60 HOUR CALIFORNIA TAX EDUCATION COUNCIL (CTEC)

QUALIFYING EDUCATION COURSE

45 HOUR FEDERAL TAX LAW, RETURN SCENARIOS, EXAMINATION

Provider Number: 2040

CTEC Course Number: 2040-QE-0003

GOLDEN STATE TAX TRAINING INSTITUTE, INC.

P. O. BOX 930

Prospect Heights, IL 60070 Voice: 877-674-9290

Fax: 877-674-3472

www.GSTTI.com

EXCLUSIVE PUBLISHERS OF THIS LIMITED EDITION ALL RIGHTS RESERVED, NO PART OF THIS PUBLICATION MAY BE REPRODUCED, STORED IN A RETRIEVAL SYSTEM, OR TRANSMITTED, IN ANY FORM OR BY ANY MEANS, ELECTRONIC, MECHANICAL, PHOTOCOPYING, RECORDING, OR OTHERWISE, WITHOUT WRITTEN PERMISSION OF THE PUBLISHER. This material is for educational purposes only and specific to the subject matter contained in the Table of Contents, and in no way does it cover all aspects of the tax code. Rather, it is constructed to offer an accurate representation of the subject matter being covered. Purchase of this course or any other course offered by Golden State Tax Training Institute, Inc. comes with the provision that they are not for the purposes of offering legal or other professional services. Additionally, the course contains the current tax law as to date of publication. This course is based on the 2017 tax year, if available, and is up to date as of publication. Any important tax law changes will be sent to students in the form of an online course supplement. ARTICLES AND COMMENTARY INCLUDED HEREIN DO NOT CONSTITUTE AN OPINION AND ARE NOT INTENDED OR WRITTEN TO BE USED, AND THEY CANNOT BE USED, BY ANY TAXPAYER FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON THE TAXPAYER. Copyright is not claimed in any material secured from official U.S. government publications, forms or circulars. © 2018 Golden State Tax Training Institute, Inc. All Rights Reserved.

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Table of Contents

Introduction ........................................................................................................................................................................ viii Course Description ............................................................................................................................................................ viii Course Learning Objectives ................................................................................................................................................ ix CTEC Registration Requirements ...................................................................................................................................... xii Taxes 101 .......................................................................................................................................................................... xiv

General Filing Information ................................................................................................................................................ 1-1 Preliminary Work and Collection of Taxpayer Data.......................................................................................................... 1-1 Accounting Periods ........................................................................................................................................................... 1-4 Accounting Methods ......................................................................................................................................................... 1-6 Filing Dates ....................................................................................................................................................................... 1-8 Determining the Tax ....................................................................................................................................................... 1-10 Completion of the Filing Process .................................................................................................................................... 1-12 Safeguarding Taxpayer Information ............................................................................................................................... 1-21 Significance of Signatures .............................................................................................................................................. 1-22 Rejected Electronically Filed Returns ............................................................................................................................. 1-24 Refunds .......................................................................................................................................................................... 1-26 Paying the Tax ................................................................................................................................................................ 1-28 Presidential Election Campaign Fund ............................................................................................................................ 1-34 Review ............................................................................................................................................................................ 1-35 Review Questions ........................................................................................................................................................... 1-35 Review Feedback ........................................................................................................................................................... 1-36

Tax Forms ......................................................................................................................................................................... 2-1 Returns not Qualifying for Use of the Tax Table .............................................................................................................. 2-4 Amended Returns and Claims for Refund ........................................................................................................................ 2-5 Form W-4 - Employee's Withholding Allowance Certificate ........................................................................................... 2-10 Form W-2 - Wage and Tax Statement ........................................................................................................................... 2-16 Form W-3 - Transmittal of Wage and Tax Statements ................................................................................................... 2-22 Various Form 1099 ......................................................................................................................................................... 2-22 Review ............................................................................................................................................................................ 2-25 Review Questions ........................................................................................................................................................... 2-25 Review Feedback ........................................................................................................................................................... 2-27

Taxable Income, Filing Status .......................................................................................................................................... 3-1 Taxable and Nontaxable Income ...................................................................................................................................... 3-1 Who is Subject to the Tax ................................................................................................................................................. 3-1 Sources of Taxable and Non-Taxable Income ................................................................................................................. 3-5 Tax Liability ..................................................................................................................................................................... 3-11

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Filing Status .................................................................................................................................................................... 3-14 Special Filing Situations ................................................................................................................................................. 3-19 Review ............................................................................................................................................................................ 3-28 Review Questions ........................................................................................................................................................... 3-28 Review Feedback ........................................................................................................................................................... 3-30

Standard Deduction, Personal Exemptions ...................................................................................................................... 4-1 The Standard Deduction ................................................................................................................................................... 4-1 Special Rules on the Standard Deduction ........................................................................................................................ 4-2 Personal Exemptions ........................................................................................................................................................ 4-4 Review ............................................................................................................................................................................ 4-12 Review Questions ........................................................................................................................................................... 4-12 Review Feedback ........................................................................................................................................................... 4-14

Income .............................................................................................................................................................................. 5-1 Earned Income ................................................................................................................................................................. 5-1 Foreign Earned Income .................................................................................................................................................... 5-2 Unemployment and Other Compensation ........................................................................................................................ 5-3 Special Rules for Certain Employees ............................................................................................................................. 5-16 Passive Income .............................................................................................................................................................. 5-16 Rental Income ................................................................................................................................................................ 5-17 Separation or Divorce Income ........................................................................................................................................ 5-18 Review ............................................................................................................................................................................ 5-20 Review Questions ........................................................................................................................................................... 5-20 Review Feedback ........................................................................................................................................................... 5-22

Investment Income ........................................................................................................................................................... 6-1 Dividends .......................................................................................................................................................................... 6-1 Interest Subject to the Tax ................................................................................................................................................ 6-5 How To Report Interest Income........................................................................................................................................ 6-9 Review ............................................................................................................................................................................ 6-12 Review Questions ........................................................................................................................................................... 6-12 Review Feedback ........................................................................................................................................................... 6-13

Capital Gains and Losses, Sale of Personal Residence .................................................................................................. 7-1 Capital Gains and Losses ................................................................................................................................................. 7-5 Sale of Personal Residences ........................................................................................................................................... 7-9 Like-Kind Exchanges ...................................................................................................................................................... 7-13 Involuntary Conversions ................................................................................................................................................. 7-16 Review ............................................................................................................................................................................ 7-18 Review Questions ........................................................................................................................................................... 7-18 Review Feedback ........................................................................................................................................................... 7-19

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Sole Proprietor, Small Business Income and Taxation .................................................................................................... 8-1 Schedule C-EZ ................................................................................................................................................................. 8-4 Schedule C - Profit or Loss From Business ..................................................................................................................... 8-4 Self-Employment Tax ..................................................................................................................................................... 8-13 Special Rules and Exceptions ........................................................................................................................................ 8-14 Household Employment - Schedule H ........................................................................................................................... 8-17 Farming Taxation - Schedule F ...................................................................................................................................... 8-18 Rent ................................................................................................................................................................................ 8-19 Other Income .................................................................................................................................................................. 8-19 Review ............................................................................................................................................................................ 8-22 Review Questions ........................................................................................................................................................... 8-22 Review Feedback ........................................................................................................................................................... 8-23

Specialized Returns .......................................................................................................................................................... 9-1 Corporation Filing Information .......................................................................................................................................... 9-1 Partnership Filing Information ......................................................................................................................................... 9-11 S Corporations ................................................................................................................................................................ 9-17 Limited Liability Company (LLC)..................................................................................................................................... 9-22 Trust and Estate Income Tax ......................................................................................................................................... 9-25 Tax Exempt Organizations ............................................................................................................................................. 9-30 Retirement Plans ............................................................................................................................................................ 9-32 Farms .............................................................................................................................................................................. 9-36 Farm Sales and Exchanges ........................................................................................................................................... 9-38 Deductible Expenses ...................................................................................................................................................... 9-40 Depreciation.................................................................................................................................................................... 9-43 Rental Real Estate .......................................................................................................................................................... 9-47 Review ............................................................................................................................................................................ 9-50 Review Questions ........................................................................................................................................................... 9-50 Review Feedback ........................................................................................................................................................... 9-52

Depreciation.................................................................................................................................................................... 10-1 Section 179 Election ..................................................................................................................................................... 10-10 Capitalization and Repairs ............................................................................................................................................ 10-14 Review .......................................................................................................................................................................... 10-17 Review Questions ......................................................................................................................................................... 10-17 Review Feedback ......................................................................................................................................................... 10-19

Retirement Income ......................................................................................................................................................... 11-1 Social Security and Medicare Taxes .............................................................................................................................. 11-1 Pensions and Annuities .................................................................................................................................................. 11-3 Individual Retirement Arrangements (IRAs) ................................................................................................................... 11-4

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Review .......................................................................................................................................................................... 11-19 Review Questions ......................................................................................................................................................... 11-19 Review Feedback ......................................................................................................................................................... 11-20

Exclusions, Deductions, Expenses, Employee Compensation ...................................................................................... 12-1 Exclusions ....................................................................................................................................................................... 12-1 Deductions for Adjusted Gross Income .......................................................................................................................... 12-3 Coverdell Education Savings Accounts (CESA) ............................................................................................................ 12-4 Health Savings Account Deduction ................................................................................................................................ 12-8 Other Deductions ............................................................................................................................................................ 12-9 Other Employee Compensation ................................................................................................................................... 12-13 Review .......................................................................................................................................................................... 12-18 Review Questions ......................................................................................................................................................... 12-18 Review Feedback ......................................................................................................................................................... 12-20

Itemized Deductions ....................................................................................................................................................... 13-1 Medical Expenses .......................................................................................................................................................... 13-2 Taxes .............................................................................................................................................................................. 13-4 Interest .......................................................................................................................................................................... 13-13 Contributions................................................................................................................................................................. 13-15 Casualty and Theft Losses ........................................................................................................................................... 13-17 Job Expenses and Other Miscellaneous Deductions ................................................................................................... 13-20 Review .......................................................................................................................................................................... 13-31 Review Questions ......................................................................................................................................................... 13-31 Review Feedback ......................................................................................................................................................... 13-33

Credits ............................................................................................................................................................................ 14-1 Earned Income Tax Credit .............................................................................................................................................. 14-2 Earned Income Tax Credit (EITC) Limitations ................................................................................................................ 14-5 Child and Dependent Care Credit .................................................................................................................................. 14-7 Child Tax Credit .............................................................................................................................................................. 14-9 Additional Child Tax Credit ........................................................................................................................................... 14-11 Credits and Deductions for Higher Education Tuition and Related Expenses ............................................................. 14-12 Student Loan Interest Deduction .................................................................................................................................. 14-12 American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit ..................................................................... 14-14 Affordable Care Act Tax Credits ................................................................................................................................... 14-17 Adoption Credit ............................................................................................................................................................. 14-20 Credit for the Elderly or the Permanently and Totally Disabled ................................................................................... 14-21 Retirement Savings Contribution Credit (Saver’s Credit) ............................................................................................. 14-23 Other Tax Credits ......................................................................................................................................................... 14-24 Review .......................................................................................................................................................................... 14-26 Review Questions ......................................................................................................................................................... 14-26

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Review Feedback ......................................................................................................................................................... 14-28

Additional Taxes ............................................................................................................................................................. 15-1 Alternative Minimum Tax ................................................................................................................................................ 15-1 Affordable Care Act Tax Provisions ............................................................................................................................... 15-4 Other Taxes .................................................................................................................................................................. 15-17 Household Employment Taxes ..................................................................................................................................... 15-21 Voluntary Classification Settlement Program (VCSP) .................................................................................................. 15-23 Review .......................................................................................................................................................................... 15-25 Review Questions ......................................................................................................................................................... 15-25 Review Feedback ......................................................................................................................................................... 15-26

Penalties ......................................................................................................................................................................... 16-1 Civil Penalties ................................................................................................................................................................. 16-1 Failure to File .................................................................................................................................................................. 16-1 Accuracy ......................................................................................................................................................................... 16-2 Fraud .............................................................................................................................................................................. 16-3 Criminal Prosecution ...................................................................................................................................................... 16-3 Review ............................................................................................................................................................................ 16-6 Review Questions ........................................................................................................................................................... 16-6 Review Feedback ........................................................................................................................................................... 16-7

Professional Responsibilities, Ethics, Penalties ............................................................................................................. 17-1 Practice Before the IRS .................................................................................................................................................. 17-2 Sarbanes-Oxley Act of 2002 ........................................................................................................................................... 17-7 Rules for Tax Preparers – Circular 230 .......................................................................................................................... 17-7 Subpart A ........................................................................................................................................................................ 17-9 Subpart B ...................................................................................................................................................................... 17-17 Subpart C ...................................................................................................................................................................... 17-23 Subpart D ...................................................................................................................................................................... 17-25 Subpart E ...................................................................................................................................................................... 17-29 Individual Income Tax Penalties ................................................................................................................................... 17-29 Tax Return Preparer Penalties ..................................................................................................................................... 17-31 Paid Preparer’s Due Diligence Checklist ...................................................................................................................... 17-31 Additional Tax Return Preparer Penalties .................................................................................................................... 17-34 Review .......................................................................................................................................................................... 17-36 Review Questions ......................................................................................................................................................... 17-36 Review Feedback ......................................................................................................................................................... 17-39

2017 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders ..................................... 18-1 Administration ................................................................................................................................................................. 18-1 2017 Federal Tax Legislation ......................................................................................................................................... 18-3

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What’s New ..................................................................................................................................................................... 18-3 Pension Plan Limitations .............................................................................................................................................. 18-10 Affordable Care Act Tax Provisions for Individuals ...................................................................................................... 18-14 Affordable Care Act Tax Provisions Employers ........................................................................................................... 18-22 Same-Sex Married Couples ......................................................................................................................................... 18-24 Other 2017 Tax Update Information ............................................................................................................................. 18-25 Section 179 Deduction ................................................................................................................................................. 18-31 2017 Tax Credits and Deductions Updates .................................................................................................................. 18-33 Gift and Estate Tax ....................................................................................................................................................... 18-40 Tax Court Decisions ..................................................................................................................................................... 18-44 Reminders .................................................................................................................................................................... 18-44 Review .......................................................................................................................................................................... 18-51 Review Questions ......................................................................................................................................................... 18-51 Review Feedback ......................................................................................................................................................... 18-53 Bibliography ........................................................................................................................................................................... I Index ................................................................................................................................................................................. VIII

Tax Tables ......................................................................................................................................................................... A-I Tax Return Preparation Instructions .............................................................................................................................. RP-1 Federal Tax Return Scenarios....................................................................................................................................... RP-1 Scenario 1 ...................................................................................................................................................................... RP-1 Scenario 2 ...................................................................................................................................................................... RP-5 Scenario 3 ...................................................................................................................................................................... RP-9 Scenario 4 .................................................................................................................................................................... RP-13 Scenario 5 .................................................................................................................................................................... RP-16 Scenario 6 .................................................................................................................................................................... RP-20 Scenario 7 .................................................................................................................................................................... RP-24 Scenario 8 .................................................................................................................................................................... RP-27 Examination Instructions - 60 Hour CTEC Qualifying Education Course ..................................................................... EX-1

Examination Questions - 45 Hour Federal Tax Law...................................................................................................... EX-2

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

Lesson 2 ........................................................................................................................................................................ EX-5

Lesson 3 ........................................................................................................................................................................ EX-7

Lesson 4 ........................................................................................................................................................................ EX-9

Lesson 5 ...................................................................................................................................................................... EX-13

Lesson 6 ...................................................................................................................................................................... EX-16

Lesson 7 ...................................................................................................................................................................... EX-18

Lesson 8 ...................................................................................................................................................................... EX-21

Lesson 9 ...................................................................................................................................................................... EX-24

Lesson 10 .................................................................................................................................................................... EX-25

Lesson 11 .................................................................................................................................................................... EX-26

Lesson 12 .................................................................................................................................................................... EX-28

Lesson 13 .................................................................................................................................................................... EX-32

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Lesson 14 .................................................................................................................................................................... EX-37

Lesson 15 .................................................................................................................................................................... EX-40

Lesson 16 .................................................................................................................................................................... EX-41

Lesson 17 .................................................................................................................................................................... EX-41

Lesson 18 .................................................................................................................................................................... EX-43 Course Evaluation ......................................................................................................................................................... CE-1

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Introduction

Thank you for choosing Golden State Tax Training Institute, Inc. This basic self-study 60 hour Qualifying Education (QE) course is approved by the California Tax Education Council (CTEC). This section contains 45 hours of Federal tax law and can be done at your own pace. Successful completion of the full 60-Hour QE course will enable you to register with CTEC as a California Registered Tax Preparer (CRTP) and prepare taxes within the State of California. We know your time is important to you so we have produced the most comprehensive and innovative tax education products on the market today. We focus on customer service and satisfaction and we strive to look for new and responsive ways to make earning your CTEC qualifying education requirements as convenient as possible. Since this is a self-study course, you can complete it at your own pace and on your own schedule. The minimum passing requirement is 70% on the examination questions at the end of the material. The exam has no time limit and is open book, so you are allowed to look up answers in the text we provide. You do not need to finish the exam in one continuous sitting as all of the answers you enter online are automatically saved. After you submit the exam to us we will grade it and, upon successful completion, e-mail you a Certificate of Completion. Additionally, we notify the California Tax Education Council (CTEC) that you passed the Qualifying Education (QE) allowing you to apply for your CRTP registration. If you should fail the exam on your first attempt, you will have the option to re-take the exam at no additional charge. You have unlimited attempts to pass an exam.

Course Description Tax Cuts and Jobs Act Most of the provisions in the Tax Cuts and Jobs Act take effect on January 1, 2018 and are operative for income tax returns filed in 2019. The bill will NOT affect income tax returns prepared in 2018. Since this course covers the 2017 tax year for income tax returns filed in 2018 the new tax laws will not be reflected with the exception of the medical expense deduction that will remain in place with a lower floor of 7.5% for tax years 2017 and 2018. In general, the bill provides new tax brackets, larger standard deduction amounts and adjusted credit amounts. It scales back a popular deduction for state and local taxes, repeals a key tenet of the Affordable Care Act and cuts the corporate tax rate from 35% to 21%. The bill also removed the personal exemption, permanently adjusted the alternative minimum tax (AMT) exemption amounts for inflation and doubled the Child Tax Credit from $1,000 to $2,000 per child, with up to $1,400 available in refunds for families who owe little or no taxes. The bill also doubles the standard deduction, to $12,000 ($24,000 for married couples). These tax provisions for individual taxpayers, including the new tax rates, will start January 1, 2018, and will expire at the end of 2025. This course is based on the 2017 tax year and highlights major tax laws that are of significant importance to a tax practitioner. This section focuses on key Federal tax law provisions recently enacted or indexed for inflation. Among other topics, this part includes information about taxable income, exclusions, the most common tax credits and deductions, capital gains and losses, small business taxation and noteworthy tax filing documents and dates. The course also highlights important small business tax topics including sole proprietorships, depreciation and the Section 179 deductions. Additionally, the course covers filing requirements for corporations, partnerships, S corporations and limited liability companies. This section includes a table of contents and comprehensive index to help guide your search for specific topics. Additionally, if you are using the electronic version of the course you can use the word search function by pressing “CTRL + F” on your keyboard and entering the word(s) you would like to look up. Along with the extensive course content you will also find a bibliography you can use to find additional reference material when searching for particular topics or answers to review and examination questions. The numbers in parentheses at the end of a sentence correspond to the numbers in the bibliography.

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Completion Deadline & Exam: This California Tax Education Council (CTEC) course must be completed within one year of the date of purchase. Course Level: This basic course is appropriate for individuals interested in becoming a California Registered Tax Preparer (CRTP). CTEC QE Credits: 45 Hours Category: Federal Taxation Prerequisite: None Advanced Preparation: None

Course Learning Objectives

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

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

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

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

companies. 7. Study the framework for using the rules of Circular 230, along with the terminology used by the circular and its

applicability to each tax practitioner. 8. Improve your knowledge regarding tax preparer penalties and the varying sanctionable acts that trigger

practitioner discipline. Review Questions and Feedback At the end of each lesson there are several review questions that are designed to help you learn the material you have just studied. Review questions are for instructional use only and you will not be graded on these questions. We provide both the answers to each question and an explanation or feedback as to how we arrived at each answer at the end of the lesson. Best practice suggests that you should try to answer these questions on your own first, and only then refer to the answer key and feedback to see how well you did in terms of learning the material. As with all self-study CPE courses, you can refer back to the course material to locate the answers - the so called 'open book' learning method is permissible. Tax Return Preparation Practice Scenarios Included with the course there are several tax return preparation scenarios that are designed to increase your practical working knowledge. The tax return preparation scenarios vary in complexity and are for instructional use only. You will not be graded on these questions however you should complete the return in its entirety. We provide both the answers to each question and an explanation or feedback as to how we arrived at each answer. The California Tax Education Council (CTEC) allows Qualifying Education (QE) credit for preparing Federal and California tax forms and their related schedules. We have included tax return scenarios that are based on the 2017 tax year so that you can obtain qualifying education credit and also get familiar with the Federal and state forms and their associated schedules. You should use the information provided in the 2017 tax tables in the appendix at the back of the course and on the 2017 forms included with each scenario to complete each return exercise. We also recommend, as a best practice, that you locate any additional 2017 tax year forms when they are made available and review them prior to preparing returns for possible changes from the previous year. For the tax return preparation scenarios, best practice suggests that you should try to answer the questions on your own first, and only then refer to the answer key and feedback to see how well you did in terms of learning the material. Final Examination The final examination is intended to test your overall comprehension of the course. Each question will relate to topics

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found throughout the course so all of the answers can be found in the material. Passing the final exam from a self-study course is contingent upon scoring 70% or higher on the exam questions related to the course material. The examination consists of 280 multiple-choice questions, meaning you must correctly answer 196 in order to pass. How To Submit The Online Examination:

Log into www.GSTTI.com. Enter your email address and your password. Click link to take online exam. Answer questions (There is no time limit). Submit answers (The exam does not need to be completed in one sitting). Get certificate by email within 24 hours. We electronically notify CTEC that you earned Qualifying Education (QE) course credits.

The exam has no time limit, and is open book, so you are allowed to look up answers in the text we provide. You do not need to finish the exam in one continuous sitting as all of the answers you enter online are automatically saved. After you submit the online exam to us you will receive a pass/fail message. If you should fail the exam on your first attempt, you will have the option to re-take the exam at no additional cost. If you score less than 70%, a message will be displayed at the bottom of the page along with a list of incorrect questions. You have unlimited attempts to pass an exam. Upon successful completion of the full 60-Hour QE course, we will e-mail you a Certificate of Completion. Additionally, we notify the California Tax Education Council (CTEC) that you passed the Qualifying Education (QE) allowing you to apply for your CRTP registration online at www.CTEC.org. You must register with CTEC within 18 months from the completion date on the certificate of completion. Information regarding registration can be found at www.CTEC.org. You must also have proof of a $5,000 tax preparer insurance bond which can be obtained from any number of bond companies for about $15 - $25 per year. After your initial registration, you must complete 20 hours of continuing education each year and register with CTEC by October 31st. There is a late registration period from November 1st to January 15th but you will have to pay CTEC a late registration fee during this period. Golden State Tax Training has a 20-Hour CTEC approved continuing professional education course that you can take each year to meet this requirement. Lastly, you must obtain a preparer tax identification number (PTIN) from the IRS (www.irs.gov/ptin). You must renew your PTIN with the IRS at the end of every year if you plan to prepare taxes the following year. We wish you every success and thank you for choosing Golden State Tax Training Institute, Inc. Understanding the Icons Used in this Book

Important: Update or Change

Tip: Significant information

Note: Additional information

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

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CTEC Registration Requirements IMPORTANT: Just because you successfully completed the 60-hour qualifying education (QE) course does not mean you can prepare tax returns in the state of California. You must also complete the registration process with the California Tax Education Council (CTEC). Carefully read the instructions below to complete that process. You have 18 months from the completion date listed on the 60-hour qualifying education (QE) completion certificate provided by your education provider to register with CTEC. If you do not register with CTEC within the allowed 18 months, you will be required to complete another 60-hour qualifying education course before being able to register. CTEC registration MUST be completed online at https://www.ctec.org/Preparer/. You will need the following to complete your registration: your social security number (SSN); proof that you have a $5,000 tax preparer bond; your IRS PTIN (Preparer Tax Identification Number); and, payment of the registration fee with a Visa, Master Card or Debit card. You have two registration options:

1. CAUTION - If you register as a new preparer before November 1 – you are registering for the cycle year ending on October 31 of that year. Example: If you register as a new preparer on October 15, 2017, that registration is only valid thru October 31, 2017. You would be required to take another 20 hours of continuing education sometime between October 15, 2017 and October 31, 2017 to renew your registration for the next registration cycle.

2. If you register as a new preparer after October 31 – you are registering for the next cycle year beginning November

1 of the current year and ending on October 31 of next year. Example: If you register as a new preparer on November 2, 2017, your registration is valid thru October 31, 2018. From November 2, 2017 thru October 31, 2018, you will be required to take 20 hours of continuing education from a CTEC approved provider in order to meet the renewal requirements for the next registration cycle, which will begin on November 1, 2018.

Education providers do not register students with CTEC, it is up to you to take the final step and complete the registration process. Registration Checklist CTEC Course Number: 2040-QE-0003 California law requires anyone who prepares tax returns for a fee within the State of California and is not an exempt preparer to register as a tax preparer with the California Tax Education Council (CTEC). Exempt preparers are California certified public accountants (CPAs), enrolled agents (EAs), and attorneys who are members of the State Bar of California. All new California Registered Tax Preparers (CRTP) must:

1. Complete 60-hours (45 hours Federal and 15 hours state) of qualifying tax education (QE) from Golden State Tax Training Institute, Inc., a CTEC Approved Education Provider.

2. Obtain a PTIN (Preparer Tax Identification Number) from the IRS. Most first-time

PTIN applicants can obtain a PTIN online on the IRS website in about 15 minutes. For more information about PTIN Requirements for Tax Return Preparers visit the IRS website at: http://www.irs.gov/Tax-Professionals/PTIN-Requirements-for-Tax-Return-Preparers

3. Purchase a $5,000 tax preparer bond. Students may obtain the bond while in

school, receive their completion certificate from the tax school, and use both the certificate and the bond to register with CTEC. Bonds can be obtained from any number of bond companies for about $15 - $25 per year. For more Bonding Requirements information visit the CTEC website at: http://www.ctec.org/Preparer/Bonding

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4. Register with CTEC within 18 months from the completion date on the certificate of completion. The Registration Fee is $33. For more information about Preparer Registration and Personal Accounts visit the CTEC website at: https://www.ctec.org/Preparer/

After your initial registration, you must complete 20 hours of continuing education each year and register with CTEC by October 31st. Golden State Tax Training has a 20-Hour CTEC approved continuing professional education course that you can take each year to meet this requirement. To renew your registration all CRTPs must:

1. Complete 20-hours (10 hours of Federal tax law, 3 hours of Federal tax updates, 2 hours of Ethics and 5 hours of California tax law) of continuing professional education each year.

2. Maintain a valid PTIN (Preparer Tax Identification Number) from the IRS.

3. Maintain a $5,000 tax preparer bond.

4. Renew the registration by October 31st of each year. Renewal Registration fee is $33. There is a late renewal period that runs from November 1st through January 15th of the following year. If you renew during that time period, a late registration fee will apply. If you fail to renew by January 15th of any given year, you will be required to retake the 60-hour qualifying education course and register as a new preparer. As a reminder, education providers do not register students with CTEC, it is up to you to take the final step and complete the registration process.

Introduction

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Taxes 101 Tax is a complex and technical area of law with frequent changes. It is common for there to be ten or twelve amendments to the Internal Revenue Code in a single year and more than fifty Revenue Rulings. In addition, there are dozens of regulatory and administrative documents generated by the IRS every year. (1) Tax History The origin of the income tax on individuals is generally cited as the passage of the 16th Amendment, passed by Congress on July 2, 1909, and ratified February 3, 1913; however, its history actually goes back even further. During the Civil War Congress passed the Revenue Act of 1861 which included a tax on personal incomes to help pay war expenses. The tax was repealed ten years later. Additionally, in 1894 Congress enacted a flat rate Federal income tax, which was ruled unconstitutional the following year by the U.S. Supreme Court because it was a direct tax not apportioned according to the population of each state. The 16th amendment, ratified in 1913, removed this objection by allowing the Federal government to tax the income of individuals without regard to the population of each State. (2) April 15th has not always been the filing deadline. March 1st was the date specified by Congress in 1913, after the passage of the 16th amendment. In 1918 Congress pushed the date forward to March 15th, where it remained until the tax overhaul of 1954, when the date was again moved ahead to April 15th. (2) Tax Law Article I Section 7 of the U.S. Constitution is the starting point for new tax law. This Section states that all revenue bills must originate in the House of Representatives. Within the House of Representatives, revenue bills are dealt with by the House Ways and Means Committee. The Ways and Means Committee initially writes a tax law bill. There is no specific time frame for the introduction of new proposed tax law by committee members. Proposals are sent to the committee chairman on a rolling basis as they work their way through regular business. Once the bill specifies the text for the new tax law being proposed it is passed on to the Rules Committee. The Rules Committee has control over when new legislation will be considered by the House. If the Rules Committee permits consideration, the new bill will then be presented to the House for ratification. If passed, the tax law bill may be considered by the Senate. Much like the House Ways and Means Committee, the Senate Finance Committee has jurisdiction over tax law bills. The Senate can amend the bill written by the House. The Senate can amend and even go as far as deleting everything in a tax law bill and start over (all tax law bills still must technically originate in the House, even if they are rewritten from scratch). Fifty-one votes are needed to pass a bill in the Senate. If passed, the tax law bill will be signed into law by the President or vetoed by the President. Brief History of the IRS The roots of the IRS go back to the Civil War when President Lincoln and Congress, in 1862, created the position of commissioner of Internal Revenue and enacted an income tax to pay war expenses. The income tax was repealed 10 years later. Congress revived the income tax in 1894, but the Supreme Court ruled it unconstitutional the following year. In 1913, Wyoming ratified the 16th Amendment, providing the three-quarter majority of states necessary to amend the Constitution. The 16th Amendment gave Congress the authority to enact an income tax. That same year, the first Form 1040 appeared after Congress levied a 1% tax on net personal incomes above $3,000 with a 6% surtax on incomes of more than $500,000. In 1918, during World War I, the top rate of the income tax rose to 77% to help finance the war effort. It dropped sharply in the post-war years, down to 24% in 1929, and rose again during the Depression. During World War II, Congress introduced payroll withholding and quarterly tax payments.

Introduction

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

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

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

Preliminary Work and Collection of Taxpayer Data Review of Prior Year’s Return for Accuracy, Comparison and Carryovers for Current Year Return Before completing a tax return, be sure to review the taxpayer’s return from last year not just for accuracy but also for comparison to the current year return. This return will provide you with a wealth of information that can be valuable in the preparation of the current year's return, including:

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

Many tax preparers neglect to go over last year's return. But it is worth the time because very often he or she will find an applicable item that is not common for all individuals such as itemized deductions, sale of a residence, retirement pay, applicable taxes or some other important piece of information that might be beneficial to this year's return. Certain items from the prior year return may be needed to complete the current-year return (state income tax refund, AMT for credit, gain/loss carryover, charitable gift carryover, etc.). A comparison may show that there were no important changes from the previous tax year. If this is the case, the current year return should total similar amounts and have a similar tax liability or refund. As you can see, the accuracy of the previous year’s return is significant as a resource. It can also increase efficiency when completing the current year’s return. Collect Taxpayer’s Biographical Information Verify taxpayer’s identity, date of birth, citizenship, and age by examining government issued identification of taxpayer such as passport, driver’s license, or national identity card. Interview the taxpayer to determine filling and dependency exemptions. The age of a taxpayer determines if he or she qualifies for certain deductions, retirement distribution and/or dependency. Also, taxpayers using the married, filing jointly status often increase dollar limits for deductions, exemptions and credits. Nationality If an individual is an alien, he or she is considered to be a nonresident alien unless either the green card or substantial presence test for the calendar year is met. However, if the individual does not meet either of these tests he or she may choose to be treated as a U. S. resident for part of the year as a dual status alien. This usually occurs in the year of arrival or departure from the United States. U.S. Citizen: (4)

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

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An individual born in Puerto Rico. An individual born in Guam. An individual born in the U.S. Virgin Islands.

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

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

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

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

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

An Illegal Alien, also known as an "Undocumented Alien," is an alien who has entered the United States illegally and is deportable if apprehended, or an alien who entered the United States legally but who has fallen "out of status" and is deportable. A Nonimmigrant Visa allows a nonimmigrant to enter the United States in one of several different categories, which correspond to the purpose for which the nonimmigrant is being admitted to the United States. For example, a foreign student will usually enter the United States on an F-1 visa, a visitor for business on a B-1 visa, an exchange visitor (including students, teachers, researchers, trainees, alien physicians, au pairs, and others) on a J-1 visa, a diplomat on an A or G visa, etc. The categories of nonimmigrant visas correspond exactly to the "nonimmigrant status" assigned to each nonimmigrant upon his arrival, based on the purpose for which the nonimmigrant was admitted to the United States. For example, a foreign student who enters the United States on an F-1 visa is considered to be in F-1 student status after he enters the United States; and he will remain in that status until he violates the conditions prescribed for that status, or until he changes to another nonimmigrant or immigrant status with USCIS permission, or until he leaves the United States. The Visa Waiver Program (VWP) enables citizens of participating countries to travel to the United States for tourism or business for 90 days or less without obtaining a United States visa. The VWP is administered by the Attorney General in consultation with the Secretary of State. The Visa Waiver Program (VWP) was created by an act of Congress as a pilot program in 1986 and implemented in 1988. Congress passed legislation to make the program permanent in October 2000, and the President signed the legislation on October 30, 2000. Accuracy The IRS reminds filers that e-filing their tax return greatly lowers the chance of errors. In fact, taxpayers are about twenty times more likely to make a mistake on their return if they file a paper return instead of e-filing their return. Here are eight common errors to avoid: (6)

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

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

3. Filing status errors. Choose the right filing status. There are five filing statuses: Single, Married Filing Jointly, Married Filing Separately, Head of Household and Qualifying Widow(er) With Dependent Child.

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

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

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

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

8. Electronic signature errors. If the taxpayer e-files his or her income tax return, he or she will sign the return electronically using a Personal Identification Number. For security purposes, the software will ask him or her to enter the Adjusted Gross Income from the originally-filed 2016 Federal tax return. Do not use the AGI amount from an amended 2016 return or an AGI provided to the taxpayer if the IRS corrected the return. The taxpayer may also use last year's PIN if he or she e-filed last year and remembers the PIN.

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

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The rule requires members of firms to compute the number of returns in the aggregate that they reasonably expect to file as a firm. If that number is 11 or more in a calendar year, then all members of the firm must e-file the returns they prepare and file. This is true even if a member prepares and files fewer than the threshold on an individual basis. Clients may independently choose to file on paper. Tax Preparers Must have a Preparer Tax Identification Number IRS regulations require all paid tax return preparers and enrolled agents (including attorneys, and CPAs if they prepare for compensation all or substantially all of a Federal tax return or claim for refund) to obtain a Preparer Tax Identification Number (PTIN) before preparing any Federal tax returns. A PTIN meets the requirements under section 6109(a)(4) of furnishing a paid tax return preparer’s identifying number on returns that you prepare. In February of 2013 the United States District Court for the District of Columbia modified its order from January of 2013 to clarify that the order does not affect the requirement for all paid tax return preparers to obtain a preparer tax identification number (PTIN). You must renew your PTIN every year during the renewal season which generally starts in October and must be completed by December 31. Your PTIN is your Federal license to prepare taxes and it must be included on all returns you prepare. Taxpayer Identification Numbers A Taxpayer Identification Number (TIN) is an identification number used by the Internal Revenue Service (IRS) in the administration of tax laws. It is issued either by the Social Security Administration (SSA) or by the IRS. Most taxpayers will use a Social Security number (SSN) issued by the SSA. Additional TINs issued by the IRS include:

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

A taxpayer generally must list on his or her individual income tax return the Social Security number (SSN) of any person for whom he or she claims an exemption. If his or her dependent or spouse does not have and is not eligible to get an SSN, the taxpayer must list the ITIN instead of an SSN. The taxpayer does not need an SSN or ITIN for a child who was born and died in the same tax year. Instead of an SSN or ITIN, attach a copy of the child's birth certificate and write Died on the appropriate exemption line of the tax return. Identity Protection Personal Identification Number (IP PIN) If a taxpayer received an IRS notice providing him or her with an Identity Protection Personal Identification Number (IP PIN), enter it in the IP PIN spaces provided below daytime phone number on the tax return form. The taxpayer must enter the IP PIN exactly as it is shown on the Notice CP01A. If the taxpayer did not receive a notice containing an IP PIN, leave these spaces blank. An IP PIN is a number the IRS gives to taxpayers who have: (7)

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

The IP PIN helps to prevent the misuse of a taxpayer's Social Security number or Taxpayer Identification Number on income tax returns. New IP PINs are issued every year. An IP PIN should be used only for the tax year it was issued. IP PINs for 2017 income tax returns generally are sent in December 2017. A new CP01A notice will be issued each subsequent year in January for the new filing season as long as the taxpayer's tax

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

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

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The taxpayer can use one of the following tax years:

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

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

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

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

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

Regulations. Fiscal Year A fiscal year is 12 consecutive months ending on the last day of any month except December 31st. If the taxpayer is allowed to adopt a fiscal year, he or she must consistently maintain his or her books and records and report his or her income and expenses using the time period adopted. 52-53-Week Tax Year The taxpayer can elect to use a 52-53-week tax year if he or she keeps his or her books and records and report his or her income and expenses on that basis. If the taxpayer makes this election, the 52-53-week tax year must always end on the same day of the week. The 52-53-week tax year must always end on:

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

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

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

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

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Accounting Methods An accounting method is a set of rules used to determine when income and expenses are reported on the taxpayer’s tax return. His or her accounting method includes not only the overall method of accounting, but also the accounting treatment he or she uses for any material item. The taxpayer can choose an accounting method when he or she files his or her first tax return. If the taxpayer later wants to change his or her accounting method, he or she must get IRS approval. No single accounting method is required of all taxpayers. The taxpayer must use a system that clearly reflects his or her income and expenses and he or she must maintain records that will enable him or her to file a correct return. In addition to the taxpayer’s permanent accounting books, he or she must keep any other records necessary to support the entries on his or her books and tax returns. The taxpayer must use the same accounting method from year to year. An accounting method clearly reflects income only if all items of gross income and expenses are treated the same from year to year. If the taxpayer does not regularly use an accounting method that clearly reflects his or her income, the taxpayer’s income will be refigured under the method that, in the opinion of the IRS, does clearly reflect income. In general, a taxpayer can compute his or her taxable income under any of the following accounting methods: (8)

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

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

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

If the taxpayer has not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses he or she paid in advance, the taxpayer must obtain approval from the IRS before using the general rule and/or the 12-month rule. Excluded Entities The following entities cannot use the cash method, including any combination of methods that includes the cash method: (8)

A corporation (other than an S corporation) with average annual gross receipts exceeding $5 million.

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A partnership with a corporation (other than an S corporation) as a partner, and with the partnership having average annual gross receipts exceeding $5 million.

A tax shelter. Generally, a taxpayer engaged in the trade or business of farming is allowed to use the cash method for its farming business. However, certain corporations (other than S corporations) and partnerships that have a partner that is a corporation must use an accrual method for their farming business. For this purpose, farming does not include the operation of a nursery or sod farm or the raising or harvesting of trees (other than fruit and nut trees). There is an exception to the requirement to use an accrual method for corporations with gross receipts of $1 million or less for each prior tax year after 1975. For family corporations engaged in farming, the exception applies if gross receipts were $25 million or less for each prior tax year after 1985. Accrual Method Under the accrual method of accounting, generally the taxpayer reports income in the year it is earned and deducts or capitalizes expenses in the year incurred. The purpose of an accrual method of accounting is to match income and expenses in the correct year. Generally, the taxpayer includes an amount in gross income for the tax year in which all events that fix his or her right to receive the income has occurred and he or she can determine the amount with reasonable accuracy. Under this rule, the taxpayer reports an amount in his or her gross income on the earliest of the following dates: (8)

When he or she receives payment. When the income amount is due to him or her. When he or she earns the income. When title has passed.

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

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

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

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

Generally, include an advance payment in income in the year in which the taxpayer receives it.

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

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

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

Changing Accounting Methods If a taxpayer is a qualifying taxpayer or qualifying small business taxpayer and wants to change to the cash method or to account for inventoriable items as non-incidental materials and supplies, he or she must file Form 3115 - Application for Change in Accounting Method. Both changes can be requested under the automatic change procedures of Revenue Procedures 2001-10 and 2002-28, as modified, amplified, and clarified by Revenue Procedure 2011-14 (or any successor). The taxpayer can file one Form 3115 if he or she chooses to request to change to the cash method and to account for inventoriable items as non-incidental materials and supplies. Inventories An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. If the taxpayer must account for an inventory in his or her business, he or she must use an accrual method of accounting for his or her purchases and sales. To figure taxable income, the taxpayer must value his or her inventory at the beginning and end of each tax year. To determine the value, the taxpayer needs a method for identifying the items in his or her inventory and a method for valuing these items. The rules for valuing inventory are not the same for all businesses. The method the taxpayer uses must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. The taxpayer’s inventory practices must be consistent from year to year.

Filing Dates The annual income tax return for individuals is due by the 15th day of the fourth month after the close of the tax year, usually April 15th. However, when the 15th falls on a weekend (Saturday or Sunday) or a holiday, the due date becomes the next regular working day. Therefore, if the 15th happened to be Saturday, the return would be due on Monday, April 17th.

Emancipation Day is an official public holiday in the District of Columbia. In 2018 it falls on Monday, April 16. This means most individuals have until Tuesday, April 17, 2018 to file their income tax return for the 2017 tax year. Note that this also affects the deadline for the first installment payment of estimated income tax.

If the taxpayer uses a fiscal year, the return is due the 15th day of the fourth month after the close of the fiscal year. For example, if the fiscal year ends June 30, his or her tax return due date would be October 15. If the taxpayer is a U.S. citizens or resident alien abroad and files on a fiscal year basis (a year ending on the last day of any month except December), the due date is 3 months and 15 days after the close of the fiscal year. If the taxpayer is a U.S. citizen or resident alien residing overseas, or is in the military on duty outside the U.S., on the regular due date of the return, he or she is allowed an automatic 2-month extension to file the return and pay any amount due without requesting an extension. For a calendar year return, the automatic 2-month extension is to June 15. Also, as of December 31, 2015:

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

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

S corporation tax returns remain unchanged. The returns are still due March 15, or the third month following the close of the taxable year;

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

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

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

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

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

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

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

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

In addition to the 180 days, the deadline is extended by the number of days that were left for the taxpayer to take the action with the IRS when he or she entered a combat zone (or began performing qualifying service outside the combat zone) or began serving in a contingency operation. If the person entered the combat zone or began serving in the contingency operation before the period of time to take the action began, the deadline is extended by the entire period of time he or she has to take the action. For example, the individual has 3½ months (January 1– April 15, 2018) to file his or her 2017 tax return. Any days of this 3½ month period that were left when he or she entered the combat zone (or the entire 3½ months if he or she entered the combat zone by January 1, 2018) are added to the 180 days when determining the last day allowed for filing the 2017 tax return. If the return is mailed, it must be placed in the mail and postmarked on or before the due date. The practice of filing sooner is encouraged by the IRS. Generally, the earliest possible date is January 1, although few, if any, taxpayers are in a position to file this soon. Employees, for example, must wait for Form W-2 to be issued by the employer. The tax law allows the employer until January 31 to prepare and issue the necessary Forms 1099 or W-2 for the previous year. If the taxpayer anticipates a refund, the sooner the tax return is filed, the sooner results can be expected. Because of the increased workload of the IRS as April 15 approaches, an early filing of a return means that a refund will be processed in less time. If a taxpayer sends his or her return by registered or certified mail, the date of the filing is the postmark date. The registration receipt is evidence that the return was filed on the postmarked date. If a taxpayer sends a return by certified mail and has a receipt postmarked by a postal employee, the date on the receipt is the postmark date. The postmarked certified mail receipt is evidence that the return was delivered and postmarked on the date stamped by the United States Post Office. Most returns are filed at regional centers geographically dispersed across the United States. The address of the Internal Revenue Service Office serving the states in which the taxpayer lives can be found in the instructions to Form 1040.

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

Death of a Taxpayer If a taxpayer died before filing a return for 2017, the taxpayer's spouse or personal representative may have to file and sign a return for that taxpayer. A personal representative can be an executor, administrator, or anyone who is in charge of the deceased taxpayer's property. If the deceased taxpayer did not have to file a return but had tax withheld, a return must be filed

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to get a refund. The person who files the return must enter “Deceased,” the deceased taxpayer's name, and the date of death across the top of the return. If this information is not provided, it may delay the processing of the return. The final income tax return is due at the same time the decedent's return would have been due had death not occurred. A final return for a decedent who was a calendar year taxpayer is generally due on April 15 following the year of death, regardless of when during that year death occurred. However, when the due date falls on a Saturday, Sunday, or legal holiday, the return is filed timely if filed by the next business day.

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

If the taxpayer’s spouse died in 2017 and he or she did not remarry in 2017, or if his or her spouse dies in 2018 before filing a return for 2017, the taxpayer can file a joint return. A joint return should show the taxpayer’s spouse's 2017 income before death and his or her income for all of 2017. Enter “Filing as surviving spouse” in the area where the taxpayer signs the return. If someone else is the personal representative, he or she must also sign. The surviving spouse or personal representative should promptly notify all payers of income, including financial institutions, of the taxpayer's death. This will ensure the proper reporting of income earned by the taxpayer's estate or heirs. A deceased taxpayer's social security number should not be used for tax years after the year of death, except for estate tax return purposes.

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

1. Collect the taxpayer’s data. 2. Review taxpayer’s prior returns. 3. Select the proper tax return form. 4. Determine Gross Income by totaling all income not specifically excluded. 5. Compute the adjusted gross income (AGI) by subtracting the adjustments. 6. Subtract itemized deductions from AGI, if their total exceeds the correct standard deduction amount. 7. Subtract the correct number of exemptions to determine taxable income. 8. Use the Tax Table (if taxable income is under $100,000) or the Tax Computation Worksheet (if taxable income is

$100,000 or more) to determine/calculate tax amount. 9. In the following order:

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

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

etc.). 10. Determine the tax refund amount or the amount owed. 11. Sign and file the tax return on time.

Types of Taxes In addition to the income tax, which is calculated on a yearly basis using the Form 1040, Form 1040A or 1040-EZ, there are various other taxes people pay throughout the year. Estate Tax The estate tax is a tax on the right to transfer property at a taxpayer’s death. It consists of an accounting of everything he or she owns or has certain interests in at the date of death. The executor of a decedent's estate uses Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return to figure the estate tax imposed by Chapter 11 of the Internal Revenue Code. This tax is levied on the entire taxable estate and not just on the share received by a particular beneficiary. Form 706 is also used to figure the generation-skipping transfer (GST) tax imposed by Chapter 13 on direct skips (transfers to skip persons of interests in property included in the decedent's gross estate).

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Gift Tax The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not. The gift tax applies to the transfer by gift of any property. The taxpayer makes a gift if he or she gives property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If the taxpayer sells something at less than its full value or if he or she makes an interest-free or reduced-interest loan, he or she may be making a gift. For 2017, the annual exclusion for gifts is $14,000, the same as 2016. Sales Tax Sales tax is a tax imposed by a state or local government on sales collected by retailers at the point-of-sale. It is based on a percentage of the selling prices of the goods and services. Forty-five states, plus the District of Columbia impose a sales tax. If the taxpayer files a Form 1040, and itemizes deductions on Schedule A, he or she has the option of claiming either state and local income taxes or state and local sales taxes. (The taxpayer cannot claim both.) If the taxpayer saved his or her receipts throughout the year, he or she can add up the total amount of sales taxes actually paid and claim that amount. Property Tax Property tax is a capital tax on property imposed by municipalities; based on the estimated value of the property. Deductible real estate taxes are generally any state, local, or foreign taxes on real property. They must be charged uniformly against all property in the jurisdiction at a like rate. Many states and counties also impose local benefit taxes for improvements to property, such as assessments for streets, sidewalks, and sewer lines. These taxes cannot be deducted. However, a taxpayer can increase the cost basis of the property by the amount of the assessment. Local benefits taxes are deductible if they are for maintenance or repair, or interest charges related to those benefits. Deductible personal property taxes are those based only on the value of personal property such as a boat or car. The tax must be charged to the taxpayer on a yearly basis, even if it is collected more than once a year or less than once a year. Excise Tax Excise taxes are taxes paid when purchases are made on a specific good, such as gasoline. Excise taxes are often included in the price of the product. There are also excise taxes on activities, such as on wagering or on highway usage by trucks. Excise Tax has several general excise tax programs. One of the major components of the excise program is motor fuel. Sin Tax A sin tax is a state-sponsored tax that is added to products or services that are seen as vices, such as alcohol, tobacco and gambling. These types of taxes are levied by governments to discourage individuals from partaking in such activities without making the use of the products illegal. These taxes also provide a source of government revenue. Self-Employment Tax Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. An individual figures self-employment tax (SE tax) using Schedule SE (Form 1040). Social Security and Medicare taxes of most wage earners are figured by their employers. Also, the taxpayer can deduct the employer-equivalent portion of the SE tax in figuring adjusted gross income. Wage earners cannot deduct Social Security and Medicare taxes. Employment Taxes Employment taxes are Federal income tax withholding, Social Security tax, Medicare tax, and Federal unemployment tax that an employer must submit on behalf of employees. Under the Federal Insurance Contributions Act (FICA) 12.4% of earned income up to an annual limit must be paid into Social Security, and an additional 2.9% must be paid into Medicare. If the taxpayer is a wage or salaried employee, he or she pays only half the FICA bill, and the tax is automatically withheld. The employer contributes the rest. The employees and the employer’s FICA tax rate for 2017 consists of the Social Security tax rate of 6.2% of each employee’s first $127,200 of wages, salaries, etc. and the Medicare tax of 1.45% of each employee’s total wages, salaries, etc. In other

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words, the FICA tax rate for 2017 is 7.65% of each employee’s first $127,200 of wages, salaries, etc. and then 1.45% of each employee’s wages, salaries, etc. that are above $127,200. In addition to withholding Medicare tax at 1.45%, an employer must withhold a 0.9% Additional Medicare Tax from wages he or she pays to an employee in excess of $200,000 in a calendar year. The employer is required to begin withholding Additional Medicare Tax in the pay period in which he or she pays wages in excess of $200,000 to an employee and continue to withhold it each pay period until the end of the calendar year. Additional Medicare Tax is only imposed on the employee. There is no employer share of Additional Medicare Tax. The Federal Unemployment Tax Act (FUTA), with state unemployment systems, provides for payments of unemployment compensation to workers who have lost their jobs. Most employers pay both a Federal and a state unemployment tax. Only the employer pays FUTA tax; it is not deducted from the employee's wages. Old-age, survivors, and disability insurance benefits (OASDI) payments under section 202 of title II of the Social Security Act are not includible in the gross income of the individuals to whom they are paid. This applies to old-age insurance benefits, and insurance benefits for wives, husbands, children, widows, widowers, mothers and fathers, and parents, as well as the lump-sum death payment.

Completion of the Filing Process Tax Return Preparers Must Use IRS e-File As of January 1, 2012, any tax return preparer who anticipates preparing and filing 11 or more Forms 1040, 1040A, 1040EZ and 1041 during a calendar year must use IRS e-file (unless the preparer or a particular return is administratively exempt from the e-file requirement or the return is filed by a preparer with an approved hardship waiver). Members of firms must count returns in the aggregate. If the number of applicable income tax returns is 11 or more, then all members of the firm generally must e-file the returns they prepare and file. This is true even if a member expects to prepare and file fewer than 11 returns on an individual basis. Specified tax return preparers may request an undue hardship waiver from the e-file requirement using Form 8944 - Preparer e-file Hardship Waiver Request. Form 8944 generally must be submitted to the IRS no later than February 15 of the year for which a waiver is being requested. Authorized e-File Provider Before a tax preparer begins the online e-file application, he or she must have an IRS e-Services account. e-Services is a suite of web-based products that will allow tax professionals and payers to conduct business with the IRS electronically. These services are only available to approved IRS business partners and not available to the general public. All tax professionals who wish to use e-services products must register online to create an individual electronic account. The registration process is a one-time automated process where the user selects a username, password and PIN. When the registration information has been validated, the registrant will receive an on-screen acknowledgement. When a tax preparer applies for an e-Services account, he or she will need to complete all of the following: (10)

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

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

The verification and approval process for creating an account with IRS e-Services can take several days. The tax preparer’s firm can start the application to become an Authorized IRS e-file Provider once all principals are approved for e-Services. The application process is not simple; however, the complexity is necessary to protect the integrity and security of the electronic filing system. The e-file application process is comprehensive, designed to allow you to save your data during the session and to return to the application when convenient. Plan accordingly since the IRS may take up to 45 days to approve an Authorized IRS e-file Provider application.

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After the tax preparer submits the application and related documents, the IRS will conduct a suitability check on the firm and each person listed on the application as either a principal or responsible official. This may include: a credit check; a tax compliance check; a criminal background check; and a check for prior non-compliance with IRS e-file requirements. Once approved, the tax preparer will get an acceptance letter from the IRS with his or her Electronic Filing Identification Number (EFIN). Electronic Filing Identification Number (EFIN) The IRS assigns an EFIN to identify firms that have completed the IRS e-file Application to become an Authorized IRS e-file Provider. After the provider completes the application and passes a suitability check, the IRS sends an acceptance letter, including the EFIN, to the provider. Providers need the EFIN to electronically file tax returns. The firm owns the EFIN. The principals of the firm use either their Social Security Number or Employer Identification Number to apply for an EFIN. On their application, the firm's ‘Doing Business As’ name and business address should be used, not a personal address. The IRS announced that effective October 1, 2012, they will no longer be accepting paper applications to become an IRS e-file provider and that all applications must be submitted online. Until October 1, 2012, the IRS has allowed tax professionals to fill out Form 8633 - Application to Participate in the IRS e-file Program. With all tax preparers now submitting their applications online, the IRS estimates that the online application process takes four to six weeks to complete and urges tax professionals not to delay. Authorized IRS e-file Providers do not have to reapply each year as long as they continue to e-file returns. However, if a Provider does not e-file returns for two consecutive years, the IRS will notify the Provider of removal from the IRS active Provider list. The IRS may reactivate a Provider if the Provider replies within sixty days and requests reactivation. Otherwise, the Provider will have to complete and submit a new application. Providers must update their application information within 30 days of the date of any changes to the information on their current application. Make all changes using the IRS e-file Application. See Changes to Your IRS e-file Application. The EFIN is not transferable and neither is the password. Even if Authorized IRS e-file Provider transfers his or her business by sale, gift or other disposition, he or she may not transfer his or her EFIN. The Provider must protect his or her EFINS, Electronic Transmitter Identification Numbers (ETINs) and passwords from unauthorized use. Statute of Limitations The IRS has three years to give the taxpayer a refund, three years to audit a tax return, and ten years from the day a tax liability has been finalized to collect any tax due. If a taxpayer filed his or her taxes before the deadline, the time is measured from the April 15th deadline. Together, these laws are called the statute of limitations. Reporting Agent Authorization Use Form 8655 - Reporting Agent Authorization to authorize a reporting agent to:

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

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

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

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

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

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

All Authorized IRS e-file Providers must adhere to IRS e-file rules and requirements to continue participation in IRS e-file. Requirements are included in Revenue Procedure 2007-40 - e-file Providers of Individual Income Tax Returns, Publication 1345 - Handbook for Authorized IRS e-file Providers of Individual Income Tax Returns and in other publications and notices that govern IRS e-file. All Providers must adhere to all rules and requirements, regardless of where published. Some rules and requirements are specific to the activities performed by the Provider and are included in Electronic Return Origination, Transmission and e-file Provider. The following list, while not all-inclusive, applies to all Providers of Individual Income Tax Returns, except Software Developers that do not engage in any other IRS e-file activity other than software development. Generally, e-file can be used to file any return of income tax imposed by subtitle A of the Internal Revenue Code on individuals, trusts, or estates, such as Forms 1040, 1040A, 1040EZ, and 1041. Forms 1040NR, 1041QFT, and 990T (when the exempt organization is a trust subject to tax on unrelated business taxable income under section 511(b)) also meet the definition of a return of income tax, but these forms cannot be electronically filed at this time. Additionally, production filing generally ends on October 15 and the last day to retransmit rejected returns is October 20 so tax returns for prior years are not eligible for the e-file program. Also, an amended tax return cannot be filed electronically under the e-file system. A Provider must: (12)

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

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

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

on the copy of the return. A Refund Anticipation Loan (RAL) is money borrowed by a taxpayer from a lender based on the taxpayer’s anticipated income tax refund. Financial Institutions also offer a variety of other financial products to taxpayers based on their refunds. The IRS is in no way involved in or responsible for RALs or the other financial products. Providers that assist taxpayers in applying for a RAL or other financial product have additional responsibilities and may be sanctioned by the IRS if they fail to adhere to certain requirements. Electronic Return Originator An Electronic Return Originator (ERO) is the Authorized IRS e-file Provider that originates the electronic submission of a return to the IRS. The ERO is usually the first point of contact for most taxpayers filing a return.

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Although an ERO may also engage in return preparation, that activity is separate and different from the origination of the electronic submission of the return to the IRS. An ERO originates the electronic submission of a return after the taxpayer authorizes the filing of the return via IRS e-file. An ERO must originate the electronic submission of only returns that the ERO either prepared or collected from a taxpayer. An ERO originates the electronic submission by either of the following: (13)

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

In originating the electronic submission of a return, the ERO has a variety of responsibilities, including, but not limited to: (13)

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

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

An ERO must clearly display the firm’s “doing business as” name at all locations and sites including Web sites at which the ERO or a third party obtains information from taxpayers for electronic origination of returns by the ERO. ERO Fees An ERO can charge a fee for providing the e-file service to their clients while others may offer it free of charge. However, this fee cannot be based on any figure from the tax return. An ERO must never charge a separate fee for Direct Deposit and must accept any Direct Deposit election by a taxpayer to any eligible financial institution. (14) When assisting a taxpayer in applying for a RAL or other financial product, the ERO may charge a flat fee for that assistance. The fee must be identical for all customers and must not relate to the amount of the refund or the financial product. The Provider must not accept a fee that is contingent upon the amount of the refund or a RAL or other financial product from a financial institution for any service connected with a financial product. The IRS has no responsibility for the payment of any fees associated with the preparation of a return, the transmission of the electronic portion of a return or a RAL or another financial product. ERO Advertising An ERO must comply with the advertising and solicitation provisions of Circular 230. This circular prohibits the use or participation in the use of any form of public communication containing a false, fraudulent, misleading, deceptive, unduly influencing, coercive, or unfair statement or claim. Providers must not use improper or misleading advertising in relation to IRS e-file, including the time frames for refunds and RALs or other financial products. Any claims by Providers concerning faster refunds by virtue of electronic filing must be consistent with the language in official IRS publications. If Providers advertise the availability of a RAL or financial product, the Provider and financial institution must clearly refer to or describe the funds they advance as a loan or other financial product, not as a refund. The advertisement on a RAL or other financial product must be easy to identify and in readable print. That is, it must make clear in the advertising that the taxpayer is borrowing against the anticipated refund or receiving another financial product and is not obtaining the refund itself from the financial institution. Participants in Online Filing must also adhere to the following: (12)

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

Number (SID) for MeF). 3. Provide effective instructions to a taxpayer concerning the entry of the DCN on Form 8453, if required.

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4. Submit any changes to the following information to the IRS Headquarters Online Filing Analyst, SE:W:CAS:SP:ES:I, 5000 Ellin Road, Lanham, MD 20706, by the 31st day of December preceding the filing season:

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

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

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

transmits no more than five returns.

Submitting a Timely Filed Electronic Tax Return All prescribed due dates for filing of returns apply to e-file returns. All Providers must ensure that returns are promptly processed. However, a Provider that receives a return for electronic filing on or before the due date of the return must ensure that it transmits the electronic portion of the return on or before the due date (including extensions). An electronically filed return is not considered filed until the IRS acknowledges acceptance of the electronic portion of the tax return for processing. The IRS accepts individual income tax returns electronically only if the taxpayer signs the return using a Personal Identification Number (PIN). If Providers transmit the electronic portion of a return on or shortly before the due date and the IRS ultimately rejects it, but the Provider and the taxpayer comply with the requirements for timely resubmission of a correct return, the IRS considers the return timely filed. (15) Once signed, an ERO must originate the electronic submission of a return as soon as possible. However, authorized IRS e-file Providers are prohibited from submitting electronic returns to the IRS prior to the receipt of all Forms W-2, W-2G, and 1099-R from the taxpayer. If the taxpayer is unable to secure and provide a correct Form W-2, W-2G, or 1099-R, the return may be electronically filed after Form 4852 - Substitute for Form W-2, Wage and Tax Statement, or Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. is completed in accordance with the use of that form. This is the only time information from Pay stubs or Leave and Earning Statements (LES) is allowed. The IRS monitors Authorized IRS e-file Providers for compliance with the Revenue Procedure 2007-40 and IRS e-file rules and requirements. Monitoring visits will be conducted to investigate complaints and to ensure compliance. Violations of IRS e-file requirements may result in warning or sanctioning an Authorized IRS e-file Provider. Sanctioning may be a written reprimand, suspension or expulsion from participation from IRS e-file, or other sanctions, depending on the seriousness of the infraction. The IRS categorizes the seriousness of infractions as Level One, Level Two, and Level Three. Providers may appeal sanctions through the Administrative Review Process. Un-reversed suspensions make Authorized IRS e-file Providers ineligible to participate in IRS e-file for a period of either one or two years from the effective date of the sanction. (15) Submission of Paper Documents to the IRS IRS e-file returns must contain all the same information as returns filed completely on paper. EROs are responsible for ensuring that they submit to the IRS all paper documents required to complete the filing of returns. Attach all appropriate supporting documents that the IRS requires to the Form 8453 - U.S. Individual Income Tax Transmittal for an IRS e-file Return and send them to the IRS. Use Form 8453 to send any required paper forms or supporting documentation listed next to the checkboxes on Form 8453 (do not send Forms W-2, W-2G, or 1099-R). If you are an ERO, you must mail Form 8453 to the IRS within 3 business days after receiving acknowledgement that the IRS has accepted the electronically filed tax return. (15) Recordkeeping and Documentation Requirements EROs must retain the following material until the end of the calendar year at the business address from which it originated

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the return or at a location that allows the ERO to readily access the material as it must be available at the time of an IRS request. An ERO may retain the required records at the business address of the Responsible Official or at a location that allows the Responsible Official to readily access the material during any period of time the office is closed, as it must be available at the time of an IRS request through the end of the calendar year. (15) Check Return for Completeness and Accuracy Before signing a tax return and sending it to your client, be sure to double check your work. This includes verifying all data from W-2, 1099, and any form that the taxpayer provided to you for the purposes of completing their tax return. Check filing status, exemption, deduction, and credit amounts and go over any information that was determined using a tax table or schedule. Also, perform your calculations again even though they may appear as simple arithmetic, it is important to ensure everything is accurate. Lastly, and importantly, review the prior year’s return even if you did not prepare it. This return will provide you with a wealth of information that can be valuable to this year's return, including Tax loss carry forward information, withholding information and information about how certain income may have been treated, such as capital gains or traditional income. Many tax preparers neglect to go over last year's return. But it is worth the time because very often you will find a carry forward or some other important piece of information that might be beneficial to this year's return. Explain and Review Tax Return Once you have completed preparing the tax return it is important that you take the time to go over it in detail with the taxpayer. This review represents an additional opportunity to check your work and verify information you used to complete the return with the taxpayer. In addition to checking all available tax credits and deductions, it gives you the chance to explain what the outcome of the return was and what the necessary next steps are. Recordkeeping for Individuals As a tax preparer you have an obligation to explain the record keeping requirements to the taxpayer. The length of time a taxpayer should keep a document depends on the action, expense, or the event the document records. Generally, he or she must keep his or her records that support an item of income or deductions on a tax return until the period of limitations for that return runs out. There are many reasons to keep records. In addition to tax purposes, a taxpayer may need to keep records for insurance purposes or for getting a loan. Good records will help the taxpayer: (16)

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

The IRS does not require a taxpayer to keep his or her records in a particular way. The records should be kept in a manner that allows the taxpayer and the IRS to determine the correct tax. The taxpayer can use his or her checkbook to keep a record of income and expenses. In his or her checkbook the taxpayer should record amounts, sources of deposits, and types of expenses. The taxpayer also needs to keep documents, such as receipts and sales slips that can help prove a deduction. All requirements that apply to hard copy books and records also apply to electronic storage systems that maintain tax books and records. When the taxpayer replaces hard copy books and records, he or she must maintain the electronic storage systems for as long as they are material to the administration of tax law. FOR items concerning... KEEP as basic records... Income Form(s) W-2

Form(s) 1099 Bank statements Brokerage statements Form(s) K-1

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Expenses Sales slips Invoices Receipts Canceled checks or other proof of payment Written communications from qualified charities

Home Closing statements Purchase and sales invoices Proof of payment Insurance records Receipts for improvement costs

Investments Brokerage statements Mutual fund statements Form(s) 1099 Form(s) 2439

Table 1-1 Publication 552 - Table 1. Proof of Income and Expense (2017)

A taxpayer should keep copies of his or her tax returns as part of his or her tax records. They can help the taxpayer prepare future tax returns, and he or she will need them if he or she files an amended return. Copies of the returns and other records can be helpful to the survivor or the executor or administrator of a taxpayer’s estate. Basic records are documents that everybody should keep. These are the records that prove the taxpayer’s income and expenses. If he or she owns a home or investments, the basic records should contain documents related to those items. Proof of Payment One of the basic records is proof of payment. The taxpayer should keep these records to support certain amounts shown on his or her tax return. Proof of payment alone is not proof that the item claimed on the return is allowable. The taxpayer also should keep other documents that will help prove that the item is allowable. Generally, the taxpayer proves payment with a cash receipt, financial account statement, credit card statement, canceled check, or substitute check. If he or she makes payments in cash, he or she should get a dated and signed receipt showing the amount and the reason for the payment.

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

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

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

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The taxpayer must keep records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means he or she must keep records that support items shown on the return until the period of limitations for that return runs out. Period of Limitations The period of limitations is the period of time in which an individual can amend his or her tax return to claim a credit or refund, or that the IRS can assess additional tax. The information below contains the periods of limitations that apply to income tax returns. Unless otherwise stated, the years refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date. (17)

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

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

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

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

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

Keep records relating to property until the period of limitations expires for the year in which the taxpayer disposes of the property in a taxable disposition. The taxpayer must keep these records to figure any depreciation, amortization, or depletion deduction and to figure the gain or loss when he or she sells or otherwise dispose of the property. (17) Generally, if an individual received property in a nontaxable exchange, the basis in that property is the same as the basis of the property he or she gave up, increased by any money paid. The taxpayer must keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which he or she disposes of the new property in a taxable disposition. (17) Schedule H - Household Employment Taxes If your client pays wages subject to FICA tax, FUTA tax, or if he or she withholds Federal income tax from an employee's wages, he or she will need to file a Form 1040, Schedule H - Household Employment Taxes. Attach Schedule H to the individual income tax return. If the taxpayer is not required to file a return, he or she must still file Schedule H to report household employment taxes. If an individual pays a household employee $2,000 or more in cash wages during 2017, he or she must report and pay Social Security and Medicare taxes on all the wages. The test applies to cash wages paid in 2017 regardless of when the wages were earned. To figure the total cash wages the taxpayer paid in 2017 to each household employee, do not include amounts paid to any of the following individuals:

His or her spouse. His or her child who was under age 21. His or her parent. His or her employee who was under age 18 at any time during 2017. If the employee was not a student and

providing household services was his or her principal occupation.

However, a sole proprietor who must file Form 940 - Employer's Annual Federal Unemployment (FUTA) Tax Return, and Form 941 - Employer's QUARTERLY Federal Tax Return, or Form 944 - Employer's ANNUAL Federal Tax Return, for business employees, or Form 943 - Employer's Annual Federal Tax Return for Agricultural Employees, for farm employees, may report household employee tax information on these forms instead of on Schedule H. If the taxpayer chooses to report the wages for

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a household employee on the forms shown above, be sure to pay any taxes due by the date required based on the form, making Federal tax deposits if required. Additional information is available in the instructions for the form. Name Change If the taxpayer changed his or her name or his or her dependent had a name change during the year, he or she should be sure to notify the Social Security Administration (SSA) before filing a tax return with the IRS. This is important because the name on the taxpayer’s tax return must match SSA records. If the names do not match the taxpayer is likely to get a letter from the IRS about the mismatch. And if he or she is expecting a refund, this mismatch may delay gettting it. The taxpayer should be sure to contact SSA if:

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

and that child’s last name changed. The taxpayer should file Form SS-5 - Application for a Social Security Card, with the SSA to let them know about a name change. Joint and Several Liability Many married taxpayers choose to file a joint tax return because of certain benefits this filing status allows. In filing jointly, both taxpayers are jointly and severally liable for the tax and any additions to tax, interest, or penalties that arise as a result of the joint return even if they later divorce. Joint and several liability means that each taxpayer is legally responsible for the entire liability. Thus, both spouses are generally held responsible for all the tax due even if one spouse earned all the income or claimed improper deductions or credits. This is also true even if a divorce decree states that a former spouse will be responsible for any amounts due on previously filed joint returns. In some cases, however, a spouse can get relief from joint and several liability. There are three types of relief from joint and several liability for spouses who filed joint returns: (18)

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

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

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

A taxpayer must request innocent spouse relief or separation of liability relief no later than 2 years after the date the IRS first attempted to collect the tax from him or her. For equitable relief, the taxpayer must request relief during the time the IRS has to collect the tax from him or her. If the taxpayer is looking for a refund of tax he or

she paid, then his or her request must be made within the time period for seeking a refund, which is generally three years after the date the return is filed or two years following the payment of the tax, whichever is later. To seek innocent spouse relief, separation of liability relief, or equitable relief, the taxpayer should submit to the IRS a completed Form 8857 - Request for Innocent Spouse Relief, or a written statement containing the same information required on Form 8857, which is signed under penalties of perjury. Relief from joint and several liability should not be confused with an injured spouse claim. The taxpayer is an "injured spouse" if he or she files a joint return and all or part of his or her share of the refund was, or will be, applied against the separate past-due Federal tax, state tax, child support, or Federal non-tax debt (such as a student loan) of his or her spouse with whom the taxpayer filed the joint return. If your client is an injured spouse, he or she may be entitled to recoup his or her share of the refund. Quick Reference Guide IRS Publication 4591- Small Business Federal Tax Responsibilities, can help a taxpayer find the information that he or

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she needs, quickly and easily. Pub 4591 includes information regarding IRS publications, www.IRS.gov and phone resources, information about small business Federal tax responsibilities, tax help for small businesses and the self-employed and small business resources.

Safeguarding Taxpayer Information Safeguarding taxpayer information is a top priority for the Internal Revenue Service. It is the responsibility of governments, businesses, organizations, and individuals that receive, maintain, share, transmit, or store taxpayers’ personal information. Tax return information is all the information tax return preparers obtain from taxpayers or other sources in any form or manner that is used to prepare tax returns or is obtained in connection with the preparation of returns. It also includes all computations, worksheets, and printouts preparers create; correspondence from IRS during the preparation, filing and correction of returns; statistical compilations of tax return information; and tax return preparation software registration information. Authorized IRS e-file Providers must safeguard taxpayer information from unauthorized disclosure, use, and destruction. Authorized IRS e-file Providers must have security systems in place to prevent unauthorized access by third parties to taxpayer accounts and personal information. The Gramm-Leach-Bliley Act, codified at 15 U.S.C. section 6801-6827, and the implementing rules and regulations promulgated by the Federal Trade Commission include rules that are designed to ensure the security and privacy of taxpayer information and are applicable to Providers. (19) The Safeguards Rule requires financial institutions, which include return preparers, data processors, transmitters, affiliates, service providers, and others who are significantly engaged in providing financial products or services that include preparation and filing of tax returns, to ensure the security and confidentiality of customer records and information. Financial institutions must develop, implement, and maintain a written Information Security Program that contains administrative, physical, and technical safeguards that are appropriate. (19) The Financial Privacy Rule requires financial institutions, which include return preparers, data processors, transmitters, affiliates, service providers, and others who are significantly engaged in providing financial products or services that include preparation and filing of tax returns, to give their customers privacy notices that explain the financial institution’s information collection and sharing practices. In turn, customers have the right to limit some sharing of their information. Also, financial institutions and other companies that receive personal financial information from a financial institution may be limited in their ability to use that information. (19) Title 26 - Internal Revenue Code (IRC) section 301 7216.1 imposes criminal penalties on any person engaged in the business of preparing or providing services in connection with the preparation of tax returns who knowingly or recklessly makes unauthorized disclosures or uses of information furnished to them in connection with the preparation of an income tax return. (19) Title 26 - Internal Revenue Code (IRC) section 6713 imposes monetary penalties on the unauthorized disclosures or uses of taxpayer information by any person engaged in the business of preparing or providing services in connection with the preparation of tax returns. (19) 26 USC section 6713 states “if any person who is engaged in the business of preparing, or providing services in connection with the preparation of, returns of tax imposed by chapter 1, or any person who for compensation prepares any such return for any other person, and who discloses any information furnished to him for, or in connection with, the preparation of any such return, or uses any such information for any purpose other than to prepare, or assist in preparing, any such return, shall pay a penalty of $250 for each such disclosure or use, but the total amount imposed under this subsection on such a person for any calendar year shall not exceed $10,000”. (20) Providers must implement security and privacy practices that are appropriate for the size, complexity, nature, and scope of their business activities. The IRS Publication 4600 - Safeguarding Taxpayer Information and Publication 4557 - Safeguarding Taxpayer Data contain information to help non-governmental businesses, organizations, and individuals to understand and meet their responsibility to safeguard taxpayer information. Identity Theft Identity theft occurs when someone uses the taxpayer’s personal information such as his or her name, Social Security number (SSN) or other identifying information, without his or her permission, to commit fraud or other crimes.

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The taxpayer should be alert to possible identity theft if he or she receives an IRS notice or letter that states that: (21)

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

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

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

Significance of Signatures Penalty of Perjury You must explain to the taxpayer that by signing their return that they are declaring that they have examined a copy of their individual income tax return and accompanying schedules and statements for the tax year, and to the best of their knowledge and belief, it is true, correct, and complete. By signing their return, the taxpayer is doing so ‘under penalty of perjury”. Perjury is the willful act of swearing a false oath or affirmation to tell the truth, whether spoken or in writing and is punishable by Federal law. The rules for perjury also apply when a person has made a statement “under penalty of perjury”. An example of this is the United States' income tax return, which, by law, must be signed as true and correct under penalty of perjury. Federal tax law provides criminal penalties of up to three years in prison for violation of the tax return perjury statute. Filing Instructions A person filling out an 8879 form either declares on the form that he or she will enter the personal identification number on an electronically filed tax return or authorizes another party such as an electronic return originator, to do so. All 8879 forms are to be retained by the taxpayer/signee for a minimum of 3 years. Form 8879 is not sent to the IRS unless the department requests it. Form 8879 IRS e-file Signature Authorization Form 8879 - IRS e-file Signature Authorization is the declaration document and signature authorization for an e-filed return filed by an electronic return originator (ERO). Complete Form 8879 when the Practitioner PIN method is used or when the taxpayer authorizes the ERO to enter or generate the taxpayer’s personal identification number (PIN) on his or her e-filed individual income tax return. Many types of these forms are available, and the form used depends on the business type. When completing Form 8879 the Electronic Return Originator (ERO) has specific responsibilities. The ERO will do the following: (22)

1. Enter the name(s) and Social Security number(s) of the taxpayer(s) at the top of the form. 2. Complete Part I using the amounts (zeros may be entered when appropriate) from the taxpayer’s 2017 tax return.

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

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

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

II. See Part I of Publication 1346 - Electronic Return File Specifications for Individual Income Tax Returns. Taxpayers have the following responsibilities for completing Form 8879 correctly: (22)

1. Verify the accuracy of the prepared income tax return, including direct deposit information. 2. Check the appropriate box in Part II to authorize the ERO to enter or generate their PIN or to do it themselves.

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3. Indicate or verify their PIN when authorizing the ERO to enter or generate it (the PIN must be five numbers other than all zeros).

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

Internet website. Form 8879-C - IRS e-file Signature Authorization for Form 1120 A corporate officer and an electronic return originator (ERO) use Form 8879-C when the corporate officer wants to use a personal identification number (PIN) to electronically sign a corporation’s electronic income tax return and, if applicable, consent to electronic funds withdrawal. A corporate officer who does not use Form 8879-C must use Form 8453-C - U.S. Corporation Income Tax Declaration for an IRS e-file Return. Do not send this form to the IRS. The ERO must retain Form 8879-C. (23) Form 8879-PE - IRS e-file Signature Authorization for Form 1065 A general partner or limited liability company member manager and an electronic return originator (ERO) use Form 8879-PE when the general partner or limited liability company member manager wants to use a personal identification number (PIN) to electronically sign a partnership’s electronic return of partnership income. A general partner or limited liability company member manager who does not use Form 8879-PE must use Form 8453-PE - U.S. Partnership Declaration for an IRS e-file Return. Do not send this form to the IRS. The ERO must retain Form 8879-PE. (24) Form 8879-EO - IRS e-file Signature Authorization for an Exempt Organization An organization officer and an electronic return originator (ERO) use Form 8879-EO when the organization officer wants to use a personal identification number (PIN) to electronically sign an organization’s electronic return and, if applicable, authorize an electronic funds withdrawal. An organization officer who does not use Form 8879-EO must use Form 8453-EO - Exempt Organization Declaration and Signature for Electronic Filing. The ERO must retain Form 8879-EO. An organization may qualify for exemption from Federal income tax if it is organized and operated exclusively for one or more of the following purposes: (25)

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

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

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

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

Return of Organization Exempt From Income Tax Form 990 - Return of Organization Exempt From Income Tax is used by tax-exempt organizations, nonexempt charitable trusts, and section 527 political organizations to provide the IRS with the information required by section 6033. Most organizations exempt from income tax under section 501(a) must file an annual information return (Form 990 or 990-EZ)

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or submit an annual electronic notice (Form 990-N), depending upon the organization's gross receipts and total assets. An organization does not have to file Form 990 or 990-EZ even if it has at least $200,000 of gross receipts for the tax year or $500,000 of total assets at the end of the tax year if they are: (26)

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Rejected Electronically Filed Returns A rejected electronic return (from E-file) is usually the result of an identity problem which triggers IRS correspondence and slows down processing of tax returns. This unique feature of e-file enables preparers and taxpayers to fix mistakes before returns are processed, decreasing overall processing time and shortening the time it takes to receive a refund. If the reject is for a simple mistake, correct the error and resubmit the return electronically. If a mistake was made when entering a Social Security number, a payer’s identification number, omitting a form, or misspelling a name; the errors can be corrected and the return can be resubmitted electronically with the IRS. However, you may not be able to correct some rejects. For example, if the return is rejected because an exemption has been claimed on another taxpayer’s return, check that the Social Security number of the exemption was entered correctly on the return. If the SSN is correct, you will not be able to file this return electronically unless the exemption is removed from the return. If you believe the taxpayer is entitled to claim the exemption, it is not necessary to remove the exemption,

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but the return must be filed on paper. Attach Form 8948 - Preparer Explanation for Not Filing Electronically, to the paper return; check box 4 and enter the reject code number. There are other situations where the rejected return may or may not be corrected but it takes one or more tries to resolve. For example, some rejects are based on information on file with the Social Security Administration (SSA). Tax returns often require that both the name and date of birth associated with an SSN match SSA records. Taxpayers sometimes forget to update their records with SSA when they marry or divorce and this can cause their tax returns to reject. This can be resolved by matching SSA records, but if there is some other problem at SSA like a problem with the date of birth, the reject sometimes cannot be resolved. When this happens the return must be filed on paper. Attach Form 8948 to the paper return and check box 4; enter the reject code number and the number of attempts you made to resolve the reject before deciding that the error could not be fixed. Resubmission of Rejected Tax Returns If the IRS rejects the electronic portion of a taxpayer’s individual income tax return for processing, and the ERO cannot rectify the reason for the rejection, the ERO must take reasonable steps to inform the taxpayer of the rejection within 24 hours. When the ERO advises the taxpayer that it has not filed the return, the ERO must provide the taxpayer with the reject code(s) accompanied by an explanation. If the taxpayer chooses not to have the electronic portion of the return corrected and transmitted to the IRS, or if the IRS cannot accept the return for processing, the taxpayer must file a paper return. In order to timely file the return, the taxpayer must file the paper return by the later of the due date of the return or ten calendar days after the date the IRS gives notification that it rejected the electronic portion of the return or that the return cannot be accepted for processing. Taxpayers should include an explanation in the paper return as to why they are filing the return after the due date. (27) Notice 2010-13 provides that a taxpayer required to e-file can request a waiver from the electronic filing requirement when it cannot meet the electronic filing requirements. Before filing a paper return, corporations, partnerships and tax-exempt organizations required to e-file must contact the e-Help Desk (1-866-255-0654) to attempt to resolve the rejection conditions. If the rejection conditions cannot be resolved, these taxpayers must receive authorization from the e-Help Desk before filing a paper return. To be considered timely filed, the paper return must be postmarked by the later of the due date of the return, including extensions, or 10 calendar days after the date the IRS last gives notification the return was rejected as long as: (28)

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

Timeframe for Submitting Electronic Returns There are several key dates related to electronic filing, listed below for 2018:

Important Dates and Filing Deadlines in 2018 for 2017 Federal Income Tax Returns

January 15 4th Quarter 2017 Estimated Tax Payment Due March 17 S Corporation and Partnership Tax Returns Due April 17 Last day to e-file timely 2017 Income Tax Returns April 17 Last day to e-file timely for 2017 Income Tax Return Extensions April 17 1st Quarter 2017 Estimated Tax Payment Due June 17 Last day to e-file timely extension request for overseas taxpayer June 17 2nd Quarter 2017 Estimated Tax Payment Due September 17 3rd Quarter 2017 Estimated Tax Payment Due October 17 Last day to e-file returns that received 6-month extension

Table 1-2 Important Dates and Filing Deadlines for Federal Tax Returns (2017)

If the taxpayer files his or her 2017 Form 1040 or Form 1040A by February 1, 2018, and pays the rest of the tax he or she owes, he or she did not need to make the payment due on January 15, 2018.

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

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

Purchase of U.S. Series I Savings Bonds. Paper check.

If the taxpayer chooses to receive his or her refund by direct deposit, he or she can request that the refund be deposited in up to three separate accounts, such as checking, savings, or retirement accounts – just complete Form 8888 - Allocation of Refund (Including Savings Bond Purchases). However, if the taxpayer files Form 8379 - Injured Spouse Allocation, he or she cannot have his or her refund direct-deposited into more than one account. The refund should only be deposited directly into accounts that are in the taxpayer’s own name, his or her spouse’s name or both if it’s a joint account. Please note that to receive the refund by direct deposit (whether into one account or more) the total refund amount must be $1.00 or more. Providers should caution taxpayers that some financial institutions do not permit the deposit of joint individual income tax refunds into individual accounts. The IRS is not responsible if the financial institution refuses Direct Deposit for this reason. Check or share draft accounts that are "payable through" another institution may not accept Direct Deposit. Taxpayers should verify their financial institution's Direct Deposit policy before they elect the Direct Deposit option. If the taxpayer files a complete and accurate tax return, the refund should be issued within 21 days of the received date. This time-frame does not include mail and IRS handling time for paper returns. Even though the IRS issues most refunds in less than 21 days, it’s possible the tax return may require review and take longer. Use Where's My Refund? (http://www.irs.gov/Refunds/Where's-My-Refund-It's-Quick,-Easy,-and-Secure.) to get personalized refund status. The taxpayer can also use IRS2Go, the free mobile app, for an iPhone or Android device, or go to www.IRS.gov. Both are available 24 hours a day, 7 days a week. The taxpayer can start checking on the status of the return within 24 hours after the IRS receives the e-filed return or 4 weeks after he or she mails a paper return. Processing may take longer under certain circumstances. Refunds from amended returns will generally be issued within 12 weeks. Injured spouse claims can take longer depending on the circumstances. If the taxpayer receives a refund to which he or she is not entitled, or one for an amount that is more than he or she expected, the person should not cash the check until he or she receives a notice explaining the difference; then follow the instructions on the notice. On the other hand, if the taxpayer receives a refund for a smaller amount than he or she expected, the person may cash the check, and, if it is determined that he or she should have received more, the person will later receive a check for the difference. The taxpayer will also get a notice explaining the difference. Direct Deposit Limits Effective January 2015 the IRS limited the number of refunds electronically deposited into a single financial account or pre-paid debit card to three. The fourth and subsequent refunds automatically will convert to a paper refund check and be mailed to the taxpayer. Taxpayers also will receive a notice informing them that the account has exceeded the direct deposit limits and that they will receive a paper refund check in approximately four weeks if there are no other issues with the return. The vast majority of taxpayers will not be affected by this limitation, and we would encourage taxpayers and tax preparers to continue to use direct deposit. It is the fastest, safest way for taxpayers to receive refunds. The direct deposit limit is intended to prevent criminals from easily obtaining multiple refunds. The limit applies to financial accounts, such as bank savings or checking accounts, and to prepaid, reloadable cards or debit cards. The limitation may affect some taxpayers, such as families in which the parent’s and children’s refunds are deposited into a family-held bank account. Taxpayers in this situation should make other deposit arrangements or expect to receive paper refund checks. Form 8888 - Allocation of Refund (Including Savings Bond Purchases) A taxpayer should use Form 8888 - Allocation of Refund (Including Savings Bond Purchases) if he or she wants to directly

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deposit his or her refund (or part of it) to one or more accounts at a bank or other financial institution (such as a mutual fund, brokerage firm, or credit union) in the United States or he or she wants to use the refund to buy up to $5,000 in paper series I savings bonds. Overpayment If a taxpayer thinks he or she paid too much tax he or she may file a claim for refund. The taxpayer must generally file the claim within 3 years from the date he or she filed the original return or 2 years from the date he or she paid the tax, whichever is later. The law generally provides for interest on the refund if it is not paid within 45 days of the date the taxpayer filed the return or claim for refund. Publication 556 - Examination of Returns, Appeal Rights, and Claims for Refund, has more information on refunds. If the taxpayer was due a refund but he or she did not file a return, the taxpayer generally must file the return within 3 years from the date the return was due (including extensions) to get that refund. (30) Refund Offsets Certain financial debts from the taxpayer’s past may affect his or her current Federal tax refund. The law allows the use of part or all of a Federal tax refund to pay other Federal or state debts that an individual owes. Here are six facts from the IRS that every taxpayer should know about tax refund offsets: (31)

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

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

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

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

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

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

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

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

was paid due to fraud or for contributions due to a state fund that were not paid due to fraud). A taxpayer can contact the agency with which he or she has a debt, to determine if the debt was submitted for a tax refund offset. If the debt was submitted for offset, BFS will take as much of the taxpayer’s refund as is needed to pay off the debt and send it to the agency he or she owes. Any portion of the refund remaining after offset will be issued in a check to the taxpayer or direct deposited. BFS will send a notice if an offset occurs. The notice will reflect the original refund amount, the offset amount, the agency receiving the payment, and the address and telephone number of the agency. BFS will notify the IRS of the amount taken from the refund. Contact the agency shown on the notice if the taxpayer believes he or she does not owe the debt, or if the taxpayer is disputing the amount taken from the refund. If a notice is not received, contact BFS. Amended Returns If the taxpayer discovers an error after his or her return has been filed, he or she may need to amend the return. The IRS may correct errors in math on a return and may accept returns with certain forms or schedules left out. In these instances, do not amend the return. However, do file an amended return if there is a change in the taxpayer’s filing status, income,

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deductions, or credits. Generally, to claim a refund, Form 1040X - Amended U.S. Individual Income Tax Return must be filed within 3 years from the due date of the original return or within 2 years from the date the taxpayer paid the tax, whichever is later. Returns filed before the due date (without regard to extensions) are considered filed on the due date. (33)

Paying the Tax Balance Due Returns Taxpayers who owe additional tax must pay their balances due by the original due date of the return or be subject to interest and penalties. An extension of time to file may be filed electronically by the original return due date, but it is an extension of time to file the return, not an extension of time to pay a balance due. Providers should inform taxpayers of their obligations and options for paying balances due. Taxpayers have several choices when paying any taxes owed on their returns as well as estimated tax payments. The taxpayer is considered to have reasonable cause for the period covered by an automatic extension if at least 90%of the current tax year’s actual tax liability is paid before the regular due date of the return through withholding, estimated tax payments, or payments made with Form 4868. Electronic Funds Withdrawal Taxpayers can e-file and, at the same time, authorize an electronic funds withdrawal (EFW). Taxpayers who choose this option must provide account numbers and routing transit numbers for qualified savings, checking or share draft accounts to the Provider. The IRS tax return instructions describe how to find and identify these numbers. Providers should encourage their clients to confirm their account numbers and routing transit numbers with their financial institution. If a financial institution is unable to locate or match the numbers entered in a payment record with account information they have on file for a given taxpayer, they reject (return) the direct debit request. Taxpayers can schedule a payment for withdrawal on a future date. Scheduled payments must be effective on or before the return due date. For example, the Provider may transmit an individual income tax return in March and the taxpayer can specify that the withdrawal be made on any day on or before the return due date. The taxpayer does not have to remember to do anything at a later date. For returns transmitted after the due date, the payment date must be the same as the date the Provider transmitted the return. The taxpayer must authorize EFW payments by completion of a payment record at the time the balance due return or form is e-filed. Taxpayers can make payments by EFW for the following:

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

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

that they electronically file the Form 1040 series return). Providers should be careful to ensure that all the information needed for the EFW request is included with the return. Estimated Taxes Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards. The taxpayer may also have to pay estimated tax if the amount of income tax being withheld from his or her salary, pension, or other income is not enough. (34) Estimated tax is used to pay income tax and self-employment tax, as well as other taxes and amounts reported on the tax return. If the taxpayer does not pay enough through withholding or estimated tax payments, he or she may be charged a penalty. If the taxpayer does not pay enough by the due date of each payment period, he or she may be charged a penalty even if he or she is due a refund when the tax return is filed. (34) If the taxpayer is filing as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual, he or she generally will have to make estimated tax payments if he or she expects to owe tax of $1,000 or more when filing the return. If the taxpayer is filing as a corporation, he or she generally has to make estimated tax payments for the corporation if he or

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she expects it to owe tax of $500 or more when filing its return. The taxpayer does not have to pay estimated tax for the current year if he or she meets all three of the following conditions: (34)

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

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

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

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

As of January 2013, a Net Investment Income Tax (NIIT) applies at a rate of 3.8% to individuals, estates, and trusts that have certain investment income above threshold amounts. When calculating the 2017 estimated tax payments, the taxpayer may need to take account of any additional tax liability associated with the NIIT.

Penalty for Underpayment In general, the taxpayer may owe a penalty for 2017 if the total of his or her withholding and timely estimated tax payments did not equal at least the smaller of:

90% of his or her 2017 tax. 100% of his or her 2016 tax. (The taxpayer‘s 2016 tax return must cover a 12-month period.)

If the taxpayer did not pay enough tax, either through withholding or by making timely estimated tax payments, he or she will have underpaid his or her estimated tax and may have to pay a penalty. Because the penalty is figured separately for each payment period, the taxpayer may owe a penalty for an earlier payment period even if he or she later paid enough to make up the underpayment. This is true even if the taxpayer is due a refund when he or she files his or her income tax return. The taxpayer will owe a penalty for any 2017 payment period for which his or her estimated tax payment plus his or her withholding for the period and overpayments for previous periods was less than the smaller of: (35)

22.5% of his or her 2017 tax. 25% of his or her 2016 tax. (The taxpayer’s 2016 tax return must cover a 12-month period.)

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

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

withheld.

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However, if these situations do not apply to the taxpayer, and he or she thinks he or she can lower or eliminate his or her penalty, complete Form 2210 - Underpayment of Estimated Tax by Individuals, Estates, and Trusts or Form 2210-F - Underpayment of Estimated Tax by Farmers and Fishermen and attach it to the return. Short Method for Figuring the Penalty The taxpayer may be able to use the short method in Part III of Form 2210 to figure his or her penalty for underpayment of estimated tax. If the taxpayer qualifies to use this method, it will result in the same penalty amount as the regular method. However, either the annualized income installment method or the actual withholding method may result in a smaller penalty. The taxpayer can use the short method only if he or she meets one of the following requirements:

The taxpayer made no estimated tax payments (or the taxpayer’s only payments were withheld for Federal income tax).

The taxpayer paid the same amount of estimated tax on each of the four payment due dates.

If the taxpayer does not meet either requirement, figure the penalty using the regular method in Part IV of Form 2210 and the Penalty Worksheet in the instructions. Part III of Form 2210 Line 14 - Total underpayment for the 2017 tax year. Subtract line 13 from line 10. If zero or less, stop; the taxpayer does not owe a penalty. Do not file Form 2210 unless the taxpayer checked box E in Part II Line 15 - Multiply line 14 by .02660 Line 16 -

If the amount on line 14 was paid on or after 4/15/18, enter -0-. If the amount on line 14 was paid before 4/15/18, make the following computation to find the amount to enter on

line 16. o Amount on line 14 × Number of days paid before 4/15/18 × .00011

Line 17 - Penalty. Subtract line 16 from line 15. Enter the result here and on Form 1040, line 79; Form 1040A, line 51; Form 1040NR, line 76; Form 1040NR-EZ, line 26; or Form 1041, line 26. Exceptions The taxpayer does not owe a penalty if the total tax shown on his or her return minus the amount he or she paid through withholding (including excess Social Security and tier 1 railroad retirement (RRTA) tax withholding) is less than $1,000. Also, the taxpayer does not owe a penalty if he or she had no tax liability last year and he or she was a U.S. citizen or resident for the whole year. For this rule to apply, the taxpayer’s tax year must have included all 12 months of the year. The taxpayer had no tax liability for the last year if his or her total tax was zero or he or she was not required to file an income tax return. Electronic Federal Tax Payment System (EFTPS) Electronic Federal Tax Payment System (EFTPS) is a system for paying Federal taxes electronically using the Internet, or by phone using the EFTPS Voice Response System. EFTPS is offered free by the U.S. Department of Treasury. Once enrolled, individual and business taxpayers can use the internet to make all their Federal tax payments or via the phone using the EFTPS Voice Response System. Both payment methods are interchangeable. (36) Debit or Credit Card A taxpayer can pay by debit or credit card whether he or she e-files, paper files or is responding to a bill or notice. The IRS uses standard service providers and commercial card networks. (37)

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

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

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

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

Individuals Tax Form Payment Type and Tax Year Limit Form 1040 series Current Tax Year (2017)

Prior Year (1997-2016)

Advanced Payment of a Determined

Deficiency (2015-2017)

Installment Agreement

(1997-2017)

2 per year

2 per year

2 per year

2 per month

Form 1040-ES Estimated Tax (2017/Q4 & 2018/Q1-3)

2 per quarter

Form 1040-X Amended (2014-2017) 2 per year Form 4868 Extension Payment (2017) 2 per year Form 5329 Current Tax Due (2017) 2 per year Health Care - Form 1040 Current Tax Year Notice (2017)

Advanced Payment of a Determined

Deficiency (2016-2017)

2 per year

2 per year

Health Care - Form 1040-X Amended (2016-2017) 2 per year Trust Fund Recovery Penalty Prior Year (1997-2017)

Installment Agreement

(1997-2017)

2 per quarter

2 per month

Table 1-3 - Frequency Limit Table by Type of Tax Payment (2017)

When a taxpayer is using a debit or credit card for payment, keep in mind these additional considerations: (37)

High balance payments of $100,000 or greater may require special coordination with the service provider chosen. The taxpayer cannot make Federal tax deposits with a debit or credit card. The taxpayer cannot get an immediate release of a Federal Tax Lien by making a debit or credit card payment. Making an electronic payment eliminates the need to use a voucher. On the monthly debit or credit card statement, the payment to the IRS will be listed as "United States Treasury

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

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

Check or Money Order If the taxpayer chooses to mail the tax payment: (38)

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

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

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

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Installment Agreements If the taxpayer cannot pay in full immediately, he or she may qualify for additional time --up to 120 days-- to pay in full. There is no fee for this full payment agreement; however, interest and any applicable penalties continue to accrue until the taxpayer’s liability is paid in full. The taxpayer may be able to set up this agreement using the Online Payment Agreement (OPA) application. If the taxpayer is not able to pay his or her balance in full immediately or within 120 days, he or she may qualify for a monthly installment agreement. The IRS has the authority to enter into a written agreement with the taxpayer, allowing for periodic partial payments of any taxes owed, if such an agreement would facilitate the collection of all taxes due. An installment agreement allows the taxpayer to make a series of monthly payments over time. The IRS offers various options for making monthly payments, such as: (39)

Direct debit from a bank account. Payroll deduction from an employer. Payment via check or money order. Payment by Electronic Federal Tax Payment System (EFTPS). Payment via check or money order. Payment with cash at a retail partner.

The taxpayer may request a pre-assessment installment agreement on current tax liabilities by using the Online Payment Agreement (OPA) application on the www.irs.gov website. The taxpayer may also submit Form 9465 - Installment Agreement Request, or attach a written request for a payment plan to the front of the return. The IRS charges a user fee of $225 when a taxpayer enters into a standard installment agreement or a payroll deduction agreement. If he or she enters a standard installment agreement and chooses to pay via direct debit from his or her bank account, the user fee is $107. If taxpayer uses the OPA application to request an installment agreement, the user fee is $149. If the taxpayer uses the OPA application to request an installment agreement and choose to pay via direct debit, the user fee is $31 for all taxpayers regardless of income levels. Taxpayers with income at or below 250% of the Department of Health and Human Services poverty guidelines may apply for a reduced user fee of $43 for entering into a new installment agreement or restructuring or reinstating an established installment agreement. (39)

The user fee for restructuring or reinstating an established installment agreement is $89 regardless of income levels or method of payment.

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

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

Offer in Compromise An offer in compromise allows the taxpayer to settle his or her tax debt for less than the full amount he or she owes. It may be a legitimate option if the taxpayer cannot pay his or her full tax liability, or doing so creates a financial hardship. The IRS will consider each taxpayer’s unique set of facts and circumstances based on: (40)

Ability to pay Income Expenses Asset equity

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

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The taxpayer’s completed offer package that is submitted to the IRS will include: (40)

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

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

3. $186 application fee (non-refundable). 4. Initial payment (non-refundable) for each Form 656.

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

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

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

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

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

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

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

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

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

If the taxpayer’s offer is rejected he or she may appeal a rejection within 30 days using Form 13711 - Request for Appeal of Offer in Compromise. IRS Notices and Letters Each year, the IRS sends millions of notices and letters to taxpayers for a variety of reasons. Here are ten things to know in case one shows up in the taxpayer’s mailbox.

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

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

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

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

instructions or he or she needs to make a payment.

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6. If the taxpayer does not agree with the notice, it is important that he or she responds. The taxpayer should write a letter to explain why he or she disagrees. The taxpayer should include any information and documents he or she wants the IRS to consider. The taxpayer mails the reply with the bottom tear-off portion of the notice and sends it to the address shown in the upper left-hand corner of the notice. Allow at least 30 days for a response.

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

8. The taxpayer should keep copies of any notices he or she receives with his or her other tax records. 9. The IRS sends letters and notices by mail. The IRS does not contact people by email or social media to ask for

personal or financial information. 10. For more on this topic, the taxpayer can visit IRS.gov and click on the link ‘Responding to a Notice’ at the bottom

left of the home page. He or she can also see Publication 594 - The IRS Collection Process.

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

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

Review Questions Answers appear in Review Feedback 1. When a taxpayer is using a debit or credit card to pay for high balance payments of what amount or greater may require

special coordination with the service provider chosen? A. $50,000 B. $75,000 C. $100,000 D. $125,000

2. Cindy is a calendar year taxpayer and she uses the cash method for her accounting. Her bank credited, and made

available, interest to her bank account in December 2017. She did not withdraw it or enter it into her books until 2018. Which of the following statements is true regarding the amount she must include in gross income?

A. Cindy must include the amount in gross income for 2017 B. Cindy must include the amount in gross income for 2018 C. Cindy has the option to include the amount in gross income for 2017 or 2018 D. Cindy does not have to include the amount in gross income for 2017 or 2018

3. A taxpayer should use Form 8888 - Allocation of Refund (Including Savings Bond Purchases) for all of the following

reasons except: A. To directly deposit his or her refund (or part of it) to one or more accounts at a bank B. To directly deposit his or her refund (or part of it) to one or more accounts in a mutual fund C. To directly deposit his or her refund (or part of it) to one or more accounts at a brokerage firm D. To use the refund to buy up to $10,000 in paper series I savings bonds.

4. The user fee for restructuring or reinstating an established installment agreement is what amount regardless of income

levels or method of payment? A. $25 B. $40 C. $50 D. $89

5. All of the following are types of relief from joint and several liability for spouses who filed joint returns except:

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

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Review Feedback Return to Review Questions Question 1 - C. $100,000 When a taxpayer is using a debit or credit card to pay for high balance payments of $100,000 or greater it may require special coordination with the service provider chosen. Additionally, the taxpayer cannot make Federal tax deposits with a debit or credit card. Question 2 - A. Cindy must include the amount in gross income for 2017 Under the cash method, a taxpayer includes in his or her gross income all items of income he or she actually or constructively receive during the tax year. If the taxpayer receives property and services, he or she must include their fair market value (FMV) in income. Cindy must include the amount in gross income for 2017, the year she constructively received it. Question 3 - D. To use the refund to buy up to $10,000 in paper series I savings bonds. A taxpayer should use Form 8888 - Allocation of Refund (Including Savings Bond Purchases) if he or she wants to directly deposit his or her refund (or part of it) to one or more accounts at a bank or other financial institution (such as a mutual fund, brokerage firm, or credit union) in the United States or he or she wants to use the refund to buy up to $5,000 in paper series I savings bonds. Question 4 - D. $89 A one-time installment agreement user fee of $225 will be charged when a taxpayer enters into a standard installment agreement or a payroll deduction installment agreement. If he or she chooses to pay through a direct debit from his or her bank account, the user fee is $107. Taxpayers with income at or below 250% of the Department of Health and Human Services poverty guidelines may apply for a reduced user fee of $89. The user fee for restructuring or reinstating an established installment agreement is $89 regardless of income levels or method of payment. Question 5 - A. Prenuptial Agreement There are three types of relief from joint and several liability for spouses who filed joint returns; Innocent Spouse Relief, Separation of Liability Relief and Equitable Relief.

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

Form 1040EZ, 1040A and 1040 Form 1040NR Form 1040X Form W-4 Form W-2 Form 1099

There are three main tax forms available for filing by individual taxpayers:

1. Form 1040EZ 2. Form 1040A 3. Form 1040

Form 1040EZ - Income Tax Return for Single and Joint Filers With No Dependents Short Form 1040EZ is the simplest form available to taxpayers. Many tax professionals call the 1040EZ "the short form". The taxpayer can opt to file a Federal Form 1040EZ if he or she is filing as single or married filing jointly with no dependents. If the taxpayer has dependents or if he or she is filing as head of household, qualifying widow(er) or married filing separately, he or she may not use Form 1040EZ no matter how easy the return. The taxpayer also cannot use Form 1040EZ if he or she intends to claim the additional standard deductions (available to those taxpayers who are blind or over age 65), those options are only available on Form 1040. In addition, the taxpayer’s taxable income must be less than $100,000. His or her income must consist only of wages, salaries and tips, taxable interest of less than $1,500 and unemployment compensation or Alaska Permanent Fund dividends. Also, the taxpayer cannot file a Form 1040EZ if he or she has self-employment income (Schedule C), rents (Schedule E) or capital gains and losses (Schedule D). The taxpayer may not itemize deductions (Schedule A) if he or she uses Form 1040EZ. He or she must claim the standard deduction. Lastly, the taxpayer’s available credits are limited to the Earned Income Tax Credit (EITC) or the nontaxable combat pay election. A taxpayer may use Form 1040EZ if he or she meets all of the following conditions: (41)

1. His or her filing status is single or married filing jointly (If the taxpayer was a nonresident alien at any time in 2017, his or her filing status must be married filing jointly to use Form 1040EZ. If his or her filing status is not married filing jointly, he or she may have to use Form 1040NR or 1040NR-EZ).

2. He or she claims no dependents. 3. He or she, and his or her spouse if filing a joint return, were under age 65 on January 1, 2017, and not blind at the

end of 2017. 4. He or she has only wages, salaries, tips, taxable scholarship and fellowship grants, unemployment compensation, or

Alaska Permanent Fund dividends, and his or her taxable interest was not over $1,500. 5. His or her taxable income is less than $100,000. 6. His or her earned tips, if any, are included in boxes 5 and 7 of his or her Form W-2. 7. He or she does not owe any household employment taxes on wages he or she paid to a household employee. 8. He or she is not a debtor in a Chapter 11 bankruptcy case filed after October 16, 2005. 9. He or she does not claim any adjustments to income. 10. He or she does not claim any credits other than the Earned Income Tax Credit. 11. Advance payments of the premium tax credit were not made for him or her, his or her spouse, or any individual he or

she enrolled in coverage for whom no one else is claiming the personal exemption. The taxpayer cannot use Form 1040EZ to claim the new Premium Tax Credit. He or she also cannot use this form if he or she received advance payments of this credit.

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Form 1040A - U.S. Individual Income Tax Return A compromise between the Federal Form 1040 and the Federal Form 1040EZ is the Federal Form 1040A. The taxpayer can file a Form 1040-A if his or her taxable income is less than $100,000 and his or her income is from the same kinds of income as he or she would claim on Form 1040EZ plus interest, dividends, capital gain distributions, IRA distributions, distributions from pensions and annuities, and taxable Social Security and Railroad Retirement Benefits. Unlike Form 1040EZ, certain “above the line” adjustments may be claimed on a Form 1040A, including educator expenses, IRA deductions and student loan interest deductions. These are deductions that the taxpayer can claim even if he or she does not itemize which is important because the taxpayer may not itemize deductions on Form 1040A. The taxpayer may claim a limited number of tax credits using the Form 1040A, including the Child Tax Credit, education credits, Earned Income Tax Credit, Credit for Child and Dependent Care Expenses, Credit for the Elderly or the Disabled and the American Opportunity Tax Credit. Form 1040A, also a short form, is used when taxpayers meet the following six conditions: (42)

1. Had income only from the following sources: a. Wages, salaries, tips. b. Interest and ordinary dividends. c. Capital gain distributions. d. Taxable scholarship and fellowship grants. e. Pensions, annuities and IRAs. f. Unemployment compensations. g. Alaska Permanent Fund dividends. h. Taxable Social Security and railroad retirement benefits.

