documents from the issuing agency along with a completed Form W-7 - Application for IRS Individual Taxpayer Identification Number and Federal tax return.

➢ In addition to direct submission of documents to the IRS centralized site or use of Certifying Acceptance Agents (CAAs), ITIN applicants will have several other avenues for verification of key documents. These options include some key IRS Taxpayer Assistance Centers (TACs), U.S. Tax Attachés in London, Paris, Beijing, and Frankfurt and at Low-Income Taxpayer Clinics (LITCs) and Volunteer Income Tax Assistance (VITA) Centers that use CAAs.

➢ New ITINs will now be issued for a five-year period rather than an indefinite period. This change will help ensure that ITINs are being used for legitimate tax purposes.

➢ There are four exceptions to this new documentation requirement. Applicants who are not impacted by these changes include:

o U.S. military spouses and U.S. military dependents. o Non-resident aliens applying for ITINs for the purpose of claiming tax treaty benefits. o Noncitizens that have approved TY 2011 extensions to file their tax returns. These are temporary ITINs. o Student Exchange Visitors Program (SEVP) participants.

The IRS issues ITINs to foreign nationals and others who have Federal tax reporting or filing requirements and do not qualify for SSNs. A non-resident alien individual not eligible for an SSN who is required to file a U.S. tax return only to claim a refund of tax under the provisions of a U.S. tax treaty needs an ITIN. Other examples of individuals who need ITINs include: (319)

➢ A nonresident alien required to file a U.S. tax return. ➢ A U.S. resident alien (based on days present in the United States) filing a U.S. tax return. ➢ A dependent or spouse of a U.S. citizen/resident alien. ➢ A dependent or spouse of a nonresident alien visa holder.

The IRS processes returns showing SSNs or ITINs in the blanks where tax forms request SSNs. IRS no longer accepts, and will not process, forms showing "SSA205c," "applied for," "NRA," blanks, etc.

All ITINs not used on a Federal tax return at least once in the last three consecutive years (2019, 2020 and 2021) will no longer be valid for use on a tax return as of December 31, 2022. In addition, ITINs with middle digits (the fourth and fifth positions) “70,” “71,” “72,” “73,” “74,” “75,” “76,” “77,” “78,” “79,” “80,” “81,” “82,” “83,” “84,” “85,” “86,” “87,” or “88” have expired. In addition, ITINs with middle digits “90,” “91,” “92,” “94,” “95,” “96,”

“97,” “98,” or “99,” IF assigned before 2013, have expired and will need to be renewed if the taxpayer will have a filing requirement in 2023. No action is needed by ITIN holders who do not need to file a tax return next year. Also, there are new documentation requirements when applying for or renewing an ITIN for certain dependents. If taxpayers have an expired ITIN and do not renew before filing a tax return next year, they could face a refund delay and may be ineligible for certain tax credits, such as the Child Tax Credit and the American Opportunity Tax Credit, until the ITIN is renewed. The ITIN changes are required by the Protecting Americans from Tax Hikes (PATH) Act enacted by Congress in December 2015. The IRS emphasizes that no action is needed by ITIN holders if they do not need to file a tax return next year. Taxpayers with ITINs set to expire at the end of the year and who need to file a tax return in 2023 must submit a renewal application. Others do not need to take any action.

➢ ITINs with middle digits (the fourth and fifth positions) “70,” “71,” “72,” “73,” “74,” “75,” “76,” “77,” “78,” “79,” “80,” “81,” “82,” “83,” “84,” “85,” “86,” “87,” or “88” have expired. In addition, ITINs with middle digits “90,” “91,” “92,” “94,” “95,” “96,” “97,” “98,” or “99,” IF assigned before 2013, have expired.

➢ Spouses and dependents are not eligible for an ITIN or to renew an ITIN unless they are claimed for an allowable tax benefit, or they file their own tax return.

➢ Taxpayers whose ITINs expired due to lack of use should only renew their ITIN if they have a filing requirement in 2023.

➢ Taxpayers who are eligible for, or who have, a Social Security number (SSN) should not renew their ITIN but should notify IRS both of their SSN and previous ITIN, so that their accounts can be merged.

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➢ An ITIN may be assigned to an alien dependent from Canada or Mexico if that dependent qualifies a taxpayer for a child or dependent care credit (claimed on Form 2441). The Form 2441 must be attached to Form W-7 along with the U.S. Federal tax return.

If the taxpayer needs to file a tax return and his or her ITIN has expired or will expire before he or she files, the IRS recommends the taxpayer submits his or her renewal application immediately to prevent potential delays in the processing of his or her return. If the taxpayer uses an expired ITIN on a U.S. tax return, it will be processed and treated as timely filed, but without any exemptions and/or credits claimed and no refund will be paid at that time. The taxpayer will receive a notice explaining the delay in any refund and that the ITIN has expired. A taxpayer whose ITIN has been deactivated and needs to file a U.S. return can reapply using Form W-7 - Application for IRS Individual Taxpayer Identification Number. As with any ITIN application, original documents, such as passports, or copies of documents certified by the issuing agency must be submitted with the form.

Review Question 9 Individual Taxpayer Identification Numbers (ITINs) not used on a Federal income tax return in the last how many years will no longer be valid to use on a tax return filed for tax year 2023?

A. Three years B. Four years C. Five years D. Ten years

See Review Feedback for answer.

IRS Direct Pay

IRS Direct Pay is a payment application that allows individual taxpayers with a valid Social Security Number to make IRS payments directly from their checking or savings accounts. It is free, secure and provides an electronic payment confirmation while reducing processing costs. Only Form 1040 payments and associated penalties can be made through IRS Direct Pay.

The taxpayer must have a valid Social Security Number (SSN) to use this application. This application cannot accommodate Individual Taxpayer Identification Numbers (ITINs).

IRS Direct Pay currently accepts 1040 series payments, including the 4868 (1040 Extension) and the 1040-ES (1040 Estimated Tax). Direct Pay will also accept form 5329 payments and Shared Responsibility payments. Other form types may be added in the future. A taxpayer can make a tax payment towards a 1040 tax return for the last 20 years for most of the Reason for Payment options. There are two exceptions: Estimated Tax Payments and Requests for Extension of Time to File. Estimated Tax Payments are paid to the IRS in the current calendar year, while Requests for Extension of Time to File payments are generally for the current tax year.

Taxpayers receive instant confirmation that the payment has been submitted, and the system is available 24 hours a day, 7 days a week. Bank account information is not retained in any IRS systems after payments are completed. IRS Direct Pay also offers 30-day advance payment scheduling, payment rescheduling or cancellations, and a payment status search. Future plans include an option for e-mailed payment confirmation, a Spanish version and one-time registration with a login and password to allow quick access on return visits.

Tax Planning

The Setting Every Community Up for Retirement Enhancement (SECURE 2.0) Act The Secure 2.0 Act retirement provisions are part of the 2023 omnibus appropriation. Some of the key provisions contained in the final bill include:

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➢ The establishment of a new Starter 401(k) which will allow employers that do not currently sponsor a retirement plan to offer a starter 401(k) plan (or safe harbor 403(b) plan).

➢ An enhanced Saver’s match that will modify the existing Saver’s Credit with respect to IRA and retirement plan contributions by changing it from a credit paid in cash as part of a tax refund to a government matching contribution that must be deposited into a taxpayer’s IRA or retirement plan.

➢ A new “pension-linked” emergency savings provision. ➢ A new student-loan matching program to treat student loan payments as elective deferrals for purposes of

matching contributions. ➢ Higher catch-up limits at age 60, 61, 62 and 63 (beginning after December 31, 2024). ➢ Increasing the required minimum distribution (RMD) age. ➢ Expansion of the current QLAC limits. ➢ Provisions for auto-portability. ➢ Establishment of a Retirement Savings Lost and Found. ➢ Expansion of the Employee Plans Compliance Resolution System (EPCRS). ➢ Reforms to the family attribution rules by removing attribution for spouses with separate and unrelated businesses

who reside in community property states and removes attribution between parents with separate and unrelated business who have minor children.

Section 101: Expands automatic enrollment in retirement plans

Section 101 requires 401(k) and 403(b) plans to automatically enroll participants in the respective plans upon becoming eligible (the employees may opt out of coverage). The initial automatic enrollment amount is at least 3% but not more than 10%. Each year thereafter, that amount is increased by 1% until it reaches at least 10%, but not more than 15%. All current 401(k) and 403(b) plans are grandfathered.

Section 103: Saver’s Match

Current law provides for a nonrefundable credit for certain individuals who make contributions to individual retirement accounts (IRA), employer retirement plans (such as 401(k) plans), and ABLE accounts. Section 103 repeals and replaces the credit with respect to IRA and retirement plan contributions, changing it from a credit paid in cash as part of a tax refund into a federal matching contribution that must be deposited into a taxpayer’s IRA or retirement plan. The match is 50% of IRA or retirement plan contributions up to $2,000 per individual. In 2023, the match phases out between $43,500 and $73,000 in the case of taxpayers filing a joint return ($21,750 to $36,500 for single taxpayers and married filing separate; $32,625 to $54,750 for head of household filers). Section 103 is effective for taxable years beginning after December 31, 2026.

Section 107: Increases required minimum distribution (RMD) age

The Secure Act of 2019 increased the required minimum distribution age to 72 from 70½. Section 107 further increases the RMD age to 73 starting on January 1, 2023 and increases the age further to 75 starting on January 1, 2033.

Section 108: Indexes IRA catch-up contribution limit to inflation

Currently, the limit on IRA contributions is increased by $1,000 (not indexed) for individuals 50 and older. Section 108 indexes that limit and is effective for taxable years beginning after December 31, 2023.

Section 109: Higher catch-up limit to apply at age 60, 61, 62, and 63

The limit on catch-up contributions for 2023 is $7,500, except in the case of SIMPLE plans, for which the limit is $3,500. Section 109 increases these limits to the greater of $10,000 or 50% more than the regular catch-up amount in 2025 for individuals who have attained ages 60, 61, 62 and 63. The increased amounts are indexed for inflation after 2025. The measure is effective for taxable years beginning after December 31, 2024.

Section 110: Treatment of student loan payments as elective deferrals for purposes of matching

contributions

Section 110 allows employees to receive matching contributions by reason of repaying their student loans. It permits an employer to make matching contributions under a 401(k) plan, 403(b) plan, or SIMPLE IRA with respect to “qualified student loan payments.” The measure is effective for contributions made for plan years beginning after December 31, 2023.

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Section 115: Withdrawals for certain emergency expenses

Section 115 provides an exception for certain distributions used for emergency expenses, which are unforeseeable or immediate financial needs. Only one distribution is allowed per year of up to $1,000, and a taxpayer has the option to repay the distribution within three years. No further emergency distributions are allowed during the repayment period unless repaid in full. This section is effective for distributions made after December 31, 2023.

Section 116: Allow additional nonelective contributions to SIMPLE plans

Current law requires employers with SIMPLE plans to make employer contributions to employees of either 2% of compensation or 3% of employee elective deferral contributions. Section 116 permits an employer to make additional contributions to each employee of the plan in a uniform manner, provided that the contribution may not exceed the lesser of up to 10% of compensation or $5,000 (indexed). Section 116 is effective for taxable years beginning after December 31, 2023.

Section 117: Contributions limit for SIMPLE plans

Under current law, the annual contribution limit for employee elective deferral contributions to a SIMPLE IRA plan is $15,500 (in 2023) and the catch-up contribution limit beginning at age 50 is $3,500. A SIMPLE IRA plan may only be sponsored by a small employer (100 or fewer employees), and the employer is required to either make matching contributions on the first 3% of compensation deferred or an employer contribution of 2% of compensation (regardless of whether the employee elects to make contributions). Section 117 increases the annual deferral limit and the catch-up contribution at age 50 by 10%, as compared to the limit that would otherwise apply in the first year this change is effective, in the case of an employer with no more than 25 employees. An employer with 26 to 100 employees would be permitted to provide higher deferral limits, but only if the employer either provides a 4% matching contribution or a 3% employer contribution. Section 117 makes similar changes to the contribution limits for SIMPLE 401(k) plans. Section 117 is effective for taxable years beginning after December 31, 2023. The Secretary of Treasury shall report to Congress on data related to SIMPLE IRAs by December 31, 2024, and annually thereafter.

Section 126: 529 plan rollovers to Roth IRAs

Section 126 amends the Internal Revenue Code to allow for tax- and penalty-free rollovers from 529 accounts to Roth IRAs, under certain conditions. Beneficiaries of 529 college savings accounts would be permitted to roll over up to $35,000 over the course of their lifetime from any 529 account in their name to their Roth IRA. These rollovers are also subject to Roth IRA annual contribution limits, and the 529 account must have been open for more than 15 years. This section is effective with respect to distributions after December 31, 2023.

Section 203: Insurance-dedicated ETFs

Section 203 directs the Treasury Department to update the regulations to reflect the exchange-traded fund structure to provide that ownership of an ETF’s shares by certain types of institutions that are necessary to the ETF’s structure would not preclude look-through treatment for the ETF, as long as it otherwise satisfies the current-law requirements for look- through treatment. Section 203 is effective for segregated asset account investments made on or after seven years after the date of enactment of the legislation.

Section 303: Retirement savings lost and found

Section 303 creates a national online searchable lost and found database for Americans’ retirement plans at the Labor Department. The database will enable retirement savers, who might have lost track of their pension or 401(k) plan, to search for the contact information of their plan administrator. This section directs the creation of the database no later than two years after the date of enactment.

Section 314: Penalty-free withdrawal from retirement plans in case of domestic abuse

Section 314 allows retirement plans to permit participants that self-certify that they experienced domestic abuse to withdraw a small amount of money (the lesser of $10,000, indexed for inflation, or 50% of the participant’s account). A distribution made under this section is not subject to the 10% tax on early distributions, and a participant has the opportunity to repay the withdrawn money over three years and will be refunded for income taxes on money that is repaid. This section is effective for distributions made after December 31, 2023.

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Topic - Standard Deduction Source - Publication 501 - Dependents, Standard Deduction, and Filing Information Question 2 - C. Alimony Deduction Under the Tax Cuts and Jobs Act (TCJA), the deductions for student loan interest and out-of-pocket teacher expenses will be retained. The alimony deduction (Choice C) is repealed. The change applies to any divorce or separation instrument executed or modified after December 31, 2018 (the modification must expressly state that the new rule applies). The educator expenses deduction (Choice B), student loan interest deduction (Choice A), health savings account (HSA) deduction, IRA deduction (Choice D), and deductions for self-employed taxpayers all stay the same. Since Choices A, B, and C are all above-the-line deductions that remain the same under the TCJA prosecution Choice D, All of the above, is the correct response.

Topic - Changes to Above-the-line Deductions Source - IRS.GOV - Be Tax Ready: Understanding tax reform changes affecting individuals and families Question 3 - D. 100% of the purchase price Per the Tax Cuts and Jobs Act, Section 179 of the IRS Tax Code allows a business to deduct, for the current tax year, the full purchase price of financed or leased equipment and off-the-shelf software that qualifies for the deduction. Therefore, Choice D, 100% of purchase price, is the only correct response. Also, the equipment purchased, financed or leased must be within the specified dollar limits of Section 179, and the equipment must be placed into service in the same tax year that the deduction is being taken.

Topic - Section 179 Deduction Source - Publication 946 - How To Depreciate Property Question 4 - D. Tax preparation expenses Under the Tax Cuts and Jobs Act miscellaneous deductions which exceed 2% of taxpayer’s adjusted gross income (AGI) will be eliminated. This includes deductions for unreimbursed employee expenses, home office expenses, and tax preparation expenses (Choice D). Deductions Not Subject to the 2% Limit:

• Amortizable premium on taxable bonds (Choice B).

• Casualty and theft losses from income-producing property.

• Federal estate tax on income in respect of a decedent (Choice C).

• Gambling losses up to the amount of gambling winnings.

• Impairment-related work expenses of persons with disabilities (Choice A).

• Loss from other activities from Schedule K-1 (Form 1065-B).

• An ordinary loss attributable to a contingent payment debt instrument or an inflation-indexed debt instrument (for example, a Treasury Inflation-Protected Security).

• Repayments of more than $3,000 under a claim of right.

• Unrecovered investment in an annuity.

Topic - Miscellaneous Itemized Deductions Source - Publication 529 - Miscellaneous Deductions

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Question 5 - A. $1,600 The portion of the Child Tax Credit that is refundable after 2017 and before 2026 is still referred to as the Additional Child Tax Credit (ACTC) but is limited to $1,600 per qualifying child in 2023. Only Choice A has the correct amount and is therefore the correct response. Topic - Child Tax Credit Source - IRS.GOV - Child Tax Credit Question 6 - A. $0 Most taxpayers no longer have the option to carryback a net operating loss (NOL) (Choice A). For most taxpayers, NOLs arising in tax years ending after 2020 can only be carried forward. The 2-year carryback rule in effect before 2018, generally, does not apply to NOLs arising in tax years ending after December 31, 2017. The CARES Act provided for a special 5-year carryback for taxable years beginning in 2018, 2019 and 2020. Exceptions apply to certain farming losses and NOLs of insurance companies other than a life insurance company. Also, for losses arising in taxable years beginning after December 31, 2020, the net operating loss deduction is limited to 80% of the excess (if any) of taxable income (determined without regard to the deduction, QBID, and Section 250 deduction over the total NOLD from NOLs arising in taxable years beginning before January 1, 2018. Only Choice A has the correct amount and is therefore the correct response. Topic - Net Operating Loss (NOL) Source - IRS.GOV - Net operating losses Question 7 - B. Qualified bicycle commuting reimbursements For tax years beginning after December 31, 2017 until January 1, 2026, the exclusion from gross income and wages for qualified bicycle commuting reimbursements is suspended (Choice B). An employer can exclude the value of any de minimis transportation benefit he or she provides to an employee from the employee's wages. This exclusion applies to the following benefits:

• A ride in a commuter highway vehicle between the employee's home and workplace (Choice A).

• A transit pass (Choice D).

• Qualified parking (Choice C). The exclusion applies whether the employer provides only one or a combination of these benefits to his or her employees. Topic - Exclusion for Qualified Transportation Fringe Benefits Source - IRS.GOV - Tax Cuts and Jobs Act: A comparison for businesses Question 8 - D. Adoption Credit Due to changes in the tax law, the paid tax return preparer Earned Income Tax Credit (EITC) due diligence requirements have been expanded to also cover the American Opportunity Tax Credit (AOTC) (Choice A), the Child Tax Credit (CTC) (Choice B), and/or the Additional Child Tax Credit (ACTC) (Choice C). Form 8867 - Paid Preparer’s Due Diligence Checklist has been modified to account for these changes. In addition, Form 8867 has been streamlined. However, completing the form is not a substitute for actually performing the necessary due diligence and completing all required forms and schedules when preparing the return. Topic - Paid Preparer’s Due Diligence Checklist Source - Instructions for Form 8867

Lesson 17 - 2023 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

Question 9 - A. Three years ITINs not used on a Federal income tax return in the last three years will no longer be valid to use on a tax return as of January 1, 2024. ITIN holders in this group who need to file a tax return next year will need to renew their ITINs. The renewal period began October 1, 2023. Only Choice A has the correct number of years and is therefore the correct response. Topic - Individual Taxpayer Identification Numbers (ITIN) Source - IRS.GOV - Individual Taxpayer Identification Number

Bibliography

1. University of Washington. Gallagher Law Library - University of Washington School of Law. uw.edu. [Online] https://guides.lib.uw.edu/law/guides. 2. Library of Congress. History of the US Income Tax. loc.gov. [Online] http://www.loc.gov/rr/business/hottopic/irs_history.html. 3. IRS. Historical Highlights of the IRS. irs.gov. [Online] https://www.irs.gov/newsroom/historical-highlights-of-the-irs. 4. —. Publication 519 - U.S. Tax Guide for Aliens. irs.gov. [Online] https://www.irs.gov/publications/p519. 5. —. Nonresident Spouse. irs.gov. [Online] https://www.irs.gov/individuals/international-taxpayers/nonresident-spouse. 6. —. Filing taxes 101: Common errors taxpayers should avoid. irs.gov. [Online] https://www.irs.gov/newsroom/filing-taxes-101-common-errors-taxpayers-should- avoid. 7. —. Understanding Your IRS Notice or Letter. irs.gov. [Online] https://www.irs.gov/individuals/understanding-your-irs-notice-or-letter. 8. —. Publication 538 - Accounting Periods and Methods. irs.gov. [Online] http://www.irs.gov/publications/p538/. 9. —. Publication 3 - Armed Forces' Tax Guide. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p3.pdf. 10. —. Publication 4163 - Modernized e-File (MeF) Information for Authorized IRS e-file Providers for Business Returns. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p4163.pdf. 11. —. Become an Authorized e-file Provider. irs.gov. [Online] https://www.irs.gov/e-file-providers/become-an-authorized-e-file-provider. 12. —. Publication 3112 - IRS e-file Application and Participation. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p3112.pdf. 13. —. Frequently Asked Questions: E-file Requirements for Specified Tax Return Preparers (sometimes referred to as the e-file mandate). irs.gov. [Online] https://www.irs.gov/e-file-providers/frequently-asked-questions-e-file-requirements-for-specified-tax-return-preparers-sometimes-referred-to-as-the-e-file- mandate. 14. —. Electronic Return Originator. irs.gov. [Online] https://www.irs.gov/e-file-providers/electronic-return-originator. 15. —. Publicaton 1345 - Handbook for Authorized IRS e-file Providers of Individual Income Tax Returns. irs.gov. [Online] 2012. http://www.irs.gov/pub/irs- pdf/p1345.pdf. 16. —. Publication 1345 - Handbook for Authorized IRS e-file Providers. irs.gov. [Online] 17. —. Publication 552 - Recordkeeping for Individuals. irs.gov. [Online] http://www.irs.gov/publications/p552/. 18. —. How long should I keep records? irs.gov. [Online] https://www.irs.gov/businesses/small-businesses-self-employed/how-long-should-i-keep-records. 19. —. Topic 205 - Innocent Spouse Relief (Including Separation of Liability and Equitable Relief). irs.gov. [Online] http://www.irs.gov/taxtopics/tc205.html. 20. —. Publication 4600 - Safeguarding Taxpayer Information. [Online] http://www.irs.gov/pub/irs-pdf/p4600.pdf. 21. Code of Federal Regulations. Disclosure or use of information by preparers of returns. ecfr.gov. [Online] https://www.ecfr.gov/current/title-26/chapter- I/subchapter-F/part-301/subpart-ECFRa197f7a9e2c9460/subject-group-ECFR32261461a26e430/section-301.7216-0. 22. IRS. Taxpayer Guide to Identity Theft. irs.gov. [Online] https://www.irs.gov/newsroom/taxpayer-guide-to-identity-theft. 23. —. Form 8879 - IRS e-file Signature Authorization. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f8879.pdf. 24. —. Form 8879-C - IRS e-file Signature Authorization for Form 1120. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f8879c.pdf. 25. —. Form 8879-PE - IRS e-file Signature Authorization for Form 1065. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f8879pe.pdf. 26. —. Publication 557 - Tax-Exempt Status for Your Organization. irs.gov. [Online] http://www.irs.gov/publications/p557/index.html. 27. —. Instructions for Form 990 - Return of Organization Exempt From Income Tax. irs.gov. [Online] http://www.irs.gov/instructions/i990/. 28. —. Electronic Return Originator (ERO) Technical Fact Sheet. irs.gov. [Online] https://www.irs.gov/e-file-providers/electronic-return-originator-ero-technical- fact-sheet. 29. —. Topic 152 - Refund Information. irs.gov. [Online] http://www.irs.gov/taxtopics/tc152.html. 30. —. Publication 1 - Your Rights as a Taxpayer. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p1.pdf. 31. —. Refund Offsets. irs.gov. [Online] https://www.taxpayeradvocate.irs.gov/get-help/refunds/refund-offsets/. 32. —. Topic 203 - Refund Offsets: For Unpaid Child Support, and Certain Federal, State and Unemployment Compensation Debts. irs.gov. [Online] http://www.irs.gov/taxtopics/tc203.html. 33. —. Estimated Taxes. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estimated-Taxes. 34. —. Publication 505 - Tax Withholding and Estimated Tax. irs.gov. [Online] http://www.irs.gov/publications/p505/ch01.html. 35. —. Instructions for Form 2210. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/i2210.pdf. 36. —. EFTPS: The Electronic Federal Tax Payment System. irs.gov. [Online] http://www.irs.gov/uac/EFTPS:-The-Electronic-Federal-Tax-Payment-System. 37. —. Pay Your Taxes by Debit or Credit Card or Digital Wallet. irs.gov. [Online] https://www.irs.gov/payments/pay-your-taxes-by-debit-or-credit-card. 38. —. Pay by Check or Money Order. irs.gov. [Online] https://www.irs.gov/payments/pay-by-check-or-money-order. 39. —. Topic 202 - Tax Payment Options. irs.gov. [Online] http://www.irs.gov/taxtopics/tc202.html. 40. —. Offer in Compromise. irs.gov. [Online] https://www.irs.gov/payments/offer-in-compromise. 41. —. Publication 17 - Your Federal Income Tax. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p17.pdf. 42. —. Instructions Form 1040NR. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040nr.pdf. 43. —. Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return . irs.gov. [Online] http://www.irs.gov/pub/irs- pdf/f4868.pdf. 44. —. Topic 308 - Amended Returns. irs.gov. [Online] http://www.irs.gov/taxtopics/tc308.html. 45. —. Instructions for Form 1040X. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040x.pdf. 46. —. Topic 203 - Refund Offsets: For Unpaid Child Support, and Certain Federal, State and Unemployment Compensation Debts. irs.gov. [Online] http://www.irs.gov/taxtopics/tc203.html. 47. —. Topic 753 - Form W-4 – Employee's Withholding Certificate. irs.gov. [Online] http://www.irs.gov/taxtopics/tc753.html. 48. —. Publication 919 - How Do I Adjust My Tax Withholding? irs.gov. [Online] http://www.irs.gov/publications/p919/. 49. —. Form W-4 - Employee's Withholding Certificate. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/fw4.pdf. 50. —. Tax Withholding for Individuals. irs.gov. [Online] https://www.irs.gov/individuals/employees/tax-withholding. 51. —. Withholding Exemptions - Personal Exemptions - Form W-4 – For Nonresident Aliens. irs.gov. [Online] https://www.irs.gov/individuals/international- taxpayers/withholding-exemptions-personal-exemptions-form-w-4-for-nonresident-aliens. 52. —. Form W-4 - Employee's Withholding Allowance Certificate. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/fw4.pdf. 53. —. Topic 307 - Backup Withholding. irs.gov. [Online] http://www.irs.gov/taxtopics/tc307.html. 54. —. Publication 15-B - Employer's Tax Guide to Fringe Benefits. irs.gov. [Online] http://www.irs.gov/publications/p15b/. 55. —. Form W-2 - Wage and Tax Statement. irs.gov. [Online] http://www.irs.gov/uac/Form-W-2,-Wage-and-Tax-Statement.

Bibliography

56. —. What to do when a W-2 or Form 1099 is missing or incorrect. irs.gov. [Online] https://www.irs.gov/newsroom/what-to-do-when-a-w-2-or-form-1099-is- missing-or-incorrect. 57. —. General Instructions for Forms W-2 and W-3. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/iw2w3.pdf. 58. Code of Federal Regulations. 26 USC § 280G - Golden parachute payments. ecfr.gov. [Online] https://www.ecfr.gov/current/title-26/chapter-I/subchapter- A/part-1/subject-group-ECFR210006225231fb0/section-1.280G-1. 59. IRS. Publication 505 - Tax Withholding and Estimated Tax. irs.gov. [Online] http://www.irs.gov/publications/p505/ch01.html. 60. —. Topic 160 - Form 1099-A (Acquisition or Abandonment of Secured Property) and Form 1099-C (Cancellation of Debt). irs.gov. [Online] http://www.irs.gov/taxtopics/tc160.html. 61. —. Form 1099-MISC - Miscellaneous Income. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f1099msc.pdf. 62. —. Form 1099-DIV - Dividends and Distributions. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f1099div.pdf. 63. —. Form 1099-INT - Interest Income. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f1099int.pdf. 64. —. Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f1099r.pdf. 65. —. Publication 915 - Social Security and Equivalent Railroad Retirement Benefits. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p915.pdf. 66. —. What is Taxable and Nontaxable Income? irs.gov. [Online] https://www.irs.gov/businesses/small-businesses-self-employed/what-is-taxable-and-nontaxable- income. 67. —. IRS provides tax inflation adjustments for tax year 2023. irs.gov. [Online] https://www.irs.gov/pub/irs-drop/rp-22-38.pdf. 68. —. Topic 407 - Business Income. irs.gov. [Online] http://www.irs.gov/taxtopics/tc407.html. 69. —. Publication 523 - Selling Your Home. irs.gov. [Online] http://www.irs.gov/publications/p523/ar02.html. 70. —. Publication 550, Chapter 1 - Investment Income. irs.gov. [Online] http://www.irs.gov/publications/p550/ch01.html. 71. —. Topic 414 - Rental Income and Expenses. irs.gov. [Online] http://www.irs.gov/taxtopics/tc414.html. 72. —. Publication 527 - Residential Rental Property. irs.gov. [Online] http://www.irs.gov/publications/p527/index.html. 73. —. Flow-Through Entities. irs.gov. [Online] https://www.irs.gov/individuals/international-taxpayers/flow-through-entities. 74. —. Publication 575 - Pension and Annuity Income. irs.gov. [Online] http://www.irs.gov/publications/p575/. 75. —. Notice 2014-21 . irs.gov. [Online] http://www.irs.gov/pub/irs-drop/n-14-21.pdf. 76. Code of Federal Regulations. 26 USC § 61 - Gross income defined. ecfr.gov. [Online] https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part- 1/subject-group-ECFR064ad1fa7d3cb20/section-1.61-1. 77. IRS. IRS provides tax inflation adjustments for tax year 2023. irs.gov. [Online] https://www.irs.gov/pub/irs-drop/rp-22-38.pdf. 78. —. Topic 556 - Alternative Minimum Tax. irs.gov. [Online] https://www.irs.gov/taxtopics/tc556. 79. —. Form 1040 - U.S. Individual Income Tax Return. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f1040.pdf. 80. —. Form W-2 - Wage and Tax Statement. irs.gov. [Online] http://www.irs.gov/uac/Form-W-2,-Wage-and-Tax-Statement. 81. —. Tax Withholding for Individuals. irs.gov. [Online] https://www.irs.gov/individuals/employees/tax-withholding. 82. —. Estimated Taxes. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estimated-Taxes. 83. —. What Is My Filing Status? irs.gov. [Online] https://www.irs.gov/help/ita/what-is-my-filing-status. 84. —. Publication 501 - Dependents, Standard Deduction, and Filing Information. irs.gov. [Online] http://www.irs.gov/publications/p501/. 85. —. Publication 17, Part One - Filing Status. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p17.pdf. 86. —. Publication 501 - Dependents, Standard Deduction, and Filing Information. irs.gov. [Online] http://www.irs.gov/publications/p501/. 87. —. Publication 17, Part One - Filing Status. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p17.pdf. 88. —. Publication 501 - Dependents, Standard Deduction, and Filing Information. irs.gov. [Online] http://www.irs.gov/publications/p501/. 89. —. Publication 519 - U.S. Tax Guide for Aliens. irs.gov. [Online] [Cited: ] 90. —. Taxation of Dual-Status Aliens. irs.gov. [Online] http://www.irs.gov/Individuals/International-Taxpayers/Taxation-of-Dual-Status-Aliens. 91. —. Publication 504 - Divorced or Separated Individuals. irs.gov. [Online] http://www.irs.gov/publications/p504/index.html. 92. —. Topic 205 - Innocent Spouse Relief (Including Separation of Liability and Equitable Relief). irs.gov. [Online] http://www.irs.gov/taxtopics/tc205.html. 93. —. Publication 17, Part One - Filing Status. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p17.pdf. 94. —. Same-sex marriages now recognized for federal tax purposes. irs.gov. [Online] https://www.irs.gov/pub/irs-utl/OC- SamesexmarriagesnowrecognizedforfederaltaxpurposesFINAL.pdf. 95. —. Publication 3 - Armed Forces' Tax Guide. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p3.pdf. 96. —. Taxation of Nonresident Aliens. irs.gov. [Online] http://www.irs.gov/Individuals/International-Taxpayers/Taxation-of-Nonresident-Aliens. 97. —. Publication 17, Part Three - Standard Deduction. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p17.pdf. 98. —. Form 2120 - Multiple Support Declaration. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f2120.pdf. 99. Code of Federal Regulations. 26 USC § 61 - Gross income defined. ecfr.gov. [Online] https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part- 1/subject-group-ECFR064ad1fa7d3cb20/section-1.61-1. 100. IRS. Earned Income and Earned Income Tax Credit (EITC) Tables. irs.gov. [Online] https://www.irs.gov/credits-deductions/individuals/earned-income-tax- credit/earned-income-and-earned-income-tax-credit-eitc-tables#. 101. —. What is Taxable and Nontaxable Income? irs.gov. [Online] https://www.irs.gov/businesses/small-businesses-self-employed/what-is-taxable-and- nontaxable-income. 102. —. Instructions for Form 2555 - Foreign Earned Income. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i2555.pdf. 103. —. Publication 15-B - Employer's Tax Guide to Fringe Benefits. irs.gov. [Online] http://www.irs.gov/publications/p15b/. 104. 116th U.S. Congress. H.R.133 - Consolidated Appropriations Act, 2021. congress.gov. [Online] https://www.congress.gov/bill/116th-congress/house-bill/133.. 105. IRS. Unemployment Compensation. irs.gov. [Online] http://www.irs.gov/Individuals/Employees/Unemployment-Compensation. 106. —. Publication 525 - Unemployment Benefits. irs.gov. [Online] http://www.irs.gov/publications/p525/. 107. —. Unemployment Compensation. irs.gov. [Online] https://www.irs.gov/individuals/employees/unemployment-compensation. 108. —. Publication 525 - Taxable and Nontaxable Income. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p525.pdf. 109. —. Publication 575 - Pension and Annuity Income. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p575.pdf. 110. —. Publication 525 - Sickness and Injury Benefits. irs.gov. [Online] http://www.irs.gov/publications/p525/ar02.html. 111. —. Publication 502 - Medical and Dental Expenses (Including the Health Coverage Tax Credit). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p502.pdf. 112. —. Publication 17, Part Two - Other Income. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p17.pdf. 113. —. Publication 525 - Taxable and Nontaxable Income. irs.gov. [Online] http://www.irs.gov/publications/p525/. 114. —. Publication 529 - Miscellaneous Deductions. irs.gov. [Online] http://www.irs.gov/publications/p529/.

