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Summary of Major Developments
- For partnership, trust, and estate returns due after January 1, 2009, the IRS has reduced
the automatic filing extension from six months to five months. This change should help
individual taxpayers obtain their Schedule K-1 information before the October 15th
extended due date.
- Individual taxpayers can check the status of their federal refund on the IRS website or by
calling the Teletax System at 800-829-4477 or the IRS Refund Hotline at 800-829-1954.
Chapter 2 - Filing Status
- The Small Business and Work Opportunity Tax Act of 2007 included a provision that
allows some husband-wife ventures to elect out of the partnership rules for federal tax
purposes for tax years beginning after 2006. To be eligible for the election out, the
spouses must file jointly, and the operation must be a qualified joint venture. Electing out
of the partnership tax rules will not change the married couple's federal income tax
liability or their SE tax liability. However, it will allow the couple to avoid having to file
annual Forms 1065 for the husband-wife venture.
Chapter 2 - Innocent Spouse Relief
- The Ninth Circuit Courts have held that to qualify for innocent spouse relief under IRC
Section 6015, a taxpayer must have filed a joint return with his or her spouse
(Christensen, No. 06-71881 9th Cir. 4/22/08). The courts rely on the language of Section
6015 itself, which states that the innocent spouse relief applies to "an individual who has
made a joint return" and provides procedures for relief from "liability applicable to all
joint filers."
Chapter 2 - Exemptions and Dependents
- The phase-out of personal exemptions is reduced by two-thirds in 2008 and 2009. For
2010 and beyond, the phase-out is scheduled to disappear.
- When a divorced or separated custodial parent (the parent with whom the child spends
more nights during the year) signs Form 8332 to release a child's dependency exemption
to the noncustodial parent, IRS Notice 2006-86 clarifies that the noncustodial parent is
allowed to claim the dependency exemption deduction and the child tax credit for that
child. However, four other tax benefits remain off limits for the noncustodial parent.
- Proposed regulations issued in 2007 clarify the rules for claiming a dependency
exemption for a child of divorced or separated parents. The proposed regulations also
explain how a custodial parent can waive the dependency exemption (by signing Form
8332) to allow the noncustodial parent to claim the exemption.
Chapter 3 - Dividend and Interest Income
- The reduced tax rates for qualified dividends were extended through the end of 2010 by
the Tax Increase Prevention and Reconciliation Act. However, the reduced tax rates
were limited by the Small Business and Work Opportunity Act of 2007. Effective for tax
years beginning after May 25, 2007, children under age 19 and students under age 24 are
subject to the "kiddie tax."
- The rule allowing a taxpayer to elect to tax dividend income at ordinary rates to create
additional investment income in order to deduct more investment interest expense was
extended through 2010 by the Tax Increase Prevention and Reconciliation Act.
Chapter 3 - Compensation Issues
- The Small Business and Work Opportunity Tax Act of 2007 (SBTA) included a
provision to ensure that the employer tip credit won't be reduced when the federal
minimum wage goes up, as it will in stages pursuant to other 2007 legislation. This
provision affects tips received on services performed after December 31, 2006. In
addition, the SBTA included a new provision that allows the taxpayer's AMT liability to
be reduced by the employer tip credit. This provision applies to credits for taxable years
beginning after December 31, 2006 and carrybacks of such credits.
Chapter 3 - Employee Stock Options
- In 2006, the Tax Court ruled that the $3,000 annual limitation on deductible net capital
losses that applies for regular tax purposes also applies for AMT purposes. The taxpayer
argued that the limitation does not apply for AMT [Merlo, 126 TC 205 (2006)]. In 2007,
the Tax Court again reached the same conclusion [Evan Marcus, 129 TC No. 4 (2007)].
Note that AMT net capital losses may be larger than regular tax net capital losses if the
losses result from selling shares acquired by exercising incentive stock options.
Chapter 3 - Nonqualified Deferred Compensation Plans
- In 2007, the IRS released final Section 409A regulations, which are nearly 400 pages
long. The final regulations are generally consistent with earlier guidance (in Notice 2005-
1 and proposed regulations), but they offer more specifics and clarifications.
- In Notice 2007-86, the IRS extended transitional relief for implementing the final
regulations under Section 409A. Nonqualified deferred compensation plans are now
generally required to comply with the final regulations beginning January 1, 2009.
- In Notice 2007-100, the IRS provided relief for certain operational failures that are
corrected in the same year. Additionally, it provides transitional relief through 2010 for
operation failures up to a certain amount that are not corrected in the same tax year.
