Most tax information that you receive from third parties, such as wage and tax statements (Form W-2), dividend and interest statements (Forms 1099-DIV and 1099-INT) and retirement distribution statements (Form 1099-R), normally should be in your hands by Feb. 1, 2010. However, if you sold real estate last year, engaged in bartering transactions or received certain payments from your broker or attorney, you may not receive the related tax forms until Feb. 16, 2010.

If you do not receive a tax statement by its due date, or if the statement you receive is incorrect, you should contact the payer and request the statement or a corrected statement.

If you do not include all of your tax information with your original return and you must file a corrected or amended return, it is likely that your refund will be delayed. So it usually pays to file a complete return on the first attempt.

Howard Morgens died in January 2000, leaving assets in trust for the benefit of his wife. Morgens’ estate divided the assets into two trusts, a qualified terminal interest property trust and a residual trust. As a result of the QTIP election, the assets of the QTIP trust qualified for the marital deduction in Mr. Morgens’ estate, and the trust assets would be included in Mrs. Morgens’ estate when she died.

Anne Morgens died in August 2002, having made a number of gifts from the QTIP trust. All of those gifts were made within the three-year period preceding her death. All of the resulting gift taxes were paid by the trustee of the residual trust.

The Tax Court ruled that the gift taxes paid from the residual trust represented taxes imposed on Mrs. Morgens as the donor of the gifts. Since the gifts were made within three years of her death, Mrs. Morgens’ estate was required to include both the value of the gifts and the related gift taxes in the calculation of the estate tax.

Read more in Estate of Anne W. Morgens v. Commissioner 133 TC No. 17, Dec. 21, 2009.

Brokers will soon be required to show the gross proceeds from the sale of a covered security, along with information about the customer’s adjusted basis in the security and whether any gain or loss is long-term or short-term. The Treasury Department and the IRS have issued proposed regulations that are expected to be finalized for the 2011 tax year.

Brokers will be required to calculate basis reflecting the total amount paid by a customer, adjusted for commissions and the effects of other transactions occurring within the account. The proposed regulations also require brokers to take into account information received from another broker when the customer transfers securities into the account. However, the broker would not be required to adjust the reported basis for transactions, elections or events occurring outside the account.

When a security is sold, the customer will be able to instruct the broker identifying the security sold or requesting that average basis be used. If no instruction is provided by the customer, the proposed regulations generally require the broker to report basis using a first-in, first-out (FIFO) method.

The proposed regulations also provide guidance on reporting obligations for wash sales, short sales and transfers of gifted, inherited and borrowed securities.

Read more here.

In a private letter ruling, the IRS Chief Counsel concluded that involuntary conversion rules applied to a situation in which corporate stock was taken in connection with a state’s unclaimed property laws.

In the facts described in the ruling, the successor trustee of a trust was unaware of an escrow account holding shares on behalf of the trust. The original trustee had died, and the escrow agent was unable to contact the successor trustee to release the shares. As a result, the shares were eventually turned over to the state and sold.

When the successor trustee became aware of the published list of unclaimed property, the trustee filed a claim and obtained the proceeds of the sale from the state. The ruling concludes that the transfer of the shares to the state was an involuntary conversion. As such, the trustee can avoid recognition of gain by purchasing replacement securities within two years from the close of the tax year in which the shares were transferred to the state.

Read more here.

As reported in prior issues of Washington Tax Update, tax withholding tables used by employers since early 2009 may cause certain employees to be under-withheld.

Now, in the instructions for the 2009 version of form 2210, Underpayment of Estimated Tax by Individuals, Estates and Trusts, the IRS has announced that it will not impose a penalty for an underpayment of tax caused by the new withholding tables.

This relief should assist higher income taxpayers and two-earner families, who are most likely to owe additional taxes as a result of being under-withheld.

You can generally figure the amount of your deductible car expense using one of two methods:

1. The standard mileage rate method

2. The actual expense method

If you qualify to use both methods, you may want to figure your deduction both ways before choosing a method to see which gives you a larger deduction.

For 2009, the standard mileage rate for business use of a car is 55 cents per mile. Effective Jan. 1, 2010, the amount is 50 cents per mile. You can add to your deduction any parking fees and tolls incurred for business purposes.

To use the actual expense method, you must determine what it actually costs to operate the car for business use. Include gas, oil, repairs, tires, insurance, registration fees, licenses and depreciation (or lease payments) attributable to the portion of the total business miles driven.

Other car expenses for parking fees and tolls attributable to business use are separately deductible, whether you use the standard mileage rate or actual expenses.

The law requires that you substantiate your expenses by adequate records or by sufficient evidence to support your own statement.

If you are an employee whose deductible business expenses are fully reimbursed under an accountable plan, the reimbursements should not be included in your wages on your Form W-2, and you should not deduct the expenses.

If your employer uses a nonaccountable plan to reimburse you for the expenses, the reimbursements are included in your wages. Your employee business expenses may be deductible as an itemized deduction.

Read more in Revenue Procedure 2009-54.

Ding’s business plan was to match American businesses interested in exporting to Asia with Asian businesses interested in investing in American businesses. He hoped to earn income through commissions and finder’s fees.

Ding thought he could develop business leads and contacts through various business associations to which he already belonged. He attended meetings of several organizations, which offered both social and networking opportunities. At the end of 2004, Ding abandoned his efforts to establish a consulting business without having generated any income.

The court ruled that Ding’s expenditures were "startup" or "pre-opening" expenditures since they were incurred before his business actually began operations to generate income. As startup expenditures, they could not be deducted when incurred. Rather, they would have to be amortized after the business commenced operations. The court also ruled that since Ding’s business never commenced operations, no amortization deduction was permitted.

Note that, under current law, a limited amount of startup expenditures can be deducted when incurred and the balance must be amortized over 180 months, beginning with the month in which business commences.

Read more in John Y. Ding, et. ux.v. Commissioner, TC Summary Opinion 2009-186, Dec. 7, 2009.

This study will be the IRS’ first Employment Tax National Research Project in a quarter century. The last employment tax study was conducted in the 1980s. The IRS will use data collected from the examinations to better understand the compliance characteristics of employment tax filers.

There are two main goals for the research project: to secure statistically valid information for computing the employment tax gap and to determine compliance characteristics so the IRS can focus its efforts on the most noncompliant employment tax areas.

The results will allow the IRS to gauge more accurately the extent to which businesses properly comply with employment tax law and related reporting requirements. When completed, this information will help the IRS select and audit future employment tax returns with the greatest compliance risk.

If your business receives a notice describing the process for the research project, you should expect to be required to produce all of your records relating to filing employment tax returns and deposits of employment taxes.

Employers who participate in ATIP report the tip income of employees based on a formula that uses a percentage of gross receipts, which are generally allocated among employees based on the practices of the restaurant.

Both employees and employers benefit from participation in the ATIP program. The IRS will not initiate a tip examination during the period the employer and employee participate in ATIP. Participating employees do not have to keep a daily tip log or other tip records.

Enrollment is simple. Employers elect participation in ATIP by checking the designated box on Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips. Employees who work for a participating employer can easily elect to participate in ATIP by signing an agreement with their employer to have their tip income computed under the program and reported as wages.

Read more in Revenue Procedure 2009-53.

Bartering is the trading of one product or service for another. Usually there is no exchange of cash. Barter may take place on an informal direct one-on-one basis between businesses and individuals, suppliers, customers, distributors, partners, contract labor and employees, or it can take place on a third-party basis through a modern Internet barter exchange.

Bartering is an exchange of one taxpayer’s property or services for another taxpayer’s property or services. The fair market value of property or services received through barter is taxable income.

If you are planning a charitable contribution and would like to secure an itemized deduction in 2009, you must make the contribution before Dec. 31.

Contributions can be made in cash, by check or by credit card. Even though you don’t receive your credit card statement until next year, the contribution is considered made on the date you provide the charity with your credit card information.

For contributions of cash, checks or other monetary gifts, regardless of amount, you must maintain either a bank record, a receipt or other communication from the charity indicating the name of the charity and the amount and date of the contribution. For contributions of $250 or more, you must obtain a contemporaneous written acknowledgment from the charity. Additional record-keeping rules apply to noncash contributions.

For the second year in a row, Congress has allowed businesses that experienced a net operating loss (NOL) an expanded carryback period to recover taxes paid in prior years.

Normally, an NOL can be used only to refund taxes paid in the prior two years. But last year, Congress allowed qualifying smaller businesses to elect a three- to five-year carryback period. Even owners, such as partners in partnerships and shareholders in S corporations, who had personally paid the taxes on the business profits were allowed to elect the extended carryback.

Now Congress has made the election available for another year, applying it to NOLs for calendar years 2008 and 2009 and fiscal years ending in 2008 and beginning in 2009. If you have an NOL in more than one qualifying year, you can generally elect the extended carryback period only one time. However, if you qualified for the extended carryback under last year’s law, you can also qualify under the new law for a different year.

Importantly, the new law removes the restriction limiting the election to smaller businesses. Businesses of all sizes can now qualify. So if you were prevented from electing the extended carryback period last year because your business was too large, the new law may qualify last year’s NOL for the extended carryback election.

Read more here.

The Tax Court has decided that parents who withdrew more than $100,000 from their IRA were not subject to the 10 percent early distribution penalty on the portion used to pay part of their daughter’s living expenses while she was away at college. However, the 10 percent penalty applied to the remaining portion that was used to pay down their $80,000 credit card debt to avoid bankruptcy.

Richard and Robert Venet were both under age 59½ at the time they took the distribution from their IRA. They paid tax on the distribution, but not the 10 percent early distribution penalty. The Venets argued that the penalty should not apply because they took the distribution while in a state of financial hardship. The court ruled that no financial hardship exception exists under the tax law.

However, the court was persuaded by the Venet’s alternative argument that no penalty should apply to the extent funds were used to pay qualified higher education expenses for their daughter. The daughter’s tuition was paid by a state education trust fund set up by the Venets in an earlier year. But the Venets also gave their daughter money to pay for food and rent and utilities on her off-campus apartment.

The court noted that an exception to the early distribution penalty is available for amounts used to pay for tuition, fees, books, supplies and equipment and, in limited circumstances, room and board. The amount for room and board is limited to the student’s allowance for room and board included in the cost of attendance as determined by the educational institution.

Read more in Venet v. Commissioner, T.C. Memo 2009-268, Nov. 24, 2009.