Bibliography

115. —. Topic 419 - Gambling Income and Losses. IRS. [Online] http://www.irs.gov/taxtopics/tc419.html. 116. —. Topic 761 - Tips – Withholding and Reporting. irs.gov. [Online] http://www.irs.gov/taxtopics/tc761.html. 117. —. Publication 531 - Reporting Tip Income. irs.gov. [Online] http://www.irs.gov/publications/p531/. 118. —. Topic 420 - Bartering Income. irs.gov. [Online] http://www.irs.gov/taxtopics/tc420.html. 119. —. Topic 420 - Bartering Income. irs.gov. [Online] https://www.irs.gov/taxtopics/tc420. 120. —. Topic 431 - Canceled Debt – Is It Taxable or Not? irs.gov. [Online] http://www.irs.gov/taxtopics/tc431.html. 121. —. Life Insurance & Disability Insurance Proceeds. irs.gov. [Online] https://www.irs.gov/faqs/interest-dividends-other-types-of-income/life-insurance- disability-insurance-proceeds. 122. —. Publication 541 - Partnerships. irs.gov. [Online] http://www.irs.gov/publications/p541/. 123. —. Source of Income - Personal Service Income. irs.gov. [Online] https://www.irs.gov/individuals/international-taxpayers/source-of-income-personal-service- income. 124. —. Form 1041 - U.S. Income Tax Return for Estates and Trusts. irs.gov. [Online] http://www.irs.gov/instructions/i1041/. 125. —. Source of Income - Personal Service Income. irs.gov. [Online] https://www.irs.gov/individuals/international-taxpayers/source-of-income-personal-service- income. 126. —. Topic 421 - Scholarship and Fellowship Grants. irs.gov. [Online] http://www.irs.gov/taxtopics/tc421.html. 127. —. Tax Implications of Settlements and Judgments. irs.gov. [Online] https://www.irs.gov/government-entities/tax-implications-of-settlements-and-judgments. 128. —. Topic 417 - Earnings for Clergy. irs.gov. [Online] http://www.irs.gov/taxtopics/tc417.html. 129. —. Tax Information for Members of the Military. irs.gov. [Online] https://www.irs.gov/individuals/military. 130. —. Passive Activity Loss Audit Technique Guide (ATG) . irs.gov. [Online] https://www.irs.gov/pub/irs-mssp/pal.pdf. 131. —. Instructions for Form 8582 - Passive Activity Loss Limitations. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8582.pdf. 132. —. Topic 414 - Rental Income and Expenses. irs.gov. [Online] http://www.irs.gov/taxtopics/tc414.html. 133. —. Topic 452 - Alimony and Separate Maintenance. irs.gov. [Online] https://www.irs.gov/taxtopics/tc452. 134. —. Publication 550, Chapter 1 - Investment Income. irs.gov. [Online] http://www.irs.gov/publications/p550/ch01.html. 135. —. Publication 550 - Investment Income and Expenses. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p550.pdf. 136. —. Stocks (Options, Splits, Traders). irs.gov. [Online] https://www.irs.gov/faqs/capital-gains-losses-and-sale-of-home/stocks-options-splits-traders. 137. —. Topic 427 - Stock Options. irs.gov. [Online] http://www.irs.gov/taxtopics/tc427.html. 138. —. Publication 550, Chapter 1 - Investment Income. irs.gob. [Online] http://www.irs.gov/publications/p550/ch01.html. 139. —. Publication 550, Chapter 1 - Investment Income. irs.gob. [Online] http://www.irs.gov/publications/p550/ch01.html. 140. —. Publication 17, Part Two - Interest Income. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p17.pdf. 141. —. Understanding Your IRS Notice or Letter. irs.gov. [Online] https://www.irs.gov/individuals/understanding-your-irs-notice-or-letter. 142. —. Instructions for Schedule D - Capital Gains and Losses. irs.gov. [Online] https://www.irs.gov/instructions/i1040sd. 143. —. Instructions for Form 8949. irs.gov. [Online] http://www.irs.gov/instructions/i8949/. 144. —. Instructions for Schedule D. irs.gov. [Online] http://www.irs.gov/instructions/i1040sd/. 145. —. Form 6781 - Gains and Losses From Section 1256 Contracts and Straddles. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f6781.pdf. 146. —. Form 8824 - Like-Kind Exchanges(and section 1043 conflict-of-interest sales). irs.gov. [Online] http://www.irs.gov/uac/Form-8824,-Like-Kind- Exchanges(and-section-1043-conflict-of-interest-sales). 147. —. Publication 550, Chapter 4 - Sales and Trades of Investment Property. [Online] http://www.irs.gov/publications/p550/ch04.html. 148. —. Topic 409 - Capital Gains and Losses. irs.gov. [Online] https://www.irs.gov/taxtopics/tc409. 149. —. Publication 550, Chapter 1 - Investment Income, Qualified Dividends. irs.gov. [Online] http://www.irs.gov/publications/p550/ch01.html. 150. —. Topic 453 - Bad Debt Deduction. irs.gov. [Online] http://www.irs.gov/taxtopics/tc453.html. 151. —. Revenue Ruling 2019-24. irs.gov. [Online] https://www.irs.gov/pub/irs-drop/rr-19-24.pdf. 152. —. Publication 523 - Selling Your Home. irs.gov. [Online] http://www.irs.gov/publications/p523. 153. —. Topic 705 - Installment Sales. irs.gov. [Online] http://www.irs.gov/taxtopics/tc705.html. 154. —. Like-Kind Exchanges - Real Estate Tax Tips. irs.gov. [Online] https://www.irs.gov/businesses/small-businesses-self-employed/like-kind-exchanges-real- estate-tax-tips. 155. —. Publication 544 - Sales and Other Dispositions of Assets. irs.gov. [Online] http://www.irs.gov/publications/p544/. 156. —. Topic 420 - Bartering Income. irs.gov. [Online] https://www.irs.gov/taxtopics/tc420. 157. —. Instructions for Schedule C. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040sc.pdf. 158. —. Publication 334 - Tax Guide for Small Business. irs.gov. [Online] http://www.irs.gov/publications/p334/. 159. —. Home Office Deduction at a Glance. irs.gov. [Online] https://www.irs.gov/credits-deductions/individuals/home-office-deduction-at-a-glance. 160. —. Instructions for Schedule C. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/i1040sc.pdf. 161. —. Publication 587 - Business Use of Your Home. irs.gov. [Online] http://www.irs.gov/publications/p587/. 162. —. Simplified Option for Home Office Deduction. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Simplified-Option-for- Home-Office-Deduction. 163. —. Publication 334 - Tax Guide for Small Business. irs.gov. [Online] http://www.irs.gov/publications/p334/ch01.html. 164. —. Instructions for Schedule SE (Form 1040). irs.gov. [Online] http://www.irs.gov/instructions/i1040sse/. 165. —. Publication 334 - Tax Guide for Small Business. irs.gov. [Online] http://www.irs.gov/publications/p334/. 166. —. Publication 926 - Household Employer's Tax Guide. irs.gov. [Online] http://www.irs.gov/publications/p926/. 167. —. Instructions for Schedule H (Form 1040). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040sh.pdf. 168. —. Publication 542 - Corporations. irs.gov. [Online] http://www.irs.gov/publications/p542/index.html. 169. —. Publication 542 - Corporations. irs.gov. [Online] http://www.irs.gov/publications/p542/index.html. 170. —. Publication 541 - Partnerships. irs.gov. [Online] http://www.irs.gov/publications/p541/. 171. SBA. Choose a business structure. sba.gov. [Online] https://www.sba.gov/business-guide/launch-your-business/choose-business-structure. 172. IRS. Publication 550, Chapter 4 - Sales and Trades of Investment Property. [Online] http://www.irs.gov/publications/p550/ch04.html. 173. —. Publication 550, Chapter 1 - Investment Income. irs.gov. [Online] http://www.irs.gov/publications/p550/ch01.html. 174. —. Instruction for Form 1120S - U.S. Income Tax Return for an S Corporation. irs.gov. [Online] http://www.irs.gov/instructions/i1120s/. 175. —. Publication 3402 - Taxation of Limited Liability Companies. irs.gov. [Online] http://www.irs.gov/publications/p3402/. 176. —. Instructions for Form 1041 and Schedules A, B, G, J, and K-1. irs.gov. [Online] http://www.irs.gov/instructions/i1041/index.html. 177. —. Instructions for Form 1023-EZ. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1023ez.pdf.

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[Online] http://www.irs.gov/publications/p946/ch04.html. 186. —. Publication 946 - How To Depreciate Property. irs.gov. [Online] http://www.irs.gov/publications/p946/. 187. —. Topic 703 - Basis of Assets. irs.gov. [Online] http://www.irs.gov/taxtopics/tc703.html. 188. —. Publication 551 - Basis of Assets. irs.gov. [Online] http://www.irs.gov/publications/p551/. 189. —. Publication 4895 - Tax Treatment of Property Acquired From a Decedent Dying in 2010. irs.gov. [Online] https://www.irs.gov/pub/irs-prior/p4895-- 2011.pdf. 190. —. Publication 946 - Electing the Section 179 Deduction. irs.gov. [Online] http://www.irs.gov/publications/p946/ch02.html. 191. Section179.org. The Section 179 Deduction. www.section179.org. [Online] http://www.section179.org/. 192. IRS. Self-Employment Tax (Social Security and Medicare Taxes). irs.gov. [Online] https://www.irs.gov/businesses/small-businesses-self-employed/self- employment-tax-social-security-and-medicare-taxes. 193. —. Questions and Answers for the Additional Medicare Tax. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Questions- and-Answers-for-the-Additional-Medicare-Tax. 194. —. Publication 17, Part Two - Social Security and Equivalent Railroad Retirement Benefits. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p17.pdf. 195. —. Publication 575 - Pension and Annuity Income. irs.gov. [Online] http://www.irs.gov/publications/p575/. 196. —. Topic 410 - Pensions and Annuities. irs.gov. [Online] http://www.irs.gov/taxtopics/tc410.html. 197. 116th U.S. Congress. Setting Every Community Up for Retirement Enhancement (SECURE) Act. waysandmeans.house.gov. [Online] https://waysandmeans.house.gov/sites/democrats.waysandmeans.house.gov/files/documents/SECURE%20Act%20section%20by%20section.pdf. 198. IRS. Topic 451 - Individual Retirement Arrangements (IRAs). irs.gov. [Online] http://www.irs.gov/taxtopics/tc451.html. 199. —. Retirement Topic - IRA Contribution Limits. irs.gov. [Online] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira- contribution-limits. 200. 116th U.S. Congress. H.R.1994 - Setting Every Community Up for Retirement Enhancement Act of 2019. congress.gov. [Online] https://www.congress.gov/bill/116th-congress/house-bill/1994. 201. IRS. Instructions for Form 8606 - Nondeductible IRAs. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8606.pdf. 202. —. Publication 590-B, Chapter 1 - Traditional IRAs. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p590b.pdf. 203. —. Substantially Equal Periodic Payments. irs.gov. [Online] https://www.irs.gov/retirement-plans/substantially-equal-periodic-payments. 204. —. Publication 590-A, Chapter 1 - Contributions to Individual Retirement Arrangements (IRAs). irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p590a.pdf. 205. —. Publication 590-B, Chapter 2 - Roth IRAs. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p590b.pdf. 206. —. Retirement Topics - Designated Roth Account. irs.gov. [Online] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics- designated-roth-account. 207. —. Choosing a Retirement Plan: SIMPLE IRA Plan. irs.gov. [Online] https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-simple-401k-plan. 208. —. Retirement Topics - Catch-Up Contributions. irs.gov. [Online] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-catch- up-contributions. 209. —. Publication 575 - Pension and Annuity Income. irs.gov. [Online] http://www.irs.gov/publications/p575/. 210. —. Topic 413 - Rollovers from Retirement Plans. irs.gov. [Online] https://www.irs.gov/taxtopics/tc413. 211. —. Publication 560 - Retirement Plans for Small Business. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p560.pdf. 212. —. Retirement Plans. irs.gov. [Online] https://www.irs.gov/retirement-plans. 213. —. Retirement Topics - Required Minimum Distributions (RMDs). irs.gov. [Online] https://www.irs.gov/retirement-plans/plan-participant- employee/retirement-topics-required-minimum-distributions-rmds. 214. —. Publication 525 - Taxable and Nontaxable Income. irs.gov. [Online] http://www.irs.gov/publications/p525/. 215. —. Publication 525 - Group-Term Life Insurance. irs.gov. [Online] http://www.irs.gov/publications/p525/ar02.html. 216. —. Publication 915 - Social Security and Equivalent Railroad Retirement Benefits. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p915.pdf. 217. —. Publication 559 - Survivors, Executors, and Administrators. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p559.pdf. 218. —. Publication 525 - Welfare and Other Public Assistance Benefits. irs.gov. [Online] http://www.irs.gov/publications/p525/. 219. —. Publication 525 - Scholarships and Fellowships. irs.gov. [Online] http://www.irs.gov/publications/p525/. 220. —. Publication 54 - Tax Guide for U.S. Citizens and Resident Aliens Abroad. irs.gov. [Online] http://www.irs.gov/publications/p54/index.html. 221. —. Publication 463 - Travel, Gift, and Car Expenses. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p463.pdf. 222. —. Publication 463 - Travel, Gift, and Car Expenses. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p463.pdf. 223. —. Topic 310 - Coverdell Education Savings Accounts. irs.gov. [Online] http://www.irs.gov/taxtopics/tc310.html. 224. —. Publication 970, Chapter 7 - Coverdell Education Savings Account (ESA). irs.gov. [Online] http://www.irs.gov/publications/p970/ch07.html. 225. —. Topic 313 - Qualified Tuition Programs (QTPs). irs.gov. [Online] http://www.irs.gov/taxtopics/tc313.html. 226. —. Tax Benefits for Education: Information Center. irs.gov. [Online] http://www.irs.gov/uac/Tax-Benefits-for-Education:-Information-Center. 227. —. Publication 970, Chapter 4 - Student Loan Interest Deduction. irs.gov. [Online] http://www.irs.gov/publications/p970/ch04.html. 228. —. Instructions for Form 8889 - Health Savings Accounts (HSAs). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8889.pdf. 229. —. Publication 969 - Health Savings Accounts and Other Tax-Favored Health Plans. irs.gov. [Online] http://www.irs.gov/publications/p969/. 230. —. Instructions for Form 8853 - Archer MSAs and Long-Term Care Insurance Contracts. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8853.pdf. 231. —. Instructions for Form 7206. irs.gov. [Online] https://www.irs.gov/instructions/i7206. 232. —. Instructions for Form 3903. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/i3903.pdf. 233. —. FAQs for government entities regarding Cafeteria Plans. irs.gov. [Online] https://www.irs.gov/government-entities/federal-state-local-governments/faqs- for-government-entities-regarding-cafeteria-plans. 234. —. Publication 551 - Basis of Assets. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p551.pdf. 235. —. Publication 525 - Taxable and Nontaxable Income. irs.gov. [Online] http://www.irs.gov/publications/p525/.

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236. —. Publication 503 - Child and Dependent Care Expenses. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p503.pdf. 237. —. Topic 502 - Medical and Dental Expenses. irs.gov. [Online] https://www.irs.gov/taxtopics/tc502. 238. —. Publication 502 - Medical and Dental Expenses (Including the Health Coverage Tax Credit). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p502.pdf. 239. —. Topic 502 - Medical and Dental Expenses. irs.gov. [Online] http://www.irs.gov/taxtopics/tc502.html. 240. —. Publication 502 - Medical and Dental Expenses. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p502.pdf. 241. —. Publication 17, Part Four - How To Figure Your Tax . irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p17.pdf. 242. —. Publication 17, Part Four - How To Figure Your Tax . irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p17.pdf. 243. —. Excise Tax. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Excise-Tax. 244. —. Frequently Asked Questions (FAQs) About International Individual Tax Matters. irs.gov. [Online] https://www.irs.gov/individuals/international- taxpayers/frequently-asked-questions-about-international-individual-tax-matters. 245. —. Instructions for Form 5329 - Additional Taxes on Qualified Plans (Including IRAs). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i5329.pdf. 246. —. Publication 551 - Basis of Assets. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p551.pdf. 247. —. Estate Tax. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estate-Tax. 248. —. Gift Tax. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Gift-Tax. 249. —. Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return. irs.gov. [Online] http://www.irs.gov/instructions/i709/. 250. —. Form 4137 - Social Security and Medicare Tax on Unreported Tip Income. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f4137.pdf. 251. —. Questions and Answers on the Net Investment Income Tax. irs.gov. [Online] https://www.irs.gov/newsroom/questions-and-answers-on-the-net- investment-income-tax. 252. —. Tax Cuts and Jobs Act, Provision 11011 Section 199A - Qualified Business Income Deduction FAQs. irs.gov. [Online] https://www.irs.gov/newsroom/tax- cuts-and-jobs-act-provision-11011-section-199a-qualified-business-income-deduction-faqs. 253. —. Publication 526 - Charitable Contributions. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p526.pdf. 254. —. Topic 505 - Interest Expense. irs.gov. [Online] http://www.irs.gov/taxtopics/tc505.html. 255. —. Publication 550 - Investment Income and Expenses. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p550.pdf. 256. —. Form 1098 - Mortgage Interest Statement. irs.gov. [Online] http://www.irs.gov/uac/Form-1098,-Mortgage-Interest-Statement. 257. —. Topic 504 - Home Mortgage Points. irs.gov. [Online] http://www.irs.gov/taxtopics/tc504.html. 258. —. Credits and Deductions for Individuals. irs.gov. [Online] https://www.irs.gov/credits-deductions-for-individuals. 259. —. IR-2011-122. irs.gov. [Online] http://www.irs.gov/uac/Starting-Jan.-1:-Tax-Preparers-Need-to-File-Due-Diligence-Checklist-with-All-Earned-Income-Tax- Credit-Claims. 260. —. Instructions for Form 8867 - Paid Preparer's Due Diligence Checklist. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8867.pdf. 261. —. Consequences of Not Meeting the Due Diligence Requirements. eitc.irs.gov. [Online] https://www.eitc.irs.gov/tax-preparer-toolkit/preparer-due- diligence/consequences-of-failing-to-meet-your-due-diligence. 262. —. Preparer Due Diligence. eitc.irs.gov. [Online] https://www.eitc.irs.gov/tax-preparer-toolkit/preparer-due-diligence/preparer-due-diligence. 263. —. Topic 601 - Earned Income Tax Credit. irs.gov. [Online] http://www.irs.gov/taxtopics/tc601.html. 264. —. Earned Income and Earned Income Tax Credit (EITC) Tables. irs.gov. 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Topic 607 - Adoption Credit and Adoption Assistance Programs. irs.gov. [Online] http://www.irs.gov/taxtopics/tc607.html. 279. —. Instructions for Form 8839 - Qualified Adoption Expenses. irs. [Online] http://www.irs.gov/pub/irs-pdf/i8839.pdf. 280. —. Publication 524 - Credit for the Elderly or the Disabled. irs.gov. [Online] http://www.irs.gov/publications/p524/ar02.html. 281. —. Form 8880 - Credit for Qualified Retirement Savings Contributions. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f8880.pdf. 282. —. Retirement Savings Contributions Credit (Saver’s Credit). irs.gov. [Online] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement- savings-contributions-savers-credit. 283. —. Publication 514 - Foreign Tax Credit for Individuals. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p514.pdf. 284. —. Foreign Taxes that Qualify for the Foreign Tax Credit. irs.gov. 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[Online] https://www.irs.gov/credits-deductions/residential-clean-energy-credit. 291. —. Alternative Fuel Vehicle Refueling Property Credit. irs.gov. [Online] https://www.irs.gov/credits-deductions/alternative-fuel-vehicle-refueling-property- credit. 292. —. Instructions for Form 6251. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i6251.pdf.

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293. —. Instructions for Form 6251 - Alternative Minimum Tax—Individuals. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i6251.pdf. 294. —. Questions and Answers on the Net Investment Income Tax. irs.gov. [Online] https://www.irs.gov/newsroom/questions-and-answers-on-the-net- investment-income-tax. 295. —. Affordable Care Act Tax Provisions. irs.gov. [Online] https://www.irs.gov/affordable-care-act/affordable-care-act-tax-provisions. 296. —. Frequently Asked Questions: Retiree Drug Subsidy. irs.gov. [Online] https://www.irs.gov/newsroom/frequently-asked-questions-retiree-drug-subsidy. 297. —. Instructions for Form 8615. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/i8615.pdf. 298. —. Topic 756 - Employment Taxes for Household Employees. irs.gov. [Online] http://www.irs.gov/taxtopics/tc756.html. 299. —. Voluntary Classification Settlement Program (VCSP). irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Voluntary- Classification-Settlement-Program. 300. —. Penalties. irs.gov. [Online] https://www.irs.gov/payments/penalties. 301. —. Topic 653 - IRS Notices and Bills, Penalties and Interest Charges. irs.gov. [Online] http://www.irs.gov/taxtopics/tc653.html. 302. —. Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return . irs.gov. [Online] http://www.irs.gov/pub/irs- pdf/f4868.pdf. 303. —. Penalties. irs.gov. [Online] https://www.irs.gov/payments/penalties. 304. —. The Tax Gap. irs.gov. [Online] https://www.irs.gov/newsroom/the-tax-gap. 305. —. The Tax Gap. irs.gov. [Online] https://www.irs.gov/newsroom/the-tax-gap. 306. —. Abusive Tax Schemes and Abusive Tax Return Preparers - IRS Lead Development Center. irs.gov. [Online] https://www.irs.gov/businesses/small-businesses- self-employed/abusive-tax-schemes-and-abusive-tax-return-preparers-irs-lead-development-center. 307. —. Abusive Tax Schemes and Abusive Tax Return Preparers - IRS Lead Development Center. irs.gov. [Online] https://www.irs.gov/businesses/small-businesses- self-employed/abusive-tax-schemes-and-abusive-tax-return-preparers-irs-lead-development-center. 308. —. Understanding IRS Guidance - A Brief Primer. irs.gov. [Online] https://www.irs.gov/newsroom/understanding-irs-guidance-a-brief-primer. 309. —. Tax Cuts and Jobs Act: A comparison for businesses. irs.gov. [Online] https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-a-comparison-for-businesses. 310. —. IRS provides tax inflation adjustments for tax year 2023. irs.gov. [Online] https://www.irs.gov/pub/irs-drop/rp-22-38.pdf. 311. —. IRS provides tax inflation adjustments for tax year 2023. irs.gov. [Online] https://www.irs.gov/pub/irs-drop/rp-22-38.pdf. 312. —. Publication 526 - Charitable Contributions. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p526.pdf. 313. —. Publication 559 - Survivors, Executors, and Administrators. irs.gov. [Online] https://www.irs.gov/publications/p559. 314. —. Publication 529 - Miscellaneous Deductions. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p529.pdf. 315. —. Instructions for Form 6251. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i6251.pdf. 316. —. Publication 525 - Taxable and Nontaxable Income. irs.gov. [Online] http://www.irs.gov/publications/p525/. 317. —. Taxpayer Guide to Identity Theft. irs.gov. [Online] https://www.irs.gov/newsroom/taxpayer-guide-to-identity-theft. 318. —. New ITIN Acceptance Agent Program Changes. irs.gov. [Online] https://www.irs.gov/individuals/new-itin-acceptance-agent-program-changes. 319. —. Individual Taxpayer Identification Number. irs.gov. [Online] https://www.irs.gov/individuals/individual-taxpayer-identification-number.

Index

$200 Property ............................................................................ 10-20

12 Month Property .................................................................... 10-20

52-53-Week Tax Year .................................................................... 1-5 529 Plan ....................................................................................... 12-7

Abandoned Spouse...................................................................... 3-22 Above-the-line Deductions ........................................................ 17-11 Abusive Foreign Trust Schemes ................................................... 16-5 Abusive Tax Schemes .................................................................. 16-5 Accounting Methods ............................................................ 1-5, 9-39

Accrual Method ............................................................... 1-7, 9-40 Cash Method ................................................................... 1-6, 9-39 Excluded Entities ...................................................................... 1-6

Accounting Periods ........................................................................ 1-4 52-53-week Tax Year ................................................................ 1-5 Calendar Year ........................................................................... 1-5 Fiscal Year................................................................................. 1-5 Short Tax Year .......................................................................... 1-5

Accumulated Earnings Tax........................................................... 9-10 Accuracy ........................................................................................ 1-3

Negligence .............................................................................. 16-3 Substantial Understatement .................................................. 16-3

Achieving a Better Life Experience (ABLE) Accounts ................. 17-27 Acquired Components ............................................................... 10-20 ACRS (Accelerated Cost Recovery System) .................................. 10-6 Additional Child Tax Credit .................................. 14-10, 14-12, 17-24 Additional Medicare Tax............................................ 8-17, 13-6, 15-7 Adjusted Gross Income (AGI) ............................................. 3-10, 3-11

Deductions ............................................................................. 3-11 Adoption Credit ......................................................................... 14-20

Special Needs Child .............................................................. 14-21 Advance Credit Payments.......................................................... 14-19 Advance Payments ........................................................................ 1-7 Advance Reimbursement .............................................................. 5-6 Advertising .................................................................................... 8-7 Affordable Care Act ................................. 5-4, 11-1, 14-18, 15-4, 15-8 Affordable Insurance Exchange ................................................. 14-18 Airdrop ........................................................................................ 7-12 Alien .............................................................................................. 1-2 Alimony .......................................................... 3-9, 5-23, 12-13, 17-12

Voluntary Payments ............................................................. 12-13 Allocated Tips .............................................................................. 5-10 Alternative Depreciation System (ADS) ....................................... 10-8 Alternative Minimum Tax (AMT) ........................................ 3-12, 15-1

Exemption .............................................................................. 15-2

Exemption Amount .............................................................. 17-25 Exemption for Certain Children .............................................. 15-2 Exemption Phase-out ............................................................. 15-2

Alternative Minimum Taxable Income (AMTI) .................... 15-2, 15-3 Amended Returns ................................................................. 1-27, 2-4 American Health Benefit Exchanges ............................................ 15-7 American Opportunity Tax Credit (AOTC) ........................... 12-6, 14-15 American Rescue Plan (ARP) .................................... 14-6, 14-14, 17-4 American Taxpayer Relief Act ...................................................... 12-5 Amortizable Premium ................................................................ 17-21 Announcement ............................................................................. 17-2 Annual Filing Season Program (AFSP) ........................................ 17-32 Annuities .......................................................... 3-9, 7-18, 11-3, 17-23 Annuity Withholding .................................................................... 2-16 Annulment ................................................................................... 3-15 Applicable Financial Statement (AFS) ........................................ 10-19 Athletic Facilities ........................................................................ 12-22 Athletic Scholarships.................................................................... 5-17 Authorized IRS e-file Provider ........................................... 1-13, 17-34 Auto-gratuities ............................................................................. 5-10

Back Pay ......................................................................................... 3-5 Backup Withholding..................................................................... 2-14 Bank Secrecy Act (BSA) ................................................................ 6-12

E-Filing System............................................................... 6-12, 6-13 Bankruptcy ................................................................................... 5-13 Bargain Purchases ...................................................................... 12-17 Bartering ............................................................................. 5-11, 7-19 Basic Housing Allowance (BHA) ................................................... 5-18 Basic Records ............................................................................... 1-18 Basis ............................................................................................... 7-3

Unrecovered Basis ................................................................ 10-17 Basis of Inherited Property .......................................................... 10-5 Basis of Property .......................................................................... 10-3 Bitcoin .......................................................................................... 3-10 Bonus Depreciation ........................................................ 10-16, 17-15 Bonuses ......................................................................................... 3-5 Built-in Gains Tax ......................................................................... 9-20 Bureau of Fiscal Service (BFS) ............................................. 1-27, 2-10 Business Interest Expense ......................................................... 17-30

Cadillac Tax .................................................................................. 15-5 Cafeteria Plans .................................................................... 5-3, 12-16 Calendar Year................................................................................. 1-5 Canadian Social Security .............................................................. 11-3 Cancellation of Debt (COD) ........................................................ 17-27 Cancelled Home Mortgage Debt ............................................... 13-23 Capital Asset ................................................................................... 7-5 Capital Assets ............................................................................. 17-29 Capital Gain Distributions .............................................................. 6-8 Capital Gains

Calculation ................................................................................ 7-8 Personal Residences ............................................................... 7-13

Index

Tax ............................................................................................ 7-9 Capital Gains and Losses................................................................ 7-7 Capital Gains Tax Rates................................................................ 17-7 Capital Losses .............................................................................. 7-10

Deduction ............................................................................... 7-10 Capitalization and Repairs ......................................................... 10-18 Capitalized Interest.................................................................... 14-14 Car and Truck Expenses ................................................................. 8-7 Carry-over Basis .............................................................. 13-11, 15-10 Carryover of Non-allowed Expenses to Next Year ....................... 8-13 Cash Method of Accounting ...................................................... 17-30 Casualty and Theft Losses.......................................................... 13-20 Catch-Up Contributions .................................................... 11-6, 11-15 Certifying Acceptance Agents (CAA) .......................................... 17-35 Charitable Contributions ........................................................... 17-17 Charitable Donations from IRAs ................................................ 11-19 Charitable Remainder Trusts ....................................................... 15-6 Child and Dependent Care Credit ................................................ 14-8 Child Support ......................................................... 5-23, 12-13, 12-14 Child Tax Credit ......................................................................... 17-24 Children of Divorced Parents ....................................................... 4-12 Claim for Refund ............................................................................ 2-6 Claim of Right ............................................................................ 17-22 Clergy ........................................................................................... 5-20 Combat Pay .................................................................... 12-14, 12-21 Combat Zone Exclusion ............................................................. 12-14 Combat Zone Service ................................................................... 3-28 Commissions ................................................................................. 3-5 Common Law Marriage ............................................................... 3-27 Community Income ............................................................ 3-23, 8-19 Community Property ................................................................... 3-23 Commuter Highway Vehicle ........................................... 12-19, 12-20 Company Car ............................................................................. 12-18 Compensation ............................................................................... 5-2

Company Car ........................................................................ 12-18 Fringe Benefits ..................................................................... 12-19 Prizes and Awards .................................................................... 5-8 Subject to the Tax .................................................................... 5-2 Unemployment ........................................................................ 5-3

Consolidated Appropriations Act, 2021................. 13-1, 13-23, 14-20 Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA)

............................................................................................. 12-19 Consumables ............................................................................. 10-20 Contests ......................................................................................... 5-8 Contract Labor ............................................................................... 8-7 Contributions

Cash ...................................................................................... 13-17 Contribution of a vehicle ...................................................... 13-18 Contribution Percentage Limitations ................................... 13-17 Non-cash charitable contributions ....................................... 13-18 Value of Services .................................................................. 13-19 Written Substantiation Required ......................................... 13-17

Coronavirus Aid, Relief, and Economic Security Act (CARES) ........ 9-9 Corporate Alternative Minimum Tax (CAMT) .............................. 17-3 Corporate Preference Items .......................................................... 9-6 Corporations

Below-market Loans................................................................. 9-7 Capital Losses ........................................................................... 9-8 Charitable Contributions .......................................................... 9-7 Closely Held .............................................................................. 9-2 Cost of Goods Sold ................................................................... 9-4

Costs of Going Into Business .................................................... 9-5 Distributions to Shareholders ................................................. 9-10 Dividends-received Deduction ................................................. 9-6 Employee-owners ..................................................................... 9-2 Extraordinary Dividends ........................................................... 9-7 Gross Rents ............................................................................... 9-4 Income ...................................................................................... 9-2 Interest ..................................................................................... 9-4 Personal Services ...................................................................... 9-1 Uniform Capitalization Rules .................................................... 9-5

Cost Basis ..................................................................................... 10-3 Cost of Goods Sold ......................................................................... 8-5 Cost of Labor .................................................................................. 8-6 Court Decisions ............................................................................ 17-1 Coverdell Education Savings Account (CESA)...................... 12-5, 12-7

Coordination with Other Education Benefits ......................... 12-6 Distributions ........................................................................... 12-6

Credit Recapture ........................................................................ 14-17 Credits

Additional Child Tax Credit ........................................ 14-10, 17-24 Additional Child Tax Credit (ACTC) ....................................... 14-12 Adoption Credit .................................................................... 14-20 Alternative Fuel Refueling Property Tax Credit .................... 14-30 American Opportunity Tax Credit (AOTC) ............................ 14-14 Child and Dependent Care Credit .................................. 14-8, 14-9 Child Tax Credit ......................................................... 14-10, 17-24 Commercial Clean Vehicle Credit ......................................... 14-28 Credit For Increasing Research Activities ............................. 14-32 Credit for Other Dependents ..................................... 14-12, 17-25 Credit for the Elderly or the Permanently or Totally Disabled . 14-