- In Notice 2006-79, the IRS extended the remedial period during which existing or new
nonqualified deferred compensation plans can be amended to comply with the Section
409A rules through December 31, 2008.
Chapter 3 - Nontaxable Fringe Benefits
- A technical correction included in the Gulf Opportunity Zone Act of 2005 clarifies that
an individual can qualify as a dependent for purposes of a dependent care assistance
program without regard to whether the individual has gross income exceeding $3,500 for
2008 or whether the individual is married and files a joint return.
- In 2007, the IRS issued updated proposed regulations covering cafeteria benefit plan
arrangements, including FSAs. The updated rules reflect current realities such as the use
of debit cards by employees to pay for reimbursable expenses. The proposed regulations
are generally effective after 2008.
- The IRS published an article on its website concluding that a sole shareholder-employee
of an S corporation cannot purchase health insurance in the shareholder's personal name
and claim an above-the-line deduction for the premiums under IRC Sec. 162(l).
- The Heroes Earning Assistance and Relief Tax Act amends IRC ~§~125 by redesignating
subsections (h) and (i) allowing for distribution of unused benefits in a health flexible
spending arrangement for individuals called to active duty.
- In Notice 2007-76, the IRS has delayed the effective date of Rev. Rul. 2006-57, IRB
2006-47, 911, which describes circumstances in which an employer may use smartcards,
debit or credit cards, and other electronic media to provide employees with qualified
transportation fringe benefits that are excludable from gross income. The original
effective date, January 1, 2008, is now delayed to January 1, 2009. Employers and
employees may, however, continue to rely on Rev. Rul. 2006-57 with respect to
transactions occurring prior to January 1, 2009.
Chapter 3 - Taxable Fringe Benefits
- Under a change enacted by the Tax Increase Prevention and Reconciliation Act, the base
housing amount used in calculating the foreign housing cost exclusion in a taxable year is
16% of the amount computed on a daily basis of the foreign earned income exclusion
limitation, multiplied by the number of days of foreign residence or presence in that year,
with reasonable foreign housing expenses in excess of the base housing amount
remaining excluded from income, but with a limitation on the exclusion of 30% of the
maximum amount of the taxpayer's foreign earned income exclusion.
Chapter 3 - Retirement Plan Distributions
- The Pension Protection Act of 2006 included a provision allowing a non-spouse
beneficiary of a retirement plan to directly rollover the inherited retirement plan balance
into an IRA, effective for distributions after December 31, 2006. The receiving IRA is
then treated as an inherited IRA of the non-spouse beneficiary and is subject to the
minimum required distribution rules for such accounts.
- The Pension Protection Act of 2006 included a provision that allows direct rollovers from
retirement plans into Roth IRAs, starting in 2008 (subject to the usual $100,000 AGI
restriction on Roth conversion transactions).
- Beginning in 2007, another Pension Protection Act of 2006 change permits rollovers of
after-tax contributions from a qualified retirement plan into a receiving defined benefit
plan (subject to a separate accounting requirement) or a receiving tax-sheltered annuity
arrangement (also subject to a separate accounting requirement). To qualify, the rollovers
must be accomplished via direct (trustee-to-trustee) transfers.
- Under yet another Pension Protection Act of 2006 change, an individual taxpayer can
now arrange for a direct deposit of all or a portion of his or her federal income tax refund
into his or her IRA, or the spouse's IRA if the individual files jointly (subject to the usual
IRA contribution limits). This is done by entering information about the receiving on
Form 1040 (for 2007) or Form 8888 if the refund is to be deposited into more than one
account.
Chapter 3 - Other Taxable Income Items
- The IRS has revised its approach to calculating the tax benefit from refunds of prior-year
state taxes to account for the option to deduct either state income or state sales tax on
Schedule A. Under the revised approach, a prior-year state income tax refund received in
the current year is taxable only to the extent the claimed prior-year income tax deduction
exceeds the sales tax deduction that could have been claimed.
- In March 2008, the Federal Circuit Court reversed the CSX decision that the qualification
of severance pay as "supplemental unemployment benefits" under Section 3402 made
such payments exempt from FICA taxes (CSX Corp., No.2007-5003 Fed. Cir. 3/6/08).
The court decision indicated that to be exempt from FICA taxes, severance payments
had to qualify under the more stringent rules of Revenue Rulings 90-72 and 56-249.
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