2. The only adjustments to income the taxpayer can claim are: a. Educator expenses. b. IRA contribution deduction. c. Student loan interest deduction.

3. Taxpayer does not itemize deductions. 4. Taxpayer’s taxable income (Line 27) is less than $100,000. 5. The only tax credits the taxpayer can claim are:

a. Child and Dependent Care Credit. b. Credit for the Elderly and Disabled. c. Education credits. d. Retirement Savings Contributions Credit (Saver’s Credit). e. Child Tax Credit. f. Earned Income Tax Credit. g. Additional Child Tax Credit. h. Premium Tax Credit.

6. The taxpayer did not have an alternative minimum tax adjustment on stock he or she acquired from the exercise of an incentive stock option.

All other tax credits are available only if the taxpayer uses Form 1040 with supporting schedules. However, the taxpayer can also use Form 1040A if he or she received dependent care benefits or if he or she owes tax from the recapture of an education credit or the alternative minimum tax.

Form 1040 - U.S. Individual Income Tax Return The best known tax form is Form 1040, or what many tax professionals call "the long form". It can always be used. Whether a taxpayer is required to use Form 1040 depends on whether he or she meets any one of the following conditions. The taxpayer must use Form 1040 if: (43)

1. The taxpayer has an income of $100,000 or more. 2. The taxpayer is itemizing deductions (such as mortgage interest or charitable contributions). 3. The taxpayer has income from a rental, business, farm, S-corporation, partnership, or trust. 4. The taxpayer has foreign wages, paid foreign taxes, or is claiming tax treaty benefits. 5. The taxpayer completed Part III of Schedule B - Interest and Ordinary Dividends (Form 1040) because:

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a. Received a distribution from a foreign trust. b. Had a bank, securities, or other financial account in a foreign country at any time during the year.

6. The taxpayer sold stocks, bonds, mutual funds, or property. 7. The taxpayer is claiming adjustments to income for moving expenses or health savings accounts. 8. The taxpayer had income that cannot be reported on Form 1040EZ or Form 1040A. This includes gain from the

sale of the taxpayer’s home or other property, barter income, alimony income, taxable refunds of state and local income taxes, and self-employment income (including farm income).

9. The taxpayer must pay tax on self-employment income. See Schedule SE (Form 1040) - Self-Employment Tax. Form 1040NR - U.S. Nonresident Alien Income Tax Return The U.S. imposes a tax on worldwide income for its citizens and residents. If the taxpayer is a nonresident alien, he or she pays Federal income tax only on U.S. source income. In most cases, the taxpayer must file a tax return if he or she is a nonresident alien even if he or she has no income from his or her trade or business in the U.S., he or she has no U.S. source income or if his or her income is exempt from U.S. tax under a tax treaty. There is an exception: the taxpayer does not need to file if, as a nonresident alien, his or her only U.S. trade or business was the performance of personal services with wages of less than $4,050 and he or she does not need to file to claim a refund of over-withheld taxes, satisfy additional withholding or claim partially exempt income. Exceptions also apply if the taxpayer is a nonresident alien student, teacher or trainee in the U.S. temporarily on an “F,” “J,” “M,” or “Q” visa, and he or she has no taxable income. The taxpayer must file Form 1040NR if any of the following four conditions apply: (44)

1. The taxpayer was a nonresident alien engaged in a trade or business in the United States during 2017. The taxpayer must file even if:

a. The taxpayer has no income from a trade or business conducted in the United States. b. The taxpayer has no U.S. source income. c. The taxpayer’s income is exempt from U.S. tax under a tax treaty or any section of the Internal Revenue

Code. 2. The taxpayer was a nonresident alien not engaged in a trade or business in the United States during the tax year

and: a. He or she received income from U.S. sources that is reportable on Schedule NEC, lines 1 through 12. b. Not all of the U.S. tax that the taxpayer owes was withheld from that income.

3. The taxpayer represents a deceased person who would have had to file Form 1040NR. 4. The taxpayer represents an estate or trust that has to file Form 1040NR.

An individual does not need to file Form 1040NR if: (44)

1. His or her only U.S. trade or business was the performance of personal services and: a. His or her wages were less than $4,050. b. He or she has no other need to file a return to claim a refund of overwithheld taxes, to satisfy additional

withholding at source, or to claim income exempt or partly exempt by treaty. 2. He or she is a nonresident alien student, teacher, or trainee who was temporarily present in the United States

under an “F,” “J,” “M,” or “Q” visa, and he or she has no income that is subject to tax under section 871 (that is, the income items listed on page 1 of Form 1040NR, lines 8 through 21, and on page 4, Schedule NEC, lines 1 through 12).

3. He or she was a partner in a U.S. partnership that was not engaged in a trade or business in the United States during 2017 and his or her Schedule K-1 (Form 1065) includes only income from U.S. sources that he or she must report on Schedule NEC, lines 1 through 12.

Form 1040NR-EZ - U.S. Income Tax Return for Certain Nonresident Aliens With No Dependents The taxpayer may be able to use Form 1040NR-EZ if his or her only income from U.S. sources is wages, salaries, tips, refunds of state and local income taxes, and scholarship or fellowship grants. The individual can use Form 1040NR-EZ instead of Form 1040NR if all items apply: (45)

1. The taxpayer does not claim any dependents.

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2. The taxpayer cannot be claimed as a dependent on another person's U.S. tax return (such as his or her parent's return).

3. The taxpayer’s only U.S. source income was from wages, salaries, tips, refunds of state and local income taxes, and scholarship or fellowship grants. Note: If the taxpayer had taxable interest or dividend income, he or she must use Form 1040NR instead of Form 1040NR-EZ.

4. The taxpayer’s taxable income (line 14 of Form 1040NR-EZ) is less than $100,000. 5. The only exclusion the taxpayer can take is the exclusion for scholarship and fellowship grants, and the only

adjustment to income the taxpayer can take is the student loan interest deduction. 6. The taxpayer does not claim any tax credits. 7. If the taxpayer was married, he or she does not claim an exemption for his or her spouse. 8. The only itemized deduction the taxpayer can claim is for state and local income taxes. Note: Residents of India

who were students or business apprentices may be able to take the standard deduction instead of the itemized deduction for state and local income taxes.

9. This is not an “expatriation return.” 10. The only taxes the taxpayer owes are:

a. The tax from the Tax Table or b. Unreported Social Security and Medicare tax from Forms 4137 or 8919.

11. The taxpayer does not claim a credit for excess Social Security and tier 1 RRTA tax withheld. Form 1040-SS - U.S. Self-Employment Tax Return The Form 1040-SS is a short form for reporting self-employment income if the taxpayer, or his or her spouse (if filing a joint return), does not have to file a Form 1040 but had net earnings from self-employment of $400 or more (or he or she had church employee income of $108.28 or more); and are a resident of Guam, American Samoa, the U.S. Virgin Islands, Commonwealth of the Northern Mariana Islands or Puerto Rico. Extensions Beginning with 2005, an individual is granted an automatic extension of six months for filing a return (but not for payment of tax), provided that Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return is properly filed before the normal due date of the return. (Previously, the automatic filing extension was good for four months.) Also, filing extensions may be obtained via telephone or via internet on the IRS website. If a taxpayer pays part of their tax liability by using a credit card using one of the prescribed IRS service providers, an automatic extension will be granted and a confirmation of such extension will be provided at the end of the credit card transaction. To obtain more information please visit the www.PAY1040.com internet site. The late payment penalty is usually ½ of 1% of any tax (other than estimated tax) not paid by the filing due date. It is charged for each month or part of a month the tax is unpaid. The maximum penalty is 25%. (46) Filing extensions can be obtained without making tax payments if taxpayers properly estimate their tax liability on the form. If tax is not properly estimated, the extension request will be disallowed and the late-filing penalty will be assessed. If the amount of tax included with the extension request is less than sufficient to cover the taxpayer's liability, the taxpayer will be charged interest on the overdue amount. The taxpayer is considered to have reasonable cause for the period covered by this automatic extension if at least 90% of the actual tax liability is paid before the regular due date of the return through withholding, estimated tax payments, or payments made with Form 4868. (46)

Returns not Qualifying for Use of the Tax Table

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

Tax Computation Worksheet The Tax Computation Worksheet is based on filing status, as follows: (47)

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

Amended Returns and Claims for Refund What should a taxpayer do if he or she already filed the Federal tax return and then discovers a mistake? The taxpayer has a chance to fix errors by filing an amended tax return. Here are 10 facts every taxpayer should know about filing an amended tax return:

1. Use Form 1040X - Amended U.S. Individual Income Tax Return, to file an amended tax return. An amended return cannot be e-filed. The taxpayer must file it on paper.

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

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

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

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

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

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

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

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

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

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

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

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

Form 1040X If an individual discovers an error after the return has been filed, he or she may need to amend the return. The IRS may correct errors in math on a return and may accept returns with certain forms or schedules left out. In these instances, do not amend the return. However, do file an amended return if there is a change in filing status, income, deductions, or credits. (33) File Form 1040X - Amended U.S. Individual Income Tax Return only after the taxpayer filed the original return. Use Form 1040X to correct the Form 1040, Form 1040A or Form 1040EZ already filed. On Form 1040X write the taxpayer’s income,

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deductions, and credits as originally reported on the return, the changes being made, and the corrected amounts. Then figure the tax on the corrected amount of taxable income and the amount the taxpayer owes or will be refunded. Do not file more than one original return for the same year, even if the taxpayer has not received the refund or has not heard from the IRS since he or she filed. Filing more than one original return for the same year, or sending in more than one copy of the same return (unless requested by the IRS), could delay the refund. If the taxpayer owes tax, pay the full amount with Form 1040X. The tax owed will not be subtracted from any amount the taxpayer had credited to his or her estimated tax. If the taxpayer overpaid tax, he or she can have all or part of the overpayment refunded, or the taxpayer can apply all or part of it to his or her estimated tax. If the taxpayer chose to get a refund, it will be sent separately from any refund shown on his/her original return. File a separate Form 1040X for each year the taxpayer is amending. Mail each form in a separate envelope. Be sure to enter the year of the return being amended at the top of Form 1040X. The form has three columns. Column A shows original or adjusted figures from the original return. Column C shows the corrected figures. The difference between Columns A and C is shown in Column B. There is an area on the back of the form to explain the specific changes being made and the reason for each change. Attach any forms or schedules that are affected by the change. Attach copies of any forms or schedules that are being changed as a result of the amendment, including any Form(s) W-2 received after the original return was filed. An amended tax return cannot be filed electronically under the e-file system. Normal processing time for Forms 1040X is 8 to 12 weeks from the IRS receipt date. Time for Filing a Claim for Refund Generally, a taxpayer must file a claim for a credit or refund within 3 years after the date the taxpayer filed the original return or within 2 years after the date the taxpayer paid the tax, whichever is later. Returns filed before the due date (without regard to extensions) are considered filed on the due date (even if the due date was a Saturday, Sunday, or legal holiday). If a claim is not filed within this period, the taxpayer may not be entitled to a credit or a refund.

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

Interest and Penalties The IRS will charge the taxpayer interest on taxes not paid by their due date, even if he or she had an extension of time to file. The IRS will also charge interest on penalties imposed for failure to file, negligence, fraud, substantial valuation misstatements, substantial understatements of tax, and reportable transaction understatements. Interest is charged on the penalty from the due date of the return (including extensions). (48) If the taxpayer does not pay the additional tax due on Form 1040X within 21 calendar days from the date of notice and demand for payment (10 business days from that date if the amount of tax is $100,000 or more), the penalty is usually ½ of 1% of the unpaid amount for each month or part of a month the tax is not paid. The penalty can be as much as 25% of the unpaid amount and applies to any unpaid tax on the return. This penalty is in addition to interest charges on late payments. The taxpayer will not have to pay the penalty if he or she can show reasonable cause for not paying the tax on time. (48) If the taxpayer files a claim for refund or credit in excess of the amount allowable, he or she may have to pay a penalty equal to 20% of the disallowed amount, unless the taxpayer can show a reasonable basis for the way he or she treated an item. The penalty will not be figured on any part of the disallowed amount of the claim that relates to the Earned Income Tax Credit or on which accuracy-related or fraud penalties are charged. (48) In addition to any other penalties, the law imposes a penalty of $5,000 for filing a frivolous return. A frivolous return is one that does not contain information needed to figure the correct tax or shows a substantially incorrect tax because the taxpayer takes a frivolous position or desire to delay or interfere with the tax laws. This includes altering or striking out the preprinted language above the space where the taxpayer signs. (48) Form 1040X Line Instructions If the taxpayer has questions such as what income is taxable or what expenses are deductible, the instructions for the form from the year being amended should help. Also use those instructions to find the method to figure the correct tax. Be sure to

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use tax laws from the year the original tax was filed. If the taxpayer is not changing any dollar amounts originally reported, but is sending in only additional information, do the following: (48)

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

If the taxpayer and his or her spouse are changing from separate returns to a joint return, follow these steps: (48)

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

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

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

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

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

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

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

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

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

Allowable charitable contributions deduction or the taxable amount of Social Security benefits. Total itemized deductions or deduction for exemptions.

Line 2 - Itemized Deductions or Standard Deduction If the taxpayer itemized deductions, enter in column A the total from the original Schedule A (Form 1040) or the deduction as previously adjusted by the IRS. If the taxpayer is now itemizing deductions instead of using the standard deduction, or has

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

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

claimed. He or she is eliminating a personal exemption for himself or herself or his or her spouse previously claimed, but

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

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

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Line 16 - Amount Paid With Extension or Tax Return On this line, the taxpayer enters the total of the following amounts:

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

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

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

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

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

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

If the taxpayer is now claiming more than four dependents, attach a separate statement with the required information. Part II - Presidential Election Campaign Fund The taxpayer can use Form 1040X to have $3 go to the Presidential Election Campaign Fund if he or she (or his or her spouse

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on a joint return) did not do so on the original return. This must be done within 20 ½ months after the original due date for filing the return. For calendar year 2017, this period ends in January 2, 2020. A previous designation of $3 to the fund cannot be changed. Part III - Explanation of Changes The IRS needs to know why the taxpayer is filing Form 1040X. For example:

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

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

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

Attach to the back of Form 1040X any Form 8805 that supports changes made on this return. If the taxpayer owes tax, enclose (do not attach) the check or money order in the envelope with the amended return. Reduced Refund The Department of Treasury's Bureau of Fiscal Service (BFS), which issues IRS tax refunds, has been authorized by Congress to conduct the Treasury Offset Program. Through this program, a refund or overpayment may be reduced by BFS and offset to pay: (49)

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

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

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

Form W-4 - Employee's Withholding Allowance Certificate An employed taxpayer must complete a Form W-4 - Employee's Withholding Allowance Certificate. Form W-4 tells an employer the marital status, the number of withholding allowances, and any additional amount to use when the employer deducts Federal income tax from the employee's pay. If an employee fails to give the employer a properly completed Form W-4, the employer must withhold Federal income taxes from his or her wages as if he or she were single and claiming no withholding allowances. (50) The employed taxpayer may want to change the number of withholding allowances or his or her withholding rate on Form W-4 for any number of reasons, such as a marriage, a change in the number of dependents, or a change in the amount of itemized deductions or tax credits anticipated for the tax year. A revised Form W-4 from an employee must be put it into effect no later than the start of the first payroll period ending on or after the 30th day from the date the revised Form W-4 was received. An exception is made when the taxpayer receives a notice (commonly referred to as a "lock-in-letter") from the IRS specifying the withholding rate and maximum number of withholding allowances permitted for the employee. The employer must then honor the lock-in letter. (50)

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There are two ways a taxpayer can increase the withholding: (51)

He or she can decrease the number of allowances he or she claims on Form W-4, line 5. He or she can enter an additional amount that he or she wants withheld from each paycheck on Form W-4, line

6. A taxpayer can request that an additional amount be withheld from each paycheck by following these steps:

Complete Worksheets 1 and 7. Complete a new Form W-4 if the amount on Worksheet 7, line 5:

o Is more than the taxpayer wants to pay with his or her tax return or in estimated tax payments throughout the year, or

o Would cause the taxpayer to pay a penalty when he or she files the current year’s tax return. Enter on the taxpayer’s new Form W-4, line 5, the same number of withholding allowances his or her employer

now uses for his or her withholding. This is the number of allowances the taxpayer entered on the last Form W-4 he or she gave his or her employer.

Enter on the taxpayer’s new Form W-4, line 6, the amount from Worksheet 7, line 6. Give the taxpayer’s newly completed Form W-4 to his or her employer.

If the taxpayer has this additional amount withheld from his or her pay each payday, he or she should avoid owing a large amount at the end of the year. If the taxpayer’s completed Worksheets 1 and 7 shows that he or she may have more tax withheld than his or her projected tax liability for the current tax year, the taxpayer may be able to decrease his or her withholding. There are two ways to do this:

Decrease any additional amount (Form W-4, line 6) he or she is having withheld. Increase the number of allowances he or she claims on Form W-4, line 5.

A taxpayer can claim only the number of allowances to which he or she is entitled. To see if a taxpayer can decrease his or her withholding by increasing his or her allowances, see the Form W-4 instructions.

If an employed taxpayer qualifies, Form W-4 is also used by him or her to tell the employer not to deduct any Federal income tax from his or her wages. To qualify for this exempt status, the employee must have had no tax liability for the previous year and must expect to have no tax liability for the current year. If the taxpayer can be claimed as a dependent on a parent's or another person's tax return additional limitations may apply. Also, the taxpayer may be subject to a $500 penalty if he or she submits, with no reasonable basis, a Form W-4 that results in less tax being withheld than is required. (50) Exemption from Withholding If the taxpayer claims exemption from withholding, his or her employer will not withhold Federal income tax from his or her wages. The exemption applies only to income tax, not to Social Security or Medicare tax. The taxpayer can claim exemption from withholding for 2017 only if both of the following situations apply:

1. For 2016 the taxpayer had a right to a refund of all Federal income tax withheld because he or she had no tax liability, and

2. For 2017 the taxpayer expects a refund of all Federal income tax withheld because he or she expects to have no tax liability.

If the taxpayer is a student, he or she is not automatically exempt. If the taxpayer works only part-time or during the summer, he or she may qualify for exemption from withholding. If another person can claim the employed taxpayer as a dependent on his or her tax return, the employee cannot claim exemption from withholding if his or her income exceeds $1,050 and includes more than $350 of unearned income (for example, interest and dividends). If another person cannot claim the employed taxpayer as a dependent total income must be less than $6,350. (52)

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An exemption is good for only 1 year. The taxpayer must give his or her employer a new Form W-4 by February 15 each year to continue the exemption. If the taxpayer claims exemption, but later his or her situation changes so that he or she will have to pay income tax after all, the taxpayer must file a new Form W-4 within 10 days after

the change. If he or she claims exemption in 2017 but he or she expects to owe income tax for 2018, he or she must file a new Form W-4 by December 1, 2017. Basic Form W-4 Instructions If the employee is not exempt, complete the Personal Allowances Worksheet on Form W-4. The worksheets adjust the withholding allowances based on itemized deductions, certain credits, adjustments to income, or two-earners/multiple jobs situations. Complete all worksheets that apply. However, the employee may claim fewer (or zero) allowances. For regular wages, withholding must be based on allowances he or she claimed and may not be a flat amount or percentage of wages. (52) For wages paid after December 31, 2005 the employer should solicit a new Form W-4 from his nonresident alien employees which reflects new procedures. If an NRA employee neglects or refuses to file a new Form W-4, then continue to withhold Federal income tax on the NRA’s wages using the old NRA withholding procedures in effect for wages paid prior to January 1, 2006 if the old Form W-4 is still a valid Form W-4. A Form W-4 remains in effect until the employee gives the employer a new one. (53) Beginning with wages paid on or after January 1, 2010, employers are required to calculate income tax withholding under section 3402 of the Internal Revenue Code on wages of nonresident alien employees by making two modifications rather than the one modification. First, employers need to add an amount to wages before determining withholding under the wage bracket or percentage method in order to offset the standard deduction built into the withholding tables. Second, employers need to determine an additional amount of withholding from a separate table applicable only to nonresident alien employees to offset the effect of the Making Work Pay Tax Credit built into the withholding tables. The specific steps to be followed for each of these two modifications will be set forth in Publication 15 and other IRS forms or publications. (53) Head of Household Generally, the employee can claim head of household filing status on the tax return only if he or she is unmarried and pays more than 50% of the costs of keeping up a home for him or herself and his or her dependent(s) or other qualifying individuals. See Publication 501 - Exemptions, Standard Deduction, and Filing Information for information. Tax Credits The employee can take projected tax credits into account in figuring the allowable number of withholding allowances. Credits for child or dependent care expenses and the child tax credit may be claimed using the Personal Allowances Worksheet. See Publication 505 - Tax Withholding and Estimated Tax for information on converting other credits into withholding allowances. Nonwage Income If the employee has a large amount of nonwage income, such as interest or dividends, consider making estimated tax payments using Form 1040-ES - Estimated Tax for Individuals. Otherwise, the employee may owe additional tax. If he or she has pension or annuity income, see Publication 505 - Tax Withholding and Estimated Tax to find out if the employee should adjust the withholding on Form W-4 or W-4P. Two Earners or Multiple Jobs If the employee has a working spouse or more than one job, figure the total number of allowances he or she is entitled to claim on all jobs using worksheets from only one Form W-4. The withholding usually will be most accurate when all allowances are claimed on the Form W-4 for the highest paying job and zero allowances are claimed on the others. (52) Special Instructions for Form W-4 For Nonresident Alien Employees A nonresident alien subject to wage withholding must give the employer a completed Form W-4 to enable the employer to figure how much income tax to withhold. In completing the form, nonresident aliens should use the following instructions instead of the instructions on Form W-4.

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For Forms W-4 completed after December 31, 2005: (53)

1. Check only "Single" marital status on line 3 (regardless of actual marital status). 2. Claim only one withholding allowance on line 5, unless the taxpayer is a resident of Canada, Mexico, South Korea,

a U.S. national, or a student or business apprentice from India. 3. Do not claim “Exempt” withholding status on line 7. 4. Write “Nonresident Alien” or “NRA” above the dotted line on line 6 of Form W-4.

For wages paid on or after January 1, 2006, the employer is required to apply the following procedure in calculating the amount of Federal income tax withholding on the wages of nonresident alien employees. Under this procedure, the employer adds an amount as set forth in the chart below to the nonresident alien's wages solely for calculating the income tax withholding for each payroll period. The employer determines the amount to be withheld by applying the income tax withholding tables to the amount of wages paid plus the additional chart amount. For more information, see Notice 2005-76. (53) The amount to be added to the nonresident alien´s wages to calculate income tax withholding is set forth in the following chart; Chapter 9 of Publication 15 - (Circular E) - Employer's Tax Guide for the current year provides an updated chart. (54)

Amount to Add to Nonresident Alien Employee's Wages for Calculating Income Tax Withholding Only

Payroll Period Add Additional* Weekly $44.20 Biweekly $88.50 Semimonthly $95.80 Monthly $191.70 Quarterly $575.00 Semiannually $1,150.00 Annually $2,300.00 Daily or Miscellaneous (each day of the payroll period) $8.80

*Nonresident alien students from India and business apprentices from India are not subject to this procedure.

Table 2-1 - Publication 15 - Chapter 9 - Withholding From Employees' Wages (2017)

The amounts added under this chart are added to wages solely for calculating income tax withholding on the wages of the nonresident alien employee. These chart amounts should not be included in any box on the employee's Form W-2 and do not increase the income tax liability of the employee. Also, these chart amounts do not increase the Social Security, Medicare, or FUTA tax liability of the employer or the employee. This procedure only applies to nonresident alien employees who have wages subject to income tax withholding. (53) Students and Business Apprentices from India A student or business apprentice who is eligible for the benefits of Article 21(2) of the United States-India Income Tax Treaty can claim an additional withholding allowance on line 5 for his or her spouse if the spouse has no U.S. source gross income and may not be claimed as a dependent by another taxpayer. In addition, he or she can claim an additional withholding allowance for each dependent (usually a child) who has become a resident alien if the dependent has met all 5 of the dependency tests as described in IRS Publication 501, Exemptions, Standard Deduction, and Filing Information. Furthermore, he or she does not have to request the additional withholding amount on line 6 of Form W-4. (53) Verify Withholding After the Form W-4 takes effect, use Publication 505 - Tax Withholding and Estimated Tax to see how the amount withheld compares to projected total tax, especially if earnings exceed $130,000 (Single) or $180,000 (Married). (52) Backup Withholding Banks or other businesses that pay certain kinds of income must file an information return Form 1099 with the IRS. The information return shows how much an individual was paid during the year. It also includes his or her name and taxpayer

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identification number (TIN). These payments generally are not subject to withholding. However, "backup" withholding is required in certain situations. Backup withholding can apply to most kinds of payments that are reported on Form 1099 including: (55)

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

MISC) Payments by brokers (Form 1099-B) Royalty payments (Form 1099-MISC) Certain other payments

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

When the taxpayer opens a new account, makes an investment, or begins to receive payments reportable on Form 1099, he or she must furnish his or her TIN to the bank or other business. In some cases, the taxpayer must furnish the TIN in writing and certify under penalties of perjury that it is correct. The bank or business will give the taxpayer Form W-9 - Request for Taxpayer Identification Number and Certification, or a similar form. The taxpayer must enter the TIN on the form and, if the account or investment will earn interest or dividends, he or she also must certify that they are not subject to backup withholding due to previous underreporting of interest and dividends. The payer must withhold at a flat 28% rate in the following situations: (55)

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

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

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

If the taxpayer receives a “B” notice from a payer, notifying him or her that the TIN given is incorrect, the taxpayer usually can prevent backup withholding from starting, or stop backup withholding once it has begun, by giving the payer the correct name and TIN. The taxpayer must certify that the TIN given is correct. If the taxpayer receives a second “B” notice from that payer, he or she will need to provide the payer with verification of the TIN from the Social Security Administration or the IRS. If the taxpayer has been notified that he or she underreported interest or dividends, the taxpayer must request and receive a determination from the IRS to prevent backup withholding from starting or to stop backup withholding once it has begun. If income tax has been withheld under the backup withholding rule, take credit for it on the tax return for the year in which the taxpayer received the income. Gambling Withholding There are two types of withholding on gambling winnings: regular gambling withholding at 25% (33.33% for certain noncash payments) and backup withholding at 28%. If a payment is already subject to regular gambling withholding, it is not subject to backup withholding. Regular Gambling Withholding A gambling business may be required to withhold 25% of gambling winnings for Federal income tax. This is referred to as regular gambling withholding. Withhold at the 25% rate if the winnings minus the wager are more than $5,000 and are from:

Sweepstakes Wagering pools

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Lotteries Other wagering transactions if the winnings are at least 300 times the amount wagered

Do not withhold at the 25% rate on winnings from bingo, keno, slot machines, or any other wagering transaction if the winnings are $5,000 or less. Regular gambling withholding is figured on the total amount of gross proceeds (the amount of winnings minus the amount wagered), not merely on the amount in excess of $5,000. The business reports the amount withheld in box 4 of Form W-2G. A noncash payment, such as a car, must be taken into account at its fair market value (FMV) for purposes of reporting and withholding. If the FMV exceeds $5,000, after deducting the price of the wager, the winnings are subject to 25% regular gambling withholding. The tax the business must withhold is computed and paid under either of the following two methods:

1. The winner pays the withholding tax to the payer. In this case, the withholding is 25% of the FMV of the noncash payment minus the amount of the wager.

2. The gambling business pays the withholding tax. In this case, the withholding is 33.33% of the FMV of the noncash payment minus the amount of the wager.

If the business uses method 2, enter the sum of the noncash payment and the withholding tax in box 1 of Form W-2G and the withholding tax paid by the payer in box 4. Backup Gambling Withholding A gambling business may be required to withhold 28% of gambling winnings (including winnings from bingo, keno, slot machines, and poker tournaments) for Federal income tax. This is referred to as backup withholding. The business should backup withhold if:

The winner does not furnish a correct taxpayer identification number (TIN). 25% has not been withheld. The winnings are at least $600 and at least 300 times the wager (or the winnings are at least $1,200 from bingo

or slot machines or $1,500 from keno or more than $5,000 from a poker tournament). Figure any backup withholding on the total amount of the winnings reduced, at the option of the payer, by the amount wagered. This means the total amount, not just the payments in excess of $600, $1,200, $1,500, or $5,000, is subject to backup withholding. Report the amount withheld in box 4 of Form W-2G. Use Form W-9 - Request for Taxpayer Identification Number and Certification, to request the TIN of the recipient. Tip Withholding Employees, who receive cash tips of $20 or more in a calendar month while working, are required to report to their employer the total amount of tips they receive. Service charges added to a bill or fixed by the employer that the customer must pay, when paid to an employee, will not constitute a tip but rather constitute non-tip wages. These non-tip wages are subject to Social Security tax, Medicare tax, and Federal income tax withholding. Employers must collect the employee's portion of the Social Security and Medicare taxes and the Federal income taxes. As of January of 2013, the Additional Medicare Tax applies to an individual’s Medicare wages that exceed a threshold amount based on the taxpayer’s filing status. Pensions and Annuity Withholding Generally, pension and annuity payments are subject to Federal income tax withholding. The withholding rules apply to the taxable part of payments from an employer pension annuity, profit-sharing, stock bonus, or another deferred compensation plan. The rules also apply to payments from an individual retirement arrangement (IRA), an annuity, endowment, or life insurance contract issued by a life insurance company. There is no withholding on any part of a distribution that is not expected to be includible in the recipient's gross income. Generally, periodic payments are pension or annuity payments made for more than 1 year that are not eligible rollover distributions. Periodic payments include substantially equal payments made at least once a year over the life of the employee and/or beneficiaries or for 10 years or more. For wage withholding purposes, these payments are treated as if they are wages. The taxpayer can figure withholding by using the recipient's Form W-4P - Withholding Certificate for Pension or Annuity Payments.

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Unless the taxpayer chooses no withholding, the withholding rate for a non-periodic distribution (a payment other than a periodic payment) that is not an eligible rollover distribution, is 10% of the distribution. He or she can also ask the payer to withhold an additional amount using Form W-4P. The part of any loan treated as a distribution (except an offset amount to repay the loan), is subject to withholding under this rule. Fringe Benefit Exclusion Some excluded fringe benefits are not subject to Federal income tax withholding. Also, in most cases, they are not subject to Social Security, Medicare, or Federal unemployment (FUTA) tax and are not reported on Form W-2. There are exclusion rules for the following fringe benefits: (56)

Accident and health benefits. Achievement awards. Adoption assistance. Athletic facilities. De minimis (minimal) benefits. Dependent care assistance. Educational assistance. Employee discounts. Employee stock options. Employer-provided cell phones. Group-term life insurance coverage. Health savings accounts (HSAs). Lodging on the business premises. Meals. Moving expense reimbursements. No-additional-cost services. Retirement planning services. Transportation (commuting) benefits. Tuition reduction. Working condition benefits.

Invalid Forms W-4 Any unauthorized change or addition to Form W-4 makes it invalid. This includes taking out any language by which the employee certifies that the form is correct. A Form W-4 is also invalid if, by the date an employee gives it to the employer, he or she indicates in any way that it is false. An employee who submits a false Form W-4 may be subject to a $500 penalty. When the employer gets an invalid Form W-4, do not use it to figure Federal income tax withholding. Tell the employee that it is invalid and asks for another one. If the employee does not give the employer a valid one, withhold taxes as if the employee was single and claiming no withholding allowances. However, if the employer has an earlier Form W-4 for this worker that is valid, withhold as before. (53)

Form W-2 - Wage and Tax Statement Every employer engaged in a trade or business who pays remuneration, including noncash payments of $600 or more for the year (all amounts if any income, Social Security, or Medicare tax was withheld) for services performed by an employee must file a Form W-2 - Wage and Tax Statement for each employee (even if the employee is related to the employer) from whom: (57)

Income, Social Security, or Medicare tax was withheld. Income tax would have been withheld if the employee had claimed no more than one withholding allowance or

had not claimed exemption from withholding on Form W-4, Employee's Withholding Allowance Certificate.

An employer must e-file if he or she is required to file 250 or more Forms W-2 or W-2c. If the employer is required to e-file but fails to do so, he or she may incur a penalty. An employer can request a waiver from this requirement by filing Form 8508 - Request for Waiver From Filing Information Returns Electronically. Submit Form 8508 to the IRS at least 45 days before the due date of Form W-2, or 45 days before filing the first Form W-2c.

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Extensions of time to file Form W-2 with the Social Security Administration (SSA) are no longer automatic. An employer may request one 30-day extension to file Form W-2 by submitting a complete application on Form 8809 - Application for Extension of Time to File Information Returns, including a detailed explanation of why the employer needs additional time and signed under penalties of perjury. The IRS will only grant the extension in extraordinary circumstances or catastrophe. The due date for filing 2017 Forms W-2, W-2AS, W-2CM, W-2GU, W-2VI, W-3, and W-3SS with the SSA is January 31, 2018, whether the employer files using paper forms or electronically. If an individual has not received a W-2, follow these four steps: (58)

1. If the individual has not received a W-2, contact his or her employer to inquire if and when the W-2 was mailed. If it was mailed, it may have been returned to the employer because of an incorrect or incomplete address. After contacting the employer, allow a reasonable amount of time for them to resend or issue the W-2.

2. If the individual does not receive a W-2 by February 14, contact the IRS for assistance at 800-829-1040. Provide the individual’s name, address, Social Security number, phone number and have the following information:

a. Employer’s name, address and phone number b. Dates of employment c. An estimate of the wages the individual earned, the Federal income tax withheld, and when he or she

worked for that employer during 2017. The estimate should be based on year-to-date information from the final pay stub or leave-and-earnings statement, if possible.

3. The individual still must file a tax return or request an extension to file by April 15, 2018, even if he or she does not receive a Form W-2. If the taxpayer has not received a Form W-2 in time to file the return by the due date, and have completed steps 1 and 2, he or she may use Form 4852 - Substitute for Form W-2, Wage and Tax Statement. Attach Form 4852 to the return, estimating income and withholding taxes as accurately as possible. There may be a delay in any refund due while the information is verified.

4. The individual may receive the missing W-2 after filing the return using Form 4852, and discover the information is different from what he or she reported on the return. If this happens, the taxpayer must amend the return by filing a Form 1040X - Amended U.S. Individual Income Tax Return.

Form Not Correct If the taxpayer receives a form with incorrect information, he or she should ask the payer for a corrected form. Call the telephone number or write to the address given for the payer on the form. The corrected Form W-2G or Form 1099 he or she receives will have an “X” in the “CORRECTED” box at the top of the form. A special form Form W-2C - Corrected Wage and Tax Statement, is used to correct a Form W-2. In certain situations, the taxpayer will receive two forms in place of the original incorrect form. This will happen when his or her taxpayer identification number is wrong or missing, his or her name and address are wrong, or he or she received the wrong type of form (for example, a Form 1099-DIV instead of a Form 1099-INT). One new form the taxpayer receives will be the same incorrect form or have the same incorrect information, but all money amounts will be zero. This form will have an “X” in the “CORRECTED” box at the top of the form. The second new form should have all the correct information, prepared as though it is the original (the “CORRECTED” box will not be checked). If the taxpayer’s attempts to have an incorrect Form W-2 corrected by his or her employer are unsuccessful and it is after February 14, the taxpayer can request that an IRS representative initiate a Form W-2 complaint. The taxpayer may call the IRS toll free at 800-829-1040, or visit an IRS Taxpayer Assistance Center (TAC) in person. A letter will be sent to the employer requesting that they furnish a corrected Form W-2 to the taxpayer within ten days. The letter advises the employer of their responsibilities to provide a correct Form W-2 and of the penalties for failure to do so. The taxpayer will be sent a letter that provides instructions and Form 4852 - Substitute for Form W-2, Wage and Tax Statement, or Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The Form 4852 may be used in the event that the employer does not provide the taxpayer with the corrected Form W-2 in time to file his or her tax return. If the taxpayer files his or her return and attach Form 4852 to support the withholding amount claimed instead of a Form W-2, the taxpayer’s refund can be delayed while the information he or she supplies the IRS is verified. If the taxpayer receives a corrected Form W-2 after he or she file his or her return and it does not agree with the income or withheld tax the taxpayer reported on his or her return, he or she should file an amended return on Form 1040X - Amended U.S. Individual Income Tax Return.

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Fiscal Years If the taxpayer files his or her tax return on the basis of a fiscal year (a 12-month period ending on the last day of any month except December), he or she must follow special rules to determine his or her credit for Federal income tax withholding. For fiscal year withholding, the taxpayer can claim credit on his or her tax return only for the tax withheld during the calendar year ending within his or her fiscal year. The taxpayer cannot claim credit for any of the tax withheld during the calendar year beginning in his or her fiscal year. The taxpayer will be able to claim credit for that withholding on his or her return for his or her next fiscal year. The Form W-2 or 1099 the taxpayer receives for the calendar year that ends during his or her fiscal year will show the tax withheld and the income he or she received during that calendar year. Although the taxpayer takes credit for all the withheld tax shown on the form, report only the part of the income shown on the form that he or she received during his or her fiscal year. Add to that the income the taxpayer received during the rest of his or her fiscal year. If income tax has been withheld under the backup withholding rule, the taxpayer takes credit for it on his or her tax return for the fiscal year in which he or she received the income. Form W-2 Specific Instructions The entries on Form W-2 must be based on wages paid during the calendar year. Use Form W-2 for the correct tax year. (59) Box a - Employee's Social Security number. The employer enters the number shown on the employee's Social Security card. The employer does not accept an ITIN in place of an SSN for employee identification or for work. An ITIN is only available to resident and nonresident aliens who are not eligible for U.S. employment and need identification for other tax purposes. Box b - Employer identification number (EIN). The employer shows the EIN assigned by the IRS (00-0000000). This should be the same number used on the Federal employment tax returns (Forms 941, 941-SS, 943, 944, CT-1, or Schedule H (Form 1040)). Box c - Employer's name, address, and ZIP code. This entry should be the same as shown on Forms 941, 941-SS, 943, 944, CT-1, or Schedule H (Form 1040). The U.S. Postal Service recommends that no commas or periods be used in return addresses. Box d - Control number. This box is optional and use to identify individual Forms W-2. Boxes e and f - Employee's name and address. The employer enters the name as shown on the employee's Social Security card (first name, middle initial, last name). The employer includes in the address the number, street, and apartment or suite number (or P.O. box number if mail is not delivered to a street address). The U.S. Postal Service recommends that no commas or periods be used in delivery addresses. Box 1 - Wages, tips, other compensation. The employer shows the total taxable wages, tips, and other compensation (before any payroll deductions) that the employer paid to the employee during the year. However, The employer does not include elective deferrals (such as employee contributions to a section 401(k) or 403(b) plan) except section 501(c)(18) contributions. Box 2 - Federal income tax withheld. The employer shows the total Federal income tax withheld from the employee's wages for the year. Include the 20% excise tax withheld on excess parachute payments. The term excess parachute payment means an amount equal to the excess of any parachute payment over the portion of the base amount allocated to such payment. The term “parachute payment” means any payment in the nature of compensation to (or for the benefit of) a disqualified individual if: (60)

1. Such payment is contingent on a change: a. In the ownership or effective control of the corporation. b. In the ownership of a substantial portion of the assets of the corporation.

2. The aggregate present value of the payments in the nature of compensation to (or for the benefit of) such individual which are contingent on such change equals or exceeds an amount equal to 3 times the base amount.

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Box 3 - Social Security wages. The employer shows the total wages paid (before payroll deductions) subject to employee Social Security tax but not including Social Security tips and allocated tips. If reporting these amounts in a subsequent year (due to lapse of risk of forfeiture), the amount must be adjusted by any gain or loss. Box 4 - Social Security tax withheld. The employer shows the total employee Social Security tax (not the employer’s share) withheld, including Social Security tax on tips. For 2017, the amount should not exceed $7,886.40 ($127,200 × 6.2%). Include only taxes withheld (or paid by the employer for the employee) for 2017 wages and tips. Box 5 - Medicare wages and tips. The wages and tips subject to Medicare tax are the same as those subject to Social Security tax (boxes 3 and 7) except that there is no wage base limit for Medicare tax. Enter the total Medicare wages and tips in box 5. The employer should be sure to enter tips that the employee reported even if the employer did not have enough employee funds to collect the Medicare tax for those tips. Box 6 - Medicare tax withheld. The employer enters the total employee Medicare tax (including any Additional Medicare Tax) withheld. The employer does not include the employer’s share. Include only tax withheld for 2017 wages and tips. Medicare tax is calculated at 1.45% of wages and tips. Box 7 - Social Security tips. The employer shows the tips that the employee reported to the employer even if the employer did not have enough employee funds to collect the Social Security tax for the tips. The total of boxes 3 and 7 should not be more than $127,200 (the maximum Social Security wage base for 2017). Box 8 - Allocated tips. If the employer is a food or beverage establishment, show the tips allocated to the employee. See the Instructions for Form 8027 - Employer's Annual Information Return of Tip Income and Allocated Tips. The employer does not include this amount in boxes 1, 3, 5, or 7. Box 9. Do not enter an amount in box 9. Box 10 - Dependent care benefits. The employer shows the total dependent care benefits under a dependent care assistance program paid or incurred by an employer for an employee. The employer includes the fair market value (FMV) of care in a daycare facility provided or sponsored by the employer for an employee and amounts paid or incurred for dependent care assistance in a section 125 (cafeteria) plan. The employer reports all amounts paid or incurred (regardless of any employee forfeitures), including those in excess of the $5,000 exclusion. Box 11 - Nonqualified plans. The purpose of box 11 is for the SSA to determine if any part of the amount reported in box 1 or boxes 3 and/or 5 was earned in a prior year. The SSA uses this information to verify that they have properly applied the Social Security earnings test and paid the correct amount of benefits. Box 12 - Codes. The employer completes and codes this box for all items that are listed as codes A through EE. If more than four items need to be reported in box 12, the employer uses a separate Form W-2 to report the additional items (but enter no more than four items on each Copy A (Form W-2)). On all other copies of Form W-2 (Copies B, C, etc.), the employer may enter more than four items in box 12 when using an approved substitute Form W-2. Some of the codes are reviewed below. Code A - Uncollected Social Security or RRTA tax on tips. The employer shows the employee Social Security or Railroad Retirement Tax Act (RRTA) tax on all of the employee's tips that the employer could not collect because the employee did not have enough funds from which to deduct it. The employer should not include this amount in box 4. Code B - Uncollected Medicare tax on tips. The employer shows the employee Medicare tax or RRTA Medicare tax on tips that the employer could not collect because the employee did not have enough funds from which to deduct it. The employers should not show any uncollected Additional Medicare Tax. Do not include this amount in box 6. Code C - Taxable cost of group-term life insurance over $50,000. The employer shows the taxable cost of group-term life insurance coverage over $50,000 provided to an employee (including a former employee). The employer also includes this amount in boxes 1, 3 (up to the Social Security wage base), and 5. Code D - Elective deferrals under section 401(k) cash or deferred arrangement (plan). The employer also shows deferrals under a SIMPLE retirement account that is part of a section 401(k) arrangement. Code E - Elective deferrals under a section 403(b) salary reduction agreement.

Lesson 2 - Tax Forms

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Code F - Elective deferrals under a section 408(k)(6) salary reduction SEP. Code G - Elective deferrals and employer contributions (including non-elective deferrals) to any governmental or nongovernmental section 457(b) deferred compensation plan. The employer should not report either section 457(b) or section 457(f) amounts that are subject to a substantial risk of forfeiture. Code H - Elective deferrals under section 501(c)(18)(D) tax-exempt organization plan. The employer should be sure to include this amount in box 1 as wages. The employee will deduct the amount on his or her Form 1040. Code J - Nontaxable sick pay. The employer shows any sick pay that was paid by a third-party and was not includible in income (and not shown in boxes 1, 3, and 5) because the employee contributed to the sick pay plan. Do not include nontaxable disability payments made directly by a state. Code K - 20% excise tax on excess golden parachute payments. If the employer made excess “golden parachute” payments to certain key corporate employees, report the 20% excise tax on these payments. If the excess payments are considered to be wages, report the 20% excise tax withheld as income tax withheld in box 2. Code L - Substantiated employee business expense reimbursements. The employer uses this code only if the employer reimbursed an employee for employee business expenses using a per diem or mileage allowance and the amount that the employer reimbursed exceeds the amount treated as substantiated under IRS rules. Code M - Uncollected Social Security or RRTA tax on taxable cost of group-term life insurance over $50,000 (for former employees). If the employer provided former employees (including retirees) more than $50,000 of group-term life insurance coverage for periods during which an employment relationship no longer exists, enter the amount of uncollected Social Security or RRTA tax on the coverage in box 12. Code N - Uncollected Medicare tax on taxable cost of group-term life insurance over $50,000 (for former employees). If the employer provided former employees (including retirees) more than $50,000 of group-term life insurance coverage for periods during which an employment relationship no longer exists, enter the amount of uncollected Medicare tax or RRTA Medicare tax on the coverage in box 12. The employer should not show any uncollected Additional Medicare Tax. Code P - Excludable moving expense reimbursements paid directly to employee. The employer shows the total moving expense reimbursements that the employer paid directly to an employee for qualified (deductible) moving expenses. Code Q - Nontaxable combat pay. If the employer is a military employer, report any nontaxable combat pay in box 12. Code R - Employer contributions to an Archer MSA. The employer shows any employer contributions to an Archer MSA. Code S - Employee salary reduction contributions under a section 408(p) SIMPLE plan. The employer shows deferrals under a section 408(p) salary reduction SIMPLE retirement account. However, if the SIMPLE plan is part of a section 401(k) arrangement, use code D. Code T - Adoption benefits. The employer shows the total that the employer paid or reimbursed for qualified adoption expenses furnished to an employee under an adoption assistance program. The employer also includes adoption benefits paid or reimbursed from the pre-tax contributions made by the employee under a section 125 (cafeteria) plan. Code V - Income from the exercise of non-statutory stock option(s). The employer shows the spread (that is, the fair market value of stock over the exercise price of option(s) granted to an employee with respect to that stock) from an employee's (or former employee's) exercise of non-statutory stock option(s). Include this amount in boxes 1, 3 (up to the Social Security wage base), and 5. Code W - Employer contributions to a health savings account (HSA). The employer shows any employer contributions (including amounts the employee elected to contribute using a section 125 (cafeteria) plan) to an HSA. Code Y - Deferrals under a section 409A nonqualified deferred compensation plan. It is not necessary to show deferrals in box 12 with code Y.

Lesson 2 - Tax Forms

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Code Z - Income under section 409A on a nonqualified deferred compensation plan. The employer enters all amounts deferred (including earnings on amounts deferred) that are includible in income under section 409A because the NQDC plan fails to satisfy the requirements of section 409A. Code AA - Designated Roth contributions under a section 401(k) plan. Use this code to report designated Roth contributions under a section 401(k) plan. Do not use this code to report elective deferrals under code D. Code BB - Designated Roth contributions under a section 403(b) plan. The employer uses this code to report designated Roth contributions under a section 403(b) plan. The employer should not use this code to report elective deferrals under code E. Code DD - Cost of employer-sponsored health coverage. The employer uses this code to report the cost of employer-sponsored health coverage. The amount reported with code DD is not taxable. Code EE - Designated Roth contributions under a governmental section 457(b) plan. The employer uses this code to report designated Roth contributions under a governmental section 457(b) plan. The employer should not use this code to report elective deferrals under code G. Code FF - Permitted benefits under a qualified small employer health reimbursement arrangement. The employer uses this code to report the total amount of permitted benefits under a QSEHRA. The maximum reimbursement for an eligible employee under a QSEHRA is $4,950 (for 2017) ($10,000 if it also provides reimbursements for family members), before indexing for inflation. Box 13 - Checkboxes. The employer will check all boxes that apply for the following: Statutory employee. Check this box for statutory employees whose earnings are subject to Social Security and Medicare taxes but not subject to Federal income tax withholding. Do not check this box for common-law employees. There are workers who are independent contractors under the common-law rules but are treated by statute as employees. They are called statutory employees. Retirement plan. Check this box if the employee was an “active participant” covered by (a) a defined benefit plan for any tax year that he or she is eligible to participate in or (b) a defined contribution plan (for example, a section 401(k) plan) for any tax year that employer or employee contributions (or forfeitures) are added to his or her account. Third-party sick pay. Check this box only if the employer is a third-party sick pay payer filing a Form W-2 for an insured's employee or are an employer reporting sick pay payments made by a third party. Box 14 - Other. If the employer included 100% of a vehicle's annual lease value in the employee's income, it also must be reported here or on a separate statement to an employee. The employer also may use this box for any other information that he or she wants to give to an employee. Label each item. Examples include state disability insurance taxes withheld, union dues, uniform payments, health insurance premiums deducted, nontaxable income, educational assistance payments, or a member of the clergy's parsonage allowance and utilities. Boxes 15 through 20 - State and local income tax information. The employer uses these boxes to report state and local income tax information. The employer enters the two-letter abbreviation for the name of the state. The employer's state ID numbers are assigned by the individual states. The state and local information boxes can be used to report wages and taxes for two states and two localities. The employer keeps each state's and locality's information separated by the broken line. If the employer needs to report information for more than two states or localities, prepare a second Form W-2. Contact the state or locality for specific reporting information. Dependent Care Benefits This exclusion applies to household and dependent care services an employer directly or indirectly pays for or provides to an employee under a dependent care assistance program that covers only his or her employees. The services must be for a qualifying person's care and must be provided to allow the employee to work. These requirements are basically the same as the tests the employee would have to meet to claim the dependent care credit if the employee paid for the services. An employer can exclude the value of benefits he or she provides to an employee under a dependent care assistance program from the employee's wages if he or she reasonably believes that the employee can exclude the benefits from gross income.

Lesson 2 - Tax Forms

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An employee can generally exclude from gross income up to $5,000 of benefits received under a dependent care assistance program each year. This limit is reduced to $2,500 for married employees filing separate returns. However, the exclusion cannot be more than the smaller of the earned income of either the employee or employee's spouse. Special rules apply to determine the earned income of a spouse who is either a student or not able to care for himself or herself. The employer reports the value of all dependent care assistance he or she provides to an employee under a dependent care assistance program in box 10 of the employee's Form W-2. The employer includes any amounts he or she cannot exclude from the employee's wages in boxes 1, 3, and 5. The employer reports both the nontaxable portion of assistance (up to $5,000) and any assistance above the amount that is taxable to the employee.

Form W-3 - Transmittal of Wage and Tax Statements Anyone required to file Form W-2 must file Form W-3 to transmit Copy A of Forms W-2. A Form W-3 - Transmittal of Wage and Tax Statements is completed only when paper Copy A of Form W-2 - Wage and Tax Statement, is being filed. Do not file Form W-3 alone. Do not file Form W-3 for a Form W-2 that was submitted electronically to the SSA. All paper forms must comply with IRS standards and be machine readable. Photocopies are not acceptable. Use a Form W-3 even if only one paper Form W-2 is being filed. Make sure both the Form W-3 and Form(s) W-2 show the correct tax year and Employer Identification Number (EIN). Make a copy of this form and keep it with Copy D (For Employer) of Form(s) W-2 for the employer’s records. The IRS recommends retaining copies of these forms for four years. Even employers with only one household employee must file Form W-3 to transmit Copy A of form W-2. On Form W-3 check the “Hshld. emp.” checkbox in box b. For more information, see Schedule H - Household Employment Taxes, and its separate instructions. The employer must have an employer identification number (EIN). A transmitter or sender (including a service bureau, reporting agent, paying agent, or disbursing agent) may sign Form W-3 (or use its PIN to e-file) for the employer or payer only if the sender satisfies both of the following:

1. He or she is authorized to sign by an agency agreement (whether oral, written, or implied) that is valid under state law.

2. He or she writes “For (name of payer)” next to the signature (paper Form W-3 only). The due date for filing 2017 Forms W-2, W-2AS, W-2CM, W-2GU, W-2VI, W-3, and W-3SS with the SSA is January 31, 2018, whether the employer files using paper forms or electronically.

Various Form 1099 An information return (generally a Form 1099) is a tax document businesses are required to file to report certain business transactions to the Internal Revenue Service (IRS). The requirement to file Information Returns is mandated by the Internal Revenue Service and associated regulations. Any person, including a corporation, partnership, individual, estate, and trust, who makes reportable transactions during the calendar year must file information returns to report those transactions to the IRS. Persons required to file Information Returns to the IRS must also furnish statements to the recipients of the income. Filers who have 250 or more must file these returns electronically. Most forms in the 1099 series are not filed with the return. In general, these forms should be furnished to the taxpayer by January 31, 2018. Unless instructed to file any of these forms with the return, keep them for the taxpayer records. There are several different forms in this series, including: (61)

Form 1099-A - Acquisition or Abandonment of Secured Property Form 1099-B - Proceeds From Broker and Barter Exchange Transactions Form 1099-C - Cancellation of Debt Form 1099-DIV - Dividends and Distributions Form 1099-G - Certain Government Payments Form 1099-INT - Interest Income Form 1099-K - Payment Card and Third-Party Network Transactions Form 1099-MISC - Miscellaneous Income Form 1099-OID - Original Issue Discount Form 1099-PATR - Taxable Distributions Received From Cooperatives Form 1099-Q - Payments From Qualified Education Programs (Under sections 529 and 530)

Lesson 2 - Tax Forms

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Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

Form SSA-1099 - Social Security Benefit Statement Form RRB-1099 - Payments by the Railroad Retirement Board

If the taxpayer received the types of income reported on some forms in the 1099 series, he or she may not be able to use Form 1040A or Form 1040EZ. See the instructions to these forms for details. Form 1099-A - Acquisition or Abandonment of Secured Property If the taxpayer borrows money from a lender to purchase property, the lender may require the loan to be secured by the purchased property. If the taxpayer transfers an interest in the secured property to the lender (such as in a foreclosure) or abandons the property, he or she may be required to treat the transfer or the abandonment as a sale of the property. If the lender acquires an interest in the secured property or has reason to know that the taxpayer abandoned, or permanently discarded from use, the secured property, the lender should send the taxpayer a Form 1099-A. On Form 1099-A, the lender reports the amount of the debt owed (principal only) and the fair market value of the secured property. The taxpayer (the debtor) uses these values to determine a gain or loss on the disposition of the property. (62) Form 1099-C - Cancellation of Debt When the taxpayer borrows money, he or she is not required to include the loan proceeds in gross income because he or she has an obligation to repay the lender later. If that obligation is subsequently canceled, the taxpayer may be required to include the amount of the canceled debt in gross income. A commercial lender canceling a debt will issue a Form 1099-C. On Form 1099-C, the lender reports the amount of the canceled debt. If the lender's acquisition of an interest in the secured property (or the debtor's abandonment of the property) and the cancellation of the debt occur in the same calendar year, the lender may issue a Form 1099-C only.

In certain situations, a taxpayer may exclude cancellation of debt income in whole or in part. For example, if he or she has cancellation of debt income on his or her principal residence, the taxpayer may be able to exclude part or the entire amount canceled from his or her income.

Debt canceled in a title 11 bankruptcy case is not included in a taxpayer’s income. A title 11 bankruptcy case is a case under title 11 of the United States Code (including all chapters in title 11 such as chapters 7, 11, and 13), but only if the debtor is under the jurisdiction of the court and the cancellation of the debt is granted by the court or occurs as a result of a plan approved by the court. A taxpayer shows that his or her debt was canceled in a bankruptcy case and is excluded from income by attaching Form 982 - Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) to his or her Federal income tax return and checking the box on line 1a. Lines 1b through 1e do not apply to a cancellation that occurs in a title 11 bankruptcy case. The taxpayer enters the total amount of debt canceled in his or her title 11 bankruptcy case on line 2. The taxpayer must also reduce his or her tax attributes in Part II of Form 982. Form 1099-MISC - Miscellaneous Income An individual should file Form 1099-MISC - Miscellaneous Income, for each person to whom he or she has paid during the year: (63)

At least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest. At least $600 in rents, services (including parts and materials), prizes and awards, other income payments,

medical and health care payments, crop insurance proceeds, cash payments for fish (or other aquatic life) he or she purchases from anyone engaged in the trade or business of catching fish, or, generally, the cash paid from a notional principal contract to an individual, partnership, or estate.

Any fishing boat proceeds. Gross proceeds of $600 or more paid to an attorney.

The requirement described in the 2011 instructions for persons receiving rental income from real estate to report payments for certain rental property expenses on Form 1099-MISC was repealed by Congress. An individual does not have to report those payments on Form 1099-MISC.

Lesson 2 - Tax Forms

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Form 1099-DIV - Dividends and Distributions An individual should file Form 1099-DIV - Dividends and Distributions, for each person: (64)

To whom he or she has paid dividends (including capital gain dividends and exempt-interest dividends) and other distributions on stock of $10 or more.

For whom he or she has withheld and paid any foreign tax on dividends and other distributions on stock. For whom he or she has withheld any Federal income tax on dividends under the backup withholding rules. To whom he or she has paid $600 or more as part of a liquidation.

If an individual makes a payment that may be a dividend but he or she is unable to determine whether any part of the payment is a dividend by the time he or she must file Form 1099-DIV, the entire payment must be reported as a dividend. See the regulations under section 6042 for a definition of dividends. Form 1099-INT - Interest Income An individual should file Form 1099-INT - Interest Income, for each person: (65)

To whom he or she paid amounts reportable in boxes 1, 3, and 8 of at least $10 (or at least $600 of interest paid in the course of his or her trade or business described in the instructions for Box 1. Interest Income).

For whom he or she withheld and paid any foreign tax on interest. From whom he or she withheld (and did not refund) any Federal income tax under the backup withholding rules

regardless of the amount of the payment. The individual reports only interest payments made in the course of his or her trade or business including Federal, state, and local government agencies and activities deemed nonprofit, or for which he or she was a nominee/middleman. The individual reports tax-exempt interest, only on Form 1099-INT. He or she does not need to report tax-exempt interest that is original issue discount (OID). He or she reports interest that is taxable OID on Form 1099-OID not on Form 1099-INT. Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs,

Insurance Contracts, etc. An individual should file Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for each person to whom he or she has made a designated distribution or are treated as having made a distribution of $10 or more from profit-sharing or retirement plans, any individual retirement arrangements (IRAs), annuities, pensions, insurance contracts, survivor income benefit plans, permanent and total disability payments under life insurance contracts, charitable gift annuities, etc. Also, an individual should report on Form 1099-R death benefit payments made by employers that are not made as part of a pension, profit-sharing, or retirement plan. Additionally, reportable disability payments made from a retirement plan must be reported on Form 1099-R. Generally, an individual does not report payments subject to withholding of Social Security and Medicare taxes on this form. Report such payments on Form W-2 - Wage and Tax Statement. Generally, an individual does not report amounts totally exempt from tax, such as workers' compensation and Department of Veterans Affairs (VA) payments. However, if part of the distribution is taxable and part is nontaxable, report the entire distribution.

There is no special reporting for qualified charitable distributions under section 408(d)(8), qualified health savings account (HSA) funding distributions described in section 408(d)(9) or for the payment of qualified health and long-term care insurance premiums for retired public safety officers described in section 402(l). (66)

Form SSA-1099 - Social Security Benefit Statement Every person who received Social Security benefits will receive a Form SSA-1099 - Social Security Benefit Statement. If the person receives benefits on more than one Social Security record, he or she may get more than one Form SSA-1099. IRS Notice 703 will be enclosed with this form. It contains a worksheet to help the person figure if any of his or her benefits are taxable. The person does not mail Notice 703 to either the IRS or the SSA. An SSA-1099 is mailed to the taxpayer in January showing the total amount of benefits he or she received in the previous year. If the taxpayer is a nonresident alien who received or repaid Social Security benefits last year, he or she will receive an SSA-1042S instead. (67)

Lesson 2 - Tax Forms

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

Review Questions Answers appear in Review Feedback 1. The taxpayer can use Form 1040X to have what amount go to the Presidential Election Campaign Fund if he or she did

not do so on the original return? A. $3 B. $5 C. $7 D. The taxpayer cannot use Form 1040X to specify that money goes to the Presidential Election Campaign Fund

2. Which form tells an employer the marital status, the number of withholding allowances, and any additional amount to

use when the employer deducts Federal income tax from the employee's pay? A. Form W-2 B. Form W-4 C. Form 1040 D. Form 1040X

3. Which of following disqualifies a taxpayer from using Form 1040EZ?

A. Taxpayer was 55 years of age B. Taxpayer does not claim dependents C. Taxpayer has interest income of $500 D. Taxpayer claims education credits

4. Form 4868 - Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, will provide the

taxpayer with the following: A. An automatic extension of 6 months to pay the taxes due B. An automatic extension of 6 months to file the return C. An automatic extension of 8 months to file the return D. An automatic extension of 2 months for taxpayers out of the country on April 15th

5. The taxpayer must use Form 1040 if he or she has an income of what amount or more?

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

6. If a taxpayer does not pay the additional tax due on Form 1040X within how many calendar days from the date of notice

and demand for payment, the penalty is usually ½ of 1% of the unpaid amount for each month or part of a month the tax is not paid?

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

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7. If the taxpayer’s attempts to have an incorrect Form W-2 corrected by his or her employer are unsuccessful and it is after February 14, the taxpayer can request that an IRS representative initiate a Form W-2 complaint. When the complaint is initiated a letter will be sent by the IRS to the employer requesting that they furnish a corrected Form W-2 to the taxpayer within how many days?

A. 10 days B. 14 days C. 21 days D. 30 days

8. If Medicare tax was withheld, an employer engaged in a trade or business who pays remuneration of what amount or

more for the year for services performed by an employee must file a Form W-2 - Wage and Tax Statement? A. $500 B. $600 C. $700 D. All amounts

Lesson 2 - Tax Forms

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Review Feedback Return to Review Questions Question 1 - A. $3 The taxpayer can use Form 1040X to have $3 go to the Presidential Election Campaign Fund if he or she (or his or her spouse on a joint return) did not do so on the original return. This must be done within 20 ½ months after the original due date for filing the return. For calendar year 2017, this period ends in January of 2020. A previous designation of $3 to the fund cannot be changed. Question 2 - B. Form W-4 An employee must complete a Form W-4 - Employee's Withholding Allowance Certificate. Form W-4 tells an employer the marital status, the number of withholding allowances, and any additional amount to use when the employer deducts Federal income tax from the employee's pay. If an employee fails to properly complete Form W-4, the employer must withhold Federal income taxes from his or her wages as if he or she were single and claiming no withholding allowances. Form W-4 includes detailed worksheets to help the employee figure his or her correct number of withholding allowances. Question 3 - D. Taxpayer claims education credits If a taxpayer paid higher education expenses, he or she may be eligible for a tax credit or deduction. The taxpayer may be eligible to claim a credit (and receive a refund) even if he or she owes no income tax. The taxpayer must file Form 1040A or 1040 to claim these tax benefits. Question 4 - B. An automatic extension of 6 months to file the return Beginning with 2005, an individual is granted an automatic extension of six months for filing a return (but not for payment of tax), provided that Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return is properly filed before the normal due date of the return. (Previously, the automatic filing extension was good for four months.) Also, filing extensions may be obtained via telephone or via internet on the IRS website. Question 5 - C. $100,000 The taxpayer must use Form 1040 if he or she has an income of $100,000 or more. Question 6 - C. 21 days If the taxpayer does not pay the additional tax due on Form 1040X within 21 calendar days from the date of notice and demand for payment (10 business days from that date if the amount of tax is $100,000 or more), the penalty is usually ½ of 1% of the unpaid amount for each month or part of a month the tax is not paid. The penalty can be as much as 25% of the unpaid amount and applies to any unpaid tax on the return. This penalty is in addition to interest charges on late payments. The taxpayer will not have to pay the penalty if he or she can show reasonable cause for not paying the tax on time. Question 7 - A. 10 days If the taxpayer’s attempts to have an incorrect Form W-2 corrected by his or her employer are unsuccessful and it is after February 14, the taxpayer can request that an IRS representative initiate a Form W-2 complaint. The taxpayer may call the IRS toll free at 800-829-1040, or visit an IRS Taxpayer Assistance Center (TAC) in person. A letter will be sent to the employer requesting that they furnish a corrected Form W-2 to the taxpayer within ten days. The letter advises the employer of their responsibilities to provide a correct Form W-2 and of the penalties for failure to do so. Question 8 - D. All amounts Every employer engaged in a trade or business who pays remuneration, including noncash payments of $600 or more for the year (all amounts if any income, Social Security, or Medicare tax was withheld) for services performed by an employee must file a Form W-2 - Wage and Tax Statement for each employee (even if the employee is related to the employer) from whom income, Social Security, or Medicare tax was withheld and income tax would have been withheld if the employee had claimed no more than one withholding allowance or had not claimed exemption from withholding on Form W-4 - Employee's Withholding Allowance Certificate.

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Taxable Income, Filing Status At the conclusion of this lesson you should have a basic knowledge of:

Taxable and Non-Taxable Income Tax Liability Filing Status Special Filing Situations

Taxable and Nontaxable Income Most types of income are taxable, but some are not. Income can include money, property or services that the taxpayer receives. Here are some examples of income that are usually not taxable: (68)

Child support payments. Gifts, bequests and inheritances (subject to limitations). Welfare benefits. Damage awards for physical injury or sickness. Cash rebates from a dealer or manufacturer for an item the taxpayer buys. Reimbursements for qualified adoption expenses.

Some income is not taxable except under certain conditions. Examples include: (68)

Life insurance proceeds paid to the taxpayer because of an insured person’s death are usually not taxable. However, if the taxpayer redeems a life insurance policy for cash, any amount that is more than the cost of the policy is taxable.

Income the taxpayer gets from a qualified scholarship is normally not taxable. Amounts the taxpayer uses for certain costs, such as tuition and required course books, are not taxable. However, amounts used for room and board are taxable.

All income, such as wages and tips, is taxable unless the law specifically excludes it. This includes non-cash income from bartering - the exchange of property or services. Both parties must include the fair market value of goods or services received as income on their tax return. If the taxpayer received a refund, credit or offset of state or local income taxes in 2017, he or she may be required to report this amount. If the taxpayer did not receive a 2017 Form 1099-G, check with the government agency that made the payments. That agency may have made the form available only in an electronic format. The taxpayer will need to get instructions from the agency to retrieve this document. Report any taxable refund received even if the taxpayer did not receive Form 1099-G.

Who is Subject to the Tax If the taxpayer is a U.S. citizen or resident, whether he or she must file a return depends on three factors:

Gross income Filing status Age

Every citizen of the U.S. and every resident alien is subject to the income tax. All citizens must pay the tax even if they are residents of a foreign country. A limited exclusion applies to income earned from foreign sources. The tax is also levied on citizens of foreign countries who are residents of the U.S., and on citizens of foreign countries who earn income in the U.S. The rates and procedures for nonresident aliens are different from those for citizens and resident aliens. In addition, the U.S. has tax treaties with many countries that exempt certain items of income from taxation or decreases the rates.

Lesson 3 - Taxable Income, Filing Status

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Tax Rates for 2017 The tax rate of 39.6% affects singles whose income exceeds $418,400 ($470,700 for married taxpayers filing a joint return), up from $415,050 and $466,950 in 2016. The following are the tax rates schedules for tax year 2017 based on certain filing status. (69)

Unmarried Individuals (other than Surviving Spouses and Heads of Households) If Taxable Income Is: The Tax Is: Not over $9,325 10% of the taxable income Over $9,325 but not over $37,950 $932.50 plus 15% of the excess over $9,325 Over $37,950 but not over $91,900 $5,226.25 plus 25% of the excess over $37,950 Over $91,900 but not over $191,650 $18,713.75 plus 28% of the excess over $91,900 Over $191,650 but not over $416,700 $46,643.75 plus 33% of the excess over $191,650 Over $416,700 not over $418,400 $120,910.25 plus 35% of the excess over $416,700 Over $418,400 $121,505.25 plus 39.6% of the excess over $418,400

Table 1-1 - Internal Revenue Bulletin (2017)

Married Individuals Filing Joint Returns and Surviving Spouses If Taxable Income Is: The Tax Is: Not over $18,650 10% of the taxable income Over $18,650 but not over $75,900 $1,865 plus 15% of the excess over $18,650 Over $75,900 but not over $153,100 $10,452.50 plus 25% of the excess over $75,900 Over $153,100 but not over $233,350 $29,752.50 plus 28% of the excess over $153,100 Over $233,350 but not over $416,700 $52,222.50 plus 33% of the excess over $233,350 Over $416,700 but not over $470,700 $112,728 plus 35% of the excess over $416,700 Over $470,700 $131,628 plus 39.6% of the excess over $470,700

Table 1-2 - Internal Revenue Bulletin (2017)

Married Individuals Filing Separate Returns If Taxable Income Is: The Tax Is: Not over $9,325 10% of the taxable income Over $9,325 but not over $37,950 $932.50 plus 15% of the excess over $9,325 Over $37,950 but not over $76,550 $5,226.25 plus 25% of the excess over $37,950 Over $76,550 but not over $116,675 $14,876.25 plus 28% of the excess over $76,550 Over $116,675 but not over $208,350 $26,111.25 plus 33% of the excess over $116,675 Over $208,350 not over $235,350 $56,364 plus 35% of the excess over $208,350 Over $235,350 $65,814 plus 39.6% of the excess over $235,350

Table 1-3 - Internal Revenue Bulletin (2017)

Heads of Household If Taxable Income Is: The Tax Is: Not over $13,350 10% of the taxable income Over $13,350 but not over $50,800 $1,335 plus 15% of the excess over $13,350 Over $50,800 but not over $131,200 $6,952.50 plus 25% of the excess over $50,800 Over $131,200 but not over $212,500 $27,052.50 plus 28% of the excess over $131,200 Over $212,500 but not over $416,700 $49,816.50 plus 33% of the excess over $212,500 Over $416,700 not over $444,500 $117,202.50 plus 35% of the excess over $416,700 Over $444,500 $126,950 plus 39.6% of the excess over $444,500

Table 1-4 - Internal Revenue Bulletin (2017)

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Estates and Trusts If Taxable Income Is: The Tax Is: Not over $2,550 15% of the taxable income Over $2,550 but not over $6,000 $382.50 plus 25% of the excess over $2,550 Over $6,000 but not over $9,150 $1,245 plus 28% of the excess over $6,000 Over $9,150 but not over $12,500 $2,127 plus 33% of the excess over $9,150 Over $12,500 $3,232.50 plus 39.6% of the excess over $12,500

Table 1-5 - Internal Revenue Bulletin (2017)

Long Term Capital Gains and Qualified Dividends Tax Bracket Short-term Long-term 10%, 15% brackets Ordinary rate 0% 25%, 28%, 33%, 35% brackets Ordinary rate 15% 39.6% brackets Ordinary rate 20%

Table 1-6 - Internal Revenue Bulletin (2017)

An additional 3.8% Net Investment Income Tax (NIIT) applies to individuals on the lesser of net investment income or modified AGI in excess of $200,000 (single) or $250,000 (married/filing jointly and qualifying widow(er)s). The tax also applies to any trust or estate on the lesser of undistributed net income or AGI in excess of the dollar amount at which the estate/trust pays income taxes at the highest rate.

The maximum tax rate for long-term capital gains and qualified dividends is 20%, as amended by the American Taxpayer Relief Act of 2012 (ATRA). For tax year 2017, the 20% rate applies to amounts above $12,500. The 0% and 15% rates continue to apply to amounts below certain threshold amounts. The 0% rate applies to amounts up to $2,550. The 15% rate applies to amounts between the two thresholds.

General Information 2015 2016 2017 IRA contributions under age 50 $5,500 $5,500 $5,500 IRA contributions age 50 and over $6,500 $6,500 $6,500 SIMPLE Contributions $12,500 $12,500 $12,500 SEP, Keogh Maximum Dollar Allocations $53,000 $53,000 $54,000 401(k), 403(b), most 457 plans and the Federal government’s Thrift Savings Plan $18,000 $18,000 $18,000

Annual compensation limit under Sections 401(a)(17), 404(l), 408(k)(3)(C) and 408(k)(6)(D)(ii) $265,000 $265,000 $270,000

Annual Benefit Limit under Defined Benefit Plans under Section 415(b)(1)(B) $210,000 $210,000 $215,000

Limitation used in definition of highly compensated employee $120,000 $120,000 $120,000

Elective catch-ups SIMPLEs $3,000 $3,000 $3,000 401(k), 403(b), 457 plans $6,000 $6,000 $6,000 Health Savings Accounts (HSA) Contributions

Self-only $3,350 $3,350 $3,400 Family $6,650 $6,750 $6,750 55 and over additional contribution $1,000 $1,000 $1,000 Alternative Minimum Tax (AMT) Exemptions Single $53,600 $53,900 $54,300 Married filing jointly, Surviving Spouse $83,400 $83,800 $84,500

Table 3-7 - IRS.GOV - COLA Increases for Dollar Limitations on Benefits and Contributions (2017)

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Age, occupation, and mental or physical conditions have no influence on who is subject to the tax. A minor must pay the tax on his or her income just like any adult, including the President of the United States. Persons institutionalized because of mental incapacity are still subject to the tax. However, not every person has to file an annual tax return with the Internal Revenue Service (IRS). Taxpayers have to file a tax return only if their gross income exceeds the total of their standard deduction plus their allowable personal exemptions. The amount varies depending on the taxpayer's filing status and, for tax year 2017, the minimum income requirements are: Filing Status Minimum Income Requirements Single individual $10,400 Single individual 65 or older $11,950 Married couple, filing jointly $20,800 Married couple, one spouse 65 or older $22,050 Married couple, both 65 or older $23,300 Married individual, filing separate return (any age) $4,050 Head of household $13,400 Head of household 65 or over $14,950 Surviving spouse $16,750 Surviving spouse 65 or older $18,000

Table 3-8 - Publication 17 - Filing Requirements for Most Taxpayers (2017)

Gross income means all income the taxpayer received in the form of money, goods, property, and services that is not exempt from tax, including any income from sources outside the United States or from the sale of his or her main home (even if the taxpayer can exclude part or all of it). The taxpayer does not include any Social Security benefits unless:

1. He or she is married filing a separate return and he or she lived with his or her spouse at any time in 2017. 2. One-half of the taxpayer’s Social Security benefits plus his or her other gross income and any tax-exempt interest

is more than $25,000 ($32,000 if married filing jointly). If (1) or (2) applies, figure the taxable part of Social Security benefits the taxpayer must include in gross income. Gross income also includes gains, but not losses, reported on Form 8949 or Schedule D. Gross income from a business means, for example, the amount on Schedule C, line 7, or Schedule F, line 9. But, in figuring gross income, do not reduce the taxpayer’s income by any losses, including any loss on Schedule C, line 7, or Schedule F, line 9. Regardless of a taxpayer’s gross income, he or she is generally required to file an income tax return if any of the following items apply:

The taxpayer owes Alternative Minimum Tax. The taxpayer owes household employment taxes. The taxpayer owes additional taxes on a retirement plan (an individual retirement arrangement (IRA) or other tax-

favored account) or health savings account. The taxpayer must repay the 2008 Homebuyer Credit (or any other recapture taxes). The taxpayer owes Social Security and Medicare taxes on unreported tip income. The taxpayer had net self-employment income of $400 or more. The taxpayer earned $108.28 or more from a tax-exempt church or church-controlled organization. The taxpayer received distributions from an MSA or Health Savings Account.

There are a number of reasons why a taxpayer may want to file a tax return even if he or she does not meet the minimum income requirements:

If the taxpayer had taxes withheld from his or her pay, he or she must file a tax return to receive a tax refund. If the taxpayer qualifies, he or she must file a return to receive the refundable Earned Income Tax Credit. If the taxpayer is claiming education credits, he or she must file to be refunded the American Opportunity Tax

Credit.

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If the taxpayer has a qualifying child but owes no tax, he or she can file to be refunded the Additional Child Tax Credit.

If the taxpayer adopted a qualifying child, he or she must file to claim the Adoption Tax Credit. If the taxpayer overpaid estimated tax or applied a prior year overpayment to this year, he or she must file to

receive the refund. Federal Income Tax Withheld - The taxpayer should file to get money back if Federal Income Tax was withheld from his or her pay, he or she made estimated tax payments, or had a prior year overpayment applied to this year’s tax. Earned Income Tax Credit - The taxpayer may qualify for the EITC if he or she worked, but did not earn a lot of money. The EITC is a refundable tax credit; which means the taxpayer could qualify for a tax refund. Additional Child Tax Credit - This refundable credit may be available if the taxpayer has at least one qualifying child and did not get the full amount of the Child Tax Credit. American Opportunity Tax Credit - The maximum credit per student is $2,500 and the first four years of postsecondary education qualify.

Sources of Taxable and Non-Taxable Income Wages Wages, salaries, and tips a taxpayer received for performing services as an employee of an employer must be included in gross income. Amounts withheld for taxes, including but not limited to income tax, Social Security and Medicare taxes are considered "received" and must be included in gross income in the year they are withheld. If the taxpayer receives advance commissions or other amounts for services to be performed in the future and he or she is a cash-method taxpayer, the taxpayer must include these amounts in his or her income in the year received. Also, include in income amounts the taxpayer is awarded in a settlement or judgment for back pay. These include payments made to him or her for damages, unpaid life insurance premiums, and unpaid health insurance premiums. They should be reported to the taxpayer by his or her employer on Form W-2. Bonuses or awards a taxpayer receives for outstanding work are included in income and should be shown on his or her Form W-2. These include prizes such as vacation trips for meeting sales goals. If the prize or award the taxpayer receives is goods or services, he or she must include the fair market value of the goods or services in his or her income. However, if the taxpayer’s employer merely promises to pay a bonus or award at some future time, it is not taxable until he or she receives it or it is made available. If the taxpayer receives tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award for length of service or safety achievement, he or she generally can exclude its value from income. However, the amount he or she can exclude is limited to his or her employer's cost and cannot be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards the taxpayer receives during the year. Interest Interest is rent on money, paid by the borrower to the lender. With few exceptions, interest is fully taxable to the taxpayer receiving it. Taxable interest includes interest received from bank accounts, loans made to others, and other sources. Non-taxable interest includes interest received from tax-free securities, most municipal bonds, and insurance dividends left on deposit with the U.S. Department of Veterans Affairs. See Publication 17 - Chapter 7 - Interest Income for details. Business Income Business income is income received from the sale of products or services. For example, fees received by a professional person are considered business income. Rents received by a person in the real estate business are business income. Payments received in the form of property or services must be included in income at their fair market value. (70) Normally a business is organized as a sole proprietorship, partnership, or corporation. A sole proprietorship is an unincorporated business owned by an individual. A sole proprietorship has no existence apart from its owner. Business debts are personal debts of the owner. A limited liability company (LLC) with one individual owner generally is treated as

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a sole proprietorship for Federal income tax purposes, unless the owner elects to treat the LLC as a corporation. A sole proprietor files Form 1040 - Schedule C - Profit or Loss From Business, or Form 1040 - Schedule C-EZ - Net Profit From Business (Sole Proprietorship), to report the income and expenses of the business. (70) A partnership is an unincorporated business organization that is the result of two or more persons joining together to carry on a trade or business. Each person contributes money, property, services, or a combination thereof, in return for a right to share in the profits and losses of the partnership. An LLC with more than one owner is generally treated as a partnership for tax purposes. A partnership's income and expenses are generally reported on Form 1065 - U.S. Return of Partnership Income, annually. (70) The term "corporation," for Federal income tax purposes, generally includes legal entities separate from the people who formed them under Federal or state law or the shareholders who own them. It also includes certain businesses that elect to be taxed as a corporation by filing Form 8832 - Entity Classification Election. The tax on a corporation's income is figured on Form 1120 - U.S. Corporation Income Tax Return. (70) Sale of Principal Residence A taxpayer may exclude from income up to $250,000 of gain ($500,000 on a joint return in most situations) realized on the sale or exchange of a principal residence if all of the following are true: (71)

He or she meets the ownership test. He or she meets the use test. During the 2-year period ending on the date of the sale, taxpayer did not exclude gain from the sale of another

home.

If the taxpayer has gain that cannot be excluded, it is taxable. Report it on Form 8949 - Sales and Other Dispositions of Capital Assets and Schedule D (Form 1040) - Capital Gains and Losses. The taxpayer may also have to complete Form 4797 - Sales of Business Property. See Publication 17 - Chapter 15 - Selling Your Home for details. Do not report the 2017 sale of a main home on the tax return unless: (71)

The taxpayer has a gain and does not qualify to exclude all of it. The taxpayer has a gain and chooses not to exclude it. The taxpayer received Form 1099-S.

If the taxpayer has a gain that he or she cannot or chooses not to exclude, if he or she received a Form 1099-S, or if he or she has a deductible loss, report the sale on the tax return. Report the sale on Part I, line 1 or Part II, line 3 of Form 8949 as a short-term or long-term transaction, depending on how long the taxpayer owned the home. Report the proceeds from the sale (Worksheet 2, line 1) in column (d) and the cost or other basis (Worksheet 2, line 4) in column (e). If there are any selling expenses, enter “E” in column (f) and the necessary adjustment in column (g). See the Instructions for Form 8949. Separate a taxpayer’s capital gains and losses according to how long he or she held or owned the property. The holding period for short-term capital gains and losses is 1 year or less. Report these transactions on Part I of Form 8949. The holding period for long-term capital gains and losses is more than 1 year. Report these transactions on Part II of Form 8949. To figure the holding period, begin counting on the day after the taxpayer received the property and include the day he or she disposed of it. Generally, if the taxpayer disposed of property that he or she acquired by inheritance, report the disposition as a long-term gain or loss regardless of how long he or she held the property. However, if the taxpayer acquired the property from someone who died in 2010 and the executor of the estate made the election to file Form 8939, see Publication 4895 - Tax Treatment of Property Acquired From a Decedent Dying in 2010. Dividends For many years, millions of people have invested in corporate stocks. For this reason, dividends are a popular source of income. A dividend on stock is similar to an interest payment received on a savings account, note or bond, but with two

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important differences. Unlike interest, the amount of the dividend is not specified by contract and dividends are not necessarily paid at regular intervals, but depend upon the decision of the corporate directors to make a distribution. The most common kinds of distributions are: (72)

Ordinary dividends. Capital gain distributions. Non-dividend distributions.

Most distributions are paid in cash (check). However, distributions can consist of more stock, stock rights, other property or services. See Publication 17 - Chapter 8 - Dividends and Other Distributions for details. Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as stock options) are distributions by a corporation of rights to acquire the corporation's stock. Generally, stock dividends and stock rights are not taxable to an individual. However, there are some exceptions. If the stock dividends are not taxable, a taxpayer must divide his or her basis for the old stock between the old and new stock. The basis of stock must be adjusted for certain events that occur after purchase. For example, if the taxpayer receives more stock from nontaxable stock dividends or stock splits, he or she must reduce the basis of the original stock. The taxpayer must also reduce the basis when he or she receives non-dividend distributions. These distributions, up to the amount of the basis, are a nontaxable return of capital. Example Eddie bought 100 shares of stock of XYZ Corporation in 2001 for $10 a share. In January 2002 he bought another 200 shares for $11 a share. In July 2002 he gave his son 50 shares. In December 2004 he bought 100 shares for $9 a share. In April 2017 he sold 130 shares. Eddie cannot identify the shares he disposed of, so he must use the stock he acquired first to figure the basis. The shares of stock he gave his son had a basis of $500 (50 × $10). Eddie figures the basis of the 130 shares of stock he sold in 2017 as follows:

50 shares (50 × $10) balance of stock bought in 2001 - $500. 80 shares (80 × $11) stock bought in January 2002 - $880. Total basis of stock sold in 2017 = $1,380.

The basis of shares in a mutual fund (or other regulated investment company) or a real estate investment trust (REIT) is generally figured in the same way as the basis of other stock and usually includes any commissions or load charges paid for the purchase. Example The taxpayer bought 100 shares of Fund A for $10 a share. She paid a $50 commission to the broker for the purchase. Her cost basis for each share is $10.50 ($1,050 ÷ 100). Rental Income Generally, cash or the fair market value of property a taxpayer receives for the use of real estate or personal property is taxable to him or her as rental income. Most individuals operate on a cash basis, which means they count their rental income as income when it is actually or constructively received, and deduct their expenses as they are paid. Some specific types of income are: (73)

Amounts paid to cancel a lease – If a tenant pays a taxpayer to cancel a lease, this money is also rental income and is reported in the year received.

Advance rent – Generally the taxpayer includes any advance rent paid in income in the year he or she receives it regardless of the period covered or the method of accounting used.

Expenses paid by a tenant – If the tenant pays any of the taxpayer’s expenses, those payments are rental income. The taxpayer may be allowed to deduct the expenses if they are considered deductible expenses.

Security deposits – Do not include a security deposit in taxpayer’s income if he or she may be required to return it to the tenant at the end of the lease. But if the taxpayer keeps part or all of the security deposit because the tenant did not live up to the terms of the lease, this money is taxable income in the year the determination is made. If the taxpayer keeps the security deposit because the tenant damaged the property, the security deposit is not taxable. If the security deposit is to be used as the tenant's final month's rent, include the money as income when received, rather than when it is applied to the last month's rent.

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If the rental agreement gives the tenant the right to buy the rental property, the payments received under the agreement are generally rental income. If the tenant exercises the right to buy the property, the payments received for the period after the date of sale are considered part of the selling price. (74)

If the taxpayer uses a dwelling unit as a home and he or she rents it less than 15 days during the year, its primary function is not considered to be a rental and it should not be reported on Schedule E (Form 1040). However, if the taxpayer uses a dwelling unit as a home and rents it 15 days or more during the year, include all rental income in his or her income. Since the taxpayer used the dwelling unit for personal purposes, he or she must divide the expenses between the rental use and the personal use. The expenses for personal use are not deductible as rental expenses. If the taxpayer had a net profit from renting the dwelling unit for the year (that is, if rental income is more than the total of rental expenses, including depreciation), deduct all of the rental expenses. However, if the taxpayer had a net loss from renting the dwelling unit for the year, the deduction for certain rental expenses is limited. See Publication 527 - Residential Rental Property to figure the deductible rental expenses and any carryover to the next year. Some examples of expenses that may be deducted from total rental income are: (74)

Depreciation – the taxpayer begins to depreciate his or her rental property when it is placed in service. The taxpayer can recover some or all of his or her original acquisition cost and improvements by using Form 4562 - Depreciation and Amortization beginning in the year the rental property is first placed in service, and beginning in any year the taxpayer makes improvements or adds furnishings. The rental is considered placed in service when it was ready and available for rent.

Repairs – repairs to keep the property in good working condition but do not add to the value of the property. Operating Expense. Uncollected rents – unless taxpayer is a cash basis taxpayer and cannot deduct uncollected rents as an expense

because he or she has not included those rents in income. If the taxpayer uses a dwelling unit for both rental and personal purposes, divide the expenses between the rental use and the personal use based on the number of days used for each purpose. When dividing the expenses, follow these rules: (74)

Any day that the unit is rented at a fair rental price is a day of rental use even if the taxpayer used the unit for personal purposes that day. (This rule does not apply when determining whether the taxpayer used the unit as a home.)

Any day that the unit is available for rent but not actually rented is not a day of rental use. Flow-Through Entities The payees of payments (other than income effectively connected with a U.S. trade or business) made to a foreign flow-through entity are the owners or beneficiaries of the flow-through entity. This rule applies for purposes of Nonresident Alien (NRA) withholding and for Form 1099 reporting and backup withholding. Income that is, or is deemed to be, effectively connected with the conduct of a U.S. trade or business of a flow-through entity, is treated as paid to the entity. All of the following are flow-through entities: (75)

A foreign partnership (other than a withholding foreign partnership and partnerships claiming treaty benefits as entities that are not fiscally transparent).

A foreign simple or foreign grantor trust (other than a withholding foreign trust), and foreign simple and foreign grantor trusts claiming treaty benefits as entities that are not fiscally transparent.

An entity receiving income for which treaty benefits are claimed by an interest holder in the entity and the entity is considered fiscally transparent.

Generally, an individual treats a payee as a flow-through entity if it provides him or her with a Form W-8IMY - Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding on which it claims such status. The person may also be required to treat the entity as a flow-through entity under the presumption rules. Alimony After the divorce or legal separation, the wife or husband loses the right to participate in the former spouse’s earnings. If

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many years of marriage have intervened, he or she may have lost marketable job skills, and advanced age could place such a person at a disadvantage in the labor market. This person may be entitled to alimony. A spouse or former spouse who is receiving alimony must report the full amount as income on Form 1040 or Form 1040 NR, Schedule NEC. He or she cannot use Form 1040A, Form 1040EZ, or Form 1040NR-EZ. If the spouse or former spouse does not give his or her Social Security number to the spouse or former spouse who is making the alimony payments, he or she may have to pay a $50 penalty. See Publication 17 - Chapter 18 - Alimony for details. An amendment to a divorce decree may change the nature of the taxpayer’s payments. Amendments are not ordinarily retroactive for Federal tax purposes. However, a retroactive amendment to a divorce decree correcting a clerical error to reflect the original intent of the court will generally be effective retroactively for Federal tax purposes. Certain Government Payments Federal, state, or local governments file Form 1099-G - Certain Government Payments if they made taxable payments of unemployment compensation; state or local income tax refunds, credits, or offsets; reemployment trade adjustment assistance (RTAA) payments; taxable grants; or agricultural payments. They also file this form if they received payments on a Commodity Credit Corporation (CCC) loan. Pensions and Annuities The pension or annuity payments that a taxpayer receives are fully taxable if he or she has no cost in the contract because any of the following situations: (76)

The taxpayer did not pay anything or is not considered to have paid anything for the pension or annuity. Amounts withheld from his or her pay on a tax-deferred basis are not considered part of the cost of the pension or annuity payment.

The taxpayer’s employer did not withhold contributions from his or her salary. The taxpayer received all of his or her contributions tax free in prior years.

If a taxpayer contributed after-tax dollars to a pension or annuity, the pension payments are partially taxable. He or she will not pay tax on the part of the payment that represents a return of the after-tax amount paid. This amount is the taxpayer’s investment in the contract, and includes the amounts his or her employer contributed that were taxable to him or her when contributed. Partly taxable pensions are taxed under either the General Rule or the Simplified Method. If the starting date of the pension or annuity payments is after November 18, 1996, the taxpayer generally must use the Simplified Method to determine how much of the annuity payments are taxable and how much is tax free. See Publication 17 - Chapter 10 - Retirement Plans, Pensions, and Annuities for details. Virtual Currency The sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or holding virtual currencies as an investment, generally has tax consequences that could result in tax liability. This guidance applies to individuals and businesses that use virtual currencies. Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies. For Federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency. The character of the gain or loss generally depends on whether the virtual currency is a capital asset in the hands of the taxpayer. A taxpayer generally realizes capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset. (77)

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Gross Income Generally, a taxpayer must file a return if his or her gross income equals or exceeds the sum of the personal exemption to which he or she is entitled plus the standard deduction amount applicable to the taxpayer. Tax law allows a $4,050 exemption for each taxpayer in 2017. The Standard Deduction is based on filing status, age and eyesight. Gross income is income from all sources, except for items specifically excluded by the Internal Revenue Code. Income on an individual's annual income tax return typically is the sum of wages and other items of income less the exclusions. The precise amount of gross income is important in order to determine whether the taxpayer must file a return. Except as otherwise provided, gross income means all income from whatever source derived, including (but not limited to) the following items: (78)

Compensation for services, including fees, commissions, fringe benefits, and similar items. Gross income derived from business. Gains derived from dealings in property. Interest. Rents. Royalties. Dividends. Alimony and separate maintenance payments. Annuities. Income from life insurance and endowment contracts. Pensions. Income from discharge of indebtedness. Distributive share of partnership gross income. Income in respect of a decedent. Income from an interest in an estate or trust.

Adjustments to Gross Income The following are major items, within limits, allowed by law to be subtracted from gross income:

Certain business expenses of reservists, performing artists, and fee-basis government officials. Archer MSA and health savings account deduction. Moving expenses. One-half of self-employment tax. Self-employed SEP, SIMPLE, and qualified plans. Self-employed health insurance deduction. Penalty on early withdrawal of savings. Alimony paid. IRA deduction. Student loan interest deduction.

Adjusted Gross Income (AGI) Adjusted gross income is the remainder of gross income after subtraction of allowed adjustments above. This intermediate amount is important because it is used for computing deductions, tax credits, and other tax benefits that are based on or limited by income. The deductions for medical expenses, contributions, casualty losses and miscellaneous itemized deductions are all based on or limited by the amount of adjusted gross income. Deductions from Adjusted Gross Income Some deductions are allowed for expenses of a personal nature. These are divided into five categories:

1. Certain Medical and Dental Expenses. 2. Paid interest and taxes on the home. 3. Gifts to Charity. 4. Casualty and Theft Losses. 5. Job Expenses and Certain Miscellaneous Deductions, including union dues, tax preparation fees, safe deposit

box fees, and un-reimbursed employee business expenses.

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Deductions from adjusted gross income are sometimes referred to as personal deductions; however, calling these expenses personal deductions can result in confusion. Most personal expenses, such as food, clothing, shelter, entertainment, and the like, are not deductible. A more appropriate designation is itemized deductions. Standard Deduction Itemized Deductions should be used only when they exceed the flat Standard Deduction amounts provided by law. The Standard Deduction amounts are: 2015 2016 2017 Single $6,300 $6,300 $6,350 Married Filing Jointly $12,600 $12,600 $12,700 Married Filing Separately $6,300 $6,300 $6,350 Head of Household $9,250 $9,300 $9,350 Qualifying Widow(er) $12,600 $12,600 $12,700

Table 3-9 - Publication 501 - Table 6 - Standard Deduction Chart for Most People (2017)

For 2017, the additional standard deduction amount for the aged or the blind is $1,250. The additional standard deduction amount is increased to $1,550 if the individual is also unmarried and not a surviving spouse.

Net Taxable Income The final remainder is the net taxable income. This amount is the base for the tax; the rates are applied to this amount to determine the gross tax liability.

Tax Liability Computation of Gross Tax Liability using the Tax Table After determining a taxpayer's taxable income and his or her filing status, arriving at his or her gross tax liability is a relatively simple chore. In fact today’s tax preparation software will do this for you. Remember, you can still refer to or check the amount by referring to the correct column (filing status) on the Tax Table provided by the Internal Revenue Service.

The Tax Table is set up based on amounts of taxable income below $100,000. A column is provided for each tax status, and the tax is determined by locating the amount shown under the correct column to the right of the taxable income amount. A person having taxable income of $100,000 or more must use the Tax Computation Worksheet (based on the Tax Rate Schedules) also provided by the IRS.

Net Tax Liability The final step in the tax formula is the determination of the net tax liability, the amount of money, which the taxpayer must pay with the filed tax return, or the amount that the tax filer will receive back from the government. To determine this amount, the following taxes, credits and payments must be either added or subtracted. Alternative Minimum Tax The Alternative Minimum Tax (AMT) applies to taxpayers who have certain types of income that receive favorable treatment, or who qualify for certain deductions, under the tax law. These tax benefits can significantly reduce the regular tax of some taxpayers with higher economic incomes. The AMT sets a limit on the amount these benefits can be used to reduce total tax. Here are some facts the Internal Revenue Service wants the taxpayer to know about the AMT and changes for 2017: (79)

1. Tax laws provide tax benefits for certain kinds of income and allow special deductions and credits for certain expenses. These benefits can drastically reduce some taxpayers’ tax obligations. Congress created the AMT in 1969, targeting higher-income taxpayers who could claim so many deductions they owed little or no income tax.

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2. The taxpayer may have to pay the AMT if his or her taxable income for regular tax purposes, plus any adjustments and preference items that apply to the taxpayer, are more than the AMT exemption amount.

3. The AMT exemption amounts are set by law for each filing status. 4. For tax year 2017, Congress raised the AMT exemption amounts to the following levels:

a. $84,500 for a married couple filing a joint return and qualifying widows and widowers. b. $54,300 for singles and heads of household.

5. The minimum AMT exemption amount for a child whose unearned income is taxed at the parents' tax rate has increased to $7,500 for 2017.

Tax Credits There are several credits that can be taken to further offset tax liability. The major tax credits are as follows:

Earned Income Tax Credit (EITC). Credit for the Elderly or the Disabled. Education credits. Retirement Savings Contributions Credit. Adoption Credit. Foreign Tax Credit. Child Tax Credit. Child and Dependent Care Credit.

Tax credits do not have the same effect as deductions. Deductions such as IRA deductions and excess itemized deductions reduce the income amount on which the tax is levied. Credits, on the other hand, are subtracted directly from the gross tax liability. If a taxpayer, for example, is in the 15% bracket on the applicable tax table, a $100 deduction reduces their tax liability by only $15. If, on the other hand, he or she has a tax credit of $100, this will reduce their tax liability by a full $100. See Publication 17 - Part Six - Figuring Your Taxes and Credits for complete details. Tax Payments Most taxpayers who earned income will have already paid some portion of their tax liability during the course of the year. Examples include: (80)

Federal income tax withheld from Forms W-2 and 1099. 2017 estimated tax payments and amount applied from 2016 return. Earned Income Tax Credit (EITC). Nontaxable combat pay election. Additional Child Tax Credit. American Opportunity Tax Credit. Amount paid with request for extension to file. Excess Social Security and tier 1 RRTA tax withheld.

The most obvious subtraction in this category is the amount of Federal income tax that has been withheld from the employee's pay (reported by employers on Form W-2 - Wage and Tax Statement). Other forms of payments are estimated taxes paid by self-employed individuals, and excess amounts of Social Security taxes that have been withheld from an employee's pay. Also included here is the amount for Earned Income Tax Credit, the additional Child Tax Credit; and the American Opportunity Tax Credit. Form W-2 - Wage and Tax Statement Every employer engaged in a trade or business who pays remuneration, including noncash payments of $600 or more for the year (all amounts if any income, Social Security, or Medicare tax was withheld) for services performed by an employee must file a Form W-2 for each employee (even if the employee is related to the employer) from whom: (81)

Income, Social Security, or Medicare tax was withheld. Income tax would have been withheld if the employee had claimed no more than one withholding allowance or

had not claimed exemption from withholding on Form W-4, Employee's Withholding Allowance Certificate.

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Tax Withholding The Federal income tax is a pay-as-you-go tax. There are two ways to pay-as-you-go. The first is withholding. If the taxpayer is an employee, his or her employer probably withholds income tax from his or her pay. Tax may also be withheld from certain other income - including pensions, bonuses, commissions, and gambling winnings. In each case, the amount withheld is paid to the IRS in the taxpayer’s name. See Publication 17 - Chapter 4 - Tax Withholding and Estimated Tax for complete information. The amount of income tax the employer withholds from regular pay depends on two things: (82)

The amount the taxpayer earns. The information the taxpayer gives his or her employer on Form W-4 - Employee's Withholding Allowance

Certificate. Form W-4 includes three types of information that the employer will use to figure the withholding: (82)

Whether to withhold at the single rate or at the lower married rate. How many withholding allowances the taxpayer claims (each allowance reduces the amount withheld). Whether the taxpayer wants an additional amount withheld.

The taxpayer must specify a filing status and a number of withholding allowances on Form W-4. He or she cannot specify only a dollar amount of withholding.

Estimated Tax Payments The second pay-as-you-go method is estimated tax payments. Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes and awards. The taxpayer may also have to pay estimated tax if the amount of income tax being withheld from his or her salary, pension, or other income is not enough. (83) Estimated tax is used to pay income tax and self-employment tax, as well as other taxes and amounts reported on the tax return. If the taxpayer does not pay enough through withholding or estimated tax payments, he or she may be charged a penalty. If the taxpayer does not pay enough by the due date of each payment period, he or she may be charged a penalty even if he or she is due a refund when the tax return is filed. U.S. citizens with no tax liability in the previous full 12-month tax year are not required to pay estimated tax. Estimated tax liability exists for 2017 when both of the following apply: (83)

1. The taxpayer expects to owe at least $1,000 in tax for 2017, after subtracting his or her withholding and refundable credits.

2. The taxpayer expects his or her withholding plus his or her refundable credits to be less than the smaller of either: a. 90% of the tax to be shown on the taxpayer’s 2017 tax return b. 100% of the tax shown on the taxpayer’s 2016 tax return (there are special rules for farmers, fishermen,

and higher income taxpayers). The taxpayer’s 2016 tax return must cover all 12 months.

If the taxpayer is filing as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual, he or she generally will have to make estimated tax payments if he or she expects to owe tax of $1,000 or more when filing the return. If the taxpayer is filing as a corporation, he or she generally has to make estimated tax payments for the corporation if he or she expects it to owe tax of $500 or more when filing its return. The taxpayer does not have to pay estimated tax for the current year if he or she meets all three of the following conditions: (83)

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

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When figuring the estimated tax for the current year, it may be helpful to use the taxpayer’s income, deductions, and credits for the prior year as a starting point. Use the worksheet in Form 1040-ES - Estimated Tax for Individuals to figure the estimated tax. It is important to remember to make adjustments both for changes in the taxpayer’s work situation and for recent changes in the tax law. See Publication 17 - Chapter 4 - Tax Withholding and Estimated Tax for complete information. For estimated tax purposes, the year is divided into four payment periods. Each period has a specific payment due date. If the taxpayer does not pay enough tax by the due date of each of the payment periods, he or she may be charged a penalty even if he or she is due a refund when the taxpayer files the income tax return. Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. The penalty may also be waived if: (83)

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

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

Presidential Election Campaign Fund This fund helps pay for Presidential election campaigns. If the taxpayer would like $3 to go to this fund, check the box on the tax return. If the taxpayer is filing a joint return, his or her spouse can also have $3 go to the fund. If the taxpayer checks a box on the tax return, his or her tax or refund will not change. Computations The taxpayer can round off cents to whole dollars on his or her return and schedules. If he or she does round to whole dollars, he or she must round all amounts. To round, drop amounts under 50 cents and increase amounts from 50 to 99 cents to the next dollar. For example, $1.39 becomes $1 and $2.50 becomes $3. If the taxpayer has to add two or more amounts to figure the amount to enter on a line, include cents when adding the amounts and round off only the total.

Filing Status The tax law divides taxpayers into five status categories based on their family responsibilities. This is referred to as the taxpayer's filing status. Because the tax rates differ for each filing status, separate tax rate schedules and tax tables are prepared by the Internal Revenue Service. See Publication 17 - Chapter 2 - Filing Status for details. Here are eight facts about the five filing status options the IRS wants the taxpayer to know so that he or she can choose the best option for their situation. (84)

1. Marital status on the last day of the year determines marital status for the entire year. 2. If more than one filing status applies, choose the status that gives the taxpayer the lowest tax obligation. 3. Single filing status generally applies to anyone who is unmarried, divorced or legally separated according to state

law. 4. A married couple may file a joint return together. The couple’s filing status would be Married Filing Jointly. 5. If a spouse died during the year and the taxpayer did not remarry during the tax year, usually he or she may still

file a joint return with that spouse for the year of death. 6. A married couple may elect to file their returns separately. Each person’s filing status would generally be Married

Filing Separately. 7. Head of household generally applies to taxpayers who are unmarried. The taxpayer must also have paid more

than half the cost of maintaining a home for him or her and a qualifying person to qualify for this filing status. 8. The taxpayer may be able to choose Qualifying Widow(er) with Dependent Child as his or her filing status if a

spouse died during 2015 or 2016, he or she has a dependent child and he or she meets certain other conditions. Single A taxpayer’s filing status is single if the person never married or if, on the last day of the year, the person is unmarried or legally separated under a divorce or separate maintenance decree.

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The taxpayer is considered unmarried for the whole year if, on the last day of his or her tax year, he or she is either: (4)

Unmarried, or Legally separated from his or her spouse under a divorce or separate maintenance decree.

State law governs whether the taxpayer is married or legally separated under a divorce or separate maintenance decree. If the taxpayer is divorced under a final decree by the last day of the year, he or she is considered unmarried for the whole year. If the taxpayer obtains a divorce for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce he or she intends to and does, in fact, remarry each other in the next tax year, the taxpayer and his or her spouse must file as married individuals in both years. If the taxpayer obtains a court decree of annulment, which holds that no valid marriage ever existed, he or she is considered unmarried even if he or she filed joint returns for earlier years. The taxpayer must file amended returns (Form 1040X) claiming single or head of household status for all tax years that are affected by the annulment and not closed by the statute of limitations for filing a tax return. Generally, for a credit or refund, the taxpayer must file Form 1040X within 3 years (including extensions) after the date he or she filed his or her original return or within 2 years after the date he or she paid the tax, whichever is later. If the taxpayer filed his or her original tax return early (for example, March 1), his or her return is considered filed on the due date (generally April 15). However, if the taxpayer had an extension to file (for example, until October 15) but he or she filed early and the IRS received it on July 1, his or her return is considered filed on July 1. Married, Filing a Joint Return The determination of whether an individual is married shall be made as of the close of his or her taxable year; except that if his or her spouse dies during the taxable year such determination shall be made as of the time of such death or an individual legally separated from his or her spouse under a decree of divorce or of separate maintenance shall not be considered as married. (3) There are many advantages to filing a joint tax return. The IRS gives joint filers one of the largest standard deductions each year, allowing them to deduct a significant amount of their income immediately. Also married couples who file together get to deduct two exemption amounts from their income and they qualify for multiple tax credits such as the Earned Income Tax Credit, the American Opportunity and Lifetime Learning Credits, the exclusion or credit for adoption expenses, and the Child and Dependent Care Credit. Joint filers also receive higher income thresholds for certain taxes and deductions which means they can earn a larger amount of income and still qualify for certain tax breaks. A joint return may be filed under the following conditions: (84)

If the individuals are married as of the last day of the taxable year. A couple could be married at 11:59.59 p.m. on December 31 of the taxable year and still file a joint return for the entire year.

If one spouse dies during the taxable year, provided that the surviving spouse has not remarried during the year. If remarried, the taxpayer may file jointly with his or her new spouse.

If the individuals are not divorced or legally separated before the end of the taxable year under a final decree. If both spouses agree to file a joint return. If a non-resident alien is married to a citizen of the United States and they both elect to be taxed on their worldwide

income. If the tax years of both spouses begin on the same date.

In some cases, one spouse may be relieved of joint responsibility for tax, interest, and penalties on a joint return for items of the other spouse that were incorrectly reported on the joint return. The taxpayer can ask for relief no matter how small the liability. There are three types of relief available: (47)

1. Innocent spouse relief. 2. Separation of liability, (available only to joint filers who are divorced, widowed, legally separated, or have not lived

together for the 12 months ending on the date the election for this relief is filed). 3. Equitable relief.

The taxpayer must file Form 8857 - Request for Innocent Spouse Relief, to request relief from joint responsibility. Publication 971 - Innocent Spouse Relief, explains these kinds of relief and who may qualify for them.