22 Earned Income Tax Credit (EITC) ................................. 14-3, 17-25 Education Credits ................................................................. 14-16 Employee Retention Credit .................................................... 17-4 Foreign Tax Credit ................................................................ 14-24 Fuel Excise Tax Credit ........................................................... 14-32 Higher Education Credits ...................................................... 14-13 Lifetime Learning Credit ....................................................... 14-16 Military Spouse Retirement Plan Eligibility Credit for Small

Employers........................................................................ 14-33 Mortgage Interest Credit ...................................................... 14-25 New Clean Vehicle Credit ..................................................... 14-26 Premium Tax Credit .............................................................. 14-18 Residential Clean Energy Credit............................................ 14-29 Retirement Plans Startup Costs Tax Credit ........................... 14-33 Retirement Savings Contribution Credit ............................... 14-23 Small Business Health Care Tax Credit ................................. 14-20 Used Clean Vehicle Credit .................................................... 14-27 Work Opportunity Tax Credit (WOTC) .................................. 14-31

Crops ............................................................................................ 8-21 Cryptocurrency ............................................................................ 7-12

Damages ...................................................................................... 8-23 Daycares ............................................................................. 8-11, 8-12 De Minimis (Minimal) Benefits .................................................. 12-19 De Minimis Safe Harbor Election ............................................... 10-19 Debit or Credit Card ..................................................................... 1-31 Deceased Spousal Unused Exclusion (DSUE) ......... 13-11, 15-9, 17-21 Decedent ................................................................................... 17-21

Index

Decedent Issues ........................................................................... 3-26 Declaration Control Number (DCN) ............................................. 1-15 Deductions

Adjusted Gross Income (AGI) ................................................. 3-11 Alimony ................................................................................ 12-12 Business Taxes ........................................................................ 13-5 Certain Business Expenses of Fee Based Government Officials12-

5 Certain Business Expenses of Performing Artists ................... 12-4 Contributions ....................................................................... 13-16 Donation of Vehicles ............................................................ 13-18 Foreign Income Taxes ............................................................ 13-9 Health Savings Accounts ........................................................ 12-9 Home Equity Loan ................................................................ 13-22 Home Mortgage Interest Deduction .................................... 12-10 Home Office Business Expenses ............................................. 8-11 Home Office Deduction Rule .................................................. 8-11 Individual Retirement Arrangements (IRAs)........................... 11-5 Interest ................................................................................. 13-20 IRA Phase-out Range .............................................................. 11-7 Medical Expenses ................................................................... 13-2 Miscellaneous ........................................................... 13-23, 17-18 Mortgage Interest ................................................................ 13-21 Nondeductible Taxes .............................................................. 13-8 Penalty On Early Withdrawal Of Savings .............................. 12-12 Penalty-Free Withdrawals from IRAs ................................... 11-11 Qualified Long-term Care ....................................................... 13-4 Rental Property ............................................................. 8-23, 9-52 Self-employed Health Insurance .......................................... 12-11 Self-employment Tax ........................................................... 12-11 Standard ................................................................................. 3-11 State, Local and Foreign Income Taxes .................................. 13-7 Student Loan Interest ........................................................... 14-13 Taxes ...................................................................................... 13-5 Teachers’ Classroom Expenses ............................................... 12-4 Tuition and Fees ........................................................ 12-14, 14-14 Utilities ................................................................................... 8-12

Deferred Exchange ...................................................................... 7-17 Defined Benefit Plans ....................................................... 9-36, 11-19 Defined Contribution Plans .............................................. 9-36, 11-19 Department of Veterans Affairs (VA) .......................................... 5-17 Depletion ....................................................................................... 8-8 Depreciation

ACRS ....................................................................................... 10-6 Business Use of the Home ...................................................... 8-12 MARCS .................................................................................... 10-6 Methods of ............................................................................. 10-6 Recovery Periods .................................................................... 10-6 Rental Property .................................................................... 10-10 Straight Line ........................................................................... 10-6

Determining and Paying the Tax Checklist ................................................................................. 1-10

Direct Rollovers ......................................................................... 11-18 Disability Payments ....................................................................... 5-6 Disability Pension .......................................................................... 5-5 Disaster Area Losses .................................................................... 9-48 Discharge of Debt Income for Student Loans ............................ 14-14 Distributable Net Income (DNI) ................................................... 9-29 Distributive Share ........................................................................ 5-14 Dividends ................................................................................ 3-7, 6-1

Holding Period .......................................................................... 6-3

Non-dividend Distributions ...................................................... 6-5 Ordinary ................................................................................... 6-2 Ordinary and Qualified ............................................................. 6-2 Qualified ................................................................................... 6-3 Subject to the Tax ..................................................................... 6-2

Divorce ..................................................................... 3-24, 5-23, 12-13 Document Retention ................................................................... 14-4 Documentary Evidence ................................................................. 9-53 Dual Status Aliens ................................................................. 1-2, 3-21 Due Diligence Requirements ....................................................... 3-20

Earned Income ............................................................................... 5-1 Earned Income Tax Credit

Age Test .................................................................................. 14-6 Claim ....................................................................................... 14-7 Disqualified income ................................................................ 14-6 Earned Income ....................................................................... 14-7 Identification Test................................................................... 14-6 Limitations .............................................................................. 14-6 Qualifying Child ...................................................................... 14-6 Residency Test ........................................................................ 14-6 Restrictions ............................................................................. 14-7

Education Savings Bond Program ................................................ 6-10 e-File ............................................................................ 1-3, 1-12, 1-14

Rejected Electronic Returns ................................................... 1-24 Elected Farm Income (EFI) ........................................................... 9-49 Electing Small Business Trusts ..................................................... 15-6 Electronic Federal Tax Payment System (EFTPS) ......................... 1-31 Electronic Filing Identification Number (EFIN) 1-13, 1-14, 1-15, 17-34 Electronic Funds Withdrawal ....................................................... 1-28 Electronic Return Originator (ERO) ..................................... 1-14, 1-22

Advertising ............................................................................. 1-15 Fees ........................................................................................ 1-15 Recordkeeping and Documentation Requirements ............... 1-16

Electronic Storage Systems .......................................................... 1-17 Employee Achievement Awards ......................................... 5-8, 17-28 Employee Benefit Programs .......................................................... 8-8 Employee Stock Purchase Plan (ESPP) ........................................... 6-5 Employer Identification Number (EIN) ......................................... 15-14 Employer-provided Child or Dependent Care Services .............. 12-20 Employment Taxes ...................................................................... 1-11 Energy-efficient Commercial Building Property Deduction ........... 9-6 Entertainment Expenses ............................................................ 17-13 Equitable Relief ................................................................... 1-20, 3-26 e-Services Account ....................................................................... 1-12 Estate Tax ...................................................... 1-10, 9-27, 13-10, 15-9 Estate Tax Deduction ................................................................. 17-20 Estates ......................................................................................... 5-15 Estimated Tax Payments ..................................................... 2-13, 3-13 Estimated Taxes .................................................................. 1-29, 9-31 Excess Accumulation ................................................................. 11-21 Excess Net Passive Income Tax .................................................... 9-20 Exchange of Principal Residence ........................................... 3-6, 7-13 Excise Taxes ............................................................... 1-11, 9-49, 13-8 Excluded Interest ........................................................................... 6-8 Exclusions .................................................................................... 12-1

Annual Gift Tax ....................................................................... 12-2 Combat Zone ........................................................................ 12-14 Intergovernmental Relations .................................................. 12-3

Index

Related to Age ........................................................................ 12-2 Related to Death .................................................................... 12-2 Related to Education .............................................................. 12-3 Related to Foreign-Earned Income ........................................ 12-3 Related to Illness .................................................................... 12-1

Exclusive Use Test ......................................................................... 8-12 Executor ...................................................................................... 9-30 Exempt Organizations ................................................................. 9-33 Exemptions

AMT ........................................................................................ 15-2 Extensions ..................................................................................... 2-4 Extraordinary Dividends ................................................................ 9-7

False Billing Schemes ................................................................... 16-6 Family Partnership ....................................................................... 9-15 Farm Employment Taxes ............................................................. 9-49 Farm Expenses ............................................................................. 8-22 Farm Inventory ............................................................................ 9-45 Farms ........................................................................................... 9-38

Conservation Expenses .......................................................... 9-43 Crop Shares ............................................................................ 9-41 Depreciation ........................................................................... 9-47 Dispositions of Property ......................................................... 9-43 Elected Farm Income (EFI)...................................................... 9-49 Farm Employment Taxes ........................................................ 9-49 Inventory ................................................................................ 9-45 Inventory Valuation Methods ................................................ 9-46 Livestock ................................................................................. 9-41 Prepaid Farm Supplies ............................................................ 9-42 Rents ...................................................................................... 9-41 Sales Caused by Weather-Related Conditions ....................... 9-42 Special Estimated Tax Rules ................................................... 9-50

Federal Insurance Contributions Act (FICA) ................... 1-11, 3-3, 13-6 Federal Unemployment Tax Act (FUTA) .................... 1-12, 13-6, 15-14 Federally Declared Disaster ............................................ 13-20, 17-18 Fellowships .................................................................................. 5-16 Fiduciary ...................................................................................... 9-30 Filing

Extensions ................................................................................ 2-4 Filing Due Dates ............................................................................. 1-8 Filing Requirements ..................................................................... 17-9 Filing Status

Head of Household ................................................................. 3-17 Married, filing a joint return................................................... 3-15 Married, Filing Separately ...................................................... 3-17 Single ...................................................................................... 3-15 Surviving Spouse With Dependent Child ................................ 3-16

Financial Privacy Rule .................................................................. 1-21 Fiscal Year ...................................................................................... 1-5 Fishing Crew Member ................................................................. 8-18 Fixed Amortization Method ........................................................ 11-10 Fixed Annuitization Method ........................................................ 11-10 Fixing America’s Surface Transportation (FAST) Act .................... 16-6 Flow-through Entities .................................................................... 3-8 Foreclosures ................................................................................ 7-18 Foreign Bank and Financial Accounts (FBAR) .............................. 6-12 Foreign Earned Income ...................................................... 5-2, 12-15 Foreign Earned Income Exclusion .................................................. 12-3 Foreign Employer ........................................................................ 5-20

Foreign Housing Exclusion ............................................................. 12-3 Foreign Tax Credit ...................................................................... 14-24 Foreign-Derived Intangible Income (FDII) ...................................... 9-9 Forms

FinCEN Form 114 - Report of Foreign Bank and Financial Accounts (FBAR) ....................................................... 6-12, 13-9

Form 1023 - Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code ............... 9-32

Form 1023-EZ - Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code .................................................................................. 9-32

Form 1024 - Application for Recognition of Exemption Under Section 501(a) ................................................................... 9-33

Form 1040 - U.S. Individual Income Tax Return ....................... 2-2 Form 1040-C - U.S. Departing Alien Income Tax Return ......... 3-29 Form 1040-ES - Estimated Tax for Individuals 1-29, 2-13, 3-14, 5-

7, 15-15 Form 1040-NR ..................................... 2-3, 3-28, 3-29, 5-10, 9-27 Form 1040-PR ......................................................................... 5-10 Form 1040-SR - U.S. Tax Return for Seniors ............................. 2-3 Form 1040-SS ......................................................................... 5-10 Form 1040-V - Payment Voucher............................................ 1-34 Form 1040-X - Amended U.S. Individual Income Tax Return. 1-28,

2-5, 2-18, 7-10, 11-9 Form 1041 - U.S. Income Tax Return for Estates and Trusts .. 5-15 Form 1065 - U.S. Return of Partnership Income3-6, 9-12, 9-13, 9-

25 Form 1065-B - U.S. Return of Income for Electing Large

Partnerships ...................................................................... 9-12 Form 1066 - U.S. Real Estate Mortgage Investment Conduit

(REMIC) Income Tax Return .............................................. 9-12 Form 1095-A - Health Insurance Marketplace Statement ... 14-18,

15-5, 17-28 Form 1098 - Mortgage Interest Statement ............... 13-21, 13-22 Form 1098-C Contributions of Motor Vehicles, Boats, and

Airplanes ......................................................................... 13-18 Form 1098-E - Student Loan Interest Statement .................. 14-13 Form 1099-A - Acquisition or Abandonment of Secured Property

.......................................................................................... 2-24 Form 1099-B - Proceeds From Broker and Barter Exchange

Transactions ............................................................. 2-24, 5-11 Form 1099-C - Cancellation of Debt .............................. 2-24, 7-19 Form 1099-DIV - Dividends and Distributions 2-24, 2-25, 6-2, 6-3,

6-12 Form 1099-G - Certain Government Payments .. 2-24, 3-9, 5-5, 5-

14 Form 1099-INT - Interest Income ........................... 2-24, 2-25, 6-6 Form 1099-K - Payment Card and Third-Party Network

Transactions ............................................................. 2-24, 2-26 Form 1099-MISC - Miscellaneous Income ..................... 2-24, 2-25 Form 1099-NEC - Nonemployee Compensation .............. 2-1, 17-5 Form 1099-OID - Original Issue Discount ............................... 2-24 Form 1099-PATR - Taxable Distributions Received From

Cooperatives ..................................................................... 2-24 Form 1099-Q - Payments From Qualified Education Programs

(Under sections 529 and 530) ........................................... 2-24 Form 1099-R - Distributions From Pensions, Annuities,

Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. ................... 1-16, 2-18, 2-24, 2-25, 11-4, 11-16

Form 1116 - Foreign Tax Credit ................................. 14-24, 14-25 Form 1120 - U.S. Corporation Income Tax Return ...3-6, 9-2, 9-12,

Index

9-26 Form 1120S - U.S. Income Tax Return for an S Corporation . 9-21,

9-26 Form 1125-A - Cost of Goods Sold ........................................... 9-4 Form 1310 - Statement of Person Claiming Refund Due a

Deceased Taxpayer ........................................................... 3-30 Form 13711 - Request for Appeal of Offer in Compromise .... 1-35 Form 14039 - Identity Theft Affidavit .......................... 1-22, 17-34 Form 2063 - U.S. Departing Alien Income Tax Statement ...... 3-29 Form 2106 - Employee Business Expenses ............................. 12-4 Form 2106-EZ - Unreimbursed Employee Business Expenses 12-4 Form 2120 - Multiple Support Declaration ............................ 4-12 Form 2210 - Underpayment of Estimated Tax by .................. 1-30 Form 2210-F - Underpayment of Estimated Tax by Farmers and

Fishermen ................................................................ 1-30, 9-51 Form 2350 - Application for Extension of Time to File U.S.

Income Tax Return for Citizens and Resident Aliens Abroad Who Expect to Qualify for Special Tax Treatment ............ 1-28

Form 2439 - Notice to Shareholder of Undistributed Long-Term Capital Gains ....................................................................... 7-2

Form 2441 - Child and Dependent Care Expenses ............... 14-10 Form 2553 - Election by a Small Business Corporation 9-18, 9-24,

9-26 Form 2555 - Foreign Earned Income ............................. 12-3, 14-5 Form 3115 - Application for Change in Accounting Method ... 1-8,

10-20 Form 3520-A - Annual Information Return of Foreign Trust With

a U.S. Owner ..................................................................... 9-28 Form 3800 - General Business Credit ................................... 14-30 Form 4136 - Credit for Federal Tax Paid on Fuels ....... 8-22, 14-32 Form 4137 - Social Security and Medicare Tax on Unreported Tip

Income ........................................................ 5-10, 13-12, 15-11 Form 433-A (OIC) -Collection Information Statement for Wage

Earners and Self-Employed Individuals ............................. 1-34 Form 433-B (OIC) - Collection Information Statement for

Businesses ......................................................................... 1-34 Form 4562 - Depreciation and Amortization.. 3-8, 5-22, 8-8, 9-52,

10-1, 10-8, 10-14, 17-13 Form 4684 - Casualties and Thefts ....................................... 13-26 Form 4797 - Sales of Business Property 3-6, 7-2, 8-21, 8-25, 9-39,

9-43, 13-26 Form 4852 - Substitute for Form W-2, Wage and Tax Statement

................................................................................. 1-16, 2-18 Form 4868 - Application for Automatic Extension of Time To File

U.S. Individual Income Tax Return ............................. 2-4, 3-29 Form 4952 - Investment Interest Expense Deduction .......... 13-20 Form 4972 - Tax on Lump-Sum Distributions ....................... 11-16 Form 5329 - Additional Taxes on Qualified Plans (Including IRAs)

and Other Tax-Favored Accounts.............. 11-20, 11-21, 13-10 Form 5500 - Annual Return/Report of Employee Benefit Plan .. 1-

24, 8-9 Form 5500-EZ - Annual Return of One-Participant (Owners and

Their Spouses) Retirement Plan .......................................... 8-9 Form 5500-SF - Short Form Annual Return/Report of Small

Employee Benefit Plan ........................................................ 8-9 Form 5695 - Residential Energy Credits ............................... 14-29 Form 5754 - Statement by Person(s) Receiving Gambling

Winnings .............................................................. 13-26, 17-20 Form 5884 - Work Opportunity Credit ................................. 14-31 Form 5884-C - Work Opportunity Credit for Qualified Tax-

Exempt Organizations Hiring Qualified Veterans ............ 14-31

Form 6251 - Alternative Minimum Tax - Individuals ..... 15-1, 15-4 Form 6252 - Installment Sale Income ..................................... 7-16 Form 6478 - Alcohol and Cellulosic Biofuel Fuels Credit . 9-4, 9-14 Form 656 - Offer Income Compromise ................................... 1-34 Form 6765 - Credit for Increasing Research Activities .......... 14-32 Form 6781 - Gains and Losses From Section 1256 Contracts and

Straddles ............................................................................. 7-2 Form 7004 - Application for Automatic Extension of Time To File

Certain Business Income Tax, Information, and Other Returns .......................................................................................... 9-11

Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return................... 1-10, 9-29, 10-5, 13-11, 15-9

Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return........................ 13-10, 13-12, 15-9, 15-10

Form 8027 - Employer's Annual Information Return of Tip Income and Allocated Tips ....................................... 2-20, 5-11

Form 8275 - Disclosure Statement ......................................... 16-3 Form 8283 – Noncash Charitable Contributions .................. 13-18 Form 8332 - Release/Revocation of Release of Claim to

Exemption for Child by Custodial Parent .......................... 4-13 Form 8379 - Injured Spouse Allocation ......................... 1-26, 1-27 Form 8396 - Mortgage Interest Credit ...................... 13-21, 14-25 Form 843 - Claim for Refund and Request for Abatement ... 14-26 Form 8453 - U.S. Individual Income Tax Transmittal for an IRS e-

file Return ......................................................................... 1-16 Form 8453-C - U.S. Corporation Income Tax Declaration ....... 1-23 Form 8453-EO - Exempt Organization Declaration and Signature

for Electronic Filing............................................................ 1-23 Form 8453-PE - U.S. Partnership Declaration ......................... 1-23 Form 8508 - Request for Waiver From Filing Information Returns

Electronically ..................................................................... 2-17 Form 8582 - Passive Activity Loss Limitations ............... 5-21, 9-19 Form 8606 - Nondeductible IRAs ............................................ 11-8 Form 8615 - Tax for Certain Children Who Have Unearned

Income ........................................................ 13-13, 15-2, 15-12 Form 8655 - Reporting Agent Authorization .......................... 1-13 Form 8689 - Allocation of Individual Income Tax to the U.S.

Virgin Islands ....................................................................... 2-9 Form 8801 - Credit for Prior Year Minimum Tax - Individuals,

Estates, and Trusts .......................................................... 17-26 Form 8809 - Application for Extension of Time to File

Information Returns .......................................................... 2-17 Form 8815 - Exclusion of Interest From Series EE and I U.S.

Savings Bonds Issued After 1989 .............................. 6-10, 12-9 Form 8824 - Like-Kind Exchanges .................................... 7-3, 7-17 Form 8829 - Expenses for Business Use of Your Home . 8-11, 8-13 Form 8832 - Entity Classification Election . 3-6, 5-15, 9-1, 9-25, 9-

26 Form 8839 - Qualified Adoption Expenses ............................. 14-2 Form 8850 - Pre-Screening Notice and Certification Request for

the Work Opportunity Credit .......................................... 14-31 Form 8855 - Election To Treat a Qualified Revocable Trust as

Part of an Estate ................................................................ 9-29 Form 8857 - Request for Innocent Spouse Relief . 1-20, 3-16, 3-25 Form 8862 - Information to Claim Earned Income Tax Credit

after Disallowance .................................................... 14-4, 14-5 Form 8863 - Education Credits .................................... 14-2, 14-17 Form 8864 - Biodiesel and Renewable Diesel Fuels Credit .. 9-4, 9-

14 Form 8867 - Paid Preparer’s Due Diligence Checklist ... 3-20, 14-3,

14-7, 14-14, 17-31

Index

Form 8879 - IRS e-file Signature Authorization ...................... 1-22 Form 8879-C - IRS e-file Signature Authorization for Form 11201-

23 Form 8879-EO - IRS e-file Signature Authorization for an Exempt

Organization ..................................................................... 1-23 Form 8879-PE - IRS e-file Signature Authorization for Form 1065

.......................................................................................... 1-23 Form 8880 - Credit for Qualified Retirement Savings

Contributions ......................................................... 11-6, 14-24 Form 8881 - Credit for Small Employer Pension Plan Startup

Costs ............................................................................... 14-33 Form 8888 - Allocation of Refund (Including Savings Bond

Purchases) ................................................................ 1-26, 1-27 Form 8889 -Health Saving Accounts (HSAs) ........................... 12-9 Form 8919 - Uncollected Social Security and Medicare Tax on

Wages .................................................................. 13-12, 15-11 Form 8925 - Report of Employer-Owned Life Insurance

Contracts ............................................................................. 9-4 Form 8936 - Qualified Plug-in Electric Drive Motor Vehicle Credit

(Including Qualified Two-Wheeled Plug-in Electric Vehicles and New Clean Vehicles) ...................................... 14-27, 14-28

Form 8938 - Statement of Specified Foreign Financial Assets ... 6- 13, 13-9

Form 8941 - Credit for Small Employer Health Insurance Premiums ........................................................................ 14-20

Form 8944 - Preparer e-file Hardship Waiver Request .......... 1-12 Form 8948 - Preparer Explanation for Not Filing Electronically . 1-

25 Form 8949 - Sales and Other Dispositions of Capital Assets3-6, 7-

1, 7-7, 7-9, 7-11, 9-16 Form 8952 - Application for Voluntary Classification Settlement

Program .......................................................................... 15-15 Form 8958 - Allocation of Tax Amounts Between Certain

Individuals in Community Property States ........................ 3-24 Form 8959 - Additional Medicare Tax .................................... 8-17 Form 8960 - Net Investment Income Tax - Individuals, Estates

and Trusts ......................................................................... 15-7 Form 8962 - Premium Tax Credit (PTC) . 14-18, 14-20, 15-5, 17-28 Form 8990 - Limitation on Business Interest Expense Under

Section 163(j) ...................................................................... 8-9 Form 8995 - Qualified Business Income Deduction Simplified

Computation ................................................................... 13-15 Form 8995-A - Qualified Business Income Deduction .......... 13-15 Form 90-22.1 .......................................................................... 6-12 Form 940 - Employer's Annual Federal Unemployment (FUTA) 1-

19, 15-15 Form 941 - Employer's QUARTERLY Federal Tax Return . 1-19, 15-

15 Form 943 - Employer's Annual Federal Tax Return for

Agricultural Employees .......................................... 1-19, 15-15 Form 944 - Employer's ANNUAL Federal Tax Return .. 1-19, 15-15 Form 9465 - Installment Agreement Request ............... 1-32, 1-33 Form 982 - Reduction of Tax Attributes Due to Discharge of

Indebtedness .................................................................... 2-25 Form 990 - Return of Organization Exempt From Income Tax ... 1-

24 Form 990-EZ - Short Form Return of Organization Exempt From

Income Tax ........................................................................ 1-24 Form 990-PF - Return of Private Foundation ......................... 1-24 Form 990-T - Exempt Organization Business Income Tax Return

.......................................................................................... 9-34

Form I-551 - Green Card ......................................................... 3-21 Form RRB-1099 - Payments by the Railroad Retirement Board11-

3 Form SS-5 - Application for a Social Security Card .................. 1-20 Form SS-8 - Determination of Worker Status for Purposes of

Federal Employment Taxes and Income Tax Withholding . 8-3, 13-12, 15-11

Form SSA-1099 - Social Security Benefit Statement ..... 2-24, 2-26, 11-3

Form W-12 - IRS Paid Preparer Tax Identification Number (PTIN) Application and Renewal................................................. 17-33

Form W-2 - Wage and Tax Statement 2-17, 2-23, 3-13, 5-2, 15-14 Form W-2C - Corrected Wage and Tax Statement ................. 2-18 Form W-2G - Certain Gambling Winnings .......... 5-9, 13-26, 17-20 Form W-3 - Transmittal of Wage and Tax Statements 2-23, 15-14 Form W-4 - Employee's Withholding Certificate .2-11, 3-13, 15-7,

15-14 Form W-4P - Withholding Certificate for Pension or Annuity

Payments.................................................................. 2-16, 11-4 Form W-4S - Request for Federal Income Tax Withholding From

Sick Pay................................................................................ 5-7 Form W-4V - Voluntary Withholding Request .......................... 5-5 Form W-7 - Application for IRS Individual Taxpayer Identification

Number ................................................................ 17-35, 17-36 Form W-8BEN - Certificate of Foreign Status of Beneficial Owner

for United States Tax Withholding .................................... 6-11 Form W-8IMY - Certificate of Foreign Intermediary, Foreign

Flow-Through Entity, or Certain U.S.Branches for United States Tax Withholding ....................................................... 3-9

Form W-9 - Request for Taxpayer Identification Number and Certification ........................................... 2-14, 2-15, 2-23, 6-11

Fraud ............................................................................................ 16-3 Failure to File .......................................................................... 16-3 Joint Return ............................................................................ 16-3 Underpayment ....................................................................... 16-3

Free File ........................................................................................ 1-36 Fringe Benefits .................................................................. 2-16, 12-18 Frivolous Return ........................................................................... 16-4 Frozen Deposits ........................................................................... 6-10 Fulbright Grants ........................................................................... 5-17

Gambling Income ........................................................................... 5-9 Gambling Losses ............................................................. 13-25, 17-20 Gambling Withholding ................................................................. 2-15 General Depreciation System (GDS) ............................................ 10-8 General Rule ................................................................................ 11-4 Gift Splitting ............................................................ 12-3, 13-11, 15-10 Gift Tax.......................................................... 1-10, 12-2, 13-11, 15-10 Global Intangible Low-Taxed Income (GILTI) ................................. 9-9 Government Disability Pensions .................................................... 5-7 Gramm-Leach-Bliley Act .............................................................. 1-21 Grantor Trusts ..................................................................... 9-28, 15-6 Grants .......................................................................................... 5-16 Green Card ................................................................................... 3-21 Gross Estate ...................................................................... 13-10, 15-9 Gross Income ............................................................................... 3-10

Adjustments ........................................................................... 3-10 Group-term Life Insurance........................................................... 12-2 Guaranteed Payments ................................................................. 9-16

Index

H.R. 4453 - S Corporation Permanent Tax Relief Act of 2014 ...... 9-20 Hard Fork ..................................................................................... 7-12 Health Coverage for Older Children ............................................ 15-5 Health Coverage Tax Credit (HCTC) ........................................... 14-20 Health Flexible Spending Arrangement (FSA) ................................ 5-4 Health Savings Accounts ..................................................... 12-1, 12-9

Contributions ......................................................................... 12-9 Healthcare Marketplace ............................................................ 14-19 High Deductible Health Insurance ............................................... 12-9 Highly Compensated Employee ................................................... 9-38 Hobby Income ............................................................................... 8-4 Holding Periods

Assets ....................................................................................... 7-8 Stock ......................................................................................... 7-9

Hollingsworth v. Perry ................................................................. 3-27 Home Acquisition Debt.............................................................. 13-21 Home Equity Loan .......................................................... 13-21, 13-22 Home Mortgage Interest Deduction ......................................... 12-10 Home Offices ................................................................................ 8-12

Business Use ........................................................................... 8-11 Daycare .................................................................................. 8-12 Deductions ............................................................................. 8-11 Depreciation ........................................................................... 8-12 Simplified Option ................................................................... 8-13

Hope Scholarship Credit ............................................................ 14-15 Household Employment .................... 1-19, 8-20, 15-12, 15-13, 15-14 HSAs vs. MSAs ............................................................................. 12-9 Husband and Wife Businesses ....................................................... 8-2

Identity Protection Personal Identification Number (IP PIN) . 1-4, 17- 34

Identity Theft .................................................................... 1-22, 17-34 Illegal Alien .................................................................................... 1-3 Immigrant ...................................................................................... 1-2 Impairment-Related Work Expenses ......................................... 17-22 In Respect of a Decedent (IRD) .................................................... 9-29 Incentive Stock Option (ISO) .......................................................... 6-5 Income ......................................................................... 5-1, 8-5, 17-11

Alimony ........................................................................... 3-9, 5-23 Business.................................................................................... 3-6 Child Support.......................................................................... 5-23 Gambling .................................................................................. 5-9 Gross ...................................................................................... 3-10 Interest .............................................................................. 3-5, 6-6 Property Settlements ............................................................. 5-24 Rental ............................................................ 3-7, 5-22, 8-23, 9-51 Royalties ................................................................................. 5-11 Separation or Divorce ............................................................ 5-23 Social Security ........................................................................ 11-1 Tips ........................................................................................... 5-9 Veterans' Benefits .................................................................. 5-17

Individual Income Tax Penalties Accuracy ................................................................................. 16-2 Civil Fraud ............................................................................... 16-3 Failure to File .......................................................................... 16-2 Failure to Pay ......................................................................... 16-2 Frivolous Tax Return .............................................................. 16-4

Individual Retirement Arrangements .......................................... 11-5 Individual Taxpayer Identification Number (ITIN).......................... 1-4 Individual Taxpayer Identification Numbers (ITIN) .................... 17-35 Inflation Reduction Act .............................................................. 14-29 Inheritance................................................................................... 5-13 Inherited Property ....................................................................... 10-5 Injured Spouse ............................................................................. 1-20 Innocent Spouse Relief ....................................................... 1-20, 3-25 Insolvency .................................................................................... 5-13 Installment Agreements .............................................................. 1-32 Installment Sale Payments ............................................................. 6-8 Installment Sales .......................................................................... 7-16 Insurance ....................................................................................... 8-8 Insurance Policies ........................................................................ 7-18 Insurance Premiums .................................................................... 13-3 Interest ......................................................................... 2-6, 6-6, 13-20

Education Savings Bond.......................................................... 6-10 Excluded ................................................................................... 6-8 Income ...................................................................................... 6-6 Subject to the Tax ..................................................................... 6-6

Interest Allocation Rules ................................................................ 8-9 Interest on Insurance Dividends .................................................... 6-8 Internal Revenue Code (IRC) ........................................................ 17-1 International Business Corporations (IBC) ................................... 16-6 Inventory ..................................................................... 1-8, 8-11, 8-12 Inventory Valuation Methods ...................................................... 9-46 Involuntary Conversions .............................................................. 7-19 IRA Penalty-free Withdrawals

Coronavirus-related Distributions ........................................ 11-12 First-time Homebuyer .......................................................... 11-11 Medical Insurance Premiums ............................................... 11-10 Qualified Birth and Adoption Expenses ................................ 11-12 Qualified Higher Education ................................................... 11-11 Qualified Reservist Distributions .......................................... 11-11 Unreimbursed Medical Expenses ......................................... 11-10

IRAs ..................................................................................... 6-10, 11-6 Annuity ................................................................................. 11-10 Catch-up Contributions ............................................... 11-6, 11-15 Contribution Limits ................................................................. 11-6 Early Distributions .................................................................. 11-9 Lump-sum Distributions ....................................................... 11-16 One-Rollover-Per-Year Rule.................................................. 11-17 Phase-out Range ..................................................................... 11-7 Required Minimum Distributions (RMD) .............................. 11-19 Rollovers .................................................................... 11-14, 11-16 Roth IRA ................................................................................ 11-12

IRS Direct Pay ............................................................................. 17-36 IRS Letters .................................................................................... 1-35 IRS Notices ................................................................................... 1-35 Itemized Deductions .................................................................... 13-1

Phase-out ............................................................................. 17-23

Joint and Several Liability ............................................................ 1-20 Judgments.................................................................................... 5-19

Kay Bailey Hutchison Spousal IRA Limit ....................................... 11-8 Kickbacks ..................................................................................... 8-24

Index

Kiddie Tax ............................................................ 13-12, 15-11, 17-26

Lawful Permanent Resident ........................................................ 3-21 Leave and Earning Statements .................................................... 1-16 Legal and Professional Services ..................................................... 8-9 Letter 608C - Dishonored Check Penalty Explained ........................ 16-4 Life Insurance Proceeds ........................................... 5-13, 13-10, 15-9 Lifetime Learning Credit ..................................................... 12-6, 14-16 Like-kind Exchanges ................................................................... 17-29 Limited Liability Company (LLC) ................................................... 9-24

Classifications ......................................................................... 9-25 Classified as Corporations ...................................................... 9-26 Classified as Disregarded Entities ........................................... 9-25 Classified as Partnerships ....................................................... 9-25 Effective Date of Election ....................................................... 9-26 Subsequent Elections ............................................................. 9-26

Line of Credit Loan ..................................................................... 13-21 Listed Property .......................................................................... 10-15 Livestock ............................................................................. 8-21, 9-41 Loan ............................................................................................... 5-6 Loan Origination Fee ................................................................. 14-13 Lock-in-letter ............................................................................... 2-11 Long-term Asset ..................................................................... 7-7, 7-9 Long-term Loss ............................................................................ 7-10 Lost Income Payments ................................................................ 8-23 Low Income Certification .............................................................. 1-34

MACRS (Modified Accelerated Cost Recovery System) ............... 10-6 Depreciation ......................................................................... 10-12 Recovery Periods .................................................................... 10-6