When it comes to taxes, the IRS giveth and the IRS taketh away.

If you are one of the affected taxpayers, that means either you will get a lesser refund or will actually owe money when you file your 2009 return.

The issue stems from the Making Work Pay credit, created as part of the stimulus legislation enacted last February. The credit is 6.2 percent of earnings up to $400 per person ($800 per couple for joint filers). The full credit is paid to people making $75,000 or less ($150,000 per couple). A partial credit applies to those making above those amounts but no more than $95,000 ($190,000 for couples).

For most people, the 2009 credit is being paid incrementally through their paychecks. It is built into income tax withholding tables the IRS issued last spring. But that can result in too high a credit in some circumstances.

For example, two spouses might be receiving the full credit at their jobs when their joint income only qualifies them for a partial credit or none at all. Or a single person with more than one job might be receiving the full credit at each job, when in fact there is only one $400 credit available.

The following taxpayers are most vulnerable:

The underpayment penalty may apply if your 2009 tax return shows a balance due of at least $1,000 and you have not paid at least 90 percent of your 2009 tax through a combination of withholdings and quarterly estimated tax payments.

You can avoid the penalty if your payments during 2009 are at least 100 percent of your 2008 income tax. If your adjusted gross income for 2008 was more than $150,000, your 2009 payments must be at least 110 percent of your 2008 income tax to avoid the underpayment penalty for 2009.

Your 2009 withholding may be less than you anticipated when you filed your 2008 return because of new withholding tables issued during 2009 under the Making Work Pay tax credit that was part of the stimulus law.

If your estimated tax payments and withholding are not going to be high enough to avoid penalties, you can increase your last quarterly estimated tax payment, which is due Jan. 15, 2010. Even better, if you receive wages, IRA distributions, annuity payments or other payments from which you can ask for withholding, have the additional taxes withheld. You are more likely to avoid penalties by increasing withholding than by increasing your last estimated tax payment.

The IRS is looking for more than 100,000 people – 107,831 to be exact. And they are trying to return over $123 million in tax refunds.

If you think you may be missing a refund check, use the "Where’s My Refund?" tool at www.irs.gov. This tool enables you to check the status of your refund. You will be asked to enter your Social Security number, filing status and the amount of the refund shown on your 2008 return. The tool will show the status of your refund and, in some cases, provide instructions on how to resolve delivery problems. You can also use the tool to update your mailing address.

You can access a telephone version of "Where’s My Refund?" by calling (800) 829-1954.

A recent Tax Court case underscores the importance of consulting with your tax adviser before cashing in a life insurance policy.

In 1980, Harvey Barr purchased a life insurance policy on his wife in the face amount of $200,000. After paying the premiums for eight or nine years, the policy had built up sufficient cash value that Barr stopped writing checks to pay the premiums. Instead, the premiums were automatically paid with dividend accumulations and loans against the cash value of the policy.

In 2005, Barr decided to surrender the policy. He received checks from the insurance company totaling about $12,000. The $12,000 represented the difference between the policy’s cash value of just over $361,000 and policy loans that had been used to pay the premiums since 1988 or 1989.

The difference between the cash value and Barr’s total investment in the contract amounted to almost $136,000, which Barr was required to include as taxable income in 2005. Moreover, the income was taxed as ordinary income, not as long-term capital gain, since a surrender of a life insurance policy is not a "sale or exchange," a requisite for capital gain treatment.

Read more in Barr v. Commissioner, TC Memo 2009/250, Nov. 3, 2009.

As predicted in the last issue of Washington Tax Update, on Nov. 6, 2009, President Obama signed the Worker, Home Ownership, and Business Assistance Act of 2009, which extends the scheduled expiration date of the popular first-time home buyer credit.

The first-time home buyer credit now includes homes under a purchase contract by April 30, 2010, and closed by June 30, 2010. The credit was originally slated to expire on Nov. 30, 2009. The maximum credit for first-time home buyers is $8,000. The credit does not have to be repaid if the buyer keeps the home for at least three years. A first-time home buyer is someone who has not owned a home during the prior three years.

The new law also creates a new credit for existing homeowners. This new $6,500 credit is available for those who have owned their existing home for at least five years. This credit is available for home purchases after Nov. 6, 2009, and before May 1, 2010, as long as closing takes place by June 30, 2010.

The income limits to qualify for both the credits have also been increased to $125,000 for individuals and $225,000 for married couples. After Nov. 6, 2009, the credits are not available for homes priced above $800,000. Both credits are also limited to 10 percent of the cost of the new home.

Barter Income – Barter dollars or trade dollars are identical to real dollars for tax reporting. If you conduct any direct barter, you should report the fair market value of the products or services you receive on your tax return.

On Oct. 29, 2009, senators announced that they had reached a compromise agreement on how to extend the $8,000 home buyer tax credit that is set to expire at the end of November. A vote in the Senate is expected soon and approval by the House is considered likely.

The revised credit includes a binding contract provision that would allow anyone who has entered into a binding contract to be eligible for the credit, as long as they close on the home within 60 days. The extended tax credit would also continue to allow military personnel to claim the credit for an additional year.

Gudmundsson amended his 1999 return, claiming a revised value of the shares he received of about $7.50 per share and requesting a refund of approximately $300,000 plus interest. The IRS denied the refund claim, and now a federal district court has agreed with the IRS.

Despite exploring the numerous arguments raised by Gudmundsson that the value of the stock was overstated on July 1, 1999, the court was persuaded that if Gudmundsson had sold the stock on that date, he would have received $1.3 million. And that was the amount he was required to include in income.

Read more in Gudmundsson v. U.S., DC-NY, Oct. 26, 2009.

The nonbusiness energy property credit equals 30 percent of the cost of eligible energy-saving improvements, up to a maximum tax credit of $1,500 for the combined 2009 and 2010 tax years. The cost of certain high-efficiency heating and air conditioning systems, water heaters and stoves that burn biomass all qualify, along with labor costs for installing these items. In addition, the cost of energy-efficient windows and skylights, energy-efficient doors, qualifying insulation and certain roofs also qualify for the credit, though the cost of installing these items does not count.

If you are going green, you should also check out a second tax credit designed to spur investment in alternative energy equipment. The residential energy efficient property credit, equals 30 percent of the cost of qualifying property such as solar electric systems, solar hot water heaters, geothermal heat pumps, wind turbines and fuel cell property. Generally, labor costs are included when calculating this credit. No cap exists on the amount of credit available except in the case of fuel cell property.

Not all energy-efficient improvements qualify for these tax credits. Be sure to check the manufacturer’s tax credit certification statement before purchasing or installing any of these improvements.

Read more here.

This special deduction is available regardless of whether you itemize your deductions. If you claim the standard deduction, that amount is increased by the special sales tax deduction.

Like so many incentives added to the tax code in recent months, this one has a limited life. To qualify, you must purchase a new vehicle before the end of this year.

Read more here.

The IRS Retirement Plan Navigator is intended to provide employers with an easy-to-use guide that focuses on three areas: choosing a plan, maintaining a plan and correcting a plan.

By using the navigator, you may find that choosing and maintaining a pension plan is not as daunting as you may have thought. Some plan types are less costly and easier to establish than others. The navigator does not suggest which plan may be best, but it does lay out the options to help you choose one that best fits your situation.

The navigator includes a side-by-side comparison of pension plans and their requirements. It also provides a checklist and suggested resources for maintaining compliance. Pension laws change frequently. You can minimize problems by doing a once-a-year review to ensure continued compliance.

Check out the Retirement Plan Navigator here.

Even if you use an outside payroll service to handle the deposits and paperwork, you remain responsible for your employment tax obligations.

In 2003, Forrest decided to again try to work as a contract attorney. She attended the ABA 2003 Midyear Meeting where she networked with colleagues and informed them she was available as a contract attorney. Before she secured any clients or earned any income as a contract attorney in 2003, she was reinstated by the California Department of  Corporations and returned to work.

Forrest argued that during 2003 she carried on a business of working as a contract attorney and that she paid certain expenses in connection with this business. The IRS argued that Forrest was not engaged in a business because she admittedly had no clients and reported no income related to the activity during 2003. Forrest argued that her activity in 2003 was a continuation of a business carried on previously.

The Tax Court concluded that, under the facts presented, Forrest’s activity in 2003 was not a continuation of a business carried on earlier. The court concluded that Forrest’s activity as a contract attorney in 2003 was not regular and continuous. Therefore, she was not entitled to a business expense deduction.

Read more in Forrest vs. Commissioner, T.C. Memo 2009-228, Oct. 5, 2009.

The IRS has provided guidance for retirement plan administrators, plan participants and retirees regarding the waiver of the RMD requirement for 2009, as provided in the Worker, Retiree, and Employer Recovery Act of 2008.

Generally, a required minimum distribution is the smallest annual amount you must withdraw from an IRA or an employer’s plan beginning with the year you reach age 70½. The 2008 law waives RMDs for 2009 for IRAs and defined contribution plans (such as 401(k) plans) and allows certain amounts that were distributed as 2009 required minimum distributions to be rolled over into an IRA or another retirement plan.

The IRS has issued a notice that provides relief for anyone who has already received a 2009 RMD this year. You generally have until the later of Nov. 30, 2009, or 60 days after the date the distribution was received, to roll over the distribution.

The notice also provides guidance for retirement plan sponsors. It contains two sample plan amendments that plan sponsors may adopt or use to amend their plans to either stop or continue 2009 RMDs. Both sample amendments provide that participants and beneficiaries can choose to receive – or not to receive – 2009 required minimum distributions. Both sample amendments allow the employer to offer direct rollover options of certain 2009 required minimum distributions.

Plan sponsors may need to tailor the sample amendment to their plan’s particular terms and administration procedures and must adopt the amendment no later than the last day of the first plan year beginning on or after Jan. 1, 2011 (Jan. 1, 2012, for governmental plans).

The IRS addressed the proper method of accounting for inventory by a franchised automobile dealership that sold new and used vehicles, sold vehicle parts and accessories and repaired vehicles in a 2007 technical advice memorandum (TAM 200736026).

The IRS concluded the dealer was engaged in production activities because it was installing parts on its own vehicles. The IRS also addressed how production costs would be handled by the taxpayer in the Simplified Resale Method absorption ratio, assuming the taxpayer was permitted to use the ratio. And the IRS addressed whether purchasing, storage and handling costs could be treated as mixed service costs or whether such costs should be treated as resale or production activities.