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Qualifying Widow(er) With Dependent Child Surviving spouses with a dependent child may also use the same tax tables and tax rate schedules as used by joint filers (up to 2 years after year of spouse’s death). A surviving spouse is a widow or widower whose spouse died not earlier than the second preceding taxable year and who has a dependent child, stepchild, adopted child, or foster child living with him or her for the entire year. To illustrate, a taxpayer's husband died in July, 2016. The taxpayer has a dependent son who lives with her. For 2016, she may file a joint return because she was still married on the date of her spouse's death. For 2017 and 2018, she qualifies as a surviving spouse. For 2019 and later years, she is not a surviving spouse because her husband died earlier than the second preceding taxable year. A taxpayer is eligible to file his or her 2017 income tax return as a qualifying widow(er) with dependent child if he or she meets all of the following tests: (85)

1. The taxpayer was entitled to file a joint return with his or her spouse for the year his or her spouse died. It does not matter whether the taxpayer actually filed a joint return.

2. The taxpayer’s spouse died in 2015 or 2016 and the taxpayer did not remarry before the end of 2017. 3. The taxpayer has a child or stepchild for whom he or she can claim an exemption. 4. This child lived in the taxpayer’s home all year, except for temporary absences. There are exceptions for a child

who was born or died during the year and for a kidnapped child. 5. The taxpayer paid more than half the cost of keeping up a home for the year.

Example Reed Johnson's wife died in 2015. Reed has not remarried. He has continued during 2016 and 2017 to keep up a home for himself and his child, who lives with him and for whom he can claim an exemption. For 2015 he was entitled to file a joint return for himself and his deceased wife. For 2016 and 2017, he can file as a qualifying widower with a dependent child. After 2017, he can file as head of household if he qualifies. Married Taxpayers Filing Separately Taxpayers who are married but elect to file separate returns must use a rate schedule which provides for the highest tax of all the classes. Normally, it will not be advantageous for married taxpayers to make this election. One consideration, however, which might lead a married person to file separate return, is the joint liability for the tax on a joint return. If one spouse fails to pay the tax, the other will have to pay the spouse’s portion. If the taxpayer chooses married filing separately as his or her filing status, the following special rules apply. Because of these special rules, the taxpayer usually pays more tax on a separate return than if he or she uses another filing status for which he or she qualifies: (86)

1. The taxpayer’s tax rate generally is higher than on a joint return. 2. The taxpayer’s exemption amount for figuring the alternative minimum tax is half that allowed on a joint return. 3. The taxpayer cannot take the Credit for Child and Dependent Care Expenses in most cases, and the amount he

or she can exclude from income under an employer's dependent care assistance program is limited to $2,500 (instead of $5,000 on a joint return). If the taxpayer is legally separated or living apart from his or her spouse, the taxpayer may be able to file a separate return and still take the credit. See Joint Return Test in Publication 503 - Child and Dependent Care Expenses, for more information.

4. The taxpayer cannot take the Earned Income Tax Credit. 5. The taxpayer cannot take the exclusion or credit for adoption expenses in most cases. 6. The taxpayer cannot take the education credits (the American Opportunity Tax Credit and Lifetime Learning

Credit) or the deduction for student loan interest. 7. The taxpayer cannot exclude any interest income from qualified U.S. savings bonds he or she used for higher

education expenses. 8. If the taxpayer lived with his or her spouse at any time during the tax year:

a. The taxpayer cannot claim the Credit for the Elderly or the Disabled. b. The taxpayer must include in income a greater percentage (up to 85%) of any Social Security or equivalent

railroad retirement benefits he or she received. 9. The following credits are reduced at income levels half those for a joint return:

a. The Child Tax Credit. b. The Retirement Savings Contributions Credit.

10. The taxpayer’s capital loss deduction limit is $1,500 (instead of $3,000 on a joint return).

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11. If the taxpayer’s spouse itemizes deductions, the taxpayer cannot claim the standard deduction. If the taxpayer can claim the standard deduction, his or her basic standard deduction is half the amount allowed on a joint return.

Head of Household If the taxpayer qualifies to file as head of household, his or her tax rate usually will be lower than the rates for single or married filing separately. The taxpayer will also receive a higher standard deduction than if he or she files as single or married filing separately. To qualify as a head of household, a taxpayer must meet the following conditions: (87)

1. The taxpayer is unmarried or considered unmarried on the last day of the year. 2. The taxpayer paid more than half the cost of keeping up a home for the year. 3. A qualifying person lived with the taxpayer in the home for more than half the year (except for temporary absences,

such as school). However, if the qualifying person is the taxpayer’s dependent parent, he or she does not have to live with him or her.

If the taxpayer’s qualifying person is his or her father or mother, he or she may be eligible to file as head of household even if his or her father or mother does not live with him or her. However, the taxpayer must be able to claim an exemption for his or her father or mother. Also, he or she must pay more than half the cost of keeping up a home that was the main home for the entire year for his or her father or mother. The taxpayer is keeping up a main home for his or her father or mother if he or she pays more than half the cost of keeping his or her parent in a rest home or home for the elderly. Example The taxpayer is unmarried. His or her mother, for whom the taxpayer can claim an exemption, lived in rest home by herself. She died on September 2. The cost of the upkeep of her apartment for the year until her death was $6,000. The taxpayer paid $4,000 and his or her brother paid $2,000. The taxpayer’s brother made no other payments towards his mother's support. The taxpayer’s mother had no income. Because the taxpayer paid more than half of the cost of keeping up the mother's apartment from January 1 until her death, and the taxpayer can claim an exemption for her, the taxpayer can file as a head of household.

If the person is the taxpayer’s qualifying child (such as a son, daughter, or grandchild who lived with him or her more than half the year and meets certain other tests) and he or she is married and the taxpayer cannot claim an exemption for him or her then that person is not a qualifying person.

To qualify for head of household status, the taxpayer must be either unmarried or considered unmarried on the last day of the year. He or she is considered unmarried on the last day of the tax year if he or she meets all the following tests: (88)

1. The taxpayer files a separate return. 2. The taxpayer paid more than half the cost of keeping up his or her home for the tax year. 3. The taxpayer’s spouse did not live in his or her home during the last 6 months of the tax year. The taxpayer’s

spouse is considered to live in his or her home even if he or she is temporarily absent due to special circumstances. 4. The taxpayer’s home was the main home of his or her child, stepchild, or foster child for more than half the year. 5. The taxpayer must be able to claim an exemption for the child. However, the taxpayer meets this test if he or she

cannot claim the exemption only because the noncustodial parent can claim the child. To qualify for head of household status, the taxpayer must pay more than half of the cost of keeping up a home for the year. If the total amount the taxpayer paid is more than the amount others paid, he or she meets the requirement of paying more than half the cost of keeping up the home. A taxpayer should include in the cost of keeping-up-a-home expenses such as rent, mortgage interest, real estate taxes, insurance on the home, repairs, utilities, and food eaten in the home. Do not include the costs of clothing, education, medical treatment, vacations, life insurance, or transportation. Also, do not include the rental value of a home the taxpayer owns or the value of his or her services or those of a member of his or her household. (87) If the taxpayer used payments he or she received under Temporary Assistance for Needy Families (TANF) or other public assistance programs to pay part of the cost of keeping up the home, he or she cannot count them as money he or she paid. However, the taxpayer must include them in the total cost of keeping up the home to figure if he or she paid over half the cost.

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The taxpayer may be eligible to file as head of household even if the individual who qualifies him or her for this filing status is born or dies during the year. The taxpayer must have provided more than half the cost of keeping up a home that was the individual's main home for more than half the part of the year he or she was alive.

Qualifying Child for Head of Household Filing Status Five tests must be met for a child to be the taxpayer’s qualifying child. The five tests are: (88)

1. Relationship 2. Age 3. Residency 4. Support 5. Joint return

To meet the relationship test, a child must be: (88)

The taxpayer’s son, daughter, stepchild, foster child, or a descendant (for example, his or her grandchild) of any of them.

The taxpayer’s brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant (for example, his or her niece or nephew) of any of them.

An adopted child is always treated as the taxpayer’s own child. The term “adopted child” includes a child who was lawfully placed with him or her for legal adoption. A foster child is an individual who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction.

To meet the age test, a child must be: (88)

Under age 19 at the end of the year and younger than the taxpayer A student under age 24 at the end of the year and younger than the taxpayer Permanently and totally disabled at any time during the year, regardless of age.

To meet the residency test, the taxpayer’s child must have lived with him or her for more than half the year. There are exceptions for temporary absences, children who were born or died during the year, kidnapped children, and children of divorced or separated parents. For example, the taxpayer’s child is considered to have lived with him or her during periods of time when the taxpayer, the child, or both, are temporarily absent due to special circumstances such as illness, education, business, vacation or military service. To meet the support test to be a qualifying child, the child cannot have provided more than half of his or her own support for the year. To meet the joint return test, the child cannot file a joint return for the year. An exception to the joint return test applies if the taxpayer’s child and his or her spouse file a joint return only to claim a refund of income tax withheld or estimated tax paid. Qualifying Relative for Head of Household Filing Status Four tests must be met for a person to be the taxpayer’s qualifying relative. The four tests are: (88)

1. Not a qualifying child test 2. Member of household or relationship test 3. Gross income test 4. Support test

Unlike a qualifying child, a qualifying relative can be any age. There is no age test for a qualifying relative.

For the not a qualifying child test, a child is not the taxpayer’s qualifying relative if the child is his or her qualifying child or the qualifying child of any other taxpayer.

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To meet the member of household or relationship test, a person must either: (88)

Live with the taxpayer all year as a member of his or her household. Be related to the taxpayer in one of the ways listed below who does not have to live with the taxpayer.

If at any time during the year the person was the taxpayer’s spouse, that person cannot be his or her qualifying relative. A person related to the taxpayer in any of the following ways does not have to live with the taxpayer all year as a member of the household to meet the relationship test: (88)

The taxpayer’s child, stepchild, foster child, or a descendant of any of them (for example, a grandchild). (A legally adopted child is considered the taxpayer’s child.)

The taxpayer’s brother, sister, half-brother, half-sister, stepbrother, or stepsister. The taxpayer’s father, mother, grandparent, or other direct ancestor, but not foster parent. The taxpayer’s stepfather or stepmother. A son or daughter of the taxpayer’s brother or sister. A son or daughter of the taxpayer’s half-brother or half-sister. A brother or sister of the taxpayer’s father or mother. The taxpayer’s son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.

To meet the gross income test, a person's gross income for the year must be less than $4,050. To meet support test to be a qualifying relative, the taxpayer generally must provide more than half of a person's total support during the calendar year. Examples of a Qualifying Person Example 1 – Child The taxpayer’s unmarried son lived with him or her all year and was 18 years old at the end of the year. He did not provide more than half of his own support and does not meet the tests to be a qualifying child of anyone else. As a result, he is the taxpayer’s qualifying child and, because he is single, the taxpayer’s qualifying person for head of household purposes. Example 2 - Child who is not qualifying person The facts are the same as in Example 1 except the taxpayer’s son was 25 years old at the end of the year and his gross income was $5,000. Because he does not meet the age test, the taxpayer’s son is not his or her qualifying child. Also, he does not meet the gross income test so he is not a qualifying relative. As a result, he is not the taxpayer’s qualifying person for head of household purposes. Example 3 - Girlfriend The taxpayer’s girlfriend lived with him all year. Even though she may be a qualifying relative if the gross income and support tests are met, she is not a qualifying person for head of household purposes because she is not related to the taxpayer in one of the ways listed above under relatives who do not have to live with the taxpayer. Example 4 - Girlfriend's child The facts are the same as in Example 3 except the taxpayer’s girlfriend's 10-year-old son also lived with him all year. He is not a qualifying child and, because he is the taxpayer’s girlfriend's qualifying child, he is not a qualifying relative. As a result, he is not the taxpayer’s qualifying person for head of household purposes.

Special Filing Situations Nonresident and Dual Status Aliens If the taxpayer is an alien (not a U.S. citizen), he or she is considered a nonresident alien unless he or she meets one of two tests: (89)

The green card test. The substantial presence test for the calendar year (January 1-December 31).

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For tax purposes, the taxpayer is a Lawful Permanent Resident of the United States, at any time, if he or she has been given the privilege, according to the immigration laws, of residing permanently in the United States as an immigrant. He or she generally has this status if the U.S. Citizenship and Immigration Service (USCIS) issued the taxpayer an alien registration card, Form I-551, also known as a green card. The taxpayer will be considered a U.S. resident for tax purposes if he or she meets the substantial presence test for the calendar year. To meet this test, the taxpayer must be physically present in the United States on at least: (89)

1. 31 days during the current year, and 2. 183 days during the 3-year period that includes the current year and the 2 years immediately before that, counting:

a. All the days he or she was present in the current year, and b. 1/3 of the days he or she was present in the first year before the current year, and c. 1/6 of the days he or she was present in the second year before the current year.

If the individual meets the green card test at any time during the calendar year, but does not meet the substantial presence test for that year, his or her residency starting date is the first day on which he or she is present in the United States as a Lawful Permanent Resident. However, an alien who has been present in the United States at any time during a calendar year as a Lawful Permanent Resident may choose to be treated as a resident alien for the entire calendar year. The taxpayer is a dual status alien when he or she has been both a resident alien and a nonresident alien in the same tax year. Dual status does not refer to citizenship, only to resident status for tax purposes in the United States. In determining U.S. income tax liability for a dual-status tax year, different rules apply for the part of the year the taxpayer is a resident of the United States and the part of the year he or she is a nonresident. The most common dual-status tax years are the years of arrival and departure. For the part of the year the taxpayer is a resident alien, he or she is taxed on income from all sources. Income from sources outside the United States is taxable if he or she receives it while a resident alien. The income is taxable even if the taxpayer earned it while he or she was a nonresident alien or if he or she became a nonresident alien after receiving it and before the end of the year. For the part of the year the taxpayer is a nonresident alien, he or she is taxed on income from U.S. sources only. If a taxpayer is a nonresident alien, he or she may file a joint return if he or she is married to a U.S. citizen or resident at the end of the year. If the couple files a joint return, both spouses are treated as U.S. residents for the entire year and both spouses are taxed on worldwide income. Most types of U.S. source income received by a foreign taxpayer are subject to a tax rate of 30%.

A scholarship, fellowship or grant received by a nonresident alien for activities conducted outside the United States is treated as foreign source income.

If the taxpayer is a resident alien on the last day of the tax year and reports income on a calendar year basis, he or she must file no later than April 15 of the year following the close of the tax year. If the taxpayer reports his or her income on other than a calendar year basis, file the return no later than the 15th day of the 4th month following the close of the tax year. In either case, file the return with the Internal Revenue Service indicated in the Form 1040 Instructions. If the taxpayer is a nonresident alien on the last day of the tax year and reports income on a calendar year basis, he or she must file no later than April 15 of the year following the close of the tax year if he or she receives wages subject to withholding. If the taxpayer reports income on other than a calendar year basis, file the return no later than the 15th day of the 4th month following the close of the tax year. If the taxpayer did not receive wages subject to withholding and reports income on a calendar year basis, he or she must file no later than June 15 of the year following the close of the tax year. If the taxpayer reports income on other than a calendar year basis, file the return no later than the 15th day of the 6th month following the close of the tax year. In any case, file the return with the Internal Revenue Service indicated in the Form 1040NR Instructions. (90) Nonresident aliens are not subject to self-employment tax unless an international Social Security agreement in effect determines that they are covered under the U.S. Social Security system. Residents of the U.S. Virgin Islands, Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, or American Samoa are considered U.S. residents for this purpose and are subject to the self-employment tax.

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Abandoned Spouse Per IRC Section 7703(b), an individual who is married but meets the following requirements shall not be considered as married: (91)

The abandoned individual pays more than half the cost of maintaining his or her household for the taxable year. The individual files a separate tax return. The individual’s household is the principal home of a dependent child for more than six months of the tax year

and the individual is entitled to claim the dependency exemption (even if no claim is made). The individual lives in a separate residence from his or her spouse for the last six months of the tax year.

Community Property Generally, the laws of the state in which the taxpayer is domiciled govern whether he or she has community property and community income or separate property and separate income for Federal tax purposes. This information applies to married taxpayers who are domiciled in one of the following community property states:

Arizona California Idaho Louisiana Nevada New Mexico Texas Washington Wisconsin

This information does not address the Federal tax treatment of income or property subject to the “community property” election under Alaska state laws. Generally, community property is property:

That the taxpayer, his or her spouse (or his or her registered domestic partner), or both acquire during their marriage (or registered domestic partnership) while the taxpayer and his or her spouse (or his or her registered domestic partner) are domiciled in a community property state.

That the taxpayer and his or her spouse (or his or her registered domestic partner) agreed to convert from separate to community property.

That cannot be identified as separate property.

Generally, community income is income from:

Community property. Salaries, wages, and other pay received for the services performed by the taxpayer, his or her spouse (or his or

her registered domestic partner), or both during their marriage (or registered domestic partnership) while domiciled in a community property state.

Real estate that is treated as community property under the laws of the state where the property is located. For income tax purposes, community property laws apply to annuities payable under the Civil Service Retirement Act (CSRS) or Federal Employee Retirement System (FERS). Whether a civil service annuity is separate or community income depends on the taxpayer’s marital status (or his or her status as a registered domestic partner) and domicile of the employee when the services were performed for which the annuity is paid. Even if the taxpayer now lives in a noncommunity property state and he or she receives a civil service annuity, it may be community income if it is based on services he or she performed while married (or during the registered domestic partnership) and domiciled in a community property state. If a civil service annuity is a mixture of community income and separate income, it must be divided between the two kinds of income. The division is based on the employee's domicile and marital status (or registered domestic partnership) in community and noncommunity property states during his or her periods of service.

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Ordinarily, filing a joint return will give the taxpayer a greater tax advantage than filing a separate return. But in some cases, his or her combined income tax on separate returns may be less than it would be on a joint return. If the taxpayer files a separate return, he or she and his or her spouse must each report half of their combined community income and deductions in addition to their separate income and deductions. Each of the taxpayers must complete and attach Form 8958 - Allocation of Tax Amounts Between Certain Individuals in Community Property States to the Form 1040 showing how he or she figured the amount he or she is reporting on the return. On the appropriate lines of the separate Form 1040, list only the taxpayer’s share of the income and deductions on the appropriate lines of his or her separate tax returns (wages, interest, dividends, etc.). An extension of time for filing the separate return does not extend the time for filing the spouse's separate return. If the taxpayer and his or her spouse file a joint return, they cannot file separate returns after the due date for filing either separate return has passed. Relief From Community Property Married persons who live in community property states, but who did not file joint returns, may also qualify for relief from liability arising from community property law or for equitable relief. The taxpayer is not responsible for the tax on an item of community income if all five of the following conditions exist: (91)

1. The taxpayer did not file a joint return for the tax year. 2. The taxpayer did not include an item of community income in gross income on the separate return. 3. The item of community income the taxpayer did not include is one of the following:

a. Wages, salaries, and other compensation the taxpayer’s spouse (or former spouse) received for services he or she performed as an employee.

b. Income the taxpayer’s spouse (or former spouse) derived from a trade or business he or she operated as a sole proprietor.

c. The taxpayer’s spouse's (or former spouse's) distributive share of partnership income. d. Income from the taxpayer’s spouse's (or former spouse's) separate property (other than income described

in (a), (b), or (c)). Use the appropriate community property law to determine what is separate property. e. Any other income that belongs to the taxpayer’s spouse (or former spouse) under community property

law. 4. The taxpayer establishes that he or she did not know of, and had no reason to know of, that community income. 5. Under all facts and circumstances, it would not be fair to include the item of community income in the taxpayer’s

gross income. In some states a husband and wife may enter into an agreement that affects the status of property or income as community or separate property. Check state law to determine how it affects the taxpayer.

All other forms of income are taxed in accordance with normal community property laws. This includes dividend, interest, rents, royalties, capital gains, and earnings of unemancipated minor children.

Divorce and Separation State law governs whether a taxpayer is married or legally separated under a divorce or separate maintenance decree. A taxpayer is unmarried for the whole year if either of the following applies: (91)

The taxpayer has obtained a final decree of divorce or separate maintenance by the last day of the tax year. He or she must follow state law to determine if he or she is divorced or legally separated.

The taxpayer has obtained a decree of annulment, which holds that no valid marriage ever existed. He or she must file amended returns for all tax years affected by the annulment that are not closed by the statute of limitations. The statute of limitations generally does not end until 3 years (including extensions) after the date the taxpayer files the original return or within 2 years after the date he or she pays the tax.

On the amended return the taxpayer will change his or her filing status to single, or if he or she meets certain requirements, head of household.

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If the taxpayer and his or her spouse obtain a divorce in one year for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce the taxpayers intend to remarry each other and do so in the next tax year, the taxpayer and his or her spouse must file as married individuals.

If the taxpayer is divorced, he or she is jointly and individually responsible for any tax, interest, and penalties due on a joint return for a tax year ending before the divorce. This responsibility applies even if the divorce decree states that the former spouse will be responsible for any amounts due on previously filed joint returns. In some cases, a spouse may be relieved of the tax, interest, and penalties on a joint return. The taxpayer can ask for relief no matter how small the liability. There are three types of relief available: (91)

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

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

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

A taxpayer must request innocent spouse relief or separation of liability relief no later than 2 years after the date the IRS first attempted to collect the tax from him or her. For equitable relief, the taxpayer must request relief during the time the IRS has to collect the tax from him or her. If the taxpayer is looking for a refund of tax he or

she paid, then the request must be made within the time period for seeking a refund, which is generally three years after the date the return is filed or two years following the payment of the tax, whichever is later. The taxpayer must meet all of the following conditions to qualify for innocent spouse relief: (92)

1. The taxpayer filed a joint return that has an understatement of tax (deficiency) that is solely attributable to his or her spouse's erroneous item. An erroneous item includes income received by his or her spouse but which was omitted from the joint return. Deductions, credits, and property basis are also erroneous items if they are incorrectly reported on the joint return.

2. The taxpayer establishes that at the time he or she signed the joint return he or she did not know, and had no reason to know, that there was an understatement of tax.

3. Taking into account all the facts and circumstances, it would be unfair to hold the taxpayer liable for the understatement of tax.

To qualify for separation of liability relief the taxpayer must have filed a joint return and must meet one of the following requirements at the time he or she requests relief: (92)

The taxpayer is divorced or legally separated from the spouse with whom he or she filed the joint return. The taxpayer is widowed. The taxpayer has not been a member of the same household as the spouse with whom he or she filed the joint

return at any time during the 12-month period ending on the date he or she files Form 8857 - Request for Innocent Spouse Relief.

The separation of liability relief does not apply to any part of the understated tax due to the taxpayer’s spouse's (or former spouse's) erroneous items of which he or she had actual knowledge. The taxpayer and his or her spouse (or former spouse) remain jointly and severally liable for this part of the understated tax. If the taxpayer had actual knowledge of only a portion of an erroneous item, the IRS will not grant relief for that portion of the item. A taxpayer had actual knowledge of an erroneous item if:

He or she knew that an item of unreported income was received. (This rule applies whether or not there was a receipt of cash.)

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He or she knew of the facts that made an incorrect deduction or credit unallowable. For a false or inflated deduction, he or she knew that the expense was not incurred, or not incurred to the extent

shown on the tax return. Knowledge of the source of an erroneous item is not sufficient to establish actual knowledge. Also, the taxpayer’s actual knowledge may not be inferred when he or she merely had a reason to know of the erroneous item. Similarly, the IRS does not have to establish that the taxpayer knew of the source of an erroneous item in order to establish that he or she had actual knowledge of the item itself. The taxpayer’s actual knowledge of the proper tax treatment of an erroneous item is not relevant for purposes of demonstrating that he or she had actual knowledge of that item. Neither is the taxpayer’s actual knowledge of how the erroneous item was treated on the tax return. For example, if the taxpayer knew that his or her spouse received dividend income, relief is not available for that income even if he or she did not know it was taxable.

To qualify for equitable relief the taxpayer must establish that, under all the facts and circumstances, it would be unfair to hold him or her liable for the understatement or underpayment of tax. In addition, the taxpayer must meet other requirements listed in Publication 971 - Innocent Spouse Relief.

Decedent Issues The personal representative must file the final income tax return (Form 1040) of the decedent for the year of death and any returns not filed for preceding years. A surviving spouse, under certain circumstances, may have to file the returns for the decedent. The final income tax return is due at the same time the decedent's return would have been due had death not occurred. A final return for a decedent who was a calendar year taxpayer is generally due on April 15 following the year of death, regardless of when during that year death occurred. However, when the due date falls on a Saturday, Sunday, or legal holiday, the return is filed timely if filed by the next business day. If the taxpayer’s spouse died during the year, he or she is considered married for the whole year for filing status purposes. If the taxpayer did not remarry before the end of the tax year, he or she can file a joint return for him or herself and his or her deceased spouse. For the next 2 years, the taxpayer may be entitled to the special qualifying widow(er) with dependent child benefits. The Qualifying Widow(er) With Dependent Child benefits filing status entitles the taxpayer to use joint return tax rates and the highest standard deduction amount (if he or she does not itemize deductions). It does not entitle the taxpayer to file a joint return. If the taxpayer files as qualifying widow(er) with dependent child, he or she can use either Form 1040A or Form 1040. Indicate filing status by checking the box on line 5 of either form. Use the Married filing jointly column of the Tax Table or Section B of the Tax Computation Worksheet to figure the tax. As previously noted, a taxpayer is eligible to file the 2017 return as a qualifying widow(er) with dependent child if he or she meets all of the following tests: (93)

The taxpayer was entitled to file a joint return with his or her spouse for the year his or her spouse died. It does not matter whether the taxpayer actually filed a joint return.

The taxpayer’s spouse died in 2015 or 2016 and the taxpayer did not remarry before the end of 2017. The taxpayer has a child or stepchild for whom he or she can claim an exemption. This does not include a foster

child. This child lived in the taxpayer’s home all year, except for temporary absences. The taxpayer paid more than half the cost of keeping up a home for the year.

After the due date of the return, the taxpayer and his or her spouse cannot file separate returns if they previously filed a joint return. However, a personal representative for a decedent can change from a joint return elected by the surviving spouse to a separate return for the decedent. The personal representative has one year from the due date (including extensions) of the joint return to make the change. (91) A taxpayer may be eligible to file as head of household if the individual who qualifies him or her for this filing status is born or dies during the year. The taxpayer must have provided more than half of the cost of keeping up a home that was the individual's main home for more than half of the year, or, if less, the period during which the individual lived. (91)

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Common Law Marriage A common law marriage is a legally recognized marriage that can arise in some jurisdictions without a license or ceremony. Many states recognize a common law marriage when two people capable of getting married live together as spouses and hold themselves out as such for a specified amount of time. Common law marriages can be contracted in nine states (Alabama, Colorado, Iowa, Kansas, Montana, Rhode Island, South Carolina, Texas, and Utah) and the District of Columbia. New Hampshire recognizes common law marriage for purposes of probate only, and Utah recognizes common law marriages only if they have been validated by a court or administrative order. For Federal tax purposes, a taxpayer and his or her spouse are considered married for the whole year if on the last day of the tax year they are living together in a common law marriage recognized in the state where they now live or in the state where the common law marriage began. Same-Sex Married Couples Obergefell v. Hodges is a landmark United States Supreme Court case in which the Court held in a 5–4 decision that the fundamental right to marry is guaranteed to same-sex couples by both the Due Process Clause and the Equal Protection Clause of the Fourteenth Amendment to the United States Constitution. Decided on June 26, 2015, Obergefell requires all states to issue marriage licenses to same-sex couples and to recognize same-sex marriages validly performed in other jurisdictions. This legalized same-sex marriage throughout the United States, its possessions and territories. The Supreme Court found that states have used marital status as the basis for other government rights, benefits and responsibilities including tax and inheritance and property rights. Tax, of course, was the driving factor in one of two same sex marriage cases United States v. Windsor and Hollingsworth v. Perry, decided at the Supreme Court just two years ago. The Obergefell case does not change the analysis in Windsor. The case does advance the analysis by clarifying that states may not have differing standards of marriage by gender. In other words, individual states may not ban same sex marriages and they may not fail to recognize same sex marriages in other states. That makes a huge difference for same sex couples at tax time. Under the ruling, same-sex couples will be treated as married for all Federal tax purposes, including income and gift and estate taxes. The ruling applies to all Federal tax provisions where marriage is a factor, including filing status, claiming personal and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA and claiming the earned income tax credit or child tax credit. Any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country will be covered by the ruling. However, the ruling does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law. (94) For tax year 2013 and going forward, same-sex spouses generally must file using a married filing separately or jointly filing status. For tax year 2012 and all prior years, same-sex spouses who filed an original tax return on or after September 16, 2013 (the effective date of Revenue Ruling 2013-17), generally must have filed using a married filing separately or jointly filing status. For tax year 2012, same-sex spouses who filed their tax return before September 16, 2013, may have chosen (but are not required) to amend their Federal tax returns to file using married filing separately or jointly filing status. (94) Combat Zone Service The time for taking care of certain tax matters can be postponed. These postponements are referred to as extensions of deadlines. The deadline for IRS to take certain actions, such as collection and examination actions, may also be extended. The deadline for filing tax returns, paying taxes, filing claims for refund, and taking other actions with the IRS is automatically extended if either of the following statements is true: (95)

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

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

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The deadline for taking actions with the IRS is extended for 180 days after the later of: (95)

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

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

In addition to the 180 days, the deadline is extended by the number of days that were left for the taxpayer to take the action with the IRS when he or she entered a combat zone (or began performing qualifying service outside the combat zone) or began serving in a contingency operation. If the person entered the combat zone or began serving in the contingency operation before the period of time to take the action began, the deadline is extended by the entire period of time he or she has to take the action. For example, the individual had 3½ months (January 1 - April 15, 2018) to file his or her 2017 tax return. Any days of this 3½ month period that were left when he or she entered the combat zone (or the entire 3½ months if he or she entered the combat zone by January 1, 2018) are added to the 180 days when determining the last day allowed for filing the 2017 tax return. (95) Taxation of Nonresident Aliens An alien is any individual who is not a U.S. citizen or U.S. national. A nonresident alien is an alien who has not passed the green card test or the substantial presence test. Any of these individuals must file a return: (96)

1. A nonresident alien individual engaged or considered to be engaged in a trade or business in the United States during the year. The taxpayer must file even if:

a. The taxpayer’s income did not come from a trade or business conducted in the United States. b. The taxpayer has no income from U.S. sources. c. The taxpayer’s income is exempt from income tax.

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

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

individual may be required to file an income tax return for that individual and pay the tax (Refer to Treas. Reg. 1.6012-3(b)).

If the taxpayer was a nonresident alien student, teacher, or trainee who was temporarily present in the United States on an F, J, M, or Q visa, he or she is considered engaged in a trade or business in the United States. The individual must file Form 1040NR (or Form 1040NR-EZ) only if he or she has income that is subject to tax, such as wages, tips, scholarship and fellowship grants, dividends, etc. Also, if the taxpayer’s only U.S. source income is wages in an amount less than the personal exemption amount, he or she is not required to file.

A nonresident alien must also file an income tax return if he or she wants to: (96)

Claim a refund of overwithheld or overpaid tax. Claim the benefit of any deductions or credits. For example, if the individual has no U.S. business activities but

has income from real property that he or she chooses to treat as effectively connected income, the individual must timely file a true and accurate return to take any allowable deductions against that income.

A nonresident alien's income that is subject to U.S. income tax must generally be divided into two categories: (96)

Income that is Effectively Connected with a trade or business in the United States. U.S. source income that is Fixed, Determinable, Annual, or Periodical (FDAP).

Effectively Connected Income, after allowable deductions, is taxed at graduated rates. These are the same rates that apply to U.S. citizens and residents. FDAP income generally consists of passive investment income; however, in theory, it could consist of almost any sort of income. FDAP income is taxed at a flat 30% (or lower treaty rate) and no deductions

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are allowed against such income. Effectively Connected Income should be reported on page one of Form 1040NR. FDAP income should be reported on page four of Form 1040NR. Nonresident aliens who are required to file an income tax return must use Form 1040NR or Form 1040NR-EZ (if qualified). If the individual is an employee or self-employed person and received wages or non-employee compensation subject to U.S. income tax withholding, or he or she has an office or place of business in the United States, the individual must generally file by the 15th day of the 4th month after the tax year ends. For a person filing using a calendar year this is generally April 15. If the taxpayer is not an employee or self-employed person who receives wages or non-employee compensation subject to U.S. income tax withholding, or if he or she does not have an office or place of business in the United States, the individual must file by the 15th day of the 6th month after the tax year ends. For a person filing using a calendar year this is generally June 15. If the taxpayer cannot file the return by the due date, he or she should file Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return to request an automatic extension of time to file. The individual should file Form 4868 by the regular due date of the return. To get the benefit of any allowable deductions or credits, the taxpayer must timely file a true and accurate income tax return. For this purpose, a return is timely if it is filed within 16 months of the due date discussed. The Internal Revenue Service has the right to deny deductions and credits on tax returns filed more than 16 months after the due dates of the returns. Before leaving the United States, all aliens (with certain exceptions) must obtain a certificate of compliance. This document, also popularly known as the sailing permit or departure permit, must be secured from the IRS before leaving the U.S. The individual will receive a sailing or departure permit after filing a Form 1040-C or Form 2063 - U.S. Departing Alien Income Tax Statement. Even if the person has left the United States and filed a Form 1040-C - U.S. Departing Alien Income Tax Return, on departure, he or she still must file an annual U.S. income tax return. If the taxpayer is married and both him or her and his or her spouse are required to file, the individual must each file a separate return, unless one of the spouses is a U.S. citizen or a resident alien, in which case the departing alien could file a joint return with his or her spouse.

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

Review Questions Answers appear in Review Feedback 1. A nonresident alien received a $40,000 scholarship from a U.S. corporation to go to a gymnastic camp in the individual’s

resident country, which has a 10% flat tax. How much U.S. tax must be paid on the scholarship? A. $0 B. $4,000 C. $8,000 D. $12,000

2. Which of the following is a requirement that must be met in determining whether a taxpayer is eligible for head of

household filing status purposes? A. An individual’s spouse must not have lived in their home for the entire tax year B. The individual must be divorced or legally separated for over one year C. An individual must pay less than one-half the cost of keeping up a home for the tax year D. An individual’s home must be, for at least 6 months, the main home of his or her child, stepchild, or adopted

child whom he or she can properly claim as a dependent 3. Mr. Jones, a calendar-year taxpayer, died January 15 of Year 2. His widow, Mrs. Jones, who has a five-year-old

daughter, remarried December 15 of Year 2. Which year is the last year for which a joint return may be filed by or for Mr. and Mrs. Jones?

A. Year 1 B. Year 2 C. Year 3 D. Year 4

4. The IRS has clearly stated that per IRC Section 7703(b), a spouse is considered abandoned when which of the following

conditions have been met? A. The abandoned individual pays more than half the cost of maintaining his or her household for the taxable

year B. The individual files a separate tax return C. The individual’s household is the principal home of a dependent child for more than six months of the tax year

and the individual is entitled to claim the dependency exemption (even if no claim is made) D. All of the above

5. Tanya is single and lives in an apartment for which she pays all the expenses. An unrelated 6-year-old child has been

living with her since May. She is raising the child as her own and receives no financial assistance. The child was not placed by an authorized adoption agency but Tanya has filed for adoption although it is not yet final. She has no other dependents. Which of the following statements is correct?

A. Tanya can file as head of household B. Tanya can claim a credit for qualified adoption expenses in the current year, even if the adoption is not final C. Tanya can claim the child as her dependent on her return D. None of the above

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6. If a taxpayer is filing as a sole proprietor, he or she generally will have to make estimated tax payments if he or she expects to owe tax of what amount or more when filing the return?

A. $1,000 B. $2,000 C. $3,000 D. $4,000

7. To get the benefit of any allowable deductions or credits, a nonresident alien must timely file a true and accurate income

tax return. For this purpose, a return is timely if it is filed within how many months of the specified due date? A. 3 months B. 6 months C. 12 months D. 16 months

8. A court order retroactively corrected a mathematical error under a taxpayer’s divorce decree to express the original

intent to spread the payments over more than 10 years. Which of the following is true regarding this change for Federal tax purposes?

A. This change is not effective for Federal tax purposes B. This change is effective retroactively for Federal tax purposes C. This change is only effective for the current tax year for Federal tax purposes D. This change is only effective for future tax years for Federal tax purposes

Lesson 3 - Taxable Income, Filing Status

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Review Feedback Return to Review Questions Question 1 - A. $0 A scholarship, fellowship, grant, etc. received by a nonresident alien for activities conducted outside of the U.S. is treated as foreign source income. Because the scholarship will not be treated as U.S. source income, there is no U.S. tax. Question 2 - D. An individual’s home must be, for at least 6 months, the main home of his child, stepchild, or adopted child whom he or she can properly claim as a dependent. The taxpayer may be able to file as head of household if he or she is unmarried or considered unmarried on the last day of the year, paid more than half the cost of keeping up a home for the year and a qualifying person lived with him or her in the home for more than half the year (except for temporary absences, such as school). Question 3 - A. Year 1 The determination of whether an individual is married is made as of the close of the taxable year, except that, if his or her spouse dies during the taxable year, such determination is made as of the time of the death. Since the decedent was married at the time of his death, he is considered married for purposes of filing status. A decedent (through a personal representative) and a surviving spouse may file a joint return unless the surviving spouse remarries before year end. Since Mrs. Jones remarried prior to the end of Year 2, they may not file a joint return for Year 2. The last year they could file a joint return was Year 1. Question 4 - D. All of the above Per IRC Section 7703(b), an individual who is married but meets the following requirements shall not be considered as married:

• The abandoned individual pays more than half the cost of maintaining his or her household for the taxable year. • The individual files a separate tax return. • The individual’s household is the principal home of a dependent child for more than six months of the tax year

and the individual is entitled to claim the dependency exemption (even if no claim is made). • The individual lives in a separate residence from his or her spouse for the last six months of the tax year.

Question 5 - D. None of the above A dependent must be a qualifying child or a qualifying relative. The child is not a qualifying child, as the adoption is not final. The child did not live with Tanya the entire year, and therefore is also not a qualifying relative. Tanya cannot file as head of household without a dependent. For expenses paid prior to the year the adoption becomes final, the credit generally is allowed for the year following the year of payment. A taxpayer who paid qualifying expenses in the current year for an adoption which became final in the current year, may be eligible to claim the credit for the expenses on the current year return, in addition to credit for expenses paid in a prior year. Question 6 - A. $1,000 Estimated tax liability exists when individuals will owe at least $1,000 in tax, after subtracting withholding and credits and withholding and credits will be less than the smaller of:

• 90% of the tax to be shown on this year's tax return. • 100% of the tax shown on last year's return (110% if AGI over $150,000).

If the taxpayer is filing as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual, he or she generally will have to make estimated tax payments if he or she expects to owe tax of $1,000 or more when filing the return. If the taxpayer is filing as a corporation, he or she generally has to make estimated tax payments for the corporation if he or she expects it to owe tax of $500 or more when filing its return. Question 7 - D. 16 months To get the benefit of any allowable deductions or credits, a nonresident alien must timely file a true and accurate income tax return. For this purpose, a return is timely if it is filed within 16 months of the specified due date. The Internal Revenue Service has the right to deny deductions and credits on tax returns filed more than 16 months after the due dates of the returns.

Lesson 3 - Taxable Income, Filing Status

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Question 8 - B. This change is effective retroactively for Federal tax purposes An amendment to a divorce decree may change the nature of the taxpayer’s payments. Amendments are not ordinarily retroactive for Federal tax purposes. However, a retroactive amendment to a divorce decree correcting a clerical error to reflect the original intent of the court will generally be effective retroactively for Federal tax purposes.

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Standard Deduction, Personal Exemptions At the conclusion of this lesson you should have a basic knowledge of:

The Standard Deduction The Personal Exemption

The Standard Deduction The standard deduction is based upon the principle that every taxpayer should be allowed some deduction for personal living expenses in addition to personal exemptions. This deduction will be allowed even if the taxpayer cannot prove that he or she spent the amount involved. In passing this part of the tax law, Congress was well aware that many taxpayers do not keep complete records of their expenditures. Without such a provision, these taxpayers might, unjustly, not be allowed to take any deduction at all. The standard deduction is more than just an escape hatch for those who are unable to itemize for want of proof; it also serves as a minimum deduction for all taxpayers. The law provides that this minimum deduction will be adjusted annually to prevent inflation-caused tax increases. See Publication 17 - Chapter 20 - Standard Deduction for details. If the taxpayer(s) check any of the boxes on Line 39a, Form 1040, they MUST use the standard deduction chart for people age 65 or older (unless Schedule A, Itemized Deductions is used) to determine their correct standard deduction amount. If 39b is checked, the taxpayer may not be able to use a standard deduction. There is also a standard deduction for dependents. If neither of the boxes of 39a or 39b are checked, then the standard deduction amount shown below which applies to the filing status of the taxpayer(s) is selected from the options on Line 40 of Form 1040 and entered on Line 40.

Standard Deduction Amounts

2015 2016 2017

Single $6,300 $6,300 $6,350

Married Filing Jointly $12,600 $12,600 $12,700

Married Filing Separately $6,300 $6,300 $6,350

Head of Household $9,250 $9,300 $9,350

Qualifying Widow(er) $12,600 $12,600 $12,700

Table 4-1 - Publication 501 - Table 6 – Standard Deduction Chart for Most People (2017)

Elderly and/or Blind Taxpayers The standard deduction chart for people age 65 or older (shown below) lists the additional standard deduction for taxpayers who are age 65 or older and/or blind at the end of the tax year. The standard deduction is calculated by adding the person's standard deduction (based on their filing status), plus the additional amount. Additional standard deduction amounts for 2017 are $1,550 for single or head of household or $1,250 for married filing jointly, married filing separately, or qualifying widow. For example, if the taxpayer is married, filing a joint return and both he and his wife are 68 years of age, what would their standard deduction amount come to for 2017? The taxpayer would check off the box for him as being 65 or older, as well as the same box for his spouse. Two boxes are checked, and looking at the married filing joint return section, we see that their available standard deduction would be $15,200.

Lesson 4 - Standard Deduction, Personal Exemptions

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If one was also blind, the standard deduction for 2017 would be $16,450 having three boxes checked. Partial blindness qualifies, with a certified statement from an eye doctor (ophthalmologist or optometrist) attesting that the vision in the taxpayer’s better eye is 20/200 or worse after being corrected with glasses or contact lenses or that the taxpayer’s field of vision is not more than 20 degrees. If the taxpayer’s eye condition is not likely to improve beyond these limits, the statement should include this fact. The taxpayer should keep the statement with his or her records. If the taxpayer is blind on the last day of the year, he or she is entitled to the higher standard deduction.

Standard Deduction Chart for People Age 65 or Older or Blind

Filing Status Number from the box on Line 39a of 1040 Standard Deduction for 2017

Single 1 2

$7,900 $9,450

Married filing jointly or qualifying widow(er)

1 2 3 4

$13,950 $15,200 $16,450 $17,700

Married filing separately*

1 2 3 4

$7,600 $8,850 $10,100 $11,350

Head of household 1 2

$10,900 $12,450

Caution: Do not use the number of exemptions from Line 6d

*The taxpayer can only have a value of 3 or 4 for the total in the box of Line 39a of Form 1040 if he or she is claiming an exemption for his or her spouse when using the Married Filing Separately status.

Table 4-2 - Publication 501 - Table 7 - Standard Deduction Chart for People who are 65 or Older or Who are Blind, (2017)

Example 1 Larry, 46, and Carolyn, 33, are filing a joint return for 2017. Neither is blind, and neither can be claimed as a dependent. They decide not to itemize their deductions. Their standard deduction is $12,700. Example 2 Scott and Mary Jane are filing a joint return for 2017. Both are over age 65. Neither is blind, and neither can be claimed as a dependent. If they do not itemize deductions their standard deduction is $15,200.

If the taxpayer’s spouse died in 2017 before reaching age 65, he or she cannot take a higher standard deduction because of his or her spouse. Even if his or her spouse was born before January 2, 1953, he or she is not considered 65 or older at the end of 2017 unless he or she was 65 or older at the time of death. A person is considered to reach age 65 on the day before his or her 65th birthday.

Special Rules on the Standard Deduction Taxpayers Not Eligible for the Standard Deduction A taxpayer’s standard deduction is zero and the taxpayer should itemize his or her deductions if:

The taxpayer is married and filed a separate return and the taxpayer’s spouse itemized his or her deductions when filing. This rule prevents shifting of itemized deductions between spouses in a way which will reduce the tax burden.

The taxpayer files a tax return for a short tax year due to a change in the taxpayer’s annual accounting period. The taxpayer is a non-resident or a dual-status alien during the tax year. But, if the non-resident alien is married

to a U.S. citizen or is a resident at the end of the tax year, such a taxpayer can choose to be treated as a U.S. resident and, as such, would be eligible to take the standard deduction.

Lesson 4 - Standard Deduction, Personal Exemptions

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Dependents of Other Taxpayers A special rule applies to an individual for whom a dependency exemption is allowable to another taxpayer. The 2017 standard deduction for an individual who can be claimed as a dependent on another person's tax return is generally limited to the greater of: (97)

$1,050, or The individual's earned income for the year plus $350 (but not more than the regular standard deduction amount,

generally $6,350 in 2017). If the taxpayer (or his or her spouse if filing jointly) can be claimed as a dependent on someone else's return, use Table 8 (see below) to determine the standard deduction. Earned income is salaries, wages, tips, professional fees, and other amounts received as pay for work the taxpayer actually perform. For purposes of the standard deduction, earned income also includes any part of a scholarship or fellowship grant that he or she must include in gross income.

Standard Deduction Worksheet for Dependents Check the correct number of boxes below. Then go to the worksheet.

Taxpayer: Born before January 2, 1953 □

Blind □

Taxpayer’s spouse, if claiming spouse's exemption: Born before January 2, 1953 □

Blind □

Total number of boxes checked 1. Enter earned income. If none, enter -0-. 1.

2. Additional amount. 2. $350

3. Add lines 1 and 2. 3. 4. Minimum standard deduction. 4. $1,050

5. Enter the larger of line 3 or line 4. 5.

6. Enter the amount shown below for the filing status.

Single or Married filing separately—$6,350 Married filing jointly—$12,700 Head of household—$9,350

6.

7. Standard deduction. a. Enter the smaller of line 5 or line 6. If

born after January 1, 1953, and not blind, stop here. This is the standard deduction. Otherwise, go on to line 7b.

7a.

b. If born before January 2, 1953, or blind, multiply $1,550 ($1,250 if married filing jointly, married filing separately, or qualifying widow (er)) by the number in the box above.

7b.

c. Add lines 7a and 7b. This is the standard deduction for 2017.

7c.

Earned income includes wages, salaries, tips, professional fees, and other compensation received for personal services performed. It also includes any amount received as a scholarship that must be included in income.

Table 4-3 - Publication 501 - Table 8 - Standard Deduction Worksheet for Dependents (2017)

Lesson 4 - Standard Deduction, Personal Exemptions

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Example 1 Joe, a 22-year-old full-time college student, can be claimed as a dependent on his parents' 2017 tax return. Joe is married and files a separate return. His wife does not itemize deductions on her separate return. Joe has $1,500 in interest income and wages of $3,800. He has no itemized deductions. Joe determines his standard deduction is $6,350. He enters his earned income, $3,800, on line 1. He adds lines 1 and 2 and enters $4,150 on line 3. On line 5, he enters $4,150, the larger of lines 3 and 4. Because Joe is married filing a separate return, he enters $6,350 on line 6. On line 7a he enters $4,150 as his standard deduction because it is smaller than $6,350, the amount on line 6. Example 2 Amy, who is single, can be claimed as a dependent on her parents' 2017 tax return. She is 18 years old and blind. She has interest income of $1,300 and wages of $2,900. She has no itemized deductions. Amy uses Table 8 to find her standard deduction. She enters her wages of $2,900 on line 1. She adds lines 1 and 2 and enters $3,250 on line 3. On line 5, she enters $3,250, the larger of lines 3 and 4. Because she is single, Amy enters $6,350 on line 6. She enters $3,250 on line 7a. This is the smaller of the amounts on lines 5 and 6. Because she checked one box in the top part of the worksheet, she enters $1,550 on line 7b. She then adds the amounts on lines 7a and 7b and enters her standard deduction of $4,800 on line 7c. Example 3 Ed is single. His parents can claim an exemption for him on their 2017 tax return. He has wages of $7,000, interest income of $500, and a business loss of $3,000. He has no itemized deductions. Ed uses Table 8 to figure his standard deduction. He enters $4,000 ($7,000 - $3,000) on line 1. He adds lines 1 and 2 and enters $4,350 on line 3. On line 5, he enters $4,350, the larger of lines 3 and 4. Because he is single, Ed enters $6,350 on line 6. On line 7a he enters $4,350 as his standard deduction because it is smaller than $6,350, the amount on line 6.

Personal Exemptions The last subtraction from income to be considered is the deduction for personal exemptions. Throughout the history of the income tax, Congress has recognized that some minimal amount is needed by everyone for the basic necessities, and has excluded this amount from taxation. The basic amount for tax year 2017 is $4,050 per person. Thus in tax year 2017, the first $4,050 earned by an unmarried individual who has not reached sixty-five years of age and who has no obligations to others dependent on him or her is not subject to the tax. No exemption is allowed when the taxpayer is a dependent of another taxpayer. See Publication 17 - Chapter 3 - Personal Exemptions and Dependents for additional information. Amount of Deduction The total deduction for tax year 2017 for personal exemptions is the sum of the following: (98)

$4,050 for the taxpayer. Every individual is entitled to an exemption for himself, and therefore a $4,050 deduction, unless a dependent of another.

$4,050 for the taxpayer's spouse (husband or wife) if a joint return is filed. A taxpayer may get a deduction for his (or her) spouse on a separate return if the spouse has no income and is not claimed as the dependent of another. A joint return is one in which the husband and wife combine their income and deductions.

$4,050 for each dependent. For 2017, the personal exemption phases out for taxpayers with the following adjusted gross income (AGI) amounts:

2017 Personal Exemption Phase-out Amounts Filing Status Beginning Phase-out AGI Completed Phase-out AGI

Married Filing Jointly, Surviving Spouses $313,800 $436,300

Head of Household $287,650 $410,150 Single (other than Surviving Spouses and Heads of Households $261,500 $384,000

Married Filing Separately $156,900 $218,150

Table 4-4 - Some Tax Benefits Increase Slightly Due to Inflation Adjustments, Others Are Unchanged (2017)

Lesson 4 - Standard Deduction, Personal Exemptions

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The taxpayer must reduce the dollar amount of his or her exemptions by 2% for each $2,500, or part of $2,500 ($1,250 if he or she is married filing separately), that his or her AGI exceeds the amount shown above for his or her filing status. If the taxpayer's AGI exceeds the amount shown above by more than $122,500 ($61,250 if married filing separately), the amount of his or her deduction for exemptions is reduced to zero. Spouse's Exemption The taxpayer’s spouse is never considered his or her dependent. On a joint return, the taxpayer can claim one exemption for him or herself and one for his or her spouse. If the taxpayer files a separate return, he or she can claim an exemption for his or her spouse only if his or her spouse had no gross income, is not filing a return, and was not the dependent of another taxpayer. This is true even if the other taxpayer does not actually claim his or her spouse as a dependent. The taxpayer can claim an exemption for his or her spouse even if he or she is a nonresident alien; in that case, his or her spouse must have no gross income for U.S. tax purposes and satisfy the other conditions listed previously. If the taxpayer qualifies for head of household filing status because he or she is considered unmarried, the taxpayer can claim an exemption for his or her spouse if the conditions described in the preceding paragraph are satisfied. If the taxpayer obtained a final decree of divorce or separate maintenance during the year, he or she cannot take his or her former spouse's exemption. This rule applies even if the taxpayer provided all of his or her former spouse's support. Rules for Claiming an Exemption for a Dependent There is no maximum limit on the deduction for dependency exemptions. A taxpayer with any number of dependents is entitled to a $4,050 exemption for each one in tax year 2017. The term dependent, like most other words used in the law, has a specific meaning established by statute. As of the tax year 2005, new definitions for a qualifying child and qualifying relative and tie-breaking rules are applicable for claiming an individual as a dependent. For years beginning after December 31, 2008, the definition of qualifying child is modified to include a new age test and a joint return test. (98)

A taxpayer cannot claim any dependents if he or she, or his or her spouse if filing jointly, could be claimed as a dependent by another taxpayer.

A taxpayer cannot claim a married person who files a joint return as a dependent unless that joint return is filed only to claim a refund of withheld income tax or estimated tax paid.

A taxpayer cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident alien, U.S. national, or a resident of Canada or Mexico (There is an exception for certain adopted children).

A taxpayer cannot claim a person as a dependent unless that person is a qualifying child or qualifying relative.

Tests to Be a Qualifying Child 1. The child must be the taxpayer’s son, daughter, stepchild, foster child, brother, sister, half-brother, half-sister,

stepbrother, stepsister, or a descendant of any of them. 2. The child must be:

a. Under age 19 at the end of the year and younger than the taxpayer (or his or her spouse, if filing jointly) b. Under age 24 at the end of the year, a full-time student, and younger than the taxpayer (or his or her

spouse, if filing jointly) c. Any age if permanently and totally disabled.

3. The child must have lived with the taxpayer for more than half of the year (there are exceptions for temporary absences, children who were born or died during the year, children of divorced or separated parents (or parents who live apart), and kidnapped children).

4. The child must not have provided more than half of his or her own support for the year. 5. The child is not filing a joint return for the year (unless that return is filed only to get a refund of income tax withheld

or estimated tax paid).

A taxpayer must provide over one-half of the support for a person to be considered a dependent. The term support includes food, shelter, clothing, medical and dental care, education, and other items contributing to the individual’s maintenance and livelihood. Although medical care is an item of support, medical insurance benefits

are not included. Medical insurance premiums are included. See Publication 501 - Exemptions, Standard Deduction and Filing Information for complete details.

Lesson 4 - Standard Deduction, Personal Exemptions

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Example 1 - Age Test The taxpayer’s son turned 19 on December 10. Unless he was permanently and totally disabled or a full-time student, he does not meet the age test because, at the end of the year, he was not under age 19. Example 2 - Child not younger than the taxpayer or his or her spouse The taxpayer’s 23-year-old brother, who is a student and unmarried, lives with the taxpayer and his or her spouse. He is not disabled. Both the taxpayer and his or her spouse are 21 years old, and file a joint return. The taxpayer’s brother is not a qualifying child because he is not younger than the taxpayer or his or her spouse. Example 3 - Child younger than the taxpayer’s spouse but not younger than the taxpayer The facts are the same as in Example 2 except the taxpayer’s spouse is 25 years old. Because the taxpayer’s brother is younger than the taxpayer’s spouse and they are filing a joint return, the taxpayer’s brother is a qualifying child, even though he is not younger than the taxpayer. To qualify as a student, the taxpayer’s child must be, during some part of each of any 5 calendar months of the year: (86)

A full-time student at a school that has a regular teaching staff, course of study, and a regularly enrolled student body at the school.

A student taking a full-time, on-farm training course given by a school, or by a state, county, or local government agency.

The 5 calendar months do not have to be consecutive. Support Test Example Adam provided $4,000 toward his 16-year-old son's support for the year. His son has a part-time job and provided $6,000 to his own support. Adam’s son provided more than half of his own support for the year. He is not Adam’s qualifying child. Tests to Be a Qualifying Relative Four tests must be met for a person to be a qualifying relative.

1. The person cannot be a qualifying child or the qualifying child of any other taxpayer. 2. The person either:

a. Be related to taxpayer in one of the ways listed: i. Taxpayer’s child, stepchild, foster child, or a descendant of any of them (for example, a

grandchild). (A legally adopted child is considered the taxpayer’s child.) ii. Taxpayer’s brother, sister, half-brother, half-sister, stepbrother, or stepsister. iii. Taxpayer’s father, mother, grandparent, or other direct ancestor, but not foster parent. iv. Taxpayer’s stepfather or stepmother. v. A son or daughter of taxpayer’s brother or sister. vi. A son or daughter of taxpayer’s half-brother or half-sister. vii. A brother or sister of taxpayer’s father or mother. viii. Taxpayer’s son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-

law. b. Must live with the taxpayer all year as a member of the household (and the taxpayer’s relationship must

not violate local law). 3. The person's gross income for the year must be less than $4,050 (Tax-exempt income, such as certain Social

Security benefits, is not included in gross income). 4. The taxpayer must provide more than half of the person's total support for the year.

Unlike a qualifying child, a qualifying relative can be any age. There is no age test for a qualifying relative. Also, a child is not a qualifying relative if the child is a qualifying child or the qualifying child of any other taxpayer. Additionally, a cousin meets this test only if he or she lives with the taxpayer all year as a member of his or her household. A cousin is a descendant of a brother or sister of the taxpayer’s father or mother.

If the taxpayer files a joint return, the person can be related to either him or her or his or her spouse. Also, the person does not need to be related to the spouse who provides support. For example, the taxpayer’s spouse's uncle who receives more than half of his support from the taxpayer may be a qualifying relative, even though he does not live with the taxpayer. However, if the taxpayer and his or her spouse file separate returns, the spouse's uncle can be a qualifying relative only if he lives with the taxpayer all year as a member of his or her household.

Lesson 4 - Standard Deduction, Personal Exemptions

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Gross income is all income in the form of money, property, and services that is not exempt from tax. In a manufacturing, merchandising, or mining business, gross income is the total net sales minus the cost of goods sold, plus any miscellaneous income from the business. Gross receipts from rental property are gross income. Do not deduct taxes, repairs, etc., to determine the gross income from rental property. Gross income also includes a partner's share of the gross (not a share of the net) partnership income. Gross income also includes all taxable unemployment compensation and certain scholarship and fellowship grants. Scholarships received by degree candidates and used for tuition, fees, supplies, books, and equipment required for particular courses generally are not included in gross income. Example 1 The taxpayer’s 22-year-old daughter, who is a student, lives with the taxpayer and meets all the tests to be a qualifying child. She is not a qualifying relative. Example 2 The taxpayer’s 2-year-old son lives with the taxpayer’s parents and meets all the tests to be their qualifying child. He is not the taxpayer’s qualifying relative. Example 3 The taxpayer’s son lives with the taxpayer but is not the taxpayer’s qualifying child because he is 30 years old and does not meet the age test. He may be a qualifying relative if the gross income test and the support test are met. Example 4 The taxpayer’s 13-year-old grandson lived with his mother for 3 months, with his uncle for 4 months, and with the taxpayer for 5 months during the year. He is not the taxpayer’s qualifying child because he does not meet the residency test. He may be a qualifying relative if the gross income test and the support test are met. Citizen or Resident Test A taxpayer generally cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident alien, U.S. national, or a resident of Canada or Mexico. However, there is an exception for certain adopted children. If the taxpayer is a U.S. citizen or U.S. national who has legally adopted a child who is not a U.S. citizen, U.S. resident alien, or U.S. national, this test is met if the child lived with the taxpayer as a member of his or her household all year. This exception also applies if the child was lawfully placed with the taxpayer for legal adoption. Foreign students brought to this country under a qualified international education exchange program and placed in American homes for a temporary period generally are not U.S. residents and do not meet this test. The taxpayer cannot claim an exemption for them. However, if he or she provided a home for a foreign student, he or she may be able to take a charitable contribution deduction. Residency Test Example The taxpayer provides all the support of his children, ages 6, 8, and 12, who live in Mexico with his mother and have no income. The taxpayer is single and lives in the United States. His mother is not a U.S. citizen and has no U.S. income, so she is not a taxpayer. His children are not his qualifying children because they do not meet the residency test. Also, they are not the qualifying children of any other taxpayer, so they are his qualifying relatives and he can claim them as dependents if all the tests are met. The taxpayer may also be able to claim his mother as a dependent if all the tests are met, including the gross income test and the support test. Support Test To meet this test, the qualifying child cannot have provided more than half of his or her own support for the year. For a qualifying relative to meet this test, the taxpayer generally must provide more than half of a person's total support during the calendar year. To figure if the taxpayer provided more than half of a person's support, he or she must first determine the total support provided for that person. Total support includes amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities. Generally, the amount of an item of support is the amount of the expense incurred in providing that item. For lodging, the amount of support is the fair rental value of the lodging. Expenses not directly related to any one member of a household, such as the cost of food for the household, must be divided among the members of the household.

Lesson 4 - Standard Deduction, Personal Exemptions

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Medical insurance premiums the taxpayer pays, including premiums for supplementary Medicare coverage, are included in the support he or she provides. However, medical insurance benefits, including basic and supplementary Medicare benefits, are not part of support. Support Test Example The taxpayer’s mother received $2,400 in Social Security benefits and $300 in interest. She paid $2,000 for lodging and $400 for recreation. She put $300 in a savings account. Even though the taxpayer’s mother received a total of $2,700 ($2,400 + $300), she spent only $2,400 ($2,000 + $400) for her own support. If the taxpayer spent more than $2,400 for her support and no other support was received, the taxpayer has provided more than half of her support. Total Support Example Grace Brown, mother of Mary Miller, lives with Frank and Mary Miller and their two children. Grace gets Social Security benefits of $2,400, which she spends for clothing, transportation, and recreation. Grace has no other income. Frank and Mary's total food expense for the household is $5,200. They pay Grace's medical and drug expenses of $1,200. The fair rental value of the lodging provided for Grace is $1,800 a year, based on the cost of similar rooming facilities. Figure Grace's total support as follows: Fair rental value of lodging - $ 1,800 Clothing, transportation, and recreation - $2,400 Medical expenses - $1,200 Share of food (1/5 of $5,200) - $1,040 Total support $6,440 The support Frank and Mary provide ($1,800 lodging + $1,200 medical expenses + $1,040 food = $4,040) is more than half of Grace's $6,440 total support. Married Dependents A taxpayer generally cannot claim a married person as a dependent if he or she files a joint return. The only exception is a taxpayer can claim an exemption for a person who files a joint return if that person and his or her spouse file the joint return only to claim a refund of income tax withheld or estimated tax paid. Example 1 - Child files joint return The taxpayer supported his or her 18-year-old daughter, and she lived with the taxpayer all year while her husband was in the Armed Forces. The couple files a joint return. The taxpayer cannot take an exemption for his or her daughter. Example 2 - Child files joint return only as claim for refund of withheld tax The taxpayer’s 18-year-old son and his 17-year-old wife had $800 of wages from part-time jobs and no other income. Neither is required to file a tax return. They do not have a child. Taxes were taken out of their pay so they file a joint return only to get a refund of the withheld taxes. The exception to the joint return test applies, so the taxpayer is not disqualified from claiming an exemption for each of them just because they file a joint return. The taxpayer can claim exemptions for each of them if all the other tests to do so are met. Example 3 - Child files joint return to claim American Opportunity Tax Credit The facts are the same as in Example 2 except no taxes were taken out of the taxpayer’s son's pay. He and his wife are not required to file a tax return. However, they file a joint return to claim an American Opportunity Tax Credit of $124 and get a refund of that amount. Because claiming the American Opportunity Tax Credit is their reason for filing the return, they are not filing it only to get a refund of income tax withheld or estimated tax paid. The exception to the joint return test does not apply, so the taxpayer cannot claim an exemption for either of them. Multiple-Support Agreements In many cases, two or more persons join together to support the same individual. For example, several children may share the cost of supporting a parent. In these situations, one member of the group can claim an exemption, even though no one provides over one-half the support. The group can enter into a multiple-support agreement if the following conditions are met: (99)

1. No one person contributes over 50% of the dependent's support.

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2. Every member of the group could claim an exemption, except for the support test. 3. The group member who claims the exemption provides more than ten percent of the support. 4. Every group member who provides more than 10% of the support files the consent on Form 2120 - Multiple

Support Declaration. In these situations, the exemptions can be rotated from year to year among members of the group who provide over 10% of the dependent's support. Better yet, give the exemption to the member who is in the highest tax bracket and pass around the tax savings.

A person can claim an exemption under a multiple support agreement for someone related to him or her or for someone who lived with him or her all year as a member of his or her household.

Example 1 The taxpayer, her sister, and her two brothers provide the entire support of their mother for the year. The taxpayer provides 45%, her sister 35%, and her two brothers each provide 10%. Either the taxpayer or her sister can claim an exemption for their mother. The other, either the taxpayer or the sister, must sign a statement agreeing not to take an exemption for their mother. The one who claims the exemption must attach Form 2120, or a similar declaration, to her return and must keep the statement signed by the other for her records. Because neither brother provides more than 10% of the support, neither can take the exemption and neither has to sign a statement. Example 2 The taxpayer’s father lives with her and receives 25% of his support from Social Security, 40% from the taxpayer, 24% from his brother (the taxpayer’s uncle), and 11% from a friend. Either the taxpayer or her uncle can take the exemption for her father if the other signs a statement agreeing not to. The one who takes the exemption must attach Form 2120, or a similar declaration, to his or her return and must keep for his or her records the signed statement from the one agreeing not to take the exemption. Children of Divorced Parents Generally, the dependency exemption for children of divorced taxpayers will go to the parent who has custody of the child for the greater part of the calendar year. The custodial parent will be determined by the number of nights in which the child resided with the parent. When the child spends an equal amount of time with each parent, the parent with the higher adjusted gross income is allowed to claim the dependency exemption. This rule applies only if the child receives over one-half of his or her support from parents who are divorced, legally separated, or have lived apart for the last six months of the calendar year. In addition, the child must have been in the custody of one or both parents for more than one-half of the calendar year. A child will be treated as the qualifying child of his or her non-custodial parent if all four of the following statements are true: (91)

1. The parents: a. Are divorced or legally separated under a decree of divorce or separate maintenance. b. Are separated under a written separation agreement. c. Lived apart at all times during the last 6 months of the year, whether or not they are or were married.

2. The child received over half of his or her support for the year from the parents. 3. The child is in the custody of one or both parents for more than half of the year. 4. Either of the following applies:

a. The custodial parent signs a written declaration, that he or she will not claim the child as a dependent for the year, and the non-custodial parent attaches this written declaration to his or her return (If the decree or agreement went into effect after 1984).

b. A pre-1985 decree of divorce or separate maintenance or written separation agreement that applies to 2017 states that the non-custodial parent can claim the child as a dependent, the decree or agreement was not changed after 1984 to say the non-custodial parent cannot claim the child as a dependent, and the non-custodial parent provides at least $600 for the child's support during the year.

If a child is emancipated under state law, the child is treated as not living with either parent. For example, when a child turned age 18 in May 2017, he or she became emancipated under the law of the state where he or she lives. As a result, he or she is not considered in the custody of his or her parents for more than half of the year. The special rule for children of divorced or separated parents (or parents who live apart) does not apply.

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If a child was not with either parent on a particular night (because, for example, the child was staying at a friend's house), the child is treated as living with the parent with whom the child normally would have lived for that night, except for the absence. But if it cannot be determined with which parent the child normally would have lived or if the child would not have lived with either parent that night, the child is treated as not living with either parent that night. If, due to a parent's nighttime work schedule, a child lives for a greater number of days but not nights with the parent who works at night, that parent is treated as the custodial parent. On a school day, the child is treated as living at the primary residence registered with the school.

If the taxpayer is the custodial parent, he or she can use Form 8332 - Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent to release a claim to exemption for his or her child so that the noncustodial parent can claim an exemption for the child or revoke a previous release of claim to exemption for

his or her child. The dependent's Social Security number must be reported on the taxpayer's tax return for all claimed dependents. Example 1 - Child lived with one parent for a greater number of nights The taxpayer and the child’s other parent are divorced. In 2017, the child lived with the taxpayer 210 nights and with the other parent 155 nights. The taxpayer is the custodial parent. Example 2 - Child is away at camp In 2017, the taxpayer’s daughter lives with each parent for alternate weeks. In the summer, she spends 6 weeks at summer camp. During the time she is at camp, she is treated as living with the taxpayer for 3 weeks and with her other parent, the taxpayer’s ex-spouse, for 3 weeks because this is how long she would have lived with each parent if she had not attended summer camp. Example 3 - Child lived same number of nights with each parent The taxpayer’s son lived with him or her 180 nights during the year and lived the same number of nights with his other parent, the taxpayer’s ex-spouse. The taxpayer’s AGI is $40,000. His or her ex-spouse's AGI is $25,000. The taxpayer is treated as his or her son's custodial parent because he or she has the higher AGI. Example 4 - Child is at parent’s home but with other parent The taxpayer’s son normally lives with him or her during the week and with his other parent, the taxpayer’s ex-spouse, every other weekend. The taxpayer becomes ill and is hospitalized. The other parent lives in the taxpayer’s home with his or her son for 10 consecutive days while the taxpayer is in the hospital. The taxpayer’s son is treated as living with the taxpayer during this 10-day period because he was living in the taxpayer’s home. Example 5 - Child emancipated in May When the taxpayer’s son turned age 18 in May 2017, he became emancipated under the law of the state where he lives. As a result, he is not considered in the custody of his parents for more than half of the year. The special rule for children of divorced or separated parents does not apply. Example 6 - Child emancipated in August The taxpayer’s daughter lives with the taxpayer from January 1, 2017, until May 31, 2017, and lives with her other parent, the taxpayer’s ex-spouse, from June 1, 2017, through the end of the year. She turns 18 and is emancipated under state law on August 1, 2017. Because she is treated as not living with either parent beginning on August 1, she is treated as living with the taxpayer the greater number of nights in 2017. The taxpayer is the custodial parent. Special Rule for Qualifying Child of More Than One Person Sometimes, a child meets the relationship, age, residency, support, and joint return tests to be a qualifying child of more than one person. Although the child is a qualifying child of each of these persons, only one person can actually treat the child as a qualifying child to take all of the following tax benefits (provided the person is eligible for each benefit): (86)

The exemption for the child. The Child Tax Credit. Head of household filing status. The Credit for Child and Dependent Care Expenses. The exclusion from income for dependent care benefits. The Earned Income Tax Credit.

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The other person cannot take any of these benefits based on this qualifying child. In other words, the taxpayer and the other person cannot agree to divide these tax benefits. The other person cannot take any of these benefits for a child unless he or she has a different qualifying child. To determine which person can treat the child as a qualifying child to claim these six tax benefits, the following tiebreaker rules apply: (86)

If only one of the persons is the child's parent, the child is treated as the qualifying child of the parent. If the parents do not file a joint return together but both parents claim the child as a qualifying child, the IRS will

treat the child as the qualifying child of the parent with whom the child lived for the longer period of time during the year. If the child lived with each parent for the same amount of time, the IRS will treat the child as the qualifying child of the parent who had the higher adjusted gross income (AGI) for the year.

If no parent can claim the child as a qualifying child, the child is treated as the qualifying child of the person who had the highest AGI for the year.

If a parent can claim the child as a qualifying child but no parent does so claim the child, the child is treated as the qualifying child of the person who had the highest AGI for the year, but only if that person's AGI is higher than the highest AGI of any of the child's parents who can claim the child. If the child's parents file a joint return with each other, this rule can be applied by dividing the parents' combined AGI equally between the parents.

Subject to these tiebreaker rules, the taxpayer and the other person may be able to choose which one claims the child as a qualifying child.

Example The taxpayer and her 3-year-old daughter, Jill, lived with the taxpayer’s mother all year. The taxpayer is 25 years old, unmarried, and has an AGI of $9,000. The taxpayer’s mother's AGI is $15,000. Jill's father did not live with the taxpayer or her daughter. The taxpayer has not signed Form 8832 (or a similar statement) to release the child's exemption to the noncustodial parent. Jill is a qualifying child of both the taxpayer and her mother because she meets the relationship, age, residency, support, and joint return tests for both. However, only one can claim her. Jill is not a qualifying child of anyone else, including her father. The taxpayer agrees to let her mother claim Jill. This means the taxpayer’s mother can claim Jill as a qualifying child for all of the six tax benefits listed earlier, if she qualifies (and if the taxpayer does not claim Jill as a qualifying child for any of those tax benefits).

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

Review Questions Answers appear in Review Feedback 1. What is the amount of the Standard Deduction for a single taxpayer, under the age of 65 with good eyesight in 2017?

A. $5,950 B. $6,350 C. $6,750 D. $9,350

2. What is the Standard Deduction for a single taxpayer, age 65 or older with good eyesight in 2017?

A. $6,350 B. $7,900 C. $9,350 D. $12,700

3. Mary and Matthew are the parents of four children, ages 5, 9, 13, and 22. Their 22-year-old child is a full-time student

with income of $4,700. Mary and Matthew provided more than 50% of the support for all their children. If they file a joint return, how many exemptions can they claim for the above family members on their 2017 income tax return?

A. 3 B. 4 C. 5 D. 6

4. Al and Donna are married filing jointly and have provided more than 50% of the support for two minor children and

Donna's mother. The children each had interest income of less than $500. Donna's mother received a taxable pension of $3,800, ordinary dividends of $1,000 and taxable interest of $2,000. How many exemptions can the taxpayers claim, including themselves, on their 2017 income tax return?

A. 2 B. 3 C. 4 D. 5

5. Mr. and Mrs. Hanauer filed a joint return. During the year, they provided more than 50% of the support for the

following individuals, all of whom are U.S. citizens: • The Hanauers’ daughter, age 23, was a full-time student for 8 months. During the summer, she earned $4,600,

which was spent on her support. • Mr. Hanauer’s cousin, age 16, lived with them from March through December. • Mr. Hanauer’s widowed mother, age 70, lived with them and had no income. • The Hanauers’ daughter, age 22, lived with them the full year. She had gross income of $5,100. • Mrs. Hanauer’s widowed father, age 64, lived alone, and his sole source of income was Social Security of $4,200.

How many exemptions may Mr. and Mrs. Hanauer claim on their tax return? A. 2 B. 5 C. 6 D. 7

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6. A taxpayer with how many dependents is entitled to a $4,050 exemption for each one in tax year 2017? A. Three B. Five C. Seven D. No Limit

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Review Feedback Return to Review Questions Question 1 - B. $6,350 The standard deduction amount depends on the taxpayer’s filing status, whether the taxpayer is 65 or older or blind, and whether an exemption can be claimed for him or her by another taxpayer. Generally, the standard deduction amounts are adjusted each year for inflation. The standard deduction amount for a single taxpayer under 65 with good eyesight is $6,350 in 2017. Question 2 - B. $7,900 The standard deduction amount for a single taxpayer, age 65 or older with good eyesight is $7,900 in 2017. Question 3 - D. 6 Since Mary and Matthew provided more than 50% of the support for all of their children and their 22-year-old child is a full-time student, each child qualifies as a dependent. Thus, Mary and Matthew can claim one personal exemption for each of themselves and each of their four children. Question 4 - C. 4 For 2017, they can claim exemptions for themselves and the two minor children (total of 4). They cannot claim Donna’s mother as a dependent (under the qualifying relative test) because she has gross income of more than $4,050. Question 5 - B. 5 Mr. and Mrs. Hanauer are entitled to one exemption each for themselves. They are also entitled to one exemption each for their 23-year-old daughter because she is a full-time student, their widowed mother, and Mrs. Hanauer’s father because Social Security is not included in determining the gross income limit. The cousin does not qualify as a member of the household because he or she did not live there all year, and the 22-year-old daughter does not qualify because her income exceeds the exemption amount. Question 6 - D. No limit A taxpayer generally can take an exemption for each of his or her dependents. A dependent is a qualifying child or qualifying relative. The taxpayer must list the Social Security number of any dependent for whom he or she claims an exemption. There is no limit to the number of exemptions a taxpayer can claim.

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

Earned Income Unemployment and Other Compensation Special Rules for Certain Employees Passive Income Rental Income Separation or Divorce Issues

The general definition of income in 26 USC section 61 is that gross income means all income from whatever source derived, including (but not limited to) the following items: (100)

Compensation for services, including fees, commissions, fringe benefits, and similar items Gross income derived from businesses Gains derived from dealings in property Interest Rents Royalties Dividends Alimony and separate maintenance payments Annuities Income from life insurance and endowment contracts Pensions Income from discharge of indebtedness Distributive share of partnership income Income in respect to the decedent Income from the interest in an estate or trust

Earned Income Earned income includes all the taxable income and wages the taxpayer gets from working or from certain disability payments. A taxpayer receives earned income by working for someone who pays him or her, or owning or running a business or farm. Taxable earned income includes: (101)

Wages, salaries, tips, and other taxable employee pay. Union strike benefits. Long-term disability benefits received prior to minimum retirement age. Net earnings from self-employment if:

o The taxpayer owns or operates a business or a farm. o The taxpayer is a minister or member of a religious order. o The taxpayer is a statutory employee and has income.

Examples of income that are not earned income: (101)

Pay received for work while an inmate in a penal institution Interest and dividends Retirement income Social Security benefits Unemployment benefits Alimony Child support

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The most common forms of income reported by the average taxpayer are compensation, dividends, and interest. About 95% of the adjusted gross income, of individuals, is from these three sources. Income from compensation alone -- salaries, wages and all fringe benefits -- accounts for about 85% of the total adjusted gross income. Compensation and Wages Form W-2 – Wage and Tax Statement is used to report to employees the annual amount of salaries and withholdings. In some cases, taxable compensation is not subject to withholding of income taxes and the compensation is not reported on Form W-2. When taxable income is not subject to withholdings, the taxpayer must report the amount on Line 21 of Form 1040 unless it fits into one of the categories shown on Lines 7 through 20b. If the space on Line 21 is insufficient to state the nature and source, then the taxpayer must attach a supplementary schedule to Form 1040 to explain the amounts reported. The IRS does not provide a printed form for this purpose. Compensation Subject to the Tax All compensation for personal services is subject to the income tax. Compensation means more than just salaries and wages. The term also includes tips, commissions, fees for personal services, overtime pay, vacation pay and every other payment for personal services. Virtually every payment made by an employer to an employee or by a customer for personal services, is compensation and is taxable income to the employee/recipient. Taxability of a payment is not affected by what the payment is called. For example, bonuses and performance awards are usually taxable as compensation. The IRS provides the following list of items that do not have to be included as taxable income: (102)

Adoption expense reimbursements for qualifying expenses. Child support payments. Gifts, bequests and inheritances (Subject to limits). Workers' compensation benefits (some exceptions may apply; see Publication 525 - Taxable and Nontaxable

Income). Meals and lodging for the convenience of the taxpayer’s employer. Compensatory damages awarded for physical injury or physical sickness. Welfare benefits. Cash rebates from a dealer or manufacturer.

Foreign Earned Income If the taxpayer is a U.S. citizen or a resident alien of the United States and he or she lives abroad, the taxpayer is taxed on his or her worldwide income. Foreign earned income for this purpose means wages, salaries, professional fees, and other compensation received for personal services the taxpayer performed in a foreign country during the period for which he or she met the tax home test and either the bona fide residence test or the physical presence test. It also includes noncash income (such as a home or car) and allowances or reimbursements. (103) A taxpayer qualifies for the tax benefits available to taxpayers who have foreign earned income if both of the following apply: (103)

The taxpayer meets the tax home test. The taxpayer meets either the bona fide residence test or the physical presence test.

Income from working abroad as an employee of the U.S. Government does not qualify for either of the exclusions or the housing deduction.

To meet the tax home test, the taxpayer’s tax home must be in a foreign country throughout his or her period of bona fide residence or physical presence, whichever applies. For this purpose, the period of physical presence is the 330 full days during which the taxpayer was present in a foreign country, not the 12 consecutive months during which those days occurred. Foreign earned income does not include amounts that are actually a distribution of corporate earnings or profits distribution of corporate earnings or profits rather than a reasonable allowance as compensation for the taxpayer’s personal services. It also does not include the following types of income: (103)

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Pension and annuity income (including Social Security benefits and railroad retirement benefits treated as Social Security).

Interest, ordinary dividends, capital gains, alimony, etc. Portion of 2016 moving expense deduction allocable to 2017 that is included in 2017 gross income. Amounts paid to the taxpayer by the U.S. Government or any of its agencies if he or she was an employee of the

U.S. Government or any of its agencies. Amounts received after the end of the tax year following the tax year in which the taxpayer performed the services. Amounts the taxpayer must include in gross income because of his or her employer's contributions to a nonexempt

employees' trust or to a nonqualified annuity contract.

Unemployment and Other Compensation Cafeteria Plans A cafeteria plan, including a flexible spending arrangement, is a written plan that allows employees to choose between receiving cash or taxable benefits instead of certain qualified benefits for which the law provides an exclusion from wages. If an employee chooses to receive a qualified benefit under the plan, the fact that the employee could have received cash or a taxable benefit instead will not make the qualified benefit taxable. Generally, a cafeteria plan does not include any plan that offers a benefit that defers pay. However, a cafeteria plan can include a qualified 401(k) plan as a benefit. Also, certain life insurance plans maintained by educational institutions can be offered as a benefit even though they defer pay. A cafeteria plan can include the following benefits: (104)

Accident and health benefits (but not Archer medical savings accounts (Archer MSAs) or long-term care insurance).

Adoption assistance. Dependent care assistance. Group-term life insurance coverage (including costs that cannot be excluded from wages). Health savings accounts (HSAs). Distributions from an HSA may be used to pay eligible long-term care insurance

premiums or qualified long-term care services. A cafeteria plan cannot include the following benefits: (104)

Archer MSAs. Athletic facilities. De minimis (minimal) benefits. Educational assistance. Employee discounts. Employer-provided cell phones. Lodging on the business premises. Meals. Moving expense reimbursements. No-additional-cost services. Transportation (commuting) benefits. Tuition reduction. Working condition benefits.

A cafeteria plan also cannot include scholarships or fellowships. For plan years beginning after December 31, 2012, a cafeteria plan may not allow an employee to request salary reduction contributions for a health flexible spending arrangement (FSA) in excess of the annual limit. For 2017, the annual dollar limit on employee contributions to employer-sponsored healthcare flexible spending arrangements (FSA) increases to $2,600. Amounts contributed are not subject to Federal income tax, Social Security tax or Medicare tax. If the plan allows, the employer may also contribute to an employee’s FSA.

In October of 2013, the U.S. Department of the Treasury and the IRS issued a notice modifying the longstanding “use-or-lose” rule for healthcare flexible spending arrangements (FSA). Participants now can carry over up to $500 of their unused balances remaining at the end of a plan year. The rule went into effect for the 2014 plan year.

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The carryover of up to $500 does not affect the maximum amount of salary reduction contributions that the participant is permitted to make under Section 125(i) of the Code ($2,600 in 2017). This carryover option provides an alternative to the current grace period rule and administrative relief similar to that rule. In most cases, if an individual is covered by an accident or health insurance plan through a cafeteria plan, and the amount of the insurance premiums was not included in income, he or she is not considered to have paid the premiums and must include any benefits received in income. If the amount of the premiums was included in income, the individual is considered to have paid the premiums and any benefits received are not taxable. The Affordable Care Act requires employers to report the cost of coverage under an employer-sponsored group health plan. However, there is nothing about the reporting requirement that causes or will cause excludable employer-provided health coverage to become taxable. The purpose of the reporting requirement is to provide employees useful and comparable consumer information on the cost of their health care coverage. For tax purposes, the taxpayer can generally exclude from his or her income any health insurance premiums (including Medicare) paid by his or her employer. The premiums can be for insurance covering the taxpayer, his or her spouse, and any dependents. It does not matter whether the premiums paid for an employer-sponsored group policy or an individual policy. If the taxpayer pays the premiums on his or her health insurance policy and receives a reimbursement from his or her employer for those premiums, the amount of the reimbursement is not taxable income. However, if the taxpayer’s employer simply pays him or her a lump sum that may be used to pay health insurance premiums but is not required to be used for this purpose, that amount is taxable. The deductibility of health insurance premiums follows the rules for deducting medical expenses. Usually, the premiums a taxpayer pays on an individual health insurance policy will not be deductible. However, if the taxpayer itemizes deductions on Schedule A, and his or her unreimbursed medical expenses exceed 7.5% of adjusted gross income (AGI) in any tax year, the taxpayer may be able to take a deduction. He or she can deduct the amount by which his or her unreimbursed medical expenses exceed this 7.5% threshold. Unreimbursed medical expenses include premiums paid for major medical, hospital, surgical, and physician's expense insurance, and amounts paid out-of-pocket for treatment not covered by the taxpayer’s health insurance.

Under the Tax Cuts and Jobs Act, the medical expense deduction is retroactively returned to 7.5% for 2017 and will remain in place with a lower floor of 7.5% for 2018. After 2018 the percentage returns to 10%.

Unemployment Compensation The term unemployment compensation means any amount received under a law of the United States, or of a State, which is in the nature of unemployment compensation. Thus, Section 85 applies only to unemployment compensation paid pursuant to governmental programs and does not apply to amounts paid pursuant to private nongovernmental unemployment compensation plans (which are includible in income without regard to Section 85). Generally, unemployment compensation programs are those designed to protect taxpayers against the loss of income caused by involuntary layoff. Ordinarily, unemployment compensation is paid in cash and on a periodic basis. The amount of the payments is usually computed in accordance with a formula based on the taxpayer's length of prior employment and wages. Such payments, however, may be made in a lump sum or other than in cash or on some other basis. At present, Federal law requires that all unemployment compensation received from governmental units must be reported as income. If unemployment compensation was received during the year, the taxpayer should receive Form 1099-G - Certain Government Payments, showing the amount he or she was paid. Any unemployment compensation received must be included in his or her income. (105) Unemployment compensation generally includes the following benefits: (106)

Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund. State unemployment insurance benefits. Railroad unemployment compensation benefits. Disability payments from a government program paid as a substitute for unemployment compensation (Amounts

received as workers' compensation for injuries or illness are not unemployment compensation).

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Trade readjustment allowances under the Trade Act of 1974. Unemployment assistance under the Disaster Relief and Emergency Assistance Act of 1974. Unemployment assistance under the Airline Deregulation Act of 1974 Program.

The taxpayer must include benefits from regular union dues paid to him or her as an unemployed member of a union in his or her income. However, other rules apply if the taxpayer contributes to a special union fund and the contributions are not deductible. If this applies, only include in income the amount the taxpayer received from the fund that is more than his or her contributions. The taxpayer can choose to have Federal income tax withheld from the unemployment benefits. He or she makes this choice using Form W-4V - Voluntary Withholding Request. If the taxpayer completes the form and gives it to the paying office, they will withhold tax at 10% of the payments. If the taxpayer chooses not to have tax withheld, he or she may have to make estimated tax payments throughout the year. (107) Sickness and Injury Benefits In most cases, the taxpayer must report as income any amount he or she receives for personal injury or sickness through an accident or health plan that is paid for by his or her employer. If both the taxpayer and the employer pay for the plan, only the amount the taxpayer receives that is due to the employer's payments is reported as income. However, certain payments may not be taxable. If the taxpayer retired on disability, he or she must include in income any disability pension he or she receives under a plan that is paid for by his or her employer. The taxpayer must report taxable disability payments as wages until he or she reaches minimum retirement age. Minimum retirement age generally is the age at which the taxpayer can first receive a pension or annuity if he or she is not disabled. (108) The taxpayer may be able to exclude from income amounts he or she receives as a pension, annuity, or similar allowance for personal injury or sickness resulting from active service in one of the following government services: (109)

The armed forces of any country. The National Oceanic and Atmospheric Administration. The Public Health Service. The Foreign Service.

The taxpayer should not include the disability payments in his or her income if any of the following conditions apply: (109)

The taxpayer was entitled to receive a disability payment before September 25, 1975. The taxpayer was a member of a listed government service or its reserve component, or was under a binding

written commitment to become a member, on September 24, 1975. The taxpayer received the disability payments for a combat-related injury. This is a personal injury or sickness

that: o Results directly from armed conflict. o Takes place while the taxpayer was engaged in extra-hazardous service. o Takes place under conditions simulating war, including training exercises such as maneuvers. o Is caused by an instrumentality of war.

The taxpayer would be entitled to receive disability compensation from the Department of Veterans Affairs (VA) if he or she filed an application for it. The exclusion under this condition is equal to the amount the taxpayer would be entitled to receive from the VA.

Workers' Compensation Amounts in the nature of unemployment compensation also include cash disability payments made pursuant to a governmental program as a substitute for case unemployment payments to an unemployed taxpayer who is ineligible for such payments solely because of the disability. Usually these disability payments are paid in the same weekly amount and for the same period as the unemployment compensation benefits to which the unemployed taxpayer otherwise would have been entitled. Amounts received under workmen's compensation acts as compensation for personal injuries or sickness are not amounts in the nature of unemployment compensation. Amounts the taxpayer receives as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act. The exemption also applies to his or her survivors. The exemption, however, does not apply to retirement plan benefits the taxpayer

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receives based on his or her age, length of service, or prior contributions to the plan, even if he or she retired because of an occupational sickness or injury. If part of the taxpayer’s workers' compensation reduces his or her Social Security or equivalent railroad retirement benefits received, that part is considered Social Security (or equivalent railroad retirement) benefits and may be taxable. If the taxpayer returns to work after qualifying for workers' compensation, salary payments he or she receives for performing light duties are taxable as wages. Reimbursement for Medical Care A reimbursement for medical care generally is not taxable. However, it may reduce the taxpayer’s medical expense deduction if he or she receives reimbursement for an expense he or she deducted in an earlier year. If a taxpayer receives an advance reimbursement or loan for future medical expenses from his or her employer without regard to whether he or she suffered a personal injury or sickness or incurred medical expenses, that amount is included in income, whether or not the taxpayer incurs uninsured medical expenses during the year. Reimbursements received under the taxpayer’s employer's plan for expenses incurred before the plan was established are included in income. Amounts a taxpayer receives under a reimbursement plan that provides for the payment of unused reimbursement amounts in cash or other benefits are included in income. However, a qualified HSA distribution from a health flexible spending account or health reimbursement account can be made to a health savings account. Sick Pay The IRS defines sick pay as any amount paid under a plan for employees because of an employee’s temporary absence from work due to injury, sickness or disability. The sick pay may be paid by either the employer or by a third party, such as an insurance company. Based on this definition, the IRS classifies Long-Term Disability Insurance (LTD), Short-Term Disability Insurance (STD) and State Disability Insurance (SDI) benefits paid to employees as sick pay. Pay a taxpayer receives from his or her employer while he or she is sick or injured is part of his or her salary or wages. In addition, the taxpayer must include in his or her income sick pay benefits received from any of the following payers: (110)

A welfare fund. A state sickness or disability fund. An association of employers or employees. An insurance company, if his or her employer paid for the plan.

However, if the taxpayer paid the premiums on an accident or health insurance policy, the benefits he or she receives under the policy are not taxable. Life Insurance and Disability Insurance Proceeds A taxpayer must report as income any amount he or she receives for disability through an accident or health insurance plan paid for by his or her employer: (111)

If both the taxpayer and the employer have paid the premiums for the plan, only the amount he or she receives for disability that is due to his or her employer’s payments is reported as income.

If the taxpayer pays the entire cost of a health or accident insurance plan, do not include any amounts he or she receives for disability as income on the tax return.

If the taxpayer pays the premiums of a health or accident insurance plan through a cafeteria plan, and the amount of the premium was not included as taxable income to him or her, the premiums are considered paid by the employer, and the disability benefits are fully taxable.

If the amounts are taxable: o The taxpayer can submit a Form W-4S - Request for Federal Income Tax Withholding From Sick Pay, to

the insurance company. o Make estimated tax payments by filing Form 1040-ES - Estimated Tax for Individuals.

Amounts a taxpayer receives from an employer while he or she is sick or injured are part of his or her salary or wages.

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Taxation of Disability Benefits

Who Pays the Insurance Premium Is the Benefit Taxable? How Much of the Benefit is Taxable?

Employer pays 100% Yes 100% Employer pays portion and employee pays balance with post-tax dollars Yes Percentage of premium paid by

employer Employer pays portion and employee pays balance with pre-tax dollars Yes 100%

Employee pays 100% with post-tax dollars No None

Employee pays 100% with pre-tax dollars Yes 100%

Table 5-1 - Internal Revenue Code (IRC) Section 105 (2017)

Military and Government Disability Pensions Certain military and government disability pensions are not taxable. The taxpayer may be able to exclude from income amounts he or she receives as a pension, annuity, or similar allowance for personal injury or sickness resulting from active service in one of the following government services:

The armed forces of any country. The National Oceanic and Atmospheric Administration. The Public Health Service. The Foreign Service.

The taxpayer does not include the disability payments in his or her income if any of the following conditions apply:

1. He or she was entitled to receive a disability payment before September 25, 1975. 2. He or she was a member of a listed government service or its reserve component, or was under a binding written

commitment to become a member, on September 24, 1975. 3. He or she receives the disability payments for a combat-related injury. This is a personal injury or sickness that:

a. Results directly from armed conflict, b. Takes place while he or she is engaged in extra-hazardous service, c. Takes place under conditions simulating war, including training exercises such as maneuvers, or d. Is caused by an instrumentality of war.

4. He or she would be entitled to receive disability compensation from the Department of Veterans Affairs (VA) if he or she filed an application for it. The taxpayer’s exclusion under this condition is equal to the amount he or she would be entitled to receive from the VA.

If the taxpayer receives a disability pension based on years of service, in most cases he or she must include it in his or her income. However, if the pension qualifies for the exclusion for a service-connected disability, the taxpayer does not include in income the part of his or her pension that he or she would have received if the pension had been based on a percentage of disability. The taxpayer must include the rest of his or her pension in his or her income. In most cases, under the statute of limitations a claim for credit or refund must be filed within 3 years from the time a return was filed. However, if the taxpayer receives a retroactive service-connected disability rating determination, the statute of limitations is extended by a 1-year period beginning on the date of the determination. This 1-year extended period applies to claims for credit or refund filed after June 17, 2008, and does not apply to any tax year that began more than 5 years before the date of the determination. Prizes and Awards Almost all contest awards and prizes are now taxable compensation. They usually represent a payment for services rendered. For example, if the taxpayer wins a photography contest, he must have taken the time and invested in the supplies necessary to produce the winning photograph. Although he must include the prize income, he is entitled to reduce the amount of the prize by direct costs. The winner of a lucky number drawing or other contest of chance must report this income on Line 21, Form 1040. (112)

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Prizes and awards in goods or services must be included in income at their fair market value. Fair market value is the price that property would sell for on the open market.

Prizes awarded in recognition of accomplishments in religious, charitable, scientific, artistic, educational, literary, or civic fields, generally must be included in income. However, do not include the prize in income if: (112)

The taxpayer was selected without any action on his or her part to enter the contest or proceeding. The taxpayer is not required to perform substantial future services as a condition to receiving the prize or award. The prize or award is transferred by the payer directly to a governmental unit or tax-exempt charitable organization

as designated by the taxpayer. Employee Achievement Awards If an individual receives tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award for length of service or safety achievement, he or she generally can exclude its value from income. However, the amount he or she can exclude is limited to the employer's cost and cannot be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards the person receives during the year. The employer can tell the individual whether the award is a qualified plan award. The employer must make the award as part of a meaningful presentation, under conditions and circumstances that do not create a significant likelihood of it being disguised pay. However, the exclusion does not apply to the following awards: (113)

A length-of-service award if the taxpayer received it for less than 5 years of service or if he or she received another length-of-service award during the year or the previous 4 years.

A safety achievement award if the taxpayer is a manager, administrator, clerical employee, or other professional employee or if more than 10% of eligible employees previously received safety achievement awards during the year.

Gambling Income Winnings or gains arising from gambling, betting, and lotteries are includible in gross income. Even winnings or gains arising from illegal transactions (such as bootlegging, extortion, embezzlement, or fraud) are includible in the taxpayer’s gross income. Income tax is withheld at a flat 25% rate from certain kinds of gambling winnings. Gambling winnings of more than $5,000 from the following sources are subject to income tax withholding: (61)

Any sweepstakes; wagering pool, including payments made to winners of poker tournaments; or lottery. Any other wager if the proceeds are at least 300 times the amount of the bet.

It does not matter whether winnings are paid in cash, in property, or as an annuity. Winnings not paid in cash are taken into account at their fair market value.

Gambling winnings from bingo, keno, and slot machines generally are not subject to income tax withholding. However, the taxpayer may need to provide the payer with a Social Security number to avoid withholding. If the taxpayer receives gambling winnings not subject to withholding, he or she may need to pay estimated tax. If a payer withholds income tax from a taxpayer’s gambling winnings, he or she should receive a Form W-2G - Certain Gambling Winnings, showing the amount he or she won and the amount withheld. The taxpayer should report the tax withheld on his or her 2017 Form 1040, along with all other Federal income tax withheld, as shown on Forms W-2 and 1099. If a taxpayer has any kind of gambling winnings and does not give the payer his or her Social Security number, the payer may have to withhold income tax at a flat 28% rate. This rule also applies to winnings of at least $1,200 from bingo or slot machines or $1,500 from keno, and to certain other gambling winnings of at least $600. Gambling losses can be deducted to the extent of taxpayer’s winnings. Gambling winnings are reported on Form 1040 line 21. For year 2017, gambling losses are deducted as an Itemized Deduction on line 28 of Form 1040 Schedule A. Only taxpayers that itemize can claim gambling losses. (112)

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It is important to keep an accurate diary or similar record of gambling winnings and losses. To deduct losses, the taxpayer must be able to provide receipts, tickets, statements or other records that show the amount of both winnings and losses. (114)

Tips When employees receive cash tips of $20 or more in a calendar month, they are required to report to their employer the total amount of tips they received. The employees must give the employer written reports by the tenth of the following month. Employees who receive tips of less than $20 in a calendar month are not required to report their tips but must report these amounts as income on their tax returns and pay taxes. (115) Cash tips include tips received directly from customers, tips from other employees under any tip-sharing arrangement, and charged tips (e.g., credit and debit card charges) that are distributed to an employee. Both directly and indirectly tipped employees must report tips received to their employer. (115) Service charges added to a bill or fixed by the employer that the customer must pay, when paid to an employee, will not constitute a tip but rather constitute non-tip wages. These non-tip wages are subject to Social Security tax, Medicare tax, and Federal income tax withholding. In addition, the employer cannot use these non-tip wages when computing the credit available to employers under Section 45B of the Internal Revenue Code, because these amounts are not tips. Common examples of service charges (sometimes called auto-gratuities) in service industries are: (115)

Large Party Charge (restaurant) Bottle Service Charge (restaurant and night-club) Room Service Charge (hotel and resort) Contracted Luggage Assistance Charge (hotel and resort) Mandated Delivery Charge (pizza or other retail deliveries)

Employers are responsible for withholding the 0.9% Additional Medicare Tax on a tipped individual’s wages paid in excess of $200,000 in a calendar year. An employer is required to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax.

If an individual received tips as a self-employed person, he or she should report these tips as income on Schedule C or C-EZ. A taxpayer must report all tips he or she received in 2017 on his or her tax return, including both cash tips and noncash tips. Any tips the taxpayer reported to his or her employer for 2017 are included in the wages shown in box 1 of his or her Form W-2. The taxpayer should add to the amount in box 1 only the tips he or she did not report to his or her employer. Generally, an individual must report all tips received during the tax year on the tax return, including both cash tips and noncash tips. If the taxpayer kept a daily tip record and reported tips to an employer as required, the employer will add the following tips to the amount in box 1 of the Form W-2: (116)

Cash and charge tips received that totaled less than $20 for any month. The value of noncash tips, such as tickets, passes, or other items of value.

If the taxpayer received $20 or more in cash and charge tips in a month from any one job and did not report all of those tips to an employer, he or she must report the Social Security and Medicare taxes on the unreported tips as additional tax on the return. To report these taxes, the individual must file a return even if he or she would not otherwise have to file. The taxpayer must use Form 1040, Form 1040NR, Form 1040NR-EZ, Form 1040-SS, or 1040-PR (as appropriate) for this purpose. (He or she cannot file Form 1040EZ or Form 1040A.) Use Form 4137 - Social Security and Medicare Tax on Unreported Tip Income, to figure these taxes. Enter the tax on the return as instructed, and attach the completed Form 4137 to the return. Allocated Tips Allocated tips are tips that an employer assigned to an individual in addition to the tips he or she reported to the employer for the year. The employer will have done this only if: (116)

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1. The taxpayer worked in an establishment (restaurant, cocktail lounge, or similar business) that must allocate tips to employees.

2. The tips the taxpayer reported to the employer were less than his or her share of 8% of food and drink sales.

Allocated tips are shown separately in box 8 of the Form W-2. They are not included in box 1 with wages and reported tips. An employer can use a tip rate lower than 8% (but not lower than 2%) to figure allocated tips only if the IRS approves the lower rate. Either the employer or the employees can request approval of a lower rate by filing a petition with the IRS. The petition must include specific information about the establishment that will justify the lower rate. A user fee must be paid with the petition. The employee petition can be filed only with the consent of a majority of the directly tipped employees (waiters, bartenders, and others who receive tips directly from customers). The petition must state the total number of directly tipped employees and the number of employees consenting to the petition. Employees filing the petition must promptly notify the employer, and the employer must promptly give the IRS copies of all Form 8027 - Employer's Annual Information Return of Tip Income and Allocated Tips, filed for the establishment for the previous 3 years. Penalty for Not Reporting Tips If a taxpayer does not report tips to his or her employer as required, he or she may be subject to a penalty equal to 50% of the Social Security and Medicare taxes or railroad retirement tax owed on the unreported tips. The penalty amount is in addition to the taxes the taxpayer owes. (116) Royalties The most common types of royalties are from copyrights and patents. Additional common royalties are from oil, gas, and mineral properties extracted from the taxpayer’s property. Royalties from copyrights on literary, musical, or artistic works, and similar property, or from patents on inventions, are amounts paid to the taxpayer for the right to use his or her work over a specified period of time. Royalties generally are based on the number of units sold, such as the number of books, tickets to a performance, or machines sold. Royalty income from oil, gas, and mineral properties is the amount the taxpayer receives when natural resources are extracted from the property. The royalties are based on units, such as barrels and tons and are paid to the taxpayer by a person or company who leases the property from him or her. Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income and should be reported on Part I of Schedule E - Supplemental Income and Loss. However, if the taxpayer holds an operating oil, gas, or mineral interest or is in business as a self-employed writer, inventor or artist, report his or her income and expenses on Schedule C or Schedule C-EZ (Form 1040). (113) Bartering Bartering occurs when a taxpayer exchanges goods or services without exchanging money. If the taxpayer barters for someone else’s products or services, he or she will have to report the fair market value of the products or services on his or her tax return. If the taxpayer barters his or her products or services through a barter exchange, the taxpayer should receive a Form 1099-B - Proceeds From Broker and Barter Exchange Transactions. The amount shown in 1099-B, Box 3, Bartering, is the barter transaction’s proceeds and is generally reportable as income included on the tax return. Generally, the taxpayer reports bartering income on Schedule C or Schedule C-EZ (Form 1040). (117)

The IRS reminds all taxpayers that the fair market value of property or services received through barter is taxable income. Both parties must report as income the value of the goods and services received in the exchange.

Here are four facts about bartering: (118)

1. Barter exchanges - A barter exchange is an organized marketplace where members barter products or services. Some exchanges operate out of an office and others over the Internet. All barter exchanges are required to issue Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, annually. The exchange must give a copy of the form to its members and file a copy with the IRS.

2. Bartering income - Barter and trade dollars are the same as real dollars for tax reporting purposes. If the taxpayer barters, he or she must report on the tax return the fair market value of the products or services received.

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3. Tax implications - Bartering is taxable in the year it occurs. The tax rules may vary based on the type of bartering that takes place. Barterers may owe income taxes, self-employment taxes, employment taxes or excise taxes on their bartering income.

4. Reporting rules - How the taxpayer reports bartering varies depending on which form of bartering takes place. Generally, if he or she is in a trade or business the taxpayer reports bartering income on Form 1040, Schedule C, Profit or Loss from Business. The taxpayer may be able to deduct certain costs incurred to perform the bartering.

Canceled Debts In most cases, if a debt the taxpayer owes is canceled or forgiven, other than as a gift or bequest, he or she must include the canceled amount in his or her income. Canceled debts that meet the requirements for any of the following exceptions or exclusions are not taxable: (119) Canceled debt that qualifies for exception to inclusion in gross income:

Amounts specifically excluded from income by law such as gifts or bequests. Cancellation of certain qualified student loans. Canceled debt, if paid by a cash basis taxpayer, would be deductible. A qualified purchase price reduction given by a seller. Any Pay-for-Performance Success Payments that reduce the principal balance of a home mortgage under the

Home Affordable Modification Program. Canceled debt that qualifies for exclusion from gross income:

Debt canceled in a Title 11 bankruptcy case (including all chapters in title 11 such as chapters 7, 11, and 13). Debt canceled during insolvency. Cancellation of qualified farm indebtedness. Cancellation of qualified real property business indebtedness.

The Bipartisan Budget Act of 2018 retroactively extended the exclusion for qualified principal residence indebtedness that provides tax relief on canceled debt for many homeowners involved in the mortgage foreclosure through 2017 (unless current tax law changes, the deduction is not available for tax years

after 2017). Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition. Life Insurance Proceeds Generally, if a taxpayer receives the proceeds under a life insurance contract as a beneficiary due to the death of the insured person, the benefits are not includable in gross income and do not have to be reported. However, any interest received is taxable and needs to be reported just like any other interest received. Additionally, if the policy was transferred to the taxpayer for cash or other valuable consideration, the exclusion for the proceeds is limited to the sum of the consideration paid, additional premiums paid and certain other amounts. (120) Recovery A recovery is a return of an amount the taxpayer deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements, and rebates of itemized deductions. The taxpayer also may have recoveries of non-itemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which he or she previously claimed a tax credit. The taxpayer must include a recovery in his or her income in the year he or she received it up to the amount by which the deduction or credit he or she took for the recovered amount reduced the tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from the deduction or credit is considered to have reduced the taxpayer’s tax in the earlier year. Refunds of Federal income taxes are not included in a taxpayer’s income because they are never allowed as a deduction from income. If the taxpayer received a state or local income tax refund (or credit or offset) in 2017, he or she generally must include it in income if he or she deducted the tax in an earlier year. The payer should send Form 1099-G - Certain

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Government Payments, to the taxpayer by January 31, 2018. The IRS also will receive a copy of the Form 1099-G. If the taxpayer files Form 1040, use the worksheet in the 2017 Form 1040 instructions for line 10 to figure the amount (if any) to include in his or her income. If the taxpayer could choose to deduct for a tax year either state and local income taxes, or state and local general sales taxes, then the maximum refund that the taxpayer may have to include in income is limited to the excess of the tax he or she chooses to deduct for that year over the tax he or she did not choose to deduct for that year. (113)

If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit and is not reported as income. If the taxpayer receives a refund or other recovery that is for amounts he or she paid in 2 or more separate years, he or she must allocate, on a pro rata basis, the recovered amount

between the years in which he or she paid it. This allocation is necessary to determine the amount of recovery from any earlier years and to determine the amount, if any, of the allowable deduction for this item for the current year. Repayments If a taxpayer had to repay an amount that he or she included as income in an earlier year, he or she may be able to deduct the amount repaid from the income for the year in which he or she repaid it. Or, if the amount the taxpayer repaid is more than $3,000, he or she may be able to take a credit against the tax for the year in which he or she repaid it. In most cases, the taxpayer can claim a deduction or credit only if the repayment qualifies as an expense or loss incurred in trade or business or in a for-profit transaction. (113) Partnerships A partnership generally is not a taxable entity. The income, gains, losses, deductions, and credits of a partnership are passed through to the partners based on each partner's distributive share of these items. The distributive share of partnership income, gains, losses, deductions, or credits generally is based on the partnership agreement. The taxpayer must report his or her distributive share of these items on the tax return whether or not they actually are distributed to him or her. However, the taxpayer’s distributive share of the partnership losses is limited to the adjusted basis of the partnership interest at the end of the partnership year in which the losses took place. (113) An organization formed after 1996 is classified as a partnership for Federal tax purposes if it has two or more members and it is none of the following: (121)

An organization formed under a Federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic.