Materials and Supplies .................................................................. 8-6 Materials and Supplies Costs ..................................................... 10-20 Medicaid Waiver Payments ......................................................... 5-18 Medical and Dental Expenses .................................................... 17-16 Medical Care ................................................................................ 13-4 Medical Device Excise Tax ........................................................... 15-5 Medical Pensions ......................................................................... 12-1 Military Disability Pensions ........................................................... 5-7 Military Personnel ....................................................................... 5-21 Minimum Income Requirements ........................................ 3-4, 17-10 Miscellaneous Itemized Deductions .......................................... 12-10 Modernized e-File (MeF) ............................................................. 1-12 Money Market Funds .................................................................... 6-9 Money Purchase Pension plans ................................................... 9-36 Mortgage ................................................................................... 13-21 Mortgage Credit Certificate (MCC) ............................................ 14-25 Mortgage Interest .......................................................... 13-21, 13-22 Moving Expense Deduction ............................................ 13-24, 17-12 Multi-asset Exchanges ................................................................. 7-18 Multiple-support Agreements ..................................................... 4-12 Municipal Bonds ............................................................................ 6-9 Mutual Funds ................................................................................ 7-8

Name Change .............................................................................. 1-19 Nationality ..................................................................................... 1-1

Net Capital Gain ............................................................................. 7-9 Net Investment Income Tax (NIIT) ............................. 1-29, 13-13, 15-5 Net Operating Loss (NOL) ................................................... 9-8, 17-27 Net Tax Liability ........................................................................... 3-12 Net Taxable Income ..................................................................... 3-11 Netting Process ............................................................................... 7-8 No-Additional-Cost Services ...................................................... 12-19 Nonbusiness Bad Debt ................................................................. 7-11 Nondeductible IRAs ..................................................................... 11-8 Nondividend Distributions ............................................................. 6-5 Non-elective Contribution Formula ........................................... 11-15 Nonimmigrant Visa ........................................................................ 1-3 Non-qualified Dividends ................................................................ 6-2 Nonrefundable Tax Credits .......................................................... 14-1 Nonresident Alien ............................................................... 3-21, 3-28 Nonstatutory Stock Option ............................................................ 6-5 Notary Public ............................................................................... 8-18 Notices ......................................................................................... 17-2

Obergefell v. Hodges ................................................................... 3-27 Offer in Compromise ................................................................... 1-34 Office Expense ............................................................................... 8-9 Old-age, Survivors, and Disability Insurance Benefits (OASDI) ........ 1-12 Omnibus Budget Reconciliation Act ............................................... 12-2 Ordinary Dividends ........................................................................ 6-2

Schedule B ................................................................................ 6-2 Other Employee Compensation ................................................. 12-15 Overpayment ............................................................................... 1-27

Paid Preparer’s Due Diligence Checklist .................................... 17-31 Partial Rollovers ......................................................................... 11-18 Partnership Interests ................................................................... 7-18 Partnerships ........................................................................ 5-14, 9-12

Bad Debts ............................................................................... 9-16 Deductions ............................................................................. 9-15 Distributions ........................................................................... 9-17 Family ..................................................................................... 9-15 Other Income ......................................................................... 9-14 Passive Activity Limitations .................................................... 9-13 Repairs and Maintenance ....................................................... 9-16 Self-employed Health Insurance Premiums ........................... 9-16 Taxes and Licenses ................................................................. 9-16

Passive Activities .......................................................................... 9-19 Passive Income ............................................................................ 5-21 Passports ..................................................................................... 16-6 Pass-Through Entities ................................................................ 17-26 Patient Protection and Affordable Care Act ................................ 11-1 Payment Settlement Entity (PSE) ................................................. 2-26 Payment Voucher ......................................................................... 1-34 Pell Grants ................................................................................... 5-17 Penalties ............................................................................... 2-6, 16-1

Accuracy .................................................................................. 16-2 Combination ........................................................................... 16-2 Fraud ...................................................................................... 16-3 Frivolous Return ..................................................................... 16-4 Late Payment .......................................................................... 16-2

Penalty for Underpayment .......................................................... 1-29

Index

Penalty-free Withdrawals from IRAs ........................................... 11-9 Pension and Profit Sharing Plans ................................................... 8-9 Pension Withholding ................................................................... 2-16 Pensions .................................................................... 3-9, 11-3, 11-19 Period of Limitations ................................................................... 1-18 Perjury ......................................................................................... 1-22 Personal Exemption ............................................................ 4-5, 17-11

Citizen or Resident Test ............................................................ 4-7 Support Test ............................................................................. 4-8

Personal Service Corporation ........................................................ 9-1 Personal Services ........................................................................... 9-2 Personal Use of Company Car ................................................... 12-18 Points ......................................................................................... 13-20 Premium Tax Credit ................................................................... 14-18 Prepaid Farm Supplies ................................................................. 9-42 Prepaid Insurance Premiums ......................................................... 6-8 Preparer Tax Identification Number (PTIN) ........................ 1-4, 17-33 Presidential Election Campaign Fund ................................. 1-36, 3-14 Principal Place of Business

Home Offices .......................................................................... 8-12 Part of Your Home Used for Business .................................... 8-12 Separate Building ................................................................... 8-12

Private Letter Ruling (PLR) ........................................................... 17-2 Prizes and Awards ......................................................................... 5-8 Produce ....................................................................................... 8-21 Product Samples .......................................................................... 8-11 Profit or Loss From Business .......................................................... 8-4 Profit-sharing Plans ..................................................................... 9-36 Prohibited Transactions ............................................................... 9-37 Promissory Notes ........................................................................ 8-23 Proof of Payment ........................................................................ 1-18 Property Inherited During 2010 .................................................. 10-5 Property Settlements ....................................................... 5-24, 12-14 Property Tax ................................................................................. 1-11 Protecting Americans from Tax Hikes Act of 2015 (PATH) . 11-19, 13-

19, 13-29, 14-15 Publication 17

Part Four - Figuring Your Taxes and Credits ........................... 3-12 Part One - Filing Status ........................................................... 3-15 Part One - Tax Withholding and Estimated Tax ............. 3-13, 3-14 Part Three - Standard Deduction ............................................. 4-1 Part Two - Interest Income ....................................................... 3-6

Publications Publication 1345 - Handbook for Authorized IRS e-file Providers

of Individual Income Tax Returns ...................................... 1-14 Publication 1346 - Electronic Return File Specifications for

Individual Income Tax Returns .......................................... 1-22 Publication 15 - (Circular E) - Employer's Tax Guide ............ 15-14 Publication 225 - Farmer's Tax Guide ..................................... 9-38 Publication 334 - Tax Guide for Small Business ...................... 8-16 Publication 3402 - Taxation of Limited Liability Companies ..... 9-1 Publication 4557 - Safeguarding Taxpayer Data ..................... 1-21 Publication 4591- Small Business Federal Tax Responsibilities .. 1-

21 Publication 4600 - Safeguarding Taxpayer Information ......... 1-21 Publication 463 - Travel, Entertainment, Gift and Car Expenses 8-

9 Publication 4895 - Tax Treatment of Property Acquired From a

Decedent Dying in 2010 ............................................... 3-7, 7-8 Publication 501 - Dependents, Standard Deduction and Filing

Information ................................................................ 4-5, 14-2

Publication 502 - Medical and Dental Expenses ..................... 13-3 Publication 503 - Child and Dependent Care Expenses . 3-17, 14-2 Publication 5093 - Healthcare Law Online Resources ............ 15-8 Publication 519 - U.S. Tax Guide for Aliens .............................. 1-2 Publication 527 - Residential Rental Property ................. 3-8, 5-22 Publication 534 - Depreciating Property Placed in Service Before

1987 .................................................................................. 8-13 Publication 54 - Tax Guide for U.S. Citizens and Resident Aliens

Abroad............................................................................... 13-9 Publication 550 - Investment Income and Expenses ....... 7-6, 10-4 Publication 551 - Basis of Assets ............................................ 10-3 Publication 556 - Examination of Returns, Appeal Rights, and

Claims for Refund .............................................................. 1-27 Publication 560 - Retirement Plans for Small Business ............ 8-9 Publication 587 - Business Use of Your Home ........................ 8-13 Publication 590-A - Contributions to Individual Retirement

Arrangements (IRAs) ................................................ 11-6, 14-2 Publication 594 - The IRS Collection Process .......................... 1-36 Publication 596 - Earned Income Tax Credit (EITC) 14-2, 14-5, 14-

6, 14-7 Publication 926 - Household Employer's Tax Guide .... 14-8, 15-14 Publication 946 - How To Depreciate Property ............... 8-8, 8-13 Publication 970 - Tax Benefits for Education ............... 14-2, 14-13 Publication 971 - Innocent Spouse Relief ...................... 3-16, 3-26

Punitive Damages ........................................................................ 8-24

Qualified Business Income (QBI) ............................ 8-14, 13-14, 17-26 Qualified Charitable Distributions (QCD) ........................ 11-19, 13-19 Qualified Dividends ........................................................................ 6-3 Qualified Dividends and Capital Gain Tax Worksheet.................... 7-9 Qualified Domestic Relations Order (QDRO) ............................... 11-5 Qualified Intermediary (QI).......................................................... 7-18 Qualified Joint Ventures ................................................................ 8-2 Qualified Moving Expense Reimbursements ............................. 17-29 Qualified Nonprofit Health Insurance Issuers .............................. 15-8 Qualified Plans ............................................................................. 9-35 Qualified Principal Residence Indebtedness ....................... 5-12, 5-13 Qualified Refinery Property ........................................................... 9-5 Qualified Rent-to-Own Property .................................................. 10-7 Qualified Retirement Plans ............................................... 11-19, 13-9 Qualified Revocable Trust (QRT) .................................................. 9-29 Qualified Tuition Program (QTP).................................................. 12-7 Qualified Tuition Reduction ......................................................... 5-18 Qualifying Child ....................................... 3-18, 4-5, 4-14, 14-6, 14-11 Qualifying Relative ................................................................ 3-19, 4-9 Qualifying Shipping Activities ........................................................ 9-5

Real Estate Investment Trusts (REITs) ........................................... 6-9 Real Property ............................................................................... 10-4 Reasonable Cause ................................................................. 2-4, 16-2 Recharacterization ..................................................................... 17-12 Recharacterize .............................................................................. 11-9 Recordkeeping ........................................................... 1-16, 1-17, 11-9

Documentation Requirements ............................................... 1-16 Recovery ............................................................................. 5-14, 8-24 Reduced Refund .......................................................................... 2-10 Refund ......................................................................................... 1-26

Index

Filing a Claim ............................................................................. 2-6 Refund Anticipation Loan (RAL) ................................................... 1-14 Refund Offsets ............................................................................. 1-27 Refundable Tax Credits ................................................................ 14-1 Rejected Electronic Return .......................................................... 1-24 Rent .................................................................................... 8-23, 9-51 Rental Expenses and Improvements ........................................... 8-23 Rental Income .................................................................... 5-22, 9-51 Rental Property ......................................................................... 10-10 Rentals

Improvements ............................................................... 8-23, 9-52 Income .......................................................... 3-7, 5-22, 8-23, 9-51 Repair ............................................................................ 8-23, 9-52

Repayments ................................................................................. 5-14 Reporting Agent Authorization.................................................... 1-13 Repossessions .............................................................................. 7-18 Required Minimum Distribution Method .................................... 11-10 Required Minimum Distributions (RMD) ................................... 11-19 Reserve Component ................................................................... 11-12 Residential Telephone ................................................................. 8-12 Restricted Property ..................................................................... 8-23 Retiree Drug Subsidies................................................................. 15-8 Retirement Planning Services .................................................... 12-21 Returns and Allowances ................................................................ 8-5 Revenue Procedure ...................................................................... 17-2 Revenue Procedure 2007-40 - e-file Providers of Individual Income

Tax Returns ............................................................................ 1-14 Revenue Procedure 2011-26 ..................................................... 10-18 Revenue Ruling 2013-17 .............................................................. 3-27 Revenue Rulings .......................................................................... 17-1 Roth IRAs ........................................................................ 11-12, 17-12 Royalties ...................................................................................... 5-11

S Corporations .................................................................... 5-15, 9-18 Built-in Gains Tax .................................................................... 9-20 Compensation ........................................................................ 9-21 Distributions ........................................................................... 9-19 Excess Net Passive Income Tax .............................................. 9-20 Returns ................................................................................... 9-21 Stock and Debt Basis Shareholder Loss Limitations ............... 9-22 Taxes ...................................................................................... 9-19 Termination of Election .......................................................... 9-23

Safe Harbor Accounting Method ............................................... 10-18 Safe Harbor Rule .......................................................................... 7-15 Safeguards Rule ........................................................................... 1-21 Sale of Principal Residence ................................................... 3-6, 7-13 Sales Tax ...................................................................................... 1-11 Same-sex Married Couples .......................................................... 3-27 Saver’s Credit ............................................................................. 14-23 Savings Incentive Match Plans (SIMPLE) ..................................... 9-35 Schedule A Deductions ................................................................ 13-1 Schedules

Schedule 1 - Additional Income and Adjustments to Income .. 2-2 Schedule 2 - Additional Taxes .................................................. 2-2 Schedule 3 - Additional Credits and Payments ......................... 2-2 Schedule 8812 - Child Tax Credit ............................................ 14-2 Schedule A .................................... 11-10, 13-1, 13-4, 13-25, 14-24 Schedule B - Interest and Ordinary Dividends ................. 6-4, 13-9 Schedule C .................. 3-6, 5-10, 5-11, 8-4, 8-13, 8-15, 8-21, 9-25

Schedule D - Capital Gains and Losses . 3-6, 7-2, 7-3, 7-6, 7-7, 7-8, 7-9

Schedule E - Supplemental Income and Loss.. 5-11, 5-21, 8-23, 9- 25, 9-41, 9-51, 9-52

Schedule EITC - Earned Income Tax Credit ............................. 14-7 Schedule F - Profit or Loss From Farming ... 8-21, 9-38, 9-41, 9-45 Schedule H - Household Employment Taxes . 1-19, 2-23, 8-21, 15-

14 Schedule J - Income Averaging for Farmers and Fishermen 9-4, 9-

48 Schedule K-1 (Form 1041) - Beneficiary’s Share of Income,

Deductions, Credits, etc .................................................... 5-15 Schedule K-1 (Form 1065) - Partner's Share of Income,

Deductions, Credits, etc. ................................................... 9-16 Schedule K-1 (Form 1120S) - Shareholder’s Share of Income,

Deductions, Credits, etc. ................................................... 9-19 Schedule R - Credit for the Elderly/Disabled ........................ 14-22 Schedule SE ............................................................................ 8-15

Scholarships ................................................................................. 5-16 Second Mortgage....................................................................... 13-21 Section 1231 Transactions ........................................................... 9-43 Section 1245 Property ................................................................. 9-44 Section 1250 Property ................................................................. 9-45 Section 179 Deduction ............................................................... 17-13 Section 179 Election .................................................................. 10-12

Deduction Limits ................................................................... 10-14 Property ................................................................................ 10-13 Selection ............................................................................... 10-12

Section 529 Plans ....................................................................... 17-27 Self-employment Tax .......................................................... 1-11, 8-14 Self-Employment Tax ................................................................. 12-11 Separation .......................................................................... 3-24, 5-23 Separation of Liability Relief ............................................... 1-20, 3-25 SEPIRA Deduction ..................................................................... 11-18 Series E Bonds ................................................................................ 6-6 Series EE Bonds .............................................................................. 6-6 Series H Bonds ............................................................................... 6-6 Series HH Bonds ............................................................................. 6-6 Series I Bonds ................................................................................. 6-7 Service Academy Cadets .............................................................. 5-17 Setting Every Community Up for Retirement Enhancement

(SECURE) Act ... 11-5, 11-6, 11-21, 12-8, 15-11, 17-5, 17-26, 17-27 Settlements ................................................................................. 5-19 Short Sales ................................................................................... 7-19 Short Tax Year ................................................................................ 1-5 Short-term Asset .............................................................. 7-7, 7-8, 7-9 Short-term Loss ........................................................................... 7-10 Sick Pay .......................................................................................... 5-6 Sickness and Injury Benefits .......................................................... 5-5 SIMPLE IRA ................................................................................. 11-14 Simplified Employee Pension Plans (SEP) ......................... 9-34, 11-18 Simplified Method ....................................................................... 11-4 Simplified Option for Home Office Deduction ............................. 8-13 Sin Tax .......................................................................................... 1-11 Small Business Health Care Tax Credit ....................................... 14-20 Small Business Health Options Program (SHOP) ........................ 14-20 Social Security

Joint Return ............................................................................ 11-3 Repayments ............................................................................ 11-3 Taxation .................................................................................. 11-1

Social Security and Medicare Taxes ............................................. 11-1

Index

Social Security Benefits ............................................................... 12-2 Maximum Taxable Part .......................................................... 11-2

Social Security Benefits Worksheet ............................................. 11-3 Social Security Equivalent Benefit (SSEB) .................................... 11-1 Social Security Number ................................................................. 1-4

Ex-spouse ............................................................................... 5-24 Sole Proprietors ..................................................................... 8-1, 8-15 Specified Service Trades or Businesses (SSTB) .......................... 13-15 Spousal IRA .................................................................................. 11-6 Spousal Support .......................................................................... 5-23 Standard Deduction ..................................................... 3-11, 4-1, 17-8

Elderly and/or Blind Taxpayers ....................................... 4-2, 17-8 Eligibility ................................................................................... 4-3

State and Local Taxes (SALT) ..................................................... 17-16 State Tax Liability ......................................................................... 2-10 Statute of Limitations .................................................................. 1-13 Statutory Stock Option .................................................................. 6-5 Stock Dividends ............................................................. 3-7, 6-1, 9-11 Stock Options .................................................................. 3-7, 6-1, 6-5 Stock Rights ............................................................................ 3-7, 6-1 Stock Spilt ...................................................................................... 6-4 Student Loan Interest Deduction ................................................ 3-11 Substantial Gainful Activity ......................................................... 14-23 Superseding Tax Return ............................................................... 2-11 Supplies ....................................................................................... 8-10

Tangible Personal Property ....................................................... 17-28 Tangible Property ......................................................................... 10-6 Tangible Property Regulations .................................................. 10-18 Tax Computation Worksheet................................................ 1-10, 2-1 Tax Credits ................................................................................... 3-12 Tax Cuts and Jobs Act 3-2, 4-5, 12-20, 13-1, 13-7, 13-16, 14-10, 17-5,

17-6, 17-11, 17-17, 17-23, 17-24, 17-25, 17-27 Tax Exempt Bonds ......................................................................... 6-9 Tax Exempt Organizations ........................................................... 9-32 Tax for Certain Children Who Have Unearned Income ............. 15-11 Tax Payments .............................................................................. 3-12 Tax Rates .............................................................................. 3-2, 17-6 Tax Table ........................................................................................ 2-1 Tax Treaties ................................................................................... 1-2 Tax Withholding ............................................................... 3-13, 15-14 Taxable Bonds ........................................................................... 17-21 Taxable Estate .................................................................. 13-10, 15-9 Taxes

Employment ........................................................................... 1-11 Foreign Income ...................................................................... 13-9 Household Employment ....................................................... 15-12 Maximum Capital Gain Rates ................................................... 7-9 Qualified Retirement Plan .................................................... 13-10 Self-employment ........................................................... 8-14, 8-15

Taxpayer Advocate Service ........................................................ 17-33 Taxpayer Assistance Center (TAC) ...................................... 2-18, 2-28 Taxpayer Identification Numbers .................................................. 1-4

Technical Advice Memorandum (TAM) ....................................... 17-2 Temporary Assistance for Needy Families (TANF) ....................... 3-18 Tips .......................................................................... 5-9, 13-12, 15-11

Withholding ............................................................................ 2-16 Transportation Fringe Benefits .................................................. 12-20 Treasury Offset Program .................................................... 1-27, 2-10 Treasury Regulations ................................................................... 17-1 Trustee ......................................................................................... 9-30 Trusts ......................................................................... 5-15, 9-28, 15-6 Tuition Reduction ........................................................................ 5-18

U.S. Citizen ..................................................................................... 1-1 U.S. National .................................................................................. 1-2 U.S. Obligations ............................................................................. 6-8 U.S. Savings Bonds ......................................................................... 6-6

Electronic Series EE Bonds ........................................................ 6-6 Series E Bonds .......................................................................... 6-6 Series EE Bonds ........................................................................ 6-6 Series H Bonds .......................................................................... 6-6 Series HH Bonds ....................................................................... 6-6 Series I Bonds ........................................................................... 6-7

U.S. Treasury Bills .......................................................................... 6-8 U.S. Treasury Notes or Bonds ...................................................... 7-18 Unemployment Compensation ...................................................... 5-5 Unified Credit.................................................................... 13-11, 15-9 Uniform Lifetime Table .............................................................. 11-20 United States v. Windsor ............................................................. 3-27 Unrecovered Basis ..................................................................... 10-17 Unrecovered Investment ........................................................... 17-23 Unreimbursed Medical Expenses .............................................. 11-10 Unrelated Business Taxable Income (UBTI) ................................. 9-34 Utilities......................................................................................... 8-11

Veterans' Benefits ........................................................................ 5-17 Virtual Currency .................................................................. 3-10, 7-11 Visa Waiver Program ..................................................................... 1-3 Voluntary Classification Settlement Program (VCSP) ................ 15-15 Voluntary Interest Payments ..................................................... 14-13

Wages . 3-24, 5-2, 7-10, 8-4, 8-13, 8-15, 10-14, 11-1, 11-6, 11-19, 14- 7, 14-10, 17-13

Work Opportunity Tax Credit (WOTC) ....................................... 14-31 Workers' Compensation ....................................................... 5-6, 12-1 Working Condition Benefits ....................................................... 12-17 Working Families Tax Relief Act of 2004 ........................................ 14-6 Worthless Securities .................................................................... 7-10

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Tax Return Preparation Instructions

The following pages contain several Federal tax return scenarios that are designed to help you learn the material you have just studied. Tax return preparation questions are for instructional use only and you will not be graded on these questions. We also provide you the answers to each question and an explanation or feedback as to how we arrived at each answer. You should use the information provided in the 2023 tax tables in the appendix at the back of the course and on the 2023 tax forms included with each scenario to complete each return exercise. For the tax return preparation scenarios, best practice suggests that you should try to answer the questions on your own first, and only then refer to the answer key and feedback to see how well you did in terms of learning the material.

2023 tax year forms are provided following each of the scenarios. All the tax forms provided may not be necessary for the particular scenario. As part of the return preparation, you will need to determine which forms to use for each unique situation. You can also access IRS forms that you can populate and complete online by clicking the links below:

➢ Form 1040 - U.S. Individual Income Tax Return ➢ Schedule 1 - Additional Income and Adjustments to Income ➢ Schedule 2 - Additional Taxes ➢ Schedule 3 - Additional Credits and Payments ➢ Schedule A - Itemized Deductions ➢ Schedule B - Interest and Ordinary Dividends ➢ Schedule C - Profit or Loss From Business ➢ Schedule D - Capital Gains and Losses ➢ Schedule SE - Self-Employment Tax ➢ Form 8839 - Qualified Adoption Expenses ➢ Form 8949 - Sales and Other Dispositions of Capital Assets

Scenario 1 Robin Wright is a 30-year-old single taxpayer with annual earnings of $55,979 which is reported to her on a Form W-2 - Wage and Tax Statement. Robin does not have children or other dependents. Additionally, she cannot be claimed as a dependent on someone else’s tax return. $3,600 was withheld from her wages for Federal taxes. She owns her own home and pays $12,000 of mortgage interest and $2,200 in property taxes. Robin’s Social Security number is 132-45-6789 and her address is 141 Sunset Blvd, Hollywood, CA, 90038. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Robin.

Scenario 1 Questions Answers appear in Scenario 1 Feedback 1. What form would Robin receive that shows how much interest she paid on her mortgage during the year?

A. Form 1099-MISC B. Form 1099-INT C. Form 1098 D. Form 1097

2. What form or schedule could Robin use to report her income if she did not own a home?

A. Form 1040 B. Schedule A C. Schedule C D. Schedule D

3. Filing status declaration is found on page 1 of Robin’s Form 1040. A. True B. False

Tax Return Preparation - Scenario 1

4. Based on the information provided Robin should: A. Use the standard deduction B. Itemize her deductions C. File for an extension with the IRS D. Not worry about filing a return

5. If Robin did not own a home, her standard deduction would be what amount?

A. $10,000 B. $13,850 C. $20,800 D. $27,700

6. What is Robin’s adjusted gross income shown on the return?

A. $22,800 B. $25,000 C. $33,800 D. $55,979

7. What dollar amount would Robin show for her personal exemptions?

A. $0 B. $1,950 C. $3,800 D. $4,700

8. What is Robin’s taxable income on Line 15?

A. $0 B. $4,200 C. $18,729 D. $41,779

9. After completing the tax return, Robin would show an amount owed on Line 37.

A. True B. False

10. Robin will owe the IRS for what amount?

A. $0, Robin will receive a refund B. $500 C. $1,193 D. $3,600

11. If Robin had a dependent, she would still itemize her deductions.

A. True B. False

12. If Robin got married and filed a joint return, she would still itemize her deductions.

A. True B. False

Tax Return Preparation - Scenario 1

Scenario 1 Feedback Return to Scenario 1 Questions Question 1 - C. Form 1098 Robin would receive Form 1098. Form 1098 - Mortgage Interest Statement is the statement the taxpayer’s mortgage lender sends him or her to let him or her know how much mortgage interest or points he or she paid during the year. Refer to Lesson 13 in the Federal tax law course for more information about Form 1098. Question 2 - A. Form 1040 Robin should use Form 1040 if she did not own a home. Form 1040 is used by U.S. taxpayers to file an annual income tax return. Refer to Lesson 2 in the Federal tax law course for more information about Form 1040. Question 3 - A. True The filing status section is found on page 1 of the Form 1040. The taxpayer should check only one box based on citizenship status, marital status, spouse's year of death (if applicable) and the percentage of the costs that the taxpayer’s household members paid towards keeping up a home. Refer to Lesson 3 in the Federal tax law course for more information about filing status. Question 4 - B. Itemize her deductions When filing a Federal income tax return, taxpayers can choose to either take the standard deduction or to itemize their deductions. The taxpayer should use the deduction method that gives him or her the lowest tax bill. In this scenario if Robin itemizes her taxes, she qualifies for a deduction of $14,200. If she chose to take the standard deduction, she would only qualify for $13,850 as a single filing taxpayer in 2023. In future years, Robin can claim the standard deduction or itemize her deductions again. Again, she should use the deduction method that gives her the lowest tax bill. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and itemized deductions. Question 5 - B. $13,850 The standard deduction amount increases to $13,850 for individuals for 2023. Robin would claim the standard deduction if she did not own a home as she would not need to use Schedule A and itemize her deductions. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction. Question 6 - D. $55,979 Robin’s adjusted gross income (AGI) is her entire annual earnings of $55,979 as she does not qualify for any above-the- line deductions for the tax year. Refer to Lesson 3 in the Federal tax law course for more information about adjusted gross income (AGI). Question 7 - A. $0 Under the Tax Cuts and Jobs Act (TCJA) personal exemption deductions for the taxpayer, his or her spouse, or his or her dependents have been eliminated beginning after December 31, 2017, and before January 1, 2026. Refer to Lesson 4 in the Federal tax law course for more information about the personal exemptions. Question 8 - D. $41,779 Robin’s total taxable income on Line 15 is equal to her adjusted gross income ($55,979) less her itemized deductions ($14,200) for a total of $41,779. Refer to Lesson 3 in the Federal tax law course for more information about taxable income. Question 9 - A. True Robin’s total tax from Line 24 is $4,793 and her total payments are $3,600 from Line 33. Robin will owe an additional amount of $1,193. Refer to Lesson 1 in the Federal tax law course for more information about refunds. Question 10 - C. $1,193 As mentioned above, Robin’s total tax from Line 24 is $4,793 and her total payments are $3,600 from Line 33. Robin will owe an additional amount of $1,193. Refer to Lesson 1 in the Federal tax law course for more information about refunds.

Tax Return Preparation - Scenario 1

Question 11 - B. False If Robin had a dependent, she may qualify for the head of household filing status. In 2023, the head of household standard deduction is $20,800 which is considerably more than her itemized deductions of $14,200. In this case, Robin would elect to take the standard deduction. Refer to Lesson 3 in the Federal tax law course for more information about filing status and Lesson 4 for more information about the standard deduction. Question 12 - B. False If Robin got married and decided to file a joint return her standard deduction would be $27,700 in 2023. This amount is considerably more than her itemized deductions of $14,200. Robin would elect to take the standard deduction. Refer to Lesson 3 for more information about filing status and Lesson 4 in the Federal tax law course for more information about the standard deduction.

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Tax Return Preparation

Scenario 2 Steve Tyler is a 36-year-old single taxpayer. He lives in Washington state but earned $53,989 for services performed in California which was reported on Form W-2 - Wage and Tax Statement. His Form W-2 also showed that $1,500 was withheld for Federal income taxes and $1,000 withheld for California income taxes. Steve did not have any other wages or salaries during the year. Steve does not have children or other dependents. Additionally, he cannot be claimed as a dependent on someone else’s tax return. He lives in an apartment with annual rent of $10,800. He has his savings invested in fixed income securities issued by the WA Trust Company which paid him $400 in ordinary dividends and $1,550 in taxable interest. Steve’s Social Security number is 589-64-1458 and his address is 8332 Winslow Way, Bainbridge Island, WA, 98110. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Steve.

Scenario 2 Questions Answers appear in Scenario 2 Feedback 1. What form would Steve receive that shows him the amount of interest he received during the year?

A. Form 1099-MISC B. Form 1099-INT C. Form 1098 D. Form 1097

2. What form would Steve receive that shows him the amount of dividends he received during the year?

A. Form 1099-DIV B. Form 1099-INT C. Form 1099-MISC D. Form 1099-OID

3. Exemption totals are found on page 1 of Steve’s Form 1040.

A. True B. False

4. If Steve did not receive any dividends, he is allowed to use Form 1040EZ.

A. True B. False

5. On what line of Form 1040 would Steve show the total amount of tax that is withheld from his paychecks for Federal

income taxes? A. Line 25a B. Line 25b C. Line 25c D. Line 25d

6. Steve would want to use the standard deduction on this return.

A. True B. False

Tax Return Preparation - Scenario 2

7. What is Steve’s total income shown on Line 9 of this return? A. $52,989 B. $53,389 C. $54,539 D. $55,939

8. What is the outcome of Steve’s return?

A. Steve will receive a $647 refund B. Steve owes a $647 tax C. Steve will receive a $3,329 refund D. Steve owes a $3,329 tax

9. If Steve owned a condo and paid $8,000 of interest and $2,800 of property tax instead of renting, he would itemize his

deductions. A. True B. False

10. Steve should ask his employer for a Form W-4 - Employee's Withholding Certificate to change his withholding.

A. True B. False

Tax Return Preparation - Scenario 2

Scenario 2 Feedback Return to Scenario 2 Questions Question 1 - B. Form 1099-INT The IRS requires payments of interest income of at least $10 be reported on Form 1099-INT - Interest Income by the person or entity that makes the payments. This entity is most commonly a bank, other financial institution, or government agency. When Steve files his taxes, he does not need to attach copies of the 1099-INT forms he receives, but he does need to report the information from the forms on the tax return. Refer to Lesson 2 in the Federal tax law course for more information about Form 1099-INT. Question 2 - A. Form 1099-DIV Form 1099-DIV - Dividends and Distributions is used by banks and other financial institutions to report dividends and other distributions to taxpayers and to the IRS. Refer to Lesson 2 in the Federal tax law course for more information about Form 1099-DIV. Question 3 - B. False The Tax Cuts and Jobs Act repeals the personal and dependency exemptions. This suspension of the personal and dependency exemptions will apply to any taxable year beginning after December 31, 2017, and before January 1, 2026. The exemptions section has been removed from Form 1040. Refer to Lesson 4 in the Federal tax law course for more information about the personal exemptions. Question 4 - B. False Steve should use Form 1040 if he did not own a home. Form 1040 is used by U.S. taxpayers to file an annual income tax return. Refer to Lesson 2 in the Federal tax law course for more information about Form 1040. Question 5 - A. Line 25a On Form 1040, the taxpayer should use Line 25a to show Federal income tax withheld from Form W-2. Refer to Lesson 2 in the Federal tax law course for more information about Form 1040 and Form W-2. Question 6 - A. True When filing a Federal income tax return, taxpayers can choose to either take the standard deduction or to itemize their deductions. The taxpayer may generally deduct the total itemized deduction amount or the standard deduction amount, whichever is greater. Because rent is not deductible, Steve does not have any deductions that make using Schedule A and itemizing deductions a greater amount than the standard deduction. He should use the standard deduction of $13,850 in 2023. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and Lesson 13 for more information about itemized deductions. Question 7 - D. $55,939 Steve is required to attach Schedule B - Interest and Ordinary Dividends. He would include the $1,550 on Line 2b and $400 on Line 3b of his Form 1040. His total income is the total of his earnings ($53,989), interest ($1,550) and his ordinary dividends ($400) or $55,939. Refer to Lesson 6 in the Federal tax law course for more information about Schedule B. Question 8 - D. Steve owes a $3,329 tax For 2023, Steve’s total tax from Line 24 of his Form 1040 is $4,829. His total payments from Line 33 equal $1,500. Subtract Line 33 from Line 24 to determine the amount Steve owes. Enter $3,329 on Line 37. Refer to Lesson 1 in the Federal tax law course for more information about paying the tax. Question 9 - B. False If Steve owed a condo, he could include interest and property taxes in his itemized deductions. The itemized deductions would amount to $10,800 which is still less than his standard deduction for a single taxpayer of $13,850 in 2023. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and Lesson 13 for more information about itemized deductions.