To give auto dealerships an opportunity to comply with the technical advice memorandum, the IRS has suspended examinations of this issue begun after Sept. 15, 2009. The suspension will last through Dec. 31, 2010, to give dealerships an opportunity to voluntarily comply with the procedures described in the memorandum.

The IRS addressed the proper method of accounting for inventory by a franchised automobile dealership that sold new and used vehicles, sold vehicle parts and accessories and repaired vehicles in a 2007 technical advice memorandum (TAM 200736026).

The IRS concluded the dealer was engaged in production activities because it was installing parts on its own vehicles. The IRS also addressed how production costs would be handled by the taxpayer in the Simplified Resale Method absorption ratio, assuming the taxpayer was permitted to use the ratio. And the IRS addressed whether purchasing, storage and handling costs could be treated as mixed service costs or whether such costs should be treated as resale or production activities.

To give auto dealerships an opportunity to comply with the technical advice memorandum, the IRS has suspended examinations of this issue begun after Sept. 15, 2009. The suspension will last through Dec. 31, 2010, to give dealerships an opportunity to voluntarily comply with the procedures described in the memorandum.

Read more in the Field Directive on the Planning and Examination of IRC 263A Issues in the Auto Dealership Industry.

Read more in Taproot Administrative Services, Inc. 133 TC No. 9, Sept. 30, 2009.

The IRS has reminded potential home buyers they must complete their first-time home purchases before Dec 1, 2009, to qualify for the first-time home buyer credit.

In other words, the last day to close on a home is Nov 30, 2009. The credit cannot be claimed until after the purchase is completed but, once completed, you may claim the credit on either your 2008 or 2009 return.

The credit is 10 percent of the purchase price of the home, up to a maximum credit amount of $8,000 ($4,000 for a married person filing a separate return). Home buyers who have never owned a home or have not owned one in the past three years may claim the credit.

The credit reduces your tax bill or increases your refund, dollar for dollar. Unlike most tax credits, the first-time home buyer credit is fully refundable. So the credit will be paid even if you owe no tax or the credit is more than the tax owed.

Only the purchase of a main home located in the United States qualifies. Vacation homes and rental properties are not eligible. If you are constructing the home, you qualify for the credit if you occupy the home before Dec. 1, 2009.

The credit is reduced or eliminated for higher-income taxpayers. The credit is phased out based on modified adjusted gross income (MAGI). For a married couple filing a joint return, the phaseout range is $150,000 to $170,000. For other taxpayers, the range is $75,000 to $95,000. Therefore, the full credit is available for married couples filing a joint return whose MAGI is $150,000 or less and for other taxpayers whose MAGI is $75,000 or less.

The credit must be repaid if, within three years of purchase, the home ceases to be your main home.

Read more in Information Release 2009-83.
 

IRS issues guidance on rollovers to Roth IRAs

The IRS has issued guidance describing the federal income tax consequences of rolling over an eligible rollover distribution from a qualified employer plan to a Roth IRA. The guidance reflects the creation of Roth accounts in qualified employer plans and the elimination of the income limitation on rollovers from traditional IRAs to Roth IRAs that takes effect Jan. 1, 2010.

Under the new guidance, a rollover from a Roth account in a qualified employer plan to a Roth IRA generally has no income tax consequences. A rollover from a non-Roth account in a qualified employer plan to a Roth IRA will have the same income tax consequences as a rollover from a traditional IRA to a Roth IRA. In general, you will be taxed on the amount transferred from the non-Roth account to the Roth IRA.

For rollovers prior to Jan. 1, 2010, the income limitations that apply to rollovers from traditional IRAs to Roth IRAs remain in effect. In other words, you cannot make a transfer from a non-Roth account to a Roth IRA prior to Jan. 1, 2010, unless your adjusted gross income for 2009 does not exceed $100,000.

Beginning Jan. 1, 2010, such rollovers will be permitted without regard to your adjusted gross income.

Persons whose business takes them to several different business locations during the course of a day can generally deduct as a business expense the cost of traveling between one business location and another. But when is traveling considered simply commuting?

Since commuting is a nondeductible personal expense, the courts have generally held that the cost of traveling from home to the first business location of the day and the cost of traveling home from the last business location of the day are nondeductible personal commuting expenses.

In an unusual set of facts, the Tax Court recently decided the case involving Leslie Freeman. Freeman worked for an auto parts distributor. He traveled each morning from his home to the company's warehouse. From the warehouse, his route took him though several stops.

Freeman's last business stop was at a point much closer to his home than to the warehouse. Rather than return to the warehouse, Freeman drove home, where he completed his reports for delivery to the warehouse the following morning, where his daily cycle began anew.

The IRS agreed that the cost of traveling between the warehouse -- the first business location of the day -- and the last business location of the day constituted business travel. Freeman argued, and the Tax Court agreed, that his morning commute was not the entire trip from home to the warehouse. Rather, the morning commute was limited to the trip from home to the last business location from the previous day.

In other words, the Tax Court allowed Freeman to treat the entire circuit of his route as a business expense. His nondeductible commute was limited to the distance from his home to the nearest point on his business route.

The IRS has launched a new Web section highlighting various tax breaks and Section 529 plan changes designed to help parents and students pay for college.

The new Tax Benefits for Education section on www.IRS.gov includes tips for taking advantage of education deductions and credits. It includes a special section highlighting 529 plans and frequently asked questions. It also features two key changes enacted earlier this year that will be in effect during 2009 and 2010.

One change allows families saving for college to use 529 plans to pay for a student's computer-related technology needs. Under the other change, more parents and students will be able to use the new American opportunity credit to pay part of the cost of college.

Tax-free college savings plans and prepaid tuition programs can be used to buy computer equipment and services for an eligible student during 2009 and 2010. Though contributions to 529 plans are not deductible, there is also no income limit for contributors.

Distributions from 529 plans are tax-free as long as they are used to pay qualified higher education expenses for a designated beneficiary. Qualified expenses include tuition, required fees, books, supplies, equipment and special needs services. For someone who is enrolled at least half time, room and board also qualify.

For 2009 and 2010, expenses for computer technology and equipment or Internet access and related services to be used by the student while enrolled at an eligible educational institution are added to the list of qualified expenses. In general, expenses for computer technology are not qualified expenses for the American opportunity credit, Hope credit, lifetime learning credit, or tuition and fees deduction.

The American opportunity credit modifies the existing Hope credit for tax years 2009 and 2010, making it available to more people. Income guidelines are expanded, and required course materials are added to the list of qualified expenses. The maximum annual credit is $2,500 per student. Some key features of the credit include:

• Tuition, related fees, books and other required course materials generally qualify. In the past, books usually were not eligible for education-related credits and deductions.
• The credit is equal to 100 percent of the first $2,000 spent and 25 percent of the next $2,000. That means the full $2,500 credit may be available if you pay $4,000 or more in qualified expenses for an eligible student.
• The full credit is available if your modified adjusted gross income (MAGI) is $80,000 or less (for married couples filing a joint return, the limit is $160,000 or less). The credit is phased out for incomes above these levels.
• Forty percent of the American opportunity credit is refundable. This means that even people who owe no tax can get an annual payment of the credit of up to $1,000 for each eligible student.

Those who do not qualify for the American opportunity credit include a married person filing a separate return, regardless of income; joint filers whose MAGI is $180,000 or more; and single taxpayers, heads of household and some widows and widowers whose MAGI is $90,000 or more.

The American opportunity credit applies only during the first four years of college. However, graduate students still qualify for the lifetime learning credit and the tuition and fees deduction.

There may be some surprises when the IRS announces the 2010 inflation adjustments later this fall.
 
Many tax provisions, such as dependency exemptions, tax brackets, etc., are adjusted annually for inflation. These adjustments generally reduce the amount of taxes you pay in the subsequent year. But, current indications are that inflation has been so low or nonexistent that new adjustments may be forthcoming.
 
Most of these adjustments can increase, but not decrease, from one year to the next. However, Mercer, the human resources consulting firm, is reporting that the maximum amount most workers can contribute to their 401(k) plans could be reduced from $16,500 in 2009 to $16,000 in 2010.
 
A flat or negative inflation rate also means that Social Security recipients may not receive a cost-of-living adjustment. Seniors have received a COLA every year since the adjustments were adopted in 1975. By law, Social Security benefits cannot decline. But because premiums for the Medicare drug program are expected to increase next year, seniors who have the premiums deducted from their benefits will see a drop in payments.

IRS issues new rules about taxation of tips

If you operate a business in which customers deposit employee tips in a jar or other receptacle, a new memorandum issued by the IRS Chief Counsel applies to you.
 
The memo addresses the employer's tax filing responsibilities for tips. It sets out rules for determining when an employer must include the tips in the income of the employees and how to deal with related issues of withholding taxes.
 
It all comes down to a matter of control. If the employer collects the tip jar, counts the money and distributes it to the employees, the tips are considered wages, and the employer is subject to the normal rules for wages paid. However, if the employees themselves are responsible for dealing with the tips, and a non-management employee is responsible for counting the tips, keeping the tips in a secure place and distributing the tips to eligible employees, the funds are not wages subject to withholding by the employer.
 
In any event, the employees should report the tips received as taxable income.
 
Read more here.

A federal district court in Arkansas has determined that a corporation was liable for penalties assessed against it for failure to timely file employer's tax returns, timely pay employer's quarterly taxes and timely make employer's federal tax deposits.

Benton Workshop, Inc., operates a commercial printing business. Janis Graves is the president of the corporation. Her husband, Thomas Graves, is the vice president.

In the spring of 2003, Mrs. Graves fell and hit her head, which caused neck and back injuries. Because of her ongoing pain and the effects of pain medication, Mr. and Mrs. Graves together decided that Mrs. Graves should generally give up her duties at the corporation, although Mrs. Graves continued to work for a few hours at a time when she was able to do so.

Mrs. Graves was responsible for preparing and filing the company's employment tax returns. Mr. Graves was aware of this fact and recognized that it was an important legal obligation of the company.

After Mrs. Graves stopped performing her duties, the company failed to timely file its payroll tax returns and timely deposit its payroll taxes for four consecutive quarters. The IRS imposed more than $25,000 in penalties.

The court upheld the penalties, ruling that even though there was no willful neglect, the president's illness was not reasonable cause for failure to file the returns and deposit the taxes.