An organization formed under a state law that refers to it as a joint-stock company or joint-stock association. An insurance company. Certain banks. An organization wholly owned by a state or local government. An organization specifically required to be taxed as a corporation by the Internal Revenue Code (for example,

certain publicly traded partnerships). Certain foreign organizations identified in Section 301.7701-2(b)(8) of the regulations. A tax-exempt organization. A real estate investment trust. An organization classified as a trust under Section 301.7701-4 of the regulations or otherwise subject to special

treatment under the Internal Revenue Code. Any other organization that elects to be classified as a corporation by filing Form 8832 - Entity Classification

Election. An organization formed before 1997 and classified as a partnership under the old rules will generally continue to be classified as a partnership as long as the organization has at least two members and does not elect to be classified as a corporation by filing Form 8832.

Allocation of Personal Service Income If the income is for personal services performed partly in the United States and partly outside the United States, the taxpayer must make an accurate allocation of income for services performed in the United States. In most cases, other than certain fringe benefits, he or she makes this allocation on a time basis. That is, U.S. source income is the amount

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that results from multiplying the total amount of pay by the fraction of days in which services were performed in the U.S. This fraction is determined by dividing the number of days services are performed in the United States by the total number of days of service for which the compensation is paid. (122) S Corporations In most cases, an S corporation does not pay tax on its income. Instead, the income, losses, deductions, and credits of the corporation are passed through to the shareholders based on each shareholder's pro rata share. The taxpayer must report his or her share of these items on the tax return. In most cases, the items passed through to the taxpayer will increase or decrease the basis of the S corporation stock as appropriate. (113) Estates and Trusts An estate or trust, unlike a partnership, may have to pay Federal income tax. If the taxpayer is a beneficiary of an estate or trust, he or she may be taxed on his or her share of its income distributed or required to be distributed to the taxpayer. However, there is never a double tax. Estates and trusts file their returns on Form 1041 - U.S. Income Tax Return for Estates and Trusts and the taxpayer’s share of the income is reported to him or her on Schedule K-1 (Form 1041) - Beneficiary’s Share of Income, Deductions, Credits. The decedent's estate fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic estate that has: (123)

Gross income for the tax year of $600 or more. A beneficiary who is a nonresident alien.

The trust’s fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic trust taxable under section 641 that has: (123)

Any taxable income for the tax year. Gross income of $600 or more (regardless of taxable income). A beneficiary who is a nonresident alien.

Scholarships, Fellowships, and Grants Scholarships, fellowships, and grants are sourced according to the residence of the payer. Those made by entities created or domiciled in the United States are generally treated as income from sources within the United States. Those made by entities created or domiciled in a foreign country are treated as income from foreign sources. A scholarship is generally an amount paid or allowed to a student at an educational institution for the purpose of study. A fellowship is generally an amount paid to an individual for the purpose of research. The amount of a scholarship or fellowship includes the following: (124)

The value of contributed services and accommodations. This includes such services and accommodations as room (lodging), board (meals), laundry service, and similar services or accommodations that are received by an individual as a part of a scholarship or fellowship.

The amount of tuition, matriculation, and other fees that are paid or remitted to the student to aid the student in pursuing study or research.

Any amount received in the nature of a family allowance as a part of a scholarship or fellowship. If the taxpayer receives a scholarship or fellowship grant, all or part of the amounts received may be tax-free. Qualified scholarship and fellowship grants are treated as tax-free amounts if the following conditions are met: (125)

1. The taxpayer is a candidate for a degree at an educational institution that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities; and

2. Amounts the taxpayer receives as a scholarship or fellowship grant are used for tuition and fees required for enrollment or attendance at the educational institution, or for fees, books, supplies, and equipment required for courses at the educational institution.

Also, a scholarship or fellowship is tax free only to the extent: (125)

1. It does not exceed the taxpayer’s expenses.

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2. It is not designated or earmarked for other purposes (such as room and board), and does not require (by its terms) that it cannot be used for qualified education expenses.

3. It does not represent payment for teaching, research, or other services required as a condition for receiving the scholarship.

The taxpayer is a candidate for a degree if he or she: (125)

1. Attends a primary or secondary school or are pursuing a degree at a college or university, or 2. Attends an educational institution that:

a. Provides a program that is acceptable for full credit toward a bachelor's or higher degree, or offers a program of training to prepare students for gainful employment in a recognized occupation; and

b. Is authorized under Federal or state law to provide such a program and is accredited by a nationally recognized accreditation agency.

An eligible educational institution is one whose main function is the presentation of formal instruction and that typically maintains a regular faculty and curriculum and generally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities. For purposes of tax-free scholarships and fellowships, these are expenses for: (125)

1. Tuition and fees required to enroll at or attend an eligible educational institution. 2. Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the

eligible educational institution. These items must be required of all students in the taxpayer’s course of instruction. Qualified education expenses do not include the cost of room and board, travel, research, clerical help, equipment or other expenses that are not required for enrollment in or attendance at an eligible educational institution. A taxpayer must include in gross income amounts used for incidental expenses, such as room and board, travel, and optional equipment, and generally amounts received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant. Generally, the taxpayer cannot exclude from his or her gross income the part of any scholarship or fellowship that represents payment for teaching, research, or other services required as a condition for receiving the scholarship. This applies even if all candidates for a degree must perform the services to receive the degree. Also, when reporting scholarship income on the tax return, a taxpayer will include the amounts on the same line as “Wages, salaries, tips, etc.” However, the taxpayer does not have to treat as payment for services the part of any scholarship or fellowship that represents payment for teaching, research or other services if he or she receives the amount under: (125)

The National Health Service Corps Scholarship Program. The Armed Forces Health Professions Scholarship and Financial Assistance Program.

Whether the taxpayer must report his or her scholarship or fellowship depends on whether he or she must file a return and whether any part of his or her scholarship or fellowship is taxable. If the taxpayer’s only income is a completely tax-free scholarship or fellowship, he or she does not have to file a tax return and no reporting is necessary. If all or part of the taxpayer’s scholarship or fellowship is taxable and he or she is required to file a tax return, the taxpayer must report the taxable amount whether or not he or she received a Form W-2. If the taxpayer receives an incorrect Form W-2, he or she should ask the payer for a corrected one. Athletic Scholarships Athletic scholarships are tax-free only if they meet the requirements discussed above. For example, if the taxpayer’s son or daughter were to receive an athletic scholarship in an amount that paid for tuition and fees, room and board, books and supplies, and miscellaneous expenses, two thirds of the scholarship would be taxable to the student-athlete in the year the funds were received. An athletic scholarship, as with other scholarships, is only tax-free when used to pay for qualified expenses. The same rules apply to any scholarship that the student may receive that is used to pay educational expenses. Fulbright Grants A Fulbright grant is generally treated as any other scholarship or fellowship in figuring how much of the grant is tax-free.

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If the taxpayer receives a Fulbright grant for lecturing or teaching, it is payment for services and is taxable. A special rule applies if the grant was paid in nonconvertible foreign currency. A Fulbright grant is a grant under the Mutual Educational and Cultural Exchange Act of 1961, known as the Fulbright-Hays Act. If the taxpayer receives a supplemental grant under the U.S. Information and Educational Exchange Act of 1948 (Smith-Mundt Act) for study, research, or teaching abroad, it is treated like a Fulbright grant. Pell Grants and Other Title IV Need-Based Education Grants These need-based grants are treated as scholarships for purposes of determining their tax treatment. They are tax-free to the extent used for qualified education expenses during the period for which a grant is awarded. Payment to Service Academy Cadets An appointment to a United States military academy is not a scholarship or fellowship. Payment the taxpayer receives as a cadet or midshipman at an armed services academy is pay for personal services and will be reported to him or her in box 1 of Form W-2. Veterans' Benefits Payments the taxpayer receives for education, training, or subsistence under any law administered by the Department of Veterans Affairs (VA) are tax free. The taxpayer does not include these payments as income on his or her Federal tax return. If the taxpayer qualifies for one or more of the education benefits, he or she may have to reduce the amount of education expenses qualifying for a specific benefit by part or all of his or her VA payments. This applies only to the part of the taxpayer’s VA payments that is required to be used for education expenses. Example Stephanie returned to college and is receiving two education benefits under the latest GI Bill. She receives a $1,534 monthly basic housing allowance (BHA) that is directly deposited to her checking account, and $3,840 paid directly to her college for tuition. Neither of these benefits is taxable and Stephanie does not report them on her tax return. She also wants to claim an American Opportunity Tax Credit on her return. She paid $5,000 in qualified education expenses. To figure the amount of credit, Stephanie must first subtract the $3,840 from her qualified education expenses because this payment under the GI Bill was required to be used for education expenses. She does not subtract any amount of the BHA because it was paid to her and its use was not restricted. Qualified Tuition Reduction If the taxpayer is allowed to study tuition free or for a reduced rate of tuition, he or she may not have to pay tax on this benefit. This is called a “tuition reduction.” The taxpayer does not have to include a qualified tuition reduction in his or her income. A tuition reduction is qualified only if the taxpayer receives it from, and uses it at, an eligible educational institution. The taxpayer does not have to use the tuition reduction at the eligible educational institution from which he or she received it. In other words, if the taxpayer works for an eligible educational institution and the institution arranges for him or her to take courses at another eligible educational institution without paying any tuition, he or she may not have to include the value of the free courses in his or her income. The rules for determining if a tuition reduction is qualified, and therefore tax free, are different if the education provided is below the graduate level or is graduate education. Also, a taxpayer must include in his or her income any tuition reduction he or she receives that is payment for his or her services. Qualified tuition reductions apply to officers, owners, or highly compensated employees only if benefits are available to employees on a nondiscriminatory basis. This means that the tuition reduction benefits must be available on substantially the same basis to each member of a group of employees. The group must be defined under a reasonable classification set up by the employer. The classification must not discriminate in favor of owners, officers, or highly compensated employees.

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Special Rules for Certain Employees Clergy For income tax purposes, a licensed, commissioned, or ordained minister is generally treated as a common law employee of his or her church, denomination, or sect. If the taxpayer is a minister performing ministerial services, he or she is taxed on wages, offerings, and on any fees received for performing marriages, baptisms, funerals and masses. (126) Special rules for housing apply to members of the clergy. Under these rules, the taxpayer does not include in income the rental value of a home (including utilities) or a designated housing allowance provided to him or her as part of pay. However, the exclusion cannot be more than the reasonable pay for the taxpayer’s service. (113) If the taxpayer is a member of a religious order who has taken a vow of poverty, how he or she treats earnings that he or she renounces and turn over to the order depends on whether the taxpayer’s services are performed for the order. If the taxpayer is performing the services as an agent of the order in the exercise of duties required by the order, do not include in his or her income the amounts turned over to the order.

If the taxpayer’s order directs him or her to perform services for another agency of the supervising church or an associated institution, the taxpayer is considered to be performing the services as an agent of the order. Any wages he or she earns as an agent of an order that he or she turns over to the order are not included in his or her income.

Example Harold is a member of a church order and has taken a vow of poverty. He renounces any claims to his earnings and turns over to the order any salaries or wages he earns. Harold is a registered nurse, so his order assigns him to work in a hospital that is an associated institution of the church. However, Harold remains under the general direction and control of the order. He is considered to be an agent of the order and any wages he earns at the hospital that he turns over to his order are not included in his income. Foreign Employer A U.S. citizen who works in the United States for a foreign government, an international organization, a foreign embassy, or any foreign employer, must include his or her salary in his or her income. The taxpayer is exempt from Social Security and Medicare employee taxes if he or she is employed in the United States by an international organization or a foreign government. However, the taxpayer must pay self-employment tax on earnings from services performed in the United States, even though he or she is not self-employed. This rule also applies if the taxpayer is an employee of a qualifying wholly-owned instrumentality of a foreign government. (113) Military For Federal tax purposes, the U.S. Armed Forces includes officers and enlisted personnel in all regular and reserve units controlled by the Secretaries of Defense, the Army, Marines, Navy and Air Force. The Coast Guard is also included, but not the U.S. Merchant Marine or the American Red Cross. However, these and other support personnel may qualify for certain tax deadline extensions because of their service in a combat zone. (127)

Passive Income Passive income can only be generated by a passive activity. Just because the taxpayer did not work for the income does not mean it is passive. There are only two sources for passive income: (128)

A rental activity. A business in which the taxpayer does not materially participate.

The following incomes may seem passive, but generally, none are passive income: (128)

Portfolio income, including interest, dividends, royalties, annuities and gains on stocks and bonds. Lottery winnings. Salaries, wages, Form 1099-MISC commissions and retirement income.

Lesson 5 - Income

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Guaranteed payments for services. Income from any activity in which the taxpayer materially participates.

Regardless of whether income is deemed to be passive or non-passive, it must always be reported somewhere on the return, most typically on Schedule E - Supplemental Income and Loss. Form 8582 - Passive Activity Loss Limitations is computational only, figuring the amount of passive loss deductible for the current year. It is not the form used to report income.

Form 8582 is filed by individuals, estates, and trusts who have passive activity deductions (including prior year unallowed losses). However, the taxpayer does not have to file Form 8582 if he or she meets the following exception. The taxpayer actively participated in rental real estate activities and he or she meets all of the following conditions: (129)

Rental real estate activities with active participation were the taxpayer’s only passive activities. The taxpayer has no prior year unallowed losses from these (or any other passive) activities. The taxpayer’s total loss from the rental real estate activities was not more than $25,000 ($12,500 if married filing

separately). If the taxpayer is married filing separately, he or she lived apart from his or her spouse all year. The taxpayer has no current or prior year unallowed credits from a passive activity. The taxpayer modified adjusted gross income was not more than $100,000 (not more than $50,000 if married

filing separately). The taxpayer does not hold any interest in a rental real estate activity as a limited partner or as a beneficiary of

an estate or trust.

For tax year 2017 if a taxpayer actively participated in a passive rental real estate activity, he or she may be able to deduct up to $25,000 of loss from the activity from his or her non-passive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. The taxpayer is not considered to actively participate in a rental real estate activity if at any time during the tax year his or her interest (including his or her spouse's interest) in the activity was less than 10% (by value) of all interests in the

activity. Also, the special allowance is not available if the taxpayer was married, is filing a separate return for the year, and lived with his or her spouse at any time during the year. (129)

Rental Income Generally, cash or the fair market value of property a taxpayer receives for the use of real estate or personal property is taxable to him or her as rental income. Most individuals operate on a cash basis, which means they count their rental income as income when it is actually or constructively received, and deduct their expenses as they are paid. Some specific types of income are: (130)

Amounts paid to cancel a lease – If a tenant pays a taxpayer to cancel a lease, this money is also rental income and is reported in the year received.

Advance rent – Generally the taxpayer includes any advance rent paid in income in the year he or she receives it regardless of the period covered or the method of accounting used.

Expenses paid by a tenant – If the tenant pays any of the taxpayer’s expenses, those payments are rental income. The taxpayer may be allowed to deduct the expenses if they are considered deductible expenses.

Security deposits – Do not include a security deposit in taxpayer’s income if he or she may be required to return it to the tenant at the end of the lease. But if the taxpayer keeps part or all of the security deposit because the tenant did not live up to the terms of the lease, this money is taxable income in the year the determination is made. If the taxpayer keeps the security deposit because the tenant damaged the property, the security deposit is not taxable. If the security deposit is to be used as the tenant's final month's rent, include the money as income when received, rather than when it is applied to the last month's rent.

If the rental agreement gives the tenant the right to buy the rental property, the payments received under the agreement are generally rental income. If the tenant exercises the right to buy the property, the payments received for the period after the date of sale are considered part of the selling price. (74)

Lesson 5 - Income

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If the taxpayer uses a dwelling unit as a home and he or she rents it less than 15 days during the year, its primary function is not considered to be a rental and it should not be reported on Schedule E (Form 1040). However, if the taxpayer uses a dwelling unit as a home and rents it 15 days or more during the year, include all rental income in his or her income. Since the taxpayer used the dwelling unit for personal purposes, he or she must divide the expenses between the rental use and the personal use. The expenses for personal use are not deductible as rental expenses. If the taxpayer had a net profit from renting the dwelling unit for the year (that is, if rental income is more than the total of rental expenses, including depreciation), deduct all of the rental expenses. However, if the taxpayer had a net loss from renting the dwelling unit for the year, the deduction for certain rental expenses is limited. See Publication 527 - Residential Rental Property to figure the deductible rental expenses and any carryover to the next year. Some examples of expenses that may be deducted from total rental income are: (74)

Depreciation – the taxpayer begins to depreciate his or her rental property when it is placed in service. The taxpayer can recover some or all of his or her original acquisition cost and improvements by using Form 4562 - Depreciation and Amortization beginning in the year the rental property is first placed in service, and beginning in any year the taxpayer makes improvements or adds furnishings. The rental is considered placed in service when it was ready and available for rent.

Repairs – repairs to keep the property in good working condition but do not add to the value of the property. Operating Expense. Uncollected rents – unless taxpayer is a cash basis taxpayer and cannot deduct uncollected rents as an expense

because he or she has not included those rents in income. If the taxpayer uses a dwelling unit for both rental and personal purposes, divide the expenses between the rental use and the personal use based on the number of days used for each purpose. When dividing the expenses, follow these rules: (74)

Any day that the unit is rented at a fair rental price is a day of rental use even if the taxpayer used the unit for personal purposes that day. (This rule does not apply when determining whether the taxpayer used the unit as a home.)

Any day that the unit is available for rent but not actually rented is not a day of rental use.

Separation or Divorce Income Whenever a husband and wife are legally separated or divorced, property and money may change hands. These exchanges, fall into one of three categories: child support payments, alimony, or property settlements. The difference between the three is more than a matter of legal terminology; they involve distinct tax consequences. Child Support These payments are nontaxable to the recipient and nondeductible by the taxpayer making the payments. If a taxpayer is in arrears in payments for both alimony and child support, payments are first applied to child support. For tax purposes, one can never pay alimony as long as child support is still owed. A recent law now allows the government to divert income tax refunds of taxpayers in arrears on child support payments. In addition, child support payments may now be withheld from the taxpayer's salary checks by employers who are so ordered by the courts. (91) Alimony Child support and alimony differ as to basic objectives. After the divorce or legal separation, the wife (or husband) loses the right to participate in the former spouse’s earnings. If many years of marriage have intervened, he or she may have lost marketable job skills, and advanced age could place such a person at a disadvantage in the labor market. Money paid from one spouse to another for day-to-day support of the spouse with fewer financial resources is alimony (sometimes also referred to as "spousal support"). The law allows courts to award alimony or spousal support to one of the former spouses when a married couple divorces. Payments made to a third party are considered alimony. Indirect alimony may include cash payments to a third party to provide a residence for a former spouse (i.e., rent, mortgage, utilities, etc.) medical cost payments or other such expenses incurred by the recipient.

Lesson 5 - Income

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Alimony does not include: (131)

Child support. Noncash property settlements. Payments that are taxpayer’s spouse's part of community property income. Payments to keep up the payer's property. Use of the payer's property.

Alimony, then, is in the nature of monetary reparations to compensate for the former spouse’s loss of earning power. Consideration of alimony as supplemental compensation is the key to determining its tax treatment. Alimony is taxable to the ex-spouse and deductible by the paying former spouse. The treatment of alimony is the opposite of that for child support. Taxpayers deducting alimony paid must report the amount paid on Line 31a of Form 1040 and the former spouse’s Social Security number on Line 31b of Form 1040. This additional information will make it possible for the Internal Revenue Service to determine that amounts being deducted by an ex-spouse are being reported as income by the recipient. (91)

If the taxpayer does not provide his or her former spouse's Social Security number, he or she may have to pay a $50 penalty and the deduction may be disallowed.

An amendment to a divorce decree may change the nature of the taxpayer’s payments. Amendments are not ordinarily retroactive for Federal tax purposes. However, a retroactive amendment to a divorce decree correcting a clerical error to reflect the original intent of the court will generally be effective retroactively for Federal tax purposes. If both alimony and child support payments are called for by the taxpayer’s divorce or separation instrument, and he or she pays less than the total required, the payments apply first to child support and then to alimony. Property Settlements Generally, there is no recognized gain or loss on the transfer of property between spouses, or between former spouses if the transfer is because of a divorce. A property transfer is incident to a taxpayer’s divorce if the transfer: (91)

Occurs within 1 year after the date the marriage ends. Is related to the ending of the marriage.

A divorce, for this purpose, includes the ending of a marriage by annulment or due to violations of state laws. A property transfer is related to the ending of a marriage if both of the following conditions apply: (91)

The transfer is made under an original or modified divorce or separation instrument. The transfer occurs within 6 years after the date the marriage ends.

Unless these conditions are met, the transfer is presumed not to be related to the ending of a marriage. However, this presumption will not apply if the taxpayer can show that the transfer was made to carry out the division of property owned by the taxpayer and his or her spouse at the time the marriage ended. For example, the presumption will not apply if the taxpayer can show that the transfer was made more than 6 years after the end of the marriage because of business or legal factors which prevented earlier transfer of the property and the transfer was made promptly after those factors were resolved. (91)

Lesson 5 - Income

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

Review Questions Answers appear in Review Feedback 1. Which of the following payments are generally taxable?

A. Qualified disaster relief payments B. Veteran Affairs (VA) benefits C. Unemployment compensation D. Payments from a government welfare fund based on need

2. Unemployment compensation generally includes any amount received under an unemployment compensation law of

the United States or of a state. Which of the following statements is false? A. The taxpayer may be liable for estimated taxes if he or she receives unemployment compensation B. Benefits paid to a taxpayer as an unemployed member of a union out of regular union dues are not included

in his or her gross income C. Benefits received from a company-financed fund, to which a taxpayer did not contribute, are taxable wages D. Payments a taxpayer receives from his or her employer during periods of unemployment, under a union

agreement that guarantees him or her full pay during the year, are taxable as wages 3. Which of the following is not rental income in the year received?

A. Security deposit, equal to one month's rent, to be refunded at the end of the lease if the building passes inspection

B. Payment to cancel the remaining lease C. Repairs paid by the tenant in lieu of rent D. January 2018 rent received December 2017

4. Unemployment compensation generally includes which of the following benefits?

A. Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund B. State unemployment insurance benefits C. Railroad unemployment compensation benefits D. All of the above

5. Which of the following is canceled debt that qualifies for exclusion from gross income?

A. Debt canceled in a Title 11 bankruptcy case B. Amounts specifically excluded from income by law such as gifts or bequests C. Cancellation of certain qualified student loans D. Canceled debt, if paid by a cash basis taxpayer, would be deductible

6. Which of the following is a source for passive income?

A. Lottery winnings B. Annuities C. Guaranteed payments for services D. Rental activity

Lesson 5 - Income

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7. A property transfer is incident to a taxpayer’s divorce if the transfer occurs within how many year(s) after the date the marriage ends?

A. One year B. Two years C. Three years D. Four years

Lesson 5 - Income

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Review Feedback Return to Review Questions Question 1 - C. Unemployment compensation The IRS provides the following list of items that do not have to be included as taxable income:

• Adoption expense reimbursements for qualifying expenses. • Child support payments. • Gifts, bequests and inheritances (Subject to limits). • Workers' compensation benefits. • Compensatory damages awarded for physical injury or physical sickness. • Welfare benefits. • Cash rebates from a dealer or manufacturer. • Qualified disaster relief payments. • VA benefits.

Unemployment compensation is not included on this list. Question 2 - B. Benefits paid to a taxpayer as an unemployed member of a union out of regular union dues are not included in his or her gross income Gross income means all income from whatever source derived unless specifically excluded. This is an intentionally broad definition. Unemployment compensation is included in gross income. Amounts paid pursuant to private nongovernmental unemployment compensation are includible without regard to Section 85. Thus, any payments made from any employer or from a union are taxable wages. Question 3 - A. Security deposit, equal to one month's rent, to be refunded at the end of the lease if the building passes inspection Do not include a security deposit in taxpayer’s income if he or she may be required to return it to the tenant at the end of the lease. But if the taxpayer keeps part or all of the security deposit because the tenant did not live up to the terms of the lease, this money is taxable income in the year the determination is made. If the taxpayer keeps the security deposit because the tenant damaged the property, the security deposit is not taxable. If the security deposit is to be used as the tenant's final month's rent, include the money as income when received, rather than when it is applied to the last month's rent. Question 4 - D. All of the above Unemployment compensation generally includes benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund, state unemployment insurance benefits, railroad unemployment compensation benefits, disability payments from a government program paid as a substitute for unemployment compensation, trade readjustment allowances under the Trade Act of 1974, unemployment assistance under the Disaster Relief and Emergency Assistance Act of 1974 and unemployment assistance under the Airline Deregulation Act of 1974 Program. Question 5 - A. Debt canceled in a Title 11 bankruptcy case Canceled debt that qualifies for exclusion from gross income include debt canceled in a Title 11 bankruptcy case, debt canceled during insolvency, cancellation of qualified farm indebtedness, cancellation of qualified real property business indebtedness and cancellation of qualified principal residence indebtedness. Question 6 - D. Rental activity Passive income can only be generated by a passive activity. Just because the taxpayer did not work for the income does not mean it is passive. There are only two sources for passive income; a rental activity or a business in which the taxpayer does not materially participate. Question 7 - A. One year Generally, there is no recognized gain or loss on the transfer of property between spouses, or between former spouses if the transfer is because of a divorce. A property transfer is incident to a taxpayer’s divorce if the transfer occurs within 1 year after the date the marriage ends and is related to the ending of the marriage. A divorce, for this purpose, includes the ending of a marriage by annulment or due to violations of state laws.

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Investment Income At the conclusion of this lesson you should have a basic knowledge of:

Dividends Interest Subject to the Tax Reporting Interest Schedule B (Form 1040A or 1040)

Investment income is generally all income other than salaries, wages, and other amounts received as pay for work actually done. It includes taxable interest, dividends, capital gains (including capital gain distributions) and royalties. Taxable interest includes interest received from bank accounts, loans made to others and other sources. Dividends are distributions of money, stock, or other property paid by a corporation or by a mutual fund. The taxpayer may also receive dividends through a partnership, an estate, a trust, or an association that is taxed as a corporation. However, some amounts received called dividends are actually interest income. Capital gain distributions (also called capital gain dividends) are paid or credited to a taxpayer’s account by mutual funds (or other regulated investment companies) and real estate investment trusts (REITs). They will be shown in box 2a of the Form 1099-DIV received from the mutual fund or REIT. (72)

Dividends For many years, millions of people have invested in corporate stocks. For this reason, dividends are a popular source of income. A dividend on stock is similar to an interest payment received on a savings account, note or bond, but with two important differences. Unlike interest, the amount of the dividend is not specified by contract and dividends are not necessarily paid at regular intervals, but depend upon the decision of the corporate directors to make a distribution. The most common kinds of distributions are: (132)

Ordinary dividends. Capital gain distributions. Non-dividend distributions.

Most distributions are paid in cash (check). However, distributions can consist of more stock, stock rights, other property or services.

Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as stock options) are distributions by a corporation of rights to acquire the corporation's stock. Generally, stock dividends and stock rights are not taxable to an individual. However, there are some exceptions. If the stock dividends are not taxable, a taxpayer must divide his or her basis for the old stock between the old and new stock. The basis of stock must be adjusted for certain events that occur after purchase. For example, if the taxpayer receives more stock from nontaxable stock dividends or stock splits, he or she must reduce the basis of the original stock. The taxpayer must also reduce the basis when he or she receives non-dividend distributions. These distributions, up to the amount of the basis, are a nontaxable return of capital. Example Bruce bought 100 shares of stock of XYZ Corporation in 2000 for $10 a share. In January 2001 he bought another 200 shares for $11 a share. In July 2001 he gave his son 50 shares. In December 2003 he bought 100 shares for $9 a share. In April 2017 he sold 130 shares. Bruce cannot identify the shares he disposed of, so he must use the stock he acquired first to figure the basis. The shares of stock he gave his son had a basis of $500 (50 × $10). Bruce figures the basis of the 130 shares of stock he sold in 2017 as follows:

50 shares (50 × $10) balance of stock bought in 2000 - $500. 80 shares (80 × $11) stock bought in January 2001 - $880. Total basis of stock sold in 2017 = $1,380.

Lesson 6 - Investment Income

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The basis of shares in a mutual fund (or other regulated investment company) or a real estate investment trust (REIT) is generally figured in the same way as the basis of other stock and usually includes any commissions or load charges paid for the purchase. Example The taxpayer bought 100 shares of Fund A for $10 a share. She paid a $50 commission to the broker for the purchase. Her cost basis for each share is $10.50 ($1,050 ÷ 100). Dividends Subject to the Tax For tax purposes, a dividend is any distribution of property made by a corporation to its stockholders, provided it is paid out of earnings and profits accumulated since March 1, 1913. When a corporation has no profits prior to a distribution, or when all accumulated profits have already been distributed to the stockholders, a distribution is nothing more than a return of the stockholders' capital investment. Such a distribution amounts to a partial liquidation of the corporation, and these distributions must receive treatment different from that given ordinary dividends. In addition, some distributions from certain corporations are taxed as capital gains. The usual example is the investments company, which distributes the ordinary dividends, received by it and the capital gains realized during the period. The form in which a dividend is received (cash or property) has no effect on its taxation. Most dividends are paid in cash. When a distribution is of some property other than cash, the fair market value of the property at the time of the distribution is the measure of the dividend. Small, closely held corporations frequently make non-cash distributions in order to preserve their working capital. Section 61(a)(7) lists dividends as being included in gross income. They are included in their entirety unless there is a specific exclusion. There is no exclusion for dividends received by an individual from a taxable domestic corporation (provided the dividends are paid out of earnings and profits, which is the assumed case unless other information is provided). An eligible domestic corporation can avoid double taxation (once to the shareholders and again to the corporation) by electing to be treated as an S corporation. Ordinary Dividends and Qualified Dividends Since January 1, 2003, dividends have been split into ordinary dividends and qualified dividends. Ordinary Dividends

Ordinary dividends received by a taxpayer are included in gross income and continue to be taxed as ordinary income. A taxpayer can assume that any dividend he or she receives on common or preferred stocks is an ordinary dividend, unless the paying corporation on its Form 1099-DIV - Dividends and Distributions states otherwise. The dividend tax on these dividends is the same as an investor's personal income tax bracket. If

the taxpayer is in the 25% tax bracket, for instance, he or she will pay a 25% dividend tax on ordinary (also known as non-qualified) dividends. Ordinary dividends are entered on Line 9a, Form 1040, and are usually shown in box 1a of the taxpayers’ Form(s) 1099-DIV. If the total ordinary dividends exceed $1,500 all ordinary dividends must be reported on Part II, Schedule B. Qualified Dividends Qualified dividends are eligible to be taxed at a lower tax rate than other ordinary income. Generally, qualified dividends are taxed at long-term capital gains rates. For 2017, this means that qualified dividends are subject to the same 0%, 15%, or 20% maximum tax rate that applies to net capital gains. The maximum rate of tax on qualified dividends is:

0% on any amount that otherwise would be taxed at a 10% or 15% rate. 15% on any amount that otherwise would be taxed at rates greater than 15% but less than 39.6%. 20% on any amount that otherwise would be taxed at a 39.6% rate.

Lesson 6 - Investment Income

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To qualify for the maximum rate, all of the following requirements must be met:

1. The dividends must have been paid by a U.S. corporation or a qualified foreign corporation. 2. The dividends are not of the type listed below under Dividends that are not Qualified Dividends. 3. The taxpayer must meet the holding period.

Additional 3.8% Federal Net Investment Income Tax (NIIT) applies to individuals on the lesser of net investment income or modified AGI in excess of $200,000 (single) or $250,000 (married/filing jointly and qualifying widow(er)s). The tax also applies to any trust or estate on the lesser of undistributed net income or adjusted gross income (AGI) in excess of the dollar amount at which the estate/trust pays income taxes at the highest rate. To help calculate the tax on qualified dividends (and capital gains) the IRS provides a Qualified Dividends and Capital Gain Tax Worksheet. Holding Period The taxpayer must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment. When counting the number of days the taxpayer held the stock, include the day he or she disposed of the stock, but not the day he or she acquired it (there are minor exceptions to these requirements). In the case of preferred stock, the taxpayer must have held the stock more than 90 days during the 181-day period that begins 90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days. If the preferred dividends are due to periods totaling less than 367 days, the holding period in the previous paragraph applies. Dividends that are not Qualified Dividends The following dividends are not qualified dividends. They are not qualified dividends even if they are shown in box 1b of Form 1099-DIV: (133)

Capital gain distributions. Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building and loan

associations, U.S. savings and loan associations, Federal savings and loan associations, and similar financial institutions.

Dividends from a corporation that is a tax-exempt organization or farmer's cooperative during the corporation's tax year in which the dividends were paid or during the corporation's previous tax year.

Dividends paid by a corporation on employer securities held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation.

Dividends on any share of stock to the extent the taxpayer is obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property.

Payments in lieu of dividends. Payments shown in Form 1099-DIV, box 1b, from a foreign corporation to the extent the taxpayer knows or has

reason to know the payments are not qualified dividends. How To Report Dividend Income Generally, the taxpayer can use either Form 1040 or Form 1040A to report dividend income. Report the total of the ordinary dividends on line 9a of Form 1040 or Form 1040A. Report qualified dividends on line 9b. If the taxpayer received capital gain distributions, he or she may be able to use Form 1040A or may have to use Form 1040. If the taxpayer received non-dividend distributions required to be reported as capital gains, he or she must use Form 1040. The taxpayer cannot use Form 1040EZ if he or she received any dividend income. Use Schedule B - Interest and Ordinary Dividends if the taxpayer had over $1,500 of taxable interest or ordinary dividends. If the taxpayer owned stock on which he or she received $10 or more in dividends and other distributions, the taxpayer should receive a Form 1099-DIV. Even if the taxpayer does not receive a Form 1099-DIV, he or she must report all taxable dividend income. Stock Spilt A stock split occurs when a company creates additional shares, thus reducing the price per share. If the taxpayer owns stock that has split and now owns additional shares, he or she must adjust his or her basis per share or per the lots of the stock he or she owns. If the old shares of stock and the new shares are uniform and identical: (134)

Lesson 6 - Investment Income

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The basis of the old shares must be allocated to the old and new shares. The per share basis is determined by dividing the adjusted basis of the old stock by the number of shares of old

and new stock. If the old shares were purchased in separate lots for differing amounts of money (a different basis per lot) the adjusted basis of the old stock must be allocated between the old and new stock on a lot by lot basis. In a stock split, a corporation issues additional shares to current shareholders, but the total basis does not change. Following a stock split, a taxpayer must reallocate his or her basis between the original shares and the shares newly acquired in the stock split. (134)

Stock splits do not create a taxable event; the taxpayer merely receives more stock evidencing the same ownership interest in the corporation that issued the stock. He or she does not report income until he or she sells the stock.

The taxpayer’s overall basis is not changed as a result of a stock split, but his or her per share basis is changed. The taxpayer will need to adjust his or her basis per share of the stock.

Example If the taxpayer owns 100 shares of a corporation with a $15 per share basis, the total basis is $1,500. In a 2-for-1 stock split, every shareholder is issued an additional share of stock for each share the shareholder owns. The taxpayer now owns 200 shares, but his or her total basis is still $1,500. Following the stock split, the taxpayer must reallocate the basis between the original shares and the shares newly acquired in the stock split. The basis per share is now $7.50 ($1,500 divided by 200) for each of the 200 shares. Stock Options If the taxpayer receives an option to buy stock, he or she may have income when he or she receives the option, when he or she exercises the option, or when he or she disposes of the option or stock received when he or she exercises the option. There are two types of stock options: statutory stock options and non-statutory stock options. Generally, options granted under an employee stock purchase plan (ESPP) or an incentive stock option (ISO) plan are considered statutory stock options. Non-statutory stock options are not granted under an employee stock purchase plan or an ISO plan. (135) If the taxpayer is granted a statutory stock option, he or she generally does not include any amount in his or her gross income when he or she is granted or exercises the option. However, the taxpayer may be subject to Alternative Minimum Tax in the year he or she exercises an ISO. The taxpayer has taxable income or deductible loss when he or she sells the stock received by exercising the option. The taxpayer generally treats this amount as a capital gain or loss. However, if he or she does not meet special holding period requirements, he or she will have to treat income from the sale as ordinary income. (135) If the taxpayer is granted a non-statutory stock option, the amount of income to include and the time to include it depends on whether the fair market value of the option can be readily determined. If an option is actively traded on an established market, the fair market value of the option can be readily determined. Most non-statutory options do not have a readily determinable fair market value. For non-statutory options without a readily determinable fair market value, there is no taxable event when the option is granted but the fair market value of the stock received on exercise, less the amount paid, is included in income when the option is exercised. The taxpayer has taxable income or deductible loss when he or she sells the stock received by exercising the option. The taxpayer generally treats this amount as a capital gain or loss. (135) Non-Dividend Distributions A non-dividend distribution is a distribution that is not paid out of the earnings and profits of a corporation or a mutual fund. The taxpayer should receive a Form 1099-DIV or other statement showing the non-dividend distribution. On Form 1099-DIV, a non-dividend distribution will be shown in box 3. If the taxpayer does not receive such a statement, he or she reports the distribution as an ordinary dividend. A non-dividend distribution reduces the basis of the taxpayer’s stock. It is not taxed until his or her basis in the stock is fully recovered. This nontaxable portion is also called a return of capital; it is a return of the taxpayer’s investment in the stock of the company. If the taxpayer buys stock in a corporation in different lots at different times, and he or she cannot definitely identify the shares subject to the non-dividend distribution, reduce the basis of the earliest purchases first.

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When the basis of the stock has been reduced to zero, report any additional non-dividend distribution the taxpayer receives as a capital gain. Whether he or she reports it as a long-term or short-term capital gain depends on how long he or she has held the stock. Example Francisco bought stock in 2002 for $100. In 2006, he received a non-dividend distribution of $80. He did not include this amount in his income, but he reduced the basis of his stock to $20. Francisco received a non-dividend distribution of $30 in 2017. The first $20 of this amount reduced his basis to zero. He reports the other $10 as a long-term capital gain for 2017. Francisco must report as a long-term capital gain any non-dividend distribution he receives on this stock in later years.

Interest Subject to the Tax Interest is rent on money, paid by the borrower to the lender. With few exceptions, interest is fully taxable to the taxpayer receiving it. Taxable interest includes interest received from bank accounts, loans made to others, and other sources. The major problem connected with interest is the determination of the year when it is included in gross income. To a cash-basis taxpayer, interest is taxable under the doctrine of constructive receipt of income when it is unqualifiedly made subject to the demand of the taxpayer. Under this rule, interest is received when it is credited to the taxpayer's account. Taxable interest income is reported on Line 8a, Form 1040. For 2017, if interest and dividend income exceed $1,500, a listing of all sources and amounts would have to be shown on Part I of Schedule B. Otherwise if the taxpayer had interest income and dividends of less than $1,500 the total amount may be placed directly on the Form 1040 Line 8a. Interest income is generally reported to taxpayers on Form 1099-INT- Interest Income, or a similar statement, by banks, savings and loans, and other payers of interest. Form 1099-INT does not have to be attached to the submitted tax return unless it has tax withholding. (132) Certain distributions commonly called dividends are actually interest. A taxpayer must report as interest so-called dividends on deposits or on share accounts in: (136)

Cooperative banks. Credit unions. Domestic building and loan associations. Domestic savings and loan associations. Federal savings and loan associations. Mutual savings banks.

U.S. Savings Bonds Series HH bonds were issued at face value. Interest is paid twice a year by direct deposit to the taxpayer’s bank account. If the taxpayer is a cash method taxpayer, he or she must report interest on these bonds as income in the year received. Series HH bonds were first offered in 1980 and last offered in August 2004. Before 1980, series H bonds were issued. Series H bonds are treated the same as series HH bonds. If the taxpayer is a cash method taxpayer, he or she must report the interest when received. Series H bonds have a maturity period of 30 years. Series HH bonds mature in 20 years. The last series H bonds matured in 2009. Interest on series EE and series I bonds is payable when the taxpayer redeems the bonds. The difference between the purchase price and the redemption value is taxable interest. Series EE bonds were first offered in January 1980 and have a maturity period of 30 years. Series E bonds were issued before July 1980. The original 10-year maturity period of series E bonds has been extended to 40 years for bonds issued before December 1965 and 30 years for bonds issued after November 1965. Paper series EE and series E bonds are issued at a discount. The face value is payable to the taxpayer at maturity. Electronic series EE bonds are issued at their face value. The face value plus accrued interest is payable to the taxpayer at maturity. As of January 1, 2012, paper savings bonds will no longer be sold at financial institutions.

Lesson 6 - Investment Income

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Owners of paper series EE bonds can convert them to electronic bonds. These converted bonds do not retain the denomination listed on the paper certificate but are posted at their purchase price (with accrued interest). Series I bonds were first offered in 1998. These are inflation-indexed bonds issued at their face amount with a maturity period of 30 years. The face value plus all accrued interest is payable to the taxpayer at maturity. If the taxpayer uses the cash method of reporting income, he or she can report the interest on series EE, series E, and series I bonds in either of the following ways:

Method 1 - Postpone reporting the interest until the earlier of the year he or she cashes or disposes of the bonds or the year they mature.

Method 2 - Choose to report the increase in redemption value as interest each year. The taxpayer must use the same method for all series EE, series E, and series I bonds he or she owns. If the taxpayer does not choose method 2 by reporting the increase in redemption value as interest each year, he or she must use method 1.

If the taxpayer uses an accrual method of accounting, he or she must report interest on U.S. savings bonds each year as it accrues. The taxpayer cannot postpone reporting interest until it is received or until the bonds mature.

Discount on Debt Instruments A debt instrument, such as a bond, note, debenture, or other evidence of indebtedness, that bears no interest or bears interest at a lower than current market rate will usually be issued at less than its face amount. This discount is, in effect, additional interest income. The following are some types of discounted debt instruments.

U.S. Treasury bonds. Corporate bonds. Municipal bonds. Certificates of deposit. Notes between individuals. Stripped bonds and coupons. Collateralized debt obligations (CDOs).

The discount on these instruments (except municipal bonds) is taxable in most instances. The discount on municipal bonds generally is not taxable. Gift for Opening Account If the taxpayer receives noncash gifts or services for making deposits or for opening an account in a savings institution, he or she may have to report the value as interest. For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest. The value is determined by the cost to the financial institution. Interest on Insurance Dividends Interest on insurance dividends left on deposit with an insurance company that can be withdrawn annually is taxable to an individual in the year it is credited to his or her account. However, if the taxpayer can withdraw it only on the anniversary date of the policy (or other specified date), the interest is taxable in the year that date occurs. Prepaid Insurance Premiums Any increase in the value of prepaid insurance premiums, advance premiums, or premium deposit funds is interest if it is applied to the payment of premiums due on insurance policies or made available to the taxpayer for withdraw.

Lesson 6 - Investment Income

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U.S. Obligations Interest on U.S. obligations, such as U.S. Treasury bills, notes, and bonds, issued by any agency or instrumentality of the United States is taxable for Federal income tax purposes. Installment Sale Payments If a contract for the sale or exchange of property provides for deferred payments, it also usually provides for interest payable with the deferred payments. That interest is taxable when the taxpayer receives it. If little or no interest is provided for in a deferred payment contract, part of each payment may be treated as interest. Other Taxable Interest Interest a taxpayer receives on tax refunds, accumulated interest on an annuity contract sold before its maturity date and the interest a condemning authority pays to compensate for a delay in payment of an award is taxable income. Excluded Interest

Interest received on the obligations of a state, a territory, or any political subdivision of a state or territory, such as a city or a county, is excluded fully from Federal income taxation. This exclusion makes an investment in state and local bonds attractive for taxpayers that are in higher tax brackets. However, tax-exempt interest must be reported on Line 8b, page 1, Form 1040 even though it is not taxed. (136)

Even if interest on the obligation is not subject to income tax, the taxpayer may have to report a capital gain or loss when he or she sells it. Estate, gift, or generation-skipping tax may apply to other dispositions of the obligation. Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a U.S. possession, or any of their political subdivisions. Political subdivisions include: (137)

Port authorities. Toll road commissions. Utility services authorities. Community redevelopment agencies. Qualified volunteer fire departments (for certain obligations issued after 1980).

Capital Gain Distributions Capital gain distributions (also called capital gain dividends) are paid to a taxpayer or credited to his or her account by mutual funds (or other regulated investment companies) and real estate investment trusts (REITs). They will be shown in box 2a of the Form 1099-DIV received from the mutual fund or REIT. Report capital gain distributions as long-term capital gains, regardless of how long the taxpayer owned his or her shares in the mutual fund or REIT. Money Market Funds Money market funds are offered by nonbank financial institutions such as mutual funds and stock brokerage houses, and pay dividends. Generally, amounts a taxpayer receives from money market funds should be reported as dividends, not as interest. Exempt-interest dividends taxpayer receives from a mutual fund or other regulated investment company, including those received from a qualified fund of funds in any tax year beginning after December 22, 2010, are not included in taxable income. Other Deferred Interest Accounts If the taxpayer opens a certificate of deposit and other deferred interest account, interest may be paid at fixed intervals of 1 year or less during the term of the account. The taxpayer generally must include this interest in his or her income when he or she actually receives it or is entitled to receive it without paying a substantial penalty. The same is true for accounts that mature in 1 year or less and pay interest in a single payment at maturity. If the taxpayer withdraws funds from a deferred interest account before maturity, he or she may have to pay a penalty. The taxpayer must report the total amount of interest paid or credited to his or her account during the year, without subtracting the penalty.

Lesson 6 - Investment Income

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The interest a taxpayer pays on money borrowed from a bank or savings institution to meet the minimum deposit required for a certificate of deposit from the institution and the interest he or she earns on the certificate are two separate items. The taxpayer must report the total interest he or she earns on the certificate in his or her income. If the taxpayer itemizes deductions, he or she can deduct the interest he or she pays as investment interest, up to the amount of his or her net investment income. Tax Exempt Bonds This is an obligation issued by or on behalf of a governmental issuer for which the interest paid is excluded from the holder's gross income under section 103. For this purpose, a bond can be in any form of indebtedness under Federal tax law, including a bond, note, loan, or lease-purchase agreement such as a municipal bond. Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a U.S. possession, or any of their political subdivisions. Political subdivisions include: (72)

Port authorities. Toll road commissions. Utility services authorities. Community redevelopment agencies. Qualified volunteer fire departments (for certain obligations issued after 1980).

There are other requirements for tax-exempt bonds. Contact the issuing state or local government agency or see sections 103 and 141 through 150 of the Internal Revenue Code and the related regulations. Interest on a state or local government obligation may be tax exempt even if the obligation is not a bond. For example, interest on a debt evidenced only by an ordinary written agreement of purchase and sale may be tax exempt. Also, interest paid by an insurer on default by the state or political subdivision may be tax exempt. Interest on Federally guaranteed state or local obligations issued after 1983 is generally taxable. This rule does not apply to interest on obligations guaranteed by the following U.S. Government agencies: (72)

Bonneville Power Authority (if the guarantee was under the Northwest Power Act as in effect on July 18, 1984). Department of Veterans Affairs. Federal home loan banks. (The guarantee must be made after July 30, 2008, in connection with the original bond

issue during the period beginning on July 30, 2008, and ending on December 31, 2010 (or a renewal or extension of a guarantee so made) and the bank must meet safety and soundness requirements).

Federal Home Loan Mortgage Corporation. Federal Housing Administration. Federal National Mortgage Association. Government National Mortgage Corporation. Resolution Funding Corporation. Student Loan Marketing Association.

Individual Retirement Arrangements (IRAs) Interest earned on an Individual Retirement Arrangement (IRA) is excluded from income until withdrawals are made from the account. This exclusion also applies to interest earned by Keogh retirement plans and other qualified pension or profit sharing plans. Education Savings Bond Program Interest income can be excluded on qualified U.S. Savings Bonds redeemed to pay for qualified higher education expenses. These are expenses for tuition and required fees at an eligible educational institution (such as an accredited college, university or eligible vocational school) or to a Coverdell education savings account for the taxpayer, his or her spouse, or his or her dependent(s). A qualified U.S. Savings bond is a Series EE savings bond that was issued after December 31, 1989, to an individual who has reached age 24 before the date of issuance and which was issued at a discount (Series I or EE bonds).

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The exclusion is subject to a phase-out in the years in which the bonds are cashed and the tuition is paid. The phase-out based on the taxpayer’s modified adjusted gross income (MAGI) for 2017 begins at $78,150 for taxpayers filing single or head of household, and $117,250 for married taxpayers filing jointly or for a qualifying widow(er) with dependent child. The taxpayer does not qualify for the interest exclusion if modified AGI is equal to or more than the upper limit for his or her filing status. In 2017, the exclusion phases out completely at MAGI levels of $147,250 for joint returns and $93,150 for other returns. This exclusion is not available to married individuals who file separate returns. If the total proceeds (interest and principal) from the qualified U.S. savings bonds the taxpayer redeems during the year are not more than his or her adjusted qualified higher educational expenses for the year, he or she may be able to exclude all of the interest. If the proceeds are more than the expenses, the taxpayer may be able to exclude only part of the interest. To determine the excludable amount, multiply the interest part of the proceeds by a fraction. The numerator of the fraction is the qualified higher educational expenses the taxpayer paid during the year. The denominator of the fraction is the total proceeds the taxpayer received during the year. To figure the interest exclusion when the bonds are redeemed, use Form 8815 - Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989. Interest Income on Frozen Deposits Exclude from gross income interest on frozen deposits. A deposit is frozen if, at the end of the year, the taxpayer cannot withdraw any part of the deposit because: (138)

The financial institution is bankrupt or insolvent. The state where the institution is located has placed limits on withdrawals because other financial institutions in

the state are bankrupt or insolvent.

The amount of interest a taxpayer must exclude is the interest that was credited on the frozen deposits minus the sum of: (138)

The net amount the taxpayer withdrew from these deposits during the year. The amount the taxpayer could have withdrawn as of the end of the year (not reduced by any penalty for premature

withdrawals of a time deposit).

If the taxpayer receives a Form 1099-INT for interest income on deposits that were frozen at the end of 2017, see frozen deposits under How To Report Interest Income in Chapter 1 of Publication 550, for information about reporting this interest income exclusion on a tax return. The interest a taxpayer excludes is treated as credited to his or her account in the following year. The taxpayer must include it in income in the year he or she can withdraw it.

How To Report Interest Income Most interest that the taxpayer either receives or is credited to his or her account and that can be withdrawn without penalty is taxable income. Examples of taxable interest are interest on bank accounts, money market accounts, certificates of deposit, and deposited insurance dividends. If the taxpayer uses this method, he or she generally reports his or her interest income in the year in which he or she actually or constructively receives it. A taxpayer constructively receives income when it is credited to his or her account or made available to him or her. The taxpayer does not need to have physical possession of it. For example, he or she is considered to receive interest, dividends, or other earnings on any deposit or account in a bank, savings and loan, or similar financial institution, or interest on life insurance policy dividends left to accumulate, when they are credited to his or her account and subject to his or her withdrawal. This is true even if they are not yet entered in the taxpayer’s passbook. The taxpayer constructively receives income on the deposit or account even if he or she must: (138)

Make withdrawals in multiples of even amounts. Give a notice to withdraw before making the withdrawal. Withdraw all or part of the account to withdraw the earnings. Pay a penalty on early withdrawals, unless the interest he or she is to receive on an early withdrawal or redemption

is substantially less than the interest payable at maturity.

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If the taxpayer uses an accrual method, he or she reports his or her interest income when he or she earns it, whether or not he or she has received it. Interest is earned over the term of the debt instrument. Generally, the taxpayer reports all taxable interest income on Form 1040, line 8a; Form 1040A, line 8a; or Form 1040EZ, line 2. He or she cannot use Form 1040EZ if taxable interest income is more than $1,500. Instead, the taxpayer must use Form 1040A or Form 1040. Form 1040A The taxpayer must complete Schedule B (Form 1040A or 1040), Part I, if he or she files Form 1040A and any of the following are true: (138)

The taxpayer’s taxable interest income is more than $1,500. The taxpayer is claiming the interest exclusion under the Education Savings Bond Program. The taxpayer received interest from a seller-financed mortgage, and the buyer used the property as a home. The taxpayer received a Form 1099-INT for U.S. savings bond interest that includes amounts he or she reported

before 2017. The taxpayer received, as a nominee, interest that actually belongs to someone else. The taxpayer received a Form 1099-INT for interest on frozen deposits. The taxpayer is reporting Original Issue Discount (OID) in an amount less than the amount shown on Form 1099-

OID. The taxpayer received a Form 1099-INT for interest on a bond he or she bought between interest payment dates. The taxpayer acquired taxable bonds after 1987 and chooses to reduce interest income from the bonds by any

amortizable bond premium. Form 1040 The taxpayer must use Form 1040 instead of Form 1040A or Form 1040EZ if: (138)

The taxpayer forfeited interest income because of the early withdrawal of a time deposit. The taxpayer acquired taxable bonds after 1987, he or she chooses to reduce interest income from the bonds by

any amortizable bond premium, and he or she is deducting the excess of bond premium amortization for the accrual period over the qualified stated interest for the period.

The taxpayer received tax-exempt interest from private activity bonds issued after August 7, 1986. Form 1040NR Nonresident aliens are not taxed on certain kinds of interest income provided that such interest income arises from one of the following sources: (138)

A U.S. bank A U.S. savings and loan association A U.S. credit union A U.S. insurance company Portfolio Interest

If the nonresident alien individual uses Form 1040NR to report his income, then such nontaxable interest income shall not be reported anywhere on Form 1040NR except in response to question L on page 5 of Form 1040NR. Reporting Tax-Exempt Interest Total tax-exempt interest (such as interest or accrued OID on certain state and municipal bonds, including tax-exempt interest on zero coupon municipal bonds) and exempt-interest dividends from a mutual fund as shown in box 8 of Form 1099-INT. Add this amount to any other tax-exempt interest received. Report the total on line 8b of Form 1040A or 1040. If the taxpayer files Form 1040EZ, enter “TEI” and the amount in the space to the left of line 2. Do not add tax-exempt interest in the total on Form 1040EZ, line 2. Form 1099-INT, box 9, and Form 1099-DIV, box 11, show the tax-exempt interest subject to the alternative minimum tax on Form 6251. These amounts are already included in the amounts on Form 1099-INT, box 8, and Form 1099-DIV, box

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10. Do not add the amounts in Form 1099-INT, box 9 and Form 1099-DIV, box 11 to, or subtract them from, the amounts on Form 1099-INT, box 8, and Form 1099-DIV, box 10. Form 1099-DIV - Dividends and Distributions An individual should file Form 1099-DIV - Dividends and Distributions, for each person: (64)

To whom he or she has paid dividends (including capital gain dividends and exempt-interest dividends) and other distributions on stock of $10 or more.

For whom he or she has withheld and paid any foreign tax on dividends and other distributions on stock. For whom he or she has withheld any Federal income tax on dividends under the backup withholding rules. To whom he or she has paid $600 or more as part of a liquidation.

If an individual makes a payment that may be a dividend but he or she is unable to determine whether any part of the payment is a dividend by the time he or she must file Form 1099-DIV, the entire payment must be reported as a dividend. See the regulations under section 6042 for a definition of dividends.

Lesson 6 - Investment Income

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

Review Questions Answers appear in Review Feedback 1. Jane purchased 500 shares of stock five years ago for $10 a share. The directors voted a 3 for 1 stock split. After the

split, Jane had 1500 shares. What is Jane's basis per share after the split? A. $3.33 B. $10.00 C. $20.00 D. $30.00

2. Tanvir and Aurora Ahmed, who are married, received $10,000 in the current year as dividends from a taxable domestic

corporation. In Tanvir and Aurora’s current-year joint return, what amount of these dividends is included in their gross income?

A. $7,000 B. $9,800 C. $9,900 D. $10,000

3. Generally, qualified dividends are taxed at what tax rate?

A. Individual tax rate B. Long-term capital gains tax rates C. Corporate tax rates D. None of the above

4. If a taxpayer receives noncash gifts or services for making deposits or for opening an account in a savings institution,

for deposits of less than $5,000, gifts or services valued at more than what amount must be reported as interest? A. $10 B. $20 C. $30 D. $40

5. The taxpayer must complete Schedule B (Form 1040A or 1040), Part II, if the total ordinary dividends exceed what

amount? A. $1,000 B. $1,200 C. $1,500 D. $2,000

6. Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the

District of Columbia, a U.S. possession, or which of their following political subdivisions? A. Port authorities B. Toll road commissions C. Utility services authorities D. All of the above

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Review Feedback Return to Review Questions Question 1 - A. $3.33 Jane had 500 shares purchased at $10 a share (or $5,000). She now has 1500 shares with the same total cost ($5,000). $5,000 / 1500 = $3.33. Question 2 - D. $10,000 Section 61(a)(7) lists dividends as being included in gross income. They are included in their entirety unless there is a specific exclusion. There is no exclusion for dividends received by an individual from a taxable domestic corporation (provided the dividends are paid out of earnings and profits, which is the assumed case unless other information is provided in a question). Therefore, the entire $10,000 of dividends are included in their gross income. Question 3 - B. Long-term capital gains tax rates Qualified dividends are eligible to be taxed at a lower tax rate than other ordinary income. Generally, qualified dividends are taxed at long-term capital gains rates. For 2017, the maximum rate of tax on qualified dividends is:

• 0% on any amount that otherwise would be taxed at a 10% or 15% rate. • 15% on any amount that otherwise would be taxed at rates greater than 15% but less than 39.6%. • 20% on any amount that otherwise would be taxed at a 39.6% rate.

Question 4 - A. $10 If the taxpayer receives noncash gifts or services for making deposits or for opening an account in a savings institution, he or she may have to report the value as interest. For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest. The value is determined by the cost to the financial institution. Question 5 - C. $1,500 Ordinary dividends are entered on Line 9a, Form 1040, and are usually shown in box 1a of the taxpayers’ Form(s) 1099-DIV. If the total ordinary dividends exceed $1,500 or the taxpayer received, as a nominee, dividends that actually belong to someone else, the taxpayer must complete Schedule B (Form 1040A or 1040), Part II. Question 6 - D. All of the above Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a U.S. possession, or any of their political subdivisions. Political subdivisions include port authorities, toll road commissions, utility services authorities, community redevelopment agencies, and qualified volunteer fire departments (for certain obligations issued after 1980).

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Capital Gains and Losses, Sale of Personal Residence At the conclusion of this lesson you should have a basic knowledge of:

Capital Gains Capital Losses Tax on Capital Gains Sale of Personal Residence

Almost everything an individual owns and uses for personal or investment purposes is a capital asset. Examples include a home, personal use items like household furnishings, and stocks or bonds held as investments. When a capital asset is sold, the difference between the basis in the asset and the amount it is sold for is a capital gain or a capital loss. Generally, an asset's basis is its original cost. A person has a capital gain if he or she sells the asset for more than the basis. The person has a capital loss if he or she sells the asset for less than the basis. Losses from the sale of personal-use property, such as a home or car, are not deductible. Sales and Other Dispositions of Capital Assets Form 8949 – Sales and Other Dispositions of Capital Assets is a relatively new form. Many transactions that, in previous years, would have been reported by corporations and partnerships on Schedule D (Form 1040) must now be reported on Form 8949. Schedule D-1 is no longer in use. Form 8949 replaces it. Individuals use Form 8949 to report: (139)

The sale or exchange of a capital asset not reported on another form or schedule. Gains from involuntary conversions (other than from casualty or theft) of capital assets not held for business or

profit. Nonbusiness bad debts. Worthlessness of a security.

If the taxpayer is filing a joint return, he or she completes as many copies of Form 8949 as he or she needs to report all of his or her and his or her spouse's transactions. The taxpayer and his or her spouse may list the transactions on separate forms or the taxpayer and his or her spouse may combine them. However, the taxpayer must include on his or her Schedule D the totals from all Forms 8949 for both him or herself and his or her spouse. Form 8949 allows the taxpayer and the IRS to reconcile amounts that were reported to him or her and the IRS on Form 1099-B or 1099-S (or substitute statement) with the amounts he or she reports on his or her return. If the taxpayer receives Form 1099-B or 1099-S (or substitute statement), always report the proceeds (sales price) shown on that form (or statement) in column (d) of Form 8949. If Form 1099-B (or substitute statement) shows that the cost or other basis was reported to the IRS, always report the basis shown on that form (or statement) in column (e). If any correction or adjustment to these amounts is needed, make it in column (g). If all Forms 1099-B the taxpayer received (and all substitute statements) show basis was reported to the IRS and if no correction or adjustment is needed, he or she may not need to file Form 8949 as it is not required for certain transactions. The taxpayer may be able to aggregate those transactions and report them directly on either line 1a (for short-term transactions) or line 8a (for long-term transactions) of Schedule D. This option applies only to transactions (other than sales of collectibles) for which:

1. He or she received a Form 1099-B (or substitute statement) that shows basis was reported to the IRS and does not show any adjustments in Box 1g.

2. He or she does not need to make any adjustments to the basis or type of gain or loss (short term or long term) reported on Form 1099-B (or substitute statement), or to his or her gain or loss.

If the taxpayer chooses to report these transactions directly on Schedule D, he or she does not need to include them on Form 8949 and does not need to attach a statement.

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Corporations and partnerships use Form 8949 to report: (140)

The sale or exchange of a capital asset not reported on another form or schedule. Nonbusiness bad debts. Undistributed long-term capital gains from Form 2439 - Notice to Shareholder of Undistributed Long-Term Capital

Gains. Worthlessness of a security.

Electing large partnerships and corporations also use Form 8949 to report their share of gain or (loss) from a partnership, S corporation, estate or trust. Complete all necessary pages of Form 8949 before completing line 1, 2, 3, 8, 9, or 10 of Schedule D. Use Schedule D: (139)

To figure the overall gain or loss from transactions reported on Form 8949. To report a gain from Form 2439 or 6252 or Part I of Form 4797. To report a gain or loss from Form 4684, 6781, or 8824. To report a gain or loss from a partnership, S corporation, estate or trust. To report capital gain distributions not reported directly on Form 1040, line 13 (or effectively connected capital

gain distributions not reported directly on Form 1040NR, line 14). To report a capital loss carryover from 2016 to 2017.

Use Form 4797 - Sales of Business Property to report the following: (141)

The sale or exchange of: o Property used in a trade or business. o Depreciable and amortizable property. o Oil, gas, geothermal, or other mineral property. o Section 126 property.

The involuntary conversion (other than from casualty or theft) of property used in a trade or business and capital assets held for business or profit.

The disposition of noncapital assets other than inventory or property held primarily for sale to customers in the ordinary course of a trade or business.

The disposition of capital assets not reported on Schedule D. The gain or loss (including any related recapture) for partners and S corporation shareholders from certain section

179 property dispositions by partnerships (other than electing large partnerships) and S corporations. The computation of recapture amounts under sections 179 and 280F(b)(2) when the business use of section 179

or listed property decreases to 50% or less. Gains or losses treated as ordinary gains or losses, if the taxpayer is a trader in securities or commodities and

made a mark-to-market election under Internal Revenue Code section 475(f). Use Form 4684 - Casualties and Thefts to report involuntary conversions of property due to casualty or theft. Use Form 6781 - Gains and Losses From Section 1256 Contracts and Straddles to report any gain or loss on Section 1256 contracts under the market-to-market rules and gains and losses under Section 1092 from straddle positions. A Section 1256 contract is any: (142)

Regulated futures contract. Foreign currency contract. Non-equity option. Dealer equity option. Dealer securities futures contract.

A Section 1256 contract does not include any interest rate swap, currency swap, basis swap, commodity swap, equity swap, equity index swap, credit default swap, interest rate cap, interest rate floor, or similar agreement.

Use Parts I, II, and III of Form 8824 - Like-Kind Exchanges to report each exchange of business or investment property for property of a like kind. Certain members of the executive branch of the Federal Government and judicial officers of the Federal

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Government use Part IV to elect to defer gain on conflict-of-interest sales. Judicial officers of the Federal Government are the following: (143)

Chief Justice of the United States. Associate Justices of the Supreme Court. Judges of the:

o United States courts of appeals. o United States district courts, including the district courts in Guam, the Northern Mariana Islands, and the

Virgin Islands. o Court of Appeals for the Federal Circuit. o Court of International Trade. o Tax Court. o Court of Federal Claims. o Court of Appeals for Veterans Claims. o United States Court of Appeals for the Armed Forces. o Any court created by Act of Congress, the judges of which are entitled to hold office during good behavior.

See the instructions for the Schedule D the taxpayer is filing for detailed information about the following: (140)

Other forms he or she may have to file. The definition of capital asset. Reporting capital gain distributions, undistributed capital gains, the sale of a main home, the sale of capital assets

held for personal use, or the sale of a partnership interest. Capital losses, nondeductible losses, and losses from wash sales. Traders in securities. Short sales. Gain or loss from options. Installment sales. Demutualization of life insurance companies. Exclusion or rollover of gain from the sale of qualified small business stock. Any other rollover of gain, such as gain from the sale of publicly traded securities. Exclusion of gain from the sale of DC Zone assets or qualified community assets. Certain other items that get special treatment. Special reporting rules for corporations and partnerships in certain situations.

Basis Basis is the amount of the investment in property for tax purposes. The basis of property the taxpayer buys is usually its cost. The taxpayer needs to know his or her basis to figure any gain or loss on the sale or other disposition of the property. The basis of property a taxpayer buys is usually its cost. The cost is the amount he or she pays for it in cash, in debt obligation, in other property, or in services. The cost also includes:

Sales tax charged on the purchase. Freight charges to obtain the property. Installation and testing charges.

If the taxpayer buys real property, such as a building and land, certain fees and other expenses he or she pays are part of the cost basis in the property. If the taxpayer agrees to pay real estate taxes on a property that were owed by the seller and the seller does not reimburse him or her, the taxes he or she pays are treated as part of the basis in the property. The taxpayer cannot deduct them as taxes paid. If the taxpayer reimburses the seller for real estate taxes the seller paid for him or her, the taxpayer can usually deduct that amount. Do not include that amount in the basis in the property. The following settlement fees and closing costs for buying the property are part of the basis in the property: (74)

Abstract fees. Charges for installing utility services. Legal fees.

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Recording fees. Surveys. Transfer taxes. Title insurance. Any amounts the seller owes that the taxpayer agrees to pay, such as back taxes or interest, recording or

mortgage fees, charges for improvements or repairs, and sales commissions. The following are settlement fees and closing costs a taxpayer cannot include in the basis in the property: (74)

Fire insurance premiums. Rent or other charges relating to occupancy of the property before closing. Charges connected with getting or refinancing a loan, such as:

o Points (discount points, loan origination fees), o Mortgage insurance premiums, o Loan assumption fees, o Cost of a credit report, and o Fees for an appraisal required by a lender.

Also, do not include amounts placed in escrow for the future payment of items such as taxes and insurance. If the taxpayer buys buildings and the land on which they stand for a lump sum, he or she allocates the basis of the property among the land and the buildings so he or she can figure the depreciation allowable on the buildings. If the taxpayer buys a tract of land and subdivides it, he or she must determine the basis of each lot. This is necessary because the taxpayer must figure the gain or loss on the sale of each individual lot. As a result, he or she does not recover the entire cost in the tract until he or she has sold all of the lots. To determine the basis of an individual lot, multiply the total cost of the tract by a fraction. The numerator is the fair market value (FMV) of the lot and the denominator is the FMV of the entire tract. If the taxpayer made a mistake in figuring the cost basis of subdivided lots sold in previous years, he or she cannot correct the mistake for years for which the statute of limitations (generally 3 tax years) has expired. The taxpayer figures the basis of any remaining lots by allocating the correct original cost basis of the entire tract among the original lots. Recordkeeping Basis is the amount of the investment in property for tax purposes. The basis of property the taxpayer buys is usually its cost. The taxpayer needs to know his or her basis to figure any gain or loss on the sale or other disposition of the property. The taxpayer must keep accurate records that show the basis and, if applicable, adjusted basis of the property. The records should show the purchase price, including commissions; increases to basis, such as the cost of improvements; and decreases to basis, such as depreciation, non-dividend distributions on stock, and stock splits. Capital Asset For the most part, everything a taxpayer owns and uses for personal purposes, pleasure, or investment is a capital asset. For example: (144)

Stocks or bonds held in a personal account. A house owned and used by the taxpayer and his or her family. Household furnishings. A car used for pleasure or commuting. Coin or stamp collections. Gems and jewelry. Gold, silver, or any other metal.

Any property the taxpayer owns is a capital asset, except the following noncapital assets: (144)

Stock in trade or other property included in inventory or held mainly for sale to customers. Accounts or notes receivable for services performed in the ordinary course of the trade or business or as an

employee, or from the sale of stock in trade or other property held mainly for sale to customers. Depreciable property used in the trade or business, even if it is fully depreciated.

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Real estate used in the trade or business. Copyrights, literary, musical, or artistic compositions, letters or memoranda, or similar property:

o Created by the taxpayer’s personal efforts. o Prepared or produced for the taxpayer (in the case of letters, memoranda, or similar property). o That the taxpayer received from someone who created them or for whom they were created, as mentioned

above, in a way (such as by gift) that entitled him or her to the basis of the previous owner. U.S. Government publications, including the Congressional Record, that the taxpayer received from the

Government, other than by purchase at the normal sales price, or that he or she received from someone who had received it in a similar way, if the basis is determined by reference to the previous owner's basis.

Certain commodities derived by financial instruments held by a dealer and not connected to the dealer's activities as a dealer.

Certain hedging transactions entered into in the normal course of the trade or business. Supplies regularly used in the trade or business.

The taxpayer can elect to treat as capital assets certain musical compositions or copyrights he or she sold or exchanged if:

The taxpayer’s personal efforts created the property. The taxpayer acquired the property under circumstances (for example, by gift) entitling him or her to the basis of

the person who created the property or for whom it was prepared or produced. The taxpayer must make a separate election for each musical composition (or copyright in a musical work) sold or exchanged during the tax year. He or she must make the election on or before the due date (including extensions) of the income tax return for the tax year of the sale or exchange. The taxpayer must make the election on Form 8949 by treating the sale or exchange as the sale or exchange of a capital asset, according to the Instructions for Form 8949 and Instructions for Schedule D (Form 1040). See Publication 550 - Investment Income and Expenses for details.

Capital Gains and Losses The tax treatment of capital gains and losses depends on how long a taxpayer has owned the capital asset. This is called the taxpayer's holding period. The rule is fairly straightforward. If the taxpayer holds an asset for more than one year, we say that it is a long-term asset. If the taxpayer holds the asset for one year or less, we say that it is a short-term asset. Here are 10 facts from the IRS on capital gains and losses: (145)

1. Almost everything the taxpayer owns and use for personal purposes, pleasure or investment is a capital asset. Capital assets include the home, household furnishings, and stocks and bonds that the taxpayer holds as investments.

2. A capital gain or loss is the difference between the taxpayer’s basis of an asset and the amount he or she receives when it is sold. The taxpayer basis is usually what he or she paid for the asset (a capital gain or loss does not impact the basis of an investment).

3. The taxpayer must include all capital gains in income. 4. The taxpayer may deduct capital losses on the sale of investment property. He or she cannot deduct losses on

the sale of personal-use property. 5. Capital gains and losses are long-term or short-term, depending on how long the taxpayer holds on to the property.

If he or she holds the property more than one year, the capital gain or loss is long-term. If the taxpayer holds it one year or less, the gain or loss is short-term.

6. If the long-term gains exceed the long-term losses, the difference between the two is a net long-term capital gain. If the net long-term capital gain is more than the net short-term capital loss, the taxpayer has a 'net capital gain’.

7. The tax rates that apply to net capital gains are generally lower than the tax rates that apply to other types of income. The maximum capital gains rate for most people in 2017 is 15%. For lower-income individuals, the rate may be 0% on some or all of their net capital gains. For high-income individuals, the rate may be 20% on some or all of their net capital gains. Rates of 25% or 28% can also apply to special types of net capital gains.

8. If the capital losses are greater than the capital gains, the taxpayer can deduct the difference between the two on the tax return. The annual limit on this deduction is $3,000, or $1,500 if married filing separately.

9. If the total net capital loss is more than the limit the taxpayer can deduct, he or she can carry over the losses he or she is not able to deduct to next year’s tax return. The taxpayer will treat those losses as if they occurred that year.

10. Form 8949 - Sales and Other Dispositions of Capital Assets, will help the taxpayer calculate capital gains and losses. He or she will carry over the subtotals from this form to Schedule D, Capital Gains and Losses.

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The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the maximum capital gain rates. The term net capital gain means the amount by which the taxpayer’s net long-term capital gain for the year is more than his or her net short-term capital loss. For 2017, the maximum capital gain rates are 0%, 15%, 20%, 25%, and 28%.

If the taxpayer calculates his or her tax using the maximum capital gain rate and the regular tax computation results in a lower tax, the regular tax computation applies.

Mutual Funds A mutual fund is a regulated investment company that pools funds of investors allowing them to take advantage of a diversity of investments and professional asset management. The taxpayer owns shares in the fund, but the fund owns assets such as shares of stock, corporate bonds, government obligations, etc. One of the ways the fund makes money for the taxpayer is to sell these assets at a gain. If the asset was held by the mutual fund for more than one year, the nature of the income is capital gain, which gets passed on to the taxpayer. These are called capital gain distributions, which are distinguished on Form 1099-DIV from other types of income such as ordinary dividends. Capital gains distributions are taxed as long-term capital gains regardless of how long the taxpayer has owned the shares in the mutual fund. Property Inherited Before 2010 and after 2010 The basis of property inherited before 2010 and after 2010 is generally the Fair Market Value (FMV) of the property on the date of the decedent's death. However, this can vary if the personal representative of the estate elects to use an alternate valuation date or other acceptable method. Property Inherited During 2010 (after December 31, 2009, and before January 1, 2011) Special rules may apply to property inherited from a decedent who died in 2010. Determining the basis of such property can be complex. For more information on the special rules, see Publication 4895 - Tax Treatment of Property Acquired From a Decedent Dying in 2010. Generally, if the taxpayer inherited investment property, his or her capital gain or loss on any later disposition of that property is long-term capital gain or loss. This is true regardless of how long he or she actually held the property. Determining the Holding Period To decide if the taxpayer has held property more than one year, he or she must know how to calculate a one-year period. The first day of the period begins the day after the day the taxpayer acquired the asset. The last day of the period includes the day on which the taxpayer disposes of the asset. For example, if the taxpayer bought an asset on June 19, 2016, the first day of the period is June 20. If the taxpayer sells the asset on June 19, 2017, this is a short-term asset. The taxpayer did not have it for more than one year. If the taxpayer sells the asset on June 20, 2017, that is now more than one year and the asset was held long-term.

If a taxpayer inherits property, he or she is considered to have held the property longer than 1 year, regardless of how long he or she actually held it.

Calculating Capital Gains and Losses – Netting Process The calculation of capital gains and losses is usually reported on a Schedule D through a so-called netting process. In general, here’s how it’s done:

1. First net the short-term (assets held one year or less) capital gain property with the short-term capital loss property. This is done by adding together all of the capital transactions involving short-term property gain, with all of the capital transactions involving short-term property losses. Subtract the total amount of short-term capital losses from the total amount of short-term capital gains. This will result in either a net short-term capital loss or a net short-term capital gain. Report it in Part I of Form 8949.

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2. Follow the same step as we did above for all long-term capital property transactions. This will result in either a net long-term capital gain or a net long-term capital loss. Report it in Part II of Form 8949.

3. Now, net the total short-term and long-term transactions together. This will result in a net capital gain or a net capital loss. (Schedule D (Form 1040), line 15).

Tax on Capital Gains - Individuals (After May 5, 2003) The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the maximum capital gain rates. The term net capital gain means the amount by which the net long-term capital gain for the year is more than the net short-term capital loss. In 2017, the tax rate on long-term capital gains is 15% for most taxpayers, while those in the top bracket pay 20% and those in the 10% or 15% tax brackets pay 0%. (144) IF net capital gain is from ... Maximum capital

gain rate is ... A collectibles gain includes a work of art, rug, antique, metal (such as gold, silver, and platinum bullion), gem, stamp, coin, or alcoholic beverage held more than 1 year and gain from sale of an interest in a partnership, S corporation, or trust due to unrealized appreciation of collectibles.

28%

An eligible gain on qualified small business stock minus the Section 1202 exclusion. 28% An unrecaptured Section 1250 gain. 25% Other gain1 and the regular tax rate that would apply is 39.6% 20% Other gain1 and the regular tax rate that would apply is 25%, 28%, 33%, or 35% 15%

Other gain1 and the regular tax rate that would apply is lower than 10% or 15%. 0% 1 Other gain means any gain that is not collectibles gain, gain on qualified small business stock, or un-recaptured Section 1250 gain.

Table 7-1 IRS Publication 550, Table 4-4: What is Your Maximum Capital Gain Rate? (2017)

The rates apply when a taxpayer is computing the income tax under the Alternative Minimum Tax (AMT).

Qualified dividends are the ordinary dividends subject to the same 0%, 15%, or 20% maximum tax rate that applies to net capital gain. Net short-term capital gains are subject to taxation at the ordinary income tax rate. These capital gains rates apply to individuals, and also apply when a taxpayer is computing the income tax under the Alternative Minimum Tax. Again, a capital asset must be held more than 12 months in order for the

realized gain to be classified as a long-term capital gain. To help calculate the tax on Capital Gains (and Qualifying Dividends) the IRS provides a Qualified Dividends and Capital Gain Tax Worksheet. (146) Holding Period of Stock for Purposes of Claiming a Qualified Dividend To qualify for lower rates, investors are required to hold the stock from which the dividend is paid for more than 60 days in the 121-day period beginning 60 days before ex-dividend date. In the case of preferred stock, investors must have held the stock more than 90 days during the 181-day period that begins 90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days. If the preferred dividends are due to periods totaling less than 367 days, the holding period in the preceding paragraph applies. (146) Capital Loss Deduction If the taxpayer ends up with a net capital loss for the year, not only is it deductible, it must be deducted. This is true even if he or she does not have enough other ordinary income (such as wages, interest, dividends, etc.) to offset the net capital loss. The maximum amount of net capital loss that an individual can deduct is $3,000 per year, or $1,500 if filing status is married filing separately. The taxpayer’s allowable capital loss deduction, figured on Schedule D (Form 1040), is the lesser of: (144)

$3,000 ($1,500 if he or she is married and file a separate return). His or her total net loss as shown on line 16 of Schedule D (Form 1040).

The taxpayer can use his or her total net loss to reduce his or her income dollar for dollar, up to the $3,000 limit.

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What if the net capital loss is more than $3,000 for the year? Then the taxpayer may carry the excess amount of the loss over to next year's tax return. The taxpayer will continue this carryover process until all of the net capital losses are finally deducted. When the taxpayer carries over a loss, it retains its original character as either a net long-term or a net short-term loss. A short-term loss carried over to next year is added to short-term losses that may have occurred in that next year. Likewise, long-term losses carried over to next year are added to long-term losses that may have been incurred in that following year. This means that a long-term loss that is carried over to next year must first be used to reduce any long-term gains in that next year. The same is true for carried over short-term losses. Worthless Securities Securities such as stocks, stock rights, bonds, etc., which are capital assets should they become worthless, are considered as a loss dating from the last day of the taxable year in which they became worthless. Thus, monetary losses from worthless securities are subject to the same deduction limitations ($3,000 per year for an individual; $1,500 per year for married filing separately) of capital losses. Also, bad debt losses developed from non-business (personal) transactions are considered short-term capital losses. Worthless securities also include securities that the taxpayer abandoned after March 12, 2008. To abandon a security, the taxpayer must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for it. All the facts and circumstances determine whether the transaction is properly characterized as an abandonment or other type of transaction, such as an actual sale or exchange, contribution to capital, dividend, or gift. If the taxpayer is a cash basis taxpayer and makes payments on a negotiable promissory note that he or she issued for stock that became worthless, the taxpayer can deduct these payments as losses in the years he or she actually makes the payments. Do not deduct them in the year the stock became worthless. If the taxpayer did not claim a loss for a worthless security on his or her original return for the year it becomes worthless, he or she can file a claim for a credit or refund due to the loss. Use Form 1040X - Amended U.S. Individual Income Tax Return, to amend the return for the year the security became worthless. The taxpayer must file it within 7 years from the date the original return for that year had to be filed, or 2 years from the date he or she paid the tax, whichever is later. (Claims not due to worthless securities or bad debts generally must be filed within 3 years from the date a return is filed, or 2 years from the date the tax is paid, whichever is later). Nonbusiness Bad Debt If someone owes an individual money that he or she cannot collect, the individual may have a bad debt. To deduct a bad debt, the taxpayer must have previously included the amount in income or loaned out cash. If he or she is a cash basis taxpayer, the taxpayer may not take a bad debt deduction for money he or she expected to receive but did not (for example, for money owed for services performed, or rent) because that amount was never included in income. For a bad debt, the individual must show that there was an intention at the time of the transaction to make a loan and not a gift. If he or she lends money to a relative or friend with the understanding that it may not be repaid, it is considered a gift and not a loan. There are two kinds of bad debts – business and nonbusiness. Generally, a business bad debt is one that comes from operating a trade or business. The following are examples of business bad debts (if previously included in income): (147)

Loans to clients and suppliers. Credit sales to customer. Business loan guarantees.

A business deducts its bad debts from gross income when figuring its taxable income. Business bad debts may be deducted in part or in full. The taxpayer can claim a business bad debt using either the specific charge-off method or the nonaccrual-experience method. All other bad debts are nonbusiness. Nonbusiness bad debts must be totally worthless to be deductible. An individual cannot deduct a partially worthless nonbusiness bad debt. A debt becomes worthless when the surrounding facts and circumstances indicate there is no reasonable expectation of payment. To show that a debt is worthless, the taxpayer must establish that he or she has taken reasonable steps to

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collect the debt. It is not necessary to go to court if it can be shown that a judgment from the court would be uncollectible. The individual may take the deduction only in the year the debt becomes worthless. He or she does not have to wait until a debt is due to determine whether it is worthless. A nonbusiness bad debt is reported as a short-term capital loss on Form 8949 - Sales and Other Dispositions of Capital Assets, Part 1, line 1. Enter the name of the debtor and “bad debt statement attached” in column (a). Enter the basis in the bad debt in column (f) and enter zero in column (e). Use a separate line for each bad debt. It is subject to the capital loss limitations. A nonbusiness bad debt deduction requires a separate detailed statement attached to the return. (147) Bartering Bartering is the trading of one product or service for another. Usually there is no exchange of cash. However, the fair market value of the goods and services exchanged must be reported as income by both parties. Income from bartering is taxable in the year it is performed. Barter dollars or trade dollars are identical to real dollars for tax reporting purposes. If the taxpayer conducts any direct barter, a barter for another’s products or services, he or she must report the fair market value of the products or services he or she received on his or her tax return. Bartering may result in liabilities for income tax, self-employment tax, employment tax or excise tax. The taxpayer’s barter activities may result in ordinary business income, capital gains or capital losses, or he or she may have a nondeductible personal loss. Virtual Currency In some environments, virtual currency (such as Bitcoin) operates like “real” currency (i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance) but it does not have legal tender status in any jurisdiction. For Federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. This also means that:

Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.

Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.

The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has a taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.

Sale of Personal Residences

Since 2013, the Affordable Care Act imposed a new 3.8% tax on investment income of taxpayers whose total income exceeds $200,000 ($250,000 if filing a joint return). All or part of the gain (not the entire proceeds) on the sale of a home is subject to the 3.8% tax if the taxpayer’s total income (including the gain on the home sale) exceeds $200,000

(or $250,000 if a joint return is filed). However, if the taxpayer meets the other requirements for exclusion, the gain on sale is reduced by $250,000 (or $500,000 if the taxpayer files a joint return). The exclusion applies in determining the amount of net investment income for purposes of the 3.8% tax. To exclude gain, the taxpayer, in most cases, must have owned and lived in the property as his or her main home for at least 2 years during the 5-year period ending on the date of sale. If he or she sells the land on which the main home is located, but not the house itself, the taxpayer cannot exclude any gain he or she realizes from the sale of the land.

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Figuring Gain or Loss To figure the gain or loss on the sale of the main home, the taxpayer must know the selling price, the amount realized, and the adjusted basis. Subtract the adjusted basis from the amount realized to get the gain or loss. Selling price −Selling expenses Amount realized −Adjusted basis Gain or loss The amount the taxpayer realizes from a sale or trade of property is everything he or she receives for the property minus his or her expenses of sale (such as redemption fees, sales commissions, sales charges, or exit fees). Amount realized includes the money the taxpayer receives plus the fair market value of any property or services he or she receives. If the taxpayer finances the buyer's purchase of his or her property and the debt instrument does not provide for adequate stated interest, the unstated interest that the taxpayer must report as ordinary income will reduce the amount realized from the sale. A taxpayer may exclude from income up to $250,000 of gain ($500,000 on a joint return in most situations) realized on the sale or exchange of a principal residence if all of the following are true: (71)

Meets the ownership test. Meets the use test. During the 2-year period ending on the date of the sale, taxpayer did not exclude gain from the sale of another

home. Ownership and Use As a general rule, gain may only be excluded if, during the five-year period that ends on the date of the sale or exchange, the individual owned and used the property as a principal residence for periods aggregating two years or more (i.e., a total of 730 days (365 x 2)). Short temporary absences for vacations or seasonal absences are counted as periods of use, even if the individual rents out the property during these periods of absence. However, an absence of an entire year is not considered a short temporary absence. The ownership and use test may be met during non-concurrent periods, provided that both tests are met during the five-year period that ends on the date of sale. Additionally, if the taxpayer owned and lived in the property as the main home for less than 2 years, he or she can still claim an exclusion in some cases. However, the maximum amount the taxpayer may be able to exclude will be reduced. (71) If a taxpayer has more than one home, he or she can exclude gain only from the sale of the main home. The taxpayer must include in income the gain from the sale of any other home. If he or she has two homes and live in each of them, the main home is ordinarily the one he or she lives in most of the time during the year. In addition to the amount of time the taxpayer lives in each home, other factors are relevant in determining which home is the main home. Those factors include the following: (148)

The taxpayer’s place of employment. The location of the taxpayer’s family members' main home. The taxpayer’s mailing address for bills and correspondence. The address listed on the taxpayer’s:

o Federal and state tax returns. o Driver's license. o Car registration. o Voter registration card.

The location of the banks the taxpayer uses. The location of recreational clubs and religious organizations of which the taxpayer is a member.

Married Individuals The amount of excludable gain is $500,000 for married individuals filing jointly if: (71)

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The taxpayer is married and files a joint return for the year. Either the taxpayer or his or her spouse meets the ownership test. Both the taxpayer and his or her spouse meet the use test. During the 2-year period ending on the date of the sale, neither the taxpayer nor his or her spouse excluded gain

from the sale of another home. The exclusion is determined on an individual basis. Thus, if a single individual who is otherwise eligible for an exclusion marries someone who has used the exclusion within the two years prior to the sale, the newly married individual is entitled to a maximum exclusion of $250,000. Once both spouses satisfy the eligibility rules and two years have passed since the exclusion was allowed to either of them, they may exclude up to $500,000 of gain on their joint return. Deceased Spouse When a spouse dies before the date of sale, the surviving spouse is considered as owning and living in the home for the same period as the deceased spouse. A widow(er) may qualify to exclude up to $500,000 of any gain from the sale or exchange of his or her main home if all of the following requirements are met: (71)

1. The sale or exchange took place after 2008. 2. The sale or exchange took place no more than 2 years after the date of death of the spouse. 3. The taxpayer has not remarried. 4. The taxpayer and his or her spouse met the use test at the time of the spouse's death. 5. The taxpayer or his or her spouse met the ownership test at the time of the spouse's death. 6. Neither the taxpayer nor his or her spouse excluded gain from the sale of another home during the last 2 years

before the date of death. Divorced Individuals When a residence is transferred to an individual incident to a divorce, the time during which the individual’s spouse or former spouse owned the residence is added to the individual’s period of ownership. An individual who owns a residence is deemed to use it as a principal residence during the time the individual’s spouse or former spouse had use of the home under a divorce or separation agreement. Hardship Relief: Safe Harbors A taxpayer who fails to meet the ownership and use requirements, or the minimum two-year time period for claiming the full exclusion (e.g.$250,000), may still be eligible for a partial exclusion when the sale of the home is due to: (71)

A change in place of employment. Health reasons. Unforeseen circumstances.

According to the IRS, in order for an individual to be eligible for the partial exclusion, the individual’s primary reason for the sale must be related to one of these three reasons. If the individual is able to satisfy one of the safe harbor tests discussed below, then the primary reason for the sale will be treated as having been due to employment, health, or unforeseen circumstances. Change of Employment The primary reason test will be satisfied if the individual’s new place of employment is at least 50 miles farther from the residence sold or exchanged than was the former place of employment. If there was no former place of employment, the distance between the individual’s new place of employment and the residence sold or exchanged must be at least 50 miles. Health Reasons The primary reason test will be satisfied if the reason for the sale is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury. Obtaining or providing medical or personal care for a qualified individual suffering from a disease, illness, or injury, will also qualify. The term qualified individual is very broad and includes the owner’s spouse, as well as children, siblings, parents, and others. A physician’s recommendation for a change of homes for health reasons also qualifies.

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Unforeseen Circumstances Examples of situations that will be recognized by the IRS as unforeseen circumstances include: (71)

Involuntary conversion of the home. Natural or man-made disasters or acts of terrorism. Death. A period of unemployment that permits the individual to be eligible for unemployment compensation. Change of employment resulting in the inability to pay the costs of housing and basic living expenses. Divorce or legal separation. Multiple births resulting from the same pregnancy. An event the IRS determines unforeseen (For example, the IRS determined the September 11, 2001 terrorist

attacks to be unforeseen circumstances). A sale of a residence due to the individual’s change in preference or improvement in financial position is not due to an unforeseen circumstance.

Other Tests If the individual does not satisfy one of the safe harbor tests listed previously, then the IRS will consider all the facts and circumstances when determining the principal reason for the sale. Factors that will be considered include:

The circumstances giving rise to the sale. The individual’s financial ability to maintain the property. Material changes that would impact the suitability of the property as the individual’s residence.

Computing the Reduced Exclusion When an individual qualifies for hardship relief, the individual may be entitled to a reduced exclusion. The reduced exclusion is computed by multiplying the maximum allowable exclusion (i.e., $250,000 or $500,000) by a fraction. The numerator of the fraction is the shortest of:

The period of time that the individual owned the property as a principal residence during the five-year period ending on the date of sale exchange.

The period of time that individual used the property as a principal residence during the five-year period ending on the date of sale or exchange.

The period between the date of the most recent prior sale or exchange to which the exclusion applied and the date of the current sale or exchange.

The numerator may be expressed in days or months. The denominator of the fraction is either 730 days or 24 months (depending on the measure of time used in the numerator).

Installment Sales An installment sale is a sale of property where at least one payment is to be received after the tax year in which the sale occurs. The taxpayer is required to report gain on an installment sale under the installment method unless he or she elects out on or before the due date for filing the tax return (including extensions) for the year of the sale. Use Form 6252 - Installment Sale Income to report the sale on the installment method. Also use Form 6252 to report any payment received in 2017 from a sale made in an earlier year that was reported on the installment method. To elect out of the installment method, report the full amount of the gain on Form 8949 on a timely filed return (including extensions) for the year of the sale. If the original return was filed on time, a taxpayer can make the election on an amended return filed no later than 6 months after the due date of the return (excluding extensions). Write “Filed pursuant to Section 301.9100-2” at the top of the amended return. Installment method rules do not apply to sales that result in a loss. A taxpayer cannot use the installment method to report gain from the sale of inventory or stocks and securities traded on an established securities market. Any portion of the gain from the sale of depreciable assets that must be reported as ordinary income under the depreciation recapture rules must be reported in the year of the sale.

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The total gain on an installment method is generally the amount by which the selling price of the property sold exceeds adjusted basis in that property. The selling price includes the money and the fair market value of property received for the sale of the property, any selling expenses, and existing debt encumbering the property that the buyer assumes. The taxpayer does not include stated interest, unstated interest, any amount refigured or recharacterized as interest, or OID.(149) Under the installment method, a taxpayer includes in income each year only part of the gain he or she receives, or is considered to have received. Use Form 6252 - Installment Sale Income, to report an installment sale in the year the sale occurs and for each year he or she receives an installment payment. Gifts and Inheritances To determine if the sale of inherited property is taxable, the taxpayer must first determine his or her basis in the property. The basis of property inherited from a decedent is generally one of the following:

The fair market value (FMV) of the property on the date of the decedent's death. The FMV of the property on the alternate valuation date if the executor of the estate chooses to use alternate

valuation.

In general, capital gains or losses from sale of inherited property are treated as long-term. Report the sale on Schedule D (Form 1040) - Capital Gains and Losses, and on Form 8949 - Sales and other Dispositions of Capital Assets if the taxpayer sells the property for more than his or her basis, he or she has a taxable gain. For information on how to report the sale on Schedule D, see Publication 550, Investment Income and Expenses.

Like-Kind Exchanges The exchange of property for the same kind of property is the most common type of nontaxable exchange. To be a like-kind exchange, the property traded and the property received must be both of the following:

1. Qualifying property. 2. Like-kind property.

Additional requirements apply to exchanges in which the property received is not received immediately upon the transfer of the property given up. Also, if the like-kind exchange involves the receipt of money or unlike property or the assumption of the taxpayer’s liabilities, he or she may have to recognize gain. To determine how long a taxpayer held the investment property, begin counting on the date after the day he or she acquired the property. The day the taxpayer disposed of the property is part of his or her holding period. Qualifying Property In a like-kind exchange, both the property the taxpayer gives up and the property he or she receives must be held by the taxpayer for investment or for productive use in his or her trade or business. Machinery, buildings, land, trucks, and rental houses are examples of property that may qualify. The rules for like-kind exchanges do not apply to exchanges of the following property: (150)

Property the taxpayer uses for personal purposes, such as his or her home and his or her family car. However, there are some exceptions.

Stock in trade or other property held primarily for sale, such as inventories, raw materials, and real estate held by dealers.

Stocks, bonds, notes, or other securities or evidences of indebtedness, such as accounts receivable. Partnership interests. Certificates of trust or beneficial interest. Choses in action, such as a lawsuit in which the taxpayer is the plaintiff. Certain tax-exempt use property subject to a lease. For more information, see section 470(e) of the Internal

Revenue Code. A dwelling unit (home, apartment, condominium, or similar property) may be, for purposes of a like-kind exchange, property held for productive use in a trade or business or for investment purposes if certain requirements are met.

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An exchange of the assets of a business for the assets of a similar business cannot be treated as an exchange of one property for another property. Whether the taxpayer engaged in a like-kind exchange depends on an analysis of each asset involved in the exchange. Like-Kind Property There must be an exchange of like-kind property. Like-kind properties are properties of the same nature or character, even if they differ in grade or quality. The exchange of real estate for real estate and the exchange of personal property for similar personal property are exchanges of like-kind property. For example, the trade of land improved with an apartment house for land improved with a store building, or a panel truck for a pickup truck, is a like-kind exchange. An exchange of personal property for real property does not qualify as a like-kind exchange. For example, an exchange of a piece of machinery for a store building does not qualify. Also, the exchange of livestock of different sexes does not qualify. Deferred Exchange A deferred exchange is an exchange in which the taxpayer transfers property he or she uses in business or holds for investment and later receives like-kind property the taxpayer will use in business or hold for investment. (The property the taxpayer receives is replacement property.) The transaction must be an exchange (that is, property for property) rather than a transfer of property for money used to buy replacement property. In addition, the replacement property will not be treated as like-kind property unless the identification and the receipt requirements are met. If, before the taxpayer receives the replacement property, he or she actually or constructively receives money or unlike property in full consideration for the property he or she transfers, the transaction will be treated as a sale rather than a deferred exchange. In that case, the taxpayer must recognize gain or loss on the transaction, even if he or she later receives the replacement property (It would be treated as if he or she bought the replacement property). If, before the taxpayer receives the replacement property, he or she actually or constructively receives money or unlike property in less than full consideration for the property he or she transfers, the transaction will be treated as a partially taxable exchange. Section 1031 Exchange Whenever a taxpayer sells business or investment property and he or she has a gain, the taxpayer generally has to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows him or her to postpone paying tax on the gain if he or she reinvests the proceeds in similar property as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free. The exchange can include like-kind property exclusively or it can include like-kind property along with cash, liabilities and property that are not like-kind. If the taxpayer receives cash, relief from debt, or property that is not like-kind, however, he or she may trigger some taxable gain in the year of the exchange. There can be both deferred and recognized gain in the same transaction when a taxpayer exchanges for like-kind property of lesser value. To qualify as a Section 1031 exchange, a deferred exchange must be distinguished from the case of a taxpayer simply selling one property and using the proceeds to purchase another property (which is a taxable transaction). Rather, in a deferred exchange, the disposition of the relinquished property and acquisition of the replacement property must be mutually dependent parts of an integrated transaction constituting an exchange of property. Taxpayers engaging in deferred exchanges generally use exchange facilitators under exchange agreements pursuant to rules provided in the Income Tax Regulations. A reverse exchange is somewhat more complex than a deferred exchange. It involves the acquisition of replacement property through an exchange accommodation titleholder, with whom it is parked for no more than 180 days. During this parking period the taxpayer disposes of its relinquished property to close the exchange. Both the relinquished property the taxpayer sells and the replacement property he or she buys must meet certain requirements. Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment. Both properties must be similar enough to qualify as like-kind. Like-kind property is property of the same nature, character or class. Quality or grade does not matter. Most real estate will be like-kind to other real estate. For example, real property

Lesson 7 - Capital Gains and Losses, Sale of Personal Residence

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that is improved with a residential rental house is like-kind to vacant land. One exception for real estate is that property within the United States is not like-kind to property outside of the United States. Also, improvements that are conveyed without land are not of like-kind to land. Real property and personal property can both qualify as exchange properties under Section 1031; but real property can never be like-kind to personal property. In personal property exchanges, the rules pertaining to what qualifies as like-kind are more restrictive than the rules pertaining to real property. As an example, cars are not like-kind to trucks. Finally, certain types of property are specifically excluded from Section 1031 treatment. Section 1031 does not apply to exchanges of: (151)

Inventory or stock in trade Stocks, bonds, or notes Other securities or debt Partnership interests Certificates of trust

While a like-kind exchange does not have to be a simultaneous swap of properties, the taxpayer must meet two time limits or the entire gain will be taxable. The first limit is that the taxpayer has 45 days from the date he or she sells the relinquished property to identify potential replacement properties. The identification must be in writing, signed by the taxpayer and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary. However, notice to an attorney, real estate agent, accountant or similar persons acting as the taxpayer’s agent is not sufficient. The second limit is that the replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The replacement property received must be substantially the same as property identified within the 45-day limit described above. Partnership Interests Exchanges of partnership interests do not qualify as nontaxable exchanges of like-kind property. This applies regardless of whether they are general or limited partnership interests or are interests in the same partnership or different partnerships. However, under certain conditions the exchange may be treated as a tax-free contribution of property to a partnership. An interest in a partnership that has a valid election to be excluded from being treated as a partnership for Federal tax purposes is treated as an interest in each of the partnership assets and not as a partnership interest. U.S. Treasury Notes or Bonds Treasury notes have maturity periods of more than 1 year, ranging up to 10 years. Maturity periods for Treasury bonds are longer than 10 years. Both generally are issued in denominations of $100 to $1 million and both generally pay interest every 6 months. Generally, a taxpayer reports this interest for the year paid. When the notes or bonds mature, he or she can redeem these securities for face value or use the proceeds from the maturing note or bond to reinvest in another note or bond of the same type and term. If the taxpayer does nothing, the proceeds from the maturing note or bond will be deposited in his or her bank account. Certain issues of U.S. Treasury obligations may be exchanged for certain other issues designated by the Secretary of the Treasury with no gain or loss recognized on the exchange. Insurance Policies and Annuities No gain or loss is recognized if the taxpayer makes any of the following exchanges, and if the insured or the annuitant is the same under both contracts: (150)

A life insurance contract for another life insurance contract, or for an endowment or annuity contract, or for a qualified long-term care insurance contract.

An endowment contract for an annuity contract or for another endowment contract providing for regular payments beginning at a date not later than the beginning date under the old contract, or for a qualified long-term insurance contract.

One annuity contract for another annuity contract. An annuity contract for a qualified long-term care insurance contract. A qualified long-term care insurance contract for another qualified long-term insurance contract.

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In addition, if certain conditions are met, no gain or loss is recognized on the direct transfer of a portion of the cash surrender value of an existing annuity contract for a second contract, regardless of whether the contracts are issued by the same or different companies. Foreclosures and Repossessions If the taxpayer does not make payments he or she owes on a loan secured by property, the lender may foreclose on the loan or repossess the property. The foreclosure or repossession is treated as a sale or exchange from which the taxpayer may realize gain or loss. This is true even if the taxpayer voluntarily returns the property to the lender. He or she also may realize ordinary income from cancellation of debt if the loan balance is more than the fair market value of the property. The taxpayer figures and reports gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale or exchange. The gain or loss is the difference between his or her adjusted basis in the transferred property and the amount realized. If the taxpayer is not personally liable for repaying the debt (nonrecourse debt) secured by the transferred property, the amount he or she realizes includes the full debt canceled by the transfer. The full canceled debt is included even if the fair market value of the property is less than the canceled debt. (150) Short Sales Similar to a foreclosure, any debt that the taxpayer’s lender cancels because of a short sale is taxable only if the terms of the mortgage hold the taxpayer personally liable for the full amount of the loan. Regardless of the tax consequences, the taxpayer’s lender will report the debt cancellation on a Form 1099-C - Cancellation of Debt. Since most mortgage lenders would not agree to a short sale if the value of the home exceeds the outstanding mortgage balance there are generally no capital gains issues. Bartering Bartering occurs when the taxpayer exchanges goods or services without exchanging money. An example of bartering is a plumber exchanging plumbing services for the dental services of a dentist. The taxpayer must include in gross income in the year of receipt the fair market value of goods or services received from bartering. A barter exchange is an organization with members who agree with each other (or with the barter exchange) to exchange property or services. The term does not include arrangements that provide solely for the informal exchange of similar services on a noncommercial basis. Income from bartering is taxable in the year it is performed. Bartering may result in liabilities for income tax, self-employment tax, employment tax or excise tax. The taxpayer’s barter activities may result in ordinary business income, capital gains or capital losses, or he or she may have a nondeductible personal loss. Barter dollars or trade dollars are identical to real dollars for tax reporting purposes. If the taxpayer conducts any direct barter], barter for another’s products or services, he or she must report the fair market value of the products or services he or she received on his or her tax return. The rules for reporting barter transactions may vary depending on which form of bartering takes place. Generally, the taxpayer reports this type of business income on Form 1040, Schedule C, or other business returns such as Form 1065 for Partnerships, Form 1120 for Corporations or Form 1120-S for Small Business Corporations. (152)

Involuntary Conversions An involuntary conversion occurs when the taxpayer’s property is destroyed, stolen, condemned, or disposed of under the threat of condemnation and he or she receives other property or money in payment, such as insurance or a condemnation award. Involuntary conversions are also called involuntary exchanges. Gain or loss from an involuntary conversion of the taxpayer’s property is usually recognized for tax purposes unless the property is his or her main home. The taxpayer reports the gain or deducts the loss on his or her tax return for the year he or she realizes it. The taxpayer cannot deduct a loss from an involuntary conversion of property he or she held for personal use unless the loss resulted from a casualty or theft. However, depending on the type of property the taxpayer receives, he or she may not have to report a gain on an involuntary conversion. Generally, the taxpayer does not report the gain if he or she receives property that is similar or related in service or use to the converted property. The taxpayer’s basis for the new property is the same as his or her basis for the converted property. This means that the gain is deferred until a taxable sale or exchange occurs.

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If the taxpayer receives money or property that is not similar or related in service or use to the involuntarily converted property and he or she buys qualifying replacement property within a certain period of time, he or she can elect to postpone reporting the gain.

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

Review Questions Answers appear in Review Feedback 1. Arthur bought his principal residence for $250,000 on May 3, 2016. He sold it on May 3, 2017, for $400,000. What is

the amount and character of his gain? A. Long-term, ordinary gain of $400,000 B. Long-term, capital gain of $150,000 C. Short-term, ordinary gain of $400,000 D. Short-term, capital gain of $150,000

2. Will purchases rental property for $150,000. He uses $20,000 cash and obtains a mortgage for $130,000. He pays

closing costs of $10,000, which includes $5,000 in points on the mortgage and $5,000 for bank fees and title costs. His initial basis in the property is what amount?

A. $30,000 B. $150,000 C. $155,000 D. $160,000

3. Paul and Nancy purchased a house to use as rental property. They paid the following amounts: $300,000 cash,

assumption of an existing $35,000 mortgage, title search $700, recording fees of $300, points for their new loan of $2,000, and the seller's part of the property taxes of $5,500. The seller did not reimburse them for the property taxes. What is their cost basis in the house?

A. $300,000 B. $335,000 C. $341,500 D. $343,500

4. To qualify for lower capital gain rates, investors are required to hold the stock from which the qualified dividend is paid for

more than how many days in the 121-day period beginning 60 days before ex-dividend date? A. 30 days B. 45 days C. 60 days D. 121 days

5. Which of the following is considered a taxpayer’s noncapital assets?

A. Supplies regularly used in the trade or business B. A car used for pleasure or commuting C. Coin or stamp collections D. Gems and jewelry

6. Which of the following are examples of business bad debts (if previously included in income)?

A. Loans to clients and suppliers B. Credit sales to customer C. Business loan guarantees D. All of the above

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Review Feedback Return to Review Questions Question 1 - D. Short-term, capital gain of $150,000 Separate a taxpayer’s capital gains and losses according to how long he or she held or owned the property. The holding period for short-term capital gains and losses is 1 year or less. Report these transactions on Part I of Form 8949. The holding period for long-term capital gains and losses is more than 1 year. Report these transactions on Part II of Form 8949. To figure the holding period, begin counting on the day after the taxpayer received the property and include the day he or she disposed of it. Question 2 - C. $155,000 The original basis in the property includes the original purchase price plus the bank fees and title costs. The points on the mortgage are not added to the basis but rather are amortized over the term of the loan. Question 3 - C. $341,500 Cost basis in the house includes $335,000 purchase price (cash and mortgages assumed), $1,000 title search and recording fees, $5,500 payment for seller’s portion of the property taxes. Points paid for business property are business expenses that must be amortized over the life of the loan. The value of the points is not added to the cost basis. Question 4 - C. 60 days A taxpayer must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment. When counting the number of days a taxpayer held the stock, include the day he or she disposed of the stock, but not the day he or she acquired it. Question 5 - A. Supplies regularly used in the trade or business Most property the taxpayer owns and uses for personal purposes, pleasure, or investment is a capital asset. For example, his or her house, furniture, car, stocks, coin and stamp collections, gems and jewelry, and bonds are capital assets. Among other items, supplies regularly used in the trade or business are noncapital assets. Question 6 - D. All of the above There are two kinds of bad debts – business and nonbusiness. Generally, a business bad debt is one that comes from operating a trade or business. Loans to clients and suppliers, credit sales to customer and business loan guarantees are examples of business bad debts (if previously included in income).