Tax Return Preparation - Scenario 2

Question 10 - A. True Steve’s employer deducts taxes from his paycheck based on the number of allowances he claims on his Form W-4 - Employee's Withholding Certificate. If Steve has too much money withheld from his paychecks, he may end up giving Uncle Sam an interest-free loan (and getting a tax refund). However, there may be better ways for him to use his money. Conversely, if Steve is having too little withheld from his paycheck this could mean an unexpected tax bill or even a penalty for underpayment. For 2023, Steve’s current tax return, he owes $3,329 so he should update the information on a new Form W-4. Refer to Lesson 2 in the Federal tax law course for more information about Form W-4.

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Tax Return Preparation

Scenario 3 Vera Wang is a 28-year-old unmarried taxpayer with a 6-year-old son, Tim. She earned $87,990 last year which was reported on Form W-2 - Wage and Tax Statement. Her Form W-2 also showed that $4,000 was withheld for Federal income taxes. Tim (SSN - 078-92-4425) lives with Vera in her home that she rents. She provides over 50% of the cost of his support. She qualifies for the $2,000 Child Tax Credit. Vera received alimony of $100 per month and child support of $75 per month from her son’s father for all twelve months of the year for a divorce executed on December 19, 2016. She also collected taxable interest income of $475. Vera’s Social Security number is 078-92-4258 and her address is 15348 49th Ave SW, Walnut Creek, CA, 94507. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Vera.

Scenario 3 Questions Answers appear in Scenario 3 Feedback 1. What is Vera’s taxable income on Line 15 of her Form 1040?

A. $68,865 B. $69,950 C. $74,000 D. $78,000

2. If Tim lived with his father who paid more than 50% of household expenses and support in what way would Vera’s total

tax change? A. Vera’s total tax would not change B. Vera’s total tax would decrease C. Vera’s total tax would increase D. Vera would need to file a tax return

3. What amount appears on Line 24 on Form 1040 and shows total tax?

A. $1,946 B. $4,270 C. $6,854 D. $9,054

4. Vera no longer receives a Child Tax Credit after Tim reaches what age?

A. 13 years old B. 14 years old C. 15 years old D. 17 years old

5. On what line on Form 1040 should Vera show the Child Tax Credit?

A. Line 16 B. Line 17 C. Line 18 D. Line 19

6. What amount would the Child Tax Credit be on Vera’s Form 1040?

A. $0 B. $1,000 C. $1,400 D. $2,000

Tax Return Preparation - Scenario 3

7. How many exemptions would Vera show on her return? A. 0 B. 1 C. 2 D. 3

8. What is the outcome of Vera’s return?

A. Vera will receive a $2,660 refund B. Vera owes a $2,660 tax C. Vera will receive a $2,854 refund D. Vera owes a $2,854 tax

9. Vera should have itemized her deduction rather than using the standard deduction.

A. True B. False

10. If Vera owned her home and paid mortgage interest of $6,500 and $2,000 of property tax she would want to itemize.

A. True B. False

Tax Return Preparation - Scenario 3

Scenario 3 Feedback Return to Scenario 3 Questions

Question 1 - A. $68,865 In 2023, Vera can use the head of household standard deduction of $20,800 on Line 12. She subtracts this amount from her adjusted gross income of $89,665 to arrive at $68,865. Refer to Lesson 3 in the Federal tax law course for more information about taxable income and filing status.

Question 2 - C. Vera’s total tax would increase If Tim lived with his father who paid more than 50% of household expenses and support Vera would not be able to use the head of household standard deduction of $20,800 in 2023. She would most likely use a single filer’s deduction of $13,850. Therefore, Vera’s taxable income would be higher as would her total tax. Refer to Lesson 3 in the Federal tax law course for more information about filing status.

Question 3 - C. $6,854 Vera’s tax from the 2023 tax table is $8,854 based on taxable income of $68,865 and the head of household filing status. She qualifies for a $2,000 Child Tax Credit bringing her total tax on Line 24 to $6,854. Refer to Lesson 3 for more information about tax liability and Lesson 14 in the Federal tax law course for more information about the Child Tax Credit.

Question 4 - D. 17 years old For the Child Tax Credit, a taxpayer may be able to reduce his or her Federal income tax by up to $2,000 for each qualifying child under the age of 17. Refer to Lesson 14 in the Federal tax law course for more information about the Child Tax Credit.

Question 5 - D. Line 19 On page 2 of Form 1040, the Child Tax Credit amount appears on Line 19. Refer to Lesson 2 in the Federal tax law course for more information about Form 1040.

Question 6 - D. $2,000 Vera meets all the requirements, including Age, Relationship, Support and Residence tests for the Child Tax Credit. The Child Tax Credit is limited if the taxpayer’s modified adjusted gross income (MAGI) is above a certain amount. The amount at which this phase-out begins varies depending on the filing status. Phase-out means that the credit is reduced as the taxpayer’s income increases. In this case, the reduction is $50 for each $1,000 by which the taxpayer’s MAGI exceeds the threshold amount. For married taxpayers filing a joint return, the phase-out begins at $400,000. For all other taxpayers, including married taxpayers filing a separate return, the phase-out begins at $200,000. Vera’s modified adjusted gross income is below the phase-out threshold, so she qualifies for the entire $2,000 credit. Refer to Lesson 14 in the Federal tax law course for more information about the Child Tax Credit.

Question 7 - A. 0 Under the Tax Cuts and Jobs Act (TCJA) personal exemption deductions for the taxpayer, his or her spouse, or his or her dependents have been eliminated beginning after December 31, 2017, and before January 1, 2026. Refer to Lesson 4 in the Federal tax law course for more information about the personal exemptions.

Question 8 - D. Vera owes a $2,854 tax Vera’s total tax from Line 24 of her Form 1040 is $6,854. Her total payments from Line 33 equal $4,000. Subtract Line 33 from Line 24 to determine the amount Vera owes. Enter $2,854 on Line 37. Refer to Lesson 1 in the Federal tax law course for more information about refunds.

Question 9 - B. False When filing his or her Federal income tax return, taxpayers can choose to either take the standard deduction or to itemize their deductions. Whether to itemize deductions on the tax return depends on how much the taxpayer spent on certain expenses last year. Money paid for medical care, mortgage interest, taxes, charitable contributions, casualty losses and miscellaneous deductions can reduce his or her taxes. If the total amount spent on those categories is more than the standard deduction, the taxpayer can usually benefit by itemizing. In Vera’s case her expenses are not more than her head of household standard deduction of $20,800 in 2023. Refer to Lesson 4 for more information about the standard deduction and Lesson 13 in the Federal tax law course for more information about itemized deductions.

Tax Return Preparation - Scenario 3

Question 10 - B. False If Vera owed her home she could include mortgage interest and property taxes in her itemized deductions. The itemized deductions would amount to $8,500 which is less than her standard deduction of $20,800 for a head of household in 2023. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and Lesson 13 for more information about itemized deductions.

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Tax Return Preparation

Scenario 4 Gwen and Andy Smith are both 50 years old. They are married and filing a joint Federal tax return. Gwen earned $53,974 last year and Andy earned $40,000 reported to them on Form W-2 - Wage and Tax Statement from which $4,400 and $4,000 respectively was withheld for Federal income taxes. The Smiths do not have children or other dependents. Additionally, they cannot be claimed as dependents on someone else’s tax return. They own their own home and pay $15,000 of mortgage interest, $3,000 of property tax and $800 for homeowners insurance. They also paid $250 for preparation of their tax return. Gwen’s Social Security number is 345-67-8999. Andy’s Social Security number is 123-45- 6789. Their address is 5617 Main St, Bakersfield, CA, 93203. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for the Smiths.

Scenario 4 Questions Answers appear in Scenario 4 Feedback 1. What is the total amount of itemized deductions allowed on the Smiths return?

A. $3,000 B. $15,000 C. $18,000 D. $18,800

2. What line on Form 1040 would show the total itemized deductions or the standard deduction amount?

A. Line 12 B. Line 13 C. Line 14 D. Line 15

3. If the interest paid on their mortgage was $18,000 the Smiths would want to itemize their deductions.

A. True B. False

4. What is the Smiths adjusted gross income (AGI) on Line 11 of their Form 1040?

A. $69,000 B. $81,000 C. $83,200 D. $93,974

5. What is the Smiths taxable income on Line 15 of their Form 1040?

A. $66,274 B. $69,974 C. $76,200 D. $83,974

6. All of the following are nondeductible expenses that may be included in the taxpayer’s house payment except:

A. Fire insurance premiums B. Homeowner’s insurance premiums C. An amount applied to reduce the principal of the mortgage D. Home mortgage interest

7. What is the Smiths total tax from Line 24 of their Form 1040?

A. $7,513 B. $7,849 C. $9,059 D. $10,485

Tax Return Preparation - Scenario 4

8. What is the outcome of the Smiths tax return? A. They will receive a $651 refund B. They owe a $651 tax C. They will receive a $887 refund D. They owe a $887 tax

9. Assuming the same amount of property tax, what is the least amount of mortgage interest the Smiths would pay in order

to itemize their deductions? A. $24,701 B. $25,850 C. $26,901 D. $27,950

10. If the Smiths had a dependent, what would their exemption amount be on their Form 1040?

A. $0 B. $8,300 C. $10,700 D. $12,150

Tax Return Preparation - Scenario 4

Scenario 4 Feedback Return to Scenario 4 Questions Question 1 - C. $18,000 The Smiths total itemized deductions include $15,000 of mortgage interest and $3,000 of property tax. The $800 for homeowners’ insurance is not deductible. The $250 in tax preparation fees are not allowed as an itemized deduction because under the Tax Cuts and Jobs Act (TCJA) miscellaneous itemized deductions subject to the 2% of adjusted gross income (AGI) floor, such as unreimbursed employee business expenses and tax preparation fees, are repealed. Refer to Lesson 13 in the Federal tax law course for more information about itemized deductions. Question 2 - A. Line 12 On page 1 of Form 1040, Line 12 shows the taxpayer’s itemized deductions amount or the standard deduction amount. Refer to Lesson 2 in the Federal tax law course for more information about Form 1040. Question 3 - B. False If the interest paid on the Smiths mortgage was $18,000 their total itemized deductions would be $21,000. As a married couple filing jointly their standard deduction would be $27,700 in 2023 so it is more advantageous for the Smiths to take the standard deduction. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and Lesson 13 for more information about itemized deductions. Question 4 - D. $93,974 The Smiths adjusted gross income (AGI) is their entire annual earnings of $93,974 ($53,974 + $40,000) as they do not qualify for any above-the-line deductions for the tax year. Refer to Lesson 3 in the Federal tax law course for more information about adjusted gross income (AGI). Question 5 - A. $66,274 The Smiths can subtract the standard deduction amount of $27,700 for 2023 from their adjusted gross income of $93,974 to arrive at taxable income of $66,274. Refer to Lesson 3 in the Federal tax law course for more information about taxable income. Question 6 - D. Home mortgage interest If the taxpayer took out a mortgage (loan) to finance the purchase of his or her home, he or she probably has to make monthly house payments. The taxpayer’s house payment may include several costs of owning a home. The only costs a taxpayer can deduct are real estate taxes actually paid to the taxing authority, interest that qualifies as home mortgage interest, and mortgage insurance premiums. Some nondeductible expenses that may be included in the taxpayer’s house payment include fire or homeowner's insurance premiums and the amount applied to reduce the principal of the mortgage. Refer to Lesson 13 in the Federal tax law course for more information about nondeductible expenses. Question 7 - A. $7,513 Based on total taxable income of $66,274 and their married, filing jointly status, the Smiths total tax from the 2023 tax table is $7,513. This amount appears on Line 24. Refer to Lesson 3 in the Federal tax law course for more information about tax liability. Question 8 - C. They will receive a $887 refund The Smiths total tax from Line 24 of their Form 1040 is $7,513. Their total payments from Line 33 equal $8,400. Subtract Line 24 from Line 33 to determine the Smiths refund amount. Enter $887 on Line 34. Refer to Lesson 1 in the Federal tax law course for more information about refunds. Question 9 - A. $24,701 If the Smiths paid $24,701 their itemized deduction would be more than the standard deduction of $27,700 for a couple filing jointly in 2023. Since they paid any amount less than $24,700, they use the standard deduction as this amount is greater than (or equal to) the Smiths itemized deductions. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and Lesson 13 for more information about itemized deductions.

Tax Return Preparation - Scenario 4

Question 10 - A. $0 Under the Tax Cuts and Jobs Act (TCJA) personal exemption deductions for the taxpayer, his or her spouse, or his or her dependents have been eliminated beginning after December 31, 2017, and before January 1, 2026. Refer to Lesson 4 in the Federal tax law course for more information about the personal exemptions. Refer to Lesson 4 in the Federal tax law course for more information about personal exemptions.

Tax Return Preparation

Scenario 5 Mike Jordan is a 53-year-old self-employed contractor who performs financial services for his clients. During the tax year, he had total revenues of $125,000, paid wages of $25,000 and spent $25,000 for supplies. He made estimated tax payments to the IRS of $5,000 for each quarter. He is single and has no other income. Mike is a calendar year taxpayer and does not have children or other dependents. Additionally, he cannot be claimed as dependents on someone else’s tax return. Mike’s Social Security number is 987-65-4321. Mike rents his house, and his address is 83 12th St, Sacramento, CA, 94203. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Mike.

Scenario 5 Questions Answers appear in Scenario 5 Feedback 1. What is Mike’s self-employment income for the year?

A. $25,000 B. $75,000 C. $100,000 D. $125,000

2. What amount is Mike’s self-employment tax for the year?

A. $0 B. $5,299 C. $10,598 D. $10,860

3. What amount of Mike’s self-employment tax is deductible?

A. $0 B. $2,649 C. $5,299 D. $10,597

4. What amount is Mike’s adjusted gross income from Line 11 of his Form 1040?

A. $59,701 B. $63,601 C. $69,701 D. $75,000

5. What amount of estimated tax payment Mike made for the year shows on Line 26 of Form 1040?

A. $5,000 B. $10,000 C. $15,000 D. $20,000

6. What is Mike’s total tax that appears on Line 24 of his Form 1040?

A. $5,299 B. $10,597 C. $10,860 D. $18,198

Tax Return Preparation - Scenario 5

7. What is the outcome of Mike’s tax return? A. Mike will receive a $167 refund B. Mike owes a $167 tax C. Mike will receive a $1,802 refund D. Mike owes a $1,802 tax

8. What form would Mike use to submit his estimated payments?

A. Form 1040 B. Form 1040-C C. Form 1040-ES D. Form 1040-X

9. All four quarterly estimated tax payments must be remitted before the end of the calendar year.

A. True B. False

10. Mike is required to use Schedule SE when completing his tax return because he calculated more than $50,000 of net profit on his Schedule C.

A. True B. False

Tax Return Preparation - Scenario 5

Scenario 5 Feedback Return to Scenario 5 Questions Question 1 - B. $75,000 Use Schedule C - Profit or Loss From Business to determine Mike’s self-employment income. Mike’s gross income on Line 7 is $125,000. From that amount subtract $25,000 for supplies on Line 22 and $25,000 for wages on Line 26. Mike does not deduct expenses for business use of his home so his net profit on Line 31 is $75,000. Refer to Lesson 8 in the Federal tax law course for more information about Schedule C. Question 2 - C. $10,598 Mike’s self-employment tax is figured on Schedule SE by entering his net profit from Schedule C, Line 31 onto Schedule SE Line 2. Combine Line 1a, 1b and 2 of Schedule SE for a total of $75,000 on Line 3. Then multiply Line 3 by 92.35% (.9235) for a total of $69,263 on Line 6. Because the amount on Line 6 is less than $160,200 (in 2023) multiply $69,263 by 12.4% (.124) and enter $8,589 on Line 10. Then multiply Line $69,263 by 2.9% (.029) and enter $2,009 on Line 11. Add Lines 10 and 11 to arrive at total self-employment tax of $10,598 on Line 12. Refer to Lesson 8 in the Federal tax law course for more information about self-employment tax. Question 3 - C. $5,299 Mike can deduct one-half of his self-employment tax. This deduction is calculated on Schedule SE - Self-Employment Tax. Multiply Line 5 by 50% (.50) and enter the result on Line 6. Refer to Lesson 8 in the Federal tax law course for more information about Schedule SE. Question 4 - C. $69,701 Mike figures adjusted gross income (AGI) on Schedule 1 (Form 1040). He can deduct the $5,299 of self-employment tax from his Schedule SE from his business income of $75,000 for a total adjusted gross income of $69,701. Refer to Lesson 3 in the Federal tax law course for more information about adjusted gross income (AGI). Question 5 - D. $20,000 Mike made estimated tax payments to the IRS of $5,000 for each quarter. The total estimated tax payments in the amount of $20,000 appear on Line 26 of Form 1040. Refer to Lesson 3 in the Federal tax law course for more information about estimated tax payments. Question 6 - D. $18,198 Mike figured his tax on Line 16 of $7,600 from the 2023 tax table based on his taxable income of $55,851. Mike adds his self-employment tax of $10,598 and reports a total tax of $18,198 on Line 24. Refer to Lesson 3 for more information about tax liability and Lesson 8 in the Federal tax law course for more information about Schedule SE. Question 7 - C. Mike will receive a $1,802 refund Mike’s total tax from Line 24 of his Form 1040 is $18,198. His total payments from Line 33 equal $20,000. Subtract Line 24 from Line 33 to determine Mike’s tax refund. Enter $1,802 on Line 34. Refer to Lesson 1 in the Federal tax law course for more information about refunds. Question 8 - C. Form 1040-ES Estimated tax is the method used to pay tax on income that is not subject to withholding (for example, earnings from self- employment, interest, dividends, rents, alimony, etc.). In addition, if the taxpayer does not elect voluntary withholding, he or she should make estimated tax payments on other taxable income, such as unemployment compensation and the taxable part of his or her Social Security benefits. Mike should use Form 1040-ES to figure and pay his estimated tax. Refer to Lesson 1 in the Federal tax law course for more information about estimated taxes.

Tax Return Preparation - Scenario 5

Question 9 - B. False A taxpayer can pay all of his or her estimated tax by April 15 of the current year, or in four equal amounts by the following dates:

• 1st payment - April 15

• 2nd payment - June 15

• 3rd payment - September 15

• 4th payment - January 15 (of the following year) The taxpayer does not have to make the payment due January 15 if he or she files his or her tax return by February 2 and pays the entire balance due with the return. Refer to Lesson 1 in the Federal tax law course for more information about estimated taxes. Question 10 - B. False The taxpayer must file Schedule SE if:

• The amount on Line 4c of Schedule SE is $400 or more, or

• He or she had church employee income of $108.28 or more. (Income from services the taxpayer performed as a minister, member of a religious order, or Christian Science practitioner is not church employee income.)

Even if the taxpayer had a loss or a small amount of income from self-employment, it may be to his or her benefit to file Schedule SE and use either "optional method" in the instructions for Part II of Schedule SE. Refer to Lesson 8 in the Federal tax law course for more information about Schedule SE and figuring net earnings from self-employment.

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Tax Return Preparation

Scenario 6 James Garfield is a 38-year-old married taxpayer with income of $74,989 reported to him on Form W-2 - Wage and Tax Statement. His Form W-2 also showed that $5,000 was withheld from his paychecks during the year for Federal income taxes. In March he and his wife Gina, also 38-years-old, adopted a daughter, 1-year-old Jane (SSN - 346-67-8999), from the United States for whom they paid $3,000 of qualified domestic adoption expenses. The Garfields do not have any other children or other dependents. They qualify for the $2,000 Child Tax Credit. Additionally, they cannot be claimed as dependents on someone else’s tax return. The Garfields own a home and paid $2,500 interest on their home mortgage and $500 property tax. James’ Social Security number is 928-56-1234. Gina’s Social Security number is 789-56-4321. Their address is 383 College Drive, Chico, CA, 95926. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for the Garfields.

Scenario 6 Questions Answers appear in Scenario 6 Feedback 1. What form or schedule would James and Gina use to calculate the credit for qualified adoption expenses?

A. Form 1040 B. Schedule A C. Schedule B D. Form 8839

2. What is the total amount of credits shown on Line 21 of the Garfield’s Form 1040?

A. $0 B. $2,000 C. $3,000 D. $5,000

3. If James and Gina pay for additional qualified adoption expenses next year, they can file for an additional tax credit.

A. True B. False

4. James and Gina should complete Schedule A and itemize their deductions because they paid home mortgage interest and personal property tax.

A. True B. False

5. What is the exemption amount the Garfields can claim on their Form 1040?

A. $0 B. $4,050 C. $8,100 D. $12,150

6. What is the Garfield’s taxable income on Line 15 of their Form 1040?

A. $47,289 B. $62,389 C. $63,300 D. $74,989

7. What amount is the Garfield’s total tax on Line 24 of their Form 1040?

A. $233 B. $2,224 C. $6,000 D. $6,776

Tax Return Preparation - Scenario 6

8. What is the outcome of the Garfield’s tax return? A. They will receive a $233 refund B. They owe a $233 tax C. They will receive a $4,767 refund D. They owe a $4,767 tax

9. The adoption credit for qualified adoption expenses can only be taken after the adoption is final.

A. True B. False

10. For how many years can the Garfields carry forward unused credit for their qualified adoption expenses?

A. Two years B. Three years C. Four years D. Five years

Tax Return Preparation - Scenario 6

Scenario 6 Feedback Return to Scenario 6 Questions Question 1 - D. Form 8839 A taxpayer uses Form 8839 - Qualified Adoption Expenses to figure his or her Adoption Credit and any employer-provided adoption benefits he or she can exclude from his or her income. The taxpayer can claim both the exclusion and the credit for expenses of adopting an eligible child. For example, depending on the cost of the adoption, the taxpayer may be able to exclude up to $15,950 from his or her income and also be able to claim a credit of up to $15,950 in 2023. But the taxpayer cannot claim both a credit and exclusion for the same expenses. Refer to Lesson 14 in the Federal tax law course for more information about Form 8839. Question 2 - D. $5,000 The Garfields are eligible to claim $2,000 for the Child Tax Credit on Line 19 of Form 1040 and $3,000 from Form 8839 for qualified adoption expenses on Line 8 of Schedule 3 (Form 1040). Total credits of $5,000 appear on Line 21. Refer to Lesson 14 in the Federal tax law course for more information about the Child Tax Credit and the Adoption Credit. Question 3 - A. True If Form 8839, Line 15 is smaller than Line 14, the taxpayer may have an unused credit to carry forward to the next 5 years or until used, whichever comes first. The taxpayer uses the Adoption Credit Carryforward Worksheet to figure the amount of his or her credit carryforward. If the taxpayer has any unused credit to carry forward to future tax years, be sure he or she keeps the worksheet. The taxpayer will need it to figure his or her credit for future tax years. Refer to Lesson 14 in the Federal tax law course for more information about Form 8839. Question 4 - B. False When filing a Federal income tax return, taxpayers can choose to either take the standard deduction or to itemize their deductions. In this case the Garfields should choose the standard deduction rather than itemizing their deductions because the total amount they spent on medical care, mortgage interest, taxes, charitable contributions, casualty losses and miscellaneous deductions is less than the standard deduction for married taxpayers filing jointly. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction. Question 5 - A. $0 Under the Tax Cuts and Jobs Act (TCJA) personal exemption deductions for the taxpayer, his or her spouse, or his or her dependents have been eliminated beginning after December 31, 2017, and before January 1, 2026. Refer to Lesson 4 in the Federal tax law course for more information about the personal exemptions. Refer to Lesson 4 in the Federal tax law course for more information about personal exemptions. Question 6 - A. $47,289 The Garfield’s taxable income is equal to their adjusted gross income of $74,989 less their standard deduction of $27,700 from Line 12 in 2023, for a total of $47,289. Refer to Lesson 3 in the Federal tax law course for more information about taxable income. Question 7 - A. $233 Using the 2023 tax table, the Garfields figured their tax on Line 16 is $5,233. They can claim the Child Tax Credit and adoption expenses from Form 8839 for a total of $5,000 entered on Line 21. By subtracting Line 21 from Line 16 they arrive at a total tax on Line 24 of $233. Refer to Lesson 3 in the Federal tax law course for more information about tax liability. Question 8 - C. They will receive a $4,767 refund The Garfield’s total tax from Line 24 of their Form 1040 is $233. Their total payments from Line 33 equal $5,000. Subtract Line 24 from Line 33 to determine the amount the Garfields overpaid. Enter $4,767 on Line 34. Refer to Lesson 1 in the Federal tax law course for more information about paying the tax.

Tax Return Preparation - Scenario 6

Question 9 - B. False The tax years for which a taxpayer can claim the credit depend on when the expenses are paid, whether the adoption is domestic or foreign, and whether the adoption has been finalized. Generally, the credit is allowable whether the adoption is domestic or foreign. In the Garfield’s case for their domestic adoptions, qualified adoption expenses paid before the year the adoption becomes final are allowable as a credit for the tax year following the year of payment (and the credit is allowable even if the adoption is never finalized). Refer to Lesson 14 in the Federal tax law course for more information about the Adoption Credit. Question 10 - D. Five years A taxpayer may have an unused credit to carry forward to the next 5 years or until used, whichever comes first. Refer to Lesson 14 in the Federal tax law course for more information about the Adoption Credit.

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Tax Return Preparation

Scenario 7 Thomas Jefferson, age 35, is a self-employed lawyer. He had gross income of $70,000. Tom is a calendar year taxpayer. During the current tax year, he paid $1500 for advertising, $200 for his business license and $100 per month for a cell phone which he uses 60% for business. He owns a car that he used to travel 800 miles for personal use and 2,000 miles for business that are documented in his mileage logbook. He uses actual expenses of $1,413 instead of the standard mileage deduction method for the vehicle. He made estimated tax payments of $4,000 for each quarter. He does not take a deduction for a home office. His wife, Maureen, who is 30 years old earned $40,000 for which she received a Form W- 2 - Wage and Tax Statement that also showed $4,000 had been withheld for Federal income taxes. They own their home and paid $15,000 for mortgage interest, $3,500 for property taxes and $900 for homeowners’ insurance. Maureen contributed $3,000 to a traditional IRA during the year. Mr. and Mrs. Jefferson do not have any children or other dependents. Additionally, they cannot be claimed as dependents on someone else’s tax return. Thomas’ Social Security number is 369-25-8147. Maureen’s Social Security number is 741-85-2963. Their address is 1914 Mountain View Drive, South Lake Tahoe, CA 96150. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Mr. and Mrs. Jefferson.

Scenario 7 Questions Answers appear in Scenario 7 Feedback 1. What are Thomas’ total business expenses from Part II of Schedule C - Profit or Loss From Business?

A. $1,500 B. $2,913 C. $3,113 D. $3,833

2. What is the Jefferson’s total income on Line 9 of Form 1040 for this return?

A. $40,000 B. $66,167 C. $98,492 D. $106,167

3. What amount of Thomas’ self-employment tax is deductible?

A. $0 B. $4,675 C. $9,349 D. $9,934

4. What is the Jefferson’s adjusted gross income shown on Line 11 of Form 1040? A. $40,000 B. $66,167 C. $98,492 D. $106,167

5. What amount is Thomas’ self-employment tax for the year? A. $0 B. $4,675 C. $9,349 D. $9,934

6. What amount is the Jefferson’s total tax on Line 24 of their Form 1040? A. $9,349 B. $9,641 C. $9,934 D. $17,402

Tax Return Preparation - Scenario 7

7. What is the outcome of the Jefferson’s tax return? A. They will receive a $2,598 refund B. They owe a $2,598 tax C. They will receive a $2,802 refund D. They owe a $2,802 tax

8. What is the maximum amount Maureen can contribute to a traditional IRA?

A. $0 B. $5,000 C. $6,500 D. $7,000

9. Both Thomas and Maureen can contribute to an IRA.

A. True B. False

Tax Return Preparation - Scenario 7

Scenario 7 Feedback Return to Scenario 7 Questions Question 1 - D. $3,833 Thomas can claim $1,500 for advertising expenses, $1,413 for car expenses, $720 for his cell phone under utilities expense and $200 for his real estate license for total expenses of $3,883. Refer to Lesson 8 in the Federal tax law course for more information about Schedule C - Profit or Loss From Business. Question 2 - D. $106,167 To calculate total income on Line 9 of page 1 of the Form 1040 combine all income including wages of $40,000 and business income from Schedule C of $66,167. The result is $106,167. Refer to Lesson 5 for more information about earned income and Lesson 8 in the Federal tax law course for more information about Schedule C. Question 3 - B. $4,675 Thomas can deduct one-half of his self-employment tax. This deduction is calculated on Schedule SE - Self-Employment Tax. Multiply Line 12 on Schedule SE by 50% (.50) and enter the result on Line 13. Refer to Lesson 8 in the Federal tax law course for more information about Schedule SE. Question 4 - C. $98,492 When figuring the Jefferson’s adjusted gross income include a deduction $4,675 for one-half of the self-employment tax from Schedule SE and a $3,000 deduction for contributions to the IRA. Add these amounts and enter $7,675 on Line 26 of Schedule 1 (Form 1040). Subtract this amount from total income of $106,167 to arrive at $98,492. Enter this amount in Line 11 of page 1 on Form 1040. Refer to Lesson 3 in the Federal tax law course for more information about adjusted gross income (AGI). Question 5 - C. $9,349 Thomas’ self-employment tax is figured on Schedule SE by entering his net profit from Schedule C, Line 31 on Line 2. Combine Line 1a, 1b and 2 for a total of $66,167 on Line 3. Then multiply Line 3 by 92.35% (.9235) for a total of $61,105 on Line 4a. No other income is included so enter $61,105 on Line 6. Because the amount on Line 6 is less than $160,200 in 2023 multiply $61,105 by 12.4% (.124) and enter $7,577 on Line 10. Then multiply $61,105 by 2.9% (.029) and enter $1,772 on Line 11. Add Lines 10 and 11 for a total self-employment tax of $9,349 on Line 12. Refer to Lesson 8 in the Federal tax law course for more information about self-employment tax. Question 6 - D. $17,402 Using the 2023 tax table, the Mr. and Mrs. Jefferson figured their tax on Line 16 is $8,053. They cannot claim additional credits. They include Thomas’ self-employment tax of $9,349 from Schedule SE for a total tax on Line 24 of $17,402. Refer to Lesson 3 in the Federal tax law course for more information about tax liability. Question 7 - A. They will receive a $2,598 refund The Jefferson’s total tax from Line 24 of their Form 1040 is $17,402. Their total payments from Line 33 equal $20,000. Subtract Line 24 from Line 33 to determine the Jeffersons refund amount. Enter $2,598 on Line 34. Refer to Lesson 1 in the Federal tax law course for more information about refunds. Question 8 - C. $6,500 For 2023, the maximum a taxpayer can contribute to all of his or her traditional and Roth IRAs is the smaller of $6,500 ($7,500 if he or she is age 50 or older), or his or her taxable compensation for the year. Because Maureen is filing jointly, she may be eligible to contribute $6,500. The deduction is limited if the taxpayer or his or her spouse is covered by a retirement plan at work and his or her income exceeds certain levels. Refer to Lesson 11 in the Federal tax law course for more information about IRAs. Question 9 - A. True If a taxpayer files a joint return, he or she and his or her spouse can each make IRA contributions even if only one of them has taxable compensation. The amount of the taxpayer’s combined contributions cannot be more than the taxable compensation reported on his or her joint return. It does not matter which spouse earned the compensation. The deduction is also limited if the taxpayer or his or her spouse is covered by a retirement plan at work and his or her income exceeds certain levels. Refer to Lesson 11 in the Federal tax law course for more information about IRAs.

Tax Return Preparation

Scenario 8 Margaret Paz is a 35-year-old unmarried taxpayer who has a daughter, Margie (SSN - 234-56-7889), age 6, who lives with her. Margaret provides over 50% of the cost of Margie’s support and she qualifies for the Child Tax Credit in the amount of $2,000 in 2023. Margaret owns her home and paid $13,000 in mortgage interest and $2,500 in property taxes. She earned $34,000 that was reported on Form W-2 - Wage and Tax Statement which also showed that $3,000 had been withheld for Federal income taxes. Margaret is a calendar year taxpayer who also has a small bookkeeping business that had gross revenue of $25,000. She spent $500 on supplies, $200 on software, and $100 per month for a cell phone used 50% for business. She made estimated tax payments of $1,500 for each quarter. She bought 100 shares of common stock in ABC Company with a cost of $2,000 that she held for exactly 4 months and sold for $2,500 on December 1. She received $150 in ordinary dividends during the holding period. She also received $1,000 in interest on fixed income securities. She contributed $3,000 to a traditional IRA and made a charitable contribution in cash of $300. She had $6,000 in unreimbursed, allowable medical expenses. Margaret’s Social Security number is 852-74-9631. Her address is 37 Ocean Terrace, Laguna Beach, CA 92607. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Margaret.

Scenario 8 Questions Answers appear in Scenario 8 Feedback

1. To complete her tax return, Margaret will need to use which of the following schedules? A. Schedule 1 B. Schedule C C. Schedule D D. All of the above

2. What is the amount of business income Margaret reported on Line 3 of her Schedule 1 (Form 1040) from Schedule C - Profit or Loss From Business?