Taking a page from David Letterman's Late Show script, the IRS has issued its own "Top 10 List" for those who plan to claim an itemized deduction for contributions to charity.
 
The points the IRS wants everyone to remember are:

1. Charitable contributions must be made to qualified organizations to be deductible. You can ask any organization whether it is a qualified organization and most will be able to tell you. You can also check IRS Publication 78, which lists most qualified organizations. IRS Publication 78 is available at www.IRS.gov.
2. Charitable contributions are deductible only if you itemize deductions using Form 1040, Schedule A.
3. You generally can deduct your cash contributions and the fair market value of most property you donate to a qualified organization. Special rules apply to several types of donated property, including clothing or household items, cars and boats.
4. If your contribution entitles you to receive merchandise, goods, or services in return -- such as admission to a charity banquet or sporting event -- you can deduct only the amount that exceeds the fair market value of the benefit received.
5. Be sure to keep good records of any contribution you make, regardless of the amount. For any contribution made in cash, you must maintain a record of the contribution such as a bank record -- including a cancelled check or a bank or credit card
   statement -- a written record from the charity containing the date and amount of the contribution and the donor's name, or a payroll deduction record.
6. Only contributions actually made during the tax year are deductible. For example, if you pledged $500 in September but paid the charity only $200 by Dec. 31, your deduction would be $200.
7. Include credit card charges and payments by check in the year they are given to the charity, even though you may not pay the credit card bill or have your bank account debited until the next year.
8. For any contribution of $250 or more, you must have written acknowledgment from the organization to substantiate your donation. This written proof must include the amount of cash and a description of any property you contributed, and whether
   the organization provided any goods or services in exchange for the gift.
9. To deduct charitable contributions of items valued at $500 or more you must complete a Form 8283, Noncash Charitable Contributions, and attach the form to your return.
10. An appraisal generally must be obtained if you claim a deduction for a contribution of noncash property worth more than $5,000. In that case, you must also fill out Section B of Form 8283 and attach the form to your return.

During difficult economic times, you may be tempted to tap into your retirement savings. Before withdrawing money from your tax-qualified retirement accounts, it pays to know the rules governing early withdrawals.
 
If you are under age 59½ and withdraw money from your retirement account, you will likely pay both income tax and a 10 percent early distribution tax on any previously untaxed money that you take out.
 
Withdrawals from a SIMPLE IRA before you are age 59½, as well as during the first twoyears from the first day that contributions are deposited, may be subject to a 25 percent additional early distribution tax instead of 10 percent.
 
You should consider the decrease in your retirement savings and the increase in tax before you withdraw money from any tax-qualified account, including an IRA, 401(k) or 403(b) account.
 
There are some exceptions to the early distribution tax. Early withdrawals from an IRA are not subject to the additional 10 percent tax if you use the amount withdrawn to pay for medical insurance premiums while unemployed, to cover qualified higher education expenses, or to buy, build or rebuild a first home. An exception also applies if you receive distributions in the form of an annuity.
 
For other types of retirement plans, the additional 10 percent tax does not apply if you separate from service and are age 55 or older in that year or you elect to receive the money in substantially equal periodic payments after separation from service.
 
Read more in Publication 590, Individual Retirement Arrangements (IRAs) and Publication 575, Pension and Annuity Income.

The tax man has entered the 21st century. The IRS has launched a YouTube video site and an iTunes podcast site.

You can visit the video site to view information about the 2009 tax provisions in the American Recovery and Reinvestment Act, including tax tips and how-to videos. The videos are in English, Spanish, American Sign Language and other languages.

The YouTube videos highlight the $8,000 first-time home buyer's credit for those who purchase a house this year, the sales or excise tax deduction on new car purchases, and the expanded credits for education and energy conservation. Also included is a video on using the IRS withholding calculator.

Many workers received the Making Work Pay tax credit in April through their tax withholding at work. However, people who have more than one job or working spouses should especially check their withholding to ensure neither too much nor too little is being withheld. People can use the calculator to help determine if they should make adjustments.

Visit the video site at www.youtube.com/irsvideos, or listen to the audio at iTunes or at:

If you deduct travel, entertainment, gift or transportation expenses, you must be able to substantiate certain elements of expense.

If you keep timely and accurate records, you will have support to show the IRS if your tax return is ever examined. You will also have proof of expenses that your employer may require if you are reimbursed for your expenses.

You should keep the proof you need in an account book, diary, statement of expense or similar record. You should also keep documentary evidence such as receipts, canceled checks or bills to support your expenses. Documentary evidence is not needed if your employer reimburses you under a per diem method for meals and/or lodging, if you have expenses other than lodging of less than $75, or if you have a transportation expense for which a receipt is not readily available.

Documentary evidence ordinarily will be considered adequate if it shows the amount, date, location and essential character of the expense. A canceled check, together with a bill from the payee, ordinarily establishes the cost. However, a canceled check by itself does not prove a business expense without other evidence to show that it was for a business purpose.

You 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 you do not need to provide a written explanation.

You must keep records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means you must keep records that support your deduction (or an item of income) for three years from the date you file the income tax return on which the deduction is claimed.

If you are a business owner, you may want to act soon if you are planning to acquire new business assets. At the end of 2009, some important tax breaks are scheduled to expire
 
For tax years beginning in 2009, you can generally deduct up to $250,000 of equipment and software placed in service this year. Both new and used assets are eligible. Known as the Section 179 deduction, this provision is an exception to the general rule that you must depreciate equipment and software costs over several years.
 
The Section 179 deduction is scheduled to be reduced to about $135,000 for tax years beginning next year. One limitation is that this deduction cannot create or increase an overall business loss. So if your business is having a marginal year, you may not be able to take full advantage of this deduction.

 Another big tax break is available for most new, but not used, business equipment and software and some leasehold improvements that are purchased and placed in service by Dec. 31, 2009. For these assets, your business can generally claim first-year bonus depreciation deductions equal to 50 percent of the cost that is left over after subtracting any allowable Section 179 deduction.

Unlike Section 179 deductions, bonus depreciation is available even if your business experiences a tax loss for the year.

The IRS has issued a private ruling detailing a plan under which a business can reimburse the cost of tools purchased by employees so that the reimbursements are not taxable to the employees.

This ruling should be useful to employers and employees in construction and other industries that require the use of specialized tools or testing equipment. If a tool reimbursement plan qualifies as an "accountable plan arrangement," reimbursements are not subject to income and Social Security taxes.

For the plan to qualify, there must be a business connection between the amount reimbursed and the performance of services as an employee. Also, the employee must substantiate the expenses to the employer within a reasonable period. Finally, the employee must return reimbursements that exceed the substantiated expenses.

Normally, the IRS has three years within which to examine your tax return and assess any additional tax. A special provision of the tax code extends that period to six years if you omit more than 25 percent of the income that should have been reported on the return.
 
In 2007, the Court of Federal Claims ruled that the six-year rule applied in a situation where a partnership overstated the basis of an asset it sold. The case involved a complex transaction involving short-sale and partnership-termination rules.
 
By overstating the basis, the partnership reported a lower gain on the sale. The amount of the missing gain was more than 25 percent of the partnership's gross income for the year.
 
Now the Court of Appeals for the Federal Circuit has ruled that overstatement of basis is not an omission of income for purposes of the six-year rule.
 
More commonly, taxpayers sometimes sell assets that were acquired many years in the past, and basis information may be sketchy at best. This case should put the IRS under a three-year limit to challenge the basis calculation.
 
Read more in Salman Ranch Ltd. v. United States, CA-FC, July 30, 2009. 

The Consumer Assistance to Recycle and Save Act of 2009 (CARS), more commonly known as, "Cash for Clunkers," became effective on July 23 and ran through its $1 billion budget in just a few days. Congress scrambled to triple the budget in the hope of extending the program at least to Labor Day.
 
For those who purchase new cars under the program, the rebate is tax exempt. But there is no exemption for auto dealers. They must include the rebate as part of the purchase price and therefore as part of gross income. However, the dealer can deduct the costs of implementing and maintaining the rebate program.
 
States are divided on whether the consumer has to pay and the dealer has to collect sales tax on the rebate amount. Some states levy sales tax on the gross vehicle price. Other states tax the sales price net of the rebate amount. Check the rules in your state before purchasing a new car.
 
For 2009, you can claim an income tax deduction for the sales tax charged on the first $49,500 of the cost of a vehicle. This deduction is available whether or not you itemize your deductions. If you live in one of the states without a sales tax, you may be able to deduct other fees imposed on the transaction.

The IRS has issued a reminder about several tax breaks made available by the American Recovery and Reinvestment Tax Act of 2009.

To take advantage of these tax benefits, in many cases, you must take action within the 2009 or 2010 calendar years.

• The expanded $8,000 first-time home buyer credit requires a home purchase before Dec. 1, 2009.
• The deduction for the local sales and excise taxes of qualified new vehicle purchases (up to $49,500 in cost) requires the purchase of the vehicle before Jan. 1, 2010.
• The 30-percent credit for energy-efficient home improvements applies to improvements placed into service in 2009 and 2010.
• The expanded Hope scholarship credit, temporarily applicable to the first four years of college rather than only the first two, applies to tax years 2009 and 2010.
• The expansion of education savings plans to allow for the purchase of computer technology, Internet access and related services applies to 2009 and 2010.

The Tax Court recently ruled that a same-sex couple was not entitled to file a joint federal income tax return.

Charles Merrill and Kevin Boyle have been together for more than 18 years. During 2004 and 2005, they lived in North Carolina, where they participated in a commitment ceremony in 2004. North Carolina did not recognize same-sex marriages. They were legally married in 2008 after moving to California.

The IRS contacted Merrill after he failed to file a tax return for 2004 or 2005. Merrill responded with a letter stating that he was not evading taxes. Rather, he refused to pay taxes as an act of civil disobedience advocating same-sex marriage equality. In response, the IRS prepared substitute returns, using the single filing status, and issued deficiency notices to Merrill.

The Tax Court noted that Merrill was not married during the years at issue. It also noted that he did not file a return for the years at issue and, therefore, is not entitled to married filing jointly status. The court observed that whether a person is married is determined by reference to the laws of the state of his marital domicile for federal income tax purposes. The court ruled against Merrill on the narrow issue that he did not file a joint return.

A stinky problem could mean a tax deduction.
 