© 2018 Golden State Tax Training Institute, Inc. 8-1

Sole Proprietor, Small Business Income and Taxation At the conclusion of this lesson you should have a basic knowledge of:

Schedule C and C-EZ Business Use of the Home Self-Employment Tax Figuring Earnings Subject to the Tax

Sole Proprietor This section covers topics regarding individuals who are self-employed. By definition, a Sole Proprietor is someone who owns an unincorporated business by himself or herself. A small business and a sole proprietorship (also known as the sole trader or simply a proprietorship), are types of business entities that are owned and operated by one individual and in which there is no legal distinction between the owner and the business. The owner thus receives all the profits (subject to taxation) and has responsibility for the losses. All assets as well as debts are owned by the proprietor. In contrast to a partnership, it is a sole proprietorship meaning the business is owned and controlled by one person even though there may be many employees working for him or her. A sole proprietor may use a business or trade name other than their legal name. They have the ability to raise capital either publicly or privately, to limit the personal liability of the officers and managers, and to limit risk to investors. Sole proprietorships also have the least government rules and regulations affecting it. Owners have complete control over all the aspects of his or her business and can take any managerial decisions that he or she wants to take. Raising capital for a proprietorship is more difficult because an unrelated investor has less peace of mind concerning the use and security of his or her investment and the investment is more difficult to formalize as other types of business entities have more documentation. The enterprise may be crippled or terminated if the owner becomes ill. Since the business is the same legal entity as the proprietor, it ceases to exist upon the proprietor's death. Because the enterprise rests exclusively on one person, it often has difficulty raising long-term capital. Unlimited Liability The biggest potential downside of operating as a sole proprietorship is the lack of protection from personal liability. Most businesses operate under alternate forms, such as standard Corporations or Limited Liability Corporations (LLC’s) because they provide considerable protection of personal assets in the event of litigation. They also help protect individuals if creditors are seeking to collect business debts, in that they can ordinarily only reach the assets of the business entity. Since a sole proprietorship is not legally distinct from its owner, personal assets may be subject to those claims. If the taxpayer is engaged in a business which has a significant chance of being the subject of litigation, he or she will want to make sure that they carry adequate insurance, and will likely wish to choose a business form which shields the taxpayer from personal liability in the event of a lawsuit. By way of example, if the taxpayer is giving piano lessons, he or she probably has a low risk of liability; but if he or she is giving swimming lessons or horseback riding lessons, a small mistake by the taxpayer or a student can result in a significant liability to the business. Taxation Another potential downside of a sole proprietorship is that any income to the business is treated as income to the business owner. It is reported on their individual tax return (using Schedule C), and is taxed in the year it is received. With other corporate forms, it may be possible for the business to have its own income (and to file its own income tax return), and it may be possible to defer income to a different tax year. With a sole proprietorship, even the money the taxpayer left in the business bank account is taxed in the year it is earned, even if the business was saving it to pay for business expenses in the coming year. It is important to consider tax consequences when selecting the form of the business. The income earned from a sole proprietorship remains subject to income and self-employment (SE) tax (Medicare and Social Security contributions), and the taxpayer will be responsible to pay those taxes at the end of the year. In most cases, they will also be required to make quarterly payments of estimated tax liability, to both the state and to the Federal government. The sole proprietor may deduct

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

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legitimate business expenses when he or she calculates the taxes, as well as report losses from a sole proprietorship on the income tax return. Husband and Wife Businesses One of the advantages of a taxpayer operating his or her own business is hiring family members. However, the employment tax requirements for family employees may vary from those that apply to other employees. Generally speaking, when two or more people engage in a business to share profits, it is considered a partnership rather than a sole-proprietorship. However, the Small Business and Work Opportunity Tax Act of 2007 changes the treatment of qualified businesses of married couples not treated as partnerships. A qualified business, or dual sole-proprietorship, is one involving the conduct of a trade or business that meets the following conditions:

The only members of the joint venture are a husband and wife. Both spouses materially participate in the trade or business. They file a joint return for the year. Both spouses elect to have the provision apply.

All items of income, gain, loss, deduction and credit are divided between the spouses in accordance with their respective interests in the business. Each spouse takes into account his or her respective share of these items as a sole proprietor. Thus, it is anticipated that each spouse would account for his or her respective share on the appropriate form, such as Schedule C. For purposes of determining net earnings from self-employment, each spouse’s share of income or loss from a qualified joint venture is taken into account just as it is for Federal income tax purposes under the provision (i.e., in accordance with their respective interests in the venture). This generally does not increase the total tax on the return, but it does give each spouse credit for Social Security earnings on which retirement benefits are based. However, this may not be true if either spouse exceeds the Social Security tax limitation. For more information on qualified businesses, refer to Election for Husband and Wife Unincorporated Businesses. Qualified Joint Ventures If the taxpayer and his or her spouse both participate as the only active members of a jointly owned and operated business and they file a joint return for the tax year, they can make an election to be taxed as a Qualified Joint Venture rather than a Partnership. Requirements for a qualified joint venture:

1. The only members in the joint venture are a husband and wife who file a joint tax return. 2. The trade or business is owned and operated by the spouses as co-owners (and not in the name of a state law

entity such as an LLC or LLP). 3. The husband and wife must each materially participate in the trade or business. 4. Both spouses must elect qualified joint venture status on Form 1040 by dividing the items of income, gain, loss,

deduction, credit and expenses in accordance with their respective interests in such venture and each spouse filing with the Form 1040 a separate Schedule C (Form 1040), Schedule C-EZ (Form 1040), or Form 4835 accordingly, and, if required, a separate Schedule SE (Form 1040) to pay self-employment tax.

There may be tax benefits for choosing this option. In order to make this election all the income, credit, deduction, gain or loss must be divided according to the percentage of equity in the business each spouse owns. For example, a spouse that owns 60% of the venture must account for 60% of the income while the other spouse need only account for 40% of the income. Each spouse must file a separate Schedule C, C-EZ, or F and enter their share on

each line with respect to income, deduction, loss, etc. They must also file separate Schedule SE’s to pay SE tax when applicable. Independent Contractor versus Employee Even though a sole proprietorship is not technically a business entity, owners can hire employees. There is no limit on the number of employees that a sole proprietor can employ. As the employer, a sole proprietor is responsible for filing taxes and proper administration for these hires. Some sole proprietors choose to use independent contractors. There are many reasons for this including less liability for the owner and greater flexibility in scheduling. With an independent contractor, the owner simply pays the agreed upon rate, and there is less bookkeeping involved. At the end of the year, however, the use of independent contractors is reported on tax returns and some insurance documents.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

© 2018 Golden State Tax Training Institute, Inc. 8-3

People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they provide their services to the general public are generally independent contractors. However, whether they are independent contractors or employees depends on the facts in each case. It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors. Generally, the business owner must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. The business owner does not generally have to withhold or pay any taxes on payments to independent contractors. If the taxpayer is a business owner hiring or contracting with other individuals to provide services, he or she must determine whether the individuals providing services are employees or independent contractors. In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered. The determination can be complex and depends on the facts and circumstances of each case. The determination is based on whether the person for whom the services are performed has the right to control how the worker performs the services. It is not based merely on how the worker is paid, how often the worker is paid, or whether the work is part-time or full-time. Facts that provide evidence of the degree of control and independence fall into three categories:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?

2. Financial: Are the business aspects of the worker’s job controlled by the payer (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)?

3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no magic or set number of factors that makes the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another. The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination. To file his or her annual tax return, the taxpayer will need to use Schedule C or Schedule C-EZ to report his or her income or loss from a business he or she operated or a profession he or she practiced as a sole proprietor. If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status. If the taxpayer classifies an employee as an independent contractor and he or she has no reasonable basis for doing so, the taxpayer may be held liable for employment taxes for that worker. See Internal Revenue Code Section 3509 for more information. Hobby Income versus Business Income In order to use Schedule C, the taxpayer must be engaged in a for-profit business. A hobby is defined as an activity done regularly in one's leisure time for pleasure and not principally done with the goal of making a profit. A hobby may, in many instances, result in a profit but what is important is intent. Conversely, a for-profit business may end with a loss but that is not the intent. In order to determine if the activity qualifies as a business, taxpayers should consider the following factors:

Does the time and effort put into the activity indicate an intention to make a profit? Does the taxpayer depend on income from the activity? If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up

phase of the business? Has the taxpayer changed methods of operation to improve profitability? Does the taxpayer or his or her advisors have the knowledge needed to carry on the activity as a successful

business? Has the taxpayer made a profit in similar activities in the past? Does the activity make a profit in some years? Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

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The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year or at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses. The following table summarizes how income and expenses are treated for hobby and for-profit business.

Sole Proprietor Hobby

Report Expenses Schedule C Schedule A*

Report Income Schedule C Line 21, Form 1040

Income subject to SE Tax Yes No * Subject to the 2% of AGI limitation

Table 8-1 – For-Profit vs. Hobby (2017)

Hobby expenses can be deducted on Schedule A but only to the extent of the income produced by the activity and subject to the 2% adjusted gross income (AGI) limitation. This means that taxpayers who do not itemize may not claim any hobby expenses.

Schedule C-EZ Schedule C-EZ was designed for sole proprietors of smaller businesses. Restrictions on using Schedule C-EZ are as follows: (153)

Business Expenses must be $5,000 or less. Cash method of accounting is used. No inventory is used. Business shows a profit. Had only one business. Did not receive any credit card or similar payments that included amounts that are not includible in income. Had no employees. Does not need a Form 456 - Depreciation and Amortization. Does not claim business expenses for use of taxpayer’s home. The business does not have any prior year un-allowed passive activity losses.

The IRS has a brief video explaining Schedule C: Who needs to file and how to do it on their website.

Schedule C - Profit or Loss From Business Schedule C - Profit or Loss From Business, is designed to report the profit (or loss) from a trade or business of a sole proprietor. Nevertheless, a sole proprietor is no different from any other individual. Such an individual may have non-business income (interest, dividends), gains and losses from property transactions, rent income, or even farm income to report. Likewise, this taxpayer must either elect to itemize deductions or use the standard deduction. Plus, the taxpayer is entitled to personal exemptions and any dependency exemptions that may be appropriate. Small business owners can deduct all ordinary and necessary business expenses incurred in operating the business. This includes such expenses as advertising, depreciation, wages, car and truck expenses, utilities, etc., which are detailed on Schedule C. In short, Schedule C is only the place to start for the sole proprietor. The taxpayer may be subject to state and local taxes and other requirements such as business licenses and fees. Check with state and local governments for more information. Here are the key parts of Schedule C discussed in detail. Line 1: Gross receipts or sales Except as otherwise provided in the Internal Revenue Code, gross income includes income from whatever source derived. Enter gross receipts from a trade or business on Line 1. Include amounts the taxpayer received in a trade or business that were properly shown on Forms 1099-MISC. If the total amounts that were reported in box 7 of Forms 1099-MISC are more than the total the taxpayer is reporting on Line 1, attach a statement explaining the difference. Do not include any amount received for the sale of property used in a business or profession on Line 1. (154)

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

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Line 2: Returns and Allowances This line is only to be used by accrual based taxpayers who previously included an amount as income when earned, but were never paid. Cash basis taxpayers should never have an amount reported on Line 2. Line 4: Cost of Goods Sold If the taxpayer makes or buys goods to sell, they can deduct the cost of goods sold from the gross receipts on Line 4 Schedule C. However, to determine these costs, they must value the inventory at the beginning and end of each tax year. This applies if they are a manufacturer, wholesaler, or retailer or if are engaged in any business that makes, buys, or sells goods to produce income. This does not apply to a personal service business, such as the business of a doctor, lawyer, carpenter, or painter. However, if the taxpayer works in a personal service business and also sells or charges for the materials and supplies normally used in business, this also applies to them. The cost of goods sold is determined in Lines 35-42 on Schedule C. If the taxpayer must account for an inventory in their business, then they must generally use an accrual method of accounting for purchases and sales. (155) Figuring Cost of Goods Sold on Schedule C Line 35 - Inventory at beginning of year. If different from last year's closing inventory, attach explanation Line 36 - Purchases less cost of items withdrawn for personal use. Line 37 - Cost of labor. Do not include any amounts paid by the taxpayer to him or herself. Line 38 - Materials and supplies. Line 39 - Other costs. Line 40 - Add lines 35 through 39. Line 41 - Inventory at end of year. Line 42 - Cost of goods sold. Subtract line 41 from line 40. Part III of Schedule C is for businesses to determine their cost of goods sold which is reported on Line 4. The following is a summary of Schedule C Part III that explains how this determination is made. Line 35: Inventory at the Beginning of the Year Beginning inventory is the cost of merchandise on hand at the beginning of the year that will be available to sell to customers. If the taxpayer is a manufacturer or producer, it includes the total cost of raw materials, work in process, finished goods, and materials and supplies used in manufacturing the goods. Opening inventory usually will be identical to the closing inventory of the year before. Any difference between these numbers must be explained by the taxpayer in a schedule attached to the return. Line 36: Purchases Less Cost of Items Withdrawn for Personal Use If the taxpayer is a merchant, use the cost of all merchandise bought for sale. If the taxpayer is a manufacturer or producer, include the cost of all raw materials or parts purchased for manufacture into a finished product. Line 37: Cost of Labor Labor costs are usually an element of cost of goods sold only in a manufacturing or mining business. Small merchandisers (wholesalers, retailers, etc.) usually do not have labor costs that can properly be charged to cost of goods sold and are taken as a business expense deduction. In a manufacturing business, labor costs properly allocable to the cost of goods sold include both the direct and indirect labor used in fabricating the raw material into a finished, saleable product. Line 38: Materials and Supplies Materials and supplies, such as hardware and chemicals, used in manufacturing goods are charged to cost of goods sold. Those that are not used in the manufacturing process are treated as deferred charges and deducted as a business expense. Line 39: Other Costs Examples of other costs incurred in a manufacturing or mining process that can be charged to the cost of goods sold are as follows:

Freight - Freight-in, express-in, and cartage-in on raw materials, supplies used in production, and merchandise purchased for sale are all part of cost of goods sold.

Containers - Containers and packages that are an integral part of the product manufactured are a part of the cost of goods sold. If they are not an integral part of the manufactured product, their costs are shipping or selling expenses.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

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Overhead expenses - Overhead expenses include expenses such as rent, heat, light, power, insurance, depreciation, taxes, maintenance, labor, and supervision. Overhead expenses that are direct and necessary expenses of the manufacturing operation are included in the cost of goods sold.

Subtract the value of taxpayer’s closing inventory (including, as appropriate, the allocable parts of the cost of raw materials and supplies, direct labor, and overhead expenses) from line 40. Inventory at the end of the year is also known as closing or ending inventory. Ending inventory will usually become the beginning inventory of the next tax year. When the closing inventory (inventory at the end of the year) is subtracted from the cost of goods available for sale, the remainder is the cost of goods sold during the tax year. Report this on Line 4 of Schedule C. Expenses This section provides an overview of business expenses that can be deducted on Schedule C. A sole proprietor can deduct the costs of operating the business and these costs are known as business expenses. These are costs that do not have to be capitalized or included in the cost of goods sold but can deducted in the current year. To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in the particular field of business. A necessary expense is one that is helpful and appropriate for the business. An expense does not have to be indispensable to be considered necessary. (155)

If the taxpayer has an expense that is partly for business and partly personal, separate the personal part from the business part. The personal part is not deductible.

Line 8: Advertising Promoting a business through paid advertisements in newspapers, trade magazines, television, radio, or on the internet are all deductible. Include the normal and necessary expenses associated with these promotions. In addition, the cost of business cards, promotional items, flyers and the cost of distributing them, etc. can also be deducted as business expense. Advertising with the intention of influencing political legislation is not deductible. Line 9: Car and Truck Expenses A sole proprietor can deduct the actual expenses of operating a car or truck or take the standard mileage rate. This is true even if the vehicle was used for hire (such as a taxicab). Actual expenses must be used if there were five or more vehicles simultaneously in active use for the business (such as in fleet operations). Actual expenses cannot be used for a leased vehicle if the taxpayer previously used the standard mileage rate for that vehicle. A taxpayer can take the standard mileage rate of 53.5 cents for 2017 only if they: (154)

Owned the vehicle and used the standard mileage rate for the first year it was placed in service. Leased the vehicle and are using the standard mileage rate for the entire lease period (except the period, if any,

before 1998). If the taxpayer takes the standard mileage rate, multiply the number of business miles driven by 53.5 cents for 2017 and add to this amount of parking fees and tolls, and enter the total on line 9. Taxpayer should keep a log of business miles driven as well as tolls and parking fees paid. Do not deduct depreciation, rent or lease payments, or the actual operating expenses. If the taxpayer deducts actual expenses, include on line 9 the business portion of expenses for gasoline, oil, repairs, insurance, tires, license plates, etc., and show depreciation on line 13 and rent or lease payments on line 20a. If the taxpayer owns or leases five or more cars that are used for business at the same time, he or she must use the actual expense method. The taxpayer may also be required to provide additional information by completion of Part IV of Schedule C or Part III of Schedule C-EZ.

Placing the company logo, displays, or advertisements on a vehicle does not change the use from personal to business use.

Expenses incurred for use of a vehicle to get from the taxpayer’s home to the place of business are treated as personal commuting expenses and are not deductible. If the taxpayer does not have a regular office, mileage driven between home and the first stop is considered to be commuting to work and is not deductible. In addition, mileage driven between the last business stop and their home is also treated as commuting mileage and is not deductible. If the taxpayer qualifies for an office within the home, however, all of their business mileage driven outside of the home is deductible.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

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Additional information that should be maintained and logged in order to deduct expenses for business use of a vehicle includes:

Basis of vehicle. Date vehicle was placed into service. Total number of business miles driven for the year. Total number of commuting miles driven for the year. Total overall miles driven for the year.

To determine the business use percentage, divide the total number of business miles driven for the year by the total overall miles driven for the year.

Line 10: Commissions and Fees Use Line 10 to enter the total commissions and fees for the tax year. The taxpayer does not include commissions or fees that are capitalized or deducted elsewhere on his or her return. Line 11: Contract Labor Use Line 11 to report the total of all payments made to independent contractors for services rendered. If the business paid $600 or more to any one individual, Form 1099-MISC must be filed and the independent contractor must receive a copy by January 31. Examples of entities that do not need to receive Form 1099-MISC include the following:

Payments made to employees as compensation. Payment made for products as opposed to services. Payments made to other corporations. Payments made that are not related to business.

Do not include any payments made to employees for wages, salaries, and commissions on Line 11. Line 12: Depletion Enter the deduction for depletion on this line. Depletion is a measure of the cost recovery of a natural resource as it is extracted and sold. Since the resource will not be replaced the taxpayer can take a deduction to account for this. Natural resources include but are not limited to mines, oil and gas wells, timber and any exhaustible natural deposit. For more detailed information, see IRS Publication 535 - Business Expenses. Line 13: Depreciation and Section 179 Expense Depreciation is the annual deduction allowed to recover the cost or other basis of business or investment property having a useful life substantially beyond the tax year. It is also permissible to depreciate improvements made to business property that is being leased. Depreciation starts upon first use of the property in the business or for the production of income. It ends when the property is taken out of service, all the depreciable cost or other basis have been taken, or the property is no longer used in the business or for the production of income. See the Instructions for Form 4562 - Depreciation and Amortization and Publication 946 - How To Depreciate Property to figure the amount to enter on line 13. Line 14: Employee Benefit Programs Deduct contributions to employee benefit programs that are not an incidental part of a pension or profit-sharing plan included on line 19. Examples are accident and health plans, group-term life insurance, and dependent care assistance programs. The sole proprietor cannot deduct contributions made on his or her behalf as a self-employed person to any benefit plan. However, they may be able to deduct on Form 1040, line 29, or Form 1040NR, line 29, the amount paid for health insurance on behalf of the taxpayer, his or her spouse, and dependents, even if the taxpayer does not itemize deductions. See the instructions for Form 1040, line 29, or Form 1040NR, line 29, for details. The taxpayer can usually deduct insurance premiums in the tax year to which they apply. If he or she uses the cash method of accounting, he or she generally deducts insurance premiums in the tax year he or she actually paid them, even if he or she incurred them in an earlier year. If the taxpayer uses an accrual method of accounting, he or she cannot deduct insurance premiums before the tax year in which he or she incurs a liability for them. In addition, the taxpayer cannot deduct insurance premiums before the tax year in which he or she actually pay them (unless the exception for recurring items applies). Also, the taxpayer cannot deduct expenses in advance, even if he or she pays them in advance. This rule

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

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applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. Expenses such as insurance are generally allocable to a period of time. The taxpayer can deduct insurance expenses for the year to which they are allocable. Line 15: Insurance (other than health) Deduct premiums paid for business insurance on line 15. Not all forms of business insurance are deductible. Refer to the table for some examples of business insurance can be deducted on Line 15.

Deductible Premiums Non-Deductible Premiums Liability insurance Insurance for loss of earnings

Workers’ compensation insurance Insurance to secure a loan Malpractice insurance Self-insurance reserve funds

Fire, storm, theft, accident, or similar losses Credit insurance that covers losses from business bad debts

Table 8-2 Publication 535 – Chapter 6 - Insurance (2017)

Line 16a and 16b: Interest The tax treatment of interest expense differs depending on its type. For example, home mortgage interest and investment interest are treated differently. Interest allocation rules require the taxpayer to allocate (classify) interest expense so it is deducted (or capitalized) on the correct line of the return and receives the right tax treatment. These rules could affect how much interest the taxpayer is allowed to deduct on Schedule C or C-EZ. If the taxpayer has a mortgage on real property used in the business, enter on line 16a the interest paid for 2017. The exception to this is if the taxpayer used the main home as the primary place of business. Interest paid on a home office in a principal residence is deducted of Form 8829. Report all other business interest paid on Line 16b. Line 17: Legal and Professional Services Include on this line fees charged by accountants and attorneys that are ordinary and necessary expenses directly related to operating a business. Include fees for tax advice related to the business and for preparation of the tax forms related to the business. Also include expenses incurred in resolving asserted tax deficiencies relating to the business. Line 18: Office Expense The cost of running and operating an office are deductible. Examples include postage such as stamps, certified mail expenses, priority and/or express mail services. Office expenses also include consumable office supplies such as pads of paper, post it notes, file folders, pens, pencils, and receipt books. The supplies needed to operate office equipment such as printing paper, toner, cash register tape, etc. are also deductible office expenses. Line 18 should also be used to deduct office expenses that are not allowable of Form 8829 Business Use of Home. Taxpayers not eligible for in home deductions can still deduct expenses such as cleaning, additional insurance for a home office, telephone and internet usage. Line 19: Pension and Profit Sharing Plans Enter the deduction for contributions to a pension, profit-sharing, or annuity plan, or plan for the benefit of the employees. If the plan included the taxpayer as a self-employed person, enter contributions made as an employer on his or her behalf on Form 1040, line 28, or Form 1040NR, line 28, not on Schedule C. (154) In most cases, the sole proprietor must file the applicable form listed below if the business maintains a pension, profit-sharing, or other funded-deferred compensation plan. The filing requirement is not affected by whether or not the plan qualified under the Internal Revenue Code, or whether or not the business claims a deduction for the current tax year. There is a penalty for failure to timely file these forms.

Form 5500-EZ - Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan. File this form if the taxpayer has a one-participant retirement plan that meets certain requirements. A one-participant plan is a plan that covers only the taxpayer (or taxpayer and their spouse).

Form 5500-SF - . Short Form Annual Return/Report of Small Employee Benefit Plan. File this form if the taxpayer has a small plan (fewer than 100 participants in most cases) that meets certain requirements.

Form 5500 - Annual Return/Report of Employee Benefit Plan. File this form for a plan that does not meet the requirements for filing Form 5500-EZ or Form 5500-SF.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

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For plan years beginning on or after January 1, 2009, the Form 5500 and its schedules and the Form 5500-SF must be filed electronically under the computerized ERISA Filing Acceptance System (EFAST2). Check the DOL website at www.efast.dol.gov for additional information about the forms and schedules concerning the EFAST2 processing system, electronic filing, and software. For more details see IRS Publication 560 - Retirement Plans for Small Business. Line 20a and 20b: Rent or Lease If the business rented or leased vehicles, machinery, or equipment, the taxpayer should enter on line 20a the business portion of a rental cost. But if the business leased a vehicle for a term of 30 days or more, it may have to reduce the deduction by an amount called the inclusion amount. See IRS Publication 463 - Travel, Entertainment, Gift and Car Expenses for more information about leasing a car. Enter on line 20b amounts paid to rent or lease other property, such as office space in a building. Line 21: Repairs and Maintenance Deduct the cost of incidental repairs and maintenance that do not add to the property's value or appreciably prolong its life. Permissible expenses that can be deducted include labor, supplies and any item that do not add value to the asset, prolong the life of the asset, or adapt the asset for use in another capacity. Do not deduct the value of the sole proprietors own labor. Do not deduct amounts spent to restore or replace property; they must be capitalized. Line 22: Supplies In most cases, the taxpayer can deduct the cost of materials and supplies only to the extent they were actually consumed and used in the business during the tax year (provided they were not deducted in a prior tax year). However, if a business had incidental materials and supplies on hand for which no inventories or records of use were kept, it can deduct the cost of those actually purchased during the tax year, provided that method clearly reflects income. Acceptable deductions include the cost of books, professional instruments, equipment, etc., if they are normally used within a year. However, if their usefulness extends substantially beyond a year, the taxpayer must generally recover their costs through depreciation. Line 23: Taxes and Licenses Taxes that are directly attributable to a trade or business are deductible. Licenses and fees that are paid to regulatory agencies or government bodies are also deductible. Examples of acceptable deductions that can be taken on Line 23 include:

Real estate and personal property taxes on business assets. State and local sales taxes imposed on the taxpayer as the seller of goods or services. If the taxpayer collected

this tax from the buyer, he or she must also include the amount collected in gross receipts or sales on line 1. Licenses and regulatory fees for a trade or business paid each year to state or local governments. But some

licenses, such as liquor licenses, may have to be amortized. Social Security and Medicare taxes paid to match required withholding from the employees' wages. Reduce the

deduction by the amount shown on Form 8846, line 4. Federal unemployment tax paid. Federal highway use tax. Contributions to state unemployment insurance fund or disability benefit fund if the contributions are considered

taxes under state law.

Do not deduct the following on Line 23:

Federal income taxes, including taxpayer’s self-employment tax. However, he or she can deduct a portion of the self-employment tax on Form 1040, line 27.

Estate and gift taxes. Taxes assessed to pay for improvements, such as paving and sewers. Taxes on the taxpayers home or personal use property. State and local sales taxes on property purchased for use in the business. Instead, treat these taxes as part of

the cost of the property. State and local sales taxes imposed on the buyer that the taxpayer was required to collect and pay over to state

or local governments. These taxes are not included in gross receipts or sales nor are they a deductible expense. However, if the state or local government allowed the business to retain any part of the sales tax collected, these need to be included as income on line 6.

Other taxes and license fees not related to the business.

Lesson 8 - Sole Proprietor, Small Business Income and Taxation

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Line 24a and 24b: Travel, meals and entertainment Enter expenses for lodging and transportation connected with overnight travel for business while away from the tax home on Line 24a. In most cases, the tax home is the main place of business, regardless of where the taxpayer maintains the family home. The taxpayer cannot deduct expenses paid or incurred in connection with employment away from home if that period of employment exceeds 1 year. Also, the taxpayer cannot deduct travel expenses for his or her spouse, dependent, or any other individual unless that person is an employee, the travel is for a bona fide business purpose, and the expenses would otherwise be deductible by that person. Enter the total deductible business meal and entertainment expenses on Line 24b. This includes expenses for meals while traveling away from home for business and for meals that are business related entertainment. Business meal expenses are deductible only if they:

Are directly related to or associated with the active conduct of the trade or business. Not lavish or extravagant. Incurred while the sole proprietor or an employee is present at the meal.

The taxpayer cannot deduct any expense paid or incurred for a facility (such as a yacht or hunting lodge) used for any activity usually considered entertainment, amusement, or recreation. Also, they cannot deduct membership dues for any club organized for business, pleasure, recreation, or other social purpose. This includes country clubs, golf and athletic clubs, airline and hotel clubs, and clubs operated to provide meals under conditions favorable to business discussion. But it does not include civic or public service organizations, professional organizations (such as bar and medical associations), business leagues, trade associations, chambers of commerce, boards of trade, and real estate boards. Line 25: Utilities Include on line 25 charges for business use electric, gas, telephone, water, sewer and other ordinary and necessary utility charges. If the taxpayer qualifies to take an office-in-home deduction, the amounts paid for utilities for the home are included on Form 8829. If the taxpayer uses his or her home telephone for business use, the base cost of the first line in to the home is not deductible. However, any long-distance charges are includible on this line. Line 26: Wages Enter the total salaries and wages for the tax year on Line 26. Do not include salaries and wages deducted elsewhere on the return or amounts paid to the sole proprietor as these payments are treated as nondeductible owner’s draw.

Wages that are attributable to the cost of goods sold should be included in the Cost of Goods Sold section (Part III Schedule C discussed earlier).

If a sole proprietor provided taxable fringe benefits to employees, such as personal use of a car, do not deduct as wages the amount applicable to depreciation and other expenses claimed elsewhere.

Line 27a: Other expenses Line 27a includes all ordinary and necessary business expenses not deducted elsewhere on Schedule C. The type and amount of each expense are listed separately on the lines provided. Line 30: Business use of the Home To determine the deductible amount of business use of a taxpayer’s home, complete and attach Form 8829, Business Use of Home. Business Use of the Home Form 8829 - Expenses For Business Use of Your Home is used when a taxpayer can claim deductions for the business use of a portion of his or her home. The general rule is that taxpayers who use a part of the home for legitimate business purposes can deduct expenses allocable to that portion of the home used for those business purposes. This is the so-called home office deduction rule. Generally, the taxpayer can deduct business expenses that apply to a part of the home only if that part is exclusively used on a regular basis: (156)

As the principal place of business for any of the trades or businesses. As a place of business used by patients, clients or customers to meet or deal with the taxpayer in the normal

course of the trade or business. In connection with the trade or business if it is a separate structure that is not attached to the home.

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Exceptions to this rule apply to space used on a regular basis for:

Storage of inventory or product samples. Certain Daycare facilities.

A home office qualifies as a principal place of business if the taxpayer meets the following requirements:

The taxpayer uses it exclusively and regularly for administrative or management activities of the trade or business. The taxpayer has no other fixed location where he or she conducts substantial administrative or management

activities of the trade or business. If the part of the property being used for a home office is not attached to the living area of the home, that is, it is a separate building, then the taxpayer must show that the separate building is used in connection with his trade or business. But it does not have to be the principal place of business.

The key is to be sure that the part of the home being claimed as the home office is used exclusively for the business activity. Thus, if the room in the house doubles as a home office and family room used by the rest of the family for entertainment, it does not qualify as being exclusively used for business. There are two exceptions to the exclusive use rule. The first is where part of the home is used for storing inventory. Then, the taxpayer can deduct the expenses related to using that room if:

The inventory is kept for use in the taxpayer's trade or business. The trade or business in question is the wholesale or retail of selling of goods. The home is the only fixed location of the taxpayer's trade or business. The storage space is used on a regular basis. The space being used is a separately identifiable space suitable for storage.

The second exception to the exclusive use rule is for homes that are used for providing daycare services. Then the rooms can be used for both business and personal use, but the taxpayer has to allocate out the personal use portion, which is nondeductible. If the taxpayer qualifies for a home office deduction, the taxpayer can deduct both direct and indirect expenses for that office. Direct expenses are those that only benefit the particular room in the house used for business purposes, such as painting or repairing the room. Indirect expenses are those that benefit the entire home, including those parts of the home not being used for business. Utilities Business expenses for heat, lights, power, telephone service, and water and sewerage are deductible. However, any part due to personal use is not deductible. Deductions for internet-related expenses include domain registrations fees and webmaster consulting costs. When starting a business, the taxpayer may have to amortize these expenses as start-up costs. (157) A taxpayer is denied a business deduction for basic local telephone service charges on the first line in the residence. Additional charges for long-distance telephone calls, equipment, optional services (such as call waiting or message-taking) or additional telephone lines may be deductible. Part of the Home Used for Business

To determine what percentage of expenses can be deducted, we must discuss the business-use percentage of the home. Do this by dividing the area used for business by the total area of the home, in square feet. If the rooms in the home are about the same in size, simply divide the number of rooms used for business by the total number of rooms in the home.

Daycare Services Taxpayers who use their personal residences on a regular basis in the business of providing qualifying day care services do not have to meet the exclusive use test in order to deduct business-related expenses. But, the daycare business expenses

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are available only if the taxpayer has applied for and has been granted a license, or certification, or approval as a daycare center under the provisions of applicable state law. Depreciation - Business Use of the Home If the taxpayer owns his or her home and qualifies to deduct expenses for its business use, he or she can claim a deduction for depreciation. Depreciation is an allowance for the wear and tear on the part of the taxpayer’s home used for business. The taxpayer cannot depreciate the cost or value of the land. He or she recovers its cost when he or she sells or otherwise dispose of the property. Before the taxpayer figures his or her depreciation deduction, he or she needs to know the following information: (158)

The month and year he or she started using his or her home for business. The adjusted basis and fair market value of his or her home (excluding land) at the time he or she began using it

for business. The cost of any improvements before and after he or she began using the property for business. The percentage of his or her home used for business.

The adjusted basis of the taxpayer’s home is generally its cost, plus the cost of any permanent improvements he or she made to it, minus any casualty losses or depreciation deducted in earlier tax years. A permanent improvement increases the value of property, adds to its life, or gives it a new or different use. Examples of improvements are replacing electric wiring or plumbing, adding a new roof or addition, paneling, or remodeling. The fair market value of the taxpayer’s home is the price at which the property would change hands between a buyer and a seller, neither having to buy or sell, and both having reasonable knowledge of all necessary facts. Sales of similar property, on or about the date the taxpayer begin using his or her home for business, may be helpful in determining the property's fair market value. If the taxpayer first used his or her home for business before 2011 but after 1986, see IRS Publication 946 - How To Depreciate Property. If first used prior to 1987, see IRS Publication 534 - Depreciating Property Placed in Service Before 1987. Additional help can be found in Publication 587 - Business Use of Your Home. Carryover of Non-allowed Expenses to Next Year There is a limit on the amount of otherwise nondeductible expenses, such as utilities, insurance, and depreciation that the taxpayer can take as a home office deduction. The total amount of deductions, with depreciation taken last, cannot be more than the gross income earned from the business use of the home. The gross income limit is determined by deducting the following from gross income:

The business percentage of expenses that would be deductible by any taxpayer regardless of whether or not he is using the home in a trade or business, such as deductible mortgage interest, real estate taxes and casualty losses.

All other business deductions such as wages and supplies that are not directly related to the use of the home office.

The home office deduction cannot be used to create or increase a loss from the taxpayer's business. The amount of the deduction available is limited to the net income for the year from the business. Any excess loss can only be carried forward and used next year, using the same limitations. Form 8829 is completed to determine the allowable expenses for business use of the home. This figure is entered on the appropriate line on Schedule C. Simplified Option for Home Office Deduction Taxpayers may use a simplified option when figuring the deduction for business use of their home. This simplified option does not change the criteria for who may claim a home office deduction. It merely simplifies the calculation and recordkeeping requirements of the allowable deduction. Some key points of the simplified option are: (159)

Standard deduction of $5 per square foot of home used for business (maximum 300 square feet or $1,500). Allowable home-related itemized deductions claimed in full on Schedule A. (For example: Mortgage interest, real

estate taxes). No home depreciation deduction or later recapture of depreciation for the years the simplified option is used.

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The taxpayer may choose to use either the simplified method or the regular method for any taxable year. He or she chooses a method by using that method on his or her timely filed, original Federal income tax return for the taxable year. Once the taxpayer has chosen a method for a taxable year, he or she cannot later change to the other method for that same year. If the taxpayer uses the simplified method for one year and uses the regular method for any subsequent year, he or she must calculate the depreciation deduction for the subsequent year using the appropriate

optional depreciation table. This is true regardless of whether the taxpayer used an optional depreciation table for the first year the property was used in business.

Self-Employment Tax All individuals engaged in a trade or business in any capacity, other than as employees, are subject to the self-employment tax. Generally, this includes a sole proprietor, a member of a partnership, and one who renders service as an independent contractor. For 2017, the SE tax rate on net earnings is 15.3% (12.4% Social Security tax plus 2.9% Medicare tax). Self-employment (SE) tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners, and is usually calculated on the net profit from Schedule C. If a husband and wife both have separate Schedule Cs, each spouse must figure their SE tax separately on individual Schedule SEs. If a taxpayer has more than one business and therefore more than one Schedule C, all business income or loss is determined before calculating SE tax. If any of the income from a trade or business, other than a partnership, is community property income under state law, it is included in the earnings subject to SE tax of the spouse carrying on the trade or business. A taxpayer must pay SE tax and file Schedule SE if either of the following applies:

Their net earnings from self-employment (excluding church employee income) were $400 or more. They had church employee income of $108.28 or more except for ministers and members of religious orders

For a sole proprietor, net income (as reported on Schedule C) must be counted as self-employment income. If net income is less than $400, the self-employment tax does not apply. (160)

The Federal Insurance Contributions Act (FICA) tax includes two separate taxes. One is Social Security tax and the other is Medicare tax. Different rates apply for each of these programs. For 2017, the tax rate for Social Security is 6.2% for employees, 6.2% for employers and 12.4% for self-employed people. The Social Security tax applies only to the first $127,200 of wages, for a maximum of $7,886.40 for employees and for employers, and $15,772.80 for self-employed people. The current rate for Medicare is 1.45% for the employer, 1.45% for the employee and 2.9% for self-employed individuals. There is not a wage base limit for Medicare tax. All covered wages are subject to Medicare tax. Federal income tax is a pay-as-you-go tax. The taxpayer must pay it as he or she earns or receives income during the year. An employee usually has income tax withheld from his or her pay. If the taxpayer does not pay his or her tax through withholding, or does not pay enough tax that way, they might have to pay estimated tax. All taxpayers generally have to make estimated tax payments if they expect to owe taxes, including self-employment tax, of $1,000 or more when they file their return.

The self-employment tax is determined by completing Schedule SE Self-Employment. Business Net Profit on Schedule C is transferred to Form 1040 and to Schedule SE. If the taxpayer has to pay SE tax, he or she must file Form 1040 (with Schedule SE attached) even if the taxpayer does not otherwise have to file a Federal income tax return.

Additional Medicare Tax The taxpayer must file Form 8959 - Additional Medicare Tax if his or her total Medicare wages and tips plus his or her self-employment income (including the Medicare wages and tips and self-employment income of his or her spouse, if married filing jointly) are greater than the threshold amount for the taxpayer’s filing status. Self-employment income includes amounts from Schedule SE – Section A, line 4, or Section B, line 6. Negative amounts should not be considered for the purposes of Form 8959.

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Filing Status Threshold Amount Married filing jointly $250,000 Married filing separate $125,000 Single $200,000 Head of household (with qualifying person) $200,000 Qualifying widow(er) with dependent child $200,000 Note: The Additional Medicare Tax of 0.9% only applies to the wages above the Threshold Amount.

Table 8-3 - Questions and Answers for the Additional Medicare Tax (2017)

If the taxpayer has both wages and self-employment income, the threshold amount for applying Additional Medicare Tax on the self-employment income is reduced (but not below zero) by the amount of wages subject to Additional Medicare Tax. Compensation subject to RRTA taxes and wages subject to FICA tax are not combined to determine Additional Medicare Tax liability. The threshold applicable to an individual’s filing status is applied separately to each of these categories of income.

Special Rules and Exceptions Fishing Crew Member If the taxpayer is a member of the crew on a boat that catches fish or other water life, the earnings are subject to SE tax if all the following conditions apply: (161)

1. The taxpayer does not get any pay for the work except his or her share of the catch or a share of the proceeds from the sale of the catch, unless the pay meets all the following conditions:

a. The pay is not more than $100 per trip. b. The pay is received only if there is a minimum catch. c. The pay is solely for additional duties (such as mate, engineer, or cook) for which additional cash pay is

traditional in the fishing industry. 2. The taxpayer gets a share of the catch or a share of the proceeds from the sale of the catch. 3. The taxpayer’s share depends on the amount of the catch. 4. The boat's operating crew normally numbers fewer than 10 individuals. (An operating crew is considered as

normally made up of fewer than 10 if the average size of the crew on trips made during the last four calendar quarters is fewer than 10).

Notary Public Fees the taxpayer receives for services he or she performs as a notary public are reported on Schedule C or C-EZ but are not subject to self-employment tax (see the Instructions for Schedule SE (Form 1040)). State or Local Government Employee The taxpayer is subject to SE tax if he or she is an employee of a state or local government, is paid solely on a fee basis, and the services are not covered under a Federal-state Social Security agreement. U.S. Citizens Employed by Foreign Governments or International Organizations If the taxpayer was a U.S. citizen employed by a foreign government for services performed in the United States, Puerto Rico, Guam, American Samoa, the Commonwealth of the Northern Mariana Islands, or the U.S. Virgin Islands, they must pay SE tax on income earned. Income from this employment is reported on either Short or Long Schedule SE, line 2. If they performed services elsewhere as an employee of a foreign government or an international organization, those earnings are exempt from SE tax.

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U.S. Citizens or Resident Aliens Living Outside the United States A self-employed U.S. citizen or resident alien living outside the United States must pay SE tax in most cases. Also, they are not allowed to reduce foreign earnings from self-employment through the foreign earned income exclusion. However, the United States has Social Security agreements with many countries to eliminate dual taxes under two Social Security systems. Under these agreements, the taxpayer must generally pay Social Security and Medicare taxes to only the country they live in. To see which countries have agreements or to learn more visit the Social Security Administration’s International Programs website at www.socialsecurity.gov/international. Chapter 11 Bankruptcy Cases While a debtor in a chapter 11 bankruptcy case, the net profit or loss from self-employment (for example, from Schedule C or Schedule F) will not be included in Form 1040 income. Instead, it will be included on the income tax return (Form 1041) of the bankruptcy estate. However, the taxpayer (not the bankruptcy estate) is responsible for paying SE tax on net earnings from self-employment. Enter on the dotted line to the left of Schedule SE, line 3, Chapter 11 bankruptcy income and the amount of net profit or (loss). Combine that amount with the total of lines 1a, 1b, and 2 (if any) and enter the result on line 3. (162) Community Income If any of the income from a business or trade (including farming) is community income, then the income and deductions are reported based on the following: (154)

If only one spouse participates in the business, all of the income from that business is the self-employment earnings of the spouse who carried on the business.

If both spouses participate, the income and deductions are allocated to the spouses based on their distributive shares.

If either or both taxpayer and spouse are partners in a partnership, they should file a partnership return. If the taxpayer and his or her spouse had community income and file separate returns, attach Schedule SE to the

return of the spouse with the self-employment income. Also, attach Schedule(s) C, C-EZ, or F (showing the spouse's share of community income and expenses) to the return of each spouse.

More Than One Business If the taxpayer had two or more businesses, the net earnings from self-employment are the combined net earnings or loss from all of the businesses. If the taxpayer had a loss in one business, it reduces the income from another. Even though a separate Schedule C is required for each business or trade, figure the combined SE tax on one Schedule SE. Income from Farming Taxpayers who have derived income from farming should use Schedule F, Profit or Loss from Farming, rather than Schedule C to determine net profit from farming activities. Schedule F is similar to Schedule C but contains deduction and income items that are specific to farming that are not found on Schedule C. Income from Partnerships, Trusts, Estates, & S-Corporations Taxpayers who are members of and receive income from partnerships, trusts, estates, and/or S-corporations will receive a Schedule K-1- Beneficiary’s Share of Income, Deductions, Credits from each individual entity they are a member of. They will need to complete Schedule E - Supplemental Income and Loss, Part II to report their income from these activities. Self-Employment Tax Deduction Self-employed individuals who pay Self-employment tax may take an adjustment to income for a portion of the Social Security tax paid on Line 27 of Form 1040. The taxpayer can deduct the employer-equivalent portion of the self-employment tax in figuring adjusted gross income. This deduction only affects income tax and not the net earnings from self-employment or self-employment tax. Figuring Earnings Subject to SE Tax Utilize the flowchart on page 1 of Schedule SE to determine whether the taxpayer can use Section A - Short Schedule SE, or if they must use Section B - Long Schedule SE. For either section, the taxpayer will need to know what their net earnings from self-employment are. Generally, net earnings are simply the net profit from a farm or nonfarm business.

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There are three methods used to calculate the taxpayer’s net earnings from self-employment:

1. The regular method. 2. The nonfarm optional method. 3. The farm optional method.

The taxpayer must use the regular method unless they are eligible to use one or both of the optional methods. Use Publication 334 - Tax Guide for Small Business for general information about the Federal tax laws that apply to small business owners who are sole proprietors and to statutory employees. Publication 334 also has information on business income, expenses, and tax credits. Income/Loss Included in Net Earnings from Self-Employment Additional income/loss that should be included in determining the net earnings from self-employment include the following: (162)

1. Fees and other payments received by the taxpayer for services as a director of a corporation. 2. Interest received in the course of any trade or business, such as interest on notes or accounts receivable. 3. Payments for the use of rooms or other space when taxpayer also provided substantial services for the

convenience of tenants. Examples are hotel rooms, boarding houses, tourist camps or homes, trailer parks, parking lots, ware-houses, and storage garages.

4. Income from the retail sale of newspapers and magazines if age 18 or older. 5. Income received as a direct seller. Newspaper carriers or distributors of any age are direct sellers if certain

conditions apply. 6. Rental income from a farm if, as landlord, taxpayer materially participated in the production or management of the

production of farm products on this land. This income is farm earnings. To determine whether the taxpayer materially participated in farm management or production, do not consider the activities of any agent who acted for the taxpayer.

7. Income of certain crew members of fishing vessels with crews of normally fewer than 10 people. 8. Fees as a state or local government employee if paid only on a fee basis and the job was not covered under a

Federal-state Social Security coverage agreement. 9. Cash or a payment-in-kind from the Department of Agriculture for participating in a land diversion program.

Income/Loss NOT Included in Net Earnings from Self-Employment Additional income/loss that should NOT be included in determining the net earnings from self-employment include the following: (162)

1. Salaries, fees, etc., subject to Social Security or Medicare tax that the taxpayer received for performing services as an employee, including services performed as an employee under the railroad retirement system.

2. Fees received for services performed as a notary public. If the taxpayer had no other income subject to SE tax, enter “Exempt - Notary” on Form 1040, line 57. Do not file Schedule SE. However, if the taxpayer had other earnings of $400 or more subject to SE tax, enter “Exempt - Notary” and the amount of the net profit as a notary public from Schedule C or C-EZ on the dotted line to the left of Schedule SE, line 3. Subtract that amount from the total of lines 1a, 1b, and 2, and enter the result on line 3.

3. Income received as a retired partner under a written partnership plan that provides for lifelong periodic retirement payments if the taxpayer had no other interest in the partnership and did not perform services for it during the year.

4. Income from real estate rentals if the taxpayer did not receive the income in the course of a trade or business as a real estate dealer. Report this income on Schedule E.

5. Income from farm rentals (including rentals paid in crop shares) if, as landlord, taxpayer did not materially participate in the production or management of the production of farm products on the land.

6. Dividends on shares of stock and interest on bonds, notes, etc., if the taxpayer did not receive the income in the course of the trade or business as a dealer in stocks or securities.

7. Payments received from the Conservation Reserve Program if the taxpayer is receiving Social Security benefits for retirement or disability. Deduct these payments on line 1b of Schedule SE.

8. Gain or loss from the sale of a capital asset. 9. Net operating losses from other years.

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Household Employment - Schedule H A taxpayer has a household employee if he or she hired someone to do household work and that worker is the taxpayer’s employee. The worker is the taxpayer’s employee if he or she can control not only what work is done, but how it is done. If the worker is the taxpayer’s employee, it does not matter whether the work is full-time or part-time or that he or she hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether the taxpayer pays the worker on an hourly, daily, or weekly basis, or by the job. Some examples of workers who do household work are: (163)

Babysitters Caretakers House cleaning workers Domestic workers Drivers Health aides Housekeepers Maids Nannies Private nurses Yard workers

The household employment taxes that the taxpayer may have to account for on Schedule H cover the same three taxes that are withheld from all employment wages: the 12.4% Social Security tax, a 2.9% Medicare tax and the 6% Federal unemployment tax, or FUTA. If the taxpayer also pays state unemployment insurance taxes, Schedule H gives him or her credit for the taxes by reducing the FUTA rate. The taxpayer is responsible for paying all of FUTA – employees do not make contributions through withholding. The taxpayer also must pay half of each household employee's Social Security and Medicare tax liability; the employee pays the other half through amounts he or she withholds from her wages. If the taxpayer has to pay these taxes to the Internal Revenue Service, Schedule H calculates the precise amount that he or she should have withheld, as well as the portion he or she owes. (164)

Employment Tax Requirements

If the taxpayer: Then he or she needs to: Pays cash wages of $2,000 or more in 2017 to any one household employee.

Withhold and pay Social Security and Medicare taxes.

• The taxes are 15.3%1 of cash wages. • The employee's share is 7.65%1. • The taxpayer’s share is 7.65%

Pays total cash wages of $1,000 or more in any calendar quarter of 2017 or 2017 to household employees.

Pay Federal unemployment tax.

• The tax is 6% of cash wages. • Wages over $7,000 a year per employee are not

taxed. • The taxpayer may also owe state unemployment tax.

1In addition to withholding Medicare tax at 1.45%, an employer must withhold a 0.9% Additional Medicare Tax from wages he or she pays to an employee in excess of $200,000 in a calendar year. The employer is required to begin withholding Additional Medicare Tax in the pay period in which he or she pays wages in excess of $200,000 to an employee and continue to withhold it each pay period until the end of the calendar year. Additional Medicare Tax is only imposed on the employee. There is no employer share of Additional Medicare Tax. All wages that are subject to Medicare tax are subject to Additional Medicare Tax withholding if paid in excess of the $200,000 withholding threshold.

Table 15-4 - Publication 926 - Table 1-Do You Need To Pay Employment Taxes? (2017)

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If a taxpayer paid one person over $2,000 during 2017, withheld Federal income tax during 2017 for any household employee or paid total cash wages of $1,000 or more in any calendar quarter of 2016 or 2017 to all household employees, he or she is required to fill out a Schedule H - Household Employment Taxes and report the taxes payable on Line 60(a) of Form 1040. To figure the total cash wages the taxpayer paid in 2017 to each household employee, do not include amounts paid to any of the following individuals: (164)

His or her spouse. His or her child who was under age 21. His or her parent. (See Exception for parents below.) His or her employee who was under age 18 at any time during 2017 (If the employee was not a student, see

Exception for employees under age 18 below). Include the cash wages the taxpayer paid his or her parent for work in or around his or her home if both 1 and 2 below apply:

1. The taxpayer’s child who lived with him or her was under age 18 or had a physical or mental condition that required the personal care of an adult for at least 4 continuous weeks during the calendar quarter in which services were performed. A calendar quarter is January through March, April through June, July through September, or October through December.

2. The taxpayer was divorced and not remarried, a widow or widower, or married to and living with a person whose physical or mental condition prevented him or her from caring for the child during that 4-week period.

Include the cash wages the taxpayer paid to a person who was under age 18 and not a student if providing household services was his or her principal occupation.

Cash wages include wages paid by check, money order, etc. Cash wages do not include the value of food, lodging, clothing, or other noncash items the taxpayer gives a household employee.

Farming Taxation - Schedule F Schedule F - Profit or Loss From Farming, is the form that farmers use to report their farm business income and expenses. To a large extent, it's very similar to a self-employed taxpayer's Schedule C. Schedule F farm income includes amounts received from cultivating the land or raising or harvesting any agricultural commodities. This includes income from the operation of stock, dairy, poultry, fish, bees, fruit, or truck farm plantation, ranch, nursery, orchard, or oyster bed operations. It also includes income received in the form of crop shares if the taxpayer materially participates in the production process, operating a nursery or sod farm or raising or harvesting of trees bearing fruit, nuts, or other crops, or ornamental trees, such as evergreen trees, if they are cut within the first 6 years. However, Schedule F specifically does not include:

Gains from the sales of farmland or depreciable farm equipment. Gains from the sales of livestock held for draft, breeding, sport, or dairy purposes. Income received by a custom grain harvester who performs harvesting and hauling operations, with his own

equipment and personnel, on farms that the harvester neither owns, rents, nor leases. Livestock and Produce When a farmer sells produce or livestock raised on his farm, any money and the fair market value of any property received is ordinary income to the farmer, reported on Schedule F. Being on a cash basis, the income is reported as earned in the year that it is received. In the case of livestock or produce originally bought for the purposes of reselling, the profit on the later sale is the difference between the farmer's basis in the livestock or produce and the amount of money or property received from the sale. Sales of livestock held for draft, breeding, dairy, or sporting purposes is considered livestock held in the farmer's trade or business, and is depreciable. Any sales of this type of livestock may result in ordinary gains and losses or in capital gains and losses, depending on the circumstances.

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Use of Form 4797 Where livestock is used in the farmer's business and is held for more than one year, two years in the case of horses or cattle, any gain or loss on its sale is reported on Form 4797 - Sales of Business Property . This form would also be used to report the sale of any depreciable farm assets. Farm Expenses Ordinary and necessary costs of operating a farm for profit are deductions reported on Part II of Schedule F. Some typical examples of deductible farm expenses are listed in Part II of Schedule F. A main point in dealing with farm expenses is to be sure to allocate out expenses that are properly charged against farm income and those that are really personal living expenses of the farmer. Credit for Federal Tax on Gasoline and Special Fuels Federal law places a special excise tax on gasoline and other fuels. The tax is usually added right to the pump price at the time the fuel is purchased. The law gives farmers a special tax credit for gasoline used in off highway operations, such as running a tractor in the field. The credit applies to gas, diesel and other special fuels, but does not apply to oil. To obtain this credit, the farmer must complete Form 4136 – Credit for Federal Tax Paid on Fuels.

Rent Income (or Loss), expenses and depreciation pertaining to Rental Real Estate are usually reported on Part I, Schedule E – Supplemental Income and Loss, on Form 1040. Rental income is any payment the taxpayer receives for the use or occupation of property. The taxpayer generally must include in gross income all amounts he or she receives as rent. Rental Expenses and Improvements The taxpayer can deduct the cost of repairs that he or she makes to a rental property. The taxpayer cannot deduct the cost of improvements. He or she recovers the costs of improvements by taking depreciation. Separate the costs of repairs and improvements, and keep accurate records showing the cost of improvements. Repairs

A repair keeps the property in good operating condition. It does not materially add to the value of the property or substantially prolong its life. Repairing property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of repairs. The taxpayer can deduct from gross rental income expenses for advertising, janitor and maid service, utilities, fire and liability insurance, taxes, interest, commissions for the collection of rent, ordinary and necessary travel and transportation and other expenses.

Improvements An improvement adds to the value of the property, prolongs its useful life, or adapts it to new uses. Putting a recreation room in an unfinished basement, paneling a den, adding a bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, putting in new cabinets, putting on a new roof, and paving a driveway are examples of improvements. These increases in value must be capitalized and depreciated.

Other Income The following discussion explains how to treat other types of business income a taxpayer may receive. Restricted Property Restricted property is property that has certain restrictions that affect its value. If the taxpayer receives restricted stock or other property for services performed, the fair market value of the property in excess of his or her cost is included in income on Schedule C or C-EZ when the restriction is lifted. However, the taxpayer can choose to be taxed in the year he or she receives the property.

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Gains and Losses Do not report on Schedule C or C-EZ a gain or loss from the disposition of property that is neither stock in trade nor held primarily for sale to customers. Instead, the taxpayer must report these gains and losses on other forms. Promissory Notes Report promissory notes and other evidences of debt issued to the taxpayer in a sale or exchange of property that is stock in trade or held primarily for sale to customers on Schedule C or C-EZ. In general, the taxpayer reports them at their stated principal amount (minus any unstated interest) when he or she receives them. Lost Income Payments If the taxpayer reduces or stops his or her business activities, report on Schedule C or C-EZ any payment he or she receives for the lost income of the business from insurance or other sources. Report it on Schedule C or C-EZ even if the business is inactive when the taxpayer receives the payment. Damages The taxpayer must include in gross income compensation he or she receives during the tax year as a result of any of the following injuries connected with his or her business:

Patent infringement. Breach of contract or fiduciary duty. Antitrust injury.

Economic Injury The taxpayer may be entitled to a deduction against the income if it compensates him or her for actual economic injury. The deduction is the smaller of the following amounts:

The amount the taxpayer receives or accrues for damages in the tax year reduced by the amount he or she pays or incurs in the tax year to recover that amount.

The taxpayer’s loss from the injury that he or she has not yet deducted. Punitive Damages The taxpayer must also include punitive damages in income. Kickbacks If the taxpayer receives any kickbacks, he or she should include them in income on Schedule C or C-EZ. However, do not include them if the taxpayer properly treats them as a reduction of a related expense item, a capital expenditure, or cost of goods sold. Recovery of Items Previously Deducted If the taxpayer recovers a bad debt or any other item deducted in a previous year, include the recovery in income on Schedule C or C-EZ. However, if all or part of the deduction in earlier years did not reduce his or her tax, the taxpayer can exclude the part that did not reduce the tax. If the taxpayer excludes part of the recovery from income, he or she must include with the return a computation showing how the exclusion was figured. This rule does not apply to depreciation. The taxpayer has to recapture the depreciation deduction. This means he or she includes in income part or all of the depreciation he or she deducted in previous years. If the taxpayer’s business use of listed property falls to 50% or less in a tax year after the tax year he or she placed the property in service, he or she may have to recapture part of the depreciation deduction. The taxpayer does this by including in income on Schedule C part of the depreciation he or she deducted in previous years. The taxpayer uses Part IV of Form 4797 - Sales of Business Property, to figure the amount to include on Schedule C.

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If the taxpayer takes a Section 179 deduction for an asset and before the end of the asset's recovery period the percentage of business use drops to 50% or less, the taxpayer must recapture part of the Section 179 deduction. The taxpayer does this by including in income on Schedule C part of the deduction he or she took. The taxpayer uses Part IV of Form 4797 - Sales of Business Property, to figure the amount to include on Schedule C. If the taxpayer sells or exchanges depreciable property at a gain, he or she may have to treat all or part of the gain due to depreciation as ordinary income. The taxpayer figures the income due to depreciation recapture in Part III of Form 4797 - Sales of Business Property.

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

Review Questions Answers appear in Review Feedback 1. A taxpayer must pay self-employment tax and file Schedule SE if net earnings from self-employment are what amount

or more? A. $400 B. $500 C. $600 D. $800

2. Bob, a single filer, has $220,000 in self-employment income and $0 in wages. All of the following are true regarding

Bob’s Additional Medicare Tax liability except: A. Bob is liable to pay Additional Medicare Tax on $20,000 B. Bob is liable to pay Additional Medicare Tax on $220,000 C. Bob must file Form 8959 - Additional Medicare Tax D. The Additional Medicare Tax threshold for Bob’s filing status is $200,000

3. When determining the cost of goods sold for a business, which of the following are included in the calculation?

A. Materials and supplies, such as hardware and chemicals, used in manufacturing goods B. The cost of merchandise on hand at the beginning of the year that will be available to sell to customers C. Overhead expenses such as rent, heat, light, power, insurance, depreciation, taxes, maintenance, labor, and

supervision of a manufacturing operation D. All of the above

4. Small business owners can use Schedule C to deduct all ordinary and necessary business expenses incurred in

operating his or her business except: A. Advertising B. Depreciation C. Car and truck expenses D. Amounts spent to restore or replace property

5. Self-employment tax applies to which of the following?

A. Individuals who report only interest and dividend income B. Corporations that report less than $50,000 in gross receipts C. Independent contractors reporting net earnings from self-employment of $100 D. Independent contractors reporting net earnings from self-employment of $400 or more

6. Which of the following statements about Self-Employment (SE) tax is correct?

A. It is a Social Security and Medicare tax primarily for individuals who work for themselves B. If a taxpayer has more than one business all business income or loss is determined before calculating SE tax C. If any of the income from a business is community property income under state law, it is included in the

earnings subject to SE tax of the spouse carrying on the business D. All of the above

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Review Feedback Return to Review Questions Question 1 - A. $400 Generally, the taxpayer must pay SE tax and file Schedule SE (Form 1040) if net earnings from self-employment were $400 or more. Use Schedule SE to figure net earnings from self-employment. Question 2 - B. Bob is liable to pay Additional Medicare Tax on $220,000 Bob is only liable to pay Additional Medicare Tax on $20,000 ($220,000 in self-employment income minus the threshold of $200,000 for his filing status). Also, Bob must file Form 8959 - Additional Medicare Tax. Therefore choice B is incorrect. Question 3 - D. All of the above Figuring Cost of Goods Sold on Schedule C includes: Line 35 - Inventory at beginning of year. If different from last year's closing inventory, attach explanation Line 36 - Purchases less cost of items withdrawn for personal use. Line 37 - Cost of labor. Do not include any amounts paid by the taxpayer to him or herself. Line 38 - Materials and supplies. Line 39 - Other costs. Line 40 - Add lines 35 through 39. Line 41 - Inventory at end of year. Line 42 - Cost of goods sold. Subtract line 41 from line 40. Question 4 - D. Amounts spent to restore or replace property On line 21 the taxpayer can deduct the cost of incidental repairs and maintenance that do not add to the property's value or appreciably prolong its life. Permissible expenses that can be deducted include labor, supplies and any item that do not add value to the asset, prolong the life of the asset, or adapt the asset for use in another capacity. However the taxpayer does not deduct the value of the sole proprietors own labor. Additionally, he or she does not deduct amounts spent to restore or replace property; they must be capitalized. Question 5 - D. Independent Contractors reporting net earnings from self-employment of $400 or more A taxpayer must pay SE tax and file Schedule SE if either of the following applies:

• Their net earnings from self-employment (excluding church employee income) were $400 or more. • They had church employee income of $108.28 or more except for ministers and members of religious orders.

For a sole proprietor, net income (as reported on Schedule C) must be counted as self-employment income. If net income is less than $400, the self-employment tax does not apply. Question 6 - D. All of the above Self-employment (SE) tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners, and is usually calculated on the net profit from Schedule C. If a husband and wife both have separate Schedule Cs, each spouse must figure their SE tax separately on individual Schedule SEs. If a taxpayer has more than one business and therefore more than one Schedule C, all business income or loss is determined before calculating SE tax. If any of the income from a trade or business, other than a partnership, is community property income under state law, it is included in the earnings subject to SE tax of the spouse carrying on the trade or business.

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Specialized Returns At the conclusion of this lesson you should have a basic knowledge of:

Corporations and S Corporations Partnerships and Limited Liability Companies Trust and Estate Income Tax Tax Exempt Organizations Retirement Income Tax Farming Income Tax Schedule F - Profit or Loss From Farming Figuring Earnings Subject to the Tax Rental Real Estate Reporting Rental Income

Corporation Filing Information

Rules on income and deductions that apply to individuals also apply, for the most part, to corporations. However, the following are some of the special provisions that apply only to corporations. Generally, for tax years beginning after December 31, 2015, a corporation must file its income tax return by the 15th day of the 4th month after the end of its tax year. A new corporation filing a short-period return must generally file by the 15th day of the 4th month after the short period ends. A corporation that has dissolved must generally file by the 15th day of the 4th month after the date it dissolved. However, a corporation with a fiscal tax year ending June 30 must file by the 15th day of the 3rd month after the end of its tax year. A corporation with a short tax year ending anytime in June will be treated as if the short period ended June 30 and must file by the 15th day of the 3rd month after the end of its tax year. If the due date falls on a Saturday, Sunday, or legal holiday, the due date is extended to the next business day The rules the taxpayer must use to determine whether a business is taxed as a corporation changed for businesses formed after 1996. A business formed before 1997 and taxed as a corporation under the old rules will generally continue to be taxed as a corporation. The following businesses formed after 1996 are taxed as corporations: (165)

A business formed under a federal or state law that refers to it as a corporation, body corporate, or body politic. A business formed under a state law that refers to it as a joint-stock company or joint-stock association. An insurance company. Certain banks. A business wholly owned by a state or local government. A business specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain

publicly traded partnerships). Certain foreign businesses. Any other business that elects to be taxed as a corporation. For example, a limited liability company (LLC) can

elect to be treated as an association taxable as a corporation by filing Form 8832 - Entity Classification Election. For more information about LLCs, see Publication 3402 - Taxation of Limited Liability Companies.

A corporation is a personal service corporation if it meets all of the following requirements: (165)

1. Its principal activity during the “testing period” is performing personal services (defined later). Generally, the testing period for any tax year is the prior tax year. If the corporation has just been formed, the testing period begins on the first day of its tax year and ends on the earlier of:

a. The last day of its tax year, or b. The last day of the calendar year in which its tax year begins.

2. Its employee-owners substantially perform the services in (1), above. This requirement is met if more than 20% of the corporation's compensation cost for its activities of performing personal services during the testing period is for personal services performed by employee-owners.

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3. Its employee-owners own more than 10% of the fair market value of its outstanding stock on the last day of the testing period.

Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts. A person is an employee-owner of a personal service corporation if both of the following apply: (165)

1. He or she is an employee of the corporation or performs personal services for, or on behalf of, the corporation (even if he or she is an independent contractor for other purposes) on any day of the testing period.

2. He or she owns any stock in the corporation at any time during the testing period. A corporation is closely held if all of the following apply: (165)

1. It is not a personal service corporation. 2. At any time during the last half of the tax year, more than 50% of the value of its outstanding stock is, directly or

indirectly, owned by or for five or fewer individuals. “Individual” includes certain trusts and private foundations. If the taxpayer transfers property (or money and property) to a corporation in exchange for stock in that corporation (other than nonqualified preferred stock), and immediately afterward he or she is in control of the corporation, the exchange is usually not taxable. This rule applies both to individuals and to groups who transfer property to a corporation. It also applies whether the corporation is being formed or is already operating. It does not apply in the following situations: (165)

The corporation is an investment company. The taxpayer transfers the property in a bankruptcy or similar proceeding in exchange for stock used to pay

creditors. The stock is received in exchange for the corporation's debt (other than a security) or for interest on the

corporation's debt (including a security) that accrued while the taxpayer held the debt. Both the corporation and any person involved in a nontaxable exchange of property for stock must attach to their income tax returns a complete statement of all facts pertinent to the exchange.

To be in control of a corporation, the taxpayer or his or her group of transferors must own, immediately after the exchange, at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the outstanding shares of each class of nonvoting stock. The term property does not include services rendered or to be rendered to the issuing corporation. The value of stock received for services is income to the recipient. Income A corporation should use Form 1120 - U.S. Corporation Income Tax Return, to report the income, gains, losses, deductions, credits, and to figure the income tax liability of a corporation. Corporations can generally electronically file (e-file) Form 1120 and certain related forms, schedules, and attachments. Certain corporations with total assets of $10 million or more, that file at least 250 returns a year must e-file Form 1120. However, in certain instances, these corporations can request a waiver. Unless exempt under section 501, all domestic corporations (including corporations in bankruptcy) must file an income tax return whether or not they have taxable income. Domestic corporations must file Form 1120, unless they are required, or elect to file a special return Except as otherwise provided in the Internal Revenue Code, gross income includes all income from whatever source derived. Gross income does not include income from qualifying shipping activities if the corporation makes an election under section 1354 to be taxed on its notional shipping income (as defined in section 1353) at the highest corporate tax rate (35%). If the election is made, the corporation generally may not claim any loss, deduction, or credit with respect to qualifying shipping activities. A corporation making this election also may elect to defer gain on the disposition of a qualifying vessel. In general, advance payments are reported in the year of receipt. For exceptions to this general rule for corporations that use the accrual method of accounting, see the following: (166)

To report income from long-term contracts, see section 460.

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For special rules for reporting certain advance payments for goods and long-term contracts, see Regulations section 1.451-5.

For rules that allow a limited deferral of advance payments beyond the current tax year, see Revenue Procedure 2004-34, 2004-22 I.R.B. 991, as modified and clarified by Revenue Procedure 2011-18, 2011-5 I.R.B. 443, for advance payments from the sale of certain gift cards.

For information on adopting or changing to a permissible method for reporting advance payments for services and certain goods by an accrual method corporation, see the Instructions for Form 3115.

Generally, the installment method cannot be used for dealer dispositions of property. A “dealer disposition” is any disposition of personal property by a person who regularly sells or otherwise disposes of personal property of the same type on the installment plan or real property held for sale to customers in the ordinary course of the taxpayer's trade or business. The restrictions on using the installment method do not apply to the following: (166)

Dealer dispositions of property before March 1, 1986. Dispositions of property used or produced in the trade or business of farming. Certain dispositions of timeshares and residential lots reported under the installment method for which the

corporation elects to pay interest under section 453(I)(3). Accrual method corporations are not required to accrue certain amounts to be received from the performance of services that, on the basis of their experience, will not be collected, if: (166)

The services are in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting, or

The corporation's average annual gross receipts have not exceeded $5 million for any prior 3-tax-year period. For more details, see Regulations sections 1.448-2(a)(2) and 1.448-1T(f)(2).

This provision does not apply to any amount if interest is required to be paid on the amount or if there is any penalty for failure to timely pay the amount. See Regulations section 1.448-2 for information on the nonaccrual experience method, including information on safe harbor methods. See Revenue Procedure 2011-46, 2011-42 I.R.B. 518, for information on a book safe harbor method of accounting for corporations that use the nonaccrual experience method of accounting. Corporations that qualify to use the nonaccrual experience method should attach a statement showing total gross receipts, the amount not accrued as a result of the application of section 448(d)(5), and the net amount accrued. Property Exchanged for Stock If the taxpayer transfers property (or money and property) to a corporation in exchange for stock in that corporation (other than nonqualified preferred stock), and immediately afterward his or she is in control of the corporation, the exchange is usually not taxable. This rule applies both to individuals and to groups who transfer property to a corporation. It also applies whether the corporation is being formed or is already operating. It does not apply in the following situations: (166)

The corporation is an investment company. The taxpayer transfers the property in a bankruptcy or similar proceeding in exchange for stock used to pay

creditors. The stock is received in exchange for the corporation's debt (other than a security) or for interest on the

corporation's debt (including a security) that accrued while the taxpayer held the debt. Both the corporation and any person involved in a nontaxable exchange of property for stock must attach to their income tax returns a complete statement of all facts pertinent to the exchange.

To be in control of a corporation, the taxpayer or his or her group of transferors must own, immediately after the exchange, at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the outstanding shares of each class of nonvoting stock. The term property does not include services rendered or to be rendered to the issuing corporation. The value of stock received for services is income to the recipient.

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Cost of Goods Sold Filers of Form 1120, 1120-C, 1120-F, 1120S, 1065 or 1065-B, use Form 1125-A - Cost of Goods Sold to calculate and deduct cost of goods sold. Enter on Form 1120, line 2, the amount from Form 1125-A, line 8. Interest Figure the taxable interest on U.S. obligations and on loans, notes, mortgages, bonds, bank deposits, corporate bonds, tax refunds, etc. Do not offset interest expense against interest income. Special rules apply to interest income from certain below-market-rate loans. Gross Rents Include the gross amount received for the rental of property. Deduct expenses such as repairs, interest, taxes, and depreciation on the proper lines for deductions. A rental activity held by a closely held corporation or a personal service corporation may be subject to the passive activity loss rules. Other Income Examples of other income to report on line 10 include the following:

1. Recoveries of bad debts deducted in prior years under the specific charge-off method. 2. The amount included in income from Form 6478 - Alcohol and Cellulosic Biofuel Fuels Credit. 3. The amount included in income from Form 8864 - Biodiesel and Renewable Diesel Fuels Credit. 4. Refunds of taxes deducted in prior years to the extent they reduced the amount of tax imposed. See section 111

and the related regulations. Do not offset current year taxes against tax refunds. 5. Ordinary income from trade or business activities of a partnership (from Schedule K-1 (Form 1065 or 1065-B)).

Do not offset ordinary losses against ordinary income. Instead, include the losses on line 26. Show the partnership's name, address, and EIN on a separate statement attached to this return. If the amount entered is from more than one partnership, identify the amount from each partnership.

6. Any LIFO recapture amount under section 1363(d). The corporation may have to include a LIFO recapture amount in income if it:

a. Used the LIFO inventory method for its last tax year before the first tax year for which it elected to become an S corporation or

b. Transferred LIFO inventory assets to an S corporation in a nonrecognition transaction in which those assets were transferred basis property.

The LIFO recapture amount is the amount by which the C corporation's inventory under the FIFO method exceeds the inventory amount under the LIFO method at the close of the corporation's last tax year as a C corporation (or for the year of the transfer, if (2) above applies). For more information, see Regulations section 1.1363-2 and Revenue Procedure 94-61, 1994-2 C.B. 775. See the instructions for Schedule J - Income Averaging for Farmers and Fishermen, Part I, line 11.

Any net positive section 481(a) adjustment. Part or all of the proceeds received from certain corporate-owned life insurance contracts issued after August 17,

2006. Corporations that own one or more employer-owned life insurance contracts issued after this date must file Form 8925 - Report of Employer-Owned Life Insurance Contracts. See section 101(j) for details.

Income from cancellation of debt (COD) for the repurchase of a debt instrument for less than its adjusted issue price. However, if a corporation elected under section 108(i), to defer the income from COD in connection with the reacquisition of an applicable debt instrument in 2009 and 2010, the income is deferred and ratably included in income over the 5-year period beginning with:

o For a reacquisition that occurred in 2009, the fifth tax year following the tax year in which the reacquisition occurred, and

o For a reacquisition that occurred in 2010, the fourth tax year following the tax year in which the reacquisition occurred.

Once made, the election is irrevocable and the exclusions for COD income under section 108(a)(1)(A), (B), (C), and (D) do not apply for the tax year of the election or any later tax year. Also, any deferred COD income that has been accelerated because of certain events under section 108(i)(5)(D) must be included in income in the current year.

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The corporation's share of the following income from Form 8621 - Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund:

o Ordinary earnings of a qualified electing fund. o Gain or loss from marking passive foreign investment company (PFIC) stock to market. o Gain or loss from sale or other disposition of Section 1296 stock. o Excess distributions from a Section 1291 fund.

Uniform Capitalization Rules The uniform capitalization rules of Section 263A require corporations to capitalize, or include in inventory, certain costs. Corporations subject to the Section 263A uniform capitalization rules are required to capitalize:

1. Direct costs, and 2. An allocable part of most indirect costs (including taxes) that (a) benefit the assets produced or acquired for resale,

or (b) are incurred because of the performance of production or resale activities. The costs required to be capitalized under Section 263A are not deductible until the property (to which the costs relate) is sold, used, or otherwise disposed of by the corporation. Recover these costs through depreciation, amortization, or cost of goods sold. Costs of Going Into Business When a company goes into business, it treats all costs it incurs to get its business started as capital expenses. However, a corporation can elect to deduct a limited amount of start-up or organizational costs. Any costs not deducted can be amortized. Start-up costs are costs for creating an active trade or business or investigating the creation or acquisition of an active trade or business. Organizational costs are the direct costs of creating the corporation. Related Persons A corporation that uses an accrual method of accounting cannot deduct business expenses and interest owed to a related person who uses the cash method of accounting until the corporation makes the payment and the corresponding amount is includible in the related person's gross income. Determine the relationship, for this rule, as of the end of the tax year for which the expense or interest would otherwise be deductible. If a deduction is denied, the rule will continue to apply even if the corporation's relationship with the person ends before the expense or interest is includible in the gross income of that person. These rules also deny the deduction of losses on the sale or exchange of property between related persons. Income From Qualifying Shipping Activities A corporation may make an election to be taxed on its notional shipping income at the highest corporate tax rate. If a corporation makes this election it may exclude income from qualifying shipping activities from gross income. Also if the election is made, the corporation generally may not claim any loss, deduction, or credit with respect to qualifying shipping activities. A corporation making this election may also elect to defer gain on the disposition of a qualifying vessel. Election to Expense Qualified Refinery Property A corporation can make an irrevocable election on its tax return filed by the due date (including extensions) to deduct 50% of the cost of qualified refinery property (defined in section 179C(c) of the Internal Revenue Code), placed in service before January 1, 2014. The deduction is allowed for the year in which the property is placed in service. A subchapter T cooperative can make an irrevocable election on its return by the due date (including extensions) to allocate this deduction to its owners based on their ownership interest. Energy-Efficient Commercial Building Property Deduction A corporation can claim a deduction for costs associated with energy-efficient commercial building property, placed in service before January 1, 2014. In order to qualify for the deduction: (166)

The costs must be associated with depreciable or amortizable property in a Standard 90.1-2001 domestic building; The property must be either a part of the interior lighting system, the heating, cooling, ventilation and hot water

system, or the building envelope (defined in section 179D(c)(1)(C) of the Internal Revenue Code); and

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The property must be installed as part of a plan to reduce the total annual energy and power costs of the building by 50% or more.

The deduction is limited to $1.80 per square foot of the building less the total amount of deductions taken for this property in prior tax years. Other rules and limitations apply. The corporation must reduce the basis of any property by any deduction taken. The deduction is subject to recapture if the corporation fails to fully implement an energy savings plan. Corporate Preference Items A corporation must make special adjustments to certain items before it takes them into account in determining its taxable income. These items are known as corporate preference items and they include the following: (166)

Gain on the disposition of section 1250 property. Percentage depletion for iron ore and coal (including lignite). Amortization of pollution control facilities. Mineral exploration and development costs.

Dividends-Received Deduction A corporation can deduct a percentage of certain dividends received during its tax year. This section discusses the general rules that apply. The deduction is figured on Form 1120, Schedule C, or the applicable schedule of the income tax return. Corporations cannot take a deduction for dividends received from the following entities: (166)

A real estate investment trust (REIT). A corporation exempt from tax under section 501 or 521 of the Internal Revenue Code either for the tax year of

the distribution or the preceding tax year. A corporation whose stock was held less than 46 days during the 91-day period beginning 45 days before the

stock became ex-dividend with respect to the dividend. Ex-dividend means the holder has no rights to the dividend. A corporation whose preferred stock was held less than 91 days during the 181-day period beginning 90 days

before the stock became ex-dividend with respect to the dividend if the dividends received are for a period or periods totaling more than 366 days.

Any corporation, if the corporation is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property.

Dividends on deposits or withdrawable accounts in domestic building and loan associations, mutual savings banks, cooperative banks, and similar organizations are interest, not dividends. They do not qualify for this deduction. The total deduction for dividends received or accrued is generally limited (in the following order) to: (166)

1. 80% of the difference between taxable income and the 100% deduction allowed for dividends received from affiliated corporations, or by a small business investment company, for dividends received or accrued from 20%-owned corporations, then

2. 70% of the difference between taxable income and the 100% deduction allowed for dividends received from affiliated corporations, or by a small business investment company, for dividends received or accrued from less-than-20%-owned corporations (reducing taxable income by the total dividends received from 20%-owned corporations).

In figuring the limit, determine taxable income without the following items: (166)

1. The net operating loss deduction. 2. The domestic production activities deduction. 3. The deduction for dividends received. 4. Any adjustment due to the nontaxable part of an extraordinary dividend. 5. Any capital loss carryback to the tax year.

If a corporation has a net operating loss (NOL) for a tax year, the limit of 80% (or 70%) of taxable income does not apply. To determine whether a corporation has an NOL, figure the dividends-received deduction without the 80% (or 70%) of taxable income limit.

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Extraordinary Dividends If a corporation receives an extraordinary dividend on stock held 2 years or less before the dividend announcement date, it generally must reduce its basis in the stock by the nontaxed part of the dividend. The nontaxed part is any dividends-received deduction allowable for the dividends. An extraordinary dividend is any dividend on stock that equals or exceeds a certain percentage of the corporation's adjusted basis in the stock. The percentages are: (166)

5% for stock preferred as to dividends, or 10% for other stock.

Treat all dividends received that have ex-dividend dates within an 85-consecutive-day period as one dividend. Treat all dividends received that have ex-dividend dates within a 365-consecutive-day period as extraordinary dividends if the total of the dividends exceeds 20% of the corporation's adjusted basis in the stock. Below-Market Loans If a corporation receives a below-market loan and uses the proceeds for its trade or business, it may be able to deduct the forgone interest. A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable Federal rate. A below-market loan generally is treated as an arm's-length transaction in which the borrower is considered as having received both the following: (166)

1. A loan in exchange for a note that requires payment of interest at the applicable Federal rate, and 2. An additional payment in an amount equal to the forgone interest.

Treat the additional payment as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction. Charitable Contributions A corporation can claim a limited deduction for charitable contributions made in cash or other property. The contribution is deductible if made to, or for the use of, a qualified organization. A corporation cannot take a deduction if any of the net earnings of an organization receiving contributions benefit any private shareholder or individual. A corporation using the cash method of accounting deducts contributions in the tax year paid. A corporation using an accrual method of accounting can choose to deduct unpaid contributions for the tax year the board of directors authorizes them if it pays them by the due date for filing the corporation’s tax return (not including extensions). Make the choice by reporting the contribution on the corporation's return for the tax year. Attach a declaration stating that the board of directors adopted the resolution during the tax year. The declaration must include the date the resolution was adopted. A corporation cannot deduct charitable contributions that exceed 10% of its taxable income for the tax year. Figure taxable income for this purpose without the following:

The deduction for charitable contributions. The dividends-received deduction. The deduction allowed under section 249 of the Internal Revenue Code. The domestic production activities deduction. Any net operating loss carryback to the tax year. Any capital loss carryback to the tax year.

The corporation can carry over, within certain limits, to each of the subsequent 5 years any charitable contributions made during the current year that exceed the 10% limit. You lose any excess not used within that period. For example, if a corporation has a carryover of excess contributions paid in 2017 and it does not use all the excess on its return for 2018, it can carry any excess over to 2019, 2020, 2021, and 2022, if applicable. Any excess not used in 2022 is lost. Do not deduct a carryover of excess contributions in the carryover year until after you deduct contributions made in that year (subject to the 10% limit). You cannot deduct a carryover of excess contributions to the extent it increases a net operating loss carryover.

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Capital Losses A corporation can deduct capital losses only up to the amount of its capital gains. In other words, if a corporation has an excess capital loss, it cannot deduct the loss in the current tax year. Instead, it carries the loss to other tax years and deducts it from any net capital gains that occur in those years. A capital loss is carried to other years in the following order: (166)

3 years prior to the loss year. 2 years prior to the loss year. 1 year prior to the loss year. Any loss remaining is carried forward for 5 years.

When the corporation carries a net capital loss to another tax year, treat it as a short-term loss. It does not retain its original identity as long-term or short-term. Net Operating Losses A corporation generally figures and deducts a net operating loss (NOL) the same way an individual, estate, or trust does. The same 2-year carryback and up to 20-year carryforward periods apply, and the same sequence applies when the corporation carries two or more NOLs to the same year. However, a corporation's NOL generally differs from individual, estate, and trust NOLs in the following ways: (166)

A corporation can take different deductions when figuring an NOL. A corporation must make different modifications to its taxable income in the carryback or carryforward year when

figuring how much of the NOL is used and how much is carried over to the next year. A corporation uses different forms when claiming an NOL deduction.

Generally, a corporation must carry an NOL back 2 years prior to the year the NOL is generated. If the NOL is not used in the prior years, the remaining NOL can be carried forward for up to 20 years after the tax year in which the NOL was generated. Special rules apply to certain losses including a specified liability loss, a farming loss, certain disaster losses, an applicable 2008 or 2009 NOL, an eligible loss, or an excess interest loss. A corporation can make an election to waive the carryback period and use only the 20-year carryforward period. To make the election check the box on Schedule K, Form 1120. Consolidated tax return filers must also attach a statement to the original return, filed by the due date (including extensions) for the NOL year. If a corporation carries back the NOL, it can use either Form 1120X - Amended U.S. Corporation Income Tax Return or Form 1139 - Corporation Application for Tentative Refund. A corporation can get a refund faster by using Form 1139. It cannot file Form 1139 before filing the return for the corporation's NOL year, but it must file Form 1139 no later than 1 year after the year it sustains the NOL. If the corporation does not file Form 1139, it must file Form 1120X within 3 years of the due date, plus extensions, for filing the return for the year in which it sustains the NOL. A personal service corporation may not carryback an NOL to or from any tax year in which a section 444 election to have a tax year other than a required tax year applies. If a corporation carries forward its NOL, it enters the carryover on Schedule K, Form 1120, line 12. It also enters the deduction for the carryover (but not more than the corporation's taxable income after special deductions) on line 29(a) of Form 1120, or the applicable line of the corporation's income tax return. If a corporation expects to have an NOL in its current year, it can automatically extend the time for paying all or part of its income tax for the immediately preceding year. It does this by filing Form 1138, Extension of Time for Payment of Taxes by a Corporation Expecting a Net Operating Loss Carryback. It must explain on the form why it expects the loss. The payment of tax that may be postponed cannot exceed the expected overpayment from the carryback of the NOL. If the NOL available for a carryback or carryforward year is greater than the taxable income for that year, the corporation must modify its taxable income to figure how much of the NOL it will use up in that year and how much it can carry over to the next tax year. Its carryover is the excess of the available NOL over its modified taxable income for the carryback or carryforward year.

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A corporation figures its modified taxable income the same way it figures its taxable income, with the following exceptions: (166)

It can deduct NOLs only from years before the NOL year whose carryover is being figured. The corporation must figure its deduction for charitable contributions without considering any NOL carrybacks.

The modified taxable income for any year cannot be less than zero. Modified taxable income is used only to figure how much of an NOL the corporation uses up in the carryback or carryforward year and how much it carries to the next year. It is not used to fill out the corporation's tax return or figure its tax. A loss corporation (one with cumulative losses) that has an ownership change is limited on the taxable income it can offset by NOL carryforwards arising before the date of the ownership change. This limit applies to any year ending after the change of ownership. Alternative Minimum Tax (AMT) The tax laws give special treatment to some types of income and allow special deductions and credits for some types of expenses. These laws enable some corporations with substantial economic income to significantly reduce their regular tax. The corporate alternative minimum tax (AMT) targets these corporations and attempts to ensure that they pay at least a minimum amount of tax on their economic income. A corporation (other than a small corporation exempt from the AMT) owes AMT if its tentative minimum tax is more than its regular tax. A corporation is treated as a small corporation exempt from the AMT for its current tax year if that year is the corporation's first tax year in existence (regardless of its gross receipts for the year) or: (166)

1. It was treated as a small corporation exempt from the AMT for all prior tax years beginning after 1997, and 2. Its average annual gross receipts for the 3-tax-year period (or portion thereof during which the corporation was in

existence) ending before its current tax year did not exceed $7.5 million ($5 million for the corporation's first 3-tax-year period).

Use Form 4626 - Alternative Minimum Tax - Corporations, to figure the tentative minimum tax of a corporation that is not a small corporation for AMT purposes. Distributions to Shareholders Common kinds of distributions by a corporation to shareholders are ordinary dividends, capital gain distributions and nontaxable distributions. Most distributions are in money, but they may also be in stock or other property. For this purpose, “property” generally does not include stock in the corporation or rights to acquire this stock. A corporation generally does not recognize a gain or loss on the distributions covered by the rules in this section however some exceptions appear below. The amount of a distribution is generally the amount of any money paid to the shareholder plus the fair market value (FMV) of any property transferred to the shareholder. However, this amount is reduced (but not below zero) by the following liabilities: (166)

Any liability of the corporation the shareholder assumes in connection with the distribution. Any liability to which the property is subject immediately before, and immediately after, the distribution.

The FMV of any property distributed to a shareholder becomes the shareholder's basis in that property.

A corporation will recognize a gain on the distribution of property to a shareholder if the FMV of the property is more than its adjusted basis. This is generally the same treatment the corporation would receive if the property were sold. However, for this purpose, the FMV of the property is the greater of the following amounts: (166)

The actual FMV. The amount of any liabilities the shareholder assumed in connection with the distribution of the property.

If the property was depreciable or amortizable, the corporation may have to treat all or part of the gain as ordinary income from depreciation recapture.

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Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as “stock options”) are distributions by a corporation of rights to acquire its stock. Distributions of stock dividends and stock rights are generally tax-free to shareholders. However, if any of the following apply to their distribution, stock and stock rights are treated as property: (166)

1. Any shareholder has the choice to receive cash or other property instead of stock or stock rights. 2. The distribution gives cash or other property to some shareholders and an increase in the percentage interest in

the corporation's assets or earnings and profits to other shareholders. 3. The distribution is in convertible preferred stock and has the same result as in (2). 4. The distribution gives preferred stock to some common stock shareholders and gives common stock to other

common stock shareholders. 5. The distribution is on preferred stock. (An increase in the conversion ratio of convertible preferred stock made

solely to take into account a stock dividend, stock split, or similar event that would otherwise result in reducing the conversion right is not a distribution on preferred stock).

The term “stock” includes rights to acquire stock and the term “shareholder” includes a holder of rights or convertible securities. When to File Generally, for tax years beginning after December 31, 2015, a corporation must file its income tax return by the 15th day of the 4th month after the end of its tax year. A new corporation filing a short-period return must generally file by the 15th day of the 4th month after the short period ends. A corporation that has dissolved must generally file by the 15th day of the 4th month after the date it dissolved. However, a corporation with a fiscal tax year ending June 30 must file by the 15th day of the 3rd month after the end of its tax year. A corporation with a short tax year ending anytime in June will be treated as if the short period ended June 30 and must file by the 15th day of the 3rd month after the end of its tax year. (165) Extension of Time to File File Form 7004 - Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns to request an extension of time to file a corporation’s income tax return. The IRS will grant the extension if the corporation completes the form properly, files it, and pays any tax due by the original due date for the return. Form 7004 does not extend the time for paying the tax due on the return. Interest, and possibly penalties, will be charged on any part of the final tax due not shown as a balance due on Form 7004. The interest is figured from the original due date of the return to the date of payment.

The IRS issued a statement on February 7, 2017 explaining that a new revision of the Instructions for Form 7004 correctly reflects that calendar year C corporations are eligible for an automatic six-month extension of time to file their income tax returns. The statement noted that, although Code Section 6081(b) provides a five-

month automatic extension period for calendar year C Corporations, the IRS is granting a six-month automatic extension under Code Section 6081(a) instead. The change is reflected in the new revision of the Instructions for Form 7004. The IRS will no longer send a notification that the extension has been approved. They will notify the corporation only if its request for an extension is disallowed. Properly filing Form 7004 will automatically give the corporation the maximum extension allowed from the due date of its return to file the return. Additionally, The IRS may terminate the automatic extension at any time by mailing a notice of termination to the entity or person that requested the extension. The notice will be mailed at least 10 days before the termination date given in the notice. Late Filing of Return A corporation that does not file its tax return by the due date, including extensions, may be penalized 5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax. If the corporation is charged a penalty for late payment of tax (discussed next) for the same period of time, the penalty for late filing is reduced by the amount of the penalty for late payment. The minimum penalty for a return that is over 60 days late is the smaller of the tax due or $210 in 2017. The penalty will not be imposed if the corporation can show the failure to file on time was due to a reasonable cause.

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Late Payment of Tax A corporation that does not pay the tax when due may be penalized half of 1% of the unpaid tax for each month or part of a month the tax is not paid, up to a maximum of 25% of the unpaid tax. The penalty will not be imposed if the corporation can show that the failure to pay on time was due to a reasonable cause.

Partnership Filing Information The term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not a corporation or a trust or estate. Generally, every domestic partnership must file Form 1065 - U.S. Return of Partnership Income, unless it neither receives income nor incurs any expenditures treated as deductions or credits for Federal income tax purposes.

Entities formed as LLCs that are classified as partnerships for Federal income tax purposes have the same filing requirements as domestic partnerships.

A religious or apostolic organization exempt from income tax under section 501(d) must file Form 1065 to report its taxable income, which must be allocated to its members as a dividend, whether distributed or not. Such an organization must figure its taxable income on an attached statement to Form 1065 in the same manner as a corporation. The organization may use Form 1120 - U.S. Corporation Income Tax Return, for this purpose. Enter the organization's taxable income, if any, on line 6a of Schedule K and each member's pro rata share in box 6a of Schedule K-1. Net operating losses are not deductible by the members but may be carried back or forward by the organization under the rules of section 172. The religious or apostolic organization also must make its annual information return available for public inspection. For this purpose, “annual information return” includes an exact copy of Form 1065 and all accompanying schedules and attached statements, except Schedules K-1. For more details, see Regulations section 301.6104(d)-1. A qualifying syndicate, pool, joint venture, or similar organization may elect under section 761(a) not to be treated as a partnership for Federal income tax purposes and will not be required to file Form 1065 except for the year of election. For details, see section 761(a) and Regulations section 1.761-2. An electing large partnership (as defined in section 775) must file Form 1065-B - U.S. Return of Income for Electing Large Partnerships. Real estate mortgage investment conduits (REMICs) must file Form 1066 - U.S. Real Estate Mortgage Investment Conduit (REMIC) Income Tax Return. Certain publicly traded partnerships treated as corporations under section 7704 must file Form 1120. Generally, a foreign partnership that has gross income effectively connected with the conduct of a trade or business within the United States or has gross income derived from sources in the United States must file Form 1065, even if its principal place of business is outside the United States or all its members are foreign persons. A foreign partnership required to file a return generally must report all of its foreign and U.S. source income. A foreign partnership with U.S. source income is not required to file Form 1065 if it qualifies for either of the following two exceptions. For foreign partnerships with U.S. partners a return is not required if: (167)

1. The partnership had no effectively connected income (ECI) during its tax year, 2. The partnership had U.S. source income of $20,000 or less during its tax year, 3. Less than 1% of any partnership item of income, gain, loss, deduction, or credit was allocable in the aggregate to

direct U.S. partners at any time during its tax year, and 4. The partnership is not a withholding foreign partnership as defined in Regulations section 1.1441-5(c)(2)(i).

For foreign partnerships with no U.S. partners a return is not required if: (167)

1. The partnership had no ECI during its tax year, 2. The partnership had no U.S. partners at any time during its tax year, 3. All required Forms 1042 and 1042-S were filed by the partnership or another withholding agent as required by

Regulations section 1.1461-1(b) and (c),

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4. The tax liability of each partner for amounts reportable under Regulations sections 1.1461-1(b) and (c) has been fully satisfied by the withholding of tax at the source, and

5. The partnership is not a withholding foreign partnership as defined in Regulations section 1.1441-5(c)(2)(i). A foreign partnership filing Form 1065 solely to make an election (such as an election to amortize organization expenses) need only provide its name, address, and employer identification number (EIN) on page one of the form and attach a statement citing “Regulations section 1.6031(a)-1(b)(5)” and identifying the election being made. A foreign partnership filing Form 1065 solely to make an election must obtain an EIN if it does not already have one. Passive Activity Limitations In general, section 469 limits the amount of losses, deductions, and credits that partners can claim from “passive activities.” The passive activity limitations do not apply to the partnership. Instead, they apply to each partner's share of any income or loss and credit attributable to a passive activity. Because the treatment of each partner's share of partnership income or loss and credit depends on the nature of the activity that generated it, the partnership must report income or loss and credits separately for each activity. Generally, passive activities include activities that involve the conduct of a trade or business if the partner does not materially participate in the activity and all rental activities regardless of the partner's participation. The level of each partner's participation in an activity must be determined by the partner. The passive activity rules provide that losses and credits from passive activities can generally be applied only against income and tax from passive activities. Thus, passive losses and credits cannot be applied against income from salaries, wages, professional fees, or a business in which the partner materially participates; against “portfolio income” or against the tax related to any of these types of income. Special provisions apply to certain activities. First, the passive activity limitations must be applied separately with respect to a net loss from passive activities held through a publicly traded partnership. Second, special rules require that net income from certain activities that would otherwise be treated as passive income must be recharacterized as non-passive income for purposes of the passive activity limitations. To allow each partner to correctly apply the passive activity limitations, the partnership must report income or loss and credits separately for each of the following: (167)

Trade or business activities. Rental real estate activities. Rental activities other than real estate. Portfolio income.

Form 1065 - U.S. Return of Partnership Income Form 1065 - U.S. Return of Partnership Income is an information return used to report the income, gains, losses, deductions, credits, etc., from the operation of a partnership. A partnership does not pay tax on its income but “passes through” any profits or losses to its partners. Partners must include partnership items on their tax or information returns. Partnerships report only trade or business activity income on lines 1a through 8 of Form 1065. They do not report rental activity income or portfolio income on these lines. Also, they do not include any tax-exempt income on lines 1a through 8. A partnership that receives any tax-exempt income other than interest, or holds any property or engages in any activity that produces tax-exempt income, reports this income on line 18b of Schedule K and in box 18 of Schedule K-1 using code B. Partnerships report tax-exempt interest income, including exempt-interest dividends received as a shareholder in a mutual fund or other regulated investment company, on line 18a of Schedule K and in box 18 of Schedule K-1 using code A. Enter on line 1a gross receipts or sales from all trade or business operations, except for amounts that must be reported on lines 4 through 7. In general, advance payments are reported in the year of receipt. To report income from long-term contracts, see section 460. For special rules for reporting certain advance payments for goods and long-term contracts, see Regulations section 1.451-5. For permissible methods for reporting advance payments for services and certain goods by an accrual method partnership, see Revenue Procedure 2004-34, 2004-22 I.R.B. 991, as clarified and modified by Revenue Procedure 2011-18, and modified by Revenue Procedure 2011-14.

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Enter the ordinary income (loss) shown on Schedule K-1 (Form 1065) or Schedule K-1 (Form 1041), or other ordinary income (loss) from a foreign partnership, estate, or trust. Show the partnership's, estate's, or trust's name, address, and EIN on a separate statement attached to this return. If the amount entered is from more than one source, identify the amount from each source. Do not include portfolio income or rental activity income (loss) from other partnerships, estates, or trusts on this line. Instead, report these amounts on Schedules K and K-1, or on line 20a of Form 8825 if the amount is from a rental real estate activity. Ordinary income (loss) from another partnership that is a publicly traded partnership is not reported on this line. Instead, report the amount separately on line 11 of Schedule K and in box 11 of Schedule K-1 using code F. Treat shares of other items separately reported on Schedule K-1 issued by the other entity as if the items were realized or incurred by this partnership. If there is a loss from another partnership, the amount of the loss that may be claimed is subject to the at-risk and basis limitations as appropriate. If the tax year of the partnership does not coincide with the tax year of the other partnership, estate, or trust, include the ordinary income (loss) from the other entity in the tax year in which the other entity's tax year ends. Other Income (Loss) Enter any other trade or business income (loss) not included on lines 1a through 6. List the type and amount of income on an attached statement. Examples of other income include the following: (167)

1. Interest income derived in the ordinary course of the partnership's trade or business, such as interest charged on receivable balances.

2. Recoveries of bad debts deducted in prior years under the specific charge-off method. 3. Taxable income from insurance proceeds. 4. The amount included in income from line 7 of Form 6478 - Alcohol and Cellulosic Biofuel Fuels Credit. 5. The amount included in income from line 8 of Form 8864 - Biodiesel and Renewable Diesel Fuels Credit. 6. The recapture amount under section 280F if the business use of listed property drops to 50% or less. To figure

the recapture amount, complete Part IV of Form 4797. 7. Any recapture amount under section 179A for clean-fuel vehicle refueling property that ceases to qualify. See

Regulations section 1.179A-1 for details. 8. All section 481 income adjustments resulting from changes in accounting methods. Show the computation of the

section 481 adjustments on an attached statement. 9. Part or all of the proceeds received from certain employer-owned life insurance contracts issued after August 17,

2006. Partnerships that own one or more employer-owned life insurance contracts issued after that date must file Form 8925, Report of Employer-Owned Life Insurance Contracts. See section 101(j) for details.

Do not include items requiring separate computations that must be reported on Schedules K and K-1. See the instructions for Schedules K and K-1. Do not report portfolio or rental activity income (loss) on this line. Deductions The following are some of the special provisions that apply to partnerships. The uniform capitalization rules of Section 263A generally require partnerships to capitalize or include in inventory costs, certain costs incurred in connection with the following: (167)

The production of real property and tangible personal property held in inventory or held for sale in the ordinary course of business.

Real property or personal property (tangible and intangible) acquired for resale. The production of real property and tangible personal property by a partnership for use in its trade or business or

in an activity engaged in for profit. Tangible personal property produced by a partnership includes a film, sound recording, videotape, book, or similar property.

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The costs required to be capitalized under section 263A are not deductible until the property to which the costs relate is sold, used, or otherwise disposed of by the partnership. Section 263A does not apply to the following: (167)

Inventoriable items accounted for in the same manner as materials and supplies that are not incidental. See Form 1125-A and its instructions for details.

Personal property acquired for resale if the partnership's average annual gross receipts for the 3 prior tax years were $10 million or less.

Timber. Most property produced under a long-term contract. Certain property produced in a farming business. Geological and geophysical costs amortized under Section 167(h).

The partnership must report the following costs separately to the partners for purposes of determinations under section 59(e): (167)

Research and experimental costs under Section 174. Intangible drilling costs for oil, gas, and geothermal property. Mining exploration and development costs.

Transactions Between Related Taxpayers Generally, an accrual basis partnership can deduct business expenses and interest owed to a related party (including any partner) only in the tax year of the partnership that includes the day on which the payment is includible in the income of the related party. Family Partnership Members of a family can be partners. However, family members (or any other person) will be recognized as partners only if one of the following requirements is met: (121)

If capital is a material income-producing factor, they acquired their capital interest in a bona fide transaction (even if by gift or purchase from another family member), actually own the partnership interest, and actually control the interest.

If capital is not a material income-producing factor, they joined together in good faith to conduct a business. They agreed that contributions of each entitle them to a share in the profits, and some capital or service has been (or is) provided by each partner.

For purposes of determining a partner's distributive share, an interest purchased by one family member from another family member is considered a gift from the seller. The fair market value of the purchased interest is considered donated capital. For this purpose, members of a family include only spouses, ancestors, and lineal descendants (or a trust for the primary benefit of those persons).

Business Start-Up and Organizational Costs Generally, a partnership can elect to deduct up to $5,000 of business start-up and organizational costs paid or incurred after October 22, 2004. Any remaining costs must be amortized. The $5,000 deduction is reduced (but not below zero) by the amount the total costs exceed $50,000. If the total costs are $55,000 or more, the deduction is reduced to zero. Guaranteed Payments Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner. This treatment is for purposes of determining gross income and deductible business expenses only. For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. Guaranteed payments are not subject to income tax withholding. The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense. They are also listed on Schedules K and K-1 of the partnership return. The individual partner reports guaranteed payments on Schedule E (Form 1040) as ordinary income, along with his or her distributive share of the partnership's other ordinary income. Also

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include on line 10 amounts paid during the tax year for insurance that constitutes medical care for a partner, a partner's spouse, a partner's dependents, or a partner's children under age 27 who are not dependents. Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenses. Generally, organizational and syndication expenses are not deductible by the partnership. However, a partnership can elect to deduct a portion of its organizational expenses and amortize the remaining expenses. Organizational expenses (if the election is not made) and syndication expenses paid to partners must be reported on the partners' Schedule K-1 as guaranteed payments. If a partner is to receive a minimum payment from the partnership, the guaranteed payment is the amount by which the minimum payment is more than the partner's distributive share of the partnership income before taking into account the guaranteed payment. Guaranteed payments are included in income in the partner's tax year in which the partnership's tax year ends. Self-Employed Health Insurance Premiums Premiums for health insurance paid by a partnership on behalf of a partner, for services as a partner, are treated as guaranteed payments. The partnership can deduct the payments as a business expense, and the partner must include them in gross income. However, if the partnership accounts for insurance paid for a partner as a reduction in distributions to the partner, the partnership cannot deduct the premiums. A partner who qualifies can deduct 100% of the health insurance premiums paid by the partnership on his or her behalf as an adjustment to income. The partner cannot deduct the premiums for any calendar month, or part of a month, in which the partner is eligible to participate in any subsidized health plan maintained by any employer of the partner, the partner's spouse, the partner's dependents, or any children under age 27 who are not dependents. Repairs and Maintenance Enter the costs of incidental repairs and maintenance that do not add to the value of the property or appreciably prolong its life, but only to the extent that such costs relate to a trade or business activity and are not claimed elsewhere on the return. The cost of new buildings, machinery, or permanent improvements that increase the value of the property are not deductible. They are chargeable to capital accounts and may be depreciated or amortized. Bad Debts Enter the total debts that became worthless in whole or in part during the year, but only to the extent such debts relate to a trade or business activity. Report deductible nonbusiness bad debts as a short-term capital loss on Form 8949 - Sales and Other Dispositions of Capital Assets. Taxes and Licenses Enter taxes and licenses paid or incurred in the trade or business activities of the partnership if not reflected elsewhere on the return. Federal import duties and Federal excise and stamp taxes are deductible only if paid or incurred in carrying on the trade or business of the partnership. Schedules K-1 - Partners' Distributive Share Items Although the partnership is not subject to income tax, the partners are liable for tax on their shares of the partnership income, whether or not distributed, and must include their shares on their tax returns. Schedule K-1 (Form 1065) - Partner’s Share of Income, Deductions, Credits, etc. shows each partner's separate share. Attach a copy of each Schedule K-1 to the Form 1065 filed with the IRS; keep a copy with a copy of the partnership return as a part of the partnership's records; and furnish a copy to each partner. If a partnership interest is held by a nominee on behalf of another person, the partnership may be required to furnish Schedule K-1 to the nominee. The amount of loss and deduction the taxpayer may claim on his or her tax return may be less than the amount reported on Schedule K-1. It is the partner's responsibility to consider and apply any applicable limitations. Partnership Distributions Partnership distributions include the following: (121)

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A withdrawal by a partner in anticipation of the current year's earnings. A distribution of the current year's or prior years' earnings not needed for working capital. A complete or partial liquidation of a partner's interest. A distribution to all partners in a complete liquidation of the partnership.