A. $23,700 B. $34,000 C. $35,000 D. $59,275

3. What is Margaret’s adjusted gross income shown on Line 11 of Form 1040? A. $54,675 B. $58,606 C. $58,625 D. $59,275

4. What is the amount of Margaret’s deduction on Line 12 of her Form 1040? A. $4,200 B. $12,200 C. $17,699 D. $20,800

5. What amount of self-employment tax does Margaret owe? A. $0 B. $1,675 C. $3,349 D. $21,818

6. What amount is Margaret’s total tax on Line 24 of her Form 1040? A. $2,129 B. $3,338 C. $3,884 D. $5,100

Tax Return Preparation - Scenario 8

7. What is the outcome of Margaret’s tax return? A. She will receive a $1,006 refund B. She owes a $1,006 tax C. She will receive a $3,900 refund D. She owes a $3,900 tax

8. If Margaret also had a short-term loss carryover of $5,300 what would be the impact on her return?

A. No Change B. She can show a $3,000 loss on Line 7 of her Form 1040 C. She can show a $5,300 loss on Line 7 of her Form 1040 D. She can show a $3,000 gain on Line 7 of her Form 1040

9. If Margaret itemized her taxes, she could deduct what part of her $6,000 in medical expenses on her Schedule A -

Itemized Deductions? A. $0 B. $1,899 C. $4,101 D. $6,000

10. Because Margaret uses the standard deduction, the outcome of her return will not change based on her filing status. A. True B. False

Tax Return Preparation - Scenario 8

Scenario 8 Feedback Return to Scenario 8 Questions Question 1 - D. All of the above Margaret will use Schedule 1 - Additional Income and Adjustments to Income to report income or adjustments to income that cannot be entered directly on Form 1040. She will also use Schedule C - Profit or Loss From Business to determine the net profit (loss) from her bookkeeping business. And lastly, she will need to complete Schedule D - Capital Gains and Losses to figure the capital gains (losses) for the common stock she sold. Refer to Lesson 13 in the Federal tax law course for more information about Schedule 1. Refer to Lesson 8 in the Federal tax law course for more information about Schedule C. Refer to Lesson 7 in the Federal tax law course for more information about Schedule D. Question 2 - A. $23,700 Margaret uses Schedule C to calculate her business income. She had $25,000 of gross income and was able to deduct $1,300 of expenses for a total of $23,700. She enters this amount on Line 3 of her Schedule 1 (Form 1040). Her expenses include $500 for supplies and $200 for software. She also had $600 for her cell phone which she used 50% of the time for business. Refer to Lesson 8 in the Federal tax law course for more information about Schedule C. Question 3 - A. $54,675 When figuring Margaret’s adjusted gross income (AGI) include a deduction of $1,675 for one-half of the self-employment tax from Schedule SE - Self-Employment Tax and a $3,000 deduction for contributions to the IRA. Enter $4,675 on Line 10 from Line 26 of Schedule 1 (Form 1040). Subtract this amount from total income of $59,350 to arrive at $54,675. Enter this amount in Line 11. Refer to Lesson 3 in the Federal tax law course for more information about adjusted gross income (AGI). Question 4 - D. $20,800 Margaret uses Schedule A to calculate her itemized deduction. Since Margaret is under age 65, she can deduct only the amount of unreimbursed allowable medical and dental expenses that is more than 7.5% of her adjusted gross income (AGI). This amount is $1,899 ($6,000 - $4,101). She can also deduct $2,500 for property taxes and $13,000 for home mortgage interest on her Schedule A. Additionally, she can deduct $300 for her charitable contribution bringing her total itemized deductions on Schedule A to $17,699. This amount is less than the standard deduction amount of $20,800 for head of household filers in 2023. Therefore, she elects to take the standard deduction. Refer to Lesson 13 in the Federal tax law course for more information about Schedule A. Question 5 - C. $3,349 Margaret’s self-employment tax is figured on Schedule SE by entering his net profit from Schedule C, Line 31 on Line 2. Combine Line 1a, 1b and 2 for a total of $23,700 on Line 3. Then multiply Line 3 by 92.35% (.9235) for a total of $21,887 on Line 4a. No other income is included so enter $21,887 on Line 6. Because the amount on Line 6 is less than $160,200 in 2023 multiply $21,887 by 12.4% (.124) and enter $2,714 on Line 10. Then multiply $21,887 by 2.9% (.029) and enter $635 on Line 11. Add Lines 10 and 11 for a total self-employment tax of $3,349 on Line 12. Refer to Lesson 8 in the Federal tax law course for more information about self-employment tax. Question 6 - D. $5,100 Using the 2023 tax table, Margaret figured her tax on Line 16 is $3,751. She can claim $2,000 credit for the Child Tax Credit and enters $1,751 on Line 22. She includes her self-employment tax of $3,349 from Schedule SE for a total tax on Line 24 of $5,100. Refer to Lesson 3 in the Federal tax law course for more information about tax liability. Question 7 - C. She will receive a $3,900 refund Margaret’s total tax from Line 24 of her Form 1040 is $5,100. Her total payments from Line 33 equal $9,000. Subtract Line 24 from Line 33 to determine Margaret’s refund amount. Enter $3,900 on Line 34. Refer to Lesson 1 in the Federal tax law course for more information about refunds.

Tax Return Preparation - Scenario 8

Question 8 - B. She can show a $3,000 loss on Line 7 of her Form 1040 On her Schedule D, Margaret would enter her $5,300 short-term loss carryover on Line 6. After combining all gain and loss her net short-term gain on Line 7 would show ($4,800). Since Margaret’s capital losses exceed her capital gains, the amount of the excess loss that can be claimed is the lesser of $3,000, ($1,500 if married filing separately) or her total net loss. Since her net capital loss is more than $3,000, she can only enter $3,000 on Line 7 of her Form 1040. She can carry the remaining loss forward to later years. Refer to Lesson 7 in the Federal tax law course for more information about capital gains and losses. Question 9 - B. $1,899 Since Margaret is under age 65, she can deduct on Schedule A - Itemized Deductions only the amount of her unreimbursed allowable medical and dental expenses that is more than 7.5% of her adjusted gross income (AGI) of $54,675, which is $4,101. Margaret’s $6,000 medical expenses would be limited to a $1,899 itemized deduction ($6,000 - $4,101). Refer to Lesson 13 in the Federal tax law course for more information about medical expenses. Question 10 - B. False Margaret qualifies for and should use the head of household filing status. Because she qualifies to file as head of household, her standard deduction will be higher than the rates for single or married filing separately. In this scenario, by choosing the head of household filing status, Margaret’s standard deduction is greater ($20,800 in 2023) than it would be if she used the single filing status ($13,850 in 2023). Refer to Lesson 3 in the Federal tax law course for more information about filing status.

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Examination Instructions - 43 Hour Federal Tax Law

Passing the Qualifying Exam (QE) from a self-study course is contingent upon scoring 70% or higher on the exam questions related to the course material. This final examination covering Federal tax law consists of 260 multiple- choice questions, meaning you must correctly answer 182 in order to pass. The exam has no time limit, and is open book, so you are allowed to look up answers in the text we provide. You do not need to finish the exam in one continuous sitting as all of the answers you enter online are automatically saved. Please keep in mind, it is necessary to click the “Next” button after changing an incorrect or unanswered question to save the new response. After you submit the online exam to us you will receive message if you fail. If you should fail the exam on your first attempt, you will have the option to re-take the exam at no additional cost. If you score less than 70%, a message will be displayed at the bottom of the page along with a list of incorrect questions. You have unlimited attempts to pass an exam. Upon successful completion of the full 60-Hour QE course, we will e-mail you a Certificate of Completion. Additionally, we notify the California Tax Education Council (CTEC) that you passed the Qualifying Education (QE) allowing you to apply for your CRTP registration online at www.CTEC.org. We wish you every success and thank you for choosing Golden State Tax Training Institute, Inc.

Submit your exam:

How To:

• Log into www.GSTTI.com

• Enter your email address and your password

• Click link to take online exam

• Answer questions (There is no time limit)

• Submit answers (The exam does not need to be

completed in one sitting)

• Get certificate by email within 24 hours

• We electronically notify CTEC that you earned

Qualifying Education (QE) course credits

IMPORTANT: Just because you successfully completed the 60-hour qualifying education (QE) course does not mean you can prepare tax returns in the state of California. You must also complete the registration process with the California Tax Education Council (CTEC).

You have 18 months from the completion date listed on the 60-hour qualifying education (QE) completion certificate provided by Golden State Tax Training Institute to register with CTEC. If you do not register with CTEC within the allowed 18 months, you will be required to complete another 60-hour qualifying education course before being able to register.

CTEC registration MUST be completed online at https://www.ctec.org/tax-professionals.

Examination Questions - 43 Hour Federal Tax Law

All questions pertain to Tax Year 2023 unless noted.

Lesson 1 1. Federal law requires paid tax return preparers to electronically file Federal income tax returns if they file how many

combined Forms 1040, 1040-NR, and 1041 returns during the year? A. 5 or more

B. 7 or more

C. 9 or more

D. 11 or more

2. All of the following are true regarding the Preparer Tax Identification Number (PTIN) except:

A. New regulations require all paid tax return preparers and enrolled agents to obtain a Preparer Tax

Identification Number (PTIN) before preparing any Federal tax returns

B. A tax preparer must renew his or her PTIN every year during the renewal season

C. Failure to have a current PTIN could result in the imposition of Internal Revenue Code Section 6695

penalties, injunction, and/or disciplinary action by the IRS Office of Professional Responsibility

D. The PTIN is not required for CPAs if they prepare for compensation all or substantially all of a Federal

tax return or claim for refund

3. Fiona is a calendar year taxpayer. Her bank credited, and made available, interest to her bank account in December 2023. She did not withdraw it or enter it into her books until 2024. Fiona must include the amount in gross income for which year?

A. 2022 B. 2023 C. 2024 D. 2025

4. A company that uses the cash method of accounting bills a customer $10,000 for services rendered on October 15

and receives payment on November 15. A sale is recorded on the cash receipt date, which is November 15. Similarly, the company receives a $500 invoice from a supplier on July 10 and pays the bill on August 10. The expense is recognized on which date?

A. July 10 B. August 10 C. October 15 D. November 15

5. A consulting company provides a $5,000 service to a client on October 30, 2023. The client receives the bill for

services rendered and makes a cash payment on November 25, 2023. The consulting company uses the accrual accounting method and will record the $5,000 revenue on which date?

A. October 30, 2023 B. November 25, 2023 C. January 1, 2024 D. April 15, 2024

6. Agnes Green was a single, calendar year taxpayer. She died on March 6, 2023. Her final income tax return must

be filed by which date (not including weekends or holidays)? A. April 15, 2023 B. January 1, 2024 C. March 6, 2024 D. April 15, 2024

Examination Questions - 43 Hour Federal Tax Law

7. Captain Margaret Jones entered Afghanistan on December 1, 2021. She remained there through March 31, 2023, when she departed for the United States. She was not injured and did not return to the combat zone. What date is her 2023 tax return due if she does not file Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return?

A. January 1, 2024 B. April 15, 2024 C. June 15, 2024 D. October 15, 2024

8. Modernized e-File (MeF) is a web-based system that allows electronic filing of corporate, individual, partnership,

exempt organization and excise tax returns through the Internet. Which item listed below is generally NOT

eligible to be filed through the Internal Revenue Service electronic filing program?

A. Form 1041

B. Form 1040-SR

C. Form 1042

D. Tax returns for prior years

9. If a taxpayer files a claim for a loss from worthless securities or bad debt deduction, he or she must keep records that support items shown for how many years after the return was filed?

A. 5 years B. 7 years C. 8 years D. No limit

10. As a tax preparer you work with a client named Mary on her 2023 income tax return and there are no issues.

However, during that process you realize Mary was due a refund in 2022 but did not file a return. Which of the following statements applies to Mary with respect to her 2022 refund?

A. Mary cannot apply for a refund for the year 2022 as it is too late B. Mary has up to three years from the date the tax return was due to file a 2022 return to obtain her refund C. Mary has up to four years from the date the tax return was due to file a 2022 return to obtain her refund D. Mary has up to five years from the date the tax return was due to file a 2022 return to obtain her refund

11. When a taxpayer is using a debit or credit card for payment to the IRS for taxes due all of the following are true

except: A. If the taxpayer made an overpayment, the IRS will refund it after the return is processed B. The taxpayer can make Federal tax deposits with a debit or credit card C. Making an electronic payment eliminates the need to use a voucher D. High balance payments of $100,000 or greater may require special coordination with the service provider

chosen 12. To figure whether she should pay estimated tax for 2023, Jane determines her expected adjusted gross income

(AGI) for 2023 will be $82,800. Her AGI for 2022 was $73,700. Her total tax on her 2022 return was $9,001. Using the 2023 Estimated Tax Worksheet she figures her total 2023 estimated tax to be $11,015. Her tax expected to be withheld in 2023 is $10,000. She will file as head of household and expects no refundable credits in 2023. All of the following are true regarding Jane’s estimated taxes except:

A. She expects to owe at least $1,000 for 2023 after subtracting her withholding from her expected total tax B. She expects her income tax withholding to be at least 90% of the tax to be shown on her 2023 return C. Jane does not need to pay estimated tax D. Jane will need to pay estimated tax

Examination Questions - 43 Hour Federal Tax Law

13. The IRS calculates the amount of the Underpayment of Estimated Tax by Individuals Penalty based on the tax shown on a taxpayer’s original return or on a more recent return that he or she filed on or before the due date. The tax shown on the return is taxpayer’s total tax minus his or her total refundable credits. The penalty based on all of the following except:

A. The amount of the underpayment B. Expected adjusted gross income C. The period when the underpayment was due and underpaid D. The interest rate for underpayments that IRS publishes quarterly

14. Ray, who is single and 22 years old, was unemployed for a few months during 2022. He earned $6,700 in wages

before he was laid off, and he received $1,400 in unemployment compensation afterwards. He had no other income. Even though he had gross income of $8,100, he did not have to pay income tax because his gross income was less than the filing requirement for a single person under age 65. He filed a return only to have his withheld income tax refunded to him. In 2023, Ray began regular work as an independent contractor and earned $28,000. Ray made no estimated tax payments in 2023 and he did owe tax at the end of the year. What amount does Ray owe for the underpayment penalty in 2023?

A. $0 B. $555 C. $558 D. $630

15. The IRS stops paying interest on overpayments on the date they refund taxpayer’s overpayment (and interest) or offset it to an outstanding liability. Typically, the IRS has administrative time of how many days to issue the taxpayer’s refund without paying interest on it?

A. 10 days B. 30 days C. 45 days D. 60 days

16. Mailing addresses for all types of returns: individual, corporation, partnership, and many others differ as each form

has its own required mailing address. For example, addresses are grouped by which geographic area for Form 1040 returns?

A. City B. Municipality C. County D. State

Lesson 2 17. Form 1040-SR - U.S. Tax Return for Seniors is available as an optional alternative to using Form 1040 for

taxpayers who are what age? A. Age 55 or older B. Age 62 or older C. Age 65 or older D. Any age

18. Andy originally reported $21,000 as his adjusted gross income on his 2023 Form 1040. He received another Form

W-2 for $500 after he filed his return. Which of the following is true? A. Andy should file another Form 1040 for 2023 B. Andy should re-file Form 1040 for 2023 C. Andy should include the $500 on his 2024 Form 1040 D. Andy should use Form 1040-X - Amended U.S. Individual Income Tax Return to correct the 2023 Form

1040

Examination Questions - 43 Hour Federal Tax Law

19. The taxpayer can now file Form 1040-X electronically with tax filing software to amend all of the following forms except:

A. 2019 or later Forms 1040 B. Older filings of Forms 1040-A C. 2021 or later Forms 1040-NR D. 2019 or later Forms 1040-SR

20. Generally, Form W-4 does not expire. But, if a taxpayer claims which of the following, he or she needs to give his

or her employer a new Form W-4 each year? A. Extra withholding B. Deductions C. Exemption from Federal income tax D. Dependents

21. Emily Smith files her tax return on the basis of a fiscal year. Her records show that she received income in

November 2022 and February 2023 from which there was backup withholding ($100 and $50, respectively). Emily takes credit for what amount of backup withholding on her tax return for the fiscal year ending September 30, 2023?

A. $0 B. $50 C. $100 D. $150

22. The taxpayer is more likely to need to increase his or her withholding if he or she is married filing jointly and his or

her spouse also works. If the taxpayer chooses to increase his or her withholding, he or she should complete the option in Step 2(b) on Form W-4. The taxpayer completes the Multiple Jobs Worksheet on only one Form W-4 to determine withholding. The withholding amount will be most accurate if, after completing the worksheet, the taxpayer enters the result in which of the following ways on Form W-4?

A. Divided equally and entered on both taxpayers’ Form W-4 B. Entered on the taxpayer’s Form W-4 with the highest paying job C. Entered on the taxpayer’s Form W-4 with the lowest paying job D. Omitted on the taxpayer’s Form W-4 and included in estimated taxes

23. Generally, pension and annuity payments are subject to Federal income tax withholding. However, there is no

withholding on any part of a distribution that: A. Is not expected to be includible in the recipient's gross income B. Is the taxable part of payments from an employer pension annuity C. Is the taxable part of payments from an endowment D. Is a payment from an individual retirement arrangement (IRA)

24. Which of the following statements regarding tip income is true?

A. If the taxpayer is an indirectly tipped employee (for example, a busser or bartender) he or she is not required to report tips to an employer

B. Any tips the taxpayer reported to an employer are to be included in the wages in box 1 (Wages, tips, other compensation) of his or her Form W-2

C. If the only tips a taxpayer receives in a month are charged tips (for example, credit and debit card charges) distributed to him or her by an employer, he or she is not required to report these tips to the employer

D. If the only tips a taxpayer receives in a month are cash tips, he or she is not required to report these tips to the employer

25. A Form W-9 - Request for Taxpayer Identification Number and Certification is a formal written request for

information only and is used solely for the purpose of confirming which of the following? A. Taxpayer identification number (TIN) B. Backup withholding amount C. Extra withholding amount D. Exemption from withholding

Examination Questions - 43 Hour Federal Tax Law

26. All of the following are true regarding the 1099 series forms except: A. Most forms in the 1099 series are not filed with the return B. Most forms in the 1099 series should be furnished to the taxpayer by January 31 C. Any individual who makes reportable transactions, such as paying dividends during the calendar year

must file 1099 series forms to report those transactions to the IRS D. Estates and trusts that make reportable transactions during the calendar year are not required to file 1099

series forms 27. Generally, Form 1099-K report payments to a taxpayer’s trade or business. As such, the income for sole

proprietors is reported on which schedule as gross receipts subject to the self-employment tax? A. Schedule 1 B. Schedule 2 C. Schedule C D. Schedule H

Lesson 3 28. The taxpayer’s filing status is single if he or she is considered unmarried, and he or she does not qualify for another

filing status. Which of following governs whether the taxpayer is married or legally separated under a divorce or separate maintenance decree?

A. City regulations B. County by-laws C. State law D. Federal Law

29. Jason is a married taxpayer filing separately. Jason and his spouse both agree to the claim the standard deduction

on their separate returns. They both meet the qualifications for the standard deduction. For 2023, Jason’s standard deduction on his tax return is what amount?

A. $10,000 B. $13,850 C. $20,800 D. $27,700

30. All of the following are requirements to claim head of household filing status except:

A. The taxpayer’s parent must live in the taxpayer’s home at least 6 months B. The taxpayer is unmarried or considered unmarried on the last day of the year C. A qualifying person lived with the taxpayer over half the year D. The taxpayer’s spouse did not live in the taxpayer’s home during the last 6 months of the tax year

31. If a taxpayer lived apart from his or her spouse from July 10 to December 31 but was not legally separated from his or her spouse under a decree of divorce or separate maintenance at the end of the year, the taxpayer may file using which of the following tax statuses?

A. Head of household B. Married filing separately C. Married filing jointly D. B or C

32. Aidan is unmarried. His mother, for whom he can claim as a dependent, lived in an apartment by herself. She died

on September 2, 2023. The cost of the upkeep of her apartment for the year until her death was $6,000. Aidan and his brother both paid support and their mother had no income. Aidan would qualify to file as head of household if he paid what amount of his mother’s support?

A. $1,000 B. $1,500 C. $2,000 D. $4,000

Examination Questions - 43 Hour Federal Tax Law

33. Henry Wright retired this year after 30 years of civil service. He and his wife were domiciled in a community property state during the past 15 years. If Mr. Wright receives $1,000 a month in retirement pay, what amount of the retirement pay is considered community income?

A. $250 B. $500 C. $750 D. $1,000

34. If the taxpayer is divorced, he or she is jointly and individually responsible which of the following on a joint return

for a tax year ending before the divorce? A. Taxes due B. Interest due C. Penalties due D. All of the above

35. State law governs whether a taxpayer is married or legally separated under a divorce or separate maintenance decree. In 2023, a calendar-year taxpayer is unmarried for the whole year if he or she has obtained a final decree of divorce or separate maintenance by which date?

A. January 1, 2023 B. April 15, 2023 C. October 15, 2023 D. December 31, 2023

36. Bill and Karen Green filed a joint return showing Karen's wages of $50,000 and Bill's self-employment income of $10,000. The IRS audited their return and found that Bill did not report $20,000 of self-employment income. The additional income resulted in a $6,000 understated tax, plus interest and penalties. After obtaining a legal separation from Bill, Karen filed Form 8857 - Request for Innocent Spouse Relief to request separation of liability relief. The IRS proved that Karen actually knew about the $20,000 of additional income at the time she signed the joint return. Bill is liable for all of the understated tax, interest, and penalties because all of it was due to his unreported income. Which of the following is true regarding Karen’s liability for the understated tax, interest and penalties due for the unreported income of $20,000?

A. Karen is not liable for the understated tax, interest, and penalties due to the $20,000 of unreported income B. The IRS cannot collect the entire $6,000 plus interest and penalties from Karen because she is not

individually liable for it C. The IRS can collect the entire $6,000 plus interest and penalties from either Karen or Bill because they

are jointly and individually liable for it D. Even though Karen knew that Bill received the income, relief is available for that income because she did

not know it was taxable

37. Jeff and Riley were married for 12 years when Riley died in July of 2023. The couple have two children who are 6 and 10 years old. Which of the following applies to Jeff regarding filing status?

A. Jeff can file using any status he wants for the next 3 years B. Since Jeff’s spouse died during the year, he may be entitled to the special surviving spouse with

dependent child benefits for tax year 2024 and 2025 C. Since Jeff’s spouse died during the year, he may be entitled to the special surviving spouse with

dependent child benefits for tax year 2023 only D. Since Jeff’s spouse died during the year, he may be entitled to the special surviving spouse with

dependent child benefits for tax year 2024 only 38. If the taxpayer is a married nonresident alien, but his or her spouse is not a U.S. citizen or residents, the taxpayer

must use the Tax Table column or the Tax Rate Schedule for which filing status when determining the tax on income effectively connected with a U.S. trade or business?

A. Married, filing separately B. Head of household C. Married, filing jointly D. Single

Examination Questions - 43 Hour Federal Tax Law

39. Mr. Green died on January 4 before filing his tax return. On April 3 of the same year, Leah Marshall was appointed by the court as the personal representative for Mr. Green’s estate and he files Form 1040 for Mr. Green. In order to claim a refund for Mr. Green’s estate all of the following are true except:

A. Leah does not need to file Form 1310 to claim the refund on Mr. Green’s tax return B. Leah must attach to Mr. Green’s return a copy of the court certificate showing her appointment C. Leah must e-file Form 1310 with Mr. Green’s Form 1040 D. Leah may also need to file taxes owed by the estate rather than the individual

Lesson 4

40. Alan, 46, and Donna, 33, are filing a joint return for 2023. Neither is blind, and neither can be claimed as a dependent. They decide not to itemize their deductions. What is their standard deduction?

A. $0 B. $13,850 C. $20,800 D. $27,700

41. In 2023, Lorena is age 39 and is a single filing taxpayer. She cannot be claimed as a dependent on another taxpayer’s income tax return. Lorena must file an income tax return if she earns what amount or more?

A. $4,700 B. $6,500 C. $10,000 D. $13,850

42. What is the amount of the 2023 standard deduction for a head of household taxpayer, who is 72 years old and

completely blind? A. $24,500 B. $25,300 C. $26,600 D. $27,900

43. Matt is 46 years old and has a certified statement from his optometrist on December 1, 2023, that confirms he can

see no better than 20/250. For tax year 2023, which is correct? A. Matt is not eligible for the higher standard deduction for blindness as he is only partially blind B. Matt is eligible for the higher standard deduction for blindness in 2023 C. Matt is eligible for the higher standard deduction for blindness in 2024, the first full year of his blindness D. Matt is not eligible for the higher standard deduction for blindness as he can see better than 20/300

44. In 2023, a taxpayer can claim as a dependent a person who files a joint return if that person files the joint return

only to claim which of the following? A. American Opportunity Tax Credit B. Lifetime Learning Credit C. Interest paid D. None of the above

45. Five tests must be met for a child to be the taxpayer’s qualifying child. To meet the Relationship Test for a qualifying

child, the individual must be which of the following? A. An adopted child B. A foreign exchange student who lived in the U.S. for six months C. A cousin who lives in a different city D. None of the above

Examination Questions - 43 Hour Federal Tax Law

46. The taxpayer’s unmarried child lived with him or her all year and was 18 years old at the end of the year. The child did not provide more than half of their own support and does not meet the tests to be a qualifying child of anyone else. As a result, which of the following is true?

A. The child is the taxpayer’s qualifying child B. Because the child is single, he or she is also a qualifying person for head of household purposes C. The child is not the taxpayer’s qualifying child D. A and B

47. Stacie’s unmarried daughter lived with her all year. Her daughter was 25 years old at the end of the year and her

daughter’s gross income was $5,000. She was not permanently and totally disabled at any time during the year. Because Stacie’s daughter does not meet which test she is not Stacie’s qualifying child?

A. The joint return test B. The age test C. The citizen test D. The resident test

48. To meet the Residency Test (for a qualifying child), the taxpayer’s child must have lived with him or her for more

than half the year. There are exceptions for temporary absences that include which of the following? A. Illness B. Education C. Military service D. All of the above

49. Daniel has a 16-year-old daughter named Amelia. He provided $4,000 toward her support in 2023. If Amelia

provided her own support for which of the following amounts she would not be claimed as Daniel’s dependent on his tax return?

A. $1,000 B. $2,000 C. $4,000 D. $6,000

50. When meeting the gross income test for claiming his father as a dependent, James must consider the income

received by his father. This income included gross rents of $3,000 (expenses were $2,000), municipal bond interest of $1,000, dividends of $1,500, and Social Security of $4,000. What is James' father's gross income for the qualifying relative test purposes in 2023?

A. $1,500 B. $3,000 C. $4,500 D. $5,500

51. Sebastian’s 18-year-old child and his child’s 17-year-old spouse had $800 of wages from part-time jobs and no

other income. They lived with Sebastian all year. Neither is required to file a tax return. They do not have a child. They file a joint return to claim an American Opportunity Tax Credit of $124 and get a refund of that amount. Therefore, when Sebastian files his 2023 income tax return, he will be able to claim how many dependents?

A. 0 B. 1 C. 2 D. 3

52. Candace supports an unrelated friend and his friend’s 3-year-old child, who lived with her all year in her home. Candace’s friend has no gross income and is not required to file a 2023 tax return and does not file a 2023 tax return. Candace provides more than half of her friend's total support during the calendar year. Which of the following statements is correct?

A. Only Candace’s friend is Candace’s qualifying relative B. Only Candace’s friend’s child is Candace’s qualifying relative C. Both Candace’s friend and her friend’s child are Candace’s qualifying relatives D. Neither Candace’s friend nor her friend’s child are Candace’s qualifying relatives

Examination Questions - 43 Hour Federal Tax Law

53. In 2023, a taxpayer can claim a person as a dependent if the person meets all other tests and is a resident of which country?

A. Mexico B. Honduras C. Panama D. Guatemala

54. When determining gross income for the gross income test (to be a qualifying relative) all of the following are

included except: A. Taxable unemployment compensation B. Scholarships received by degree candidates and used for tuition, fees, supplies, books, and equipment

required for particular courses C. Taxable Social Security benefits D. Gross receipts from rental property

55. Tim and Gail are divorced. In 2023, their child lived with Tim 190 nights and with Gail 165 nights. Their child also

spent ten nights with Tim’s parents during the summer. Who is the custodial parent? A. Tim B. Gail C. Tim and Gail D. Neither Tim nor Gail

56. Lisa and her 2-year-old daughter, Courtney, lived with Lisa’s mother all year. Lisa is 25 years old and unmarried.

Her mother's AGI is $18,000. Courtney's father did not live with Lisa, or her daughter, and she has not signed Form 8332 (or a similar statement) to release claiming the child as a dependent to the noncustodial parent. If Lisa does not claim Courtney as a qualifying child, her mother can treat her as a qualifying child to claim certain tax benefits unless Lisa has an adjusted gross income (AGI) of what amount?

A. $5,000 B. $7,500 C. $10,000 D. $20,000

57. Danielle and her 3-year-old daughter Kyra lived with her mother all year. Danielle is 25 years old, unmarried, and

her adjusted gross income (AGI) is $18,000. Danielle’s mother's AGI is $15,000. Kyra's father did not live with Danielle or her daughter. Also, Danielle has not signed Form 8332 (or a similar statement) to release claiming the child as a dependent to the noncustodial parent. Because Danielle’s mother's AGI is not higher than hers, she cannot claim Kyra as a qualifying child on her income tax return. Only Danielle can claim Kyra as a qualifying child and is entitled, if additional eligibility requirements are met, to which of the following tax benefit?

A. The Child Tax Credit B. The Credit for Child and Dependent Care Expenses C. Head of household filing status D. All of the above

Lesson 5 58. Taxable earned income includes which of the following?

A. Interest and dividends B. Unemployment benefits C. Alimony D. Bonuses

Examination Questions - 43 Hour Federal Tax Law

59. Penelope Morton’s adjusted gross income (AGI) for 2023 was $157,000. She also received certain income benefits in 2023. She received $1,400 of state unemployment insurance benefits, $2,000 from a Federal Unemployment Trust Fund and $3,700 workers’ compensation received for an occupational injury. What amount of the compensation must Penelope include in her income?

A. $1,400 B. $3,400 C. $3,700 D. $5,700

60. Perry returns to work after qualifying for workers' compensation. He receives $1,000 a month for performing light

duties. What percentage of his salary payments is taxable? A. 0% B. 50% C. 75% D. 100%

61. Sally receives $300 each month for sick pay from her employer for the three months she is on sick leave. What

amount will she need to include as income on her tax return? A. $0 B. $300 C. $600 D. $900

62. Melissa is 35 years old. She receives a $3,000 long-term disability payment from an accident insurance plan paid

for by her employer. What amount will she need to include as income on her tax return? A. $0 B. $1,000 C. $2,000 D. $3,000

63. Paul Casey retired from the U.S. Navy in 2017. He receives a military pension based on his years of service. On

August 3, 2023, he received a determination of service-connected disability retroactive to 2017. Which of the following is true regarding Paul’s claim for a refund for taxes paid on his pension?

A. Paul cannot file a claim a refund for the taxes paid on his pension for any year B. Under the special limitation period, Paul can file a claim for a refund for taxes paid on his pension for 2019

as long as he files the claim by August 3, 2024 C. Paul can file a claim for a refund for taxes paid on his pension for 2017 and 2018 D. Paul can only file a claim for a refund for taxes paid on his pension for 2022

64. While on vacation in Las Vegas, Jennifer, who is from Utah, wins a progressive jackpot playing cards worth

$15,875 at the Casino Royale. What implication does she encounter when she goes to collect her prize? A. The State of Utah withholds 25% of her winnings B. The Casino Royale withholds 15% of her winnings when she collects her prize C. The Casino Royale withholds 24% of her winnings when she collects her prize D. The Casino Royale withholds 30% of her winnings when she collects her prize

65. Anne is a full-time student at UCLA buts works part-time as a waitress at a diner near her dormitory. She earns an hourly wage but also receives tips as part of her compensation. Last month she collected $51 in tips while working night shifts in the diner. What obligation does she have regarding these tips?

A. Anne must report the tips to her employer because they exceeded $20 for the month B. Anne does not have to report the tips to her employer because they did not exceed $100 for the month C. Anne must report the tips to her employer because they exceeded $50 for the month D. Anne’s employer is responsible for keeping track of tips

Examination Questions - 43 Hour Federal Tax Law

66. All of the following are true regarding royalty income except: A. A self-employed writer reports royalty income on Schedule A - Itemized Deductions B. Royalties from copyrights, patents, and oil, gas and mineral properties are taxable as ordinary income C. A taxpayer generally reports royalties in Part I of Schedule E - Supplemental Income and Loss D. Royalties from copyrights on literary, musical, or artistic works, and similar property, or from patents on

inventions, are amounts paid to the taxpayer for the right to use his or her work over a specified period of time

67. If the death benefit of a life insurance policy is $500,000 but it earns 10% interest for one year before being paid out, the taxpayer will owe taxes on what amount?

A. $0 B. $50,000 C. $500,000 D. $550,000

68. A son inherits a house from his mother that has a fair market value (FMV) of $200,000 at the time of her death.

Her tax basis was $75,000, the amount she paid for the house 30 years ago. Therefore, the son’s tax basis of the property inherited from his mother is what amount?

A. $0 B. $75,000 C. $200,000 D. $275,000

69. A single taxpayer itemizes and claims itemized deductions totaling $15,000 on his or her 2022 Federal income tax return. The taxpayer’s state and local taxes listed on the return was the maximum amount deductible, or $10,000. In 2023, the taxpayer receives a $750 refund of state income taxes paid in 2022. Because of the state and local tax (SALT) limit, the taxpayer’s 2022 SALT deduction would still have been $10,000, even if it had not overpaid state taxes. The taxpayer did not receive a tax benefit on his or her 2022 Federal income tax return from the taxpayer’s overpayment of state income tax in 2022. Therefore, the taxpayer is required to include what amount of his or her 2023 state income tax refund on his or her 2023 Federal income tax return?

A. $0 B. $250 C. $500 D. $750

70. In 2023, Kate, a single taxpayer, has $70,000 in wages, $15,000 income from a limited partnership, a $26,000 loss from rental real estate activities in which she actively participated, and is not subject to the modified adjusted gross income (MAGI) phase-out rule. She can use $15,000 of her $26,000 loss to offset her $15,000 passive income from the partnership. She actively participated in her rental real estate activities, so she can use what amount to offset her nonpassive income (wages)?