Between 2004 and 2006, more than 100,000 homes were built in 14 states using defective drywall manufactured in China. In heat and humidity, sulfur gas is released from the walls, which causes a rotten-egg or ammonia-like odor that makes homeowners sick. The fumes can corrode copper pipes and wire. Most of the homes identified so far are in Louisiana, Florida, South Carolina and California.
 
In a recent letter from an IRS associate chief counsel to members of Congress, the IRS determined that any damage sustained by the homeowners resulted from "an identifiable event that is sudden, unexpected, and unusual." That is the criteria for claiming a casualty loss deduction on a homeowner's tax return.
 
The letter does not address how to measure the amount of the deduction, but the obvious starting point might be the cost of removing the old drywall and replacing it.
 
Casualty losses are an itemized deduction, and the amount of each loss must be reduced by $100. The deduction is limited to the total of all casualty losses for the year that exceeds 10 percent of your adjusted gross income.
 
Read more in the IRS drywall letter.

A recent Tax Court case ruling refused to allow the IRS to treat losses from businesses operated as a limited liability partnership (LLP) or a limited liability company (LLC) as passive losses, without reviewing the extent to which the business owner was actively involved in the business (Garnett v. Commissioner, 132 T.C. No. 19, June 30, 2009).
 
Now the Court of Federal Claims has gone one step further and ruled that owners of interests in LLPs and LLCs are not "limited partners." They are not governed by the passive loss rules relating to limited partners. As such, the decision as to whether the passive activity rules apply to owners of LLPs and LLCs is determined by whether the owner "materially participates" in the business. This is the same standard that applies to business owners in general.
 
If you are the owner of a LLP or LLC interest that produced losses in prior years that you treated as passive losses, you may want to review your prior returns to determine whether refund claims may be appropriate.
 
Read more in James R. Thompson v. United States, US Ct of Fed Claims, 06-211, July 20, 2009.

Here's a tax break for the busy summer.

Many working parents must arrange for care of their children under 13 years of age during the school vacation period. A popular solution -- with a tax benefit -- is a day camp program.

The cost of day camp can count as an expense toward the child and dependent care credit. Expenses for overnight camps do not qualify.

You figure the credit on up to $3,000 of expenses for one child or $6,000 for two or more children. The credit rate ranges from 20 to 35 percent of expenses, depending on your income. The 35 percent rate applies if your income is under $15,000; the 20 percent rate, if your income is over $43,000.

If you own an interest in a business that operates as a limited liability partnership (LLP) or a limited liability company (LLC), you may wish to follow future developments in a recently decided Tax Court case, particularly if your business interest produces losses that have been treated as passive losses for tax-reporting purposes.
 
In the new case, Paul and Alicia Garnett owned interests in seven LLPs and two LLCs that were engaged in agribusiness operations, primarily the production of poultry, eggs and hogs. Following its standard procedure, the IRS treated all of the Garnetts' losses from these businesses as passive activity losses, meaning that those losses could be used only to offset passive activity income. The Garnetts argued that they were actively involved in these businesses, which should make the losses active rather than passive, thereby allowing them to fully deduct the losses.
 
While the Tax Court ruled in favor of the Garnetts, the ruling is quite technical, and the implications tend to be misreported in the popular press. In effect, the Tax Court ruled that the IRS could not treat the losses as passive simply because they were generated from LLPs and LLCs. Rather, the case will have to go to trial to determine whether, in fact, the Garnetts actively participated in the business activities.
 
The confusion stems from the fact that Congress wrote the applicable tax law at a time when LLPs and LLCs did not exist. So the court will ultimately have to determine how Congress intended the law to apply to these types of entities.
 
The ultimate resolution of this case may resolve not only whether LLP and LLC losses are passive but also whether profits from those entities are subject to self-employment tax.
 
Read more in Garnett v. Commissioner, 132 T.C. No. 19, June 30, 2009.
 

Congress has passed the cash-for-clunkers bill, more formally known as the Car Allowance Rebate System (CARS).

Under this bill, car buyers will be eligible for a tax-free voucher of either $3,500 or $4,500 toward the purchase or lease of a new, more fuel-efficient vehicle between July 1 and Nov. 1, 2009.

The amount of the credit generally depends on the type of vehicle you purchase and the difference in fuel economy between your new vehicle and the vehicle you trade-in. You must purchase a new vehicle to be entitled to the credit. The new vehicle may be U.S.- or foreign-made, and the price cannot exceed $45,000.

Car dealers are referring to the voucher as a credit, but it is not a credit to be claimed on your tax return nor will you receive a voucher. Instead, the dealer will reduce the purchase price of the vehicle and be reimbursed by the federal government.

To qualify as a "clunker," your trade-in vehicle must have a combined city/highway fuel economy of 18 miles per gallon or less, be drivable, have been continuously registered and insured by you for one year before trade-in, and be no more than 25 years old.

Since the program requires the dealer to "junk your clunker," don't expect to get a significant trade-in allowance in addition to the credit.

The IRS has responded to  a recent letter it received from members of the Senate Finance Committee and the House Ways and Means Committee. The letter had asked the IRS to suspend certain "tax shelter" penalties assessed on small businesses and individuals while Congress works on corrective legislation.

IRS Commissioner Douglas H. Shulman has responded by announcing that the IRS will hold off until at least Sept. 30, 2009, before taking any collection enforcement action on cases in which the annual tax benefit from the transaction is less than $100,000 for individuals or $200,000 for businesses per year.

Because the penalty determination is related to the underlying transaction, and the IRS can determine the amount of tax benefit only through examination, it will not suspend its examination of such cases.

The summer months can be a stormy time of the year. Hurricane season is now under way, and high winds and tornadoes can accompany thunderstorms. Add flooding and the occasional earthquake and no area of the country is entirely safe from natural disasters.

From a tax standpoint, you should develop a disaster recovery plan for your business and personal affairs by taking a few simple steps:

1. Create a backup set of electronic records
Keep your backup records in a safe place, stored at a different location from the original records. Keeping a backup set of records is easier now that many financial institutions provide statements and documents electronically, and much financial information is available on the Internet. Even if the original records are provided only on paper, they can be scanned into an electronic format. With documents in electronic form, you can download them to a backup storage device, like an external hard drive, or burn them to a CD or DVD.

2. Document your valuables
Photograph or videotape the contents of your home and business, especially items of higher value. The IRS has a disaster loss workbook, Publication 584, which can help you compile a room-by-room list of belongings. A photographic record can help prove the market value of items for insurance and casualty loss claims. Photos can be stored electronically or given to a friend or family member who lives outside your area.

3. Update emergency plans
Emergency plans should be reviewed annually. Personal and business situations change over time, as do preparedness needs. When employers hire new employees or when a company or organization changes functions, plans should be updated accordingly and employees should be informed of the changes.

4. Check your insurance coverage
Make sure property insurance covers the full replacement cost of the asset insured. Meet with your insurance agent to review deductibles and determine whether additional riders are necessary. Be sure you understand what risks are covered and which are excluded. If you have a business, consider business interruption coverage.

A few simple steps now can prevent unpleasant surprises later

The federal Making Home Affordable modification program helps homeowners who have defaulted, or are at risk of default, on their mortgages.

A homeowner who makes timely payments on a modified loan is eligible to have incentive payments made to lenders/investors that reduce the principal balance on the loan. The IRS has determined that these Pay-for-Performance Success Payments are excludable from the homeowner's income under the general welfare exclusion of the income tax law.

For many businesses, summer traditionally brings an influx of part-time or seasonal workers into the work force. Employers are responsible for treating these workers properly for employment tax purposes.

Generally, workers are either employees or independent contractors, based upon the facts and circumstances of the relationship between the business and the worker. For federal income tax withholding, Social Security, Medicare, and federal unemployment tax purposes, neither the number of hours worked nor the amount earned determines the status of an individual as independent contractor or employee.

For example, an individual can be an employee even though the individual works one hour a week or one day a year. Part-time or seasonal workers who are employees are subject to the same tax withholding rules that apply to other employees.

Members of the Senate Finance Committee and House Ways and Means Committee have asked IRS Commissioner Douglas H. Shulman to suspend certain penalties assessed on small businesses while Congress works on legislation to address what they term an inequitable and unintended consequence in the tax code.

The members of Congress are concerned that small businesses with investments in listed tax shelter transactions have been assessed tax penalties significantly larger than the tax benefits received.

 In a letter dated June 12, 2009, the lawmakers requested that Shulman "use the discretion provided to the IRS with its effective tax administration authority to suspend efforts to collect IRC (Internal Revenue Code) Section 6707A liabilities ... while Congress acts to remedy this situation." Code Sec. 6707A was enacted in 2004 as part of a package of provisions intended to help the IRS detect, deter and shut down tax shelters.
 
Treasury regulations require taxpayers to tell the IRS if they invest in "listed" tax shelter transactions, and Code Section6707A imposes penalties on taxpayers who fail to disclose this information. For listed transactions, the penalties are $100,000 for natural persons and $200,000 for others.
 
The lawmakers pointed out that the inequitable consequences were unexpected at the time the penalty was enacted, and they plan to introduce legislation that would result in penalty amounts that are more reasonable in proportion to the tax benefits. No timetable was offered as to when new legislation might be introduced.
 
Read more in the Letter to the IRS

The IRS has clarified the income tax deduction authorized by Congress to stimulate new car sales.

The deduction for state and local sales or excise taxes on the purchase of new vehicles is available to purchasers in states without a sales tax. If you purchase a new motor vehicle in a state that does not have state sales taxes, you are entitled to deduct other fees or taxes imposed by the state or local government. The fees or taxes must be assessed on the purchase of the vehicle and must be based on the vehicle's sales price or as a per-unit fee.

To qualify for the deduction, you must purchase a new vehicle between Feb. 17 and Dec. 31, 2009. Importantly, the deduction is available even if you don't itemize. That means the deduction also reduces your adjusted gross income (AGI) for purposes of determining whether you qualify for other tax breaks.

If your new vehicle is very expensive, the deduction is limited to the portion of the tax attributable to the first $49,500 of the purchase price. To qualify for the full deduction, your modified AGI cannot exceed $125,000 for individuals or $250,000 for married couples. No deduction is available if your modified AGI is greater than $135,000 for individuals or $260,000 on a joint return.
 
The deduction is available for any qualified purchase of a new car, light truck, motor home or motorcycle.
 
Read Information Release 2009-60 here.

IRS clarifies rules for unemployed, formerly self-employed, workers

If you are living and working abroad, you may be entitled to the foreign earned income exclusion. But qualifying for the exclusion may be more complicated than it sounds.