A partnership distribution is not taken into account in determining the partner's distributive share of partnership income or loss. If any gain or loss from the distribution is recognized by the partner, it must be reported on his or her return for the tax year in which the distribution is received. Money or property withdrawn by a partner in anticipation of the current year's earnings is treated as a distribution received on the last day of the partnership's tax year. Partner's Gain or Loss

A partner generally recognizes gain on a partnership distribution only to the extent any money (and marketable securities treated as money) included in the distribution exceeds the adjusted basis of the partner's interest in the partnership. Any gain recognized is generally treated as capital gain from the sale of the partnership interest

on the date of the distribution. If partnership property (other than marketable securities treated as money) is distributed to a partner, he or she generally does not recognize any gain until the sale or other disposition of the property. Partner's Basis for Distributed Property Unless there is a complete liquidation of a partner's interest, the basis of property (other than money) distributed to the partner by a partnership is its adjusted basis to the partnership immediately before the distribution. However, the basis of the property to the partner cannot be more than the adjusted basis of his or her interest in the partnership reduced by any money received in the same transaction. (121) Example The adjusted basis of Emily's partnership interest is $30,000. She receives a distribution of property that has an adjusted basis of $20,000 to the partnership and $4,000 in cash. Her basis for the property is $20,000. When to File Generally, a domestic partnership must file Form 1065 by the 15th day of the 3rd month following the date its tax year ended as shown at the top of Form 1065. If the due date falls on a Saturday, Sunday, or legal holiday, file by the next day that is not a Saturday, Sunday, or legal holiday. Extension of Time To File File Form 7004 - Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns to request an extension of time to file. File Form 7004 by the regular due date of the partnership return. Form 7004 can be electronically filed. Late Filing of Return A penalty is assessed against the partnership if it is required to file a partnership return and it (a) fails to file the return by the due date, including extensions, or (b) files a return that fails to show all the information required, unless such failure is due to reasonable cause. In 2017, the penalty is $200 for each month or part of a month (for a maximum of 12 months) the failure continues, multiplied by the total number of persons who were partners in the partnership during any part of the partnership's tax year for which the return is due. If the partnership receives a notice about a penalty after it files the return, the partnership may send the IRS an explanation and the Service will determine if the explanation meets reasonable-cause criteria. The taxpayer does not attach an explanation when filing the return. Failure To Furnish Timely Information For each failure to furnish Schedule K-1 to a partner when due and each failure to include on Schedule K-1 all the information required to be shown (or the inclusion of incorrect information), a $260 penalty may be imposed for each Schedule K-1 for which a failure occurs. The maximum penalty in 2017 is $3,218,500 for all such failures during a calendar year. If the requirement to report correct information is intentionally disregarded, each $260 penalty is increased to $530 or, if greater, 10% of the aggregate amount of items required to be reported. There is no limit to the amount of the penalty.

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S Corporations S corporations are corporations that elect to pass corporate income, losses, deductions and credits through to their shareholders for Federal tax purposes. Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. This allows S corporations to avoid double taxation on the corporate income. S corporations are responsible for tax on certain built-in gains and passive income. To qualify for S corporation status, the corporation must meet the following requirements:

Be a domestic corporation. Have only allowable shareholders:

o Including individuals, certain trust, and estates and o May not include partnerships, corporations or non-resident alien shareholders.

Have no more than 100 shareholders. Have one class of stock. Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and domestic international

sales corporations. In order to become an S corporation, the corporation must submit Form 2553 - Election by a Small Business Corporation signed by all the shareholders. Advantages of an S Corporation One of the best features of the S Corp is the tax savings for the taxpayer and his or her business. While members of an LLC are subject to employment tax on the entire net income of the business, only the wages of the S Corp shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a "distribution," which is taxed at a lower rate, if at all. Some expenses that shareholder/employees incur can be written off as business expenses. Nevertheless, if such an employee owns 2% or more shares, then benefits like health and life insurance are deemed taxable income. An S Corp designation also allows a business to have an independent life, separate from its shareholders. If a shareholder leaves the company, or sells his or her shares, the S Corp can continue doing business relatively undisturbed. Maintaining the business as a distinct corporate entity defines clear lines between the shareholders and the business that improve the protection of the shareholders. (168) Disadvantages of an S Corporation As a separate structure, S Corps require scheduled director and shareholder meetings, minutes from those meetings, adoption and updates to by-laws, stock transfers and records maintenance. A shareholder must receive reasonable compensation. The IRS takes notice of shareholder red flags like low salary/high distribution combinations and may reclassify the taxpayer’s distributions as wages. He or she could pay a higher employment tax because of an audit with these results. A corporation may not carry a capital loss from, or to, a year for which it is an S corporation. In general, an S corporation does not pay a tax on its income. Instead, its income and expenses are passed through to the shareholders, who then report these items on their own income tax returns. If the taxpayer is an S corporation shareholder, his or her share of the corporation's current year income or loss and other tax items are taxed to him or her whether or not he or she receives any amount. Generally, those items increase or decrease the basis of the S corporation stock as appropriate. The taxpayer must increase his or her basis in stock of an S corporation by his or her pro rata share of the following items: (169)

All income items of the S corporation, including tax-exempt income, that are separately stated and passed through to the taxpayer as a shareholder.

The non-separately stated income of the S corporation. The amount of the deduction for depletion (other than oil and gas depletion) that is more than the basis of the

property being depleted.

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The taxpayer must decrease his or her basis in stock of an S corporation by his or her pro rata share of the following items: (169)

Distributions by the S corporation that were not included in the taxpayer’s income. All loss and deduction items of the S corporation that are separately stated and passed through to the taxpayer. Any non-separately stated loss of the S corporation. Any expense of the S corporation that is not deductible in figuring its taxable income and not properly chargeable

to a capital account. The amount of the taxpayer’s deduction for depletion of oil and gas wells to the extent the deduction is not more

than his or her share of the adjusted basis of the wells. The basis in the stock cannot be reduced below zero. Generally, S corporation distributions, except dividend distributions, are considered a return of capital and reduce the taxpayer’s basis in the stock of the corporation. The part of any distribution that is more than the basis is treated as a gain from the sale or exchange of property. The corporation's distributions may be in the form of cash or property. (170)

S corporation distributions are not treated as dividends except in certain cases in which the corporation has accumulated earnings and profits from years before it became an S corporation.

The S corporation should send the taxpayer a copy of Schedule K-1 (Form 1120S) - Shareholder’s Share of Income, Deductions, Credits, etc. showing his or her share of the S corporation's income, credits, and deductions for the tax year. The taxpayer must report his or her distributive share of the S corporation's income, gain, loss, deductions, or credits on the appropriate lines and schedules of the Form 1040. The deduction for a taxpayer’s share of losses and deductions shown on Schedule K-1 (Form 1120S) is limited to the adjusted basis of his or her stock and any debt the corporation owes the taxpayer. Any loss or deduction not allowed because of this limit is carried over and treated as a loss or deduction in the next tax year. Rules apply that limit losses from passive activities. The taxpayer’s copy of Schedule K-1 (Form 1120S) and its instructions will explain the limits and tell him or her where on the return to report his or her share of S corporation items from passive activities. If the taxpayer has a passive activity loss from an S corporation, he or she must complete Form 8582 - Passive Activity Loss Limitations to figure the allowable loss to enter on the return. Taxes Most businesses need to register with the IRS, register with state and local revenue agencies, and obtain a tax ID number or permit. All states do not tax S Corps equally. Most recognize them similarly to the Federal government and tax the shareholders accordingly. However, some states (like Massachusetts) tax S Corps on profits above a specified limit. Other states don't recognize the S Corp election and treat the business as a C corp with all of the tax ramifications. Some states (like New York and New Jersey) tax both the S Corps profits and the shareholder's proportional shares of the profits. The taxpayer’s corporation must file the Form 2553 to elect "S" status within two months and 15 days after the beginning of the tax year or any time before the tax year for the status to be in effect. Built-in Gains Tax Section 1374 provides for a tax on built-in gains. The built-in gains tax may apply to the following S corporations:

1. An S corporation that was a C corporation before it elected to be an S corporation. 2. An S corporation that acquired an asset with a basis determined (in whole or in part) by reference to its basis (or

the basis of any other property) in the hands of a C corporation (a transferred-basis acquisition). See section 1374(d)(8).

An S corporation may owe the tax if it has net recognized built-in gains during the applicable recognition period. The Tax Increase Prevention Act (H.R. 5771) extended the reduction of the recognition period for the built-in gains of S corporation. The applicable recognition period is the 5-year period beginning:

1. For an asset held when the S corporation was a C corporation, on the first day of the first tax year for which the corporation is an S corporation; or

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2. For an asset with a basis determined by reference to its basis (or the basis of any other property) in the hands of a C corporation, on the date the asset was acquired by the S corporation.

The Protecting Americans from Tax Hikes (PATH) Act of 2015 permanently extended the rule reducing to five years (rather than ten years) the period for which an S corporation must hold its assets following conversion from a C corporation to avoid the tax on built-in gains.

A corporation described in both (1) and (2), above, must figure the built-in gains tax separately for the group of assets it held at the time its S election became effective and for each group of assets it acquired from a C corporation with basis determined (in whole or in part) by reference to the basis of the asset (or any other property) in the hands of the C corporation. For details, see Regulations section 1.1374-8.

Certain transactions involving the disposal of timber, coal, or domestic iron ore under section 631 are not subject to the built-in gains tax.

Excess Net Passive Income Tax S Corporations that have previously been a C Corporation and have accumulated earnings and profits at the end of the tax year will be assessed a passive income tax if passive investment income for the year exceeds 25% of gross receipts for the year. The tax is assessed at the maximum corporate tax rate of 35%. Recognized built-in gains and losses are not taken into account in determining the amount of passive investment income. Code Section 1362(d) (3(C)(i) defines passive investment income to be income derived from royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities. An exception is made for interest on notes from sales of inventory (Code Section 1362(d) (3(C)(ii)), and for income derived directly from the active and regular conduct of a lending or finance business (Code Section 1362(d) (3(C)(iii)). If passive investment income exceeds 25% of gross receipts for three consecutive years, then the S Corporation election is terminated immediately following the third tax year. To avoid the passive income tax, the S Corporation can either distribute E&P from C corporation years as an actual or deemed dividend, or generate enough operating income so that passive investment income does not exceed 25% of gross receipts for the year. Also, the passive income tax calculated using the lesser of "excessive net passive income" or taxable income. By reducing taxable income, the S Corporation is able to minimize the passive income tax. Keep in mind, however, that the S Corporation election will still terminate if passive investment income exceeds 25% of gross receipts for three consecutive years. Any passive income tax paid is a reduction to income that passes to the S Corporation shareholders. Return of S Corporation Every S corporation shall make a return for each taxable year, stating specifically the items of its gross income and the deductions allowable by subtitle A, the names and addresses of all persons owning stock in the corporation at any time during the taxable year, the number of shares of stock owned by each shareholder at all times during the taxable year, the amount of money and other property distributed by the corporation during the taxable year to each shareholder, the date of each such distribution, each shareholder's pro rata share of each item of the corporation for the taxable year, and such other information. Each S corporation required to file a return for any taxable year shall (on or before the day on which the return for such taxable year was filed) furnish to each person who is a shareholder at any time during such taxable year a copy of such information shown on such return as may be required by regulations. S Corporation Compensation S corporations must pay reasonable compensation to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. The amount of reasonable compensation will never exceed the amount received by the shareholder either directly or indirectly. Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for the service rendered to the corporation. The instructions to the Form 1120S - U.S. Income Tax Return for an S Corporation, state "Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation."

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The key to establishing reasonable compensation is determining what the shareholder-employee did for the S corporation. As such, we need to look to the source of the S corporation's gross receipts. The three major sources are:

1. Services of shareholder, 2. Services of non-shareholder employees, or 3. Capital and equipment. 4. If the gross receipts and profits come from items 2 and 3, then that should not be associated with the shareholder-

employees personal services and not be allocated as compensation. On the other hand, if most of the gross receipts and profits are associated with the shareholder’s personal services, then most of the profit distribution should be allocated as compensation. In addition to the shareholder-employee direct generation of gross receipts, the shareholder-employee should also be compensated for administrative work performed for the other income producing employees or assets. For example, a manager may not directly produce gross receipts, but he assists the other employees or assets which are producing the day-to-day gross receipts. Some factors in determining reasonable compensation:

Training and experience. Duties and responsibilities. Time and effort devoted to the business. Dividend history. Payments to non-shareholder employees. Timing and manner of paying bonuses to key people. What comparable businesses pay for similar services. Compensation agreements. The use of a formula to determine compensation.

Health and accident insurance premiums paid on behalf of greater than two percent of S corporation shareholder-employee are deductible and reportable by the S corporation as wages for income tax withholding purposes on the shareholder-employee’s Form W-2. These benefits are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes. The additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement, issued to the shareholder-employee, but would not be included in Boxes 3 and 5 of Form W-2. A 2% shareholder-employee is eligible for an Adjusted Gross Income (AGI) deduction for amounts paid during the year for medical care premiums if the medical care coverage is established by the S corporation and the shareholder meets the other self-employed medical insurance deduction requirements. If, however, the shareholder or the shareholder’s spouse is eligible to participate in any subsidized health care plan then the shareholder is not entitled to the AGI deduction. A medical plan can be considered established by the S corporation if the S corporation paid or reimbursed the shareholder-employee for premiums and reported:

The premium payment. Reimbursement as wages on the shareholder-employee’s W-2.

S Corporation Stock and Debt Basis Shareholder Loss Limitations An S corporation is a corporation with an election in effect. The impact of the election is that the S corporation's items of income, loss and deduction flow to the shareholder and thus taxed on the shareholder's personal return. The two main reasons for electing S corporation status are:

1. Avoid double taxation on distributions. 2. Allow corporate losses to flow through to its owners.

There are three shareholder loss limitations:

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1. Stock and Debt Basis Limitations. 2. At Risk Limitations. 3. Passive Activity Loss Limitations.

Each limitation must be met, and in the order presented, before a shareholder is allowed to claim a flow-through loss. The fact that a shareholder receives a K-1 reflecting a loss does not mean that the shareholder is automatically entitled to claim the loss. The amount of a shareholder's stock and debt basis in the S corporation is very important. Unlike a C corporation, each year a shareholder's stock and/or debt basis of an S corporation increases or decreases based upon the S corporation's operations. The S corporation will issue a shareholder a Schedule K-1. It is important to understand that the K-1 reflects the S corporation's items of income, loss and deduction that are allocated to the shareholder for the year. The K-1 shows the amount of non-dividend distribution the shareholder receives; it does not state the taxable amount of a distribution. The taxable amount of a distribution is contingent on the shareholder's stock basis. It is not the corporation's responsibility to track a shareholder's stock and debt basis but rather it is the shareholder's responsibility. If a shareholder receives a non-dividend distribution from an S corporation, the distribution is tax-free to the extent it does not exceed the shareholder's stock basis. Debt basis is not considered when determining the taxability of a distribution. If a shareholder is allocated an item of S corporation loss or deduction, the shareholder must first have adequate stock and/or debt basis to claim that loss and/or deduction item. In addition, it is important to remember that, even when the shareholder has adequate stock and/or debt basis to claim the S corporation loss or deduction item, the shareholder must also consider the at-risk and passive activity loss limitations and therefore may not be able to claim the loss and/or deduction item. It is important that a shareholder know his or her stock basis when:

The S corporation allocates a loss and/or deduction item to the shareholder - In order for the shareholder to claim a loss, they need to demonstrate they have adequate stock and/or debt basis.

The S corporation makes a non-dividend distribution to the shareholder - In order for the shareholder to determine whether or not the distribution is non-taxable they need to demonstrate they have adequate stock basis.

The shareholder disposes of their stock - As with any asset, including C corporation stock, when the asset is sold or disposed of, basis needs to be established in order to reflect the proper gain or loss on the disposition.

Since shareholder stock basis in an S Corporation changes every year, it must be computed every year. In computing stock basis, the shareholder starts with their initial capital contribution to the S corporation or the initial cost of the stock they purchased (the same as a C corporation). That amount is then increased and/or decreased based on the flow-through amounts from the S corporation. An income item will increase stock basis while a loss, deduction or distribution will decrease stock basis. Some examples of items that increase a taxpayer’s basis include the taxpayer’s pro rata share of the following:

All income items of the S corporation, including tax-exempt income, that are separately stated. Any non-separately stated income of the S corporation. The amount of the deduction for depletion (other than oil and gas) that is more than the basis of the property being

depleted.

Only non-dividend distributions reduce stock basis, dividend distributions do not. The corporation is responsible for telling the shareholder the amount of non-dividend and dividend distributions. Box 16D of Schedule K-1 reflects non-dividend distributions. Form 1099-DIV is used to report dividend distributions; dividends are not reported on the shareholder's Schedule K-1.

Additional S Corporation Information

A non-dividend distribution in excess of stock basis is taxed as a capital gain on the shareholder's personal return. Stock held for longer than one year is a long-term capital gain (LTCG).

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Non-deductible expenses reduce a shareholder's stock and/or debt basis before loss and deduction items. If non-deductible expenses exceed stock and/or debt basis, they are not suspended and carried forward.

If the current year has different types of loss and deduction items, which exceed stock and/or debt basis, the allowable loss and deduction items must be allocated pro rata based on the size of the particular loss and deduction items.

A shareholder is not allowed to claim loss and deduction items in excess of stock and/or debt basis. Loss and deduction items not allowable in the current year are suspended due to basis limitations.

Suspended losses and deductions due to basis limitations retain their character in subsequent years. Any suspended loss or deduction items in excess of stock and/or debt basis are carried forward indefinitely.

In determining current year allowable losses, current year loss and deduction items are combined with the suspended loss and deduction items carried over from the prior year, though the current year and suspended items should be separately stated on the Form 1040 Schedule E or other appropriate schedule on the return.

A shareholder is only allowed debt basis to the extent he or she has personally lent money to the S corporation. A loan guarantee is not sufficient to allow the shareholder debt basis.

If a shareholder contends he or she has contributed or loaned substantial funds to the S corporation, consideration should be given to whether the shareholder had the financial means to make the contribution or loan.

Part or all of the repayment of a reduced basis debt is taxable to the shareholder. If a shareholder sells their stock, suspended losses due to basis limitations are lost. Any gain on the sale of the

stock does not increase the shareholder's stock basis. A stock basis computation should be reviewed in the year stock is sold or disposed of.

Termination of Election Once the election is made, it stays in effect until it is terminated. If the election is terminated, the corporation (or a successor corporation) can make another election on Form 2553 - Election by a Small Business Corporation only with IRS consent for any tax year before the 5th tax year after the first tax year in which the termination took effect. See Regulations section 1.1362-5 for details. An election terminates automatically in any of the following cases: (171)

1. The corporation is no longer a small business corporation as defined in section 1361(b). This kind of termination of an election is effective as of the day the corporation no longer meets the definition of a small business corporation. Attach to Form 1120S for the final year of the S corporation a statement notifying the IRS of the termination and the date it occurred.

2. The corporation, for each of three consecutive tax years, (a) has accumulated earnings and profits and (b) derives more than 25% of its gross receipts from passive investment income as defined in section 1362(d)(3)(C). The election terminates on the first day of the first tax year beginning after the third consecutive tax year. The corporation must pay a tax for each year it has excess net passive income. See the line 22a instructions for details on how to figure the tax.

3. The election is revoked. An election can be revoked only with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares of stock (including non-voting stock). The revocation can specify an effective revocation date that is on or after the day the revocation is filed. If no date is specified, the revocation is effective at the start of the tax year if the revocation is made on or before the 15th day of the 3rd month of that tax year. If no date is specified and the revocation is made after the 15th day of the 3rd month of the tax year, the revocation is effective at the start of the next tax year.

To revoke the election, the corporation must file a statement with the appropriate service center listed under Where To File in the Instructions for Form 2553. In the statement, the corporation must notify the IRS that it is revoking its election to be an S corporation. The statement must be signed by each shareholder who consents to the revocation and contain the information required by Regulations section 1.1362-6(a)(3).

Limited Liability Company (LLC) A limited liability company (LLC) is a business entity organized in the United States under state law. Unlike a partnership, all of the members of an LLC have limited personal liability for its debts. An LLC may be classified for Federal income tax purposes as a partnership, corporation, or an entity disregarded as separate from its owner by applying the rules in Regulations section 301.7701-3.

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A Limited Liability Company (LLC) is a business structure allowed by state statute. Each state may use different regulations, and the taxpayer should check with his or her state if he or she is interested in starting a Limited Liability Company. Owners of an LLC are called members. Most states do not restrict ownership, and so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit “single-member” LLCs, those having only one owner. A few types of businesses generally cannot be LLCs, such as banks and insurance companies. Check the taxpayer’s state’s requirements and the Federal tax regulations for further information. There are special rules for foreign LLCs. Classifications Depending on elections made by the LLC and the number of members, the IRS will treat an LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return (a “disregarded entity”). Specifically, a domestic LLC with at least two members is classified as a partnership for Federal income tax purposes unless it files Form 8832 - Entity Classification Election and affirmatively elects to be treated as a corporation. And an LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes), unless it files Form 8832 and affirmatively elects to be treated as a corporation. LLCs Classified as Partnerships If an LLC has at least two members and is classified as a partnership, it generally must file Form 1065 - U.S. Return of Partnership Income. Generally, an LLC classified as a partnership is subject to the same filing and reporting requirements as partnerships. For certain purposes, members of an LLC are treated as limited partners in a limited partnership. For example, LLC members are treated as limited partners for purposes of material participation under the passive activity limitation rules (see Temporary Regulation section 1.469-5T(e)). See the Instructions for Form 1065 for reporting rules that apply specifically to LLCs. Only a member manager of an LLC can sign the partnership tax return. And only a member manager can represent the LLC as the tax matters partner under the consolidated audit proceedings in sections 6221 through 6234. A member manager is any owner of an interest in the LLC who, alone or together with others, has the continuing authority to make the management decisions necessary to conduct the business for which the LLC was formed. If there are no elected or designated member managers, each owner is treated as a member manager. If the number of members in an LLC classified as a partnership is reduced to only one member, it becomes an entity disregarded as separate from its owner under Regulations section 301.7701-3(f)(2). However, if the LLC has made an election to be classified as a corporation and that elective classification is in effect at the time of the change in membership, the default classification as a disregarded entity will not apply. Other tax consequences of a change in membership, such as recognition of gain or loss, are determined by the transactions through which an interest in the LLC is acquired or disposed of. If a partnership that becomes a disregarded entity as a result of a decrease in the number of members makes an election to be classified as a corporation, the applicable deemed transactions discussed under Subsequent Elections, below, apply. LLCs Classified as Disregarded Entities If an LLC has only one member and is classified as an entity disregarded as separate from its owner, its income, deductions, gains, losses, and credits are reported on the owner's income tax return. For example, if the owner of the LLC is an individual, the LLC's income and expenses would be reported on the following schedules filed with the owner's Form 1040:

Schedule C - Profit or Loss From Business (Sole Proprietorship). Schedule C-EZ - Net Profit From Business (Sole Proprietorship). Schedule E - Supplemental Income and Loss. Schedule F - Profit or Loss From Farming.

A single-member LLC that is classified as a disregarded entity for income tax purposes is treated as a separate entity for purposes of employment tax and certain excise taxes. For wages paid after January 1, 2009, the single-member LLC is

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required to use its name and employer identification number (EIN) for reporting and payment of employment taxes. A single-member LLC is also required to use its name and EIN to register for excise tax activities on Form 637; pay and report excise taxes reported on Forms 720, 730, 2290, and 11-C; and claim any refunds, credits, and payments on Form 8849. An individual owner of a single-member LLC classified as a disregarded entity is not an employee of the LLC. Instead, the owner is subject to tax on the net earnings from self-employment of the LLC which is treated in the same manner as a sole-proprietorship. If a single-member LLC classified as a disregarded entity for income tax purposes acquires an additional member, it becomes a partnership under Regulations section 301.7701-3(f)(2). However, if the LLC has made an election to be classified as a corporation and that elective classification is in effect at the time of the change in membership, the default classification as a partnership will not apply. Other tax consequences of a change in membership, such as recognition of gain or loss, are determined by the transactions through which an interest in the LLC is acquired or disposed of. If a disregarded entity that becomes a partnership as a result of an increase in the number of members makes an election to be classified as a corporation, the applicable deemed transactions apply. Example Bart, who is not related to Alain, buys 50% of Alain's interest in an LLC that is a disregarded entity for $5,000. Alain does not contribute any portion of the $5,000 to the LLC. Alain and Bart continue to operate the business of the LLC as co-owners of the LLC. The LLC is converted to a partnership when the new member, Bart, buys an interest in the disregarded entity from the owner, Alain. Bart's buying a 50% interest in Alain's ownership interest in the LLC is treated as Bart's buying a 50% interest in each of the LLC's assets, which are treated as owned directly by Alain for Federal income tax purposes. Immediately thereafter, Alain and Bart are treated as contributing their respective interests in those assets to a partnership in exchange for ownership interests in the partnership. Alain recognizes gain or loss from the deemed sale to Bart of the 50% interest in the assets. Neither Alain nor Bart recognizes any gain or loss as a result of the deemed contribution of the assets to the partnership. LLCs Classified as Corporations An LLC with either a single member or more than one member can elect to be classified as a corporation rather than be classified as a partnership or disregarded entity under the default rules. The taxpayer should file Form 8832 - Entity Classification Election, to elect classification as a C corporation. He or she should file Form 2553 - Election by a Small Business Corporation, to elect classification as an S corporation. LLCs electing classification as an S corporation are not required to file Form 8832 to elect classification as a corporation before filing Form 2553. By filing Form 2553, an LLC is deemed to have elected classification as a corporation in addition to the S corporation classification. (172) If the LLC elects to be classified as a corporation by filing Form 8832, a copy of the LLC's Form 8832 must be attached to the Federal income tax return of each direct and indirect owner of the LLC for the tax year of the owner that includes the date on which the election took effect. If the LLC is classified as a corporation, it must file a corporation income tax return. If it is a C corporation, it is taxed on its taxable income and distributions to the members are includible in the members' gross income to the extent of the corporation's earnings and profits (double taxation). If it is an S corporation, the corporation is generally not subject to any income tax and the income, deductions, gains, losses, and credits of the corporation “pass through” to the members. Corporations generally file either: (172)

Form 1120 - U.S. Corporation Income Tax Return. Form 1120S - U.S. Income Tax Return for an S Corporation.

Effective Date of Election An LLC that does not want to accept its default Federal tax classification, or that wishes to change its classification, uses Form 8832 - Entity Classification Election, to elect how it will be classified for Federal tax purposes. Generally, an election specifying an LLC’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed. An LLC may be eligible for late election relief in certain circumstances. See Form 8832 General Instructions for more information.

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Subsequent Elections An LLC can elect to change its classification. Generally, once an LLC has elected to change its classification, it cannot elect again to change its classification during the 60 months after the effective date of the election. An election by a newly formed LLC that is effective on the date of formation is not considered a change for purposes of this limitation. For more information and exceptions, see Regulations section 301.7701-3(c) and the Form 8832 instructions. An election to change classification can have significant tax consequences based on the following transactions that are deemed to occur as a result of the election. An election to change classification from a partnership to a corporation will be treated as if the partnership contributed all of its assets and liabilities to the corporation in exchange for stock and the partnership then immediately liquidated by distributing the stock to its partners. An election to change classification from a corporation to a partnership will be treated as if the corporation distributed all of its assets and liabilities to its shareholders in liquidation and the shareholders then immediately contributed all of the distributed assets and liabilities to a new partnership. An election to change classification from a corporation to a disregarded entity will be treated as if the corporation distributed all of its assets and liabilities to its single owner in liquidation. An election to change classification from a disregarded entity to a corporation will be treated as if the owner of the disregarded entity contributed all of the assets and liabilities to the corporation in exchange for stock.

Trust and Estate Income Tax A trust or a decedent's estate is a separate legal entity for Federal tax purposes. A decedent's estate comes into existence at the time of death of an individual. A trust may be created during an individual's life (inter vivos) or at the time of his or her death under a will (testamentary). If the trust instrument contains certain provisions, then the person creating the trust (the grantor) is treated as the owner of the trust's assets. Such a trust is a grantor type trust. A trust or decedent's estate figures its gross income in much the same manner as an individual. Most deductions and credits allowed to individuals are also allowed to estates and trusts. However, there is one major distinction. A trust or decedent's estate is allowed an income distribution deduction for distributions to beneficiaries. To figure this deduction, the fiduciary must complete Schedule B. The income distribution deduction determines the amount of any distributions taxed to the beneficiaries. For this reason, a trust or decedent's estate sometimes is referred to as a “pass-through” entity. The beneficiary, and not the trust or decedent's estate, pays income tax on his or her distributive share of income. Schedule K-1 (Form 1041) is used to notify the beneficiaries of the amounts to be included on their income tax returns. Before preparing Form 1041, the fiduciary must figure the accounting income of the estate or trust under the will or trust instrument and applicable local law to determine the amount, if any, of income that is required to be distributed, because the income distribution deduction is based, in part, on that amount. The fiduciary of a domestic decedent's estate, trust, or bankruptcy estate uses Form 1041 to report: (173)

The income, deductions, gains, losses, etc., of the estate or trust. The income that is either accumulated or held for future distribution or distributed currently to the beneficiaries. Any income tax liability of the estate or trust. Employment taxes on wages paid to household employees.

Decedent's Estate The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic estate that has: (173)

Gross income for the tax year of $600 or more. A beneficiary who is a nonresident alien.

An estate is a domestic estate if it is not a foreign estate. A foreign estate is one the income of which is from sources outside the United States that is not effectively connected with the conduct of a U.S. trade or business and is not includible in gross income. If the taxpayer is the fiduciary of a foreign estate, file Form 1040NR - U.S. Nonresident Alien Income Tax Return, instead of Form 1041.

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Trust The fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic trust taxable under section 641 that has:

Any taxable income for the tax year, Gross income of $600 or more (regardless of taxable income). A beneficiary who is a nonresident alien.

Two or more trusts are treated as one trust if the trusts have substantially the same grantor(s) and substantially the same primary beneficiary(ies) and a principal purpose of such trusts is avoidance of tax. This provision applies only to that portion of the trust that is attributable to contributions to corpus made after March 1, 1984. A trust is a domestic trust if: (173)

A U.S. court is able to exercise primary supervision over the administration of the trust (court test), and One or more U.S. persons have the authority to control all substantial decisions of the trust (control test).

See Regulations section 301.7701-7 for more information on the court and control tests. Also treated as a domestic trust is a trust (other than a trust treated as wholly owned by the grantor) that: (173)

1. Was in existence on August 20, 1996, 2. Was treated as a domestic trust on August 19, 1996, and 3. Elected to continue to be treated as a domestic trust.

A trust that is not a domestic trust is treated as a foreign trust. If the taxpayer is the trustee of a foreign trust, file Form 1040NR instead of Form 1041. Also, a foreign trust with a U.S. owner generally must file Form 3520-A - Annual Information Return of Foreign Trust With a U.S. Owner. If a domestic trust becomes a foreign trust, it is treated under section 684 as having transferred all of its assets to a foreign trust, except to the extent a grantor or another person is treated as the owner of the trust when the trust becomes a foreign trust. Grantor Trusts A trust is a grantor trust if the grantor retains certain powers or ownership benefits. This can also apply to only a portion of a trust. In general, a grantor trust is ignored for income tax purposes and all of the income, deductions, etc., are treated as belonging directly to the grantor. This also applies to any portion of a trust that is treated as a grantor trust.

If only a portion of the trust is a grantor type trust, indicate both grantor trust and the other type of trust, for example, simple or complex trust, as the type of entities checked in Section A on page 1 of Form 1041.

If the entire trust is a grantor trust, fill in only the entity information of Form 1041. Do not show any dollar amounts on the form itself; show dollar amounts only on an attachment to the form. Do not use Schedule K-1 (Form 1041) as the attachment. If only part of the trust is a grantor type trust, the portion of the income, deductions, etc., that is allocable to the non-grantor part of the trust is reported on Form 1041, under normal reporting rules. The amounts that are allocable directly to the grantor are shown only on an attachment to the form. Do not use Schedule K-1 (Form 1041) as the attachment. However, Schedule K-1 is used to reflect any income distributed from the portion of the trust that is not taxable directly to the grantor or owner. The fiduciary must give the grantor (owner) of the trust a copy of the attachment. On the attachment, show:

The name, identifying number, and address of the person(s) to whom the income is taxable. The income of the trust that is taxable to the grantor or another person under sections 671 through 678. Report

the income in the same detail as it would be reported on the grantor's return had it been received directly by the grantor.

Any deductions or credits that apply to this income. Report these deductions and credits in the same detail as they would be reported on the grantor's return had they been received directly by the grantor.

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The income taxable to the grantor or another person under sections 671 through 678 and the deductions and credits that apply to that income must be reported by that person on their own income tax return. Special Rule for Certain Revocable Trusts Section 645 provides that if both the executor (if any) of an estate (the related estate) and the trustee of a qualified revocable trust (QRT) elect the treatment in section 645, the trust must be treated and taxed as part of the related estate during the election period. This election may be made by a QRT even if no executor is appointed for the related estate. In general, Form 8855 - Election To Treat a Qualified Revocable Trust as Part of an Estate, must be filed by the due date for Form 1041 for the first tax year of the related estate. This applies even if the combined related estate and electing trust do not have sufficient income to be required to file Form 1041. However, if the estate is granted an extension of time to file Form 1041 for its first tax year, the due date for Form 8855 is the extended due date. Once made, the election is irrevocable. In general, a QRT is any trust (or part of a trust) that, on the day the decedent died, was treated as owned by the decedent because the decedent held the power to revoke the trust as described in section 676. An electing trust is a QRT for which a section 645 election has been made. The election period is the period of time during which an electing trust is treated as part of its related estate. The election period begins on the date of the decedent's death and terminates on the earlier of:

The day on which the electing trust and related estate, if any, distribute all of their assets. The day before the applicable date.

To determine the applicable date, first determine whether a Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return, is required to be filed as a result of the decedent's death. If no Form 706 is required to be filed, the applicable date is 2 years after the date of the decedent's death. If Form 706 is required, the applicable date is the later of 2 years after the date of the decedent's death or 6 months after the final determination of liability for estate tax. For additional information, see Regulations section 1.645-1(f). Distributable Net Income (DNI) The income distribution deduction allowable to estates and trusts for amounts paid, credited, or required to be distributed to beneficiaries is limited to DNI. This amount, which is figured on Schedule B, line 7, is also used to determine how much of an amount paid, credited, or required to be distributed to a beneficiary will be includible in his or her gross income. When completing Form 1041, the taxpayer must take into account any items that are income in respect of a decedent (IRD). In general, IRD is income that a decedent was entitled to receive but that was not properly includible in the decedent's final income tax return under the decedent's method of accounting. IRD includes:

All accrued income of a decedent who reported his or her income on the cash method of accounting. Income accrued solely because of the decedent's death in the case of a decedent who reported his or her income

on the accrual method of accounting. Income to which the decedent had a contingent claim at the time of his or her death.

Some examples of IRD for a decedent who kept his or her books on the cash method are:

Deferred salary payments that are payable to the decedent's estate Uncollected interest on U.S. savings bonds. Proceeds from the completed sale of farm produce. The portion of a lump-sum distribution to the beneficiary of a decedent's IRA that equals the balance in the IRA at

the time of the owner's death. This includes unrealized appreciation and income accrued to that date, less the aggregate amount of the owner's nondeductible contributions to the IRA. Such amounts are included in the beneficiary's gross income in the tax year that the distribution is received.

The IRD has the same character it would have had if the decedent had lived and received such amount. The following deductions and credits, when paid by the decedent's estate, are allowed on Form 1041 even though they were not allowable on the decedent's final income tax return:

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Business expenses deductible under section 162. Interest deductible under section 163. Taxes deductible under section 164. Investment expenses described in section 212 (in excess of 2% of adjusted gross income (AGI)). Percentage depletion allowed under section 611. Foreign tax credit.

Income required to be distributed currently is income that is required under the terms of the governing instrument and applicable local law to be distributed in the year it is received. The fiduciary must be under a duty to distribute the income currently, even if the actual distribution is not made until after the close of the trust's tax year. A fiduciary is a trustee of a trust, or an executor, executrix, administrator, administratrix, personal representative, or person in possession of property of a decedent's estate. Misuse of Trusts For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts. While there are legitimate uses of trusts in tax and estate planning, some highly questionable transactions promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. Such trusts rarely deliver the tax benefits promised and are used primarily as a means of avoiding income tax liability and hiding assets from creditors, including the IRS. IRS personnel have seen an increase in the improper use of private annuity trusts and foreign trusts to shift income and deduct personal expenses. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering a trust arrangement. Promoters of fraudulent trust arrangements use a variety of methods to advertise their schemes. They may include seminars, flyers, and even the Internet. The main selling point of fraudulent trust arrangements is that the paperwork will look like the taxpayer is giving up control of his or her assets and money; when in reality he or she still controls how his or her money and assets are used. A fraudulent trust only has the appearance of a trust. It is typically promoted by the promise of tax benefits or avoidance with no meaningful change in the taxpayer's control over or benefit from the taxpayer's income or assets. Using the name "trust" in association with financial arrangements does not make it a legitimate trust. No matter how carefully written the trust documents are, if the intent is to evade taxes, the trust will be treated as fraudulent. Fraudulent trusts are illegal and are a specific area of concern for IRS Criminal Investigation. When To File For calendar year estates and trusts, file Form 1041 - U.S. Income Tax Return for Estates and Trusts and Schedule(s) K-1 by April 17, 2018. The due date is April 17, instead of April 15, because of the Emancipation Day holiday in the District of Columbia. For fiscal year estates and trusts, file Form 1041 by the 15th day of the 4th month following the close of the tax year. For example, an estate that has a tax year that ends on June 30, 2017, must file Form 1041 by October 15, 2017. If the due date falls on a Saturday, Sunday, or legal holiday, file on the next business day. (165) Extension of Time To File If more time is needed to file the estate or trust return, use Form 7004 - Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns, to apply for an automatic 5½-month extension of time to file.

As of June 2011, the automatic extension of time to file a bankruptcy estate return has been increased to 6 months.

The IRS will no longer send a notification that the extension has been approved. They will notify the business entity only if its request for an extension is disallowed. Properly filing Form 7004 will automatically give the business entity the maximum extension allowed from the due date of its return to file the return. Additionally, The IRS may terminate the automatic extension at any time by mailing a notice of termination to the entity or person that requested the extension. The notice will be mailed at least 10 days before the termination date given in the notice.

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Period Covered File the 2017 return for calendar year 2016 and fiscal years beginning in 2017 and ending in 2018. If the return is for a fiscal year or a short tax year (less than 12 months), fill in the tax year space at the top of the form. The 2017 Form 1041 may also be used for a tax year beginning in 2018 if:

1. The estate or trust has a tax year of less than 12 months that begins and ends in 2018, and 2. The 2018 Form 1041 is not available by the time the estate or trust is required to file its tax return. However, the

estate or trust must show its 2018 tax year on the 2017 Form 1041 and incorporate any tax law changes that are effective for tax years beginning after December 31, 2017.

Estimated Tax Generally, an estate or trust must pay estimated income tax for 2017 if it expects to owe, after subtracting any withholding and credits, at least $1,000 in tax, and it expects the withholding and credits to be less than the smaller of:

1. 90% of the tax shown on the 2017 tax return, or 2. 100% of the tax shown on the 2016 tax return (110% of that amount if the estate's or trust's adjusted gross income

on that return is more than $150,000, and less than ⅔ of gross income for 2016 or 2017 is from farming or fishing).

However, if a return was not filed for 2016 or that return did not cover a full 12 months, item 2 does not apply. For this purpose, include household employment taxes in the tax shown on the tax return, but only if either of the following is true:

The estate or trust will have Federal income tax withheld for 2017 or The estate or trust would be required to make estimated tax payments for 2016 even if it did not include household

employment taxes when figuring estimated tax. Estimated tax payments are not required from:

1. An estate of a domestic decedent or a domestic trust that had no tax liability for the full 12-month 2016 tax year; 2. A decedent's estate for any tax year ending before the date that is 2 years after the decedent's death; or 3. A trust that was treated as owned by the decedent if the trust will receive the residue of the decedent's estate

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

Section 643(g) Election Fiduciaries of trusts that pay estimated tax may elect under section 643(g) to have any portion of their estimated tax payments allocated to any of the beneficiaries. The fiduciary of a decedent's estate may make a section 643(g) election only for the final year of the estate. Interest Interest is charged on taxes not paid by the due date, even if an extension of time to file is granted. Interest is also charged on penalties imposed for failure to file, negligence, fraud, substantial valuation misstatements, substantial understatements of tax, and reportable transaction understatements. Interest is charged on the penalty from the due date of the return (including extensions). The interest charge is figured at a rate determined under section 6621. Late Filing of Return The law provides a penalty of 5% of the tax due for each month, or part of a month, for which a return isn't filed up to a maximum of 25% of the tax due (15% for each month, or part of a month, up to a maximum of 75% if the failure to file is fraudulent). If the return is more than 60 days late, the minimum penalty is the smaller of $210 or the tax due. The penalty will not be imposed if the taxpayer can show that the failure to file on time was due to reasonable cause. If he or she receives a notice about penalty and interest after he or she files this return, send the IRS an explanation and they will determine if the taxpayer meets reasonable-cause criteria. The taxpayer does not attach an explanation when he or she files Form 1041.

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Late Payment of Tax Generally, the penalty for not paying tax when due is ½ of 1% of the unpaid amount for each month or part of a month it remains unpaid. The maximum penalty is 25% of the unpaid amount. The penalty applies to any unpaid tax on the return. Any penalty is in addition to interest charges on late payments. Failure To Provide Information Timely The taxpayer must provide Schedule K-1 (Form 1041), on or before the day he or she is required to file Form 1041, to each beneficiary who receives a distribution of property or an allocation of an item of the estate. In 2017, for each failure to provide Schedule K-1 to a beneficiary when due and each failure to include on Schedule K-1 all the information required to be shown (or the inclusion of incorrect information), a $260 penalty may be imposed with regard to each Schedule K-1 for which a failure occurs. The maximum penalty is $3,218,500 for all such failures during a calendar year. If the requirement to report information is intentionally disregarded, each $260 penalty is increased to $530 or, if greater, 10% of the aggregate amount of items required to be reported, and the $3,218,500 maximum does not apply. The penalty will not be imposed if the fiduciary can show that not providing information timely was due to reasonable cause and not due to willful neglect. Underpaid Estimated Tax If the fiduciary underpaid estimated tax, use Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, to figure any penalty. Enter the amount of any penalty on Form 1041, line 26. Trust Fund Recovery Penalty This penalty may apply if certain excise, income, Social Security, and Medicare taxes that must be collected or withheld are not collected or withheld, or these taxes are not paid. These taxes are generally reported on Forms 720, 941, 943, 944, or 945. The trust fund recovery penalty may be imposed on all persons who are determined by the IRS to have been responsible for collecting, accounting for, or paying over these taxes, and who acted willfully in not doing so. The penalty is equal to the unpaid trust fund tax. See the Instructions for Form 720, Publication 15 (Circular E), Employer's Tax Guide, or Publication 51 (Circular A), Agricultural Employer's Tax Guide, for more details, including the definition of responsible persons.

Tax Exempt Organizations To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates. Organizations described in section 501(c)(3) are commonly referred to as charitable organizations. Organizations described in section 501(c)(3), other than testing for public safety organizations, are eligible to receive tax-deductible contributions in accordance with Code section 170. The organization must not be organized or operated for the benefit of private interests, and no part of a section 501(c)(3) organization's net earnings may inure to the benefit of any private shareholder or individual. If the organization engages in an excess benefit transaction with a person having substantial influence over the organization, an excise tax may be imposed on the person and any organization managers agreeing to the transaction. Section 501(c)(3) organizations are restricted in how much political and legislative (lobbying) activities they may conduct. Form 1023 - Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code is used to apply for recognition as a tax-exempt organization under section 501(c)(3). Organizations that may qualify for exemption under section 501(c)(3) include corporations, unincorporated associations and trusts. A partnership may not qualify for exemption and therefore may not file Form 1023. Form 1023-EZ - Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code is the streamlined version of Form 1023. Any organization may file Form 1023 to apply for recognition of exemption

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from Federal income tax under section 501(c)(3). Only certain organizations are eligible to file Form 1023-EZ. The organization must complete the Form 1023-EZ Eligibility Worksheet in the Instructions for Form 1023-EZ to determine if they are eligible to file this form. Form 1023-EZ is filed electronically only on Pay.gov. If the organization is not eligible to file Form 1023-EZ, they can still file Form 1023. Most organizations seeking exemption from Federal income tax under section 501(c)(3) are required to complete and submit an application. However, the following types of organizations may be considered tax exempt under section 501(c)(3) even if they do not file Form 1023 or Form 1023-EZ: (174)

Churches, including synagogues, temples, and mosques. Integrated auxiliaries of churches and conventions or associations of churches. Any organization that has gross receipts in each taxable year of normally not more than $5,000.

A limited liability company that files Form 1023 is treated as a corporation rather than a partnership. As a corporation, it may file Form 1023. Note, however, that a limited liability company should not file an exemption application if it wants to be treated as a disregarded entity by its tax-exempt parent. The IRS will only recognize a limited liability company under section 501(c)(3) if all its members are section 501(c)(3) organizations. A charity's organizing document must limit the organization's purposes to exempt purposes set forth in section 501(c)(3) and must not expressly empower it to engage, other than as an insubstantial part of its activities, in activities that do not further those purposes. This requirement may be met if the purposes stated in the organizing document are limited by reference to section 501(c)(3). In addition, an organization's assets must be permanently dedicated to an exempt purpose. This means that if an organization dissolves, its assets must be distributed for an exempt purpose described in section 501(c)(3), or to the Federal government or to a state or local government for a public purpose. To establish that an organization's assets will be permanently dedicated to an exempt purpose, the organizing document should contain a provision insuring their distribution for an exempt purpose if the organization dissolves. Although reliance may be placed upon state law to establish permanent dedication of assets for exempt purposes, an organization's application can be processed by the IRS more rapidly if its organizing document includes a provision ensuring permanent dedication of assets for exempt purposes. If the organizing document does not contain these provisions, an organization should amend it before submitting its exemption application. State officials can provide more information about how to amend organizing documents. Organizations applying for recognition of exemption under a provision other than section 501(c)(3) generally use Form 1024 - Application for Recognition of Exemption Under Section 501(a). Even if these organizations are not required to file Form 1024 to be tax-exempt, they may wish to file Form 1024 to receive a determination letter of IRS recognition of their section 501(c) status in order to obtain certain incidental benefits such as:

Public recognition of tax-exempt status. Exemption from certain state taxes. Advance assurance to donors of deductibility of contributions (in certain cases). Nonprofit mailing privileges.

Generally, Form 1024 is not used to apply for a group exemption letter.

Exempt Organizations - Required Filings Although they are exempt from income taxation, exempt organizations are generally required to file annual returns of their income and expenses with the Internal Revenue Service. As of 2008, small tax-exempt organizations that previously were not required to file returns because their gross receipts did not exceed a certain threshold may be required to file an annual electronic notice. Some organizations, such as churches and certain church-affiliated organizations, are not required to file annual returns or notices. If an organization has unrelated business income, it must file an unrelated business income tax return. In addition to filing an annual exempt organization return, exempt organizations may be required to file other returns of and pay employment taxes. Some organizations may be required to file certain returns electronically. In addition to required filings, a charity may have other ongoing compliance obligations.

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Unrelated Business Taxable Income (UBTI) Even though an organization is recognized as tax exempt, it still may be liable for tax on its unrelated business income. For most organizations, unrelated business income is income from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization's exemption. An exempt organization that has $1,000 or more of gross income from an unrelated business must file Form 990-T - Exempt Organization Business Income Tax Return. An organization must pay estimated tax if it expects its tax for the year to be $500 or more. The obligation to file Form 990-T is in addition to the obligation to file the annual information return, Form 990, 990-EZ or 990-PF. Each organization must file a separate Form 990-T, except title holding corporations and organizations receiving their earnings that file a consolidated return under Internal Revenue Code section 1501. Employment Taxes If a tax-exempt organization (EO) has employees, the EO is responsible for Federal Income Tax Withholding and Social Security and Medicare taxes. In addition, some EOs are responsible for Federal Unemployment Tax.

Retirement Plans SEP, SIMPLE, and qualified plans offer the employer and his or her employees a tax-favored way to save for retirement. The employer can deduct contributions he or she makes to the plan for his or her employees. If the taxpayer is a sole proprietor, he or she can deduct contributions he or she makes to the plan for him or herself. An employer can also deduct trustees' fees if contributions to the plan do not cover them. Earnings on the contributions are generally tax free until the employer or his or her employees receive distributions from the plan. Under a 401(k) plan, employees can have an employer contribute limited amounts of their before-tax (after-tax, in the case of a qualified Roth contribution program) pay to the plan. These amounts (and the earnings on them) are generally tax free until his or her employees receive distributions from the plan or, in the case of a qualified distribution from a designated Roth account, completely tax free. Simplified Employee Pension Plans (SEP) SEPs provide a simplified method for an employer to make contributions to a retirement plan for him or herself and his or her employees. Instead of setting up a profit-sharing or money purchase plan with a trust, the employer can adopt a SEP agreement and make contributions directly to a traditional individual retirement account or a traditional individual retirement annuity (SEP-IRA) set up for him or herself and each eligible employee. Contributions an employer makes for 2017 to a common-law employee's SEP-IRA cannot exceed the lesser of 25% of the employee's compensation or $54,000. Compensation generally does not include the employer’s contributions to the SEP. The SEP plan document will specify how the employer contribution is determined and how it will be allocated to participants. If the employer contributes to a defined contribution plan, annual additions to an account are limited to the lesser of $54,000 or 100% of the participant's compensation. When the employer figures this limit, he or she must add his or her contributions to all defined contribution plans maintained by him or her. Because a SEP is considered a defined contribution plan for this limit, the employer’s contributions to a SEP must be added to the employer’s contributions to other defined contribution plans he or she maintains. Generally, the employer can deduct the contributions he or she makes each year to each employee's SEP-IRA. If the taxpayer is self-employed, he or she can deduct the contributions he or she makes each year to his or her own SEP-IRA. The most an employer can deduct for his or her contributions to the employer’s or his or her employee's SEP-IRA is the lesser of the following amounts:

1. The employer’s contributions (including any excess contributions carryover). 2. 25% of the compensation (limited to $270,000 per participant) paid to the participants during 2017 from the

business that has the plan, not to exceed $54,000 per participant.

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Savings Incentive Match Plans (SIMPLE) Generally, if an employer had 100 or fewer employees who received at least $5,000 in compensation last year, he or she can set up a SIMPLE plan. Under a SIMPLE plan, employees can choose to make salary reduction contributions rather than receiving these amounts as part of their regular pay. In addition, the employer will contribute matching or non-elective contributions. The two types of SIMPLE plans are the SIMPLE IRA plan and the SIMPLE 401(k) plan. Contributions are made up of salary reduction contributions and employer contributions. The employer must make either matching contributions or non-elective contributions. No other contributions can be made to the SIMPLE IRA plan. These contributions, which the employer can deduct, must be made timely. The amount the employee chooses to have the employer contribute to a SIMPLE IRA on his or her behalf cannot be more than $12,500 for 2017. These contributions must be expressed as a percentage of the employee's compensation unless the employer permits the employee to express them as a specific dollar amount. The employer cannot place restrictions on the contribution amount (such as limiting the contribution percentage), except to comply with the $12,500 limit. If the employer or an employee participates in any other qualified plan during the year and the employer’s or his or her employee have salary reduction contributions (elective deferrals) under those plans, the salary reduction contributions under a SIMPLE IRA plan also count toward the overall annual limit, $18,000 in 2017, on exclusion of salary reduction contributions and other elective deferrals. A SIMPLE IRA plan can permit participants who are age 50 or over at the end of the calendar year to also make catch-up contributions. The catch-up contribution limit for 2017 for SIMPLE IRA plans is $3,000. Salary reduction contributions are not treated as catch-up contributions for 2017 until they exceed $12,500. However, the catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts:

The catch-up contribution limit. The excess of the participant's compensation over the salary reduction contributions that are not catch-up

contributions.

The employer is generally required to match each employee's salary reduction contributions on a dollar-for-dollar basis up to 3% of the employee's compensation. This requirement does not apply if the employer makes non-elective contributions.

Instead of matching contributions, the employer can choose to make non-elective contributions of 2% of compensation on behalf of each eligible employee who has at least $5,000 (or some lower amount if the employer selects) of compensation from him or her for the year. If employer makes this choice, he or she must make non-elective contributions whether or not the employee chooses to make salary reduction contributions. Only $270,000 of the employee's compensation can be taken into account to figure the contribution limit in 2017. If the employer chooses this 2% contribution formula, he or she must notify the employees within a reasonable period of time before the 60-day election period for the calendar year. The employer can deduct SIMPLE IRA contributions in the tax year within which the calendar year for which contributions were made ends. The employer can deduct contributions for a particular tax year if they are made for that tax year and are made by the due date (including extensions) of his or her Federal income tax return for that year. Qualified Plans The qualified plan rules are more complex than the SEP plan and SIMPLE plan rules. However, there are advantages to qualified plans, such as increased flexibility in designing plans and increased contribution and deduction limits in some cases. Qualified retirement plans set up by self-employed individuals are sometimes called Keogh or H.R.10 plans. A sole proprietor or a partnership can set up one of these plans. A common-law employee or a partner cannot set up one of these plans. These plans can also be set up and maintained by employers that are corporations. All the rules discussed here apply to corporations except where specifically limited to the self-employed. There are two basic kinds of qualified plans—defined contribution plans and defined benefit plans—and different rules apply to each. The employer can have more than one qualified plan, but his or her contributions to all the plans must not total more than the overall limits.

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Defined Contribution Plan A defined contribution plan provides an individual account for each participant in the plan. It provides benefits to a participant largely based on the amount contributed to that participant's account. Benefits are also affected by any income, expenses, gains, losses, and forfeitures of other accounts that may be allocated to an account. A defined contribution plan can be either a profit-sharing plan or a money purchase pension plan. Although it is called a “profit-sharing plan,” the employer does not actually have to make a business profit for the year in order to make a contribution (except for him or herself if he or she is self-employed). A profit-sharing plan can be set up to allow for discretionary employer contributions, meaning the amount contributed each year to the plan is not fixed. An employer may even make no contribution to the plan for a given year. The plan must provide a definite formula for allocating the contribution among the participants and for distributing the accumulated funds to the employees after they reach a certain age, after a fixed number of years, or upon certain other occurrences. In general, the employer can be more flexible in making contributions to a profit-sharing plan than to a money purchase pension plan or a defined benefit plan. Contributions to a money purchase pension plan are fixed and are not based on the employer’s business profits. For example, if the plan requires that contributions be 10% of the participants' compensation without regard to whether the employer has profits (or the self-employed person has earned income), the plan is a money purchase pension plan. This applies even though the compensation of a self-employed individual as a participant is based on earned income derived from business profits. Defined Benefit Plan A defined benefit plan is any plan that is not a defined contribution plan. Contributions to a defined benefit plan are based on what is needed to provide definitely determinable benefits to plan participants. Actuarial assumptions and computations are required to figure these contributions. Generally, the taxpayer will need continuing professional help to have a defined benefit plan. A qualified plan is generally funded by the employer’s contributions. However, employees participating in the plan may be permitted to make contributions, and the employer may be permitted to make contributions on his or her own behalf. An employer can make deductible contributions for a tax year up to the due date of his or he return (plus extensions) for that year. The plan must provide that contributions or benefits cannot exceed certain limits. The limits differ depending on whether the plan is a defined contribution plan or a defined benefit plan. For 2017, the annual benefit for a participant under a defined benefit plan cannot exceed the lesser of the following amounts:

100% of the participant's average compensation for his or her highest 3 consecutive calendar years. $215,000 in 2017.

For 2017, a defined contribution plan's annual contributions and other additions (excluding earnings) to the account of a participant cannot exceed the lesser of the following amounts:

100% of the participant's compensation. $54,000.

Catch-up contributions are not subject to the above limit.

Employees may be permitted to make nondeductible contributions to a plan in addition to an employer’s contributions. Even though these employee contributions are not deductible, the earnings on them are tax free until distributed in later years. Also, these contributions must satisfy the nondiscrimination test of section 401(m). An employer can usually deduct, subject to limits, contributions he or she makes to a qualified plan, including those made for his or her own retirement. The contributions (and earnings and gains on them) are generally tax free until distributed by the plan. The deduction limit for the contributions to a qualified plan depends on the kind of plan the employer has. The deduction for contributions to a defined contribution plan (profit-sharing plan or money purchase pension plan) cannot be more than 25% of the compensation paid (or accrued) during the year to the employer’s eligible employees participating

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in the plan. If the taxpayer is self-employed, he or she must reduce this limit in figuring the deduction for contributions he or she makes for his or her own account. When figuring the deduction limit, the following rules apply:

Elective deferrals (discussed later) are not subject to the limit. Compensation includes elective deferrals. The maximum compensation that can be taken into account for each employee in 2017 is $270,000.

The deduction for contributions to a defined benefit plan is based on actuarial assumptions and computations. Consequently, an actuary must figure the deduction limit. Prohibited Transactions Prohibited transactions are transactions between the plan and a disqualified person that are prohibited by law. If the employer is a disqualified person who takes part in a prohibited transaction, he or she must pay a tax. Prohibited transactions generally include the following transactions:

1. A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person. 2. Any act of a fiduciary by which he or she deals with plan income or assets in his or her own interest. 3. The receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a

transaction that involves plan income or assets. 4. Any of the following acts between the plan and a disqualified person:

a. Selling, exchanging, or leasing property. b. Lending money or extending credit. c. Furnishing goods, services, or facilities.

Certain transactions are exempt from being treated as prohibited transactions. For example, a prohibited transaction does not take place if the employer is a disqualified person and receives any benefit to which he or she is entitled as a plan participant or beneficiary. However, the benefit must be figured and paid under the same terms as for all other participants and beneficiaries. The taxpayer is a disqualified person if he or she is any of the following:

1. A fiduciary of the plan. 2. A person providing services to the plan. 3. An employer, any of whose employees are covered by the plan. 4. An employee organization, any of whose members are covered by the plan.

a. Any direct or indirect owner of 50% or more of any of the following. b. The combined voting power of all classes of stock entitled to vote, or the total value of shares of all classes

of stock of a corporation that is an employer or employee organization described in (3) or (4). c. The capital interest or profits interest of a partnership that is an employer or employee organization

described in (3) or (4). 5. The beneficial interest of a trust or unincorporated enterprise that is an employer or an employee organization

described in (3) or (4). 6. A member of the family of any individual described in (1), (2), (3), or (5). (A member of a family is the spouse,

ancestor, lineal descendant, or any spouse of a lineal descendant.) 7. A corporation, partnership, trust, or estate of which (or in which) any direct or indirect owner described in (1)

through (5) holds 50% or more of any of the following. a. The combined voting power of all classes of stock entitled to vote or the total value of shares of all classes

of stock of a corporation. b. The capital interest or profits interest of a partnership. c. The beneficial interest of a trust or estate.

8. An officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10% or more shareholder, or highly compensated employee (earning 10% or more of the yearly wages of an employer) of a person described in (3), (4), (5), or (7).

9. A 10% or more (in capital or profits) partner or joint venture of a person described in (3), (4), (5), or (7). 10. Any disqualified person, as described in (1) through (9) above, who is a disqualified person with respect to any

plan to which a section 501(c)(22) trust is permitted to make payments under section 4223 of ERISA.

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The term “highly compensated employee” means any employee who:

Owned more than 5% of the interest in the business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or

For the preceding year: o Received compensation from the business of more than $120,000 if the preceding year is 2017, and o If the employer so chooses, was in the top 20% of employees when ranked by compensation for the

preceding year. The initial tax on a prohibited transaction is 15% of the amount involved for each year (or part of a year) in the taxable period. If the transaction is not corrected within the taxable period, an additional tax of 100% of the amount involved is imposed. Both taxes are payable by any disqualified person who participated in the transaction (other than a fiduciary acting only as such). If more than one person takes part in the transaction, each person can be jointly and severally liable for the entire tax.

Farms The taxpayer is in the business of farming if he or she cultivates, operates, or manages a farm for profit, either as owner or tenant. A farm includes livestock, dairy, poultry, fish, fruit, and truck farms. It also includes plantations, ranches, ranges, and orchards. Gross farm income refers to the monetary and non-monetary income received by farm operators. Its main components include cash receipts from the sale of farm products, government payments, other farm income (such as income from custom work), value of food and fuel produced and consumed on the same farm, rental value of farm dwellings, and change in value of year-end inventories of crops and livestock. Here are 10 things about farm income and expenses that the IRS wants the taxpayer to know. (175)

1. Crop insurance proceeds. Insurance payments from crop damage count as income. They should generally be reported the year they are received.

2. Deductible farm expenses. Farmers can deduct ordinary and necessary expenses as business expenses. An ordinary farming expense is one that is common and accepted in the farming business. A necessary expense is one that is appropriate for that business.

3. Employees and hired help. The taxpayer can deduct reasonable wages paid to the farm’s full and part-time workers. The taxpayer must withhold Social Security, Medicare and income taxes from the employees’ wages.

4. Items purchased for resale. If the taxpayer purchased livestock and other items for resale, he or she may be able to deduct their cost in the year of the sale. This includes freight charges for transporting livestock to the farm.

5. Repayment of loans. The taxpayer can only deduct the interest paid on a loan if the loan proceeds are used for the farming business. He or she cannot deduct interest on a loan used for personal expenses.

6. Weather-related sales. Bad weather may force the taxpayer to sell more livestock or poultry than normal. If so, he or she may be able to postpone reporting a gain from the sale of the additional animals.

7. Net operating losses. If deductible expenses are more than income for the year, the taxpayer may have a net operating loss. He or she can carry that loss over to other years and deduct it. The taxpayer may get a refund of part or all of the income tax paid for past years, or may be able to reduce his or her tax in future years.

8. Farm income averaging. The taxpayer may be able to average some or all of the current year's farm income by spreading it out over the past three years. This may lower his or her taxes if the farm income is high in the current year and low in one or more of the past three years. This method does not change the prior year tax. It only uses the prior year information to figure the current year tax.

9. Fuel and road use. The taxpayer may be able to claim a tax credit or refund of Federal excise taxes on fuel used on the farm for farm work.

10. Farmers Tax Guide. More information about farm income and deductions is in Publication 225 - Farmer’s Tax Guide.

Schedule F (Form 1040) Individuals, trusts, and partnerships report farm income on Schedule F (Form 1040) - Profit or Loss From Farming. Use this schedule to figure the net profit or loss from regular farming operations. Income from farming reported on Schedule F includes amounts the taxpayer receives from cultivating, operating, or managing a farm for gain or profit, either as owner or tenant. This includes income from operating a stock, dairy, poultry, fish, fruit, or truck farm and income from operating

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a plantation, ranch, range, or orchard. It also includes income from the sale of crop shares if the taxpayer materially participates in producing the crop. Income received from operating a nursery, which specializes in growing ornamental plants, is considered to be income from farming. Income reported on Schedule F does not include gains or losses from sales or other dispositions of the following farm assets: (176)

Land. Depreciable farm equipment. Buildings and structures. Livestock held for draft, breeding, sport, or dairy purposes.

Amounts received from the sales of products the taxpayer raised on his or her farm for sale (or bought for resale), such as livestock, produce, or grains, are reported on Schedule F. This includes money and the fair market value of any property or services the taxpayer receives. When he or she sells farm products bought for resale, the profit or loss is the difference between the selling price (money plus the fair market value of any property) and the basis in the item (usually the cost). The taxpayer generally reports these amounts on Schedule F for the year he or she receives payment. Sales of livestock held for draft, breeding, sport, or dairy purposes may result in ordinary or capital gains or losses, depending on the circumstances. In either case, the taxpayer should always report these sales on Form 4797 - Sales of Business Property instead of Schedule F. Animals the taxpayer does not hold primarily for sale are considered business assets of his or her farm. Accounting Methods A farmer must use an accounting method that clearly shows his or her income and expenses. He or she must also figure his or her taxable income and file an income tax return for an annual accounting period called a tax year. Cash Method Most farmers use the cash method because they find it easier to keep records using the cash method. However, certain farm corporations and partnerships and all tax shelters must use an accrual method of accounting. Under the cash method, include in the taxpayer’s gross income all items of income he or she actually or constructively received during the tax year. Items of income include money received as well as property or services received. If the taxpayer receives property or services, he or she must include the fair market value (FMV) of the property or services in income. Income is constructively received when an amount is credited to the taxpayer’s account or made available to him or her without restriction. The taxpayer does not need to have possession of the income for it to be treated as income for the tax year. If he or she authorizes someone to be his or her agent and receive income for him or her, the taxpayer is considered to have received the income when the agent receives it. Income is not constructively received if the taxpayer’s receipt of the income is subject to substantial restrictions or limitations. The taxpayer cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. He or she must report the income in the year the money or property is received or made available to him or her without restriction. Accrual Method Under an accrual method of accounting, a farmer generally reports income in the year earned and deducts or capitalizes expenses in the year incurred. The purpose of an accrual method of accounting is to correctly match income and expenses. Certain businesses engaged in farming must use an accrual method of accounting for its farm business and for sales and purchases of inventory items. Generally, the taxpayer includes an amount in income for the tax year in which all events that fix his or her right to receive the income have occurred, and he or she can determine the amount with reasonable accuracy. Under this rule, include an amount in income on the earliest of the following dates: (177)

When the taxpayer receives payment. When the income amount is due to the taxpayer. When the taxpayer earns the income. When title passes.

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If the taxpayer keeps an inventory, generally he or she must use an accrual method of accounting to determine his or her gross income. An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. Under an accrual method of accounting, the taxpayer generally deducts or capitalizes a business expense when both of the following apply: (177)

1. The all-events test has been met. This test is met when: a. All events have occurred that fix the fact that the taxpayer has a liability. b. The amount of the liability can be determined with reasonable accuracy.

2. Economic performance has occurred. Generally, the taxpayer cannot deduct or capitalize a business expense until economic performance occurs. If his or her expense is for property or services provided to him or her, or for his or her use of property, economic performance occurs as the property or services are provided or as the property is used. If the taxpayer’s expense is for property or services he or she provides to others, economic performance occurs as he or she provides the property or services. Generally, the following businesses, if engaged in farming, must use an accrual method of accounting: (177)

1. A corporation (other than a family corporation) that had gross receipts of more than $1,000,000 for any tax year beginning after 1975.

2. A family corporation that had gross receipts of more than $25,000,000 for any tax year beginning after 1985. 3. A partnership with a corporation as a partner, if that corporation meets the requirements of (1) or (2) above. 4. A tax shelter.

Items (1), (2), and (3) above do not apply to an S corporation or a business operating a nursery or sod farm, or the raising or harvesting of trees (other than fruit and nut trees).

Farm Sales and Exchanges If the taxpayer sells, exchanges, or otherwise disposes of his or her property, he or she usually has a gain or a loss. A sale is a transfer of property for money or a mortgage, note, or other promise to pay money. An exchange is a transfer of property for other property or services. Amounts received from the sales of products the taxpayer raised on his or her farm for sale (or bought for resale), such as livestock, produce, or grains, are reported on Schedule F - Profit or Loss From Farming. This includes money and the fair market value of any property or services he or she receives. When the taxpayer sells farm products bought for resale, his or her profit or loss is the difference between the selling price (money plus the fair market value of any property) and the basis in the item (usually the cost). The taxpayer generally reports these amounts on Schedule F for the year he or she receives payment. Ordinary or Capital Gain or Loss Generally, the taxpayer will have a capital gain or loss if he or she sells or exchanges a capital asset. He or she may also have a capital gain if his or her section 1231 transactions result in a net gain. To figure the net capital gain or loss, the taxpayer must classify his or her gains and losses as either ordinary or capital (and his or her capital gains or losses as either short-term or long-term). The net capital gains may be taxed at a lower tax rate than ordinary income. The deduction for a net capital loss may be limited. Livestock This part discusses the sale or exchange of livestock used in a farm business. Gain or loss from the sale or exchange of this livestock may qualify as a section 1231 gain or loss. However, any part of the gain that is ordinary income from the recapture of depreciation is not included as section 1231 gain. The rules discussed here do not apply to the sale of livestock held primarily for sale to customers. The sale of this livestock is reported on Schedule F. The sale or exchange of livestock used in a farm business qualifies as a section 1231 transaction if the taxpayer held the livestock for 12 months or more (24 months or more for horses and cattle). For section 1231 transactions, livestock

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includes cattle, hogs, horses, mules, donkeys, sheep, goats, fur-bearing animals, and other mammals. Also, for section 1231 transactions, livestock does not include chickens, turkeys, pigeons, geese, emus, ostriches, rheas, or other birds, fish, frogs, reptiles, etc. If livestock is held primarily for draft, breeding, dairy, or sporting purposes, it is used in a farm business. The purpose for which an animal is held ordinarily is determined by a farmer's actual use of the animal. An animal is not held for draft, breeding, dairy, or sporting purposes merely because it is suitable for that purpose, or because it is held for sale to other persons for use by them for that purpose. However, a draft, breeding, or sporting purpose may be present if an animal is disposed of within a reasonable time after it is prevented from its intended use or made undesirable as a result of an accident, disease, drought, or unfitness of the animal. Example Ben discovers an animal that he intends to use for breeding purposes is sterile. He disposes of it within a reasonable time. This animal was held for breeding purposes. Gain on the sale of raised livestock is generally the gross sales price reduced by any expenses of the sale. Expenses of sale include sales commissions, freight or hauling from a farm to a commission company, and other similar expenses. The basis of the animal sold is zero if the costs of raising it were deducted during the years the animal was being raised. Rents The rent a taxpayer receives for the use of his or her farmland is generally rental income, not farm income. However, if the taxpayer materially participates in farming operations on the land, the rent is farm income. If the taxpayer pastures someone else's livestock and takes care of them for a fee, the income is from his or her farming business. The taxpayer must enter it as Other income on Schedule F. If the taxpayer simply rents his or her pasture for a flat cash amount without providing services, report the income as rent on Part I of Schedule E (Form 1040) - Supplemental Income and Loss. Crop Shares The taxpayer must include rent he or she receives in the form of crop shares in income in the year he or she converts the shares to money or the equivalent of money. It does not matter whether the taxpayer uses the cash method of accounting or an accrual method of accounting. If the taxpayer materially participates in operating a farm from which he or she receives rent in the form of crop shares or livestock, the rental income is included in self-employment income. If the taxpayer does not materially participate in operating the farm, report this income on Form 4835 and carry the net income or loss to Schedule E (Form 1040). The income is not included in self-employment income. Sales Caused by Weather-Related Conditions If the taxpayer sells or exchanges more livestock, including poultry, than he or she normally would in a year because of a drought, flood, or other weather-related condition, he or she may be able to postpone reporting the gain from the additional animals until the next year. The taxpayer must meet all the following conditions to qualify: (176)

His or her principal trade or business is farming. He or she uses the cash method of accounting. He or she can show that, under his or her usual business practices, he or she would not have sold or exchanged

the additional animals this year except for the weather-related condition. The weather-related condition caused an area to be designated as eligible for assistance by the Federal

government. Sales or exchanges made before an area became eligible for Federal assistance qualify if the weather-related condition that caused the sale or exchange also caused the area to be designated as eligible for Federal assistance. The designation can be made by the President, the Department of Agriculture (or any of its agencies), or by other Federal departments or agencies. The taxpayer should follow these steps to figure the amount of gain to be postponed for each class of animals:

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1. Divide the total income realized from the sale of all livestock in the class during the tax year by the total number of such livestock sold. For this purpose, do not treat any postponed gain from the previous year as income received from the sale of livestock.

2. Multiply the result in (1) by the excess number of such livestock sold solely because of weather-related conditions.

Deductible Expenses The ordinary and necessary costs of operating a farm for profit are deductible business expenses. Schedule F, Part II, lists some common farm expenses that are typically deductible. If the reimbursement is received in the same year that the expense is claimed, reduce the expense by the amount of the reimbursement. If the reimbursement is received in a year after the expense is claimed, include the reimbursement amount in income. Some expenses the taxpayer pays during the tax year may be part personal and part business. These may include expenses for gasoline, oil, fuel, water, rent, electricity, telephone, automobile upkeep, repairs, insurance, interest, and taxes. The taxpayer must allocate these mixed expenses between their business and personal parts. Generally, the personal part of these expenses is not deductible. The business portion of the expenses is deductible on Schedule F. Prepaid Farm Supplies Prepaid farm supplies include the following items if paid for during the year:

Feed, seed, fertilizer, and similar farm supplies not used or consumed during the year, but not including farm supplies that the taxpayer would have consumed during the year if not for a fire, storm, flood, other casualty, disease, or drought.

Poultry (including egg-laying hens and baby chicks) bought for use (or for both use and resale) in the taxpayer’s farm business. However, include only the amount that would be deductible in the following year if he or she had capitalized the cost and deducted it ratably over the lesser of 12 months or the useful life of the poultry.

Poultry bought for resale and not resold during the year. If the taxpayer uses the cash method of accounting to report his or her income and expenses, the deduction for prepaid farm supplies in the year he or she pays for them may be limited to 50% of the other deductible farm expenses for the year (all Schedule F deductions except prepaid farm supplies). This limit does not apply if the taxpayer meets certain exceptions. If the limit applies, the taxpayer can deduct the excess cost of farm supplies other than poultry in the year he or she uses or consumes the supplies. The excess cost of poultry bought for use (or for both use and resale) in the taxpayer’s farm business is deductible in the year following the year he or she pays for it. The excess cost of poultry bought for resale is deductible in the year he or she sells or otherwise dispose of that poultry. Conservation Expenses A taxpayer can deduct conservation expenses only for land he or she or his or her tenant are using, or have used in the past, for farming. These expenses include, but are not limited to, the following.

1. The treatment or movement of earth, such as: a. Leveling, b. Conditioning, c. Grading, d. Terracing, e. Contour furrowing, and f. Restoration of soil fertility.

2. The construction, control, and protection of: a. Diversion channels, b. Drainage ditches, c. Irrigation ditches, d. Earthen dams, and e. Watercourses, outlets, and ponds. f. The eradication of brush. g. The planting of windbreaks.

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The taxpayer cannot deduct expenses to drain or fill wetlands, or to prepare land for center pivot irrigation systems, as soil and water conservation expenses. These expenses are added to the basis of the land. The basis of property a taxpayer buys is usually its cost. Cost is the amount he or she pays in cash, debt obligations, other property, or services. The taxpayer’s cost includes amounts he or she pays for sales tax, freight, installation, and testing. The basis of real estate and business assets will include other items. Basis generally does not include interest payments. Dispositions of Property Used in Farming When the taxpayer disposes of property used in his or her farm business, the taxable gain or loss is usually treated as ordinary income (which is taxed at the same rates as wages and interest income) or capital gain (which is generally taxed at lower rates) under the rules for section 1231 transactions. When the taxpayer disposes of depreciable property (section 1245 property or section 1250 property) at a gain, he or she may have to recognize all or part of the gain as ordinary income under the depreciation recapture rules. Any gain remaining after applying the depreciation recapture rules is a section 1231 gain, which may be taxed as a capital gain. Gains and losses from property used in farming are reported on Form 4797 - Sales of Business Property. Gain or loss on the following transactions is subject to section 1231 treatment: (176)

Sale or exchange of cattle and horses - The cattle and horses must be held for draft, breeding, dairy, or sporting purposes and held for 24 months or longer.

Sale or exchange of other livestock - This livestock must be held for draft, breeding, dairy, or sporting purposes and held for 12 months or longer. Other livestock includes hogs, mules, sheep, goats, donkeys, and other fur-bearing animals. Other livestock does not include poultry.

Sale or exchange of depreciable personal property - This property must be used in the taxpayer’s business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business. Examples of depreciable personal property include farm machinery and trucks. It also includes amortizable section 197 intangibles.

Sale or exchange of real estate - This property must be used in the taxpayer’s business and held longer than 1 year. Examples are his or her farm or ranch (including barns and sheds).

Sale or exchange of unharvested crops - The crop and land must be sold, exchanged, or involuntarily converted at the same time and to the same person, and the land must have been held longer than 1 year. The taxpayer cannot keep any right or option to reacquire the land directly or indirectly (other than a right customarily incident to a mortgage or other security transaction). Growing crops sold with a leasehold on the land, even if sold to the same person in a single transaction, are not included.

Distributive share of partnership gains and losses - The taxpayer’s distributive share must be from the sale or exchange of property listed earlier and held longer than 1 year (or for the required period for certain livestock).

Cutting or disposal of timber - The taxpayer must treat the cutting or disposal of timber as a sale. Condemnation - The condemned property must have been held longer than 1 year. It must be business property

or a capital asset held in connection with a trade or business or a transaction entered into for profit, such as investment property. It cannot be property held for personal use.

Casualty or theft - The casualty or theft must have affected business property, property held for the production of rents or royalties, or investment property (such as notes and bonds). The taxpayer must have held the property longer than 1 year. However, if his or her casualty or theft losses are more than his or her casualty or theft gains, neither the gains nor the losses are taken into account in the section 1231 computation. Section 1231 does not apply to personal casualty gains and losses.

Section 1245 Property A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable. Any recognized gain that is more than the part that is ordinary income because of depreciation is a section 1231 gain. Section 1245 property includes any property that is or has been subject to an allowance for depreciation or amortization and that is any of the following types of property:

1. Personal property (either tangible or intangible). 2. Other tangible property (except buildings and their structural components) used as any of the following. See

Buildings and structural components below: a. An integral part of manufacturing, production, or extraction, or of furnishing transportation,

communications, electricity, gas, water, or sewage disposal services.

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b. A research facility in any of the activities in (a). c. A facility in any of the activities in (a) above, for the bulk storage of fungible commodities.

3. That part of real property (not included in (2)) with an adjusted basis reduced by (but not limited to) the following: a. Amortization of certified pollution control facilities. b. The section 179 expense deduction. c. Deduction for clean-fuel vehicles and certain refueling property. d. Certain expenditures for child care facilities. (Repealed by Public Law 101-58, Omnibus Budget

Reconciliation Act of 1990, section 11801(a)(13) except with regards to deductions made prior to November 5, 1990.)

e. Expenditures to remove architectural and transportation barriers to the handicapped and elderly. f. Certain reforestation expenditures.

4. Single purpose agricultural (livestock) or horticultural structures. 5. Storage facilities (except buildings and their structural components) used in distributing petroleum or any primary

product of petroleum. The gain treated as ordinary income on the sale, exchange, or involuntary conversion of section 1245 property, including a sale and leaseback transaction, is the lesser of the following amounts. The depreciation (which includes any section 179 deduction claimed) and amortization allowed or allowable on the property. The gain realized on the disposition (the amount realized from the disposition minus the adjusted basis of the property). For any other disposition of section 1245 property, ordinary income is the lesser of (1) above or the amount by which its fair market value (FMV) is more than its adjusted basis. For details, see chapter 3 of Publication 544. If the taxpayer elects not to use the uniform capitalization rules, he or she must treat any plant he or she produces as section 1245 property. If the taxpayer has a gain on the property's disposition, he or she must recapture the pre-productive expenses he or she would have capitalized if he or she had not made the election by treating the gain, up to the amount of these expenses, as ordinary income. For section 1231 transactions, show these expenses as depreciation on Form 4797, Part III, line 22. For plant sales that are reported on Schedule F - Profit or Loss From Farming, this recapture rule does not change the reporting of income because the gain is already ordinary income. The taxpayer can use the farm-price method or the unit-livestock-price method to figure these expenses. Farm Inventory If the taxpayer is required to keep an inventory, he or she should keep a complete record of his or her inventory as part of his or her farm records. This record should show the actual count or measurement of the inventory. It should also show all factors that enter into its valuation, including quality and weight, if applicable. If the taxpayer is in the hatchery business, and use an accrual method of accounting, he or she must include in inventory eggs in the process of incubation. All harvested and purchased farm products held for sale or for feed or seed, such as grain, hay, silage, concentrates, cotton, tobacco, etc., must be included in inventory. Supplies acquired for sale or that become a physical part of items held for sale must be included in inventory. Deduct the cost of supplies in the year used or consumed in operations. Do not include incidental supplies in inventory as these are deductible in the year of purchase. Livestock held primarily for sale must be included in inventory. Livestock held for draft, breeding, or dairy purposes can either be depreciated or included in inventory. If the taxpayer is in the business of breeding and raising chinchillas, mink, foxes, or other fur-bearing animals, these animals are livestock for inventory purposes. Generally, growing crops are not required to be included in inventory. However, if the crop has a preproductive period of more than 2 years, the taxpayer may have to capitalize (or include in inventory) costs associated with the crop. See Uniform capitalization rules below. The taxpayer’s inventory should include all items held for sale, or for use as feed, seed, etc., whether raised or purchased, that are unsold at the end of the year. Uniform Capitalization Rules The following applies if the taxpayer is required to use an accrual method of accounting:

The uniform capitalization rules apply to all costs of raising a plant, even if the preproductive period of raising a plant is 2 years or less.

The costs of animals are subject to the uniform capitalization rules.

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In a farming business using the cash method of accounting, the uniform capitalization rules do not apply to:

Any animal. Any plant with a preproductive period of 2 years or less. Any costs of replanting certain plants lost or damaged due to casualty.

In addition, the taxpayer can elect not to use the uniform capitalization rules for plants with a preproductive period of more than 2 years. If he or she makes this election, special rules apply. This election cannot be made by a corporation, partnership, or tax shelter required to use an accrual method of accounting. This election also does not apply to any costs incurred for the planting, cultivation, maintenance, or development of any citrus or almond grove (or any part thereof) within the first 4 years the trees were planted. If the taxpayer elects not to use the uniform capitalization rules, he or she must use the alternative depreciation system for all property used in any of his or her farming businesses and placed in service in any tax year during which the election is in effect. Inventory Valuation Methods The following methods are those generally available for valuing inventory. The method the taxpayer uses must conform to generally accepted accounting principles for similar businesses and must clearly reflect income:

Cost. Lower of cost or market. Farm-price method. Unit-livestock-price method.

If the taxpayer values his or her livestock inventory at cost or the lower of cost or market, he or she does not need IRS approval to change to the unit-livestock-price method. However, if the taxpayer values his or her livestock inventory using the farm-price method, then he or she must obtain permission from the IRS to change to the unit-livestock-price method.

Depreciation The taxpayer can depreciate most types of tangible property (except land), such as buildings, machinery, equipment, vehicles, certain livestock, and furniture. He or she can also depreciate certain intangible property, such as copyrights, patents, and computer software. To be depreciable, the property must meet all the following requirements:

1. It must be property the taxpayer owns. 2. It must be used in the taxpayer’s business or income-producing activity. 3. It must have a determinable useful life. 4. It must have a useful life that extends substantially beyond the year the taxpayer places it in service.

To claim depreciation on property, the taxpayer must use it in his or her business or income-producing activity. If the taxpayer uses property to produce income (investment use), the income must be taxable. The taxpayer cannot depreciate property that he or she uses solely for personal activities. However, if the taxpayer uses property for business or investment purposes and for personal purposes, he or she can deduct depreciation based only on the percentage of business or investment use. Example If the taxpayer uses his or her car for farm business, he or she can deduct depreciation based on its percentage of use in farming. If he or she also uses it for investment purposes, he or she can depreciate it based on its percentage of investment use. A taxpayer can never depreciate inventory because it is not held for use in his or her business. Inventory is any property the taxpayer holds primarily for sale to customers in the ordinary course of his or her business. Livestock purchased for draft, breeding, or dairy purposes can be depreciated only if they are not kept in an inventory account. Livestock the taxpayer raises usually has no depreciable basis because the costs of raising them are deducted and not added to their basis.

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Depreciation for livestock begins when the livestock reaches the age of maturity. If the taxpayer bought immature livestock for drafting purposes, depreciation begins when they can be worked. If the taxpayer bought immature livestock for dairy purposes, depreciation begins when they can be milked. If the taxpayer bought immature livestock for breeding purposes, depreciation begins when they can be bred. The taxpayer’s basis for depreciation is his or her initial cost for the immature livestock. If the taxpayer acquires an orchard, grove, or vineyard before the trees or vines have reached the income-producing stage, and they have a preproductive period of more than 2 years, he or she must capitalize the preproductive-period costs under the uniform capitalization rules (unless he or she elects not to use these rules). The depreciation begins when the trees and vines reach the income-producing stage (that is, when they bear fruit, nuts, or grapes in quantities sufficient to commercially warrant harvesting). (176) Certain property cannot be depreciated, even if the requirements explained earlier are met. This includes the following:

The taxpayer can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping. Although the taxpayer cannot depreciate land, he or she can depreciate certain costs incurred in preparing land for business use.

Property placed in service and disposed of in the same year. Equipment used to build capital improvements. The taxpayer must add otherwise allowable depreciation on the

equipment during the period of construction to the basis of the taxpayer’s improvements. Intangible properties, such as section 197 intangibles, are properties that do not have a determinable useful life

and generally cannot be depreciated. Certain term interests.

Disaster Area Losses Special rules apply to Federally declared disaster area losses. A Federally declared disaster is a disaster that occurred in an area declared by the President to be eligible for Federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. It includes a major disaster or emergency declaration under the act. The taxpayer generally must deduct a casualty loss in the year it occurred. However, if he or she has a deductible loss from a disaster that occurred in an area warranting public or individual assistance (or both), he or she can choose to deduct that loss on his or her return or amended return for the tax year immediately preceding the tax year in which the disaster happened. If the taxpayer makes this choice, the loss is treated as having occurred in the preceding year. Qualified disaster relief payments are not included in the income of individuals to the extent any expenses compensated by these payments are not otherwise compensated for by insurance or other reimbursement. These payments are not subject to income tax, self-employment tax, or employment taxes (Social Security, Medicare, and Federal unemployment taxes). No withholding applies to these payments. Qualified disaster relief payments include payments the taxpayer receives (regardless of the source) for the following expenses:

Reasonable and necessary personal, family, living, or funeral expenses incurred as a result of a Federally declared disaster.

Reasonable and necessary expenses incurred for the repair or rehabilitation of a personal residence due to a Federally declared disaster. (A personal residence can be a rented residence or one the taxpayer owns.)

Reasonable and necessary expenses incurred for the repair or replacement of the contents of a personal residence due to a Federally declared disaster.

Qualified disaster relief payments include amounts paid by a Federal, state, or local government in connection with a Federally declared disaster to individuals affected by the disaster. Qualified disaster relief payments do not include:

Payments for expenses otherwise paid for by insurance or other reimbursements, or Income replacement payments, such as payments of lost wages, lost business income, or unemployment

compensation.

Income Averaging for Farmers If the taxpayer is engaged in a farming business, he or she may be able to average all or some of his or her farm income by using income tax rates from the 3 prior years (base years) to calculate the tax on that income. This may give the

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taxpayer a lower tax if his or her current year income is high and his or her taxable income which includes income from farming from one or more of the 3 prior years was low. The term “farming business” is defined in the Instructions for Schedule J - Income Averaging for Farmers and Fishermen. The taxpayer can use income averaging to figure his or her tax for any year in which he or she was engaged in a farming business as an individual, a partner in a partnership, or a shareholder in an S corporation. Services performed as an employee are disregarded in determining whether an individual is engaged in a farming business. However, if the taxpayer is a shareholder of an S corporation engaged in a farming business, he or she may treat compensation received from the corporation that is attributable to the farming business as farm income. The taxpayer does not need to have been engaged in a farming business in any base year.

Corporations, partnerships, S corporations, estates, and trusts cannot use income averaging.

Elected Farm Income (EFI) EFI is the amount of income from the taxpayer’s farming business that he or she elects to have taxed at base year rates. The taxpayer can designate as EFI any type of income attributable to his or her farming business. However, the taxpayer’s EFI cannot be more than his or her taxable income, and any EFI from a net capital gain attributable to his or her farming business cannot be more than his or her total net capital gain. he taxpayer can elect to use income averaging to compute his or her regular tax liability. However, income averaging is not used to determine his or her regular tax or tentative minimum tax when figuring his or her alternative minimum tax (AMT). Using income averaging may reduce the total tax even if he or she owes AMT. The taxpayer can use income averaging by filing Schedule J (Form 1040) with his or her timely filed (including extensions) return for the year. The taxpayer can also use income averaging on a late return, or use, change, or cancel it on an amended return, if the time for filing a claim for refund has not expired for that election year. The taxpayer generally must file the claim for refund within 3 years from the date he or she filed his or her original return or 2 years from the date he or she paid the tax, whichever is later. Excise Taxes The taxpayer may be eligible to claim a credit on his or her income tax return for the Federal excise tax on certain fuels. He or she may also be eligible to claim a quarterly refund of the fuel taxes during the year, instead of waiting to claim a credit on his or her income tax return. Whether the taxpayer can claim a credit or refund depends on whether the fuel was taxed and the purpose (nontaxable use) for which he or she used the fuel. The nontaxable uses of fuel for which a farmer may claim a credit or refund are generally the following:

Use on a farm for farming purposes. Off-highway business use. Uses other than as a fuel in a propulsion engine, such as home use.

Farm Employment Taxes In general, the taxpayer is an employer of farmworkers if his or her employees do any of the following types of work:

Raising or harvesting agricultural or horticultural products on a farm, including raising and feeding of livestock. Operating, managing, conserving, improving, or maintaining his or her farm and its tools and equipment. Services performed in salvaging timber, or clearing land of brush and other debris, left by a hurricane (also known

as hurricane labor). Handling, processing, or packaging any agricultural or horticultural commodity if he or she produced more than

half of the commodity (for a group of up to 20 unincorporated operators, all of the commodity). Work related to cotton ginning, turpentine, gum resin products, or the operation and maintenance of irrigation

facilities. Generally, a worker who performs services for the taxpayer is his or her employee if he or she has the right to control what will be done and how it will be done. This is so even when the taxpayer gives the employee freedom of action. What matters is that the taxpayer has the right to control the details of how the services are performed. The taxpayer is

Lesson 9 - Specialized Returns

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responsible for withholding and paying employment taxes for his or her employees. He or she is also required to file employment tax returns. These requirements do not apply to amounts that the taxpayer pays to independent contractors. If the taxpayer employs a family of workers, each worker subject to his or her control (not just the head of the family) is an employee. All cash wages the taxpayer pays to an employee during the year for farmwork are subject to Social Security and Medicare taxes if he or she meets either of the following tests.

The taxpayer pays the employee $150 or more in cash wages (count all wages paid on a time, piecework, or other basis) during the year for farmwork (the $150 test). The $150 test applies separately to each farmworker that he or she employs. If the taxpayer employs a family of workers, each member is treated separately. Do not count wages paid by other employers.

The taxpayer pays cash and noncash wages of $2,500 or more during the year to all his or her employees for farmwork (the $2,500 test).

If the $2,500 test for the group is not met, the $150 test for an employee still applies. Annual cash wages of less than $150 the taxpayer pays to a seasonal farmworker are not subject to Social Security and Medicare taxes, even if he or she pays $2,500 or more to all his or her farmworkers. However, these wages count toward the $2,500 test for determining whether other farmworkers' wages are subject to Social Security and Medicare taxes. A seasonal farmworker is a worker who:

Works as a hand-harvest laborer. Is paid piece rates in an operation usually paid on this basis in the region of employment. Commutes daily from his or her permanent home to the farm. Worked in agriculture less than 13 weeks in the preceding calendar year.

Only cash wages paid to farmworkers are subject to Social Security and Medicare taxes. Cash wages include checks, money orders, and any kind of money or cash. Noncash wages include food, lodging, clothing, transportation passes, and other goods and services. Noncash wages paid to farmworkers, including commodity wages, are not subject to Social Security and Medicare taxes. However, they are subject to these taxes if the substance of the transaction is a cash payment. If the cash wages the taxpayer pays to farmworkers are subject to Social Security and Medicare taxes, they are also subject to Federal income tax withholding. Although noncash wages are subject to Federal income tax, the taxpayer should only withhold income tax he or she and the employee agree to do so. The amount to withhold is figured on gross wages without taking out Social Security and Medicare taxes, union dues, insurance, etc. Special Estimated Tax Rules for Qualified Farmers If at least two-thirds of the taxpayer’s gross income for 2016 or 2017 is from farming, he or she has only one payment due date for his or her 2017 estimated tax, January 15, 2018. The due dates for the first three payment periods do not apply. For purposes of estimated tax exceptions for farmers, gross income from farming is income from cultivating the soil or raising agricultural commodities. It includes the following amounts: (176)

Income from operating a stock, dairy, poultry, bee, fruit, or truck farm. Income from a plantation, ranch, nursery, range, orchard, or oyster bed. Crop shares for the use of the taxpayer’s land. Gains from sales of draft, breeding, dairy, or sporting livestock. Gross income from farming is the total of the following amounts from the taxpayer’s tax return. Gross farm income from Schedule F (Form 1040). Gross farm rental income from Form 4835. Gross farm income from Schedule E (Form 1040), Parts II and III. Gains from the sale of livestock used for draft, breeding, sport, or dairy purposes reported on Form 4797.

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Farm income does not include any of the following: (176)

Wages the taxpayer receives as a farm employee. Income the taxpayer receives from contract grain harvesting and hauling with workers and machines he or she

furnishes. Gains the taxpayer receives from the sale of farm land and depreciable farm equipment.

The following special estimated tax rules apply if the taxpayer was a qualified farmer for 2017: (176)

The taxpayer does not have to pay estimated tax if he or she files his or her 2017 Form 1040 and pays all the tax due by March 1, 2018.

The taxpayer does not have to pay estimated tax if he or she expects his or her 2017 income tax withholding (including any amount applied to 2017 estimated tax from the 2016 return) to be at least 66 ⅔% (.6667) of the total tax to be shown on the taxpayer’s 2017 tax return or 100% of the total tax shown on his or her 2016 income tax return.

If the taxpayer must pay estimated tax, he or she is required to make only one estimated tax payment (his or her required annual payment) by January 15, 2018, using special rules to figure the amount of the payment.

If the taxpayer does not pay all his or her required estimated tax for 2017 by January 15, 2018, or file his or her 2017 return and pay any tax due by March 1, 2018, the taxpayer should use Form 2210-F - Underpayment of Estimated Tax by Farmers and Fishermen, to determine if he or she owes a penalty.

Rental Real Estate If the taxpayer owns rental real estate, he or she should be aware of the Federal tax responsibilities. All rental income must be reported on the tax return, and in general the associated expenses can be deducted from rental income. If the taxpayer is a cash basis taxpayer, he or she should report rental income on the return for the year it was received, regardless of when it was earned. As a cash basis taxpayer, the taxpayer generally deducts rental expenses in the year paid. If the taxpayer uses an accrual method, he or she generally reports income when it is earned, rather than when received and the taxpayer deducts expenses when incurred, rather than when paid. Most individuals use the cash method of accounting. Below are some tips about tax reporting, recordkeeping requirements and information about deductions for rental property to help avoid mistakes. Rental Income The taxpayer generally must include in gross income all amounts received as rent. Rental income is any payment received for the use or occupation of property. The taxpayer must report rental income for all properties. In addition to amounts received as normal rent payments, there are other amounts that may be rental income and must be reported on the tax return: (178)

Advance rent is any amount received before the period that it covers. Include advance rent in rental income in the year received regardless of the period covered or the method of accounting used.

Security deposits used as a final payment of rent are considered advance rent. Include it in income when received. Do not include a security deposit in income when the taxpayer receives it if he or she plans to return it to the tenant at the end of the lease. But if the taxpayer keeps part or all of the security deposit during any year because the tenant does not live up to the terms of the lease, include the amount kept in income in that year.

Payment for canceling a lease occurs if the tenant pays the taxpayer to cancel a lease. The amount received is rent. Include the payment in income in the year received regardless of method of accounting.

Expenses paid by tenant occur if the tenant pays any of expenses. The taxpayer must include them in rental income. He or she can deduct the expenses if they are deductible rental expenses. For example, the tenant pays the water and sewage bill for the rental property and deducts it from the normal rent payment. Under the terms of the lease, the tenant does not have to pay this bill. Include the utility bill paid by the tenant and any amount received as a rent payment in rental income.

Property or services received, instead of money, as rent, must be included as the fair market value of the property or services in rental income. For example, the tenant is a painter and offers to paint the rental property instead of paying rent for two months. If the taxpayer accepts the offer, include in the rental income the amount the tenant would have paid for two months worth of rent.

Lease with option to buy occurs if the rental agreement gives the tenant the rights to buy the rental property. The payments received under the agreement are generally rental income.

Lesson 9 - Specialized Returns

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If the taxpayer owns a part interest in rental property, he or she must report his or her part of the rental income from the property. Income (or Loss), expenses and depreciation pertaining to Rental Real Estate or Royalties are usually reported on Part I, Schedule E – Supplemental Income and Loss, on Form 1040. Rental income is any payment the taxpayer receives for the use or occupation of property. The taxpayer generally must include in gross income all amounts he or she receives as rent. Deductions for Rental Property It the taxpayer receives rental income from the rental of a dwelling unit, there are certain rental expenses he or she may deduct on the tax return. These expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs. The taxpayer can also deduct the ordinary and necessary expenses for managing, conserving and maintaining the rental property. Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities and insurance. (178) Repairs The taxpayer can deduct the cost of repairs that he or she makes to a rental property. A repair keeps the property in good operating condition. It does not materially add to the value of the property or substantially prolong its life. Repairing property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of repairs. The taxpayer can also deduct the expenses paid by the tenant if they are deductible rental expenses. When the taxpayer includes the fair market value of the property or services in the rental income, he or she can deduct that same amount as a rental expense.

The taxpayer can deduct from gross rental income expenses for advertising, janitor and maid service, utilities, fire and liability insurance, taxes, interest, commissions for the collection of rent, ordinary and necessary travel and transportation and other expenses.

Improvements The taxpayer cannot deduct the cost of improvements. He or she recover the costs of improvements by taking depreciation, explained later. Separate the costs of repairs and improvements, and keep accurate records showing the cost of improvements. An improvement adds to the value of the property, prolongs its useful life, or adapts it to new uses. Putting a recreation room in an unfinished basement, paneling a den, adding a bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, putting in new cabinets, putting on a new roof, and paving a driveway are examples of improvements. These increases in value must be capitalized and depreciated. The taxpayer can recover some or all of improvements by using Form 4562 - Depreciation and Amortization to report depreciation beginning in the year the rental property is first placed in service, and beginning in any year he or she makes an improvement or add furnishings. These expenses must be depreciated over the useful life of the property. Only a percentage of these expenses are deductible in the year they are incurred. (178) Local Transportation Expenses The taxpayer may be able to deduct ordinary and necessary local transportation expenses if he or she incurs them to collect rental income or to manage, conserve, or maintain his or her rental property. Transportation expenses incurred to travel between the taxpayer’s home and a rental property generally constitute nondeductible commuting costs unless he or she uses the home as his or her principal place of business. Generally, if the taxpayer uses his or her personal car, pickup truck, or light van for rental activities, he or she can deduct the expenses using one of two methods: actual expenses or the standard mileage rate. For 2017, the standard mileage rate for business use is 53.5 cents per mile. Reporting Rental Income and Expenses If the taxpayer rents buildings, rooms or apartments, and provide only heat and light, and trash collection, he or she normally reports rental income and expenses on Form 1040, Schedule E - Supplemental Income and Loss, Part I. List total income, expenses, and depreciation for each rental property. If the rental expenses exceed rental income the taxpayer may report a loss up to $25,000 on the tax return, limited for adjusted gross incomes above $100,000. (178) Records Good records will help the taxpayer monitor the progress of the rental property, prepare financial statements, identify the

Lesson 9 - Specialized Returns

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source of receipts, keep track of deductible expenses, prepare tax returns and support items reported on tax returns. The taxpayer should keep adequate records to prove his or her expenses or have sufficient evidence that will support his or her own statement. The taxpayer must generally prepare a written record for it to be considered adequate. This is because written evidence is more reliable than oral evidence alone. However, if the taxpayer prepares a record on a computer, it is considered an adequate record. The taxpayer generally must have documentary evidence, such as receipts, canceled checks, or bills, to support his or her expenses. Documentary evidence ordinarily will be considered adequate if it shows the amount, date, place, and essential character of the expense. Keep track of any travel expenses incurred for rental property repairs. Separate receipts for minor repairs like plumbing, fixing a broken door or minor repainting from receipts for capital improvements like adding a new roof, remodeling a kitchen or installing insulation. The taxpayer must be able to substantiate certain elements of expenses to deduct them. He or she generally must have documentary evidence, such as receipts, canceled checks or bills, to support expenses. If the taxpayer is audited and cannot provide evidence to support items reported on the tax returns, he or she may be subject to additional taxes and penalties. For example, if the taxpayer cannot substantiate the rental real estate expenses of replacing the door locks, with appropriate records, the IRS may disallow that expense which may mean that the taxpayer incurs additional taxes and penalties. (178)

Lesson 9 - Specialized Returns

© 2018 Golden State Tax Training Institute, Inc. 9-50

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

Review Questions Answers appear in Review Feedback 1. William Hayes transfers property worth $35,000 and renders services valued at $3,000 to a corporation in exchange for

stock valued at $38,000. Right after the exchange, he owns 85% of the outstanding stock. What amount of ordinary income must William recognize for the exchange?

A. $0 B. $3,000 C. $35,000 D. $38,000

2. Wanda and Sylvester are members of an LLC. They agree that the LLC should be classified as a corporation but do

not want to elect to have the LLC treated as an S corporation. The LLC must file which form? A. Form 1120 - U.S. Corporation Income Tax Return B. Form 1120S - U.S. Income Tax Return for an S Corporation C. Form 2553 - Election by a Small Business Corporation D. Form 8832 - Entity Classification Election

3. Which of the following statements regarding the termination of an S corporation election is true?

A. The election may be revoked with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares

B. The election may be revoked by the board of directors of the corporation only if they are not shareholders C. The election terminates automatically if the corporation derives more than 25% of its gross receipts from

passive investment income during the year D. The election may be revoked by the Internal Revenue Service if there is a history of 10 years of operating

losses

4. An S corporation can be subject to which of the following taxes: A. Built-in gains tax B. Excess net passive income tax C. Both A and B D. None of the above

5. An S corporation will be subject to Excess Net Passive Income Tax:

A. Even if it has always been an S corporation B. It has passive investment income for the year that is at least 20% of gross receipts C. Both A and B D. None of the above

6. Frances Jones, a farmer who uses the cash method of accounting, was entitled to receive a $10,000 payment on a

grain contract in December 2017. She was told in December that her payment was available. She requested not to be paid until January 2018. In what year must Frances include this payment in her income?

A. 2016 B. 2017 C. 2018 D. 2019

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7. Jane, who is a farmer, uses a calendar tax year and an accrual method of accounting. She entered into a contract with ABC Farm Consulting in 2016. The contract stated that Jane pay ABC Farm Consulting $2,000 in December 2016. It further stipulates that ABC Farm Consulting will develop a plan for integrating her farm with a larger farm operation based in a neighboring state by March 1, 2017. Jane paid ABC Farm Consulting $2,000 in December 2016. Integration of operations according to the plan began in May 2017 and they completed the integration in December 2017. Jane incurs what amount of cost in 2017?

A. $0 B. $500 C. $1,000 D. $2,000

8. In 2015, Carmen bought 20 feeder calves for $11,000 for resale. She sold them in 2017 for $21,000. What amount of

profit will Carmen report her on 2017 Schedule F? A. $0 B. $10,000 C. $11,000 D. $21,000

9. During 2017, Sean, a cash method taxpayer, bought fertilizer ($4,000), feed ($1,000), and seed ($500) for use on his

farm in the following year. Sean’s total prepaid farm supplies expense for 2017 is $5,500. His other deductible farm expenses totaled $10,000 for 2017. Therefore, Sean’s deduction for prepaid farm supplies cannot be more than what amount for 2017?

A. $0 B. $5,000 C. $5,500 D. $10,000

Lesson 9 - Specialized Returns

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Review Feedback Return to Review Questions Question 1 - B. $3,000 If the taxpayer transfers property (or money and property) to a corporation in exchange for stock in that corporation (other than nonqualified preferred stock), and immediately afterward he or she is in control of the corporation, the exchange is usually not taxable. This rule applies both to individuals and to groups who transfer property to a corporation. The term property does not include services rendered or to be rendered to the issuing corporation. The value of stock received for services is income to the recipient. In William’s case, no gain is recognized on the exchange of property. However, he recognizes ordinary income of $3,000 as payment for services he rendered to the corporation. Question 2 - D. Form 8832 - Entity Classification Election An LLC with either a single member or more than one member can elect to be classified as a corporation rather than be classified as a partnership or disregarded entity under the default rules. The taxpayer should file Form 8832 - Entity Classification Election, to elect classification as a C corporation. Question 3 - A. The election may be revoked with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares An election terminates automatically in any of the following cases:

1. The corporation is no longer a small business corporation as defined in section 1361(b). This kind of termination of an election is effective as of the day the corporation no longer meets the definition of a small business corporation. Attach to Form 1120S for the final year of the S corporation a statement notifying the IRS of the termination and the date it occurred.

2. The corporation, for each of three consecutive tax years, (a) has accumulated earnings and profits and (b) derives more than 25% of its gross receipts from passive investment income as defined in section 1362(d)(3)(C). The election terminates on the first day of the first tax year beginning after the third consecutive tax year. The corporation must pay a tax for each year it has excess net passive income. See the line 22a instructions for details on how to figure the tax.

3. The election is revoked. An election can be revoked only with the consent of shareholders who, at the time the revocation is made, hold more than 50% of the number of issued and outstanding shares of stock (including non-voting stock). The revocation can specify an effective revocation date that is on or after the day the revocation is filed. If no date is specified, the revocation is effective at the start of the tax year if the revocation is made on or before the 15th day of the 3rd month of that tax year. If no date is specified and the revocation is made after the 15th day of the 3rd month of the tax year, the revocation is effective at the start of the next tax year.

Question 4 - C. Both A and B Section 1374 provides for a tax on built-in gains. The built-in gains tax may apply to an S corporation that was a C corporation before it elected to be an S corporation or that acquired an asset with a basis determined (in whole or in part) by reference to its basis (or the basis of any other property) in the hands of a C corporation (a transferred-basis acquisition). Also, S corporations that have previously been a C corporation and have accumulated earnings and profits at the end of the tax year will be assessed a passive income tax if passive investment income for the year exceeds 25% of gross receipts for the year. The tax is assessed at the maximum corporate tax rate of 35%. Recognized built-in gains and losses are not taken into account in determining the amount of passive investment income. Question 5 - D. None of the above S corporations that have previously been a C corporation and have accumulated earnings and profits at the end of the tax year will be assessed a passive income tax if passive investment income for the year exceeds 25% of gross receipts for the year. Question 6 - B. 2017 The taxpayer cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. He or she must report the income in the year the money or property is received or made available to him or her without restriction. Frances must still include this payment in her 2017 income because it was made available to her in 2017.

Lesson 9 - Specialized Returns

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Question 7 - D. $2,000 Generally, the taxpayer cannot deduct or capitalize a business expense until economic performance occurs. If his or her expense is for property or services provided to him or her, or for his or her use of property, economic performance occurs as the property or services are provided or as the property is used. If the taxpayer’s expense is for property or services he or she provides to others, economic performance occurs as he or she provides the property or services. Economic performance for Jane's liability in the contract occurs as the services are provided. Jane incurs the $2,000 cost in 2017. Question 8 - B. $10,000 Amounts received from the sales of products the taxpayer raised on his or her farm for sale (or bought for resale), such as livestock, produce, or grains, are reported on Schedule F - Profit or Loss From Farming. This includes money and the fair market value of any property or services he or she receives. When the taxpayer sells farm products bought for resale, his or her profit or loss is the difference between the selling price (money plus the fair market value of any property) and the basis in the item (usually the cost). The taxpayer generally reports these amounts on Schedule F for the year he or she receives payment. In Carmen’s case, she reports the $21,000 sales price on Schedule F, line 1b, subtracts the $11,000 basis on line 1d, and reports the resulting $10,000 profit on line 1e. Question 9 - B. $5,000 If the taxpayer uses the cash method of accounting to report his or her income and expenses, his or her deduction for prepaid farm supplies in the year the taxpayer pays for them may be limited to 50% of his or her other deductible farm expenses for the year. Therefore, Sean’s deduction for prepaid farm supplies cannot be more than $5,000 (50% of $10,000) for 2017. The excess prepaid farm supplies expense of $500 ($5,500 − $5,000) is deductible in a later tax year when he uses or consumes the supplies.