A. $0 B. $5,500 C. $10,000 D. $11,000

71. Jim has a primary residence that he uses as his home. Twice a year he rents it out for local sporting events for a

total of 7 days in each instance. How is Jim’s home treated for tax purposes given these circumstances? A. Jim must treat his home as a rental because he rents it for more than 10 days a year B. Jim must treat his home as a rental because he rents it for more than 12 days a year C. Jim must treat his home as a rental because he rents it for at least 14 days a year D. Jim uses the dwelling as a home and rents it for less than 15 days during the year so Jim may treat the

home as his main home and there is no tax implication 72. Which of the following are examples of expenses that may be deducted from total rental income?

A. Fixing leaks in the plumbing B. Putting a recreation room in an unfinished basement C. Paneling a den that previously had wallpaper D. Adding a bathroom or a spare bedroom

Examination Questions - 43 Hour Federal Tax Law

73. On April 6, 2023, Ben purchased a house to use as residential rental property. He made extensive repairs to the house and had it ready for rent on July 5, 2023. He began to advertise the house for rent in July and actually rented it beginning September 1, 2023. When is the house considered to be placed in service for the purposes of rental expenses?

A. January 1, 2023 B. April 6, 2023 C. July 5, 2023 D. September 1, 2023

Lesson 6 74. Some dividends may not be qualified dividends even if they are shown in box 1b of Form 1099-DIV. Which of the

following is a qualified dividend? A. Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building

and loan associations, U.S. savings and loan associations, Federal savings and loan associations, and similar financial institutions

B. Dividends from a corporation that is a tax-exempt organization or farmer's cooperative during the corporation's tax year in which the dividends were paid or during the corporation's previous tax year

C. Dividends paid from a stock held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date

D. Dividends paid by a corporation on employer securities held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation

75. Taxpayers who are required to file taxes in the United States and receive more than $1,500 in taxable interest

and/or ordinary dividends during the year must fill out which of the following schedules? A. Schedule A - Itemized Deductions B. Schedule B - Interest and Ordinary Dividends C. Schedule C - Profit or Loss from Business (Sole Proprietorship) D. Schedule D - Capital Gains and Losses

76. Nontaxable dividends are dividends from a mutual fund or some other regulated investment company that are not

subject to taxes. One common type of tax-exempt income is interest earned on which of the following? A. Additional stock or stock rights B. Municipal bonds C. Money market accounts D. Certificates of deposit

77. Money market funds are offered by nonbank financial institutions such as mutual funds and stock brokerage

houses. Generally, amounts a taxpayer receives from money market funds should be reported as which of the following?

A. Interest B. Dividends C. Short-term capital gain D. Long-term capital gain

78. Hillary deposited $5,000 with a bank and borrowed $5,000 from the bank to make up the $10,000 minimum deposit

required to buy a 6-month certificate of deposit. The certificate earned $575 at maturity in 2023, but she only received $265, which represented the $575 she earned minus $310 interest charged on the $5,000 loan. The bank gives Hillary a Form 1099-INT for 2023 showing the $575 interest she earned. The bank also gives her a statement showing that she paid $310 interest for 2023. What amount must Hillary include in her income?

A. $0 B. $265 C. $310 D. $575

Examination Questions - 43 Hour Federal Tax Law

79. Sylvia bought stock in 2010 for $100. In 2013, she received a non-dividend distribution of $80. She did not include this amount in her income, but she reduced the basis of her stock to $20. She received a non-dividend distribution of $30 in 2023. What amount must Sylvia report as a long-term capital gain for 2023?

A. $10 B. $20 C. $30 D. $80

80. Interest income can be excluded on qualified U.S. Savings Bonds, either a series EE bond issued after 1989 or a

series I bond, redeemed for which of the following reasons? A. Qualified higher education expenses B. Transfer to a trust C. Ownership transfer D. Distribution from a retirement or profit-sharing plan

81. The interest on which of the following discounted debt instruments is generally not taxable?

A. U.S. Treasury bonds B. Corporate bonds C. Municipal bonds D. Certificates of deposit

82. The interest on which of the following dividends is generally not taxable?

A. Interest received on the obligations of a state B. U.S. Treasury Bills C. U.S. Treasury Bonds D. Federal savings and loan associations dividends

83. Interest on a state or local government obligation may be tax exempt for all of the following except: A. Interest on a debt evidenced only by an ordinary written agreement of purchase and sale B. Interest paid by an insurer on default by the state C. Interest paid by an insurer on default by a political subdivision D. Interest paid on Federally guaranteed state obligations

84. Nonresident aliens are not taxed on certain kinds of interest income provided that such interest income arises from

which of the following sources? A. U.S. savings and loan association B. U.S. credit union C. U.S. insurance company D. All of the above

85. All of the following are true regarding a Report of Foreign Bank and Financial Accounts (FBAR) except:

A. The FBAR is a calendar year report, which must be filed with the Department of Treasury on or before April 15 of the year following the calendar year reported

B. The law affords an FBAR extension of up to six months to be available to all taxpayers, which coincides with the October 15 extension due date for individual income tax returns

C. An FBAR is mandatory if the aggregate value of the taxpayer’s accounts is less than $1,000 D. FBARs must be filed electronically through the FinCEN BSA E-Filing System

Examination Questions - 43 Hour Federal Tax Law

Lesson 7 86. Which of the following statements is false regarding Form 8949 - Sales and Other Dispositions of Capital Assets?

A. The taxpayer uses Form 8949 to report sales and exchanges of capital assets B. Form 8949 allows the taxpayer and the IRS to reconcile amounts that were reported to him or her and the

IRS on Form 1099-B or 1099-S (or substitute statement) with the amounts he or she reports on his or her income tax return

C. If all Forms 1099-B the taxpayer received (and all substitute statements) show basis was reported to the IRS and if no correction or adjustment is needed, the taxpayer must always file Form 8949 and attach a statement of these transactions

D. Corporations and partnerships use Form 8949 to report undistributed long-term capital gains from Form 2439

87. If an asset was purchased for $10,000 and then sold a year later after registering $500 in depreciation and $1,000

being spent on enhancements, it would have an adjusted basis of what amount? A. $10,000 B. $10,500 C. $11,000 D. $11,500

88. The amount of casualty loss is the lesser of the adjusted basis of the property, immediately prior to the disaster,

or the decrease in fair market value as a result of the casualty. The decrease in fair market value may be determined by which of the following?

A. Appraisal B. Cost of repairs C. A and B D. None of the above

89. The taxpayer should keep accurate records that show the basis of a property and, if applicable, the adjusted basis

of the property should show which of the following? A. The purchase price B. The cost of improvements C. Depreciation D. All of the above

90. Which of the following is considered a taxpayer’s capital asset?

A. Taxpayer’s house B. Real estate used in the trade or business C. Depreciable property used in the trade or business D. Supplies regularly used in the trade or business

91. All of the following are considered capital improvements that increase the tax basis of a structure except:

A. Adding solar panels B. Building a tool shed C. Replacing the roof D. Fixing a broken fence

92. Gwen inherited 100 shares of SuperShoes stock when her mother died on October 21, 2021; the fair market value

of the stock was $20 per share. Her mother paid $200 per share when she purchased the stock on March 1, 2012. If Gwen sells all 100 shares for $50 per share on July 3, 2023, how should she report the sale on her income tax return?

A. $3,000 long-term capital gain B. $3,000 short-term capital gain C. $12,000 long-term capital gain D. $15,000 short-term capital loss

Examination Questions - 43 Hour Federal Tax Law

93. John and Jill Jones sold stock that resulted in a short-term capital loss of $5,000. They had no other capital transactions during the year. Their taxable income was $10,000. How much of the capital loss is deductible on their joint return and how much must be carried over to the next year?

A. $0 loss; $5,000 carryover B. $1,500 loss; $1,500 carryover C. $3,000 loss; $0 carryover D. $3,000 loss; $2,000 carryover

94. Mateo bought machinery on December 4, 2022. On June 4, 2023, he traded this machinery for other machinery

in a nontaxable exchange. On December 6, 2023, Mateo sold the machinery he got in the exchange. His holding period for this machinery began on which date?

A. December 4, 2022 B. December 5, 2022 C. June 4, 2023 D. June 5, 2023

95. Brandt exchanged his collection of stamp albums for a tractor from Virgil in September 2023. The fair market value

of the stamp albums is $3,000. The tractor has the same $3,000 fair market value. The collection of stamps cost Brandt $2,000 over the years to assemble. How should Brandt report this transaction on his income tax return?

A. He reports it as a capital transaction with a $0 gain B. He is not required to report it because it is not taxable C. He attaches a statement to his return explaining that the exchange was for something of equal value D. He reports a $1,000 capital gain

96. Virtual currency is treated as property for U.S. Federal tax purposes. General tax principles that apply to property

transactions apply to transactions using virtual currency. Consequently, all of the following are true regarding virtual currency except:

A. Wages paid to employees using virtual currency are not taxable to the employee and are not subject to Federal income tax withholding and payroll taxes

B. Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply

C. The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer

D. A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property

97. In 2023, Colin and Laura sold their house for $990,000. They paid $40,000 in expenses so their proceeds are

$950,000. They bought the house in 2015 and paid $300,000 for the home and spent $30,000 to add on a garage so their basis would be $330,000. They subtract $330,000 from $950,000 to find their gain equals $620,000. When filing their joint income tax return, if all of other conditions are met, what is the maximum amount Colin and Laura could exclude from the sale of their home?

A. $330,000 B. $500,000 C. $620,000 D. $950,000

98. Sheila sold her house. Her amount realized after selling expenses was $385,000. At the time of the sale, the

adjusted basis for the house was $300,000. If all of other conditions are met, what is the gain on the sale of her house?

A. $0 B. $42,500 C. $85,000 D. $300,000

Examination Questions - 43 Hour Federal Tax Law

99. Naomi bought and moved into a house in July 2019. She lived there for 13 months and then moved in with a friend. She moved back into her own house in 2022 and lived there for 12 months until she sold it in July 2023. Which of the following is true regarding Naomi’s exclusion for the sale of her home?

A. Naomi meets the ownership test but not the use test B. Naomi meets the use test but not the ownership test C. Naomi meets both the ownership and use tests D. Naomi does not qualify for a partial or the entire exclusion

Lesson 8 100. Which of the following statements about taxation of a sole proprietorship is correct?

A. Any income to the business is treated as income to the business owner B. It may be possible to defer income and therefore income tax to a different tax year C. They are not required to make quarterly payments of estimated tax liability, to both the state and to the

Federal government D. The income earned from a sole proprietorship is not subject to income and self-employment tax

101. Dustin is a sole proprietor who owns a small business that makes business cards for other companies. He started

the company in 2023 and had $4,800 in total business expenses for the year. Which of the following applies to Dustin’s small business?

A. Dustin must use Schedule C when filing the business return B. Dustin can use Schedule SE because he had less than $5,000 of expenses C. Dustin can use Schedule A because he had less than $5,000 of expenses D. Dustin does not have to file a Schedule C because his business had less than $5,000 in expenses

102. Liberty is calculating the cost of goods sold to enter on her Schedule C. Her inventory at the beginning of the

year amounted to $50,000. Her cost for labor and materials was $20,000. She had no other costs. Her inventory at the end of the year totaled $58,000. What amount for cost of goods sold will Liberty enter on her Schedule C?

A. $12,000 B. $20,000 C. $25,000 D. $50,000

103. If the taxpayer makes or buys goods to sell, he or she can deduct the cost of goods sold from the gross receipts on line 4 of Schedule C. However, to determine these costs, he or she must value the inventory at the beginning and end of each tax year. This applies if the taxpayer is in which of the following professions?

A. Doctor B. Lawyer C. Accountant D. Manufacturer

104. Harvey is the sole proprietor of a flower shop. During 2023, he drove his van 20,000 miles during the year. 16,000 miles were for delivering flowers to customers and 4,000 miles were for personal use. Instead of figuring actual expenses, Harvey decides to use the standard mileage rate to figure the deductible costs of operating his van. What amount can Harvey claim as the cost of operating his van as a business expense in 2023?

A. $0 B. $4,640 C. $10,480 D. $11,600

105. In 2023, Noelle, a self-employed landscaper who uses the cash method of accounting, signed a 3-year health insurance contract. She paid premiums of $500 for 2023, $550 for 2024, and $600 for 2025 when she signed the contract. What amount can she deduct for the premiums on her 2023 income tax return?

A. $0 B. $250 C. $500 D. $1,050

Examination Questions - 43 Hour Federal Tax Law

106. In 2023, travel expenses are the ordinary and necessary expenses of traveling away from home for business. Which of the following kinds of travel expenses are not applicable for deduction on Schedule C?

A. Cost of a hotel stay in the general area in which the taxpayer’s business is located B. Cost of travel by car between the taxpayer’s tax home and the out-of-town business destination C. Cost of business calls while on the business trip D. Costs of dry cleaning and laundry while on the business trip

107. Tom is an insurance agent and small business consultant during 2023. He takes one of his clients golfing to give guidance on a business transaction and sell an insurance policy. During the outing he spends $400. Tom can take a deduction for what amount on his income tax return for his entertainment expenses?

A. $0 B. $100 C. $200 D. $400

108. The general rule is that taxpayers who use a part of the home for legitimate business purposes can deduct

expenses allocable to that portion of the home used for those business purposes. To meet this qualification all of the following must apply except:

A. Part of the home is exclusively used on a regular basis as the principal place of business for any of the trades or businesses

B. Part of the home is exclusively used on a regular basis as a place of business used by patients, clients or customers to meet or deal with the taxpayer in the normal course of the trade or business

C. Part of the home is exclusively used on a regular basis in connection with the trade or business if it is a separate structure that is not attached to the home

D. Part of the home is used on a regular basis as a home office and family room used by the rest of the family for entertainment

109. Vanessa earns $1,500 from a freelance job and claims $500 in deductions. What amount of her earnings are

subject to self-employment tax? A. $500.25 B. $923.50 C. $1,050.75 D. $1,500.00

110. Mona is self-employed working as a fortune teller. Her net income from this activity was $250 in 2023. Which of

the following is true regarding her self-employment (SE) tax for the year? A. She has SE tax because she was self-employed B. She has SE tax because net income was earned C. She has no SE tax since net income was less than $400 D. She has no SE tax because net income was less than $1,000

111. When determining earnings subject to SE tax, the taxpayer may want to use one of the optional methods whether

if they have a small net profit or loss and which of the following conditions applies? A. They are eligible to receive the Additional Child Tax Credit B. They can claim a Credit for Dependent or Child Care Expenses C. Taxpayer wants to receive a Credit for Social Security Benefit Coverage D. All of the above

112. Carl, a single filer, has $145,000 in self-employment income and $130,000 in wages. Carl’s employer did not

withhold Additional Medicare Tax. Therefore, Carl is liable to pay Additional Medicare Tax on what amount of self- employment income?

A. $0 B. $75,000 C. $130,000 D. $145,000

Examination Questions - 43 Hour Federal Tax Law

113. Victor’s gross farm income is $540, and his net farm profit is $460. Consequently, his net earnings figured under the farm optional method are $360 (⅔ of $540) and his actual net earnings are $425 (92.35% of $460). Victor owes what amount of Self-Employment (SE) tax if he uses the farm optional method to determine the tax?

A. $0 B. $360 C. $425 D. $540

114. If the taxpayer was a general or limited partner in a partnership all of the following are true regarding partnership income when filing Schedule SE except:

A. The taxpayer includes on line 1a or line 2 of Schedule SE, whichever applies, the amount of net earnings from self-employment from Schedule K-1 (Form 1065), box 14, code A

B. General partners should not reduce this amount by certain expenses before entering it on Schedule SE C. Limited partners should include only guaranteed payments for services actually rendered to or on behalf

of the partnership D. If a partner died and the partnership continued, include in self-employment income the deceased's

distributive share of the partnership's ordinary income or loss through the end of the month in which he or she died

115. IRC Section 104(a)(2) excludes from gross income compensatory damages for which of the following? A. Patent infringement B. Breach of contract or fiduciary duty C. Paid on account of physical personal injuries or sickness D. Antitrust injury

116. In which of the following situations does a taxpayer have to recapture the depreciation deduction (meaning he or she includes in income part or all of the depreciation he or she deducted in previous years)?

A. If his or her business use of listed property falls to 50% or less in a tax year after the tax year, he or she placed the property in service

B. If he or she takes a Section 179 deduction for an asset and before the end of the asset's recovery period, the percentage of business use drops to 50% or less

C. If he or she sells or exchanges depreciable property at a gain D. All of the above

Lesson 9 117. Under the terms of a partnership agreement, Erica is entitled to a fixed annual payment of $10,000 without regard

to the income of the partnership. Her distributive share of the partnership income is 10%. The partnership has $50,000 of ordinary income after deducting the guaranteed payment. Erica must include what amount of ordinary income on her individual income tax return for her tax year in which the partnership's tax year ends?

A. $0 B. $5,000 C. $10,000 D. $15,000

118. An S corporation stockholders' basis is generally increased by: A. Distributions B. Taxable income C. Nontaxable discharge of indebtedness D. Separately stated loss items

119. Jessica paid $1,500 for electricity during the tax year. She used one-third of the electricity for personal purposes

and two-thirds for farming. Under these circumstances, Jessica can deduct what amount of her electricity expense as a farm business expense?

A. $0 B. $500 C. $750 D. $1,000

Examination Questions - 43 Hour Federal Tax Law

120. Janet Maple sold her apple orchard in 2023 for $80,000. Her adjusted basis at the time of sale was $60,000. She bought the orchard in 2016, but the trees did not produce a crop until 2019. Her pre-productive expenses were $6,000. She elected not to use the uniform capitalization rules. Janet must treat what amount of the gain as ordinary income?

A. $4,000 B. $6,000 C. $8,000 D. $10,000

121. Larry Johnson gives his son Section 1250 property on which he took $2,000 in depreciation deductions, of which

$500 is additional depreciation. Immediately after the gift, the son's adjusted basis in the property is the same as his father's and reflects the $500 additional depreciation. On January 1 of the next year, after taking depreciation deductions of $1,000 on the property, of which $200 is additional depreciation, the son sells the property. At the time of sale, the additional depreciation is what amount?

A. $0 B. $200 C. $500 D. $700

122. If the taxpayer uses a dwelling unit as a home and he or she rents it less than 15 days during the year, its primary

function is not considered to be a rental. Any expenses related to the home, such as mortgage interest, property taxes, and any qualified casualty loss, will be reported as normally allowed on which of the following schedules?

A. Schedule 1 B. Schedule A C. Schedule E D. Schedule SE

123. A taxpayer generally must include in his or her gross income all amounts he or she receives as rent. Rental

income is any payment he or she receives for the use or occupation of property. In addition to amounts the taxpayer receives as normal rent payments, there are other amounts that may be rental income and must be reported on his or her tax return. These amounts include all of the following except:

A. Security deposits B. Utilities required to be paid by the tenant under the terms of the lease C. Advance rent D. Payment for canceling a lease

124. Kai signed a 10-year lease to rent a property. In the first year, he receives $5,000 for the first year's rent and

$5,000 as rent for the last year of the lease. What amount must Kai include in income in the first year? A. $0 B. $2,500 C. $5,000 D. $10,000

125. Larry rents his townhouse to Sue for $1,400 a month. At the beginning of the lease, he asked for a $2,000 security

deposit. When Sue moved out at the end of the lease Larry used $1,400 of the security deposit for the last month’s rent. What amount of the security deposit will Larry need to include in rental income on his tax return?

A. $0 B. $1,000 C. $1,400 D. $2,000

126. Jana receives an insurance bill for her rental property. The bill is for $600, is due by January 15, and will provide

insurance coverage for her property for the months of January through June. Jana pays the bill in full on January 12. Using the cash method, Jana records a business insurance expense of $600 on which date?

A. January 1 B. January 12 C. January 15 D. January 31

Examination Questions - 43 Hour Federal Tax Law

127. Molly purchased a rental property for $500,000 with a $350,000 mortgage loan. For the first year of the loan the interest amounts to $15,000. If Molly’s rental property produces $50,000 in rental income for the year, she can take a deduction as expense for the mortgage interest on Schedule E for what amount?

A. $0 B. $5,000 C. $10,000 D. $15,000

128. For which of the following reasons may a taxpayer deduct charges for local benefits as a rental expense?

A. Charges for putting in streets B. Charges for putting in sidewalks C. Charges for putting in water or sewer systems D. Local benefit taxes that are for maintaining, repairing, or paying interest charges for the benefits

129. Wendy is a single taxpayer with adjusted gross income of $92,300 for tax year 2023. She has rental income of

$55,000 and rental expenses of $80,000. What can Wendy report on her tax return given this situation? A. She can deduct $10,000 because her rental expenses exceeded her rental income B. She can deduct $15,000 because her rental expenses exceeded her rental income C. She can deduct $25,000 because her rental expenses exceeded her rental income D. She can deduct $30,000 because her rental expenses exceeded her rental income

130. A taxpayer should keep adequate records to prove his or her expenses or have sufficient evidence that will

support his or her own statement. This documentary evidence ordinarily will be considered adequate if it shows all of the following except:

A. The amount of the expense B. The date C. The place D. The method of payment

131. Francisco rents a room in his house. The room is 12 × 15 feet, or 180 square feet. His entire house has 1,800

square feet of floor space. If Francisco’s heating bill for the year for the entire house was $600, what amount can be considered a rental expense?

A. $0 B. $60 C. $100 D. $600

Lesson 10 132. A taxpayer cannot use Form 4562 - Depreciation and Amortization to claim deductions for the depreciation or

amortization for which of the following? A. Land B. Buildings C. Machinery D. Equipment (tangible)

133. To figure the basis of property a taxpayer receives as a gift; it is necessary to have which of the following?

A. Adjusted basis to the donor just before it was given to the taxpayer B. The Fair Market Value (FMV) at the time it was given to the taxpayer C. Any gift tax paid on the property D. All of the above

Examination Questions - 43 Hour Federal Tax Law

134. Alyssa is an attorney. She maintains a library for use in her profession. She also buys technical books and journals for use in her business. Which of the following is true regarding Alyssa’s depreciable property?

A. She can depreciate any books and journals that have a useful life that extends substantially beyond the year she placed them in service

B. She cannot depreciate her library C. She can depreciate all of her technical books and journals regardless of useful life D. She can depreciate her library but none of her technical books and journals

135. Dave buys a building for $20,000 cash and assumes a mortgage of $80,000 on it, what is his basis in the property?

A. $0 B. $20,000 C. $80,000 D. $100,000

136. Astrid has a $150,000 single-family rental house that was put into service on January 1, 2023. The land value of the lot is $20,000 and at the time of purchase she made $5,000 in capital improvements. Under the General Depreciation System (GDS), Astrid’s annual depreciation expense is what amount?

A. $2,679 B. $4,909 C. $5,112 D. $6,238

137. Ken Larch is a tailor. He bought two industrial sewing machines from his father. He placed both machines in service in the same year he bought them. All of the following are true except:

A. The sewing machines do not qualify as Section 179 property B. Ken cannot claim a Section 179 deduction for the cost of these machines C. Ken can claim a partial Section 179 deduction D. The asset must be used at least 50% of the time for business in the first year it is placed in service to

qualify for a Section 179 deduction

138. Which of the following is a false statement regarding Bonus Depreciation? A. Bonus Depreciation is useful to very large businesses spending more than the Section 179 spending limit B. Businesses with a net loss in a given tax year qualify to carry-forward the Bonus Depreciation to a future

year C. Bonus Depreciation only covers new equipment D. When applying these provisions, Section 179 is generally taken first, followed by Bonus Depreciation

139. In 2023, Company XYZ has net taxable income of $50,000 before taking the Section 179 deduction into account. During the year the company purchased $60,000 worth of eligible Section 179 property. Company XYZ can claim a Section 179 deduction for what amount?

A. $0 B. $10,000 C. $50,000 D. $60,000

140. Generally, under final Capitalization and Repairs regulations, a taxpayer must capitalize as an improvement an

amount paid for which of the following? A. For a betterment to the unit of property B. To restore the unit of property C. To adapt the unit of property to a new or different use D. All of the above

141. Under Treasury Disposition Regulations Section 1.168(i)-8(d)(2), taxpayers may recognize a partial disposition

on the retirement of a building structural component that is what type of property? A. Modified Accelerated Cost Recovery System (MACRS) property B. Intangible property C. Section 1245 property D. Section 1250 property

Examination Questions - 43 Hour Federal Tax Law

Lesson 11 142. If a resident of the United States receives Social Security from Canada, it will only be taxable in the United States

as if it was being received as which of the following? A. Interest B. Dividends C. U.S. Social Security D. Annuity

143. The pension or annuity payments that a taxpayer receives are fully taxable if he or she has no cost in the contract

because of which of the following situations? A. The taxpayer did not pay anything or is not considered to have paid anything for the pension or annuity.

Amounts withheld from his or her pay on a tax-deferred basis are not considered part of the cost of the pension or annuity payment

B. The taxpayer’s employer did not withhold contributions from his or her salary C. The taxpayer received all of his or her contributions tax free in prior years D. All of the above

144. Alec’s annuity starting date is after 1986, and he excludes $100 a month ($1,200 a year) under the Simplified

Method. The total cost of his annuity is $12,000. His exclusion ends when he has recovered his cost tax free after how many months?

A. 100 months B. 120 months C. 150 months D. 240 months

145. The only requirement for setting up a traditional IRA is the taxpayer must have received some taxable

compensation income during the year. Taxable compensation includes all of following except: A. Wages B. Tips C. Annuity Income D. Commissions

146. George, who is 34 years old and single, earns $24,000 in 2023. His IRA contributions for 2023 are limited to what

amount? A. $0 B. $1,000 C. $3,500 D. $6,500

147. Wayne, age 53, and Janet, age 51, are married and file a joint return. Wayne is covered by an employer retirement plan. In 2023, Wayne had compensation of $50,000 and Janet had compensation of $175,000. Their modified adjusted gross income (MAGI) was $200,000. What is the amount of the deductible contribution that can be made for Janet to her traditional IRA for 2023?

A. $0 B. $2,500 C. $3,000 D. $6,500

Examination Questions - 43 Hour Federal Tax Law

148. Aubrey Beck is single, covered by an employer retirement plan, and she contributed $4,000 to a new Roth IRA on June 16, 2023. On December 29, 2023, she determines that her 2023 modified AGI will allow a full traditional IRA deduction. On that same date, Aubrey recharacterizes the Roth IRA contribution as a traditional IRA contribution and has $4,200, the balance in the Roth IRA account ($4,000 contribution plus $200 related earnings), transferred from her Roth IRA to a traditional IRA in a trustee-to-trustee transfer. Aubrey can deduct what amount as a traditional IRA contribution on her 2023 Form 1040?

A. $0 B. $2,000 C. $4,000 D. $4,200

149. Joe is 57 years old and unemployed. He decides to take an early withdrawal or distribution from his IRA to make

ends meet. Which of the following applies to Joe as a result of this transaction? A. Joe incurs a 10% Federal penalty because he withdrew funds for an unqualified purpose before he was 59½

years old B. Joe incurs a 15% Federal penalty because he withdrew funds for an unqualified purpose before he was 59½

years old C. Joe incurs a 20% Federal penalty because he withdrew funds for an unqualified purpose before he was 59½

years old D. Joe does not incur a penalty because he is over the age of 55

150. Peter is 38 years old and has just purchased his first home. In order to come up with the down payment he

withdraws $10,000 from a traditional IRA account he set up when he was 18. Which of the following applies to Peter as a result of this transaction?

A. He incurs no penalty if he redeposits the funds into his IRA within 5 years B. He incurs no penalty since he is a first-time homebuyer, used the funds for this purpose, and did not

exceed the maximum withdrawal amount of $10,000 C. He incurs a 15% Federal penalty for withdrawing funds before he was 59½ years old D. He incurs a 20% Federal penalty for withdrawing funds before he was 59½ years old

151. Elizabeth works for the Rockland Quarry Company, a small business with 50 employees. Rockland has decided

to establish a SIMPLE IRA plan for its employees and will match its employees’ contributions dollar-for-dollar up to 3% of each employee’s compensation. Elizabeth has a yearly compensation of $50,000 and contributes 5% of her compensation to her SIMPLE IRA. What is the total contribution to Elizabeth’s SIMPLE IRA for 2023?

A. $0 B. $2,000 C. $2,500 D. $4,000

152. Which of the following is a false statement regarding a direct rollover option distribution to another qualified retirement plan?

A. To be a direct eligible rollover, the taxpayer must pay withholding tax on the amount being rolled over B. On a direct eligible rollover, no tax will be withheld from any part of the distribution C. The taxpayer may choose to have any part or all of an eligible rollover distribution paid directly to another

retirement plan D. If an eligible rollover distribution is paid from an employer-sponsored retirement plan to the taxpayer

generally there will be tax withheld 153. Section 307 of the SECURE 2.0 Act expands the IRA qualified charitable distribution (QCD) provision to allow

for a one-time, $50,000 distribution to charities through all of the following except: A. Charitable gift annuities (CGA) B. Charitable donations from a SEP or SIMPLE IRA C. Charitable remainder unitrusts (CRUT) D. Charitable remainder annuity trusts (CRAT)

Examination Questions - 43 Hour Federal Tax Law

154. The SECURE 2.0 Act pushes back the beginning date for required minimum distributions (RMD) from qualified plans. Individuals turning age 72 during 2023 or later will start their RMD at what age?

A. Age 73 B. Age 74 C. Age 75 D. Age 76

155. Under the SECURE 2.0 Act, if a required minimum distribution (RMD) is not taken, the tax penalty is reduced

from 50% to 25% for taxable years beginning in 2023. The penalty is further reduced to what amount if a correction to the missed RMD is made within two years after the end of the taxable year in which the distribution was missed?

A. 2% B. 5% C. 10% D. 20%

Lesson 12

156. Connie and her spouse, Mark, (both over 65) are filing a joint return for 2023. They both received Social Security benefits during the year. In January 2023, Connie received a Form SSA-1099 showing net benefits of $7,500 in box 5. Mark received a Form SSA-1099 showing net benefits of $3,500 in box 5. Connie also received a taxable pension of $22,000 and interest income of $500. She did not have any tax-exempt interest income. What amount of Connie’s Social Security benefits is taxable for 2023?

A. $0 B. $500 C. $3,750 D. $7,500

157. In 2023, in addition to the annual gift tax exclusion of $17,000, a taxpayer also can give which of the following

without triggering the gift tax? A. Gifts to a political organization for its use B. Gifts to cover educational expenses C. Gifts used to pay for medical expenses D. All of the above

158. Heidi received a scholarship of $2,500. The scholarship was not received under either the National Health Service

Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program. As a condition for receiving the scholarship, Heidi must serve as a part-time teaching assistant. Of the $2,500 scholarship, $1,000 represents payment for teaching. The provider of her scholarship gives Heidi a Form W-2 showing $1,000 as income. Her qualified education expenses were $2,000. Assuming that all other conditions are met, what portion of Heidi’s scholarship is taxable?

A. $0 B. $500 C. $1,000 D. $2,000

159. Under the COVID-related Tax Relief Act of 2020, which was enacted as part of the Consolidated Appropriations

Act, 2021, unreimbursed expenses paid or incurred after March 12, 2020, by eligible educators for which of the following qualify for the educator expense deduction?

A. Personal Protective Equipment (PPE) B. Plexiglass C. Disinfectant used to prevent the spread of COVID-19 D. All of the above

Examination Questions - 43 Hour Federal Tax Law

160. If a member of a reserve component of the Armed Forces of the United States travels more than how many miles away from home in connection with the performance of services as a member of the reserves, the reservist can deduct travel expenses as an adjustment to gross income rather than as a miscellaneous itemized deduction?

A. 10 miles B. 50 miles C. 100 miles D. 200 miles

161. In August 2021, Marisela took out a $10,000 qualified student loan to pay the tuition at State College. In 2023,

she refinanced the student loan for an additional $5,000 that she used to buy a car to drive to and from campus. Under the terms of the refinanced loan, Marisela will be charged an additional $150 a year in interest. When completing her income tax return, Marisela can deduct what amount of the additional interest she is charged for her refinanced student loan?

A. $0 B. $75 C. $100 D. $150

162. In January 2023, a taxpayer takes out a $500,000 mortgage to purchase a main home with a fair market value

of $800,000. In February 2023, the taxpayer takes out a $250,000 home equity loan to put an addition on the main home. Both loans are secured by the main home and the total does not exceed the cost of the home. What percentage of the interest paid on the loans is deductible on the taxpayer’s income tax return?

A. 25% B. 50% C. 75% D. 100%

163. Henry takes out a home-equity loan for $50,000. He deposits the loan proceeds into an account used by his sole

proprietorship, a business in which he actively participates. The money is immediately spent on new equipment for the business. Henry should elect to treat the $50,000 loan as:

A. Small business loan B. Not secured by a qualified residence C. Short term loan D. Working capital loan

164. From Schedule SE, Ondine determines she owes $2,000 in self-employment tax for the year. Even though she

will need to pay that money when it is due during the year, she will be able to deduct what amount on her Schedule 1 (Form 1040) when she files her income tax return?