The Tax Court ruled recently that a flight attendant could not treat income earned in international airspace as income earned in a foreign country because such airspace is not under the sovereignty of a foreign government. The court had previously denied the exclusion to a worker in Antarctica for the same reason.
 
Yen-Ling Rogers was a flight attendant for United Airlines based in Hong Kong. She regularly flew round-trip flights from Hong Kong to San Francisco or Chicago. Rogers contended that all of her income was earned for services performed outside the United States. However, the IRS contended, and the Tax Court agreed, that only services she provided in a foreign country or while flying over a foreign country qualified for the exclusion.

Generally, the earned income exclusion is available to United States citizens and resident aliens who live and work abroad. These individuals may be able to exclude all or part of their foreign salary or wages from their income when filing their U.S. federal tax return. They may also qualify to exclude compensation for their personal services or certain foreign housing costs.
 
To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must have a tax home in a foreign country and income received for working in a foreign country, otherwise known as foreign earned income. The taxpayer must also meet one of two tests: the bona fide residence test or the physical presence test.
 
The foreign earned income exclusion is adjusted annually for inflation. For 2009, the maximum exclusion is $91,400 per qualifying person. 
 
Read more in W.D. Rogers v. Commissioner, TC Memo. 2009-111, May 20, 2009.

June 30 is the deadline for filing the current year Report of Foreign Bank and Financial Accounts, Treasury Form TD F 90-22.1 (FBAR).

FBAR forms are deemed filed when received by the IRS, not when postmarked, so use certified mail with return receipt when filing these forms. There is no extension of time to file available. 
 
The IRS has announced that you can rely on the definition of a United States person as set forth in the prior instructions to the FBAR form when determining your filing requirement. The IRS took this action to reduce the burden after concerns and questions were raised regarding the new instructions issued last year on who must file the revised Form TD F 90-22.1.
 
For this year, you can rely on the definition of a United States person included in the prior instruction: "United States Person - The term "United States person" means (1) a citizen or resident of the United States, (2) a domestic partnership, (3) a domestic corporation, or (4) a domestic estate or trust."
 
All other requirements of the current version of the FBAR form and instructions (revised in October 2008) are still in effect. The current version of the form must be used when filing an FBAR.

This substitution affecting who must file the FBAR applies only to FBARs due on June 30, 2009. The IRS will follow up with additional guidance on the requirement to file for future years.
 
Read more in Announcement 2009-51.

Businesses planning to claim the newly expanded work opportunity tax credit (WOTC) for eligible unemployed veterans and unskilled younger workers hired during the first part of 2009 have until Aug. 17 to request the certification required for these workers, according to the IRS.

The American Recovery and Reinvestment Act, enacted in February, added unemployed veterans returning to civilian life and "disconnected youth" to the list of groups covered by the credit. Though eligible unemployed veterans and disconnected youth who begin work anytime during 2009 or 2010 may qualify a business for the credit, certification by the state work force agency is required.

In general, an unemployed veteran is a person discharged or released from the military during the five years preceding the hiring date, who received unemployment benefits for at least four weeks during the one-year period ending on the hiring date. A "disconnected youth" is a person age 16 to 24 on the hiring date who has not been regularly employed or attending school and who meets other requirements.

The WOTC offers tax savings to businesses that hire workers belonging to any of 12 targeted groups. The other 10 groups include people ages 18 to 39 living in designated communities in 43 states and the District of Columbia, Hurricane Katrina victims, recipients of various types of public assistance, and certain veterans, summer youth workers and ex-felons.
The certification requirement applies to all groups of workers except employees who were Hurricane Katrina victims.

Normally, a business must file Form 8850 with the state work force agency within 28 days after the eligible worker begins work. But under a special rule, businesses have until Aug. 17, 2009, to file this form for unemployed veterans and disconnected youth who begin work on or after Jan. 1, 2009, and before July 17, 2009.

The IRS has published proposed regulations allowing employers that incur a substantial business hardship an alternative to terminating their §401(k) safe harbor plans. Qualifying employers can reduce or suspend required safe harbor nonelective contributions without losing their plan's qualified status.

Prior to issuance of the proposed regulations, employers were required to maintain the safe harbor plan throughout the entire plan year, with two exceptions:

1. The employer could amend the plan to reduce or suspend safe harbor matching contributions on future employee elective contributions.
2. The employer could terminate the plan. 

The proposed regulations allow an employer that suffers a substantial business hardship to amend its plan to reduce or suspend the plan's safe harbor nonelective contributions if procedural requirements specified in the proposed regulations are followed. 

In determining whether the employer is suffering a substantial business hardship, the IRS will consider whether: 

• The employer is operating at an economic loss.
• There is substantial unemployment or underemployment in the trade or business and in the industry concerned.
• The sales and profits of the industry concerned are depressed or declining.
• It is reasonable to expect that the plan will be continued only if the waiver is granted. 

The Small Business Administration has announced a new loan program for debt-burdened small businesses. The program is called the American Recovery Capital (ARC) Loan Program.

Guaranteed by the SBA, the ARC Loan Program provides interest free loans to small businesses "for the purpose of making principal and interest payments on existing, qualifying small business loans for up to six months." These loans can include credit card loans, capital leases, Certified Development Company (504) loans, other loans made without an SBA guaranty, and loans made with or without an SBA guaranty since Feb. 17, 2009.

The ARC Loan provides up to $35,000 to qualified small businesses to make payments of principal and interest, on one or more existing qualifying small business loans for up to six months. The loan is interest free and 100 percent guaranteed by the SBA. No collateral is needed, and there are no fees associated with the loan.

Repayment of the ARC Loan principal is deferred for 12 months after the last disbursement of the proceeds. Repayment can extend up to five years.

The loan is available to viable, for-profit small businesses in the United States that are experiencing immediate financial hardship. To qualify, you must be able to prove the viability of your business by providing evidence that you can project sufficient cash flow to be able to meet the loan payments over a two-year period from the loan approval date.

ARC Loans are provided by commercial lenders. Your lender or bank can help determine your eligibility.

The Tax Court has agreed that the leasehold improvements made by a partnership to a hotel property owned by a city were substitutes for rent, and the cost of the leasehold improvements was allowed as a tax deduction. The partnership operated a Sheraton Hotel at the Cleveland Hopkins International Airport.

The property was owned by the city of Cleveland. The partnership was losing money, and the property was in need of repair. Through a series of negotiations, the partnership and the city reached an agreement whereby the cost of certain improvements approved by the city would be credited against rent otherwise payable by the partnership.

In allowing the deduction for the cost of the improvements, the Tax Court ruled that:

• The partnership's transfer of the improvements to the city was not illusory because the benefits and burdens of ownership shifted to the city in the year the improvements were credited against rent.
• The rent credit arrangement had a subjective business purpose and had objective economic substance.
• The negotiation of the lease agreements to include rent credits provided the partnership with a significant benefit independent of any tax considerations.
• The parties to the lease had valid business reasons for choosing the rent credit structure over other alternatives.
  Finally, the court ruled that the partnership's method of accounting for the improvements clearly reflected income and was not a change in accounting method.

The first-time home buyer tax credit is set to expire at the end of November. Now the Department of Housing and Urban Development (HUD) has announced a plan to allow borrowers who use Federal Housing Administration (FHA) financing to apply the first-time home buyer credit toward the purchase of a home. The new policy is the latest move by the Obama administration to spur demand in the housing market.

Through Nov. 30, 2009, qualified first-time home buyers are entitled to a tax credit equal to 10 percent of the purchase price of the dwelling, or $8,000, whichever is smaller. Normally, the tax credit can be claimed only by filing your federal income tax return once the home has been purchased. Several states -- including Colorado, Idaho, Missouri, New Jersey and Ohio -- allow people to "monetize" the tax credit by advancing money to qualified borrowers so that they can apply the funds from the tax credit toward the down payment on a home purchase.

HUD has announced that it will allow FHA borrowers to do something similar. However, amounts advanced by FHA lenders cannot be used to meet FHA's minimum 3.5 percent down payment. The law bars such lenders from assisting borrowers with their down payments. FHA borrowers may use the money to increase the size of their down payment above the 3.5 percent minimum or to pay closing costs, any upfront interest charges or FHA's upfront premium.

State and local housing finance agencies as well as certain nonprofits aren't barred from assisting FHA borrowers with their down payment. They will be allowed to provide short-term loans to borrowers for that purpose under FHA's new policy. To assure that lenders and borrowers don't abuse the program, HUD requires that any fees and costs charged by the lender to advance funds from the tax credit must be reasonable.

If you are thinking about buying one of those new electric vehicles designed to get you to the grocery store and run other neighborhood errands, both the Emergency Economic Act of 2008 and the American Recovery and Reinvestment Act of 2009 created tax credits that can help lower your out-of-pocket cost.

The credit for qualified plug-in electric drive motor vehicles placed in service between Jan. 1, 2009, and Dec. 31, 2014, is $2,500 plus an additional $417 for each kilowatt hour of traction battery capacity in excess of four kilowatt hours.

For purchases after Feb. 17, 2009, a separate credit is available for 10 percent of the cost of acquiring certain electrically powered two-wheeled vehicles, three-wheeled vehicles and low-speed vehicles. The credit is available in the tax year the vehicle is placed in service.

Qualifying vehicles, often called "neighborhood electric vehicles," must be manufactured primarily for use on public roadways. Some vehicles may qualify for either or both credits, but you can claim only one credit per vehicle.

The IRS has issued a new ruling clarifying the tax treatment when you sell or surrender a life insurance policy. The ruling describes three situations: a surrender of a cash-buildup policy to the insurance company, a sale of a cash-buildup policy to a third party, and a sale of a term policy to a third party.

The ruling describes how to calculate the tax basis in the insurance policy to determine the amount of gain on the sale. For a policy you own personally, as opposed to one owned by a business, gains are taxable but losses are nondeductible personal losses.

The ruling also concluded that any gain attributable to the cash buildup in the policy is taxed as ordinary income. Only gain attributable to a payment from a third party in excess of the policy's cash buildup would qualify for capital gain treatment.

Read Revenue Ruling 2009-13 here.

The federal minimum wage rate will be increased to $7.25 per hour, effective July 24, 2009. The rate has been set at $6.55 per hour since July 24, 2008.

The federal minimum wage provisions are contained in the Fair Labor Standards Act (FLSA).   