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

Basis of Property Methods of Depreciation Section 179 Election

If property acquired for business is expected to last more than one year, generally a taxpayer cannot deduct the entire cost as a business expense in the year the item was acquired. The cost must be spread over more than one tax year and part of the cost should be deducted each year on Schedule C. This method of deducting the cost of business property is called depreciation. (179) Most types of tangible property (except, land), such as buildings, machinery, vehicles, furniture, and equipment are depreciable. Likewise, certain intangible property, such as patents, copyrights, and computer software is depreciable. In order for a taxpayer to be allowed a depreciation deduction for a property, the property must meet all the following requirements: (180)

The taxpayer must own the property. Taxpayers may also depreciate any capital improvements for property the taxpayer leases. A taxpayer is considered as owning property even if it is subject to a debt.

A taxpayer must use the property in business or in an income-producing activity. If a taxpayer uses a property for business and for personal purposes, the taxpayer can only deduct depreciation based only on the business use of that property.

The property must have a determinable useful life of more than one year.

A taxpayer can depreciate leased property only if he or she retains the incidents of ownership in the property. This means the taxpayer bears the burden of exhaustion of the capital investment in the property. Therefore, if he or she leases property from someone to use in his or her trade or business or for the production of income,

the taxpayer generally cannot depreciate its cost because he or she does not retain the incidents of ownership. As mentioned above, the taxpayer can depreciate any capital improvements he or she makes to the property. Even if a taxpayer meets the preceding requirements for a property, a taxpayer cannot depreciate the following property: (180)

Property placed in service and disposed of in same year. Equipment used to build capital improvements. A taxpayer must add otherwise allowable depreciation on the

equipment during the period of construction to the basis of the improvements. Certain term interests.

Depreciation begins when a taxpayer places property in service for use in a trade or business or for the production of income. The property ceases to be depreciable when the taxpayer has fully recovered the property’s cost or other basis or when the taxpayer retires it from service, whichever happens first.

A taxpayer cannot depreciate the cost of land because land does not wear out, become obsolete, or get used up. The cost of land generally includes the cost of clearing, grading, planting, and landscaping. Although the taxpayer cannot depreciate land, he or she can depreciate certain land preparation costs, such as landscaping

costs, incurred in preparing land for business use. These costs must be so closely associated with other depreciable property that the taxpayer can determine a life for them along with the life of the associated property. (181) If the taxpayer is a tenant-stockholder in a cooperative housing corporation and uses his or her cooperative apartment in his or her business or for the production of income, he or she can depreciate his or her stock in the corporation, even though the corporation owns the apartment.

Lesson 10 - Depreciation

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The taxpayer figures his or her depreciation deduction as follows: (182)

1. Figure the depreciation for all the depreciable real property owned by the corporation in which the taxpayer has a proprietary lease or right of tenancy. If he or she bought his or her cooperative stock after its first offering, figure the depreciable basis of this property as follows:

a. Multiply the taxpayer’s cost per share by the total number of outstanding shares, including any shares held by the corporation.

b. Add to the amount figured in (a) any mortgage debt on the property on the date he or she bought the stock.

c. Subtract from the amount figured in (b) any mortgage debt that is not for the depreciable real property, such as the part for the land.

2. Subtract from the amount figured in (1) any depreciation for space owned by the corporation that can be rented but cannot be lived in by tenant-stockholders.

3. Divide the number of the taxpayer’s shares of stock by the total number of outstanding shares, including any shares held by the corporation.

4. Multiply the result of (2) by the percentage the taxpayer figured in (3). This is his or her depreciation on the stock. The taxpayer’s depreciation deduction for the year cannot be more than the part of his or her adjusted basis in the stock of the corporation that is allocable to his or her business or income-producing property. The taxpayer must also reduce his or her depreciation deduction if only a portion of the property is used in a business or for the production of income. Basis of Property Basis is generally the amount of a taxpayer’s capital investment in a property for tax purposes. Use the basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange or other disposition of the property. (183) In most situations, the basis of an asset the taxpayer purchases is its cost. The cost is the amount he or she pays for it in cash, debt obligations, and other property or services. Cost includes sales tax and other expenses connected with the purchase. The basis in some assets is not determined by cost (such as a gift or an inheritance). If the taxpayer acquired the property from an individual who died in 2010, special rules may apply to the calculation of basis. For more information, refer to Publication 551 - Basis of Assets. (183) Cost Basis The basis of property a taxpayer buys is usually its cost. The cost is the amount paid in cash, debt obligations, other property, or services. The cost also includes amounts the taxpayer pays for the following items: (184)

Sales tax. Freight. Installation and testing. Excise taxes. Legal and accounting fees (when they must be capitalized). Revenue stamps. Recording fees. Real estate taxes (if assumed for the seller).

The taxpayer may also have to capitalize (add to basis) certain other costs related to buying or producing property. The basis of stocks or bonds a taxpayer buys is generally the purchase price plus any costs of purchase, such as commissions and recording or transfer fees. If the taxpayer receives stocks or bonds other than by purchase, the basis is usually determined by the fair market value (FMV) or the previous owner's adjusted basis of the stock. The taxpayer must adjust the basis of stocks for certain events that occur after purchase. See Stocks and Bonds in Publication 550 - Investment Income and Expenses for more information on the basis of stock. (184) Real property, also called real estate, is land and generally anything built on or attached to it. If the taxpayer buys real property, certain fees and other expenses become part of the cost basis in the property. The basis includes the settlement fees and closing costs for buying property. The taxpayer cannot include in the basis the fees and costs for getting a loan on property. A fee for buying property is a cost that must be paid even if the taxpayer bought the property for cash.

Lesson 10 - Depreciation

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The following items are some of the settlement fees or closing costs the taxpayer can include in the basis of the property:

Abstract fees (abstract of title fees). Charges for installing utility services. Legal fees (including title search and preparation of the sales contract and deed). Recording fees. Surveys. Transfer taxes. Owner's title insurance. Any amounts the seller owes that the taxpayer agrees to pay, such as back taxes or interest, recording or

mortgage fees, charges for improvements or repairs, and sales commissions. Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance. The following items are some settlement fees and closing costs the taxpayer cannot include in the basis of the property:

1. Casualty insurance premiums. 2. Rent for occupancy of the property before closing. 3. Charges for utilities or other services related to occupancy of the property before closing. 4. Charges connected with getting a loan. The following are examples of these charges:

a. Points (discount points, loan origination fees). b. Mortgage insurance premiums. c. Loan assumption fees. d. Cost of a credit report. e. Fees for an appraisal required by a lender.

5. Fees for refinancing a mortgage. If these costs relate to business property, items (1) through (3) are deductible as business expenses. Items (4) and (5) must be capitalized as costs of getting a loan and can be deducted over the period of the loan. If the taxpayer pays points to obtain a loan (including a mortgage, second mortgage, line of credit, or a home equity loan), do not add the points to the basis of the related property. Generally, he or she deducts the points over the term of the loan. If the taxpayer buys property and assumes (or buys subject to) an existing mortgage on the property, his or her basis includes the amount he or she pays for the property plus the amount to be paid on the mortgage. Basis of Inherited Property The basis in property a taxpayer inherited from a decedent is generally one of the following: (184)

The FMV of the property at the date of the individual's death. The FMV on the alternate valuation date if the personal representative for the estate chooses to use alternate

valuation. For information on the alternate valuation date, see the Instructions for Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return.

The value under the special-use valuation method for real property used in farming or a closely held business if chosen for estate tax purposes.

The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a qualified conservation easement. For information on a qualified conservation easement, see the Instructions for Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return.

If a Federal estate tax return does not have to be filed, the basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes.

The above rule does not apply to an appreciated property the taxpayer receives from a decedent if the taxpayer or his or her spouse originally gave the property to the decedent within one year before the decedent's death. The basis in this property is the same as the decedent's adjusted basis in the property immediately before his or her death, rather than the Fair Market Value (FMV). Appreciated property is any property whose FMV on the day it was given to the decedent is more than its adjusted basis. (184)

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In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), husbands and wives are each usually considered to own half the community property. When either spouse dies, the total value of the community property, even the part belonging to the surviving spouse, generally becomes the basis of the entire property. For this rule to apply, at least half the value of the community property interest must be includable in the decedent's gross estate, whether or not the estate must file a return. (184) Special Basis for Property Inherited During 2010 (after Dec. 31, 2009, and before Jan. 1, 2011) Under the Special Basis for Property Inherited During 2010, the starting point for basis is the lesser of the asset’s fair market value on the date of death or the decedent’s basis. The executor can allocate General Basis and/or Spousal Property Basis Increase to eligible property but not in excess of the amount needed to increase the decedent's adjusted basis to the property's Fair Market Value (FMV) as of the date of the decedent's death. The result is that, for each property, the sum of the decedent’s adjusted basis in that property and the Basis Increase allocated to that property cannot exceed the FMV of that property on the decedent’s date of death. (185) Aggregate Basis Increase is $1,300,000. However, for a decedent who was neither a resident nor citizen of the United States, the Aggregate Basis Increase is $60,000. Spousal Property Basis Increase is $3,000,000. Generally, the executor can allocate Spousal Property Basis Increase only to qualified spousal property that was both acquired from and owned by the decedent. Qualified spousal property means: (185)

Outright transfer property. Qualified terminable interest property.

Basis of Property Received as a Gift To figure the basis of property a taxpayer receives as a gift, it is necessary to have:

Adjusted basis to the donor just before it was given to the taxpayer. The Fair Market Value (FMV) at the time it was given to the taxpayer. Any gift tax paid on the property.

If the FMV of the property at the time of the gift is less than the donor's adjusted basis, the basis depends on whether the taxpayer has a gain or a loss when he or she disposes of the property. The basis for figuring gain is the same as the donor's adjusted basis plus or minus any required adjustment to basis while holding the property. The basis for figuring loss is its FMV when the taxpayer received the gift plus or minus any required adjustment to basis while holding the property. Methods of Depreciation There are three systems involved in the computation of depreciation. The depreciation system that applies to a particular piece of property is determined by the type of property and when the property was placed in service. For tangible property use:

MACRS (Modified Accelerated Cost Recovery System) if placed in service after December 31, 1986. ACRS (Accelerated Cost Recovery System) if placed in service after December 31, 1980, but before January 1,

1987. Straight line or an accelerated method of depreciation, such as the declining balance method, if placed in service

before January 1, 1981.

Tangible property is any property that the taxpayer can see and touch. This includes automobiles, buildings, and equipment. The total of all the yearly depreciation deductions cannot be more than the cost or other basis of the property.

Recovery Periods Under MACRS, most property used in business (income-producing) activities that is placed in service during the current tax year would fall into one of the following nine property classifications under GDS:

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3-year property - o Tractor units for over-the-road use. o Any race horse over 2 years old when placed in service. (All race horses placed in service after December

31, 2008, and before January 1, 2017, are deemed to be 3-year property, regardless of age). o Any other horse (other than a race horse) over 12 years old when placed in service. o Qualified rent-to-own property.

5-year property - o Automobiles, taxis, buses, and trucks. o Computers and peripheral equipment. o Office machinery (such as typewriters, calculators, and copiers). o Any property used in research and experimentation. o Breeding cattle and dairy cattle. o Appliances, carpets, furniture, etc., used in a residential rental real estate activity. o Certain geothermal, solar, and wind energy property.

7-year property - o Office furniture and fixtures (such as desks, files, and safes). o Agricultural machinery and equipment. o Any property that does not have a class life and has not been designated by law as being in any other class. o Certain motorsports entertainment complex property placed in service before January 1, 2017. o Any natural gas gathering line placed in service after April 11, 2005.

10-year property - o Vessels, barges, tugs, and similar water transportation equipment. o Any single purpose agricultural or horticultural structure. o Any tree or vine bearing fruits or nuts. o Qualified small electric meter and qualified smart electric grid system placed in service on or after October 3,

2008. 15-year property -

o Certain improvements made directly to land or added to it (such as shrubbery, fences, roads, sidewalks, and bridges).

o Any retail motor fuels outlet, such as a convenience store. o Any municipal wastewater treatment plant. o Any qualified leasehold improvement property. o Any qualified restaurant property. o Initial clearing and grading land improvements for gas utility property. o Electric transmission property (that is Section 1245 property) used in the transmission at 69 or more kilovolts

of electricity placed in service after April 11, 2005. o Any natural gas distribution line placed in service after April 11, 2005 and before January 1, 2011. o Any qualified retail improvement property.

20-year property - o Farm buildings (other than single purpose agricultural or horticultural structures). o Municipal sewers not classified as 25-year property. o Initial clearing and grading land improvements for electric utility transmission and distribution plants.

25-year property - o This class is water utility property, which is either of the following: o Property that is an integral part of the gathering, treatment, or commercial distribution of water, and that,

without regard to this provision, would be 20-year property. o Municipal sewers other than property placed in service under a binding contract in effect at all times since

June 9, 1996. 27.5-Year Residential Rental Property - Residential rental property includes any building or structure, such as

a rental home (including a mobile home), if 80% or more of its gross rental income for the tax year is from dwelling units. A dwelling unit is a house or apartment used to provide living accommodations in a building or structure. It does not include a unit in a hotel, motel, or other establishment where more than half the units are used on a transient basis. If the taxpayer occupies any part of the building or structure for personal use, its gross rental income includes the fair rental value of the part occupied.

Nonresidential Real Property - This is Section 1250 property, such as an office building, store, or warehouse that is neither residential rental property nor property with a class life of less than 27.5 years. The cost of nonresidential real property generally placed in service after May 12, 1993, is recovered over 39 years.

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The accelerated depreciation of property on an Indian reservation will not apply to property placed in service after December 31, 2016, or, if the taxpayer makes an irrevocable election out of all property in a class of property that is placed in service in a tax year beginning after December 31, 2015.

Qualified Rent-to-Own Property Qualified rent-to-own property is property held by a rent-to-own dealer for purposes of being subject to a rent-to-own contract. It is tangible personal property generally used in the home for personal use. It includes computers and peripheral equipment, televisions, videocassette recorders, stereos, camcorders, appliances, furniture, washing machines and dryers, refrigerators, and other similar consumer durable property. Consumer durable property does not include real property, aircraft, boats, motor vehicles, or trailers.

Depreciation Systems

Use of either the General Depreciation System (GDS) or the Alternative Depreciation System (ADS) to depreciate property under MACRS determines what depreciation method and recovery period is used. Generally, the taxpayer must use GDS unless specifically required by law to use ADS or if he or she elects to use ADS. The General Depreciation System (GDS) is the most commonly used MACRS system as this method provides for greater deduction during the early years of a property’s life.

MACRS provides three depreciation methods under GDS: (181)

The regular MACRS 200% declining balance method over a GDS recovery period (listed above). The 150% declining balance method over a GDS recovery period. The straight line method over a GDS recovery period.

Instead of using the 200% declining balance method over the GDS recovery period for nonfarm property in the 3, 5, 7 and 10-year property classes, the taxpayer can elect to use the 150% declining balance method. Make the election by entering “150 DB” under column (f) in Part III of Form 4562 - Depreciation and Amortization. (181) Instead of using either the 200% or 150% declining balance methods over the GDS recovery period, the taxpayer can elect to use the straight line method over the GDS recovery period. Make the election by entering “S/L” under column (f) in Part III of Form 4562. Under GDS, property that is not qualified Indian reservation property is depreciated over one of the following recovery periods: (181) Property Class Recovery Period 3-year property 3 years 5-year property 5 years 7-year property 7 years 10-year property 10 years 15-year property 15 years 20-year property 20 years 25-year property 25 years Residential rental property 27.5 years Nonresidential real property 39 years

Table 10-1 – IRS Publication 946 - Recovery Periods Under GDS (2017)

The taxpayer can elect to use the Alternative Depreciation System (ADS) even though his or her property may come under GDS. ADS uses the straight line method of depreciation over fixed ADS recovery periods. Make the election by completing line 20 in Part III of Form 4562. The following table shows some of the ADS recovery periods:

Property ADS Recovery Period

Rent-to-own property 4 years Automobiles and light duty trucks 5 years

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Computers and peripheral equipment 5 years High technology telephone station equipment installed on customer premises 5 years High technology medical equipment 5 years Personal property with no class life 12 years Natural gas gathering lines 14 years Single purpose agricultural and horticultural structures 15 years Any tree or vine bearing fruit or nuts 20 years Initial clearing and grading land improvements for gas utility property 20 years Initial clearing and grading land improvements for electric utility transmission and distribution plants 25 years

Electric transmission property used in the transmission at 69 or more kilovolts of electricity 30 years Natural gas distribution lines 35 years Any qualified leasehold improvement property 39 years Any qualified restaurant property 39 years Nonresidential real property 40 years Residential rental property 40 years Railroad grading and tunnel bore 50 years

Table 10-2 – Publication 946 - Recovery Periods Under ADS (2017)

The recovery periods for most property generally are longer under ADS than they are under GDS. The following table shows some of the ADS recovery periods in relation to class life and GDS recovery periods.

Property Class Life (In years)

GDS Recovery Period

(in years)

ADS Recovery Period

(In years) Automobiles and taxis 3 5 5 Light general-purpose trucks 4 5 5 Information systems including computers and peripheral equipment 6 5 5

Data Handling Equipment; except computers 6 5 6 Heavy general-purpose Trucks 6 5 6 Buses 9 5 9 Office Furniture, Fixtures and Equipment 10 7 10 Vessels, Barges Tugs and Similar Water Transportation Equipment, except those used in marine construction

18 10 18

Airplanes (airframes and engines) except those used in commercial or contract carrying of passengers of freight, and all Helicopters

6 5 6

Tractor Units for Use Over-the-road 4 3 4 Trailers and Trailer-mounted Containers 6 5 6 Land Improvements 20 15 20 Industrial Steam and Electric Generation and/or Distribution Systems 22 15 22

Table 10-3 - Publication 946 -Table B-1. Table of Class Lives and Recovery Periods (2017)

A taxpayer must use ADS for the following property:

Listed property used 50% or less in a qualified business. Any tangible property used predominantly outside the United States during the year. Any tax-exempt use property.

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Any tax-exempt bond-financed property. All property used predominantly in a farming business and placed in service in any tax year during which an

election not to apply the uniform capitalization rules to certain farming costs is in effect. Any property imported from a foreign country for which an Executive Order is in effect because the country

maintains trade restrictions or engages in other discriminatory acts. If the taxpayer elects to use a different method for one item in a property class, he or she must apply the same method to all property in that class placed in service during the year of the election. However, the taxpayer can make the election on a property-by-property basis for nonresidential real and residential rental property. Depreciation Conventions Under MACRS, averaging conventions establish when the recovery period begins and ends. The convention a taxpayer uses determines the number of months for which he or she can claim depreciation in the year the property was placed in service and in the year the property is disposed. Use the mid-month convention for nonresidential real property, residential rental property, and any railroad grading or tunnel bore. (181) Use the mid-quarter convention if the mid-month convention does not apply and the total depreciable bases of MACRS property placed in service during the last 3 months of the tax year (excluding nonresidential real property, residential rental property, any railroad grading or tunnel bore, property placed in service and disposed of in the same year, and property that is being depreciated under a method other than MACRS) are more than 40% of the total depreciable bases of all MACRS property the taxpayer placed in service during the entire year. (181) Use the half-year convention if neither the mid-quarter convention nor the mid-month convention applies. Under this convention, the taxpayer treats all property placed in service or disposed of during a tax year as placed in service or disposed of at the midpoint of the year. This means that a one-half year of depreciation is allowed for the year the property is placed in service or disposed. (181) Rental Property A taxpayer can depreciate rental property if it meets all the following requirements. (74)

1. The taxpayer owns the property. 2. The property is used in a business or income-producing activity (such as rental property). 3. The property has a determinable useful life. 4. The property is expected to last more than one year.

Three factors determine how much depreciation a taxpayer can deduct each year: (74)

1. Basis in the property. 2. The recovery period for the property. 3. The depreciation method used.

A taxpayer cannot simply deduct the mortgage or principal payments, or the cost of furniture, fixtures and equipment, as an expense. The basis of property is usually its cost. The cost is the amount paid for the property in cash, in debt obligation, in other property, or in services. The cost also includes: (74)

Sales tax charged on the purchase. Freight charges to obtain the property. Installation and testing charges.

The taxpayer begins to depreciate his or her rental property when he or she places it in service for the production of income. The taxpayer stops depreciating it either when he or she has fully recovered his or her cost or other basis, or when he or she retires it from service, whichever happens first. The taxpayer places property in service in a rental activity when it is ready and available for a specific use in that activity. Even if he or she is not using the property, it is in service when it is ready and available for its specific use.

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If the taxpayer places property in service in a personal activity, he or she cannot claim depreciation. However, if he or she changes the property's use to business or the production of income, he or she can begin to depreciate it at the time of the change. The taxpayer places the property in service for business or income-producing use on the date of the change. Under MACRS, property that a taxpayer placed in service during 2017 for rental activities generally falls into one of the following classes: (74)

5-year property - This class includes computers and peripheral equipment, office machinery (typewriters, calculators, copiers, etc.), automobiles, and light trucks. This class also includes appliances, carpeting, furniture, etc., used in a residential rental real estate activity. Depreciation on automobiles, other property used for transportation, computers and related peripheral equipment, and property of a type generally used for entertainment, recreation, or amusement is limited.

7-year property - This class includes office furniture and equipment (desks, file cabinets, etc.). This class also includes any property that does not have a class life and that has not been designated by law as being in any other class.

15-year property - This class includes roads, fences, and shrubbery (if depreciable). Residential rental property - This class includes any real property that is a rental building or structure (including

a mobile home) for which 80% or more of the gross rental income for the tax year is from dwelling units. It does not include a unit in a hotel, motel, inn, or other establishment where more than half of the units are used on a transient basis. If the taxpayer lives in any part of the building or structure, the gross rental income includes the fair rental value of the part he or she lives in.

The recovery period of property is the number of years over which the taxpayer recovers its cost or other basis. The recovery periods are generally longer under ADS than GDS. The recovery period of property depends on its property class. Under GDS, the recovery period of an asset is generally the same as its property class. The following table contains some of the MACRS recovery periods for property used in rental activities.

Type of Property General Depreciation System

Alternative Depreciation System

Computers and their peripheral equipment 5 years 5 years Office machinery, such as typewriters, calculators, copiers 5 years 6 years Automobiles 5 years 5 years Light trucks 5 years 5 years Appliances, such as stoves, refrigerators 5 years 9 years Carpets 5 years 9 years Furniture used in rental property 5 years 9 years Office furniture and equipment, such as desks, files 7 years 10 years

Any property that does not have a class life and that has not been designated by law as being in any other class 7 years 12 years

Roads 15 years 20 years Shrubbery 15 years 20 years Fences 15 years 20 years

Residential rental property (buildings or structures) and structural components such as furnaces, water pipes, venting, etc.

27.5 years 40 years

Table 10-4 – IRS Publication 527 - Table 2-1 - MACRS Recovery Periods for Property Used in Rental Activities (2017)

For rental properties, MACRS consists of two systems that determine how a taxpayer depreciates property; the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). The taxpayer must use GDS unless he or she is specifically required by law to use ADS or he or she elects to use ADS.

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Figuring MACRS Depreciation The following information is necessary to calculate the depreciation using MACRS:

Depreciation System: o ADS or GDS o Property class o Recovery period

Date placed in service Basis amount Depreciation convention Depreciation method (200 DB, 150 DB, S/L)

The taxpayer can figure his or her MACRS depreciation in one of two ways:

Actually compute the deduction using the applicable depreciation method and convention over the recovery period.

Use the percentage from the optional MACRS tables. The deduction is the same under both methods.

Section 179 Election When it comes to tax planning, there's an old adage that says, "When in doubt, accelerate deductions and postpone income”. This concept is based on the time value of money. When it comes to depreciating property, following this adage can be difficult. Remember, as a general rule, business assets are depreciated over a specified period of years. There is one major exception under the Code. It is the so-called Section 179 Election. Under Section 179 of the Internal Revenue Code, a taxpayer might be able to treat all or part of the cost of certain qualifying property as an expense in the year that the property was acquired. This means that instead of treating a depreciable asset as a capital expenditure, where he or she can only recover the cost of the asset through the general depreciation system, the taxpayer might be able to take an immediate current year's deduction for all or part of the cost of the asset. In common tax jargon, we say that he might be able to expense the asset instead of capitalizing and depreciating the asset. When Can the Section 179 Election Be Made? We say that this is an election. By that we mean that the taxpayer has to make a decision during the first year that the asset is placed in service as to whether he wants a current year's deduction, or instead wants to depreciate it over a period of years. An asset placed in service under Section 179 means that the decision must be made in the first year that the asset is placed in a condition or state of readiness and availability for a specifically assigned function. Be careful with this concept. For example, let us say that the taxpayer bought a car last year and used it entirely for personal purposes. This year, he or she starts using the car for legitimate business use. Can the taxpayer take a Section 179 deduction for the car this year? No, they cannot. Any Section 179 expense that would have been allowed is only allowed during the first year that the asset was placed in service which, in our example, was last year. However, because the property was not used in a trade or business, or held for production of income last year, the taxpayer could not take the deduction during last year. Although this year may be the first year that the car was placed in business use, that does not matter. Any deduction now available has to be taken through the general depreciation system (GDS). What Property Can Be Expensed?

Not only is a Section 179 expense deduction available only in the first year that the property is placed in service, it is only available for qualifying property. The asset must be used more than 50% of the time for business in the first year it is placed in service and must have a useful life of more than one year. Property that may be written off in the tax year of purchase, rather than depreciated over the asset's useful life, includes: (186)

Tangible personal property (except heating or air-conditioning units) including: o Machinery and equipment.

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o Property contained in or attached to a building (other than structural components), such as refrigerators, grocery store counters, office equipment, printing presses, testing equipment, and signs.

o Gasoline storage tanks and pumps at retail service stations. o Livestock, including horses, cattle, hogs, sheep, goats, and mink and other furbearing animals.

Other tangible property (except most buildings and their structural components) that: o Is used as an integral part of manufacturing, production, or extraction, or of providing transportation,

communications, electricity, gas, water, or sewage disposal services. o Is a research facility used in connection with any of the activities listed above. o Is a facility used in connection with any of the activities referred to above for the bulk storage of

interchangeable commodities such as grain. Elevators and escalators built or bought new. Single purpose livestock or horticultural structures. Storage facilities, again excluding buildings and their structural components, that are used in connection with the

distribution of petroleum or any primary product of petroleum. Off-the-shelf computer software. Qualified real property.

Although some of this may seem technical, it is not really very difficult to understand. The vast majority of all tangible personal property can be expensed if it is used in the taxpayer's trade or business in the first year that the property was acquired. This would include, for example, machinery, equipment, and even most livestock. However, some types of property are specifically excluded, and therefore cannot be expensed under Section 179. Some examples of non-qualifying property are:

Buildings and structural components. Certain property used primarily outside the United States. Property used for lodging, including property used to operate an apartment building such as furniture, office

equipment and laundry facilities. However, this does not include property used by hotels, motels and the like that serve transient guests, or facilities used in commercial facilities such as a restaurant serving the public.

Property acquired from a related taxpayer which would result in a non-recognition of loss. To qualify for the Section 179 deduction, the taxpayer’s property must have been acquired for use in a trade or business. Property the taxpayer acquires only for the production of income, such as investment property, rental property (if renting property is not his or her trade or business), and property that produces royalties, does not qualify. When the taxpayer uses property for both business and nonbusiness purposes, he or she can elect the Section 179 deduction only if he or she uses the property more than 50% for business in the year he or she places it in service. If the taxpayer uses the property more than 50% for business, multiply the cost of the property by the percentage of business use. Use the resulting business cost to figure the Section 179 deduction. To qualify for the Section 179 deduction, the taxpayer’s property must have been acquired by purchase. For example, property acquired by gift or inheritance does not qualify. Property is not considered acquired by purchase in the following situations:

1. It is acquired by one component member of a controlled group from another component member of the same group.

2. Its basis is determined either: a. In whole or in part by its adjusted basis in the hands of the person from whom it was acquired. b. Under the stepped-up basis rules for property acquired from a decedent.

3. It is acquired from a related person. For this purpose, related persons consist of the taxpayer and a member of his or her family, including only a spouse, child, parent, brother, sister, half-brother, half-sister, ancestor, and lineal descendant. How Much Can the Taxpayer Deduct? The taxpayer’s Section 179 deduction is generally the cost of the qualifying property. However, the total amount he or she can elect to deduct under Section 179 is subject to a dollar limit and a business income limit. These limits apply to each taxpayer,

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not to each business. For a passenger automobile, the total Section 179 deduction and depreciation deduction are limited. If the taxpayer deducts only part of the cost of qualifying property as a Section 179 deduction, he or she can generally depreciate the cost he or she does not deduct.

If the taxpayer buys qualifying property with cash and a trade-in, its cost for purposes of the section 179 deduction includes only the cash he or she paid.

Section 179 Dollar Limitations The maximum amount the taxpayer can elect to deduct for most Section 179 property he or she placed in service in tax years beginning in 2017 is $510,000. This limit is reduced by the amount by which the cost of Section 179 property placed in service during the tax year exceeds $2,030,000. (187)

With the passage and signing into law of the Tax Cuts and Jobs Act, the deduction limit for Section 179 increases from $500,000 to $1,000,000 for 2018 and beyond. The limit on equipment purchases likewise has increased, from $2,000,0000 to $2,500,000. In addition, the deduction now includes any of the following improvements to existing nonresidential property (i.e., the improvement must be placed in service after the date the property itself

was first placed in service): roofs; heating, air-conditioning, and ventilation systems; fire protection, alarm, and security systems. Further, the bonus depreciation increases from 50% to 100%. This part is retroactive to September 27, 2017, and is good through 2022. The bonus depreciation also now includes used equipment. The total cost that can be deducted under Section 179 is also limited to the taxable income earned from the taxpayer's trade or business during the year. Taxable income (including salaries and wages paid to the taxpayer(s) from the business and reported as W-2 income) is figured without regard to any available Section 179 expense deduction. However, the amount of any disallowed deduction in this tax year can be carried over to next tax year and be added to the amount of qualified Section 179 property placed in service in that next tax year. To elect the Section 179 Deduction a taxpayer needs to fill out Part One of IRS Form 4562 - Depreciation and Amortization. For passenger vehicles, trucks, and vans (not meeting the guidelines below), that are used more than 50% in a qualified business use, the total deduction for depreciation including both the Section 179 expense deduction as well as Bonus Depreciation is limited to $11,160 for passenger cars and $11,560 for trucks and vans during 2017. For automobiles placed in service during 2017 but not eligible for bonus depreciation, the deduction limit is $3,160 for passenger cars and $3,560 for trucks and vans. The guidance will be published in the Internal Revenue Bulletin sometime after mid-year). For later years, the taxpayer must compute his or her depreciation on the car or truck using the usual methods. As long as the taxpayer continues to use the car more than 50% for business, he or she would multiply the business percentage of the car's cost by the percentage shown in the normal MACRS table for five-year property. Exceptions include the following vehicles:

Taxis, transport vans, and other vehicles used to specifically transport people or property for hire. Ambulance or hearse used specifically in a taxpayer’s business. Qualified non-personal use vehicles specifically modified for business (i.e. van without seating behind driver,

permanent shelving installed, and exterior painted with company’s name).

Certain vehicles (with a gross vehicle weight rating above 6,000lbs but no more than 14,000lbs) qualify for expensing up to $25,000 if the vehicle is financed and placed in service prior to December 31 and meets other conditions. Many vehicles that by their nature are not likely to be used for personal purposes qualify for full Section 179 deduction including the following vehicles:

1. Heavy non-SUV vehicles with a cargo area at least six feet in interior length (this area must not be easily accessible from the passenger area.).

2. Vehicles that can seat nine-plus passengers behind the driver's seat (i.e.: Hotel / Airport shuttle vans, etc.). 3. Vehicles with a fully-enclosed driver's compartment / cargo area, no seating at all behind the driver's seat, and no

part of the body Section protruding more than 30 inches ahead of the leading edge of the windshield. Some of the property and equipment that does not qualify for the Section 179 Deduction is:

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Property used outside the United States generally does not qualify for the Section 179 Deduction. Property that is used to furnish lodging is generally not qualified for the Section 179 Deduction. Real Property does not qualify for the Section 179 Deduction. Real Property is typically defined as land, buildings,

permanent structures and the components of the permanent structures (including improvements). Other examples of property that would not qualify for the Section 179 Deduction include paved parking areas and fences.

Air conditioning and heating equipment is generally not eligible for the Section 179 Deduction. Property acquired by gift or inheritance, as well as property purchased from related parties does not qualify for

the Section 179 Deduction (No, a taxpayer cannot sell equipment to him or herself and qualify for Section 179). Any property that is not considered to be personal property, may not qualify for the Section 179 Deduction. Used Equipment (that is new to the taxpayer) qualifies for Section 179, however used equipment does not qualify

for Bonus Depreciation. Bonus Depreciation Under the Tax Cuts and Jobs Act, the bonus depreciation increases from 50% to 100%. This provision is retroactive to September 27, 2017, and is good through 2022. The bonus depreciation also now includes used equipment. Bonus Depreciation is useful to very large businesses spending more than the Section 179 Spending Cap on new capital equipment. Also, businesses with a net loss are still qualified to deduct some of the cost of new equipment and carry-forward the loss. When applying these provisions, Section 179 is generally taken first, followed by Bonus Depreciation - unless the business had no taxable profit, because the unprofitable business is allowed to carry the loss forward to future years. Unrecovered Basis There are limits on the amount a taxpayer can deduct for depreciation of his or her car, truck, or van. The Section 179 deduction is treated as depreciation for purposes of the limits. The maximum amount a taxpayer can deduct each year depends on the year he or she puts the car in service. If the depreciation deductions for the taxpayer’s car are reduced, he or she will have unrecovered basis in his or her car at the end of the recovery period. If the taxpayer continues to use his or her car for business, he or she can deduct that unrecovered basis (subject to depreciation limits) after the recovery period ends. Unrecovered basis is the taxpayer’s cost or other basis in the car reduced by any clean-fuel vehicle deduction (for vehicles placed in service before January 1, 2006), alternative motor vehicle credit, electric vehicle credit, gas guzzler tax, and depreciation and Section 179 deductions that would have been allowable if the taxpayer had used the car 100% for business and investment use. For 5-year property, the taxpayer’s recovery period is 6 calendar years. A part year's depreciation is allowed in the first calendar year, a full year's depreciation is allowed in each of the next 4 calendar years, and a part year's depreciation is allowed in the 6th calendar year. Under MACRS, the taxpayer’s recovery period is the same whether he or she utilizes declining balance or straight line depreciation. The taxpayer determines his or her unrecovered basis in the 7th year after he or she placed the car in service. If the taxpayer continues to use his or her car for business after the recovery period, he or she is due a depreciation deduction in each succeeding tax year until he or she recovers the basis in the car. The maximum amount the taxpayer can deduct each year is determined by the date he or she placed the car in service and his or her business-use percentage. For example, no deduction is allowed for a year the taxpayer uses a car 100% for personal purposes. Per Revenue Procedure 2011-26 the IRS provides a safe harbor accounting method. This procedure provides guidance with respect to the 100% additional first year depreciation deduction under Section 168(k)(5) of the Code, and the extension of the 50% bonus depreciation deduction for qualified property placed in service in 2010. This procedure defines which property is eligible for the 100% bonus depreciation deduction and provides guidance regarding the time and manner for making certain elections under Sections 168(k)(2) and (5). The procedure also provides a safe harbor method of accounting for passenger automobiles that qualify for the 100% additional first year depreciation deduction and that are subject to first-year limitations under Section 280F.

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The taxpayer selects the safe harbor method by choosing it to deduct depreciation on a passenger car on the return of the year that follows the placed-in-service year of the car when the cost exceeded the first-year luxury auto limit and the 100% bonus depreciation deduction was claimed.

Capitalization and Repairs In the past, the ability to take an immediate deduction for certain expenditures was somewhat liberal. However, the IRS began to take notice and as a result, the Treasury Department has attempted to produce rules that will tighten this flexibility with Treasury Decision 9636. These new rules are commonly referred to as the “Cap and Repair Regs”. There are two different versions of the regulation:

The temporary cap and repair regulations were issued in 2011. If the taxpayer’s operation elected to implement the temporary regulations, those would apply during the time period from 2011-2013, and new regulations would be effective for taxable years beginning January 1, 2014.

The final cap and repair regulations were issued in September 2013. If the taxpayer’s operation did not elect to implement the temporary regulations, the final regulations will apply and are effective for taxable years beginning January 1, 2014.

Section 162 of the Internal Revenue Code (IRC) allows a taxpayer to deduct all the ordinary and necessary expenses he or she incurs during the taxable year in carrying on his or her trade or business, including the costs of certain materials, supplies, repairs, and maintenance. However, Section 263(a) of the IRC requires the taxpayer to capitalize the costs of acquiring, producing, and improving tangible property, regardless of the size or the cost incurred. The tax law has long required the taxpayer to determine whether expenditures related to tangible property are currently deductible business expenses or non-deductible capital expenditures. Before the issuance of the final tangible property regulations on September 17, 2013, [Treasury Decision 9636 ("final regulations")], the taxpayer’s decisions were guided by decades of often conflicting case law, as well as administrative rulings on specific factual situations. The basic structure and requirements within the temporary regulations remained intact. Although the final regulations have been “simplified” in several key areas, they remain complex overall. The final regulations follow the basic outline of the proposed and temporary regulations, with changes made within each of five main areas:

1. Materials and supplies (Regulation 1.162-3). 2. Repairs and maintenance (Regulation 1.162-4). 3. Capital expenditures (Regulation 1.263(a)-1). 4. Amounts paid for the acquisition or production of tangible property (Regulation 1.263(a)-2. 5. Amounts paid for the improvement of tangible property (Regulation 1.263(a)-3).

The changes emphasized by the IRS include:

1. A revised and simplified de minimis safe harbor under Regulation 1.263(a)-1(f). 2. The extension of the safe harbor for routine maintenance to buildings. 3. An annual election for buildings that cost $1 million or less to deduct up to $10,000 of maintenance costs or, if

less, 2% of the building’s adjusted basis. 4. A new annual election to capitalize repair costs that are capitalized on a taxpayer’s books and records. 5. The refinement of the criteria for defining betterments and restorations to tangible property.

The final regulations apply to anyone who pays or incurs amounts to acquire, produce, or improve tangible real or personal property. These regulations apply to corporations, S corporations, partnerships, LLCs, and individuals filing a Form 1040 with Schedule C, E, or F. The final regulations affect the taxpayer if he or she incurs amounts to acquire, produce or improve tangible real or personal property in carrying on his or her trades or businesses. The rules are most significant for those that regularly incur large capital expenditures, e.g., electric utilities, telecommunications companies, and businesses with substantial real estate holdings. The final regulations are effective for taxable years beginning on or after January 1, 2014. De Minimis Safe Harbor Election Effective for taxable years beginning on or after January 1, 2016, the Internal Revenue Service in Notice 2015-82 increased the de minimis safe harbor threshold from $500 to $2,500 per invoice or item for taxpayers without applicable

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financial statements. In addition, the IRS will provide audit protection to eligible businesses by not challenging the use of the $2,500 threshold for tax years ending before January 1, 2016 if the taxpayer otherwise satisfies the requirements of Treasury Regulation § 1.263(a)-1(f)(1)(ii). Under the final regulations, the taxpayer may elect to apply a de minimis safe harbor to amounts paid to acquire or produce tangible property to the extent such amounts are deducted by him or her for financial accounting purposes or in keeping his or her books and records. If the taxpayer has an applicable financial statement (AFS), he or she may use this safe harbor to deduct amounts paid for tangible property up to $5,000 per invoice or item. If the taxpayer does not have an AFS, he or she may use the safe harbor to deduct amounts up to $500 (prior to January 1, 2016) per item or invoice.

These limitations are for purposes of determining whether particular expenses qualify under the safe harbor; they are not intended as a ceiling on the amount the taxpayer can deduct as business expenses under the IRC.

Amounts paid for the acquisition or production of tangible property that exceed the safe harbor limitations are not subject to the de minimis safe harbor election. Therefore, the safe harbor does not require the taxpayer to capitalize all amounts paid for tangible property in excess of the applicable limitation. If an amount does not qualify under the de minimis safe harbor, the taxpayer should treat the amount under the normal rules that apply, i.e., currently deductible if paid for incidental materials and supplies or for repair and maintenance. This treatment is proper regardless of whether the amount exceeds the applicable de mininis safe harbor limitation. The de minimis safe harbor is simply an administrative convenience that generally allows the taxpayer to elect to deduct small-dollar expenditures for the acquisition or production of property that otherwise must be capitalized under the general rules. The facts and circumstances analysis for distinguishing capital improvements from deductible repairs are:

For buildings – The unit of property is generally the entire building including its structural components. However, under the final regulations and for these purposes only, the improvement analysis applies to the building structure and each of the key building systems. The key building systems are the plumbing system, electrical system, HVAC system, elevator system, escalator system, fire protection and alarm system, gas distribution system, and the security system. Lessees of portions of buildings apply the analysis to the portion of the building structure and portion of each building system subject to the lease. Lessors of an entire building apply the improvement rules to the entire building structure and each of the key building systems.

For non-buildings – The unit of property is, and the analysis applies to, all components that are functionally interdependent. Components of property are functionally interdependent if the taxpayer cannot place in service one component of property without placing in service another component of property.

For plant property, e.g., manufacturing plant, generation plant, etc. – The unit of property is, and the analysis applies to, each component or group of components within the plant that performs a discrete and major function or operation.

For network assets, e.g., railroad track, oil and gas pipelines, etc. – The taxpayer’s particular facts and circumstances or industry guidance from the Treasury Department and the IRS determines the unit of property and the application of the improvement analysis.

To reduce the difficulty with applying the facts and circumstances analysis to identify the tax treatment of costs and to recognize simpler administration by permitting the taxpayer to follow financial accounting policies for Federal tax purposes, the final regulations include an election to capitalize repair and maintenance expenses as improvements, if he or she treats such costs as capital expenditures for financial accounting purposes. The taxpayer may elect to treat repair and maintenance costs paid during the taxable year as amounts paid to improve property if he or she:

1. Pays these amounts in carrying on a trade or business; and 2. Treats these amounts as capital expenditures on his or her books and records regularly used in computing his or

her income. 3. Makes the election to capitalize for each taxable year in which qualifying amounts are incurred by attaching a

statement to his or her timely filed original Federal tax return including extensions for the taxable year that the amounts are paid.

a. If he or she makes the election to capitalize repair and maintenance expenses, he or she must apply the election to all amounts paid for repair and maintenance that he or she treats as capital expenditures on his or her books and records in that taxable year.

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b. An annual election is not a change in method of accounting. Therefore, he or she should not file Form 3115 - Application for Change in Accounting Method, to make this election or to stop capitalizing repairs and maintenance costs for a subsequent year.

Materials and Supplies Costs In most cases, the final regulations do not change the general rules for deducting materials and supplies. The final regulations merely incorporate pre-existing precedents on the definition and treatment of materials and supplies and add some safe harbors to provide the taxpayer with additional certainty. The final regulations also provide additional elections and methods for those using rotable spare parts. Materials and supplies are tangible, non-inventory property used and consumed in the taxpayer’s operations including:

Acquired components – Costs of components acquired to maintain, repair, or improve tangible property owned, leased, or serviced by the taxpayer and that is not acquired as part of a larger item of tangible property.

Consumables – Costs of fuel, lubricants, water, and similar items that are reasonably expected to be consumed in 12 months or less, beginning when used in operations.

12-month property – Costs of tangible property that has an economic useful life of 12 months or less, beginning when the property is used or consumed in the taxpayer’s operations.

$200 property – Costs of tangible property that has an acquisition cost or production cost of $200 or less. As under prior rules, the taxpayer may deduct the costs of incidental and nonincidental materials and supplies in the following manner:

Incidental materials and supplies – If the materials and supplies are incidental, i.e., of minor or secondary importance, carried on hand without keeping a record of consumption, and no beginning and ending inventories are recorded, e.g., pens, paper, staplers, toner, trash baskets, then the taxpayer deducts the materials and supplies costs in the taxable year in which the amounts are paid or incurred, provided taxable income is clearly reflected.

Nonincidental materials and supplies – If the materials and supplies are not incidental, then the taxpayer deducts the materials and supplies costs in the taxable year in which the materials and supplies are first used or consumed in his or her operations. For example, the taxpayer deducts certain expendable spare parts in a trucking business for which records of consumption are kept and inventories are recorded in the taxable year the part is removed from his or her storage area and installed in one of his or her trucks. However, an otherwise deductible material or supply cost could be subject to capitalization under Section 263(a) if he or she uses the material or supply to improve property or under Section 263A if he or she incorporates the material or supply into property he or she produces or acquires for resale.

Application with de minimis safe harbor – If the taxpayer elects to use the de minimis safe harbor and any materials and supplies also qualify for the safe harbor, he or she must deduct amounts paid for these materials or supplies under the safe harbor in the taxable year the amounts are paid or incurred. Such amounts are not treated as amounts paid for materials and supplies and may be deducted as business expenses in the taxable year they are paid or incurred.

Because the final regulations governing the treatment of materials and supplies are based primarily on prior law, if the taxpayer was previously in compliance with the rules he or she generally will still be in compliance and generally no action will be required to continue to apply these rules on a prospective basis. Also, the final regulations governing the treatment of material and supplies apply to amounts paid or incurred in taxable years beginning on or after January 1, 2014. Therefore, for the taxpayer’s first taxable year beginning January 1, 2014, most taxpayers will not have a change in accounting method for his or her materials and supplies. If the taxpayer desires to change his or her method of accounting for materials and supplies in a subsequent taxable year, he or she would file Form 3115 and compute a Section 481(a) adjustment taking into account only amounts paid after January 1, 2014. Nothing in the final regulations under Section 263(a) changes the treatment of any amount that is specifically provided for under any provision of the IRC or the Treasury regulations other than Section 162(a) or Section 212. For example, the final regulations do not eliminate the requirements of Section 263(a), which generally provides that the taxpayer must capitalize the direct and allocable indirect costs of producing real or tangible personal property and acquiring property for resale. Generally, the final regulations apply to taxable years beginning on or after January 1, 2014, or in certain circumstances, apply to costs paid or incurred in taxable years beginning on or after January 1, 2014.

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

Review Questions Answers appear in Review Feedback 1. Generally, a taxpayer cannot deduct the entire cost as a business expense in the year the item was acquired if property

acquired for the business is expected to last more than how long? A. One year B. Two years C. Three years D. Four years

2. All of the following types of property are depreciable except:

A. Vehicles B. Furniture C. Patents D. Land

3. Phil bought a new van that he will use only for his courier business. Phil will be making payments on the van over the

next 5 years. With regards to depreciation which of the following statements is true? A. Phil does not own the van and he cannot depreciate it B. Phil owns the van but he cannot depreciate it because it is subject to debt C. Phil owns the van and he can depreciate it D. Phil does not own the van but he can depreciate it

4. Basis is generally the amount of a taxpayer’s capital investment in a property for tax purposes. Use the basis to figure

all of the following except: A. Depreciation B. Amortization C. Depletion D. Recovery Period

5. The cost of a property also includes amounts for which of the following items?

A. Sales tax B. Freight C. Excise taxes D. All of the above

6. Which of following is a settlement fee or closing cost the taxpayer can include in the basis of the property?

A. Owner's title insurance B. Points (discount points, loan origination fees) C. Mortgage insurance premiums D. Loan assumption fees

7. Which of following is a settlement fee or closing cost the taxpayer cannot include in the basis of the property?

A. Recording fees B. Surveys C. Transfer taxes D. Mortgage insurance premiums

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8. Using the MACRS GDS method of depreciation, any tree or vine bearing fruits or nuts appears in which property class? A. 7-year property B. 10-year property C. 15-year property D. 20-year property

9. As a general rule, business assets are depreciated over a specified period of years. What is the one major exception?

A. Tangible Property B. MACRS Depreciation C. Section 179 Election D. General Depreciation System

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Review Feedback Return to Review Questions Question 1 - A. One year In order for a taxpayer to be allowed a depreciation deduction for a property; he or she must own the property, the taxpayer must use the property in business or in an income-producing activity and the property must have a determinable useful life of more than one year. Question 2 - D. Land The taxpayer can depreciate most types of tangible property (except land), such as buildings, machinery, vehicles, furniture, and equipment. He or she also can depreciate certain intangible property, such as patents, copyrights, and computer software. Question 3 - C. Phil owns the van and he can depreciate it To claim depreciation, the taxpayer usually must be the owner of the property. He or she is considered as owning property even if it is subject to a debt. Question 4 - D. Recovery Period Basis is generally the amount of a taxpayer’s capital investment in a property for tax purposes. Use the basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange or other disposition of the property. Question 5 - D. All of the above The cost also includes amounts paid for sales tax, freight, installation and testing, excise taxes, legal and accounting fees (when they must be capitalized), revenue stamps, recording fees, and real estate taxes (if assumed for the seller). The taxpayer may also have to capitalize (add to basis) certain other costs related to buying or producing property. Question 6 - A. Owner's title insurance The following items are some of the settlement fees or closing costs a taxpayer can include in the basis of the property; abstract fees (abstract of title fees), charges for installing utility services, legal fees (including title search and preparation of the sales contract and deed), recording fees surveys, transfer taxes, owner's title insurance and any amounts the seller owes that the taxpayer agrees to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions. Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance. Question 7 - D. Mortgage insurance premiums Charges connected with getting a loan such as points (discount points, loan origination fees), mortgage insurance premiums, loan assumption fees, cost of a credit report and fees for an appraisal required by a lender cannot be can include in the basis of the property. Question 8 - B. 10-year property The 10-year property class under GSD includes vessels, barges, tugs, and similar water transportation equipment, any single purpose agricultural or horticultural structure, any tree or vine bearing fruits or nuts and qualified small electric meter and qualified smart electric grid system placed in service on or after October 3, 2008. Question 9 - C. Section 179 Election A taxpayer can elect to recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year he or she placed the property in service. This deduction is the Section 179 deduction. A taxpayer can elect the Section 179 deduction instead of recovering the cost by taking depreciation deductions. However, estates and trusts cannot elect the Section 179 deduction.

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Retirement Income At the conclusion of this lesson you should have a basic knowledge of:

Taxation of Social Security Benefits Individual Retirement Arrangement (IRA) Contributions Individual Retirement Arrangement (IRA) Distributions Roth Individual Retirement Arrangements

Social Security and Medicare Taxes The Federal Insurance Contributions Act (FICA) tax includes two separate taxes. One is Social Security tax and the other is Medicare tax. Different rates apply for each of these programs. For 2017, the tax rate for Social Security is 6.2% for employees, 6.2% for employers and 12.4% for self-employed people. The Social Security tax applies only to the first $127,200 of wages, for a maximum of $7,886.40 for employees and for employers, and $15,772.80 for self-employed people. The current rate for Medicare is 1.45% for the employer and 1.45% for the employee, or 2.9% total. There is not a wage base limit for Medicare tax. All covered wages are subject to Medicare tax. Social Security and Medicare taxes apply to the wages of household workers the taxpayer pays $2,000 or more in cash or an equivalent form of compensation. Social Security and Medicare taxes apply to election workers who are paid $1,700 or more in cash or an equivalent form of compensation. (188)

The 2013 Additional Medicare Tax (imposed by the Patient Protection and Affordable Care Act) requires individuals to pay a supplemental 0.9% tax (in addition to the 1.45% contribution that applies to all wages) on wages in excess of $200,000 ($250,000 if married, filing jointly). (189)

Any excess Social Security tax withheld over these maximums (usually from having two or more employers), is taken in additional paid-in income taxes and is combined with amounts withheld from wages or with estimates. If a joint return is filed, these amounts withheld from each spouse cannot be added together to exceed the maximums. (188) Taxation of Social Security Benefits If the only income the taxpayer received during the year was his or her Social Security or the Social Security Equivalent Benefit (SSEB) portion of tier 1 railroad retirement benefits, his or her benefits generally are not taxable and the taxpayer probably does not have to file a return. If the taxpayer has income in addition to his or her benefits, he or she may have to file a return even if none of his or her benefits are taxable. If any portion of the benefits is taxable, the taxpayer should file using Form 1040 or Form 1040A; Form 1040EZ cannot be used. The base amounts used to figure the tax on Social Security benefits are: (190)

$25,000 if the taxpayer is single, head of household or qualifying widow(er). $25,000 if the taxpayer is married filing separately and lived apart from his or her spouse for all of current year. $32,000 if the taxpayer is married filing jointly. $0 if the taxpayer is married filing separately and lived with his or her spouse at any time during the current year.

How much of the benefits are taxable depends on the total amount of the taxpayer’s benefits and other income. Generally, the higher the income amount, the greater the taxable portion of the taxpayer’s benefits. Maximum Taxable Part Some people have to pay Federal income taxes on their Social Security benefits. This usually happens only if the taxpayer has other substantial income (such as wages, self-employment, interest, dividends and other taxable income that must be reported on his or her tax return) in addition to his or her benefits. No one pays Federal income tax on more than 85% of his or her Social Security benefits based on Internal Revenue Service (IRS) rules.

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In order to determine the taxability of Social Security benefits, it’s first necessary to calculate “combined income” – a measurement of income used specifically for these purposes. Combined income is calculated as the taxpayer’s total income from taxable sources (essentially the net amounts included on the front page of his or her tax return in calculating Adjusted Gross Income), plus any tax-exempt interest (i.e., from municipal bonds) and excluded foreign income, plus one half of his or her Social Security benefits. If this total exceeds $25,000 for individuals ($32,000 for married couples), then 50% of the excess is the amount of Social Security benefits that must be included in income. If provisional income exceeds $34,000 for individuals ($44,000 for married couples), then 85% of the excess amount is included in income. If the taxpayer files a single, Federal tax return and his or her combined income is: (188)

Between $25,000 and $34,000, he or she may have to pay income tax on up to 50% of his or her benefits. More than $34,000, up to 85% of his or her benefits may be taxable.

If the taxpayer files a joint, Federal tax return and his or her combined income is:

Between $32,000 and $44,000, he or she may have to pay income tax on up to 50% of his or her benefits More than $44,000, up to 85% of his or her benefits may be taxable.

If the taxpayer is married and files a separate tax return, he or she probably will pay taxes on his or her benefits. To find out whether any of the taxpayer’s benefits may be taxable, compare the base amount for his or her filing status with his or her combined income which is the total of: (190)

1. One-half of his or her benefits, plus 2. The taxpayer’s adjusted gross, including tax-exempt interest.

When making this comparison, do not reduce the taxpayer’s other income by any exclusions for:

Interest from qualified U.S. savings bonds. Employer-provided adoption benefits. Foreign earned income or foreign housing. Income earned by bona fide residents of American Samoa or Puerto Rico.

Any repayment of benefits the taxpayer made during 2017 must be subtracted from the gross benefits he or she received in 2017. It does not matter whether the repayment was for a benefit the taxpayer received in 2017 or in an earlier year.

Joint Return If the taxpayer is married and files a joint return for 2017, the taxpayer and his or her spouse must combine incomes and benefits when figuring if the combined benefits are taxable. Even if the taxpayer’s spouse did not receive any benefits, he or she must add the spouse's income to his or hers when figuring if any of the benefits are taxable. The IRS provides a Social Security Benefits Worksheet upon which the taxpayer can calculate taxable Social Security benefits. Repayments If the taxpayer received benefits during the year, he or she should receive a Form SSA-1099 - Social Security Benefit Statement, or Form RRB-1099 - Payments by the Railroad Retirement Board. These forms show the amounts received and repaid, and taxes withheld for the year. The taxpayer may receive more than one of these forms for the same year. He or she should add the amounts shown on all the Forms SSA-1099 and Forms RRB-1099 he or she receives for the year to determine the total amounts received and repaid, and taxes withheld for that year. Any repayment of benefits the taxpayer made during the current year must be subtracted from the gross benefits he or she received. It does not matter whether the repayment was for a benefit he or she received in the current year or in an earlier year. The taxpayer’s gross benefits are shown in box 3 of Form SSA-1099 or RRB-1099. His or her repayments are shown in box 4. The amount in box 5 shows his or her net benefits for the current (box 3 minus box 4). Use the amount in box 5 to figure whether any of taxpayer’s benefits are taxable.

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Pensions and Annuities The pension or annuity payments that a taxpayer receives are fully taxable if he or she has no cost in the contract because any of the following situations: (191)

The taxpayer did not pay anything or is not considered to have paid anything for the pension or annuity. Amounts withheld from his or her pay on a tax-deferred basis are not considered part of the cost of the pension or annuity payment.

The taxpayer’s employer did not withhold contributions from his or her salary. The taxpayer received all of his or her contributions tax free in prior years.

If a taxpayer contributed after-tax dollars to a pension or annuity, the pension payments are partially taxable. He or she will not pay tax on the part of the payment that represents a return of the after-tax amount paid. This amount is the taxpayer’s investment in the contract, and includes the amounts his or her employer contributed that were taxable to him or her when contributed. Partly taxable pensions are taxed under either the General Rule or the Simplified Method. If the starting date of the pension or annuity payments is after November 18, 1996, the taxpayer generally must use the Simplified Method to determine how much of the annuity payments are taxable and how much is tax free. Under the Simplified Method, the taxpayer figures the tax-free part of each annuity payment by dividing the cost by the total number of anticipated monthly payments. For an annuity that is payable for the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date and is determined from a table. For any other annuity, this number is the number of monthly annuity payments under the contract. The taxpayer must use the Simplified Method if the annuity starting date is after November 18, 1996, and he or she meets both of the following conditions: (191)

1. The taxpayer receives his or her pension or annuity payments from any of the following plans: a. A qualified employee plan. b. A qualified employee annuity. c. A tax-sheltered annuity plan (403(b) plan).

2. On the annuity starting date, at least one of the following conditions applies to the taxpayer: a. He or she is under age 75. b. He or she is entitled to less than 5 years of guaranteed payments.

The General Rule is used to figure the tax treatment of various types of pensions and annuities, including nonqualified employee plans. A nonqualified employee plan is an employer's plan that does not meet Internal Revenue Code requirements. It does not qualify for most of the tax benefits of a qualified plan. The taxpayer can use the General Rule if he or she receives pension or annuity payments from:

A nonqualified plan (for example, a private annuity, a purchased commercial annuity, or a nonqualified employee plan),

A qualified plan if: o The annuity starting date is before November 19, 1996 (and after July 1, 1986), and the taxpayer does

not qualify to use, or chooses not to use, the Simplified Method. o The taxpayer is 75 or over and the annuity payments are guaranteed for at least 5 years (regardless of

the annuity starting date). The following are qualified plans:

A qualified employee plan. A qualified employee annuity. A tax-sheltered annuity (TSA) plan or contract.

If the taxpayer receives pension or annuity payments before age 59 ½, he or she may be subject to an additional 10% tax on early distributions unless the distribution qualifies for an exemption.

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The additional tax does not apply to any part of a distribution that is tax free or to any of the following types of distributions: (192)

Distributions made as a part of a series of substantially equal periodic payments from a qualified plan that begins after the taxpayer’s separation from service.

Distributions made because the taxpayer is totally and permanently disabled. Distributions made on or after the death of the plan participant or contract holder. Distributions made from a qualified retirement plan after the taxpayer’s separation from service in or after the year

he or she reached age 55. The taxpayer may choose not to have income tax withheld from the pension or annuity payments (unless they are eligible rollover distributions) or want to specify how much tax is withheld. If so, provide the payer Form W-4P - Withholding Certificate for Pension or Annuity Payments, or a similar form provided by the payer. Withholding from periodic payments of a pension or annuity is generally figured the same way as for salaries and wages. If the taxpayer does not submit the withholding certificate, the payer must withhold tax as if the taxpayer is married and claiming three withholding allowances. If the taxpayer does not provide the payer with the correct Social Security number, tax will be withheld as if the taxpayer is single and claiming no withholding allowances, even if the taxpayer submitted a Form W-4P and elected a lower amount. A taxpayer should receive Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., from each person to whom he or she has received a designated distribution or was treated as having made a distribution of $10 or more from profit-sharing or retirement plans, any individual retirement arrangements (IRAs), annuities, pensions, insurance contracts, survivor income benefit plans, permanent and total disability payments under life insurance contracts, charitable gift annuities, etc.

Individual Retirement Arrangements (IRAs) The main purpose for a taxpayer to set up an Individual Retirement Arrangement (IRA) is to save for future retirement. The main tax advantage for taxpayers is that any earnings on the deposits remain tax-free until distributions are taken from the IRA, and at retirement age the taxpayer would probably be in a lower tax-bracket. The taxpayer’s basis in traditional IRAs is the total of all nondeductible contributions and nontaxable amounts included in rollovers made to traditional IRAs minus the total of all nontaxable distributions, adjusted if necessary. Here are ten important tips from the IRS about setting aside money for a taxpayer’s retirement in an Individual Retirement Arrangement:

1. The taxpayer must be under age 70½ at the end of the tax year in order to contribute to a traditional IRA. 2. The taxpayer must have taxable compensation to contribute to an IRA. This includes income from wages, salaries,

tips, commissions and bonuses. It also includes net income from self-employment. If he or she files a joint return, generally only one spouse needs to have taxable compensation.

3. The taxpayer can contribute to a traditional IRA at any time during the year. He or she must make all contributions by the due date for filing the tax return. This due date does not include extensions. For most people this means the taxpayer must contribute for 2017 by April 15, 2018. If he or she contributes between January 1 and April 15, contact the IRA plan sponsor to make sure they apply it to the right year.

4. For 2017, the most a taxpayer can contribute to an IRA is the smaller of either taxable compensation for the year or $5,500. If the taxpayer was 50 or older at the end of 2017 the maximum amount increases to $6,500.

5. Generally, the taxpayer will not pay income tax on the funds in a traditional IRA until he or she begins taking distributions from it.

6. The taxpayer may be able to deduct some or all of the contributions to a traditional IRA. 7. Use the worksheets in the instructions for either Form 1040A or Form 1040 to figure the amount of the

contributions that can be deducted. 8. The taxpayer may also qualify for the Savers Credit, formally known as the Retirement Savings Contributions

Credit. The credit can reduce taxes up to $1,000 (up to $2,000 if filing jointly). Use Form 8880 - Credit for Qualified Retirement Savings Contributions, to claim the Saver’s Credit.

9. The taxpayer must file either Form 1040A or Form 1040 to deduct IRA contribution or to claim the Saver’s Credit. 10. See Publication 590 - Individual Retirement Arrangements, for more about IRA contributions.

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Contributions to Traditional IRAs There are two requirements necessary for setting up a traditional IRA. First, the taxpayer must have received some taxable compensation income during the year, and, second, he or she has not reached age 70 ½ by the end of the year. Taxable compensation includes wages, salaries, alimony, tips, commissions and the like. However, the following are not considered compensation income for purposes of setting up or contributing to an IRA: (193)

Earnings and profits from property, such as rental income, interest income, and dividend income. Pension or annuity income. Deferred compensation income. Any other income that is an exclusion from gross income.

An IRA can be set up either in the name of the taxpayer or the taxpayer and his or her spouse, in a so called spousal IRA. Contributions can be made to a spousal IRA even if the spouse has no compensation income. There are specific limitations on the amount that he or she can contribute to a traditional IRA during the year.

The maximum amount of contribution is limited to the smaller of: (194)

For tax year 2017, $5,500 if the taxpayer is under age 50. If he or she is over 50 the catch-up contribution limit is $6,500.

The taxpayer’s compensation income for the tax year.

The IRA contribution limit does not apply to rollover contributions or qualified reservist repayments. For 2017, the limit on annual contributions to an Individual Retirement Arrangement (IRA) remains unchanged at $5,500. The additional catch-up contribution limit for individuals aged 50 and over is not subject to an annual cost-of-living adjustment and remains $1,000.

There are established time frames during which a taxpayer can make an IRA contribution. An IRA contribution can be made at any time during the tax year or by the due date of the tax return for the year in which he or she wants the contribution to apply, not including any extensions in time to file requests. In other words, most taxpayers can make an IRA contribution for 2017 by April 15, 2018. In fact, the taxpayer can even claim an IRA contribution and file his or her tax return before the contribution is actually made, as long as it in fact is made before the due date of the return. However, if contributions to the traditional IRA for a year were less than the limit, the taxpayer cannot contribute more after the due date of his or her return for that year to make up the difference. Line 32 on Form 1040, under "Adjusted Gross Income" is where the taxpayer claims a deduction for an IRA contribution for the year. The rules for claiming this deduction have become remarkably complicated over the last several years. Specifically, if either the taxpayer or his spouse is covered by an employer provided retirement plan, the amount of available deduction may be reduced or even eliminated. Not only is the amount of available IRA deduction dependent on filing status, but it may also be subject to certain income limitations. The amount of available IRA deduction can be determined by using an IRS supplied IRA worksheet. Deductible Phase-Out Range A taxpayer’s deduction may be limited if he or she (or his or her spouse, if married) is covered by a retirement plan at work and the taxpayer’s income exceeds certain levels. The deductible IRA income 2017 phase-out limits, for individuals who are active participants, are increased as follows:

2017 IRA Deduction Limits - Effect of Modified AGI on Deduction if the Taxpayer is Covered by a Retirement Plan at Work

Filing Status Modified AGI Amount Deduction Amount

Single or Head of Household $62,000 or less Full Deduction to Contribution Limit

$62,000 - $72,000 Partial Deduction $72,000 or more No Deduction

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Married filing jointly or Qualifying Widow(er)

$99,000 or less Full Deduction to Contribution Limit $99,000 - $119,000 Partial Deduction $119,000 or more No Deduction

Married filing separately Less than $10,000 Partial Deduction

$10,000 or more No Deduction

If the taxpayer files separately and did not live with his or her spouse at any time during the year, the taxpayer’s IRA deduction is determined under the single filing status.

Table 11-1 - IRA Deduction Limits - Effect of MAGI on Deduction if You Are Covered by a Retirement Plan at Work. (2017)

If the taxpayer is not covered by a retirement plan at work, he or she should use the following table to determine if his or her modified AGI affects the amount of his or her deduction. The deduction is limited only if his or her spouse is covered by a retirement plan.

2017 IRA Deduction Limits - Effect of Modified AGI on Deduction if the Taxpayer is not Covered by a Retirement Plan at Work

Filing Status Modified AGI Amount Deduction Amount Single, Head of Household or Qualifying widow(er) Any Amount Full Deduction to Contribution Limit

Married filing jointly or separately with a spouse who is not covered by a plan at work

Any Amount Full Deduction to Contribution Limit

Married filing jointly with a spouse who is covered by a plan at work

$186,000 or less Full Deduction to Contribution Limit $186,000 - $196,000 Partial Deduction

$196,000 or more No Deduction

Married filing separately with a spouse who is covered by a plan at work

Less than $10,000 Partial Deduction

$10,000 or more No Deduction

If the taxpayer files separately and did not live with his or her spouse at any time during the year, the taxpayer’s IRA deduction is determined under the single filing status.

Table 11-2 - IRA Deduction Limits - Effect of MAGI on Deduction if You Are NOT Covered by a Retirement Plan at Work (2017)

The taxpayer’s deduction is allowed in full if he or she (and his or her spouse, if married) are not covered by a retirement plan at work. Kay Bailey Hutchison Spousal IRA Limit For 2017, if the taxpayer files a joint return and his or her taxable compensation is less than that of his or her spouse, the most that can be contributed for the year to his or her IRA is the smaller of the following two amounts:

1. $5,500 ($6,500 if the taxpayer is age 50 or older). 2. The total compensation includible in the gross income of both the taxpayer and his or her spouse for the year,

reduced by the following two amounts: a. The taxpayer’s spouse's IRA contribution for the year to a traditional IRA. b. Any contributions for the year to a Roth IRA on behalf of the taxpayer’s spouse.

This means that the total combined contributions that can be made for the year to a taxpayer’s IRA and his or her spouse's IRA can be as much as $11,000 ($12,000 if only one person is age 50 or older or $13,000 if both people are age 50 or older). Nondeductible IRAs A nondeductible IRA is like a traditional IRA in all respects but one: an individual cannot take a tax deduction for contributions

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made to the IRA. An individual can set up a Nondeductible IRA if that person is covered by a pension, 401(k) or other retirement plan, and that person's income is above the limits for a Traditional (Deductible) IRA. Although the money that a person puts into the IRA is not tax-deductible, that individual will not be taxed on the investment earnings on their contributions until that person withdraws the money. This allows the individual to accumulate more than if the investment earnings were taxed immediately. If a taxpayer makes a nondeductible contribution, he or she must fill out Form 8606 - Nondeductible IRAs. Use Form 8606 to report: (195)

Nondeductible contributions made to traditional IRAs. Distributions from traditional, SEP, or SIMPLE IRAs, if the taxpayer has ever made nondeductible contributions

to traditional IRAs. Conversions from traditional, SEP, or SIMPLE IRAs to Roth IRAs. Distributions from Roth IRAs.

Penalty for Not Filing Form 8606 If the taxpayer is required to file Form 8606 to report a nondeductible contribution to a traditional IRA for 2017, but does not do so, he or she must pay a $50 penalty, unless he or she can show reasonable cause. Overstatement Penalty If the taxpayer overstates the nondeductible contributions for 2017, he or she must pay a $100 penalty, unless he or she can show reasonable cause. Amending Form 8606 After the taxpayer files the return, he or she can change a nondeductible contribution to a traditional IRA to a deductible contribution or vice versa. The taxpayer also may be able to make a recharacterization. If necessary, complete a new Form 8606 showing the revised information and file it with Form 1040X - Amended U.S. Individual Income Tax Return. Recharacterizations Generally, a taxpayer can recharacterize (correct) an IRA contribution, Roth IRA conversion, or a Roth IRA rollover from a qualified retirement plan by making a trustee-to-trustee transfer from one IRA to another type of IRA. Trustee-to-trustee transfers are made directly between financial institutions or within the same financial institution. The taxpayer generally must make the transfer by the due date of the return (including extensions) and reflect it on the return. However, if the taxpayer filed a timely return without making the transfer, he or she can make the transfer within 6 months of the due date of the return, excluding extensions. If necessary, file an amended return reflecting the transfer. Recordkeeping To verify the nontaxable part of distributions from IRAs, including Roth IRAs, the taxpayer should keep a copy of the following forms and records until all distributions are made: (195)

Page 1 of Forms 1040 (or Forms 1040A, 1040NR, or 1040-T) filed for each year the taxpayer made a nondeductible contribution to a traditional IRA.

Forms 8606 and any supporting statements, attachments, and worksheets for all applicable years. Forms 5498 or similar statements the taxpayer received each year showing contributions made to a traditional

IRA or Roth IRA. Forms 5498 or similar statement received showing the value of the taxpayer’s traditional IRAs for each year he or

she received a distribution. Forms 1099-R or W-2P received for each year the taxpayer received a distribution.

Penalty-Free Withdrawals from IRAs Generally, if the taxpayer is under age 59½, he or she must pay a 10% additional tax (10% in addition to any regular income tax on the amount) on the distribution of any assets (money or other property) from a traditional IRA. Distributions before age 59½ are called early distributions. The 10% additional tax applies to the part of the distribution that is included in gross income. There are certain distributions a taxpayer can receive before age 59 ½ without paying the early distribution penalty.

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A taxpayer may not have to pay the additional tax for one of the following situations: (196)

The taxpayer has unreimbursed medical expenses that are more than 10% of adjusted gross income. The distributions are not more than the cost of medical insurance due to a period of unemployment. The taxpayer is totally and permanently disabled. The taxpayer is the beneficiary of a deceased IRA owner. The taxpayer is receiving distributions in the form of an annuity. The distributions are not more than qualified higher education expenses. The taxpayer uses the distributions to buy, build, or rebuild a first home. The distribution is due to an IRS levy of the qualified plan. The distribution is a qualified reservist distribution.

Penalty-Free Withdrawals from IRAs for Unreimbursed Medical Expenses The taxpayer does not have to pay the 10% additional tax on distributions that are not more than the amount he or she paid for unreimbursed medical expenses during the year of the distribution minus 10% of adjusted gross income for the year of the distribution. The taxpayer can only take into account unreimbursed medical expenses that he or she would be able to include in figuring a deduction for medical expenses on Schedule A (Form 1040). The taxpayer does not have to itemize deductions to take advantage of this exception to the 10% additional tax. (196) Penalty-Free Withdrawal from IRAs for Medical Insurance Premiums Certain unemployed persons who make an early distribution to pay for qualifying medical insurance premiums are not subjects to the 10% penalty. Eligible unemployed individuals are those who have received Federal or state unemployment compensation for 12 consecutive weeks. Qualifying premiums are deductible premiums for the medical care of the unemployed individual, spouse and dependents. To be excludable, the distributions must be received in the tax year during which unemployment compensation is received or in the following year. In determining whether the premiums are deductible, the 10% medical expense floor is ignored. This exception to the 10% penalty imposed on certain early distribution ceases to apply after the person has been reemployed for 60 days (not necessarily consecutive) after initial unemployment. (196) Penalty-Free Withdrawals from IRAs for Disability If the taxpayer becomes disabled before reaching the age 59½, any distributions from a traditional IRA because of the disability are not subject to the 10% additional tax. A taxpayer is considered disabled if he or she can furnish proof that he or she cannot do any substantial gainful activity because of physical or mental condition. A physician must determine that the condition can be expected to result in death or to be of long, continued, and indefinite duration. (196) Penalty-Free Withdrawals from IRAs for a Beneficiary If a person dies before reaching age 59½, the assets in a traditional IRA can be distributed to a beneficiary or to an estate without either having to pay the 10% additional tax. However, if the taxpayer inherits a traditional IRA from a deceased spouse and elects to treat it as his or her own, any distribution the taxpayer later receives before he or she reaches age 59½ may be subject to the 10% additional tax. (196) Penalty-Free Withdrawals from IRAs for an Annuity The taxpayer can receive distributions from a traditional IRA that are part of a series of substantially equal payments over his or her life (or his or her life expectancy), or over the lives (or the joint life expectancies) of the taxpayer and his or her beneficiary, without having to pay the 10% additional tax, even if the taxpayer receives such distributions before the taxpayer is age 59½. The taxpayer must use an IRS approved distribution method and he or she must take at least one distribution annually for this exception to apply. The required minimum distribution method, when used for this purpose, results in the exact amount required to be distributed, not the minimum amount. There are two other IRS-approved distribution methods that the taxpayer can use. They are generally referred to as the fixed amortization method and the fixed annuitization method. These two methods are not fully discussed in this publication because they are more complex and generally require professional assistance. (196) Example: Bob, age 50, is the owner of an IRA from which he would like to start taking distributions beginning in 2017. He would like to

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avoid the additional 10% tax imposed on early distributions by taking advantage of the substantially-equal-periodic-payment exception: (197)

Bob’s IRA account balance is $400,000 as of December 31, 2016 (the last valuation prior to the first distribution). 120% of the applicable Federal mid-term rate is assumed to be 2.98%, and this will be the interest rate Bob uses

under the amortization and annuitization methods. Bob will determine distributions over his own life expectancy only.

Penalty-Free Withdrawals from IRAs for Qualified Higher Educational Expenses Penalty-free distributions from IRAs may be made for qualified educational purposes. The penalty-free withdrawal is available for qualified higher education expenses including tuition, fees, supplies, and equipment required for enrollment or attendance at a post-secondary educational institution. This penalty-free withdrawal (up to the amount of the IRA) is available to the taxpayer, the taxpayer's spouse, or any child or stepchild or grandchild of taxpayer or the taxpayer's spouse. When determining the amount of the distribution that is not subject to the 10% additional tax, include qualified higher education expenses paid with any of the following funds: (196)

Payment for services, such as wages. A loan. A gift. An inheritance given to either the student or the individual making the withdrawal. A withdrawal from personal savings (including savings from a qualified tuition program).

Do not include expenses paid with any of the following funds: (196)

Tax-free distributions from a Coverdell education savings account. Tax-free part of scholarships and fellowships. Pell grants. Employer-provided educational assistance. Veterans' educational assistance. Any other tax-free payment (other than a gift or inheritance) received as educational assistance.

Penalty-Free Withdrawal from IRAs for First-time Homebuyer Expenses The 10% early distribution penalty will not be charged if the taxpayer uses the money from his or her IRA for qualified expenses associated with buying a principal residence. A maximum of $10,000 during the individual’s lifetime may be withdrawn without a penalty for this purpose. Qualified expenses include acquisition costs, settlement charges and closing costs. The principal residence may be for the individual or the individual’s spouse, child, grandchild or ancestor of the individual or the individual’s spouse. In order to be considered a first-time homebuyer, the individual (and spouse, if married) must not have had an ownership interest in a principal residence during the two-year period ending on the date that the new home is acquired. (196) Penalty-Free Withdrawal from IRAs for Qualified Reservist Distributions A qualified reservist distribution is not subject to the additional tax on early distributions if the following requirements are met:

The taxpayer was ordered or called to active duty after September 11, 2001. The taxpayer was ordered or called to active duty for a period of more than 179 days or for an indefinite period

because he or she is a member of a reserve component. The distribution is from an IRA or from amounts attributable to elective deferrals under a Section 401(k) or 403(b)

plan or a similar arrangement. The distribution was made no earlier than the date of the order or call to active duty and no later than the close of

the active duty period. The term reserve component includes the: (196)

Army National Guard of the United States. Army Reserve.

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Naval Reserve. Marine Corps Reserve. Air National Guard of the United States. Air Force Reserve. Coast Guard Reserve. Reserve Corps of the Public Health Service.

Roth IRAs

Contributions to a Roth IRA are never deductible. The advantage of the Roth IRA is that the buildup within the IRA (e.g., interest, dividends, and/or price appreciation) may be free from Federal income tax when the individual withdraws money from the account. In general, a Roth IRA is subject to the same rules that apply to a traditional IRA.

For tax year 2017, the Roth IRA allows individuals under the age of 50 to make a maximum annual nondeductible contribution of up to $5,500 ($6,500 if age 50 or older). However, no more than $5,500 ($6,500 if age 50 or older) can be contributed to all of an individual's IRAs, whether they are traditional (deductible) or Roth (not deductible). Basically, a Roth IRA is an IRA that is subject to the rules that apply to a traditional IRA with the following exceptions: (194)

The taxpayer can make contributions after age 70½. The taxpayer cannot deduct contributions to a Roth IRA. The taxpayer can leave amounts in the Roth IRA as long as he or she lives. The account or annuity must be designated as a Roth IRA when it is set up. Distributions for any of the following purposes are not taxable if: (198)

o 5 year holding period has been met. o Made on or after age 59½. o Made to an individual's beneficiary or estate at death. o Made when the individual becomes disabled. o Made for a qualified purpose, such as first-time home buyer expenses, subject to a $10,000 lifetime cap.

There are several restrictions that the taxpayer should be aware of. One restriction is that a payment or distribution is not a qualified distribution if it is made less than 5 tax years from the first tax year in which the individual made a contribution to a Roth IRA. Another restriction is that a rollover from a deductible IRA to a Roth IRA will be taxable. The following table shows whether a taxpayer’s contribution to a Roth IRA is affected by the amount of his or her modified AGI as computed for Roth IRA purpose.

Amount of Roth IRA Contributions That a Taxpayer Can Make For 2017 Filing Status Modified AGI Amount Contribution Amount

Single, Head of Household or Married Filing Separately (taxpayer did not live with his or her spouse at any time during the year)

$118,000 or less Up to Contribution Limit

$118,000 - $133,000 Reduced Amount

$133,000 or more $0

Married filing jointly or Qualifying Widow(er)

$186,000 or less Up to Contribution Limit $186,000 - $196,000 Reduced Amount

$196,000 or more $0 Married filing separately (taxpayer lived with his or her spouse at any time during the year)

Less than $10,000 Reduced Amount

$10,000 or more $0

Table 11-3 - Amount of Roth IRA Contributions (2017)

If the amount the taxpayer can contribute must be reduced, figure his or her reduced contribution limit as follows:

1. Start with his or her modified AGI.

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2. Subtract from the amount in (1): a. $186,000 if filing a joint return or qualifying widow(er), b. $0 if married filing a separate return, and the taxpayer lived with his or her spouse at any time during the

year, or c. $118,000 for all other individuals.

3. Divide the result in (2) by $15,000 ($10,000 if filing a joint return, qualifying widow(er), or married filing a separate return and the taxpayer lived with his or her spouse at any time during the year).

4. Multiply the maximum contribution limit (before reduction by this adjustment and before reduction for any contributions to traditional IRAs) by the result in (3).

5. Subtract the result in (4) from the maximum contribution limit before this reduction. 6. The result is the taxpayer’s reduced contribution limit.

Designated Roth Accounts - In-Plan Rollovers to Designated Roth Accounts A plan with a designated Roth program may allow participants to transfer eligible rollover distributions to a designated Roth account from another account in the same plan. The Roth contribution program must be in place before a plan can offer in-plan Roth rollovers. A Roth program cannot be set up solely to accept in-plan rollovers - it must also accept elective deferrals from participants. Not all pre-tax plan balances can be transferred to a designated Roth account. To be eligible for an in-plan rollover, the amount must be eligible for distribution to the participant under the terms of the plan and must be otherwise eligible for rollover (an eligible rollover distribution). In general, an eligible rollover distribution is a distribution that is not: (199)

A required minimum distribution. A corrective distribution of excess contributions or deferrals. A hardship distribution. A loan treated as a distribution. A distribution that is one of a series of substantially equal payments made at least annually over a lifetime or 10

years. Dividends on employer securities. The cost of life insurance coverage.

The value of the distribution less the participant’s basis, if any (the taxable amount of the distribution) must be included in the participant’s gross income. For a typical rollover of money from a pre-tax 401(k) account, the entire amount of the rollover, including earnings, will be taxable. The additional 10% early withdrawal tax does not apply to an in-plan Roth rollover. However, there are special rules that could make the rollover subject to this tax if it is withdrawn from the designated Roth account within five years.

20% mandatory withholding does not apply to an in-plan Roth direct rollover. However, if the taxpayer receives his or her distribution in cash, 20% withholding will apply even if the amount is rolled over to a designated Roth account within 60 days. (199)

IRA Catch-Up Amounts A taxpayer who will be at least age 50 by the end of the tax year is able to make an additional contribution to a traditional IRA (or Roth IRA). For tax year 2017, the maximum annual amount of the catch-up contribution is $1,000, so the total contribution maximum is $6,500. In future years, the maximum catch-up amount will remain at $1,000. SIMPLE IRA A SIMPLE IRA plan (Savings Incentive Match Plan for Employees) allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan. SIMPLE IRA plans can provide a significant source of income at retirement by allowing employers and employees to set aside money in retirement accounts. SIMPLE IRA plans do not have the start-up and operating costs of a conventional retirement plan.

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The amount the employee contributes to a SIMPLE IRA cannot exceed $12,500 in 2017. If an employee participates in any other employer plan during the year and has elective salary reductions under those plans, the total amount of the salary reduction contributions that an employee can make to all the plans he or she participates in is limited to $18,000 in 2017. SIMPLE IRA contributions include: (200)

Salary reduction contributions. Employer contributions:

o Matching contributions. o Nonelective contributions.

No other contributions can be made to a SIMPLE IRA plan. The following are specifics regarding a SIMPLE IRA: (200)

Available to any small business – generally with 100 or fewer employees. Easily established by adopting Form 5304-SIMPLE, 5305-SIMPLE, a SIMPLE IRA prototype or an individually

designed plan document. Employer cannot have any other retirement plan. No filing requirement for the employer.

The following are specifics regarding contributions to a SIMPLE IRA: (200)

Employer is required to contribute each year either a: o Matching contribution up to 3% of compensation. o 2% non-elective contribution for each eligible employee.

Under the non-elective contribution formula, even if an eligible employee doesn’t contribute to his or her SIMPLE IRA, that employee must still receive an employer contribution to his or her SIMPLE IRA equal to 2% of his or her compensation.

Employees may elect to contribute. Employee is always 100% vested in (or, has ownership of) all SIMPLE IRA money.

Employers must deposit employees’ salary reduction contributions to the SIMPLE IRA within 30 days after the end of the month in which the employee would have received them in cash. They must make matching contributions or nonelective contributions by the due date (including extensions) of their Federal income tax return for the year. SIMPLE Plan Catch-Up Amounts A SIMPLE IRA or a SIMPLE 401(k) plan may permit catch-up contributions up to $3,000 in 2017 for individuals aged 50 or over. Salary reduction contributions in a SIMPLE IRA plan are not treated as catch-up contributions for 2017 until they exceed $12,500. Catch-Up Contributions Individuals who are age 50 or over at the end of the calendar year can make annual catch-up contributions. Catch-up contributions up to $6,000 in 2017 may be permitted by these plans: (201)

401(k) (other than a SIMPLE 401(k)) 403(b) SARSEP Governmental 457(b)

Elective deferrals are not treated as catch-up contributions until they exceed the $18,000 limit in 2017, the ADP test limit of Section 401(k)(3) or the plan limit (if any). A participant can make catch-up contributions for a year up to the lesser of the following amounts:

The catch-up contribution dollar limit. The excess of the participant's compensation over the elective deferral contributions that are not catch-up

contributions.

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Plan participants must make catch-up contributions to a retirement plan via elective deferrals. Catch-up contributions must be made before the end of the plan year. Lump-Sum Distributions A lump-sum distribution is the distribution or payment, within one tax year, of a plan participant's entire balance from all of the employer's qualified pension, profit-sharing, or stock bonus plans. All of the participant's accounts under the employer's qualified pension, profit-sharing, or stock bonus plans must be distributed in order to be a lump-sum distribution. If a taxpayer received a lump-sum distribution from a qualified retirement plan or a qualified retirement annuity and he or she was born before January 2, 1936, he or she may be able to elect optional methods of figuring the tax on the distribution. These optional methods can be elected only once after 1986 for any eligible plan participant. Additionally, a lump-sum distribution is a distribution that was paid: (202)

Because of the plan participant's death. After the participant reaches age 59½. Because the participant, if an employee, separates from service. After the participant, if a self-employed individual, becomes totally and permanently disabled.

A distribution from a nonqualified plan (such as a privately purchased commercial annuity or a Section 457 deferred compensation plan of a state or local government or tax-exempt organization) cannot qualify as a lump-sum distribution. The participant's entire balance from a plan does not include certain forfeited amounts. It also does not include any deductible voluntary employee contributions allowed by the plan after 1981 and before 1987. The taxpayer should receive a Form 1099-R - Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. from the payer of the lump-sum distribution showing his or her taxable distribution and the amount eligible for capital gain treatment. If the taxpayer does not receive Form 1099-R by January 31st of the year following the year of the distribution, he or she should contact the payer of the lump-sum distribution. The part from active participation in the plan before 1974 may qualify as capital gain subject to a 20% tax rate. The part from participation after 1973 (and any part from participation before 1974 that the taxpayer does not report as capital gain) is ordinary income. He or she may be able to use the 10-year tax option to figure tax on the ordinary income part. Use Form 4972 - Tax on Lump-Sum Distributions to figure the separate tax on a lump-sum distribution using the optional methods. The tax figured on Form 4972 is added to the regular tax figured on the taxpayer’s other income. This may result in a smaller tax than he or she would pay by including the taxable amount of the distribution as ordinary income in figuring the regular tax. Rollovers An IRA rollover occurs when the taxpayer withdraws cash or other assets from one eligible retirement plan and contributes all or part of it, within 60 days, to another eligible retirement plan. This rollover transaction is not taxable but it is reportable on the Federal tax return. A taxpayer can roll over most distributions from an eligible retirement plan except for: (203)

The nontaxable part of a distribution, such as an after-tax contribution to a retirement plan (in certain situations after-tax contributions can be rolled over).

A distribution that is one of a series of payments made for a life (or life expectancy), or the joint lives (or joint life expectancies) of the taxpayer and his or her beneficiary, or made for a specified period of 10 years or more.

A required minimum distribution. A hardship distribution. Dividends on employer securities. The cost of life insurance coverage.

If an eligible rollover distribution is paid, the taxpayer has 60 days from the date he or she received it to roll it over to another eligible retirement plan. Any taxable eligible rollover distribution paid from an employer-sponsored retirement plan to an individual is subject to a mandatory income tax withholding of 20%, even if he or she intends to roll it over later. If the taxpayer does roll it over and wants to defer tax on the entire taxable portion, he or she will have to add funds from other sources equal to the amount withheld. The taxpayer can choose to have the payer transfer a distribution directly to

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another eligible retirement plan or to an IRA. Under this direct rollover option, the 20% mandatory withholding does not apply.

In Revenue Procedure 2016-47, effective August 2016, the IRS has created a new “self-certification” procedure that allows someone who misses the 60-day deadline for rollovers to avoid the expense and delay of obtaining a private letter ruling. Instead, a taxpayer submits a model IRS letter to the new retirement account custodian, checking in that letter one of 11 acceptable excuses for missing the deadline.

A self-certification is not a waiver by the IRS of the 60-day rollover requirement. However, a taxpayer may report the contribution as a valid rollover unless later informed otherwise by the IRS. The IRS, in the course of an examination, may consider whether a taxpayer’s contribution meets the requirements for a waiver. The taxpayer must have missed the 60-day deadline because of his or her inability to complete a rollover due to one or more of the following reasons:

An error was committed by the financial institution receiving the contribution or making the distribution to which the contribution relates.

The distribution, having been made in the form of a check, was misplaced and never cashed. The distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an

eligible retirement plan. The taxpayer’s principal residence was severely damaged. A member of the taxpayer’s family died. The taxpayer or a member of the taxpayer’s family was seriously ill. The taxpayer was incarcerated. Restrictions were imposed by a foreign country. A postal error occurred. The distribution was made on account of a levy under Section 6331 and the proceeds of the levy have been

returned to the taxpayer. The party making the distribution to which the rollover relates delayed providing information that the receiving plan

or IRA required to complete the rollover despite the taxpayer’s reasonable efforts to obtain the information. While the reasons are comprehensive, they only apply if the taxpayer was initially eligible to complete a 60-day rollover. As a result of a 2014 U.S. Tax Court decision, taxpayers may only perform one 60-day IRA rollover every 12 months, no matter how many IRAs they have. The contribution must be made to the plan or IRA as soon as practicable after the reason or reasons listed above no longer prevent the taxpayer from making the contribution. This requirement is deemed to be satisfied if the contribution is made within 30 days after the reason or reasons no longer prevent the taxpayer from making the contribution.

One reason the IRS will not allow is that the taxpayer was using his or her retirement money as a short-term loan for some non-retirement purpose, such as a down payment on a house, and missed the 60-day deadline because of a complication or delay.

IRA One-Rollover-Per-Year Rule As of January 1, 2015, a taxpayer can make only one rollover from a traditional IRA to another (or the same) traditional IRA in any 12-month period, regardless of the number of IRAs he or she owns. The limit will apply by aggregating all of an individual’s IRAs, including SEP and SIMPLE IRAs as well as traditional and Roth IRAs,

effectively treating them as one IRA for purposes of the limit. However, trustee-to-trustee transfers between IRAs and rollovers from traditional to Roth IRAs ("conversions") are not limited. If the taxpayer receives a distribution from an IRA of previously untaxed amounts:

1. He or she must include the amounts in gross income if he or she made an IRA-to-IRA rollover in the preceding 12 months, and

2. He or she may be subject to the 10% early withdrawal tax on the amounts he or she includes in gross income.

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Additionally, if the taxpayer pays the distributed amounts into another (or the same) IRA, the amounts may be:

1. Treated as an excess contribution, and 2. Taxed at 6% per year as long as they remain in the IRA.

The one-per year limit does not apply to:

Rollovers from traditional IRAs to Roth IRAs (conversions). Trustee-to-trustee transfers to another IRA. IRA-to-plan rollovers. Plan-to-IRA rollovers. Plan-to-plan rollovers.

Partial Rollovers If the taxpayer withdraws assets from a traditional IRA, he or she can roll over part of the withdrawal tax free and keep the rest of it. The amount the taxpayer keeps will generally be taxable (except for the part that is a return of nondeductible contributions). The amount he or she keeps may be subject to the 10% additional tax on early distributions. Direct Rollovers The taxpayer’s employer's qualified plan must give him or her the option to have any part of an eligible rollover distribution paid directly to a traditional IRA. The plan is not required to give the taxpayer this option if his or her eligible rollover distributions are expected to total less than $200 for the year. If he or she chooses the direct rollover option, no tax is withheld from any part of the designated distribution that is directly paid to the trustee of the traditional IRA. If any part is paid to the taxpayer, the payer must withhold 20% of that part's taxable amount. SEP-IRA Deduction A Simplified Employee Pension Plan (SEP) plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. A business of any size, even self-employed, can establish a SEP. An employee eligible to participate in an SEP is an individual (including a self-employed individual) who meets all the following requirements:

Has reached age 21. Has worked for the employer in at least 3 of the last 5 years. Received at least $600 in compensation from the employer during the year for 2017.

An employer can use less restrictive participation requirements than those listed, but not more restrictive ones. An employer can exclude the following employees from a SEP:

Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and the employer.

Nonresident alien employees who do not have U.S. wages, salaries or other personal services compensation from the employer.

Contributions an employer can make for 2017 to an employee's SEP-IRA cannot exceed the lesser of: (204)

1. 25% of the compensation, limited to $270,000 per participant, paid to the participants during 2017 from the business that has the plan.

2. $54,000 per participant. An employee cannot contribute to SEPs because SEPs only permit employer contributions. SEPs do not include a salary reduction arrangement. Participants in Salary Reduction Simplified Employee Pension (SARSEP) plans established before 1997 were entitled to elective deferral contributions. For these plans, a participant’s elective deferral contributions are further limited to $18,000 in 2017 or 100% of their compensation, whichever is less. Catch-up contributions are not subject to this limit.

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The My Retirement Account (myRA) The U.S. Department of the Treasury has decided to phase out the myRA retirement savings program and the program is no longer accepting new enrollments. However, existing accounts remain open and accessible at this time. The taxpayer’s account remains open and he or she can continue to manage his or her account. At this time, the taxpayer will be able to continue making deposits and his or her account will continue to earn interest. The funds in the account remain in an investment issued by the U.S. Department of the Treasury. The taxpayer can initiate a transfer of his or her full account balance to another Roth IRA at any time. Before initiating a direct rollover or transfer, the taxpayer will want to identify or open an account at the new Roth IRA provider where he or she will continue to save and invest. Then, by working with a new Roth IRA provider selected, the taxpayer can transfer his or her myRA balance to his or her new Roth IRA. By using a direct rollover or transfer to move the funds, the taxpayer avoids withholding and potential tax liabilities that may apply to earnings if funds paid directly to the taxpayer are not deposited within 60 days of a distribution to a new Roth IRA. If the taxpayer chooses not to transfer his or her balance to another Roth IRA, he or she can make a withdrawal for the amount of his or her myRA balance online by signing into his or her account. To maintain all of the benefits of a Roth IRA, the taxpayer must deposit funds paid to him or her (as well as any tax withholding) into another Roth IRA within 60 days of the distribution. Failure to do so may result in tax liability and penalties related to withdrawn earnings that would have been avoided by working with taxpayer’s new Roth IRA provider to transfer his or her account balance. Any myRA with a zero ($0) balance as of September 15, 2017 or later, will be subject to possible automatic closure beginning on September 18, 2017. If the taxpayer has a $0 balance and recently set up direct deposit with his or her employer, the U.S. Department of the Treasury recommends contacting the taxpayer’s employer to cancel his or her request as soon as possible. Employers may ask the taxpayer to follow their own paper or electronic process to cancel direct deposits. Qualified Retirement Plans There are two broad categories of qualified retirement plans, a defined benefit plan and a defined contribution plan. Defined benefit plans include employer contributed pension and annuity plans that provide a specific retirement benefit to employees. The benefit is usually in the form of a monthly retirement pension that is based on the employee’s wages and years of service with the employer. An employer’s annual contributions to the plan are based on actuarial assumptions and are not allocated to individual accounts maintained for employees. (205) Defined contribution plans include contributions by the employee and/or the employer to the employee’s individual account under the plan. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans. A separate account must be provided for each employee covered by the plan and the employee’s retirement benefit will be based solely on contributions to the account, as well as its investment gains and earnings. The amount for self-employed SEP, SIMPLE, and qualified plans is typically entered on Line 28, Form 1040. Charitable Donations from IRAs The Protecting Americans from Tax Hikes Act of 2015 made permanent the tax exemption of distributions from individual retirement accounts for charitable purposes. Individuals age 70½ or over can exclude up to $100,000 from gross income for donations paid directly to a qualified charity from their IRA. Key points about qualified charitable contributions (QCDs) include:

Married individuals filing a joint return could exclude up to $100,000 donated from each spouse’s own IRA ($200,000 total).

The donation satisfies any IRA required minimum distributions for the year. The amount excluded from gross income is not deductible. Donations from an inherited IRA are eligible if the beneficiary is at least age 70½. Donations from a SEP or SIMPLE IRA are not eligible. Donations from a Roth IRA are eligible.

IRA owners reported charitable donations from an IRA on Form 1040.

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Required Minimum Distributions (RMD) A taxpayer cannot keep retirement funds in his or her account indefinitely. The taxpayer generally has to start taking withdrawals from his or her IRA or retirement plan account when he or she reaches age 70½. Roth IRAs do not require withdrawals until after the death of the owner. These minimum distribution rules apply to: (206)

Traditional IRAs SEP IRAs SIMPLE IRAs 401(k) plans 403(b) plans 457(b) plans Profit sharing plans Other defined contribution plans

The required minimum distribution is the minimum amount a taxpayer must withdraw from his or her account each year. The taxpayer can withdraw more than the minimum required amount. His or her withdrawals will be included in his or her taxable income except for any part that was taxed before (the taxpayer’s basis) or that can be received tax-free (such as qualified distributions from designated Roth accounts). The required minimum distribution for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s Uniform Lifetime Table. A separate table is used if the sole beneficiary is the owner’s spouse who is ten or more years younger than the owner. The beginning date for the first required minimum distribution for IRAs (including SEP and SIMPLE IRAs) is April 1 of the year following the calendar year in which the taxpayer reaches age 70½. The beginning date for the first required minimum distribution for 401(k), profit-sharing, 403(b), or other defined contribution plan is generally, April 1 following the later of the calendar year in which the taxpayer reaches age 70½, or retires.

The plan’s terms may allow the taxpayer to wait until the year he or she actually retires to take his or her first RMD (unless he or she is a 5% owner). Alternatively, a plan may require the taxpayer to begin receiving distributions by April 1 of the year after he or she reaches age 70½, even if he or she has not retired. If the

taxpayer owns 5% or more of the business sponsoring the plan, then he or she must begin receiving distributions by April 1 of the year after the calendar year in which he or she reaches age 70½. For each subsequent year after the taxpayer’s required beginning date, he or she must withdraw his or her RMD by December 31. If the taxpayer does not take any distributions, or if the distributions are not large enough, he or she may have to pay a 50% excise tax on the amount not distributed as required. To report the excise tax, the taxpayer may have to file Form 5329 - Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. For the year of the account owner’s death, use the RMD the account owner would have received. For the year following the owner’s death, the RMD will depend on the identity of the designated beneficiary. The account balance is divided by this life expectancy to determine the RMD. Spouses who are the sole designated beneficiary can: (206)

Treat an IRA as their own. Base RMDs on their own current age. Base RMDs on the decedent’s age at death, reducing the distribution period by one each year. Withdraw the

entire account balance by the end of the 5th year following the account owner’s death, if the account owner died before the required beginning date.

If the account owner died before the required beginning date, the surviving spouse can wait until the owner would have turned 70½ to begin receiving RMDs.

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Individual beneficiaries other than a spouse can: (206)

Withdraw the entire account balance by the end of the 5th year following the account owner’s death, if the account owner died before the required beginning date.

o Calculate RMDs using the distribution period from the Single Life Table based on: o If the owner died after RMDs began, the longer of the:

Beneficiary’s remaining life expectancy determined in the year following the year of the owner’s death reduced by one for each subsequent year.

Owner’s remaining life expectancy at death, reduced by one for each subsequent year. If the account owner died before RMDs began, the beneficiary’s age at year-end following the year of the owner’s

death, reducing the distribution period by one for each subsequent year.

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

Review Questions Answers appear in Review Feedback. 1. In 2017, Andrea, a non-working spouse, files a joint return with Jed, who is not covered by a pension plan at work.

Their AGI is $50,000 and Jed plans to contribute $3,000 to a traditional IRA account. Andrea, who is 51, wishes to contribute to an IRA account. What is the maximum amount she can contribute?

A. $5,000 B. $5,500 C. $6,500 D. $8,000

2. If a calendar-year taxpayer makes a conversion contribution to a Roth IRA on February 25, 2017, and makes a regular

contribution for 2016 on the same date, the 5-year period for the conversion begins January 1, 2017, while the 5-year period for the regular contribution begins on what date?

A. January 1, 2016 B. January 1, 2017 C. February 25, 2017 D. March 25, 2017

3. Partly taxable pensions are taxed under either of which two methods?

A. The General Rule or the Simplified Method B. The General Rule or MACRS C. The Simplified Method or MACRS D. The General Rule or the Multiple Lives Annuity Rule

4. To contribute to a traditional IRA, the taxpayer must be under what age at the end of the tax year?

A. 50 B. 59 ½ C. 70 ½ D. 72

5. Certain unemployed persons who take an early IRA distribution to pay for qualifying medical insurance premiums are

not subjects to the 10% penalty. Eligible unemployed individuals are those who have received Federal or state unemployment compensation for how many consecutive weeks?

A. 10 weeks B. 12 weeks C. 15 weeks D. 18 weeks

6. A lump-sum distribution is the distribution or payment, within how many tax year(s), of a plan participant's entire balance

from an employer's qualified pension? A. One year B. Two years C. Three years D. Four years

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Review Feedback Return to Review Questions Question 1 - C. $6,500 Because Andrea is over age 50 and otherwise qualifies to make a contribution, she can contribute up to $6,500 to her traditional IRA for 2017 ($5,500 regular contribution plus $1,000 catch-up contribution). Question 2 - A. January 1, 2016 The 5-year period used for determining whether the 10% early distribution tax applies to a distribution from a conversion or rollover contribution to a Roth IRA is separately determined for each conversion and rollover and is not necessarily the same as the 5-year period used for determining whether a distribution is a qualified distribution. In this example, if a calendar-year taxpayer makes a conversion contribution on February 25, 2017 and makes a regular contribution for 2016 on the same date, the 5-year period for the conversion begins January 1, 2017, while the 5-year period for the regular contribution begins on January 1, 2016. Question 3 - A. The General Rule or the Simplified Method Partly taxable pensions are taxed under either the General Rule or the Simplified Method. The Modified Accelerated Cost Recovery System (MACRS) is used to recover the basis of most business and investment property placed in service after 1986 and multiple-lives annuities are annuities payable for the lives of more than one annuitant. Question 4 - C. 70 ½ To contribute to a traditional IRA, a taxpayer must be under age 70½ at the end of the tax year. The taxpayer, and/or his or her spouse if filing a joint return, must have taxable compensation, such as wages, salaries, commissions, tips, bonuses, or net income from self-employment. Taxable alimony and separate maintenance payments received by an individual are treated as compensation for IRA purposes. Question 5 - B. 12 weeks Certain unemployed persons who make an early distribution to pay for qualifying medical insurance premiums are not subjects to the 10% penalty. Eligible unemployed individuals are those who have received Federal or state unemployment compensation for 12 consecutive weeks. Qualifying premiums are deductible premiums for the medical care of the unemployed individual, spouse and dependents. Question 6 - A. One year A lump-sum distribution is the distribution or payment in one tax year of a plan participant's entire balance from all of the employer's qualified plans of one kind (for example, pension, profit-sharing, or stock bonus plans).

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Exclusions, Deductions, Expenses, Employee Compensation At the conclusion of this lesson you should have a basic knowledge of:

Deductions for Adjusted Gross Income Education Saving Accounts Health Savings Accounts Moving Expenses Other Expenses Fringe Benefits

Exclusions Many items that are commonly thought of as income are excluded from taxation because of Congressional action; they are called exclusions. The distinction between increases in wealth that are not income, such as gifts, and those that are exclusions has no effect on the amount of tax paid by each taxpayer. Both types are subtracted from the taxpayer's total increase in wealth for a taxable year to arrive at the taxpayer's gross

income. However, the distinction can be important because some exclusions must be reported on Form 1040 or Form 1040A. For now, keep in mind that excludable and nontaxable mean about the same thing. These exclusions (and exemptions) should not be confused with deductions from Gross Income (such as Moving expenses, Alimony paid, etc.) or from Adjusted Gross Income (such as Standard Deduction or any Itemized Deduction), which must be shown on an individual’s income tax return. Generally, an exclusion does not have to be posted on a tax return.

It is important to note that most of the exclusions which deal with employer-employee relations are tax-free only if the benefits are provided on a nondiscriminatory basis to all employees. That is, the plans must not favor highly compensated employees or owner-employees. These nondiscrimination rules apply to group term life

insurance plans, accident and health plans, legal assistance plans, educational assistance plans, and dependent care assistance plans, to mention only a few. Exclusions Related to Illness There are four primary groups of exclusions relating to illness: (207)

1. Payments made by an employer to a Health Savings Account and other tax-favored health plans on behalf of the employee to provide health and accident coverage for the employee and his or her family. This covers not only medical expenses, but also disability insurance. (208)

2. Amounts which are received by an employee under an accident and health plan which reimburse him or her for amounts spent for medical services. (110)

3. Amounts which are received by an employee directly from his or her employer which reimburse him or her for amounts spent for medical services. (110)

4. Amounts which represent restitution for a permanent loss of, or loss of use of, a member or function of the body, or for permanent disfigurement of the taxpayer, his or her spouse, or a dependent. (209)

Compensation received under the following special provisions is also excluded: (110)

Workers’ compensation. Damages for personal injury, such as for injuries the taxpayer received in an auto accident while traveling on

personal time. Medical pensions and allowances resulting from injuries or illnesses while in the armed forces. Payments made to government employees for injuries received during terrorist attacks outside the U.S. Compensatory damages received for physical injury or physical sickness, whether paid in a lump sum or in

periodic payments.

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Exclusions Related to Death The following exclusions relate to the death of the taxpayer: (113)

Premiums paid by an employer for group-term life insurance, up to $50,000 face amount for each employee. Policies of this type provide only temporary coverage, and do not have a cash surrender or loan value. When the face amount of the policy is greater than $50,000, then the premium applicable to the excess is taxable income to the employee. (210)

Amounts received by beneficiaries of life insurance contracts because of the death of the insured are, with minor exceptions, excluded from income. So are amounts received under a life insurance contract from a terminally ill taxpayer. (211)

Exclusions Related to Age Our tax laws reflect a continuing concern about the social and economic needs of the aged. Prior to 1983, the entire amount of Social Security benefits and Railroad Retirement benefits received could be excluded. In 1993, as part of Omnibus Budget Reconciliation Act, the Social Security taxation provision was modified to add a secondary set of thresholds and a higher taxable percentage for beneficiaries who exceeded the secondary thresholds.