A. $0 B. $500 C. $1,000 D. $2,000

165. Elizabeth executes her divorce on November 23, 2017. She earns $200,000 and pays $40,000 alimony annually

to her spouse who earns $55,000. Elizabeth will be required to pay taxes on what amount of her income? A. $0 B. $40,000 C. $160,000 D. $200,000

166. Sandra executes her divorce on January 18, 2023. She earns $120,000 and pays $30,000 alimony annually to

her spouse who earns $25,000. Sandra will be required to pay taxes on what amount of her income? A. $0 B. $30,000 C. $90,000 D. $120,000

Examination Questions - 43 Hour Federal Tax Law

167. All of the following are true regarding child support payments except: A. If both alimony and child support payments are called for by the taxpayer’s divorce or separation

instrument, and he or she pays less than the total required, the payments apply first to alimony and then to child support

B. Child support payments are not deductible by the payer and are not taxable to the payee C. The amount of child support may vary over time D. A payment that is specifically designated as child support or treated as specifically designated as child

support under a divorce or separation instrument is not alimony

168. Rich’s divorce decree, executed on June 3, 2018, calls for him to pay his former spouse $200 a month as child support and $150 a month as alimony. If he pays the full amount of $4,200 during the year, Jeanna, his former spouse, can exclude what amount from her income?

A. $150 B. $200 C. $1,800 D. $2,400

169. Generally, no gain or loss is recognized on a transfer of property from the taxpayer to (or in trust for the benefit

of) his or her former spouse if the transfer is incident to their divorce. This rule applies even if the transfer was in exchange for all of the following except:

A. Cash B. The release of marital rights C. The assumption of liabilities D. Certain transfers in trust

170. If a taxpayer receives educational assistance benefits from his or her employer under an educational assistance

program, he or she can exclude up to $5,250 of those benefits each year. Tax-free educational assistance benefits include payments for which of the following?

A. Meals B. Lodging C. Transportation D. Textbooks

171. Renee works at Indigo Inc. and attends school part-time as part of her company’s educational assistance

program. In 2023 her company reimbursed her a total of $6,250 for tuition, books, supplies, fees, etc., related to her schooling. How much of this amount can Renee exclude from her gross income?

A. $0, this is a company sponsored benefit and does affect the individual’s return B. $5,250, the maximum exclusion allowed under an employer’s educational assistance program C. $5,750, the maximum exclusion allowed under an employer’s educational assistance program D. $6,250, the maximum exclusion allowed under an employer’s educational assistance program

172. Participants in a cafeteria plan must be permitted to choose from at least how many taxable benefits (such as

cash) and at least one qualified benefit? A. One B. Two C. Three D. Four

173. Using a company car for business purposes is not considered a fringe benefit, while personal use is a taxable

fringe benefit. Personal use includes all of the following except: A. Commuting to and from work B. Running errands C. Allowing a family member who is not a company employee to use the vehicle D. Making company deliveries

Examination Questions - 43 Hour Federal Tax Law

174. The No-additional-cost services exclusion applies to a service the employer provides to an employee if it does not cause the employer to incur any substantial additional costs. No-additional-cost services are excess capacity services that include all of the following except:

A. Train tickets provided free B. Facilitation by a stock brokerage firm of the purchase of stock by employees C. Hotel rooms provided free D. Telephone services provided free

175. The American Rescue Plan (ARP) provides a temporary 100% reduction in the premium that individuals would

have to pay when they elect which of the following? A. Short term disability insurance for maternity leave B. Short term disability insurance for self employed C. COBRA continuation health coverage following a reduction in hours or an involuntary termination of

employment D. Universal life insurance

176. In tax year 2023, employers can generally exclude a maximum of what amount per month from the employee's

wages for combined commuter highway vehicle transportation and transit passes? A. $300 B. $375 C. $400 D. $445

177. Which of the following is incorrect regarding an employer-provided dependent care assistance program?

A. The taxpayer’s employer has to report that value on his or her Form W-2 B. This type of plan is a voluntary agreement to reduce the taxpayer’s salary in return for an employer-

provided fringe benefit C. The taxpayer must include his or her nontaxable combat pay in earned income when figuring the exclusion

or deduction if he or she chooses to include it in earned income for the Earned Income Tax Credit D. The taxpayer is receiving a tax benefit because under the plan he or she is not paying taxes on the money

set aside to pay for the dependent care expenses

178. In 2023, Sawyer was released from an obligation to pay a personal credit card debt in the amount of $5,000. Sawyer received a 2023 Form 1099-C from the credit card lender showing the entire amount of discharged debt of $5,000 in box 2. None of the exceptions to the general rule that canceled debt is included in income apply. Sawyer uses the Insolvency Worksheet to determine that the total liabilities immediately before the cancellation were $15,000 and the FMV of the total assets immediately before the cancellation was $7,000. This means that immediately before the cancellation, Sawyer was insolvent to the extent of $8,000 ($15,000 total liabilities minus $7,000 FMV of the total assets). Because the amount by which Sawyer was insolvent immediately before the cancellation was more than the amount of debt canceled, Sawyer can exclude the entire what amount canceled debt from income?

A. $5,000 B. $7,000 C. $8,000 D. $15,000

179. Chad operates a restaurant business. He furnishes his employee, Carol, who is a waitress working 7a.m. to

4p.m., two meals (lunch and dinner) during each workday. Chad encourages but do not require Carol to have her breakfast on the business premises before starting work. She must have her lunch on the premises. Chad also allows Carol to have meals on his business premises without charge on her days off. Since Carol is a food service employee and works during the normal breakfast and lunch periods, all of the following are true except:

A. Chad can exclude from Carol’s wages the value of her breakfast B. Chad can exclude from Carol’s wages the value of her lunch C. Chad cannot exclude from Carol’s wages the value of her meals on her days off D. Chad can exclude from Carol’s wages the value of her meals on her days off

Examination Questions - 43 Hour Federal Tax Law

Lesson 13 180. During 2023, Bill Jones drove 3,800 miles for medical reasons. He spent $500 on gas, $30 on oil, and $100 for

tolls and parking. Using either actual expenses or standard mileage rate, what is the largest amount he can include for car expenses in his medical expenses on his tax return?

A. $630 B. $658 C. $936 D. $978

181. XYZ Sample Company has 100 employees in 2023. XYZ Sample Company qualifies to receive the credit of 5.4% of Employer's Annual Federal Unemployment (FUTA) taxable wages when it files Form 940. As such, XYZ Sample Company’s FUTA tax due on each employee’s wages paid in 2023 would be what amount?

A. $0 B. $21 C. $42 D. $63

182. If an employee’s taxable wages are $700 for the week, their total Social Security and Medicare contribution would be what amount?

A. $0 B. $10.15 C. $43.40 D. $53.55

183. Trevor, a single taxpayer, received $170,000 in wages from his employer through November 30, 2023. On December 1, 2023, the employer pays Trevor a $50,000 bonus. Prior to December 1, the employer was not required to withhold the Medicare tax surcharge. On December 1, the employer is required to withhold Additional Medicare Tax on what amount of the $50,000 bonus?

A. $10,000 B. $20,000 C. $30,000 D. $50,000

184. Amanda and Steve Smith are married and file jointly. During 2023 they paid state property taxes of $15,000 and state income taxes of $2,000. If they decided to itemize their deductions what amount of combined property and state income taxes can Amanda and Steve claim on their Schedule A - Itemized Deductions?

A. $2,000 B. $10,000 C. $15,000 D. $17,000

185. In 2023, Ron pays $25 each quarter for a state property tax based only on the value of his boat. What amount of

this personal property tax is deductible on his Federal tax return? A. $0 B. $25 C. $50 D. $100

186. Generally, the taxpayer may take an itemized deduction, subject to limitations, for certain state, local, and foreign

taxes he or she pays even if he or she did not pay the tax while in a trade or business or while carrying on a for- profit activity. The taxpayer deducts the tax in the taxable year he or she pays them. Deductible taxes included all of the following except:

A. Estate and inheritance taxes B. State, local, and foreign income taxes or state and local general sales taxes in lieu of state and local

income taxes C. State and local real property taxes D. State and local personal property taxes

Examination Questions - 43 Hour Federal Tax Law

187. For 2023, if a dependent child has no earned income and $3,500 of unearned income, $1,000 would be subject to the Kiddie Tax and is taxed using the brackets and rates for which of the following?

A. Capital gains B. Estates and trusts C. The child’s parents D. Partnerships

188. A single tax filer with annual gross income of $188,000 and net investment income of $21,055 has a modified adjusted gross income (MAGI) of $209,055. Since this amount exceeds the Net Investment Income Tax exceeds the applicable threshold, the individual will pay net investment income tax of what amount?

A. $225.72 B. $344.09 C. $392.43 D. $408.28

189. Joseph and Rachel are married and earn $228,700 a year, which includes $98,700 in wages from Joseph’s job managing a theater, and $130,000 of net income from Rachel’s clothing store (which is simply a sole proprietorship business reported on her Schedule C). In addition, the couple has a $150,000 portfolio, which produced $3,000 of qualified dividends and $2,000 of real estate investment trust (REIT) income in the past year. The couple’s total income is $228,700, of which $132,000 (including Rachel’s business income and the REIT income) is qualified business income (QBI). In 2023, the couple will be eligible for a $27,700 standard deduction, reducing their $228,700 of income down to $201,000. In addition, they will receive a qualified business income (QBI) deduction for what amount?

A. $0 B. $13,200 C. $26,400 D. $52,800

190. Under the Tax Cuts and Jobs Act (TCJA), mortgage interest on loans used to acquire a principal residence and/or

a second home remains deductible, but only on debt up to $750,000. This represents an unfavorable decrease of what amount compared to the limitation under prior tax law?

A. $100,000 B. $250,000 C. $300,000 D. $350,000

191. In 2023, John and Peggy Harris sold their home on May 7. Through April 30, they made home mortgage interest payments of $1,220. The settlement sheet for the sale of the home showed $50 interest for the 6-day period in May up to, but not including the date of sale. What is the amount of their mortgage interest deduction?

A. $0 B. $610 C. $1,220 D. $1,270

192. Sally owns her home and has a mortgage principal remaining of $100,000. She makes annual mortgage payment of $6,080 at an interest rate of 4.5%. Her annual mortgage payment includes the annual principal payment of $1,613 and the annual interest payment of $4,467. In 2023, Sally is able to deduct the interest payments of what amount on her income tax return?

A. $0 B. $1,613 C. $4,467 D. $6,080

193. Bill donated $100 to the American Red Cross, $200 to the Boy Scouts of America, and $300 to his neighbor whose home was destroyed by an earthquake. How much is Bill's deduction for charitable contributions?

A. $100 B. $300 C. $400 D. $500

Examination Questions - 43 Hour Federal Tax Law

194. Salma contributes $100 cash to her city's police department to be used as a reward for information about a crime. The city police department is a qualified organization, and her contribution is for a public purpose. Salma can deduct what amount of her contribution on her income tax return?

A. $10 B. $50 C. $75 D. $100

195. A taxpayer contributing a qualified vehicle valued at over what amount must obtain from the charity a Form 1098-

C Contributions of Motor Vehicles, Boats, and Airplanes? A. $500 B. $750 C. $1,000 D. $1,500

196. Nelson makes a cash contribution of $1,000 to Charity X, a qualified organization. In return for his payment, he

receives a state tax credit of 70% of his $1,000 contribution. The result is Nelson’s charitable contribution deduction to Charity X cannot exceed what amount?

A. $100 B. $300 C. $700 D. $1,000

197. During 2023, Royce has an adjusted gross income (AGI) of $40,000. What is the maximum amount Royce can

deduct for qualified contributions charitable made to qualified organizations if he itemizes his deductions? A. $0 B. $10,000 C. $20,000 D. $24,000

198. Pablo is 75 years old. He made a $5,000 qualified charitable distribution (QCD) from his IRA to a qualified local

charity. If he uses the cash method of accounting, what amount of the distribution can he claim as a charitable contribution deduction on his income tax return?

A. $0 B. $1,000 C. $2,500 D. $5,000

199. Mary suffers $25,000 in uninsured losses in 2023 when her house burns down while she was on vacation. This

loss was not due to a Federally declared disaster, therefore Mary can deduct what amount of the casualty losses relating to her home on her Federal income tax return?

A. $0 B. $10,000 C. $12,500 D. $25,000

200. In 2023, Chloe lived in Portland and accepted a job in Atlanta. Under an accountable plan, her employer

reimbursed her for her actual traveling expenses from Portland to Atlanta and the cost of moving her furniture to Atlanta. Chloe’s employer included $3,200 on her Form W-2. However, Chloe’s moving expenses were $3,900. What amount can she deduct as moving expenses on her income tax return?

A. $0 B. $350 C. $700 D. $3,200

Examination Questions - 43 Hour Federal Tax Law

201. Shannon won $1,000 in a poker tournament she entered in May. In July and September, she lost $600 and $700 in two other tournaments. She reported $1,000 of gambling winnings on Form 1040. What amount can Shannon deduct as gambling losses for the year on Schedule A?

A. $0 B. $700 C. $1,000 D. $1,300

202. All of the following are true regarding a Claim of Right overpayment under Section 1341 except:

A. The taxpayer generally deducts the repayment on the same form or schedule on which he or she previously reported it as income

B. If the amount the taxpayer repaid was more than $3,000, he or she can choose to take a tax credit for the year of repayment if he or she included the income under a claim of right

C. When determining whether the amount the taxpayer repaid was more or less than $3,000, he or she should consider each instance of repayment separately

D. The taxpayer can use the method (deduction or credit) that results in less tax 203. Melissa is blind. She is self-employed and must use a reader to do her work. She uses the reader both during

her regular working hours at her place of work and outside her regular working hours away from her place of work. The reader's services are only for her work. Which of the following is true regarding Melissa’s work-related expenses in 2023?

A. She cannot deduct her expenses for the reader because the expense is subject to the 2% floor for miscellaneous deductions and suspended under the Tax Cuts and Jobs Act

B. She cannot deduct her expenses for the reader because she is self-employed C. She can deduct her expenses for the reader as an impairment-related work expense because it is an

expense in connection with her place of work that is necessary for her to be able to work D. She cannot deduct her expenses for the reader because she uses it away from her place of work

204. In 2023, Paola files as a head of household and has an adjusted gross income (AGI) of $289,890. She made

charitable contributions of $10,000 and paid $25,000 of mortgage interest. Her total itemized deductions are $35,000. Of Paola’s $35,000 total itemized deductions, what amount can be listed on her Schedule A?

A. $0 B. $10,000 C. $25,000 D. $35,000

Lesson 14

205. In 2023, the failure to meet due diligence requirements by a paid tax preparer in determining the taxpayer's eligibility for the Earned Income Credit (EITC), the Child Tax Credit (CTC)/Additional Child Tax Credit (ACTC), and/or the American Opportunity Tax Credit (AOTC) could result in a penalty of what amount?

A. $100 for each failure B. $250 for each failure C. $600 for each failure D. $650 for each failure

206. Catherine claimed the Earned Income Tax Credit (EITC) on her 2022 tax return, which she filed in March 2023.

The IRS determined she was not entitled to the EITC and that her error was due to reckless or intentional disregard of the EITC rules. In September 2023, Catherine received a statutory notice of deficiency telling her an adjustment would be made and tax assessed unless she filed a petition with the Tax Court within 90 days. Catherine did not act on this notice within 90 days. Therefore, her EITC was denied in December 2023, and she cannot claim the EITC for which of the following tax years?

A. Only 2023 B. Only 2024 C. 2023 or 2024 D. 2024 or 2025

Examination Questions - 43 Hour Federal Tax Law

207. If the taxpayer’s Earned Income Tax Credit (EITC) for any year after 1996 was denied and it was determined that his or her error was due to fraud, then he or she cannot claim the EITC for the next how many years?

A. 2 years B. 5 years C. 7 years D. 10 years

208. In the event that two or more taxpayers claim the same child in the same calendar year, the child will be the

qualifying child for the parents first and then for a taxpayer, other than the parents, with: A. The highest adjusted gross income (AGI) B. The highest child support payment C. The highest alimony payment D. The highest interest and dividends income

209. A taxpayer should file Form 8862 - Information to Claim Earned Income Tax Credit after Disallowance for which

of the following reasons? A. He or she filed Form 8862 in a later year and his or her EITC for that later year was allowed B. His or her EITC for any year after 1996 was denied or reduced for any reason other than a math or clerical

error C. His or her EITC has not been reduced or disallowed for any reason other than a math or clerical error D. He or she is taking the EITC without a qualifying child for 2023 and the only reason his or her EITC was

reduced or disallowed in the earlier year was because the IRS determined that a child listed on Schedule EITC was not his or her qualifying child

210. All of the following child and dependent care expenses may qualify as work-related expenses for the Child and

Dependent Care Credit except: A. Expenses for a child in nursery school, preschool, or similar programs for children below the level of

kindergarten B. Expenses that allow the taxpayer to work or look for work C. The cost of sending a child to a day camp specializing in computer technology D. The cost of sending a child to an overnight camp

211. Gina works 3 days a week. While she works, her 6-year-old child attends a dependent care center, which

complies with all state and local regulations. Gina can pay the center $150 for any 3 days a week or $250 for 5 days a week. Her child attends the center 5 days a week. For the purposes of the Child and Dependent Care Credit, what are Gina’s work-related expenses for the center per week?

A. $0 B. $75 C. $150 D. $250

212. Tim Thompson is a single taxpayer, and he qualifies for the entire Child Tax Credit. In 2023, Tim has a modified

adjusted gross income (MAGI) of $203,000. When Tim prepares his income tax return his Child Tax Credit will be reduced by what amount?

A. $0 B. $150 C. $500 D. $1,000

213. Although the Federal tax code generally treats forgiven debt as taxable income, the American Rescue Plan (ARP)

includes a measure that exempts which of the following from taxation through 2025? A. Foreclosure B. Repossession C. Forgiven student loan debt D. Abandonment of the property

Examination Questions - 43 Hour Federal Tax Law

214. George Alexander pays $9,300 in tuition and fees in December 2023, and his child began college in January 2024. He filed his 2023 tax return on February 14, 2024, and claimed a Lifetime Learning Credit of $1,860. He claimed no other tax credits. After he filed his return, his child withdrew from two courses and George received a refund of $2,900. He must refigure his 2023 Lifetime Learning Credit using $6,400 of qualified education expenses instead of $9,300. After George refigures the credit, he determines his tax liability increased by what amount?

A. $0 B. $580 C. $1,280 D. $1,860

215. For the purposes of the Lifetime Learning Credit, which of the following is not a qualifying student?

A. A student who claims the American Opportunity Tax Credit in the same year B. A part-time student C. A student in a graduate program D. A student in a vocational program

216. Sabine is a sophomore at California Community College. She paid $2,000 in tuition, $300 for books, and $150 for student fees. She also paid room and board of $2,500. For the calculation of the American Opportunity Tax Credit, what is the total qualifying educational expense for Sabine?

A. $2,000 B. $2,150 C. $2,450 D. $4,500

217. All of the following changes in circumstances can affect the amount of the taxpayer’s actual Premium Tax Credit except:

A. Marriage B. Divorce C. Birth or adoption of a child D. Opting out of advance credit payments

218. Mary is a single taxpayer and has modified adjusted gross income of $80,000, what is the maximum Adoption Credit she can claim on her 2023 income tax return?

A. $12,650 per eligible child B. $13,190 per eligible child C. $15,950 per eligible child D. $16,500 per eligible child

219. Miranda and Tony adopted a child, not determined to have special needs, in the current year. During 2023 their qualified adoption expenses were $17,000 and they had a modified adjusted gross income (MAGI) of $293,500. What is the amount of Miranda and Tony’s Adoption Credit?

A. $0 B. $6,700 C. $15,950 D. $17,000

220. Evelyn is 68 years old, her tax filing status is single, her adjusted gross income (AGI) is $16,000, and her nontaxable Social Security benefits are $6,000. When filing her income tax return, Evelyn can claim what amount for the Credit for the Elderly or the Permanently and Totally Disabled?

A. $0 B. $100 C. $250 D. $500

Examination Questions - 43 Hour Federal Tax Law

221. Jill files a joint tax return with her husband. She works at a retail store and earns $30,000 in 2023. Jill’s husband was unemployed in 2023 and did not have any earnings. Jill contributed $1,000 to her IRA in 2023. After deducting her IRA contribution, the adjusted gross income shown on her joint return is $29,000. Jill may claim what amount for the Retirement Savings Contributions Credit (Saver’s Credit) for her $1,000 IRA contribution?

A. $0 B. $200 C. $500 D. $1,000

222. If a taxpayer has foreign taxes available for credit but cannot use them because of the limit, he or she may be able to carry them back how many tax year(s)?

A. 1 tax year B. 2 tax years C. 3 tax years D. 4 tax years

223. In 2023, Jake receives a qualified mortgage credit certificate (MCC) from California. This year, his regular tax

liability is $1,100, he owes no alternative minimum tax, and his Mortgage Interest Credit is $1,700. Additionally, Jake claims no other credits. What amount of Jake’s unused Mortgage Interest Credit for this year can he carry forward to the next 3 years or until used, whichever comes first?

A. $0 B. $600 C. $1,100 D. $1,700

224. If the taxpayer buys a new plug-in electric vehicle (EV) or fuel cell vehicle (FCV) in 2023 or after, he or she may

qualify for a New Clean Vehicle Credit under the Inflation Reduction Act. To qualify, the taxpayer must buy the vehicle for his or her own use, not for resale, and use it primarily in the U.S. In addition, the taxpayer’s modified adjusted gross income (MAGI) may not exceed what amount for married couples filing jointly?

A. $100,000 B. $200,000 C. $300,000 D. $400,000

225. In February 2023, Francisco purchased a new electric vehicle (EV). The purchase meets all the requirements to

qualify for the New Clean Vehicle Credit. Francisco is a single taxpayer, and his modified adjusted gross income (MAGI) is $67,500. He determines he owes $3,500 in income tax for 2023. What is the amount of the New Clean Vehicle Credit Francisco can claim on his Federal tax return?

A. $0 B. $3,500 C. $4,000 D. $7,500

226. In January 2023, Brian purchases a used electric vehicle (EV) from a licensed dealer for $15,000. The purchase

meets all the requirements to qualify for the Used Clean Vehicle Credit. Brian is a married taxpayer, and his modified adjusted gross income (MAGI) is $87,300. He determines he owes $4,200 in income tax for 2023. What is the amount of the Used Plug-In Electric Drive Vehicle Credit Brian can claim on his 2023 Federal tax return?

A. $0 B. $4,000 C. $4,200 D. $4,500

227. Which of the following is incorrect regarding the Commercial Clean Vehicle Credit?

A. A business can only claim the credit one time B. The maximum credit is $7,500 for qualified vehicles with gross vehicle weight ratings (GVWRs) of under

14,000 pounds and $40,000 for all other vehicles C. Businesses and tax-exempt organizations qualify for the credit D. For businesses, the credit is nonrefundable

Examination Questions - 43 Hour Federal Tax Law

228. In 2023, Charlotte purchases solar panels for her main home for $30,000. The installation qualifies for the Residential Energy Property Credit. When Charlotte completes her income tax return what amount can she claim for the Residential Energy Property Credit?

A. $7,800 B. $9,000 C. $10,000 D. $15,000

229. In one taxable year, a taxpayer purchases and installs the following: two exterior doors at a cost of $1,000 each,

windows at a total cost of $2,200, and one central air conditioner at a cost of $5,000. All property installed meets the applicable energy efficiency and other requirements for qualifying for the Energy Efficient Home Improvement Credit. After applying the maximum limits for each of the improvements the taxpayer's total amount of Energy Efficient Home Improvement Credit is what amount?

A. $1,200 B. $1,800 C. $2,900 D. $3,200

230. The taxpayer should file Form 3800 - General Business Credit to claim any of the general business credits. He

or she should attach which of the following for each credit? A. A statement showing the tax year the credit originated B. The amount of the credit reported on the original return C. The amount of credit allowed for that year D. All of the above

231. Statute defines the maximum amount of qualified wages that are Work Opportunity Tax Credit (WOTC)-eligible

for each eligible population. For example, the maximum eligible wages for a qualified ex-felon are $6,000, so the maximum WOTC for an employer that hired such an individual would be what amount?

A. $1,200 B. $2,400 C. $3,600 D. $6,000

232. An employer hires Mr. Smith for $10 an hour. Mr. Smith is an ex-felon and he works 300 hours (seven and a half

weeks). The employer will have paid him $3,000 in gross wages at the end of the year. In that case, the total Work Opportunity Tax Credit (WOTC) is available to the employer is what amount?

A. $0 B. $550 C. $750 D. $1,200

233. The Windy River Automotive Corporation makes automobiles and related technologies. During the 2023 tax year

they spent $400,000 on research and development and came up with a brand-new idea for automobiles to come with global positioning tags. This will help family members track one another’s movements while they are on the road, decreasing the need to contact someone while they are driving. The same year, Windy River Automotive Corporation spent $100,000 to improve the design of their 2023 model sports utility vehicle, making the front end more visually appealing than the prior year’s version. What amount of the qualified research and development expenses qualify for the Credit For Increasing Research Activities (Research Credit)?

A. $0 B. $100,000 C. $400,000 D. $500,000

Examination Questions - 43 Hour Federal Tax Law

234. Tom decides to offer a new qualified retirement plan at his business. He is opening a Guideline Core plan and adds an auto-enrollment feature to the plan. For the 3-year taxable period beginning with the first taxable year that he includes the auto-enrollment feature Tom can claim a Retirement Plans Startup Costs Tax Credit for what amount?

A. $100 B. $200 C. $500 D. $1,000

235. Under the SECURE Act 2.0, all of the following are true regarding the Military Spouse Retirement Plan Eligibility

Credit for Small Employers except: A. The tax credit equals the sum of (1) $200 per military spouse and (2) 100% of all employer contributions

(up to $300) made on behalf of the military spouse B. The credit applies to highly compensated employees C. The maximum tax credit of $500 D. The credit applies for three years with respect to each military spouse

Lesson 15 236. Alejandro is a married taxpayer, and he files a joint return. His adjusted gross income after deductions in 2023 is

$250,000. The deductions that he needs to add back in for alternative minimum tax (AMT) purposes are $6,000 in state and local taxes and $4,000 in personal property taxes. Based on Alejandro’s alternative minimum taxable income (AMTI) of $260,000, he is entitled to subtract what amount of the AMT exemption to arrive at his final taxable amount?

A. $0 B. $63,250 C. $81,300 D. $126,500

237. The Credit for Prior Year Alternative Minimum Tax may be carried: A. Back three years B. Forward indefinitely C. Back three years or forward a maximum of 15 years D. Forward for a maximum of 15 years

238. The Alternative Minimum Tax (AMT) is a separate tax that is imposed in addition to the taxpayer’s regular tax. It is caused by two types of adjustments and preferences: deferral items and exclusion items. Deferral items include which of the following?

A. Depreciation B. Standard deduction C. Itemized deductions D. Tax-exempt interest

239. In 2023, if the taxpayer’s child's interest, dividends, and other unearned income total more than what amount, it may be subject to a specific tax on the unearned income of certain children (kiddie tax)?

A. $2,000 B. $2,500 C. $3,500 D. $4,000

240. Amanda Black, age 13, received the following income: Dividends - $1,100, Wages - $2,100, Taxable interest - $1,400, Tax-exempt interest - $100, Capital gains - $300, and Capital losses ($200). The dividends were qualified dividends on stock given to her by her grandparents. Therefore, Amanda's unearned income is what amount?

A. $1,100 B. $1,400 C. $2,600 D. $3,200

Examination Questions - 43 Hour Federal Tax Law

Lesson 16

241. If a taxpayer fails to file a return and it is no more than 60 days past the due date (including extensions), what is usually the penalty for failure to file?

A. 5% for each month, but not more than 25% B. 10% for each month, but not more than 30% C. 15% for each month, but not more than 35% D. 20% for each month, but not more than 40%

242. What is the penalty for a tax return filed with an accuracy error based on either substantial understatement or

negligence? A. A flat 10% of the net understatement of the tax B. A flat 15% of the net understatement of the tax C. A flat 20% of the net understatement of the tax D. A flat 25% of the net understatement of the tax

243. Abusive tax schemes have evolved from simple structuring of abusive domestic and foreign trust arrangements

into sophisticated strategies that take advantage of the financial secrecy laws of some foreign jurisdictions and the availability of credit/debit cards issued from offshore financial institutions. Generally, these schemes are characterized by the use of all of the following flow-through entities except:

A. International Business Companies B. Foreign Trusts C. Qualified Intermediaries D. Foreign Partnerships

244. Section 6662(d)(1) generally defines "substantial understatement" of income tax to be an understatement for the

taxable year that exceeds the greater of what percentage of the correct tax required to be shown on the return or $5,000?

A. 10% B. 20% C. 25% D. 30%

245. If a taxpayer alters or strikes out the preprinted language above the space provided for the taxpayer’s signature

on Form 1040, he or she may have to pay a frivolous return penalty in which amount? A. $1,000 B. $2,500 C. $5,000 D. $7,500

246. If a taxpayer writes a $3,000 check to the IRS for payment of taxes and it does not clear his or her bank the

penalty for the dishonored check is what amount? A. $25 B. $30 C. $50 D. $60

247. A taxpayer can face the Civil Fraud Penalty under Section 6663 for all of the following types of tax violations

except: A. Concealment or transfer of income B. Failure to make reasonable attempts to comply with the tax code C. Falsification of documents D. Overstatement of deductions and exemptions

Examination Questions - 43 Hour Federal Tax Law

248. If a taxpayer’s Federal Insurance Contributions Act (FICA) deposit is seven calendar days late, the total Failure to Deposit Penalty is what percent?

A. 2% B. 5% C. 7% D. 10%

249. In 2023, if any failure to file a correct information return is due to intentional disregard of the filing or correct information requirements, the penalty is at least what amount per information return with no maximum penalty?

A. $50 B. $110 C. $270 D. $630

Lesson 17 250. A taxpayer can continue to claim the Employee Retention Credit (ERC) because the original program allowed

businesses to claim this credit for 3 years. This means he or she can claim 2020 expenses until: A. April 15, 2023 B. January 1, 2024 C. April 15, 2024 D. December 31, 2024

251. Which of the following is true regarding the phase-out of itemized deductions (Pease limitation) under the Tax Cuts and Jobs Act (TCJA)?

A. For taxpayers who exceed certain thresholds, the otherwise allowable amount of itemized deductions is reduced by 3% of the amount of the taxpayers’ adjusted gross income (AGI) exceeding the threshold

B. The total reduction cannot be greater than 80% of all itemized deductions C. The phase-out of itemized deductions for high-income taxpayers is repealed D. Certain itemized deductions are exempt from the Pease limitation

252. Beginning with the 2020 tax year, the IRS requires business taxpayers to report nonemployee compensation on Form 1099-NEC instead of on Form 1099-MISC. Businesses need to use Form 1099-NEC if they made payments totaling what amount or more to a nonemployee, such as an independent contractor?

A. $600 B. $750 C. $1,000 D. $1,500

253. For passenger automobiles placed in service in 2023 for which no Section 168(k) additional (bonus) first-year depreciation deduction applies, the depreciation limit under Section 280F(d)(7) is what amount for the first tax year?

A. $9,500 B. $12,200 C. $16,400 D. $20,000

254. During 2023, Debra Smith visits a casino and a race track. She has gambling winnings of $5,400 and gambling losses of $5,700. Debra must report the full amount of her gambling winnings for the year on her Schedule 1 (Form 1040). Additionally, she may deduct what amount of her gambling losses for the year on her Schedule A (Form 1040)?

A. $0 B. $300 C. $5,400 D. $5,700

Examination Questions - 43 Hour Federal Tax Law

255. Under the Tax Cuts and Jobs Act (TCJA) which of the following statements is true regarding changes to charitable contributions?

A. The new law provides that for charitable contributions made after December 31, 2017, until January 1, 2026, the limitation for cash contributions to public charities and certain private foundations is decreased to 25% of adjusted gross income (AGI)

B. A charitable deduction is allowed for any payment to an institution of higher education in exchange for which the payor receives the right to purchase tickets or seating at an athletic event

C. The new law repeals the donee-reporting exemption from the contemporaneous written acknowledgment requirement for tax years beginning after December 31, 2017

D. Under the new law contributions exceeding the annual limitation are not allowed to be carried forward

256. Under the Tax Cuts and Jobs Act (TCJA), to reduce waste, fraud, and abuse, a taxpayer is required to provide which of the following in order to claim the refundable Earned Income Tax Credit?

A. Valid Driver’s License Number B. Work-eligible Social Security Number (SSN) C. U.S. Military ID card D. U.S. Passport

257. The Tax Cuts and Jobs Act includes which of the following new rules with respect to the Earned Income Tax

Credit? A. Taxpayers are required to properly reflect any net earnings from self-employment in their claims for the

credit B. Employers are required to provide additional information on their payroll tax returns C. The IRS is granted additional authority with respect to the substantiation of earned income amounts D. All of the above

258. In 2021, Susan borrows from the U.S. Department of Education (ED) pursuant to the Direct Loan Program to

finance her attendance at an institution of higher learning. In 2023, when the balance of her outstanding Direct loans is $20,000, Susan establishes as a defense against repayment within the meaning of the Higher Education Act of 1965 that the school misled her and that its actions would give rise to a cause of action against the school under applicable state law. ED cancels Susan’s outstanding student loan and reports the discharge to the IRS on Form 1099-C - Cancellation of Debt. Under the Tax Cuts and Jobs Act, Susan must include what amount of the cancellation of debt in her gross income on her income tax return?

A. $0 B. $5,000 C. $10,000 D. $20,000

259. The Tax Cuts and Jobs Act (TCJA) provides that for tax years beginning after December 31, 2017 until January

1, 2026, the deduction for moving expenses is suspended, except for which of the following? A. Merchant marines serving aboard vessels under the operational control of the Department of Defense B. Red Cross personnel C. Members of the Armed Forces (or their spouse or dependents) on active duty who move pursuant to a

military order and incident to a permanent change of station D. Army reserve personnel

260. The Tax Cuts and Jobs Act (TCJA) expands a paid preparer’s due diligence and record keeping requirements

under IRC Section 6695(g) to include determining a client’s eligibility to file as which of the following? A. A head of household (HOH) B. A trust C. A tax-exempt organization D. A qualified charitable organization