Many states also have minimum wage laws. Some state laws provide greater employee protections, and employers must comply with both. If the state minimum wage is higher than the federal amount, employees are entitled to the greater amount.

Read more in FSLA Fact Sheet #14 here.

Do the abbreviations "i.e." and "e.g." confuse you? Are you unsure which one to use? A recent tax case required the court to deliver a grammar lesson.

First a little background on the tax issue involved in the case. Compensation received for physical injury is generally excluded from income. However, emotional trauma is not considered physical injury. So payments received for emotional distress are fully taxable.

In a settlement with her former employer, Laura Seidel received $157,000. The settlement agreement described the payment as being for "personal injury (i.e., emotional distress) damages only."

The case originally went before the Tax Court in 2007. All of the parties - the court, Seidel and the IRS - focused their attention on the "i.e." Seidel argued that emotional distress was an example of the types of injuries she received. The IRS argued that "i.e." is a limiting phrase that should be read to mean that emotional distress was the only type of personal injury being compensated by the payment.

The Tax Court observed that "i.e." is an abbreviation for the Latin phrase id est, which roughly means "that is" or "that is to say." Accordingly, the court agreed with the IRS.

Now the Court of Appeals for the 9th Circuit has upheld the Tax Court. Interestingly, the higher court did not comment on the Tax Court's grammar skills. The appellate court simply upheld the Tax Court's decision in an unpublished opinion.

Note that Seidel might have fared better if the settlement agreement had used "e.g." instead of "i.e." Both are abbreviations for Latin terms. However, "e.g." stands for exempli gratia, which means "for example."   

In the last issue of Washington Tax Update, we advised pensioners that new IRS withholding tables may, in some cases, cause too little to be withheld from pension payments, resulting in additional taxes owed when 2009 income tax returns are filed.

Now the IRS has advised payors of pension benefits, that they are not required to use new withholding tables that reflect lower withholding due to the Making Work Pay tax credit in effect for 2009. However, payors are given the choice of using the new withholding tables or the withholding tables that were issued before the new tax credit was enacted.

Pension recipients are now faced with an additional challenge. If you qualify for the Making Work Pay tax credit, and taxes are being withheld using the old withholding tables, you may be overwithheld. If you don't qualify for the credit and your payor uses the new withholding tables, your taxes may be underwithheld. You are going to have to check carefully to avoid a surprise next April 15. 

Read Information Release 2009-50 here.

You may have noticed a modest increase in your take-home pay recently.

To encourage you to spend more to stimulate economic activity, the government adjusted the income tax withholding tables so the tax savings from the new Making Work Pay Credit is immediately available. This credit is equal to 6.2 percent of earned income – from a job or from self-employment – up to a maximum of $400. A married couple can get up to $800, even if only one works.

Everyone is not eligible for the credit, however, including high income households, dependents and nonresident aliens. Because withholding tables cannot always distinguish those eligible for the credit, it is possible that you could have your withholding reduced inappropriately.

You are most likely to have this problem if you and your spouse are both working, you hold more than one job at the same time or you are someone else’s dependent. If you are self-employed, you will not benefit from the credit until you file your 2009 return unless you reduce your quarterly estimated tax payments to account for the credit.

If you want to check to see if the credit has been reflected in your take-home pay, compare a recent pay stub to one issued in February to see if your withholding has gone down. For most people, the amount will drop by $10 to $15 per week. If you don’t think you will qualify for the credit, consider filing a new Form W-4 with your employer to increase your withholding and avoid a tax surprise next April 15.

Here are some reasons you may not qualify for the Making Work Pay Credit:

• You make too much money. The credit phases out for single filers with adjusted gross income between $75,000 and $95,000 and for joint filers with adjusted gross income between $150,000 and $190,000. Adjusted gross income counts all of your income, not just the amount you earn from your job.
• You are a dependent. Young people can often be claimed as dependents by their parents, while elders can sometimes be claimed as dependents by their children.  Dependents are not eligible for the credit.

Here are some reasons you may qualify for the Making Work Pay Credit, but your employer may reduce your withholding too much.

• You work more than one job at the same time. Each employer may cut your withholding by up to $400, but you are entitled to only one credit.
• You and your spouse both work. The new withholding tables generally reduce withholding by $600 for married workers. That means it is possible that the combined withholding for you and your working spouse could be reduced by $1,200, although your maximum credit is $800.

The IRS has released three pieces of guidance regarding new energy credits available to both individuals and businesses.

In Information Release 2009-44, the IRS reminds taxpayers that new tax benefits were enacted as part of the American Recovery and Reinvestment Tax Act of 2009. These benefits are available to individuals and businesses that reduce energy use and to producers that create new energy sources.

For homeowners, tax credits have been increased for energy-efficient improvements or installation of alternative energy equipment. Homeowners seeking to claim these credits may rely temporarily on existing manufacturer certifications or Energy Star labels in determining which products are qualified until the IRS announces updated certification guidelines.

Under provisions relevant to energy producers, taxpayers who place in service facilities that produce electricity from wind or other renewable resources can choose among the following:

• The energy investment tax credit
• The renewable electricity production tax credit
• A grant from the Treasury Department

The IRS has also issued Fact Sheet 2009-10, which summarizes the provisions of the new law that provide new, extended or increased incentives for taxpayers' efforts to increase energy efficiency. The most in-depth discussion focuses on the residential energy property credit. This credit is available for improvements including the addition of insulation, energy-efficient exterior windows and energy-efficient heating and air conditioning systems.

Other credits discussed in the fact sheet include:

• The residential energy efficient property credit
• The plug-in electric drive vehicle credit
• The plug-in electric vehicle credit for smaller vehicles
• The credit for plug-in electric drive conversion kits
• The alternative motor vehicle credit
• The renewable energy production tax credit
• The energy investment credit
• The credit for alternative fuel vehicle refueling property

The fact sheet also discusses the opportunity for businesses to obtain renewable energy grants in place of the energy investment credit or the renewable energy production credit.

Finally, in Notice 2009-41, the IRS has provided interim guidance on the credit provided for residential energy-efficient property. This credit applies to expenditures on qualified solar electric property, qualified solar water-heating property; qualified fuel cell property; qualified small wind energy property and qualified geothermal heat pump property. The credit extends to labor costs for site preparation, assembly, original installation and piping or wiring to connect the property to the dwelling.

The IRS has issued a ruling describing the payroll tax consequences for employers who continue to pay employees who leave their job to go on active duty with the military.

According to the ruling, this differential pay is subject to income tax withholding but is not subject to either Federal Insurance Contributions Act (FICA) or Federal Unemployment Tax Act (FUTA) taxes. The payments must be reported to employees annually on Form W-2.

The Court of Appeals for the 10th Circuit has upheld a decision of the Tax Court that the lead defense attorney for Timothy McVeigh in the Oklahoma City bombing trial could not claim a charitable contribution deduction for the donation of discovery material he had accumulated during the trial.

The attorney's tax basis in the material was zero. Therefore, unless the property was a long-term capital asset, the amount of the deduction would also be zero because the charitable contribution deduction would be reduced by the amount that would be ordinary income in a hypothetical sale.

The Tax Court had previously held that the attorney did not own the property because, under Oklahoma law, discovery materials belong to the client. Alternatively, the material was not a capital asset because capital assets do not include "a letter or memorandum, or similar property, held by a taxpayer whose personal efforts created such property ... (or by) a taxpayer for whom such property was prepared or produced."

The appellate court ruled that copies of FBI memoranda, lab reports, computer discs and photographs containing information regarding McVeigh, as well as letters to McVeigh from the FBI and Department of Justice, were clearly letters, memoranda or similar property within the plain language of the statute.

Although the material was not originally created for the attorney's benefit, it was produced or prepared for the attorney. The material was copied, organized and categorized by the government for the benefit of the attorney and his client and then placed in boxes with a letter listing the contents. The material, which was of the type typically produced for use in a criminal trial, was then provided to the defense attorney. The appeals court never ruled on ownership.

Read more in Sherrel and Leslie Steven Jones v. Commissioner, CA-10, 2009-1 USTC ¶50,316, March 27, 2009.

The IRS recently provided a six-month grace period during which taxpayers with offshore financial interests can voluntarily reveal previously undisclosed foreign financial accounts and pay a reduced penalty.

U.S. citizens and residents are required to pay tax on worldwide income. They are also required to disclose to the IRS ownership interests in foreign accounts, often by filing form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, commonly known as FBAR.

The IRS has indicated it will not pursue criminal penalties against those who voluntarily disclose during the grace period.

This opportunity to become compliant is available until Sept. 23, 2009. 

Read more in the IRS's FBAR Voluntary Disclosure Memo.

If you paid your taxes with a credit or debit card this year, keep track of any convenience fees charged by your card company. Convenience fees can be charged to offset the costs associated with the processing of credit card charges  The IRS had previously declined to allow a deduction for these fees but has reconsidered.

 If you itemize your deductions in 2009, you will be able to deduct the convenience fees as a miscellaneous itemized deduction. Miscellaneous itemized deductions are deductible only to the extent the total exceeds 2 percent of your adjusted gross income (AGI).

Read IRS Information Release 2009-37 here.

Will the tax code change in 2011?

President Obama has formed a task force, chaired by former Federal Reserve chairman Paul Volcker, to study ways to revise the federal tax laws. The task force is charged with closing loopholes, streamlining the law and generating revenue to pay for the stimulus/recovery program.

Consistent with promises made during the campaign, the president has directed the panel not to increase taxes on families earning less than $250,000 a year and not to increase taxes in 2009 or 2010. The timetable is to have recommendations ready for the 2011 budget.

Past attempts to simplify the tax code have met with mixed results. President Reagan managed to remove a plethora of loopholes and tax breaks to construct a two-tiered system of 28 percent and 15 percent tax rate, with a "bubble rate" of 33 percent, on all personal income. The system did not last long.

Both Presidents George H. W. Bush and Bill Clinton raised income taxes, expanding the number of tax brackets from two to eventually five. Currently, there are six tax brackets.

Congress regularly inserts tax breaks and loopholes to satisfy political objectives and lobbyists. The first President Bush appointed the most recent bipartisan commission to study tax revisions. The recommendations of the commission were largely ignored.

The tax law provides a couple of incentives to assist you in purchasing a new hybrid vehicle.

Depending on the type of vehicle you purchase and the date of purchase, you may be entitled to a tax credit. In addition, if you purchase the vehicle after Feb. 16, 2009, and before Jan. 1, 2010, you will be able to deduct some or all of any sales or use tax you pay on the purchase.

If you are planning to support the American auto industry by purchasing a new Ford hybrid, however, your tax benefits may be limited. For purchases made after March 31, 2009, the tax credit for hybrid passenger automobiles and light trucks manufactured by the Ford Motor Company has begun to phase out. The full credit ranges from $1,950 on some Ford Escapes and Mercury Mariners to $3,400 on the 2010 Ford Fusion and Mercury Milan.

The phaseout has already begun because, during the last quarter of 2008, Ford's total sales of credit-qualified vehicles reached 60,000 units. Those who purchased or leased Ford hybrids prior to April 1, 2009, will receive the full credit. From April 1 through Sept. 30, 2009, the credit level will be 50 percent of the full amount. The credit drops to 25 percent on Oct. 1, 2009, and is eliminated after March 31, 2010.

Compensation issues are an ongoing point of dispute between taxpayers and the IRS when a corporation pays compensation to a controlling shareholder who is also an employee of the corporation.

The portion of the compensation that reasonably rewards the services as an employee is fully deductible. However, any excess amount is considered a disguised dividend, paid to a shareholder. The corporation may not deduct dividend payments.

In a recent case, the Court of Appeals for the 7th Circuit reversed a decision of the Tax Court, which had disallowed a deduction for almost $10 million paid as a bonus to the CEO and controlling shareholder of a home improvement retailer. The appeals court chastised the Tax Court for gauging the reasonableness of the compensation by comparing the CEO's compensation to the cash salaries and stock options received by CEOs of two publicly traded competitors, while ignoring the value of severance packages, retirement plans and other perquisites available to the other executives.

The appellate court also questioned whether the Tax Court adequately compared the duties of this CEO, who took only seven days of vacation per year and micromanaged the business, with the duties of the CEOs of the public companies, who employed large staffs to whom they might delegate responsibilities.

The appeals court also was unimpressed by several arguments normally put forth by the IRS in reasonable compensation cases. First, the court disagreed that the payment of a year-end bonus is indicative of a disguised dividend.

The court observed that bonuses are normally paid at the end of the year and are based on profits. Dividends are seldom calculated based on the corporation's profits.

The court also rejected the Tax Court's view that a controlling shareholder would be willing to work without compensation because the shareholder would benefit from the retained profits of the business.

Read more in Menard v. Commissioner, CA-7, 2009-1 USTC ¶ 50,270, March 10, 2009.

In a recent article, TIME magazine quoted an auto dealer as saying that the average car in America is more than nine years old.

 In the same article, TIME quotes an industry economist as predicting that 35 million cars now on the road will be at least 10 years old in two years. TIME's conclusion: "There's not enough duct tape in America to hold that much junk together."

 If you are driving one of these limping lizzies and you're thinking it may be time for a replacement, consider the recently enacted tax deduction available for new passenger vehicles purchased this year. The vehicle must be purchased after Feb. 16, 2009, and before Jan. 1, 2010, to qualify for the deduction.

 The deduction is limited to the state and local sales and excise taxes paid on up to $49,500 of the purchase price of a qualified new car, light truck, motor home or motorcycle. The amount of the deduction is phased out for those with modified adjusted gross income between $125,000 and $135,000 for individual filers and between $250,000 and $260,000 for joint filers. The special deduction is available regardless of whether you itemize deductions.

Read more in Information Release 2009-030.

You can deduct as an itemized deduction the interest you pay on a mortgage used to acquire a home. However, the deduction is limited to the interest paid on the first $1 million of mortgage debt. A $100,000 limit applies for home-equity debt.

 The IRS Office of the Chief Counsel was recently asked to address the question of how the $1 million limitation applies to a home with multiple owners. Does each owner receive a $1 million limit, or is the $1 million limit shared among the owners? If each owner has a $1 million limit, then a married couple could deduct the interest paid on a $2 million mortgage.

 The chief counsel concluded that the $1 million limit is applied "per home," rather than "per taxpayer." For example, if three people pool their funds to purchase a home in which they all live, the $1 million limit is distributed proportionately to the share of the total interest payments each owner makes during the year.

Read more in CCA 200911007.

In addition to tax relief, the American Recovery and Reinvestment Act includes a number of additional provisions aimed at stimulating small businesses.

Last month, the White House, the United States Department of the Treasury and the Small Business Administration (SBA) all announced measures aimed at addressing the economic challenges faced by small businesses and entrepreneurs.

The SBA recently announced changes to its lending and investment programs that will make it easier and less expensive for more small businesses to get financing. These changes include:

• Temporarily eliminating fees on SBA-backed loans and raising SBA's guarantee percentage on some loans to 90 percent. The elimination of fees is retroactive to Feb. 17, 2009, and will remain in effect until the end of the calendar year or until the funding is exhausted.
• Introducing a new loan program to help small businesses meet existing debt payments.
• Expanding the Microloan program to finance new lending and technical assistance grants to microlenders.
• Streamlining lending and oversight processes. 
•  Expanding the Surety Bond Guarantee program.
• Adding staffing to meet demands for new programs.

Read more here. 

The IRS ruled that investors in the Ponzi scheme perpetrated by Bernard Madoff are entitled to a theft loss deduction. However, a recent Tax Court case highlights some of the challenges a taxpayer faces when trying to claim that deduction.

To support a deduction for a theft loss, you must be prepared to prove three claims: (1) the fact that a theft occurred; (2) the amount of the loss; and (3) the year of discovery of the loss.

For Madoff investors, the fact that a theft occurred and the year of discovery of the loss seem to be satisfied by Madoff's guilty plea and the IRS's own pronouncements.

Under the income tax regulations, however, if you have a reasonable prospect of recovery on a claim for reimbursement by insurance or otherwise, the loss deduction is postponed until it can be ascertained with reasonable certainty whether the recovery will be received. Many of Madoff's victims invested through other advisers and may have claims against those intermediaries.

In the Tax Court case, Dominick Vincentini had invested in a phony investment scheme. The operators of the scheme were convicted of numerous federal criminal charges including money laundering, tax fraud, mail fraud and wire fraud. Vincentini claimed a theft loss deduction, either in the year the operators were charged with fraud or in the year they were convicted.

The IRS objected and the Tax Court sided with the IRS, ruling that Vincentini was unable to prove that he had no reasonable possibility of recovering some or all of his investments because he had yet to fully pursue his recovery plans. Therefore the amount of the theft loss could not yet be determined.

Read more in Dominick J. Vincentini v. Commissioner, T.C. Memo 2008-271.

As economic conditions continue to tighten, more people are operating businesses out of their homes. If you use part of your home exclusively for business, you may be able to deduct expenses for the business use of your home.

 The home office deduction is available for homeowners and renters and applies to all types of homes, from apartments to mobile homes. Deductible expenses may include mortgage interest, insurance, utilities, repairs and depreciation.

 But be careful. The IRS is concerned that the Internet may provide a new medium for promoters to sponsor illegal tax avoidance schemes. Some of these schemes suggest the conversion of a hobby or recreational activity into a "business" to claim personal expenses improperly as business expenses.

 Many schemes involve the use of fictitious online businesses including online retail and services, online auction sales and bartering.

 You must carry on a bona fide business, as well as meet other specific requirements, to deduct expenses related to the business use of your home. Even then, your deduction may be limited.

 To qualify to claim a home office deduction for business expenses, your business use of that part of your home must be both exclusive and regular. In addition, the business part of your home must be one of the following:

• Your principal place of business
• A place where you meet and deal with customers in the normal course of your trade or business
• A separate structure you use in connection with your trade or business 

Read more in IRS Headline Volume 263. 

Eligible small businesses may carry back a 2008 net operating loss up to five years instead of the normal two-year limit, according to guidance recently issued by the IRS.

The guidance applies to the enhanced net operating loss (NOL) carryback provisions of the American Recovery and Reinvestment Act. Eligible small businesses are those with average gross receipts of $15 million or less for the three-year period ending in 2008.

 These provisions do not apply just to corporations. Individuals who experience an NOL as a result of losses from one or more eligible small businesses that operate as sole proprietorships, partnerships, LLCs or S corporations also qualify for the extended carryback period.

Fiscal year businesses may make the election for an NOL occurring in a tax year either beginning or ending in calendar 2008, but not both.

 Depending upon whether you have already filed a return for the NOL year, you may be required to take action as early as April 17, 2009, to perfect your right to a five-year carryback. In an accompanying news release, the IRS said it will work to issue NOL-related refunds within 45 days or sooner.

Read more in Revenue Procedure 2009-19.

The IRS has decided that an investor's loss resulting from a Ponzi-type scheme is a theft loss rather than a capital loss.

This guidance is for investors who lost money in the Ponzi scheme operated by Bernard Madoff. It also applies to losses in any similar frauds.

The loss is deductible as an ordinary loss from a transaction entered into for profit. As such, the loss is fully deductible and not subject to the limitations that apply to personal theft losses.

Also, to the extent the loss creates a net operating loss, the investor is eligible to carry the loss back to receive a refund of taxes paid in prior years.

As a theft loss, the loss is deductible in the year discovered rather than in the year it occurred. The amount deductible is the amount of the loss not covered by a claim for reimbursement. In some cases, the IRS will allow investors to claim the deduction before the person charged with the crime is actually convicted.

Read more in Revenue Ruling 2009-9 and
Revenue Procedure 2009-20.

 The federal government has reported a new scam involving fake economic stimulus grants for small businesses.

Undoubtedly, you have read a number of reports about scammers impersonating the IRS in an attempt to gain access to your personal information and steal your identity. Because of these reports, crooks know you are suspicious, so they set up Web sites that discuss government grants. The information sites then direct you to the scammers' other sites.

Here's how a typical scam works. For a fee of $30 to $50 you get a subscription to a grants database or a grant package with information on how to write a grant proposal, along with a list of government agencies that provide grants to businesses.

After you pay the fee, you may or may not receive the information promised. And if you pay by credit or debit card, you may receive continuing charges for your subscription.

Federal and state agencies do not provide small business grants to start a business, pay off debt or cover operating expenses. However, they do provide guarantees on low-interest loans that can be used for these purposes.

Government agencies publish free grant information on the Web. You do not need to pay anyone to gain access to this information.

Visit agency Web sites and use your favorite search engine to access a wealth of free information from the government.