Generally, if Social Security benefits were the only income for the tax year, the benefits are not taxable. However, if the taxpayer received income from other sources, up to 50% of the retirement benefit will be taxable if the total of one-half of the benefits and adjusted gross income is more than the following base amount for his or her filing status. The base amounts are: (212)

$25,000 if the taxpayer is single, head of household, or qualifying widow(er). $25,000 if the taxpayer is married filing separately and lived apart from his or her spouse for all of the current year. $32,000 if the taxpayer is married filing jointly. $0 if the taxpayer is married filing separately and lived with his or her spouse at any time during the current year.

Additionally, up to 85% of the retirement benefit will be taxable if one-half of the Social Security benefit plus adjusted gross income exceeds the following secondary base amount for filing status: (212)

$44,000 for married couples filing jointly. $34,000 for single, head of household, qualifying widow/widower with a dependent child, or married individuals

filing separately who did not live with their spouses at any time during the year. $0 for married persons filing separately who lived together during the year.

Annual Gift Tax Exclusion In 2017, a taxpayer can give $14,000 per person, to any number of people, and none of the gifts will be taxable. A separate annual exclusion applies to each person and the exclusion is subject to cost-of-living increases. The exclusion applies to the transfer by gift of any property. The taxpayer makes a gift if he or she gives property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. The basis of property received as a gift is the donor's carry-over basis (adjusted basis). If a taxpayer sells something at less than its full value or if he or she makes an interest-free or reduced-interest loan, it may be a gift. In addition to the annual exclusion, a taxpayer also can give the following without triggering the gift tax: (213)

Charitable gifts. Gifts to a spouse. Gifts to a political organization for its use. Gifts of educational expenses. These are unlimited as long as the taxpayer makes a direct payment to the

educational institution for tuition only. Gifts of medical expenses. These, too are unlimited as long as they are paid directly to the medical facility.

If the taxpayer or his or her spouse made a gift to a third party, the gift can be considered as made one-half by the taxpayer and one-half by his or her spouse. This is known as gift splitting. Both of the spouses must agree to split the gift. If they do, each can take the annual exclusion for his or her part of the gift. For gifts made in 2017, gift splitting allows married couples to give up to $28,000 to a person without making a taxable gift. If the taxpayers split a gift they made, both must file a gift tax

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return to show that the taxpayer and his or her spouse agree to use gift splitting. Form 709 must be filed even if half of the split gift is less than the annual exclusion. Exclusions and Intergovernmental Relations The Federal tax law specifically excludes interest received from any city, state, territory, or any political subdivision, or the District of Columbia. These rules also exclude amounts received from any possession of the United States. This exclusion is one of the most widely used tax-planning tools at present. Welfare payments by state and other governmental units remain excluded from taxation. (214) Exclusions Related to Education Institutions for higher learning very often grant scholarships and fellowships to outstanding students, and to good students who need assistance to pursue their program of study. A fellowship or scholarship grant qualifies for an exclusion if the person receiving it is a candidate for a degree, and if the payments are made for tuition, books, fees, supplies and equipment. Amounts received for meals and lodging, or other expenses must be included by the taxpayer as income. The amounts received may not represent compensation for past, present, or future services of any kind. If the student is required to perform duties such as teaching classes or grading papers, and these chores are not required of all candidates for the degree, then the exclusion does not apply. (215) Exclusion Related to Foreign-Earned Income

As mentioned previously, every citizen of the United States is subject to the income tax, even if they are residents of a foreign country receiving income from foreign sources. Special provisions are available, however, so that these taxpayers are not taxed heavier than citizens residing in the United States because of the foreign taxes they must pay and the higher cost of living in the foreign country. To qualify for the Foreign Earned Income Exclusion, however, U.S. citizens must establish that they are bona fide residents of a foreign country, or resident aliens who

are present in a foreign country at least 330 days out of any consecutive twelve-month period. Single taxpayers meeting the above qualifications may exclude up to $102,100 for tax year 2017, up from $101,300, for 2016. If married and both individuals work abroad and both meet either the bona fide residence test or the physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $204,200 for the 2017 tax year. (216) The taxpayer can also choose to exclude from income a foreign housing amount. If he or she chooses to exclude a foreign housing amount, the taxpayer must figure the foreign housing exclusion before the foreign earned income exclusion. The foreign earned income exclusion is limited to the foreign earned income minus the foreign housing exclusion. The foreign housing exclusion applies only to amounts considered paid for with employer provided funds and is the total of the housing expenses for the year minus the base housing amount. The taxpayer’s housing amount is the total of his or her housing expenses for the year minus the base housing amount. The computation of the base housing amount (line 32 of Form 2555 - Foreign Earned Income) is tied to the maximum foreign earned income exclusion. The amount is 16% of the exclusion amount (computed on a daily basis), multiplied by the number of days in the taxpayer’s qualifying period that fall within his or her tax year. (216)

Deductions for Adjusted Gross Income Adjusted Gross Income is defined as gross income minus adjustments to income. These adjustments are deductions for adjusted gross income, or what many professional tax preparers call "above the line deductions”. Some common adjustments to income include:

50% of Self-employment tax. 100% of Self-employment health insurance premiums. Penalties on early withdrawal of savings. Alimony paid. Student loan interest paid up to $2,500. Jury duty income repaid to employer.

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Teachers’ Classroom Expenses If the taxpayer is an eligible educator, he or she can deduct up to $250 ($500 if married filing jointly and both spouses are educators, but not more than $250 each) of any unreimbursed expenses (otherwise deductible as a trade or business expense). Qualified expenses are amounts the taxpayer paid or incurred for books, supplies, computer equipment (including related software and services), other equipment, and supplementary materials that he or she uses in the classroom. For courses in health and physical education, expenses for supplies are qualified expenses only if related to athletics. This deduction is for expenses paid or incurred during the tax year.

The Protecting Americans from Tax Hikes Act of 2015 made the above-the-line deduction for certain qualified expenses of elementary and secondary school teachers permanent.

Armed Forces Reservists If a member of a reserve component of the Armed Forces of the United States travels more than 100 miles away from home in connection with the performance of services as a member of the reserves, the reservist can deduct travel expenses as an adjustment to gross income rather than as a miscellaneous itemized deduction. The amount of expenses such a taxpayer can deduct as an adjustment to gross income is limited to the Federal per diem rate (for lodging, meals, and incidental expenses) and the standard mileage rate (for car expenses) plus any parking fees, ferry fees, and tolls. Any expenses in excess of these amounts can be claimed only as a miscellaneous itemized deduction subject to the 2% limit. If the taxpayer has reserve-related travel that takes him or her more than 100 miles from home, he or she should first complete Form 2106 - Employee Business Expenses or Form 2106-EZ - Unreimbursed Employee Business Expenses. Then include his or her expenses for reserve travel over 100 miles from home, up to the Federal rate, from Form 2106, line 10, or Form 2106-EZ, line 6, in the total on Form 1040, line 24. Subtract this amount from the total on Form 2106, line 10, or Form 2106-EZ, line 6, and deduct the balance as an itemized deduction on Schedule A (Form 1040), line 21. (217) Performing Artists If a taxpayer is a performing artist, such a taxpayer may qualify to deduct his or her employee business expenses as an adjustment to gross income rather than as a miscellaneous itemized deduction. This adjustment is arrived at using Form 2106 or 2106-EZ and is posted on Form 1040, Line 24. To qualify, the performing artist must meet all of the following requirements: (217)

1. During the tax year, he or she performed services in the performing arts as an employee for at least two employers. 2. The artist received at least $200 each from any two of these employers. 3. Such a taxpayer’s related performing-arts business expenses are more than 10% of the taxpayer’s gross income

from the performance of those services. 4. Such a taxpayer’s adjusted gross income is not more than $16,000 before deducting these business expenses.

Officials Paid on a Fee Basis Certain fee-basis officials can claim their employee business expenses whether or not they itemize their other deductions on Schedule A (Form 1040). Fee-basis officials are persons who are employed by a state or local government and who are paid in whole or in part on a fee basis. Such taxpayers can deduct their business expenses in performing services in that job as an adjustment to gross income (rather than as a miscellaneous itemized deduction). Claim this adjustment on Form 1040, Line 24. (218)

Coverdell Education Savings Accounts (CESA) The American Taxpayer Relief Act made permanent the $2,000 total contributions per year for the beneficiary of a Coverdell ESA. Low and middle-income taxpayers may open up a Coverdell Education Savings Account (CESA) for qualified higher education as well as elementary and secondary education expenses (i.e., grades kindergarten through 12). The school may be public, private or religious. Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed. A Coverdell ESA is a tax-exempt trust. The requirements to establish a CESA are: (219)

1. When the account is established, the designated beneficiary must be under the age of 18 or a special needs beneficiary.

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2. Except in the case of rollover contributions, annual contributions may not exceed $2,000. 3. The account must be designated as a Coverdell ESA when it is created. 4. The document creating and governing the account must be in writing and must meet certain requirements. 5. Contributions must be in cash. 6. The trustee must be a bank or other qualified person. 7. No portion of the trust’s assets may be invested in life insurance contracts. 8. Trust assets must not be commingled with other property, except in a common trust or investment fund. 9. Upon death of the beneficiary, any balance in the fund must be distributed to the beneficiary’s estate within 30

days of death. Qualified High Education Expenses are related to enrollment or attendance at an eligible post-secondary school. To be qualified some expenses must be required by the school and some must be incurred by students who are enrolled at least half time. (220)

The following expenses must be required for enrollment or attendance of a designated beneficiary at an eligible postsecondary school:

o Tuition and fees. o Books, supplies, and equipment.

Expenses for special needs services needed by a special needs beneficiary must be incurred in connection with enrollment or attendance at an eligible postsecondary school.

Expenses for room and board must be incurred by students who are enrolled at least half-time. The expense for room and board qualifies only to the extent that it is not more than the greater of the following

two amounts: o The allowance for room and board, as determined by the school, that was included in the cost of

attendance (for Federal financial aid purposes) for a particular academic period and living arrangement of the student.

o The actual amount charged if the student is residing in housing owned or operated by the school. Qualified Elementary and Secondary Education Expenses are expenses related to enrollment or attendance at an eligible elementary or secondary school. As shown in the following list, to be qualified, some of the expenses must be required or provided by the school. There are special rules for computer-related expenses. (220) The following expenses must be incurred by a designated beneficiary in connection with enrollment or attendance at an eligible elementary or secondary school: (220)

Tuition and fees. Books, supplies, and equipment. Academic tutoring. Special needs services for a special needs beneficiary.

The following expenses must be required or provided by an eligible elementary or secondary school in connection with attendance or enrollment at the school: (220)

Room and board. Uniforms. Transportation. Supplementary items and services (including extended day programs).

The purchase of computer technology, equipment, or internet access and related services is a qualified elementary and secondary education expense if it is to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in elementary or secondary school. (This does not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature). The maximum annual contribution that could be made to a CESA is $2,000 per beneficiary; and, the annual contribution is phased out for joint filers with modified adjusted gross income at or above $190,000 and less than $220,000 (at or above $95,000 and less than $110,000 for single filers). (220)

Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed. The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution.

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CESA Distributions Amounts remaining in the account must be distributed within 30 days after the beneficiary reaches age 30 or 30 days after the death of the beneficiary. One way of avoiding taking an unwanted distribution is to take advantage of the rollover provision for Coverdell ESAs. Distributed amounts are not subject to Federal income taxes if they are rolled-over to another ESA for the benefit of the same beneficiary or a member of the beneficiary's family that is under the age of 30 including: (220)

Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them. Brother, sister, stepbrother, or stepsister. Father or mother or ancestor of either. Stepfather or stepmother. Son or daughter of a brother or sister. Brother or sister of father or mother. Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. The spouse of any individual listed above. First cousin.

The age limit does not apply to beneficiaries with special needs. CESA Coordination with Other Education Benefits The American opportunity or Lifetime learning credit can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used for both benefits. Qualified expenses will first be reduced for tax-exempt scholarships or fellowship grants and any other tax-free educational benefits. Expenses will then be reduced for amounts taken into account in determining the American opportunity and Lifetime learning credits. Where a student receives distributions from both a CESA and a qualified tuition program that together exceed these remaining expenses, the expenses must be allocated between the distributions. (220) Generally, contributions to CESAs are treated as gifts to the beneficiaries. Distributions from CESAs are excludable from gross income to the extent that the distribution does not exceed the qualified higher education expenses incurred by the beneficiary during the year in which the distribution is made. Qualified distributions, with the exception of room and board, are tax exempt regardless of whether the beneficiary attends an eligible educational institution on a full-time, half-time, or less than half-time basis. Room and board expenses constitute qualified higher education expenses only if the student is enrolled at an eligible institution on at least a half-time basis. Distributions are deemed paid from both contributions (which are always tax free) and earning (which may be excludable). The amount of contributions distributed is determined by multiplying the distribution by the ratio that the aggregate amount of contributions bears to the total balance of the account at the time the distribution is made. If aggregate distributions exceed expenses during the tax year, qualified education expenses are deemed to be paid from a pro rata share of both principal and interest. To calculate, the portion of earnings excludable from income is based on the ratio that the qualified higher education expenses bear to the total amount of the distribution. The remaining portion of earnings is included in the income of the distributee. The tax imposed on any taxpayer who receives a payment or distribution from a CESA that is includible in gross income will be increased by an additional 10% penalty. Qualified higher education expenses include tuition, fees, books, supplies and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution fall under the definition of qualified education expenses. The term also generally includes the room and board expenses. Also, for students residing in housing owned or operated by an eligible educational institution, the term will be expanded to cover, if greater, the actual room and board expenses charged by the institution. Room and board expenses are considered qualified higher education costs only if the designated beneficiary is enrolled in a degree, certificate, or other program leading to a recognized educational credential at an eligible educational institution and the student carries at least one-half the normal full-time work-load for the course of study pursued. Furthermore, funds from a CESA may be used to pay for elementary and secondary education expenses, including tutoring, computer equipment, room and board, uniforms and extended day program costs.

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An eligible educational institution is generally an accredited postsecondary educational institution providing credit towards a bachelor’s degree, an associate’s degree, a graduate-level or professional degree, or another recognized postsecondary credential. Generally, proprietary and postsecondary vocational institutions are eligible educational institutions. Section 529 Plan A Qualified Tuition Program (QTP) is also called a Section 529 plan. If the program is established and maintained by a state, or agency or instrumentality of a state, the program may allow either prepaying or contributing to an account for paying a beneficiary's qualified higher education expenses at an eligible educational institution. Eligible educational institutions can also establish and maintain QTPs but only to allow prepaying a beneficiary's qualified higher education expenses. Contributions to a QTP on behalf of any beneficiary cannot be more than the amount necessary to provide for the qualified higher education expenses of the beneficiary. Contact the program’s trustee or administrator to determine the program’s contribution limit. Contributions made to a QTP are not deductible on the taxpayer’s Federal tax return. The benefits of establishing a QTP are that earnings accumulate tax free while in the account, and no tax is due on a distribution that is used to pay qualified higher education expenses. The beneficiary generally does not have to include in income any of the earnings from a QTP unless the amount distributed is greater than the beneficiary's qualified higher education expenses. The important differences between a Coverdell ESA and a 529 plan include: (221)

529 plans do not have age limits on beneficiaries, while Coverdell ESAs must be used, or rolled-over to another beneficiary, by age 30.

Contribution limits for Coverdell ESAs are much lower than 529 plans. While the annual contributions are almost limitless for 529 plans, Coverdell contributions are limited to $2,000 per year.

Coverdell ESAs can offer taxpayers a much broader range of investment options when compared to state run 529 plans.

Coverdell ESAs offer greater flexibility when using the funds for qualified education expenses. For example, the account can be used to pay for expenses of qualified elementary and secondary schools.

Qualified Student Loan Generally, personal interest the taxpayer pays, other than certain mortgage interest, is not deductible on his or her tax return. However, if the taxpayer’s modified adjusted gross income (MAGI) is less than $80,000 ($165,000 if filing a joint return) there is a special deduction allowed for paying interest on a student loan (also known as an education loan) used for higher education. For most taxpayers, MAGI is the adjusted gross income as figured on their Federal income tax return before subtracting any deduction for student loan interest. This deduction can reduce the amount of the taxpayer’s income subject to tax by up to $2,500. A qualified student loan is any loan an individual took out to pay the qualified higher education expenses for his or her self, for his or her spouse, or any for any person who was the taxpayer’s dependent when the student loan was taken out (usually for a son or daughter). The loan must be for an eligible student and pay for qualified higher education expenses. An eligible student is a person who:

1. Was enrolled in a degree, certificate, or other program (including a program of study abroad that was approved for credit by the institution at which the student was enrolled) leading to a recognized educational credential at an eligible educational institution and

2. Carried at least half the normal full-time workload for the course of study he or she was pursuing. For purposes of the student loan interest deduction, these expenses are the total costs of attending an eligible educational institution, including graduate school. They include amounts paid for the following items: (222)

Tuition and fees. Room and board. Books, supplies and equipment. Other necessary expenses (such as transportation).

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The cost of room and board qualifies only to the extent that it is not more than the greater of:

The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for Federal financial aid purposes) for a particular academic period and living arrangement of the student.

The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

Qualified education expenses must be reduced by certain non-taxable benefits such as employer-provided educational assistance, excludable U.S. Series EE and I savings bond interest (from Form 8815 - Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989), nontaxable qualified state tuition program earnings, nontaxable earnings from Coverdell education savings accounts, and any scholarship, educational assistance allowance, etc. Furthermore, a loan is not a qualified student loan if any of the proceeds were used for other purposes or the loan was from either a related person or a person who borrowed the proceeds under a qualified employer plan or a contract purchased under such a plan. (223)

Health Savings Account Deduction Health Savings Accounts Individuals and employees, through an employer’s cafeteria plan, can establish Health Savings Accounts (HSA) to reimburse them for qualified medical expenses paid during the year. For 2017, these accounts allow taxpayers with high deductible health insurance to make pre-tax contributions for self-coverage of up to $3,400 each year ($6,750 for family coverage) to cover health care costs. Amounts are excluded from gross income if paid or distributed from an HSA that is used exclusively to pay the qualified medical expenses of the account beneficiary or dependent. Other distributions are included in income and subject to an additional 20% tax unless made after the participant reaches age 65, dies or becomes disabled. Qualified medical expenses are the same expenses that qualify for the medical expenses deduction. An exception is that premiums for long-term care and coverage during periods of unemployment, whether through COBRA or not, also qualify. (224)

In order for an individual to be eligible for an HSA, on the first day of each month, the individual must be covered by a high deductible health plan and not covered by any other health plan that is not a high deductible health plan. Individual eligibility for an HSA is determined on a monthly basis. For 2017, a high deductible health plan is defined as a plan that has at least a $1,300 annual deductible for self-only coverage and a $2,600 deductible

for family coverage. In addition, annual out-of-pocket expenses paid under the plan must be limited to $6,550 for individuals and $13,100 for families. Out-of-pocket expenses include deductibles, co-payments and other amounts (does not include premiums) that must be paid for plan benefits. Contributions to HSAs are deductible in determining adjusted gross income. The maximum annual aggregate contribution to an HSA is the lesser of the amount of the annual deductible for the high deductible health plan or the maximum deductible permitted under an Archer Medical Savings Account (MSA). Excess contributions are subject to a 6% excise tax and are includible in gross income. Additionally, contributions by an employer that exceed the annual HSA limits are taxable as income to the employee. Taxpayers use Form 8889 - Health Saving Accounts (HSAs) to calculate their HSA deductions and any taxable distributions. (225) Individuals who reach age 55 by the end of the tax year can increase their annual contributions by $1,000. Contributions, however, cannot be made after the participant attains age 65 and is eligible for Medicare. However, distributions for qualified medical expenses continue to be excludable from gross income and premiums for health insurance other than for a Medicare supplemental policy are considered qualified medical expenses. (224) HSAs vs. MSAs HSAs differ from MSAs in several ways. MSAs are limited to individuals working for small employers (generally 50 employees or fewer), or who are self-employed, while there is no such limitation for HSAs. Archer MSA’s generally cannot be established after 2007, although eligible individuals can still make MSA contributions, and receive distributions. HSAs are available for a wider range of high deductible plans than are MSAs. In addition, contributions for MSAs must be made by the self-employed individual or the taxpayer’s employer, while contributions to HSAs may be made by the taxpayer, their family or their employer. Contributions to HSAs may be made even if the individual on whose behalf it is made has no compensation, or if the contribution exceeds the individual’s compensation. (226)

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Other Deductions Moving Expenses The key to understanding the availability of a moving expense deduction is that it must be job related. Employees and self-employed individuals may deduct as an adjustment to gross income the reasonable expenses of moving themselves and their families if the move is related to starting work in a new location. The deduction is computed on Form 3903 - Moving Expenses and reported on Line 26, Form 1040. Deductible moving expenses are limited to the cost of: (227)

Transportation of household goods and personal effects. Travel (including lodging but not meals) to the new residence.

When an automobile is used in making the move, a taxpayer may deduct either:

The actual out-of-pocket expenses incurred (gasoline and oil, but not repairs, depreciation, etc.) A standard mileage allowance. For 2017, the rate is 17 cents per mile, down 2 cents per mile from 2016.

Whether the taxpayer uses actual expenses or the standard mileage rate to figure his or her expenses, the taxpayer can deduct the parking fees and tolls paid to move. The taxpayer cannot deduct any part of general repairs, general maintenance, insurance, or depreciation for his or her car. A taxpayer must meet a distance test, a length-of-employment test and a commencement-of-work test. The new principal place of work must be at least 50 miles farther from the taxpayer’s old residence than the old residence was from the taxpayer’s old place of work. For example, if the taxpayer’s old main job location was 4 miles from his or her former home, his or her new main job location must be at least 54 miles from that former home. If there was no old place of work, the new place of work must be at least 50 miles from the old residence. (137) A taxpayer must also meet a time test. During the 12-month period immediately following the move, the taxpayer must be employed full-time for at least 39 weeks. A self-employed taxpayer must be employed or performing services full-time for at least 78 weeks of the 24-month period immediately following the move and at least 39 weeks during the first 12 months. The full-time work requirement is waived, however, if death, disability, involuntary separation from work (other than for willful misconduct) or transfer to another location for the benefit of the employer occurs. (227) In general, the move must be in connection with the commencement of work at the new location and the moving expenses must be incurred within one year from the time the taxpayer first reports to the new job or business. If the move is not made within one year, the expenses ordinarily will not be deductible unless it can be shown that circumstances prevented incurring the expenses within that period. An eligible taxpayer is permitted to deduct moving expenses in 2017 even though the 39 or 78-week residence requirement has not been satisfied by the due date for the return (including extensions) for the tax year in which the moving expenses were incurred and paid. The taxpayer can do this if he or she expects to meet the 39-week test in 2018 or the 78-week test in 2018 or 2019. However, a taxpayer who fails to meet the requirements must either file an amended return or include as gross income on the next year's return the amount previously claimed as expenses. Gross income does not include qualified moving expense reimbursements received from an employer as a payment for or reimbursement of expenses that would be deductible as a moving expense if directly paid or incurred by the employee. Any amount other than a qualified reimbursement received or accrued, directly or indirectly, from the employer as a payment for or reimbursement of moving expenses must be included in the employee’s gross income as compensation for services and is considered wages subject to withholding. None of the following expenses are deductible as moving expenses: (227)

Any part of the purchase price of a new home. Car tags. Driver's license. Expenses of buying or selling a home (including closing costs, mortgage fees, and points). Expenses of entering into or breaking a lease. Home improvements to help sell the home. Loss on the sale of the home.

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Losses from disposing of memberships in clubs. Mortgage penalties. Pre-move house hunting expenses. Real estate taxes. Refitting of carpet and draperies. Return trips to a former residence. Security deposits (including any given up due to the move). Storage charges except those incurred in transit and for foreign moves.

Moving Expense Reimbursement If the taxpayer receives a reimbursement for moving expenses, how he or she reports this amount and his or her expenses depends on whether the reimbursement is paid to the taxpayer under an accountable plan or a nonaccountable plan. The employer should tell the taxpayer what method of reimbursement is used and what records are required. To be an accountable plan, the employer's reimbursement arrangement must require the taxpayer to meet all three of the following rules: (227)

1. His or her expenses must have a business connection – that is, the taxpayer must have paid or incurred deductible expenses while performing services as an employee of the employer. Two examples of this are the reasonable expenses of moving the possessions from the former home to the new home, and traveling from the former home to the new home.

2. The taxpayer must adequately account to the employer for these expenses within a reasonable period of time. 3. The taxpayer must return any excess reimbursement or allowance within a reasonable period of time.

If for all reimbursements the taxpayer meets the three rules for an accountable plan, his or her employer should not include any reimbursements of expenses in his or her income in box 1 of the Form W-2 - Wage and Tax Statement. Instead, the employer should include the reimbursements in box 12 of the taxpayer’s Form W-2 with Code P. If the taxpayer’s moving expenses are more than his or her reimbursement, he or she may be able to deduct the additional expenses on Form 3903 - Moving Expenses. A nonaccountable plan is a reimbursement arrangement that does not meet the three rules listed earlier under Accountable Plans. In addition, the following payments will be treated as paid under a nonaccountable plan: (227)

Excess reimbursements the taxpayer fails to return to the employer. Reimbursements of nondeductible expenses.

If an arrangement pays for the taxpayer’s moving expenses by reducing his or her wages, salary, or other pay, the amount of the reduction will be treated as a payment made under a nonaccountable plan. This is because the taxpayer is entitled to receive the full amount of his or her pay regardless of whether he or she had any moving expenses. Living Expenses Reimbursement Reimbursement from an insurance company for excess living expenses as a result of destruction of the taxpayer's home by fire or other casualty loss is excluded from the taxpayer's gross income. This exclusion does not apply to an insurance recovery for the loss of rental income. Nor does the exclusion apply to any insurance recovery which compensates for the loss of, or damage to, real or personal property. (228) One Half Self-Employment Tax Deduction The taxpayer can deduct the employer-equivalent portion of self-employment tax in figuring adjusted gross income. This deduction only affects the income tax. It does not affect either net earnings from self-employment or self-employment tax. A taxpayer can claim 50% of what he or she paid in self-employment tax as an income tax deduction. See the Form 1040 and Schedule SE instructions for calculating and claiming the deduction. (188) Self-Employed Health Insurance Deduction Self-employed persons may deduct from gross income 100% of amounts paid during the year for health insurance for themselves, spouses, and dependents. The deduction is limited to the taxpayer’s net earned income derived from the trade

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or business for which the insurance plan was established, minus the deductions for 50% of the self-employment tax and/or the deduction for contributions to Keogh, self-employed SEP or SIMPLE plans. Amounts eligible for the deduction do not include amounts paid during any month, or part of a month, that the self-employed individuals were able to participate in a subsidized health plan maintained by a previous employer or their spouses’ employers. (229) Penalty on Early Withdrawal of Savings Interest that was previously earned on a time savings account or deposit with a savings institution and that is later forfeited because of premature withdrawals is deductible from gross income in the year when the interest is forfeited. The taxpayer can deduct the entire penalty even if it is more than the interest income. The deduction for this penalty is taken on Line 30 of the 1040 return. (136) Alimony Alimony is defined as a payment to or for a spouse or former spouse under a written divorce or separation decree. The following never qualify as being alimony: (91)

Child support. The key to this problem is that true alimony is a deduction to the payer, and is included in the income of the payee. Child support, on the other hand, is never deductible by the payer, and is excluded from the income of the payee.

Non-cash property settlements. The concept is that there was property obtained during the marriage of the parties. This is called marital property.

In a divorce, when there is a splitting of the marital property between the parties, each is theoretically only getting what they had a property right to receive. There are no tax consequences to a party who receives property pursuant to a divorce property settlement agreement.

Use of property. For example, the taxpayer’s former spouse lives rent-free in a home the taxpayer owns and the taxpayer must pay the mortgage, real estate taxes, insurance, repairs, and utilities for the home. Because the taxpayer owns the home and the debts are his or hers, the taxpayer’s payments for the mortgage, real estate taxes, insurance, and repairs are not alimony. Neither is the value of the taxpayer’s former spouse's use of the home

Payments to keep up the payer's property. For example, say that the decree says that a former spouse can live rent free in an apartment that the taxpayer owns. The taxpayer still has to make the mortgage payments and the like. These payments will not be considered alimony.

Voluntary payments. If the decree says a taxpayer is to pay $1,000 a month, and he or she pays $1,200, the additional $200 payment is a voluntary payment and is NOT deductible as alimony.

If the taxpayer must pay all the mortgage payments (principal and interest) on a jointly-owned home, and they otherwise qualify as alimony, he or she can deduct one-half of the total payments as alimony. If the taxpayer itemizes deductions and the home is a qualified home, he or she can claim one-half of the interest in figuring the deductible interest. The taxpayer’s spouse must report one-half of the payments as alimony received. If the taxpayer’s spouse itemizes deductions and the home is a qualified home, he or she can claim one-half of the interest on the mortgage in figuring deductible interest.

The taxpayer can deduct alimony he or she paid, whether or not he or she itemizes deductions on the return. The taxpayer must file Form 1040. He or she cannot use Form 1040A, 1040EZ, or 1040NR. The taxpayer enters the amount of alimony paid on Form 1040, line 31a. In the space provided on line 31b, enter the former spouse's Social Security number. If the taxpayer paid alimony to more than one person, enter the Social Security number of one of

the recipients. Show the Social Security number and amount paid to each other recipient on an attached statement. Enter total payments on line 31a. If the taxpayer does not provide the spouse's Social Security number, he or she may have to pay a $50 penalty and the deduction may be disallowed. Child Support A payment that is specifically designated as child support or treated as specifically designated as child support under a divorce or separation instrument is not alimony. The amount of child support may vary over time. Child support payments are not deductible by the payer and are not taxable to the payee.

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A payment will be treated as specifically designated as child support to the extent that the payment is reduced either: (91)

On the happening of a contingency relating to the child, or At a time that can be clearly associated with the contingency.

A payment may be treated as specifically designated as child support even if other separate payments are specifically designated as child support. If both alimony and child support payments are called for by the taxpayer’s divorce or separation instrument, and he or she pays less than the total required, the payments apply first to child support and then to alimony. Property Settlements Generally, no gain or loss is recognized on a transfer of property from the taxpayer to (or in trust for the benefit of): (91)

His or her spouse. His or her former spouse, but only if the transfer is incident to their divorce.

This rule applies even if the transfer was in exchange for cash, the release of marital rights, the assumption of liabilities, or other consideration. This rule does not apply in the following situations:

The taxpayer’s spouse or former spouse is a nonresident alien. Certain transfers in trust. Certain stock redemptions under a divorce or separation instrument or a valid written agreement that are taxable

under applicable tax law, as discussed in Regulations Section 1.1041-2.

The term property includes all property whether real or personal, tangible or intangible, or separate or community. It includes property acquired after the end of the marriage and transferred to the taxpayer’s former spouse. It does not include services. Tuition and Fees Deduction The Bipartisan Budget Act of 2018 extended through 2017 the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction is capped at $4,000 for an individual whose adjusted gross income (AGI) does not exceed $65,000 ($130,000 for joint filers) or $2,000 for an individual whose AGI does not exceed $80,000 ($160,000 for joint filers). The Tuition and Fees Deduction was not renewed by the Tax Cuts and Jobs Act. Combat Zone Exclusion If the taxpayer is a member of the U.S. Armed Forces who serves in a combat zone, he or she can exclude certain pay from income. This pay is generally referred to as combat pay. The taxpayer does not actually need to show the exclusion on the tax return because income that qualifies for the combat zone exclusion is not included in the wages reported on his or her Form W-2. The month for which the taxpayer received the pay must be a month in which he or she either served in a combat zone or was hospitalized as a result of wounds, disease, or injury incurred while serving in the combat zone. The taxpayer does not have to receive the excluded pay while he or she is in a combat zone, is hospitalized, or in the same year the taxpayer served in a combat zone. If the taxpayer is an enlisted member, warrant officer, or commissioned warrant officer, he or she can exclude the following amounts from income: (95)

Active duty pay earned in any month he or she served in a combat zone. Imminent danger/hostile fire pay. A reenlistment bonus if the voluntary extension or reenlistment occurs in a month he or she served in a combat

zone. Pay for accrued leave earned in any month he or she served in a combat zone. The Department of Defense must

determine that the unused leave was earned during that period. Pay received for duties as a member of the Armed Forces in clubs, messes, post and station theaters, and other

non-appropriated fund activities. The pay must be earned in a month he or she served in a combat zone. Awards for suggestions, inventions, or scientific achievements he or she is entitled to because of a submission

he or she made in a month he or she served in a combat zone.

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Student loan repayments. If the entire year of service required to earn the repayment was performed in a combat zone, the entire repayment made because of that year of service is excluded. If only part of that year of service was performed in a combat zone, only part of the repayment qualifies for exclusion. For example, if the individual served in a combat zone for 5 months, 5/12 of the repayment qualifies for exclusion.

Retirement pay and pensions do not qualify for the combat zone exclusion. Employee Educational Assistance Plans If a taxpayer receives educational assistance benefits from his or her employer under an educational assistance program, he or she can exclude up to $5,250 of those benefits each year. This means the taxpayer’s employer should not include the benefits with his or her wages, tips, and other compensation shown in box 1 of his or her Form W-2. If the taxpayer’s employer pays more than $5,250 for educational benefits for him or her during the year, the taxpayer must generally pay tax on the amount over $5,250. His or her employer should include in his or her wages (Form W-2, box 1) the amount that the taxpayer must include in income. If the benefits over $5,250 also qualify as a working condition fringe benefit, the taxpayer’s employer does not have to include them in his or her wages. A working condition fringe benefit is a benefit which, had the taxpayer paid for it, he or she could deduct as an employee business expense. (222) Excludable assistance payments may not cover tools or supplies that the employee retains after completion of the course or the cost of meals, lodging, or transportation. Although the courses covered by the plan need not be job-related, courses involving sports, games, or hobbies may be covered if they involve the employer's business or are required as part of a degree program. (56) The taxpayer cannot use any of the tax-free education expenses paid for by his or her employer as the basis for any other deduction or credit, including the American Opportunity Tax Credit and Lifetime Learning Credit.

Other Employee Compensation Cafeteria Plans A cafeteria plan is a separate written plan maintained by an employer for employees that meets the specific requirements of and regulations of Section 125 of the Internal Revenue Code. It provides participants an opportunity to receive certain benefits on a pretax basis. Participants in a cafeteria plan must be permitted to choose among at least one taxable benefit (such as cash) and one qualified benefit. A qualified benefit is a benefit that does not defer compensation and is excludable from an employee’s gross income under a specific provision of the Code, without being subject to the principles of constructive receipt. Qualified benefits include the following: (230)

Accident and health benefits (but not Archer medical savings accounts or long-term care insurance). Adoption assistance. Dependent care assistance. Group-term life insurance coverage. Health savings accounts, including distributions to pay long-term care services.

The written plan must specifically describe all benefits and establish rules for eligibility and elections.

A Section 125 plan is the only means by which an employer can provide employees a choice between taxable and nontaxable benefits without the choice causing the benefits to become taxable. A plan providing only a choice between taxable benefits is not a Section 125 plan.

Bargain Purchases A bargain purchase is a purchase of an item for less than its fair market value (FMV). If, as compensation for services, the taxpayer buys goods or other property at less than FMV, include the difference between the purchase price and the property's FMV in his or her income. The individual’s basis in the property is its FMV (the purchase price plus the amount included in income). (231)

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If the difference between the purchase price and the FMV is a qualified employee discount, do not include the difference in income. This exclusion applies to a price reduction an employer gives an employee on property or services he or she provides to customers in the ordinary course of the line of business in which the employee performs substantial services. However, it does not apply to discounts on real property or discounts on personal property of a kind commonly held for investment (such as stocks or bonds). For this exclusion, any of the following individuals can be treated as employees:

A current employee. A former employee who retired or left on disability. A widow or widower of an individual who died while an employee. A widow or widower of an employee who retired or left on disability. A leased employee who has provided services on a substantially full-time basis for at least a year if the services

are performed under primary direction or control. A partner who performs services for a partnership.

An employer can generally exclude the value of an employee discount he or she provides an employee from the employee's wages, up to the following limits:

For a discount on services, 20% of the price charged nonemployee customers for the service. For a discount on merchandise or other property, gross profit percentage times the price charged nonemployee

customers for the property. The employer determines gross profit percentage in the line of business based on all property provided to customers (including employee customers) and the experience during the tax year immediately before the tax year in which the discount is available. To figure gross profit percentage, subtract the total cost of the property from the total sales price of the property and divide the result by the total sales price of the property. An employer cannot exclude from the wages of a highly compensated employee any part of the value of a discount that is not available on the same terms to one of the following groups:

All of the employees. A group of employees defined under a reasonable classification the employer set up that does not favor highly

compensated employees. For this exclusion, a highly compensated employee for 2017 is an employee who meets either of the following tests:

The employee was a 5% owner at any time during the year or the preceding year. The employee received more than $120,000 in pay for the preceding year (can be ignored if the employee was

not also in the top 20% of employees when ranked by pay for the preceding year).

Personal Use of Company Car One of the fringe benefits left untaxed until 1984 was the personal use of a company car. Under current regulations, there are various methods available for employers to use in determining the amount which must be included in an employee's gross income when he or she uses a company car for personal benefit. However, regardless of the method chosen by the employer, the employee is bound to that method. (104) If an employer provides a car for an employee's use, the amount the employer can exclude as a working condition benefit is the amount that would be allowable as a deductible business expense if the employee paid for its use. If the employee uses the car for both business and personal use, the value of the working condition benefit is the part determined to be for business use of the vehicle. However, instead of excluding the value of the working condition benefit, the employer can include the entire annual lease value of the car in the employee's wages. The employee can then claim any deductible business expense for the car as an itemized deduction on his or her personal income tax return. This option is available only if the employer uses the lease value rule to value the benefit.

Lesson 12 - Exclusions, Employee Compensation, Deductions

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All of an employee's use of a qualified non-personal use vehicle is a working condition benefit. A qualified non-personal use vehicle is any vehicle the employee is not likely to use more than minimally for personal purposes because of its design. Qualified non-personal use vehicles generally include all of the following vehicles. (104)

Clearly marked, through painted insignia or words, police, fire, and public safety vehicles. Unmarked vehicles used by law enforcement officers if the use is officially authorized. An ambulance or hearse used for its specific purpose. Any vehicle designed to carry cargo with a loaded gross vehicle weight over 14,000 pounds. Delivery trucks with seating for the driver only, or the driver plus a folding jump seat. A passenger bus with a capacity of at least 20 passengers used for its specific purpose. School buses. Tractors and other special-purpose farm vehicles. Bucket trucks, cement mixers, combines, cranes and derricks, dump trucks (including garbage trucks), flatbed

trucks, forklifts, qualified moving vans, qualified specialized utility repair trucks, and refrigerated trucks.

Using a company car for business purposes is not considered a fringe benefit, while personal use is a taxable fringe benefit. Personal use of a company car includes commuting to and from work, running errands or allowing a family member who is not a company employee to use the vehicle.

Fringe Benefits Any fringe benefit provided by an employer is taxable and must be included in the recipient's pay unless the law specifically excludes it. The following non-cash benefits qualify for exclusion for all or part of their value from an employee's gross income:

No-additional-cost services (e.g., free stand-by flights by airlines to their employees). Qualified employee discounts (e.g., reduced sales prices of products and services sold by the employer). Working condition fringe benefits (e.g., use of company car for business purposes). De minimis fringe benefits (e.g., use of copying machine for personal purposes). Qualified transportation fringe benefits (e.g., transportation in a commuter highway vehicle, transit passes, and

qualified parking). Qualified moving expense reimbursements. Qualified retirement planning services. On-premises athletic facilities provided and operated by the employer.

These benefits may be extended to retired and disabled former employees, to widows and widowers of deceased employees, and to spouses and dependent children of employees. Applicable nondiscrimination conditions must be met. No-Additional-Cost Services The value of services a taxpayer receives from his or her employer for free, at cost, or for a reduced price is not included in his or her income if the employer: (232)

1. Offers the same service for sale to customers in the ordinary course of the line of business in which the taxpayer works.

2. Does not have a substantial additional cost (including any sales income given up) to provide the taxpayer with the service (regardless of what he or she paid for the service).

In most cases, no-additional-cost services are excess capacity services, such as airline, bus, or train tickets, hotel rooms, and telephone services. Qualified Moving Expense Reimbursement A qualified moving expense reimbursement is an excludable fringe benefit. This is an amount received (directly or indirectly) by an individual from an employer as a payment for (or a reimbursement of) expenses that would be deductible as moving expenses if directly paid or incurred by the individual. To qualify for the moving expense exclusion, the employee must move at least 50 miles from previous job location and work at least 39 weeks at the new location during the first 12 months of employment. (104)

Lesson 12 - Exclusions, Employee Compensation, Deductions

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Transportation Fringe Benefits The exclusion applies whether the employee provides only one or a combination of these benefits to his or her employees. This exclusion applies to the following benefits: (104)

A ride in a commuter highway vehicle between the employee's home and work place. A transit pass. Qualified parking. Qualified bicycle commuting reimbursement.

Qualified transportation benefits can be provided directly by the employer or through a bona fide reimbursement arrangement. However, cash reimbursements for transit passes qualify only if a voucher or a similar item that the employee can exchange only for a transit pass is not readily available for direct distribution by the employer to his or her employee. A voucher is readily available for direct distribution only if an employee can obtain it from a voucher provider that does not impose fare media charges or other restrictions that effectively prevent the employer from obtaining vouchers. Generally, the employer can exclude qualified transportation fringe benefits from an employee's wages even if he or she provides them in place of pay. However, qualified bicycle commuting reimbursements cannot be excluded if the reimbursements are provided in place of pay. In tax year 2017, employers can generally exclude a maximum of $255 per month from the employee's wages for combined commuter highway vehicle transportation and transit passes. A qualifying vehicle must seat at least six adults (excluding the driver), and at least 80% of its mileage use must be reasonably expected to be for employees' commuting purposes and for trips when the vehicle is at least one-half full (excluding the driver). (104) In tax year 2017, employers can generally exclude up to $255 per month from the employee's wages for the value of qualified parking. The parking must be provided on or near the business premises of the employer or on or near a location from which the employee commutes to work by mass transit, in a commuter highway vehicle, or by carpool. The exclusion does not apply to parking on or near property used by the employee for residential purposes. (104) In tax year 2017, employers may reimburse bicycle commuters up to $20 per month tax free for each month a bicycle is used for transportation between the employee's home and place of employment. Reimbursement may be for reasonable expenses incurred for the purchase of a bicycle, bicycle improvements, repair and storage. Bike commuters who receive any other transportation fringe benefit under Section 132 are not eligible to receive the bike commuter benefit. The taxpayer should be aware that the bicycle commuter benefit is more restrictive than other qualified transportation fringe benefits in several ways: (104)

1. An employee cannot choose to reimburse themselves with pre-tax income, the reimbursement must be paid by the employer; and

2. An employee cannot receive both the transit and bicycle fringe benefits in the same month. The exclusion for these types of transportation fringe benefits also applies if an employer reimburses an employee's expenses for transit passes, van pooling, or qualified parking. Furthermore, employers may provide the employee a choice of one or more qualified transportation benefits or the cash equivalent without loss of the exclusion. The amount is includable if the cash option is chosen. With respect to mass transit passes, employers must provide vouchers and not make cash reimbursements unless vouchers are not readily available for direct distribution by the employer to its employees. Employer-Provided Child or Dependent Care Services The value of child or dependent care services provided by an employer pursuant to a written plan generally is not includable in the employee's gross income. To qualify for dependent care assistance, the dependent must be: (233)

A qualifying child who is the taxpayer’s dependent and who was under age 13 when the care was provided. A spouse who was not physically or mentally able to care for himself or herself and lived with the taxpayer for

more than half the year. A person who was not physically or mentally able to care for himself or herself, lived with the taxpayer for more

than half the year, and either: o Was the taxpayer’s dependent.

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o Would have been the taxpayer’s dependent except that: He or she received gross income of $4,050 or more. He or she filed a joint return. The taxpayer, or taxpayer’s spouse if filing jointly, could be claimed as a dependent on someone

else's 2017 return.

The plan generally must not discriminate in favor of employees who are highly compensated. However, if a plan would qualify as a dependent care assistance program except for the fact that it fails to meet discrimination, eligibility, or other requirements, then despite the failure the plan may still be treated as a dependent care assistance program in the case of employees who are not highly compensated.

The amount a taxpayer can exclude or deduct is limited to the smallest of: (233)

The total amount of dependent care benefits the taxpayer received during the year. The total amount of qualified expenses the taxpayer incurred during the year Taxpayer’s earned income Taxpayer’s spouse's earned income. $5,000 ($2,500 if married filing separately).

A taxpayer can choose to include his or her nontaxable combat pay in earned income when figuring the exclusion or deduction, even if he or she chooses not to include it in earned income for the Earned Income TAx Credit or the Credit for Child and Dependent Care Expenses.

Food and Lodging Provided by Employer An employer can exclude the value of lodging he or she furnishes to an employee from the employee's wages if it meets the following tests: (104)

It is furnished on the business premises. It is furnished for the employer’s convenience. The employee must accept it as a condition of employment.

The exclusion does not apply if the employer allows the employee to choose to receive additional pay instead of lodging.

Meals that are excluded from an employee's income will be considered a de minimis fringe benefit, if more than one-half of the employees to whom such meals are provided are furnished for the convenience of the employer, all such meals are treated as furnished for the convenience of the employer. Therefore, the meals will be fully deductible by the employer, instead of possibly being subject to the 50% limit on business meal deductions, and excludable by the employees. (104) Working Condition Benefits If the taxpayer’s employer provides him or her with a product or service and the cost of it would have been allowable as a business or depreciation deduction if the taxpayer paid for it him or herself, the cost is not included in the taxpayer’s income.

Lesson 12 - Exclusions, Employee Compensation, Deductions

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

Review Questions Answers appear in Review Feedback 1. Which of the following special provision compensations are excluded from income?

A. Disability benefits received for loss of income B. Damages for personal injury C. Medical pensions D. All of the above

2. Beth's employer transferred her from Boston, Massachusetts, to Buffalo, New York. On her way to Buffalo, Beth drove

into Canada to visit the Toronto Zoo. Beth's excursion into Canada cost her an additional $50 in gas and $200 for a hotel room. What amount can Beth deduct as moving expenses for the sightseeing excursion?

A. $0 B. $50 C. $200 D. $250

3. Barbara works as an engineer and her employer provides her with a $200 subscription to an engineering trade

magazine. What amount of the cost of the subscription is included in Barbara’s income? A. $0 B. $50 C. $100 D. $200

4. Under Christopher’s divorce decree, he must pay his former spouse's medical and dental expenses of $500. If the

payments otherwise qualify, what amount can Christopher deduct as alimony on his return? A. $0 B. $50 C. $250 D. $500

5. Which of the following expenses are not deductible as moving expenses?

A. Transportation of household goods B. Transportation of personal effects C. Lodging D. Meals

6. Pricilla’s qualifying period in relation to the Foreign Housing Exclusion and Deduction includes all of 2017. During the

year, she spent $18,756 for her housing. This amount is below the limit for the location in which she incurred the expenses. What is Pricilla’s qualified housing amount for 2017?

A. $0 B. $2,420 C. $16,208 D. $18,628

Lesson 12 - Exclusions, Employee Compensation, Deductions

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7. A taxpayer qualifies for the tax benefits available to taxpayers who have foreign earned income if which of the following apply?

A. The taxpayer meets the tax home test B. The taxpayer meets the bona fide residence test C. The taxpayer meets the physical presence test D. All of the above

8. To deduct moving expenses, a self-employed taxpayer must be employed or performing services full-time for at least

how many weeks during the first 24 months immediately following the move? A. 50 weeks B. 70 weeks C. 78 weeks D. 84 weeks

Lesson 12 - Exclusions, Employee Compensation, Deductions

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Review Feedback Return to Review Questions Question 1 – D. All of the above Many amounts received as compensation for sickness or injury are not taxable. These include compensatory damages received for physical injury or physical sickness, benefits received under an accident or health insurance policy, disability benefits received for loss of income or earning capacity as a result of injuries under a no-fault car insurance policy, compensation received for permanent loss or loss of use of a part or function of the body, and reimbursement for medical care. Question 2 - A. $0 The cost of traveling from the taxpayer’s former home to his or her new one should be by the shortest, most direct route available by conventional transportation. If during the taxpayer’s trip to his or her new home, he or she stops over, or makes side trips for sightseeing, the additional expenses for his or her stopover or side trips are not deductible as moving expenses. The expenses Beth paid or incurred for the excursion are not deductible. Beth can only deduct what it would have cost to drive directly from Boston to Buffalo. Likewise, Beth cannot deduct any expenses, such as the cost of a hotel room, caused by the delay for sightseeing. Question 3 - A. $0 If the taxpayer’s employer provides him or her with a product or service and the cost of it would have been allowable as a business or depreciation deduction if the taxpayer paid for it him or herself, the cost is not included in the taxpayer’s income. Question 4 - D. $500 Cash payments, checks, or money orders to a third party on behalf of the taxpayer’s spouse under the terms of his or her divorce or separation instrument can be alimony, if they otherwise qualify. These include payments for medical expenses, housing costs (rent, utilities, etc.), taxes, tuition, etc. The payments are treated as received by the taxpayer’s spouse and then paid to the third party. Chris can deduct the expenses as alimony on his return. His former spouse must report them as alimony received and can include them in figuring deductible medical expenses. Question 5 - D. Meals The deduction is computed on Form 3903 - Moving Expenses and reported on Line 26, Form 1040. Deductible moving expenses are limited to the cost of transportation of household goods and personal effects and travel (including lodging but not meals) to the new residence. Question 6 - B. $2,240 For 2017, the maximum foreign earned income exclusion is $102,100 per year; 16% of this amount is $16,336 for a full 365 days, or $44.76 per day. Since Pricilla’s qualifying period includes all of 2017 and is below the limit for the location in which she incurred the expenses her housing amount is $18,756 minus $16,336, or $2,420. Question 7 - D. All of the above A taxpayer qualifies for the tax benefits available to taxpayers who have foreign earned income if he or she meets the tax home test and he or she meets either the bona fide residence test or the physical presence test. Question 8 - C. 78 weeks To qualify for the time test portion of the moving expense deduction, a self-employed taxpayer must be employed or performing services full-time for at least 78 weeks of the 24-month period immediately following the move and at least 39 weeks during the first 12 months.

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Itemized Deductions At the conclusion of this lesson you should have a basic knowledge of:

Deducting Taxes Deducting Interest Deducting Contributions Deducting Losses Deducting Job Expenses Other Itemized Deductions

There are certain personal expenses which Congress has allowed as deductions. These are called itemized expenses, or often called Schedule A deductions, as this is the form that is attached to the return to claim the itemized deductions.

Schedule A Categories Category Line(s) Medical and Dental Expenses 1-4 Taxes Paid 5-9 Interest Paid 10-15 Gifts to Charity 16-19 Casualty and Theft Losses 20 Job Expenses and Certain Miscellaneous Deductions 21-27 Other Miscellaneous Deductions 28

Table 13-1 Schedule A Form 1040 (2017)

Limit on Itemized Deductions The limitation on itemized deductions is often referred to by its short-hand name of Pease after the Congressman who originally developed it. The limitation provides that a taxpayer must reduce his or her total itemized deductions by 3% of the excess of his or her adjusted gross income (AGI) over the applicable threshold. The limitation for itemized deductions to be claimed on tax year 2017 returns of individuals begins with incomes

of $261,500 or more ($313,800 for married couples filing jointly). For head of household taxpayers, the limitation begins with incomes of $287,650 and for married filing separately individuals the limitation begins with incomes of $156,900. The limitation does not apply to deductions for medical expenses, investment interest, casualty and theft losses, or gambling losses. If the taxpayer’s adjusted gross income (AGI) does not exceed the applicable threshold, he or she is not impacted by the Pease limitation. The following Schedule A (Form 1040) deductions are subject to the overall limit on itemized deductions: (234)

Taxes paid - line 9. Interest paid - lines 10, 11, 12, and 13. Gifts to charity - line 19. Job expenses and certain miscellaneous deductions - line 27. Other miscellaneous deductions - line 28, excluding gambling and casualty or theft losses.

The following Schedule A (Form 1040) deductions are not subject to the overall limit on itemized deductions. However, they are still subject to other applicable limits: (234)

Medical and dental expenses - line 4. Investment interest expense - line 14. Casualty and theft losses of personal use property - line 20. Casualty and theft losses of income-producing property - line 28. Gambling losses - line 28.

Lesson 13 - Itemized Deductions

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If the taxpayer’s itemized deductions are subject to the limit, the total of all his or her itemized deductions is reduced by the smaller of: (235)

80% of the taxpayer’s itemized deductions that are affected by the limit. 3% of the amount by which the taxpayer’s AGI exceeds $313,800 for 2017 if married filing jointly or qualifying

widow(er) or $261,500 for 2017 if single.

Before the taxpayer calculates the overall limit on itemized deductions, he or she first must complete Schedule A (Form 1040), lines 1 through 28, including any related forms (such as Form 2106, Form 4684, etc.). The overall limit on itemized deductions is figured after the taxpayer has applied any other limit on the allowance of any itemized deduction. These other limits include charitable contribution limits, the limit on certain meal and entertainment expenses, and the 2%-of-adjusted-gross-income limit on certain miscellaneous deductions. Making the Election Between Using the Standard Deduction or Itemized Deductions

Each year the taxpayer must decide whether the standard deduction amount or the total of allowed itemized deductions provides him or her with the lowest tax liability. This election is made each year, and does not depend on what was done in past years. The taxpayer is entitled to select the most favorable alternative each year. If

the taxpayer elects to itemize deductions even though the total is less than the amount of the Standard Deduction to which the taxpayer is entitled, the taxpayer must check the box on Line 30, Schedule A, Form 1040.

Medical Expenses If the taxpayer paid for medical or dental expenses in 2017, he or she may be able to get a tax deduction for costs not covered by insurance. Here are seven facts from the IRS about claiming the medical and dental expense deduction: (236)

1. The taxpayer can only claim medical and dental expenses for costs not covered by insurance if he or she itemizes deductions on the tax return. The taxpayer cannot claim medical and dental expenses if he or she takes the standard deduction.

2. The taxpayer can deduct medical and dental expenses that are more than 7.5% of adjusted gross income. 3. The taxpayer can include medical and dental costs paid in 2017, even if he or she received the services in a

previous year. Keep good records to show the amount paid. 4. The taxpayer may include most medical or dental costs paid for him or herself, his or her spouse and his or her

dependents. Some exceptions and special rules apply. 5. The taxpayer can normally claim the costs of diagnosing, treating, easing or preventing disease. The costs of

prescription drugs and insulin qualify. The cost of medical, dental and some long-term care insurance also qualify. 6. The taxpayer may be able to claim the cost of travel to obtain medical care. That includes the cost of public

transportation or an ambulance as well as tolls and parking fees. If he or she uses his or her car for medical travel, the taxpayer can deduct the actual costs, including gas and oil. Instead of deducting the actual costs, the taxpayer can deduct the standard mileage rate for medical travel, which is 17 cents per mile for 2017, down 2 cents per mile from 2016.

7. Funds from Health Savings Accounts or Flexible Spending Arrangements used to pay for medical or dental costs are usually tax-free. Therefore, the taxpayer cannot deduct expenses paid with funds from those plans.

Medical expenses are defined as expenditures to prevent, cure, or improve a physical or mental defect or illness. These expenses include but are not limited to the following items: (237)

Amount paid to physicians, surgeons, dentists, optometrists, chiropractors, chiropodists, podiatrists, osteopaths, psychiatrists, psychologists, and Christian Science practitioners.

Hospital and clinic charges for in-patient board and lodging, X-rays, therapy treatments, laboratory, nursing care, surgery, obstetrics, treatment for alcoholism, etc.

Cost and maintenance of certain appliances and medical aids such as false teeth, hearing aids, seeing eye dogs, orthopedic braces, artificial limbs, arch supports, eyeglasses, crutches, wheelchairs, truss belts, etc.

Prescription medicines and insulin. Certain transportation costs incurred for the purpose of securing medical treatment. Personal use of automobile

for medical transportation can be deducted at a standard rate per mile. The rate for tax year 2017 is 17 cents per mile, down 2 cents per mile from 2016.

Lesson 13 - Itemized Deductions

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Premiums paid for hospitalization insurance. Certain capital expenditures made to a taxpayer's home for medical reasons. Cost of special training for the handicapped (such as for the blind to learn the Braille system or the deaf to learn

lip-reading). Expenses incurred to remove structural barriers in the home of a physically handicapped person. Lodging costs essential to medical care provided by a physician in a licensed hospital.

A taxpayer cannot include in medical expenses the cost of dancing lessons, swimming lessons, etc., even if they are recommended by a doctor, if they are only for the improvement of general health. For a complete list of medical expenses that are includible and are not includible see Publication 502 - Medical and Dental Expenses.

Expenses that fall into any of these categories are said to be deductible. In some cases, however, certain percentage limitations may apply to reduce the amount of the deduction. Medical expenses for elective cosmetic surgery are not deductible. The relationship between deductions and limitations is expressed in the following formula: Medical expenses that qualify as deductions less applicable limitations equal medical expenses that result in an itemized deduction. Rules for Deduction of Medical Expenses

Under the Tax Cuts and Jobs Act, the medical expense deduction is retroactively returned to 7.5% for 2017 and will remain in place with a lower floor of 7.5% for 2018. After 2018 the percentage returns to 10%.

A taxpayer can deduct only the part of his or her medical and dental expenses that exceed 7.5% of his or her adjusted gross income (AGI). However, the current cost of medical insurance is so high that many families can exceed this limitation. Not only is the entire amount of medical or health insurance added with other medical expenses, but all prescription drugs and insulin are included. (237) Medical care expenses include the insurance premiums the taxpayer paid for policies that cover medical care or for a qualified long-term care insurance policy covering qualified long-term care services. If the taxpayer is an employee, medical expenses do not include that portion of his or her premiums treated as paid by the employer under its sponsored group accident or health policy or qualified long-term care insurance policy. Further, medical expenses do not include the premiums that the taxpayer paid under his or her employer-sponsored policy under a premium conversion policy. (238) If the taxpayer is self-employed and has a net profit for the year, he or she may be able to deduct (as an adjustment to income) the premiums paid on a health insurance policy covering medical care including a qualified long-term care insurance policy for him or herself and their spouse and dependents. The taxpayer cannot take this deduction for any month in which he or she was eligible to participate in any subsidized health plan maintained by an employer, a former employer, his or her spouse's employer, or a former spouse's employer. If the taxpayer does not claim 100% of the self-employed health insurance deduction, he or she can include the remaining premiums with other medical expenses as an itemized deduction on Form 1040, Schedule A. The taxpayer may not deduct insurance premiums paid by an employer-sponsored health insurance plan (cafeteria plan) unless the premiums are included in Box 1 of Form W-2. Qualified Long-Term Care Insurance Premiums The definition of medical care was expanded to include the amounts paid for qualified long-term care services and eligible long-term premiums paid under approved long-term care insurance policies. Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, rehabilitative services, and maintenance and personal care services that are: (111)

1. Required by a chronically ill individual. 2. Provided pursuant to a plan of care prescribed by a licensed health care practitioner.

A qualified long-term care insurance contract is an insurance contract that provides only coverage of qualified long-term care services. The contract must: (111)

1. Be guaranteed renewable. 2. Not provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed.

Lesson 13 - Itemized Deductions

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3. Provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract, and dividends under the contract must be used only to reduce future premiums or increase future benefits.

4. Generally, not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer, or the contract makes per diem or other periodic payments without regard to expenses.

The amount of qualified long-term care insurance premiums a taxpayer can include is limited. He or she can include the following as medical expenses on Schedule A (Form 1040) by age (at of the close of the tax year) of the taxpayer:

Age Group 2017 Eligible Premium Amount

Age 40 and under $410 Ages 41 through 50 $770

Ages 51 through 60 $1,530

Ages 61 through 70 $4,090

Age 71 and over $5,110

Note: The limit on premiums is for each person.

Table 13-2 Publication 502 - Medical and Dental Expenses (2017)

Transportation Include in medical expenses amounts paid for transportation primarily for, and essential to, medical care. A taxpayer can include: (239)

Bus, taxi, train, or plane fares, or ambulance service. Transportation expenses of a parent who must go with a child who needs medical care. Transportation expenses of a nurse or other person who can give injections, medications, or other treatment

required by a patient who is traveling to get medical care and who is unable to travel alone. Transportation expenses for regular visits to see a mentally ill dependent, if these visits are recommended as a

part of treatment. The taxpayer can take into account out-of-pocket expenses, such as the cost of gas and oil, when he or she utilizes his or her car for medical reasons. The taxpayer cannot include depreciation, insurance, general repair, or maintenance expenses. If the taxpayer does not want to use his or her actual automobile expenses for 2017, he or she can use the standard medical mileage rate of 17 cents per mile. The taxpayer can also include parking fees and tolls. He or she can add these fees and tolls to his or her medical expenses whether he or she uses actual automobile expenses or use the standard mileage rate.

Taxes The itemized deduction for taxes may vary from state to state and even from city to city. Much depends upon the nature of the tax imposed, and there is little uniformity in state and local taxation. Any general rules, therefore, may be subject to qualifications that depend on state and local circumstances. But general rules are a good place to start, since they provide a basis for further investigation of the taxpayer’s own state and local taxes. To deduct any tax the following two tests must be met: (240)

1. The tax must be imposed on the taxpayer. 2. The taxpayer must pay the tax during the tax year.

Another useful rule is that Federal taxes are never deductible, but some state and local taxes are allowed. The rule is only valid as to deductions claimed on the Federal income tax return. Many states permit the deductions of some Federal taxes against the state income tax.

Lesson 13 - Itemized Deductions

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Business Taxes Fees and charges that are expenses of a trade or business or of producing income can be deducted. (155)

Income taxes - The taxpayer can deduct on Schedule C or C-EZ a state tax on gross income (as distinguished from net income) directly attributable to a business. The taxpayer can deduct other state and local income taxes on Schedule A (Form 1040) if he or she itemizes deductions. Do not deduct Federal income tax.

Employment taxes - The taxpayer can deduct the Social Security, Medicare, and Federal unemployment (FUTA) taxes paid out of his or her own funds as an employer. The taxpayer can also deduct payments made as an employer to a state unemployment compensation fund or to a state disability benefit fund. Deduct these payments as taxes.

Self-employment tax - The taxpayer can deduct the employer-equivalent portion of self-employment tax on line 27 of Form 1040.

Personal property tax - The taxpayer can deduct on Schedule C or C-EZ any tax imposed by a state or local government on personal property used in a business. The taxpayer can also deduct registration fees for the right to use property within a state or local area.

Real estate taxes - The taxpayer can deduct on Schedule C or C-EZ the real estate taxes he or she paid on a business property. Deductible real estate taxes are any state, local, or foreign taxes on real estate levied for the general public welfare. The taxing authority must base the taxes on the assessed value of the real estate and charge them uniformly against all property under its jurisdiction.

Excise taxes - The taxpayer can deduct on Schedule C or C-EZ all excise taxes that are ordinary and necessary expenses of carrying on a business.

Taxes on gasoline, diesel fuel, and other motor fuels the taxpayer uses in a business are usually included as part of the cost of the fuel. Do not deduct these taxes as a separate item. The taxpayer may be entitled to a credit or refund for Federal excise tax he or she paid on fuels used for certain purposes.

Federal Unemployment Tax Act (FUTA) The Federal unemployment tax is part of the Federal and state program under the Federal Unemployment Tax Act (FUTA) that pays unemployment compensation to workers who lose their jobs. Most employers may owe both the Federal unemployment tax (the FUTA tax) and a state unemployment tax. Or, the employer may owe only the FUTA tax or only the state unemployment tax. To find out whether the employer will owe state unemployment tax, contact the employer’s state's unemployment tax agency. For a list of state unemployment tax agencies, visit the U.S. Department of Labor's website. The employer should also find out if he or she needs to pay or collect other state employment taxes or carry workers' compensation insurance. The FUTA tax is 6.0% of the employee's FUTA wages. However, the employer may be able to take a credit of up to 5.4% against the FUTA tax, resulting in a net tax rate of 0.6%. The employer’s credit for 2017 is limited unless he or she pays all the required contributions for 2017 to his or her state unemployment fund by April 17, 2018. The credit the employer can take for any contributions for 2017 that he or she pays after April 17, 2018, is limited to 90% of the credit that would have been allowable if the contributions were paid by April 17, 2018.

The 5.4% credit is reduced for wages paid in a credit reduction state. Also, the employer does not withhold the FUTA tax from his or her employee's wages. The employer must pay it from his or her own funds.

The employer figures the FUTA tax on the FUTA wages he or she pays. If the employer pays cash wages to all of his or her household employees totaling $1,000 or more in any calendar quarter of 2016 or 2017, the first $7,000 of cash wages he or she pays to each household employee in 2017 is FUTA wages. (A calendar quarter is January through March, April through June, July through September, or October through December.) If his or her employee's cash wages reach $7,000 during the year, the employer does not figure the FUTA tax on any wages he or she pays that employee during the rest of the year. The employer does not count wages he or she pays to any of the following individuals as FUTA wages: (163)

His or her spouse. His or her child who is under the age of 21. His or her parent.

Lesson 13 - Itemized Deductions

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Federal Insurance Contributions Act (FICA) The 2017 Combined (Employee and Corporate) FICA tax is 7.65% each for the employee and employer on the first $127,200 (or $19,461.60) plus 2.9% on earnings greater than $127,200. The result for most American wage earners is a total FICA tax of 15.3% (Social Security plus Medicare). Self-employed individuals are responsible for the entire FICA tax rate of 15.3% (12.4 percent Social Security plus 2.9% Medicare). The tax rate and the overall tax obligation have remained the same as 2016. Additional Medicare Tax In 2014 the IRS added an Additional Medicare Tax of 0.9% if an individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) exceeds the threshold amount for the individual’s filing status: Filing Status Threshold Amount Married filing jointly $250,000 Married filing separate $125,000 Single $200,000 Head of household (with qualifying person) $200,000 Qualifying widow(er) with dependent child $200,000 Note: The Additional Medicare Tax of 0.9% only applies to the wages above the Threshold Amount.

Table 13-3 - Questions and Answers for the Additional Medicare Tax (2017)

Additional Medicare Tax withholding applies only to compensation paid to an employee that is in excess of these thresholds in a calendar year. These thresholds are not inflation-adjusted, and thus they apply to more employees each year. The Additional Medicare Tax raises the wage earner’s portion on compensation above the threshold amounts to 2.3%. The employer-paid portion of the Medicare tax on these amounts remains at 1.45%. Compensation subject to RRTA taxes and wages subject to FICA tax are not combined to determine Additional Medicare Tax liability. The threshold applicable to an individual’s filing status is applied separately to each of these categories of income. State, Local and Foreign Income Taxes Nearly all states impose some form of tax on the individual's personal income. In addition, many cities, counties, and other political subdivisions use personal income as the base for a tax. In all such cases, the tax is fully deductible as an itemized expense. Deductible state and local taxes include: (240)

State and local income taxes withheld from salaries during the current taxable year. These amounts are shown on W-2 form(s) and may also be shown on Forms W-2G, 1099-G, 1099-R, and 1099-MISC.

State and local estimated tax payments paid during the current tax year, including any part of the prior year's tax refund that was credited to the current year's state or local income taxes (generally shown on the prior year's tax return).

State and local income taxes paid during the current tax year for a prior tax year(s). These are usually for prior year(s) tax deficiencies. Be sure not to include amounts for penalties or interest.

Mandatory contributions to state benefit funds withheld from wages that provide protection against loss of wages such as contributions to state funds providing disability or unemployment insurance benefits.

State Sales Taxes The Protecting Americans from Tax Hikes Act of 2015 permanently extended the option to claim an itemized deduction for State and local general sales taxes in lieu of an itemized deduction for State and local income taxes. If the taxpayer files a Form 1040, and itemizes deductions on Schedule A, he or she has the option of claiming either state and local income taxes or state and local sales taxes (the taxpayer cannot claim both). If the taxpayer saved his or her receipts throughout the year, he or she can add up the total amount of sales taxes he or she actually paid and claim that amount.

Lesson 13 - Itemized Deductions

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The deduction for state and local general sales tax is meant to be the amount of sales tax actually paid by the taxpayer. Rather than require taxpayers to keep all of their receipts, the tax law allows taxpayers to use the optional sales tax tables provided by the IRS to approximate their sales tax payments using average consumption patterns, taking into account the relevant tax rates and the taxpayer’s income and family size. If a locality (defined as a state-county-ZIP Code combination) has more than one taxing district, the calculator uses the average of the local sales tax rates among those districts in order to estimate the amount of sales tax the average taxpayer in that locality actually paid. This assumes that residents purchase taxable items throughout the locality, not just in the taxing jurisdiction where they reside. For example, if there are two tax districts within a locality, with local tax rates of 1% and 2%, then the calculator uses 1.5%, which is the average of the two local tax rates. The average provides a much more accurate estimate of the sales tax actually paid by taxpayers in localities with multiple taxing districts. The taxpayer can use the Sales Tax Deduction Calculator on the IRS website to approximate his or her sales tax payments. The Sales Tax Deduction Calculator does not use a methodology that differs from the worksheet in the Schedule A instructions. However, it has built into it information on local sales tax rates, which are not contained in the paper instructions. It also does the math for the taxpayer.

The Sales Tax Deduction Calculator has been updated with overseas U.S. Military Zone and Districts where members of U.S. Military pay no sales tax. U.S. Military Personnel who are deployed overseas can use the calculator to determine the sales tax they paid while they were within the United States.

Real Estate Tax Real estate taxes are allowed as itemized deductions, unless they constitute special assessments that improve the value of the property. Generally, deductible real estate taxes “are any state, local, or foreign taxes on real property levied for the general public welfare”.

Payments for the following items generally are not deductible as real estate taxes: (240)

Taxes for local benefits. Itemized charges for services (such as trash and garbage pickup fees). Transfer taxes (or stamp taxes). Rent increases due to higher real estate taxes. Homeowners' association charges.

For certain sales or exchanges of real estate, the person responsible for closing the sale (generally the settlement agent) prepares Form 1099-S - Proceeds From Real Estate Transactions, to report certain information to the IRS and to the seller of the property. Box 2 of Form 1099-S is for the gross proceeds from the sale and should include the portion of the seller's real estate tax liability that the buyer will pay after the date of sale. The buyer includes these taxes in the cost basis of the property, and the seller both deducts this amount as a tax paid and includes it in the sales price of the property. For a real estate transaction that involves a home, any real estate tax the seller paid in advance but that is the liability of the buyer appears on Form 1099-S, box 5. The buyer deducts this amount as a real estate tax, and the seller reduces his or her real estate tax deduction (or includes it in income) by the same amount. Generally, transactions required to be reported on Form 1099-S consist in whole or in part of the sale or exchange for money, indebtedness, property, or services of any present or future ownership interest in any of the following:

Improved or unimproved land, including air space. Inherently permanent structures, including any residential, commercial, or industrial building. A condominium unit and its appurtenant fixtures and common elements, including land. Stock in a cooperative housing corporation (as defined in Section 216). Any non-contingent interest in standing lumber.

No reporting is required for the sale or exchange of an interest in the following types of property, provided the sale is not related to the sale or exchange of reportable real estate.

An interest in surface or subsurface natural resources (for example, water, ores, or other natural deposits) or crops, whether or not such natural resources or crops are severed from the land. For this purpose, the terms natural resources and crops do not include standing timber.

A burial plot or vault.

Lesson 13 - Itemized Deductions

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A manufactured structure used as a dwelling that is manufactured and assembled at a location different from that where it is used, but only if such structure is not affixed, on the closing date, to a foundation. This exception applies to the transfer of an unaffixed mobile home that is unrelated to the sale or exchange of reportable real estate.

Personal Property Taxes Deductible personal property taxes are those based only on the value of personal property such as a boat or car. Personal property tax is deductible if it is a state or local tax that is: (240)

Charged on personal property. Based only on the value of the personal property. Charged on a yearly basis, even if it is collected more or less than once a year.

Nondeductible Taxes The following taxes are not deductible for Federal income tax purposes: (240)

Federal and state gift taxes Federal and state death taxes Federal income taxes Federal excise taxes on telephone calls, airline tickets, gasoline, tobacco, wine, whiskey, etc. Federal stamp taxes on the sale of securities or real estate and the issuance of bonds and stock Employment taxes including Medicare, Federal Social Security and railroad retirement taxes (other than one-half

self-employment tax paid by a self-employed taxpayer) State excise taxes State sales taxes State occupational taxes Per capita taxes State license fees, including dog license, auto tags, hunting and fishing licenses, marriage license, and safety

inspection charges for automobiles State and local gasoline taxes Fines and penalties Estate, inheritance, legacy or succession taxes (except when the estate tax is a miscellaneous deduction that is

not subject to the 2%-of-adjusted-gross-income limit).

Excise Taxes Excise taxes are taxes paid when purchases are made on a specific good, such as gasoline. Excise taxes are often included in the price of the product. There are also excise taxes on activities, such as on wagering or on highway usage by trucks. Excise Tax has several general excise tax programs. One of the major components of the excise program is motor fuel. (241) Foreign Income Taxes U.S. citizens and residents who lived or worked abroad may need to file a Federal income tax return. If the taxpayer is living or working outside the United States, he or she generally must file and pay taxes in the same way as people living in the U.S. This includes people with dual citizenship. Here are seven tips taxpayers with foreign income should know: (242)

1. Report Worldwide Income - The law requires U.S. citizens and resident aliens to report any worldwide income. This includes income from foreign trusts, and foreign bank and securities accounts.

2. File Required Tax Forms - In most cases, affected taxpayers need to file Schedule B - Interest and Ordinary Dividends, with their tax returns. Some taxpayers may need to file additional forms. For example, some may need to file Form 8938 - Statement of Specified Foreign Financial Assets, while others may need to electronically file Financial Crimes Enforcement Network (FinCEN) Form 114 - Report of Foreign Bank and Financial Accounts (FBAR), to the Internal Revenue Service.

3. Consider the Automatic Extension - U.S. citizens and resident aliens living abroad on April 15, 2018, may qualify for an automatic two-month extension to file their 2017 Federal income tax returns. The extension of time to file until June 15, 2018, also applies to those serving in the military outside the U.S. Taxpayers must attach a statement to their returns explaining why they qualify for the extension.

Lesson 13 - Itemized Deductions

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4. Review the Foreign Earned Income Exclusion - Many Americans who live and work abroad qualify for the foreign earned income exclusion. This means taxpayers who qualify will not pay taxes on up to $102,100 of their wages and other foreign earned income they received in 2017.

5. Do Not Overlook Credits and Deductions - Taxpayers may be able to take either a credit or a deduction for income taxes paid to a foreign country. This benefit reduces the taxes these taxpayers pay in situations where both the U.S. and another country tax the same income.

6. Use IRS Free File - Taxpayers who live abroad can prepare and e-file their Federal tax return for free by using IRS Free File. People who make $64,000 or less can use Free File’s brand-name software. Free File is available exclusively through the IRS.gov website.

7. Get Tax Help Outside the U.S. - Taxpayers living abroad can get IRS help in four U.S. embassies and consulates. IRS staff at these offices can help with tax filing issues and answer questions about IRS notices and tax bills. The offices also have tax forms and publications. To find the nearest foreign IRS office, visit the IRS.gov website. At the bottom of the home page click on the link labeled ‘Contact Your Local IRS Office.’ Then click on ‘International’.

Generally, a taxpayer can take either a deduction or a credit for income taxes imposed by a foreign country or a U.S. possession. Also, a taxpayer can change his or her choice for each year's taxes. However, a deduction or credit cannot be taken for foreign income taxes paid on income that is exempt from U.S. tax under the foreign earned income exclusion or the foreign housing exclusion. If a taxpayer claimed an itemized deduction for a

given year for qualified foreign taxes, he or she can choose instead to claim a foreign tax credit that will result in a refund for that year by filing an amended return on Form 1040X within 10 years from the original due date of his or her return. The 10-year period also applies to calculation corrections of his or her previously claimed foreign tax credit. See Publication 54 - Tax Guide for U.S. Citizens and Resident Aliens Abroad for additional details. Additional Taxes on Qualified Retirement Plans (including IRAs and MSAs) In general, if a taxpayer takes a distribution from an IRA and/or MSA before they have reached age 59½ (including an involuntary cashout), not only is the distribution included in their income, but they are also subject to a special penalty tax for the early withdrawal from their qualified retirement plan. The amount of the penalty is equal to 10% of the amount of the early distribution, and is reported on Form 5329 - Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. (243) Estate Tax If the taxpayer inherited property from a decedent, except those who died in 2010, the basis in property he or she inherits from a decedent is generally one of the following: (244)

The Fair Market Value (FMV) of the property at the date of the decedent's death. The FMV on the alternate valuation date if the personal representative for the estate elects to use alternate

valuation. The value under the special-use valuation method for real property used in farming or a closely held business if

elected for estate tax purposes. The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a

qualified conservation easement. If a Federal estate tax return does not have to be filed, the basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes. The Estate Tax is a tax on the right to transfer property at the time of a person’s death. It consists of an accounting of everything he or she owns or has certain interests in on the date of death. The fair market value of these items is used, not necessarily what the taxpayer paid for them or what their values were when acquired. The total of all of these items is the gross estate. The gross estate includes the value of all property to the extent of the decedent’s interest in the property at the time of death. Unpaid interest that has accrued on savings from the date of the last interest payment to the date of death is included in the gross estate. Outstanding dividends declared to shareholders of record on or before the date of death are included in the gross estate. The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets. A taxpayer’s gross estate also includes the following: (213)

Life insurance proceeds payable to the estate or, if the taxpayer owned the policy, to his or her heirs. The value of certain annuities payable to the estate or the heirs. The value of certain property transferred within 3 years before the decedent’s death.

Lesson 13 - Itemized Deductions

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Once the taxpayer has accounted for the Gross Estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at the taxable estate. These deductions may include mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The value of some operating business interests or farms may be reduced for estates that qualify. (245) The allowable deductions used in determining the taxable estate include: (213)

Funeral expenses paid out of the estate. Debts owed at the time of death. The marital deduction (generally, the value of the property that passes from the estate to the surviving spouse). The charitable deduction (generally, the value of the property that passes from the estate to the United States,

any state, a political subdivision of a state, the District of Columbia, or to a qualifying charity for exclusively charitable purposes).

The state death tax deduction (generally any estate, inheritance, legacy, or succession taxes paid as the result of the decedent's death to any state or the District of Columbia).

The generation-skipping transfer tax is imposed as a separate tax, in addition to the gift and estate taxes, on generation-skipping transfers that are taxable distributions or terminations with respect to a generation skipping trust or direct skips. See Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return.

After the net amount is computed, the value of lifetime taxable gifts (beginning with gifts made in 1977) is added to this number and the tax is computed. The tax is then reduced by the available unified credit. The unified credit applies to both the gift tax and the estate tax and it equals the tax on the applicable exclusion amount. A taxpayer must subtract the unified credit from any gift or estate tax that he or she owes. Any unified credit the taxpayer uses against gift tax in one year reduces the amount of credit that he or she can use against gift or estate taxes in a later year. (213) As of 2011, the amount of unified credit available to a person will equal the tax on the basic exclusion amount plus the tax on any deceased spousal unused exclusion (DSUE) amount. The DSUE is only available if an election was made on the deceased spouse's Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return. The applicable exclusion amount consists of the basic exclusion amount ($5,490,000 in 2017) and, in the case of a surviving spouse, any unused exclusion amount of the last deceased spouse (who died after December 31, 2010). The executor of the predeceased spouse's estate must have elected on a timely and complete Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return to allow the donor to use the predeceased spouse's unused exclusion amount.

Estates of decedents who die during 2017 have a basic exclusion amount of $5,490,000, up from a total of $5,450,000 for estates of decedents who died in 2016.

Most relatively simple estates (cash, publicly traded securities, small amounts of other easily valued assets, and no special deductions or elections, or jointly held property) do not require the filing of an estate tax return. A filing is required for estates with combined gross assets and prior taxable gifts exceeding the following amounts:

Decedents dying in: Estate Tax Exemption Amount Tax Rate 2012 $5,120,000 35% 2013 $5,250,000 40% 2014 $5,340,000 40% 2015 $5,430,000 40% 2016 $5,450,000 40% 2017 $5,490,000 40%

* An executor of the estate of a decedent dying in 2010 could opt out of the estate tax in exchange for Modified Carryover Basis.

Table 13-4 - IRS Estate and Gift Tax (2017)

Lesson 13 - Itemized Deductions

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Gift Tax The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not. The gift tax applies to the transfer by gift of any property. The taxpayer makes a gift if he or she gives property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. The basis of property received as a gift is the donor's carry-over basis (adjusted basis). If a taxpayer sells something at less than its full value or if he or she makes an interest-free or reduced-interest loan, it may be a gift. The annual gift exclusion for 2017 remains at $14,000. For gifts made to spouses who are not U.S. citizens, the annual exclusion has increased to $149,000 for 2017. The top rate for gifts and generation-skipping transfers has increased to 40%. (246) The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts:

Gifts, excluding gifts of future interest, that are not more than the annual exclusion for the calendar year. For 2017, a taxpayer generally can give gifts valued up to $14,000 per person, to any number of people, and none of the gifts will be taxable.

Tuition or medical expenses paid directly to an educational or medical institution for someone else. Gifts to the taxpayer’s spouse. Gifts to a political organization for its use. Gifts to charities.

If the taxpayer or his or her spouse makes a gift to a third party, the gift can be considered as made one-half by the taxpayer and one-half by the spouse. This is known as gift splitting. Both the taxpayer and the spouse must agree to split the gift. For 2017, gift splitting allows married couples to give up to $28,000 to a person without making a taxable gift. (213) Use Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return to report the following: (247)

Transfers subject to the Federal gift and certain generation-skipping transfer (GST) taxes and to figure the tax due, if any, on those transfers, and

Allocation of the lifetime GST exemption to property transferred during the transferor's lifetime. (For more details, Regulations Section 26.2632-1).

In general, if the taxpayer is a citizen or resident of the United States, he or she must file a gift tax return (whether or not any tax is ultimately due) in the following situations: (247)

If he or she gave gifts to someone in 2017 totaling more than $14,000 (other than to his or he spouse), he or she probably must file Form 709.

Certain gifts, called future interests, are not subject to the $14,000 annual exclusion and the taxpayer must file Form 709 even if the gift was under $14,000.

A husband and wife may not file a joint gift tax return. Each individual is responsible for his or her own Form 709. The taxpayer must file a gift tax return to split gifts with his or her spouse (regardless of their amount). If a gift is of community property, it is considered made one-half by each spouse. For example, a gift of $100,000

of community property is considered a gift of $50,000 made by each spouse, and each spouse must file a gift tax return.

Likewise, each spouse must file a gift tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety.

Only individuals are required to file gift tax returns. If a trust, estate, partnership, or corporation makes a gift, the individual beneficiaries, partners, or stockholders are considered donors and may be liable for the gift and GST taxes.

The donor is responsible for paying the gift tax. However, if the donor does not pay the tax, the person receiving the gift may have to pay the tax.

If a donor dies before filing a return, the donor's executor must file the return. If the taxpayer meets all of the following requirements, he or she is not required to file Form 709: (247)

1. He or she made no gifts during the year to his or her spouse. 2. He or she did not give more than $14,000 to any one person. 3. All the gifts he or she made were of present interests.

Lesson 13 - Itemized Deductions

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If the only gifts a taxpayer made during the year are deductible as gifts to charities, he or she does not need to file a return as long as he or she transferred the entire interest in the property to qualifying charities. If the taxpayer transferred only a partial interest, or transferred part of the interest to someone other than a charity, he or she must still file a return and report all of his or her gifts to charities. Unreported Social Security and Medicare Tax Use Form 4137 - Social Security and Medicare Tax on Unreported Tip Income only to figure the Social Security and Medicare tax owed on tips the taxpayer did not report to an employer, including any allocated tips shown on the Form(s) W-2 that he or she must report as income. Use Form 8919 - Uncollected Social Security and Medicare Tax on Wages to figure and report the taxpayer’s share of the uncollected Social Security and Medicare taxes due on his or her compensation if the taxpayer was an employee but was treated as an independent contractor by his or her employer. An Individual can file Form SS-8 - Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding if he or she wants the IRS to determine whether the taxpayer is an independent contractor or an employee. Complete a separate line for each firm. If the taxpayer worked as an employee for more than five firms in 2017, attach additional Form(s) 8919 with lines 1 through 5 completed. Complete lines 6 through 13 on only one Form 8919. The line 6 amount on that Form 8919 should be the combined totals of all lines 1 through 5 of all the Forms 8919. (248) Unearned Income of a Minor Child (Kiddie Tax) The transfer or shifting of income from a parent’s higher tax bracket over to the parent’s child who has a lower tax bracket in order for the parents to save money on their income tax is greatly limited before the child reaches age 14 (prior to 2006 year). The limit was increased to age 18 for the 2006 and subsequent tax years as amended by the Tax Increase Prevention and Reconciliation Act of 2005. Since the Dependent Standard Deduction is $1,050 for tax year 2017, the child’s unearned income between $1,050 and $2,100 is taxed at the child’s rate; and, the remaining unearned income of the child over $2,100 for tax year 2017 is taxed at the parents’ highest tax rate.

Kiddie Tax

Tax Bracket Tax

$0 to $1,050 0% Earned income > $1,050 Child’s tax rate Unearned income > $1,050 ≤ $2,100 Child’s tax rate Unearned income > $2,100 Generally, the parent’s highest marginal tax rate

Table 13-5 - Various Tax Benefits Increase Due to Inflation Adjustments (2017)

The tax is computed on Form 8615 - Tax for Certain Children Who Have Unearned Income. If the child’s parents file their returns as married filing separately the parent with the highest marginal tax rate is the rate to be used. However, for tax year 2017, the parent of a child under age 19 may elect to include the gross income of the child in excess of $2,100 into the parents’ income which can be accommodated by filing Form 8814 - Parents' Election To Report Child's Interest and Dividends. A parent can make this election if his or her child meets all of the following conditions: (249)

The child was under age 19 (or under age 24 if a full-time student) at the end of 2017. The child’s only income was from interest and dividends, including capital gain distributions and Alaska Permanent

Fund dividends. The child’s gross income for 2017 was less than $10,500. The child is required to file a 2017 return. The child does not file a joint return for 2017. There were no estimated tax payments for the child for 2017 (including any overpayment of tax from his or her

2016 return applied to 2017 estimated tax). There was no Federal income tax withheld from the child’s income.

Lesson 13 - Itemized Deductions

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Examples of unearned income that may be subject to income tax include Social Security benefits, dividends from stocks given as a gift, payments from trusts or annuities and taxable interest. Example Sara is 18 and single. Her parents can claim an exemption for her on their income tax return. She received $1,700 of taxable interest and dividend income. She did not work during the year. She must file a tax return because she has unearned income only and her total income is more than $1,050. The same $1,050 amount is used to determine whether a parent may elect to include a child's gross income in the parent's gross income and to calculate the "kiddie tax". For example, in 2017 one of the requirements for the parental election is that a child's gross income must be more than $1,050 but less than 10 times that amount which is $10,500.

If a child’s earned income represents not more than one half of support needs, the kiddie tax generally also applies to unearned income of children who have not attained age 19 by the close of the year, and children who are full-time students and have not attained age 24 as of the close of the year.

Net Investment Income Tax The Net Investment Income Tax is imposed by Section 1411 of the Internal Revenue Code (IRC) and took effect on January 1, 2013. The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts. In general, investment income includes, but is not limited to interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer. (250)

The amount subject to the 3.8% tax is the lesser of the taxpayer’s net investment income or the amount by which modified adjusted gross (MAGI) exceeds the applicable threshold. Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds:

Filing Status Threshold Amount* Married filing jointly $250,000 Married filing separately $125,000 Single $200,000 Head of household (with qualifying person) $200,000 Qualifying widow(er) with dependent child $250,000 *Taxpayers should be aware that these threshold amounts are not indexed for inflation.

Table 13-6 - IRS.GOV Net Investment Income Tax FAQs (2017)

If an individual is exempt from Medicare taxes, he or she still may be subject to the Net Investment Income Tax if he or she has Net Investment Income and also has modified adjusted gross income over the applicable thresholds.

Interest Interest expense probably leads all other personal deductions from adjusted gross income in placing taxpayers in a position to itemize. Interest on home mortgages is the largest single deduction for most taxpayers. As mortgages run for longer and longer periods of time and as down payments on the purchase of homes decrease, interest charges increase. Mortgage points are also generally deductible as interest, but only if paid on loans used to purchase a principal residence of the taxpayer. To be deductible, interest must actually be owed by the taxpayer claiming the expense. The purpose for which the interest is paid is very important. In addition to excluding interest on funds borrowed to purchase tax-free securities, consumer interest was removed from the list of deductible expenses. Since 1991, no personal consumer interest deduction is allowed. Excluded is interest on credit cards, auto loans and insurance policies. Interest on indebtedness incurred in a trade or business is deductible, as is mortgage interest on the taxpayer's first and second residence, subject to certain limitations. Interest on home equity loans is deductible regardless of what or how the funds are used.

Lesson 13 - Itemized Deductions

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Investment interest is interest paid on money a person borrowed that is allocable to property held for investment. It does not include any interest allocable to passive activities or to securities that generate tax-exempt income. Complete and attach Form 4952 - Investment Interest Expense Deduction to figure the deduction. Deductible Home Mortgage Interest Mortgage interest is any interest that a person pays on a loan that is secured by his or her principal residence. Secured debt, for purposes of the mortgage interest deduction, means that there is a signed written document:

1. That makes ownership in a qualified home security, or collateral for the mortgage debt. 2. That, in case of default on the loan, the home could be taken by the creditor to satisfy the debt. 3. That is recorded or otherwise protected under state or local law.

This includes a mortgage, a second mortgage, a line of credit loan, or a home equity loan. In most cases, the entire amount of interest paid on a mortgage is deductible as an itemized deduction on Schedule A. However, there are some limitations. We will consider only those rules for mortgages taken out after October 13, 1987. First, the home mortgage must be on a qualified home. The qualified home is where the taxpayer lives most of the time. It can be a house, cooperative apartment, condominium, mobile home, house trailer, or houseboat that has sleeping, cooking, and toilet facilities. (251) A second home can include any other residence the taxpayer owns and treats as a second home. The taxpayer does not have to use the home during the year. However, if he or she rents it to others, the taxpayer must also use it as a home during the year for more than the greater of 14 days or 10% of the number of days it is rented, for the interest to qualify as qualified residence interest. Qualified residence interest and points are generally reported on Form 1098 - Mortgage Interest Statement, by the financial institution to which the taxpayer made the payments. The following mortgages yield qualified residence interest and the taxpayer can deduct all of the interest on these mortgages: (251)

A mortgage taken out on or before October 13, 1987 (grandfathered debt). A mortgage taken out after October 13, 1987, to buy, build, or improve a home (called home acquisition debt) up

to a total of $1 million for this debt plus any grandfathered debt. The limit is $500,000 if the taxpayer is married filing separately.

Home equity debt other than home acquisition debt taken out after October 13, 1987, up to a total of $100,000. The limit is $50,000 if married filing separately. Home equity debt other than home acquisition debt is further limited to the home's fair market value reduced by the grandfathered debt and home acquisition debt.

The taxpayer may be able to take a credit against Federal income tax if he or she was issued a mortgage credit certificate by a state or local government for low income housing. Use Form 8396 - Mortgage Interest Credit, to figure the amount. However, the taxpayer may be subject to a limit (phase-out) on some of the itemized deductions including mortgage interest. Home Equity Loans Loans that are secured by a person’s home and not used to buy, build or improve his or her residence may fall under the heading of home equity loans. The general limitation is that a home equity loan cannot be more than the fair market value of the home minus the amount of acquisition debt remaining on the home at the time of the home equity loan. Further, the maximum dollar limitation on a home equity debt is $100,000 or less, $50,000 if married filing separately, and totaling no more than the fair market value of the home. The taxpayer reports the amount of mortgage interest paid on either Lines 10 or 11 of Schedule A, Form 1040. (252) If the mortgage interest was paid to a financial institution, it is reported on Line 10, and if to a private person, on Line 11. If the taxpayer paid more than $600 in mortgage interest during the year, the taxpayer should receive a Form 1098 - Mortgage Interest Statement, telling the taxpayer exactly how much mortgage interest the taxpayer had paid during the year. If the taxpayer paid mortgage interest and did not receive a Form 1098, report the amount of interest on Line 11. (253) Points The term “points” is used to describe certain charges paid to obtain a home mortgage. Points are prepaid interest and may be deductible as home mortgage interest, if the taxpayer itemizes deductions on Form 1040, Schedule A. If the

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taxpayer can deduct all of the interest on the mortgage, he or she may be able to deduct all of the points paid on the mortgage. If the acquisition debt exceeds $1,000,000 ($500,000 if married filing separately) or the home equity debt exceeds $100,000 ($50,000 if married filing separately), the taxpayer cannot deduct all the interest on his or her mortgage and he or she cannot deduct all the points. The taxpayer can deduct the points in full in the year they are paid, if all the following requirements are met: (254)

1. The loan is secured by the taxpayer’s main home (the main home is the one he or she lives in most of the time). 2. Paying points is an established business practice in the taxpayer’s area. 3. The points paid were not more than the amount generally charged in that area. 4. The taxpayer uses the cash method of accounting. This means the taxpayer reports income in the year received

and deducts expenses in the year paid. 5. The points were not paid for items that usually are separately stated on the settlement sheet such as appraisal

fees, inspection fees, title fees, attorney fees, or property taxes. 6. The funds the taxpayer provided at or before closing, plus any points the seller paid, were at least as much as the

points charged. The taxpayer cannot have borrowed the funds from a lender or mortgage broker in order to pay the points.

7. The taxpayer uses the loan to buy or build a main home. 8. The points were computed as a percentage of the principal amount of the mortgage. 9. The amount is clearly shown as points on the settlement statement.

The taxpayer can also fully deduct (in the year paid) points paid on a loan to improve the main home if the above tests one through six are met. Points that do not meet these requirements may be deductible over the life of the loan. Points paid for refinancing generally can only be deducted over the life of the new mortgage. However, if the taxpayer uses part of the refinanced mortgage proceeds to improve the main home, and he or she meets the first six requirements stated above, the taxpayer can fully deduct the part of the points related to the improvement in the year paid with their own funds. The taxpayer can deduct the rest of the points over the life of the loan. (254) Points charged for specific services, such as preparation costs for a mortgage note, appraisal fees, or notary fees are not interest and cannot be deducted. Points paid by the seller of a home cannot be deducted as interest on the seller's return, but they are a selling expense which will reduce the amount of gain realized. Points paid by the seller may be deducted by the buyer, provided the buyer subtracts the amount from the basis or cost of the residence. Points the taxpayer pays on loans secured by a second home can be deducted only over the life of the loan. (254) Mortgage Insurance Premiums Deduction The Bipartisan Budget Act extends through 2017 the treatment of qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction. This deduction phases out ratably for taxpayers with adjusted gross income of $100,000 to $110,000. The Mortgage Insurance Premiums Deduction was not renewed by the Tax Cuts and Jobs Act. Cancelled Home Mortgage Debt The Bipartisan Budget Act extends through 2017 the exclusion from gross income of a discharge of qualified principal residence indebtedness. The provision also modifies the exclusion to apply to qualified principal residence indebtedness that is discharged pursuant to a binding written agreement entered into in 2017. The Mortgage Debt Exclusion was not renewed by the Tax Cuts and Jobs Act. (255)

Contributions Donations to qualified organizations by a taxpayer are deductible only if the taxpayer itemizes. To be qualified, an organization must be set up and operated exclusively for charitable, religious, educational, scientific, or literary purposes, or for the prevention of cruelty to children or animals. Typical organizations that meet these tests are nonprofit schools and hospitals, churches, the Salvation Army, the Y.M.C.A. and Y.W.C.A., the American Red Cross, the Boy Scouts and Girl Scouts of America, the Disabled American Veterans, CARE, the American Heart Association, the American Cancer Society, the United Cerebral Palsy Association, the Multiple Sclerosis National Society, Lincoln College, The Civil War Preservation Trust, The Abraham Lincoln Association, and The Civil War Round Table. To be deductible, charitable contributions must be made to qualified organizations. Payments to individuals, a political organization or a political candidate are never deductible. To determine if the organization that the taxpayer contributed

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to qualifies as a charitable organization for income tax deductions, review Exempt Organizations Select Check on the IRS.gov website. Qualified organizations generally include nonprofit groups whose purpose is:

Religious. Charitable. Educational. Scientific. Literary. Preventing cruelty to children or animals.

If the contribution entitles an individual to merchandise, goods, or services, including admission to a charity ball, banquet, theatrical performance, or sporting event, he or she can deduct only the amount that exceeds the fair market value of the benefit received. Contribution Percentage Limitations In any one year, the deductions for contributions to qualified public charities are limited to 50% of adjusted gross income (computed without regard to any net operating loss carry back). The following is a partial list of the types of organizations that are 50% limit organizations: (256)

Churches and conventions or associations of churches. Educational organizations with a regular faculty and curriculum that normally have a regularly enrolled student

body attending classes on site. Hospitals and certain medical research organizations associated with these hospitals. Publicly supported charities.

A 30% limit applies to the following gifts: (256)

Gifts to all qualified organizations other than 50% limit organizations. This includes gifts to veterans' organizations, fraternal societies, non-profit cemeteries, and certain private non-operating foundations.

Gifts for the use of any organization.

Where the donation is made in the form of capital gain property, to a 50% Limit Organization the limit is reduced to 30%. If these gifts are of capital gain property to a 30% Limit Organization, they are subject to the 20% limit. (256)

If the donations made in a given year exceed the 50% limit (or the 30% limit for capital gain property), the unused amount may be carried forward and deducted over the next five years. For example, if a taxpayer with an adjusted gross income of $20,000 in 2017 donates $12,000 in cash to the American Cancer Society, the taxpayer can only deduct $10,000. The $2,000 balance can be carried forward for five years.

Additionally, for 2017, the taxpayer may have to reduce the total amount of certain itemized deductions, including charitable contributions, if his or her adjusted gross income is more than: (257)

$261,500 if single. $313,800 if married filing jointly. $287,650 if head of household. $156,900 if married filing separately.

Written Substantiation Required Charitable contributions of $250 or more must be substantiated by a written acknowledgment from the donee or receiving organization. Generally, the acknowledgment must include the amount of cash and a description of non-cash contributions, together with a description and good-faith estimate of the value of any goods or services received for the contributions. Contributions made by payroll deduction may be substantiated with an employer-provided document, such as a pay-stub or Form W-2. Appraisal fees incurred by a taxpayer in determining the fair market value of donated property are not to be treated as part of the charitable contribution, but may be claimed as a miscellaneous deduction on Schedule A of Form 1040, subject to the 2% floor and must be greater than 2% of AGI in order to be deductible. (256) If the taxpayer made the contribution by phone or text message, a telephone bill showing the name of the donee organization, the date of the contribution, and the amount of the contribution will satisfy the recordkeeping requirement.

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Therefore, for example, if the taxpayer made a $10 charitable contribution by text message that was charged to his or her telephone or wireless account, a bill from the taxpayer’s telecommunications company containing this information satisfies the recordkeeping requirement. Noncash Deductions Over $500 A taxpayer is required to attach Form 8283 – Noncash Charitable Contributions if the taxpayer claims a deduction over $500 for all non-cash charitable contributions. Generally, the taxpayer cannot take a deduction for clothing or household items donated unless the clothing or household items are in good used condition or better. However, he or she can take a deduction for $500 or more for a contribution of an item of clothing or household item (such as an appliance or furniture) that is not in good used condition or better if he or she includes a qualified appraisal of it with the return. (256) Charitable Donation of Vehicles Effective since tax year 2005, a taxpayer contributing a qualified vehicle valued at over $500 to a charity must meet new more stringent substantiation requirements. The taxpayer must obtain from the charity a Form 1098-C Contributions of Motor Vehicles, Boats, and Airplanes or a contemporaneous written statement that names the taxpayer, contains the taxpayer’s Social Security number and the vehicle’s identification number. This statement must be attached to the donor’s tax return.

If the vehicle is sold, the gross proceeds are the taxpayer’s charitable contribution for the vehicle. If the charity retains the vehicle for their use or to make a substantial improvement, the statement must state this fact with the estimated amount of time the charity will use the vehicle. The taxpayer will then be allowed to claim the fair market value of the qualified vehicle as a charitable donation. Qualified vehicles are defined as motor vehicles manufactured for use on public roads and highways, boats and aircraft.

Contributions From Which the Taxpayer Benefits If the taxpayer receives a benefit as a result of making a contribution to a qualified organization, he or she can deduct only the amount of his or her contribution that is more than the value of the benefit he or she receives. If the taxpayer pays more than fair market value to a qualified organization for goods or services, the excess may be a charitable contribution. For the excess amount to qualify, he or she must pay it with the intent to make a charitable contribution. If the taxpayer makes a payment to, or for the benefit of, a college or university and, as a result, he or she receives the right to buy tickets to an athletic event in the athletic stadium of the college or university, the taxpayer can deduct 80% of the payment as a charitable contribution. If any part of the taxpayer’s payment is for tickets (rather than the right to buy tickets), that part is not deductible. Subtract the price of the tickets from his or her payment. The taxpayer can deduct 80% of the remaining amount as a charitable contribution. Value of Services A taxpayer may deduct certain out of pocket costs that a taxpayer incurs in the giving of services to a qualified charity. For example, in tax year 2017, a taxpayer can deduct the cost of special uniforms, telephone expenses, car expenses, either using the actual mileage method or the standard mileage rate of 14 cents per mile, and other travel expenses as long as there is no significant element of personal recreation or pleasure involved in the travel. Gifts to Charity are claimed on Lines 16-19, Schedule A, Form 1040. (256) Direct Donations of IRAs to Charity The Protecting Americans from Tax Hikes Act of 2015 made permanent the tax exemption of distributions from individual retirement accounts for charitable purposes. Individuals age 70½ or over can exclude up to $100,000 from gross income for donations paid directly to a qualified charity from their IRA.

Casualty and Theft Losses A casualty is defined as the complete or partial destruction of property from a sudden, unexpected, or unusual cause. Within certain limits, the owner of property may claim a deduction for damage or loss of the property resulting from a casualty or theft. Deductible casualty losses can result from a number of different causes, including the following: (258)

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Car accidents. Earthquakes. Fires. Floods. Government-ordered demolition or relocation of a home that is unsafe to use because of a disaster. Mine cave-ins. Shipwrecks. Sonic booms. Storms, including hurricanes and tornadoes. Terrorist attacks. Vandalism. Volcanic eruptions.

A casualty loss is not deductible if the damage or destruction is caused by the following: (258)

Accidentally breaking articles such as glassware or china under normal conditions. A family pet. A fire if the taxpayer willfully set it, or pays someone else to set it. A car accident if the taxpayer’s willful negligence or willful act caused it. The same is true if the willful act or willful

negligence of someone acting for him or her caused the accident. Progressive deterioration.

Loss of property due to progressive deterioration is not deductible as a casualty loss. This is because the damage results from a steadily operating cause or a normal process, rather than from a sudden event. The following are examples of damage due to progressive deterioration: (258)

The steady weakening of a building due to normal wind and weather conditions. The deterioration and damage to a water heater that bursts. However, the rust and water damage to rugs and

drapes caused by the bursting of a water heater does qualify as a casualty. Most losses of property caused by droughts. To be deductible, a drought-related loss generally must be incurred

in a trade or business or in a transaction entered into for profit. Termite or moth damage. The damage or destruction of trees, shrubs, or other plants by a fungus, disease, insects, worms, or similar pests.

However, a sudden destruction due to an unexpected or unusual infestation of beetles or other insects may result in a casualty loss.

A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking of property must be illegal under the law of the state where it occurred and it must have been done with criminal intent. The taxpayer does not need to show a conviction for theft. Theft includes the taking of money or property by the following means: (258)

Blackmail. Burglary. Embezzlement. Extortion. Kidnapping for ransom. Larceny. Robbery.

The taking of money or property through fraud or misrepresentation is theft if it is illegal under state or local law. Proof of Loss To deduct a casualty or theft loss, the taxpayer must be able to show that there was a casualty or theft. He or she also must be able to support the amount he or she takes as a deduction. For a casualty loss, the taxpayer should be able to show all of the following:

1. The type of casualty (car accident, fire, storm, etc.) and when it occurred. 2. That the loss was a direct result of the casualty.

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3. That he or she was the owner of the property, or if he or she leased the property from someone else, that he or she was contractually liable to the owner for the damage.

4. Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery. For a theft loss, the taxpayer should be able to show all of the following:

1. When he or she discovered that his or her property was missing. 2. That his or her property was stolen. 3. That he or she was owner of the property. 4. Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.

It is important that the taxpayer has records that will prove his or her deduction. If he or she does not have the actual records to support his or her deduction, he or she can use other satisfactory evidence to support it.

Figuring a Loss Figure the amount of the taxpayer’s loss using the following steps:

1. Determine the adjusted basis in the property before the casualty or theft. 2. Determine the decrease in fair market value of the property as a result of the casualty or theft. 3. From the smaller of the amounts determined in (1) and (2), subtract any insurance or other reimbursement

received or expect to be received.

For personal-use property and property used in performing services as an employee, apply the deduction limits below to determine the amount of the deductible loss. Fair market value (FMV) is the price for which the taxpayer could sell a piece of property to a willing buyer when neither of the parties has to sell or buy and both parties know all the relevant facts. The decrease in FMV used to figure the amount of a casualty or theft loss is the difference between the property's fair market value immediately before and immediately after the casualty or theft. The FMV of property immediately after a theft is considered to be zero, since the taxpayer no longer has the property. In the case of a casualty to personal property (furniture, automobile, etc.), Steps 1 through 3 apply to each individual item of property damaged or destroyed. If the loss was to property for personal use or family's use, there are two limits on the amount of the deduction for casualty or theft loss: the $100 Rule and the 10% Rule. (259) $100 Rule After the taxpayer has figured his or her casualty or theft loss on personal-use property, he or she must reduce that loss by $100. This reduction applies to each total casualty or theft loss. It does not matter how many pieces of property are involved in an event. Only a single $100 reduction applies. 10% Rule The taxpayer must reduce the total of all his or her casualty or theft losses on personal-use property by 10% of his or her adjusted gross income. Apply this rule after the taxpayer reduces each loss by $100. Reporting Casualty and Theft Losses A separate Form 4684 - Casualties and Thefts is required for each casualty or theft loss which occurred during the tax year.

1. If casualty losses exceed casualty gains, Form 4684 must be completed. Each casualty loss is subject to a $100 floor, and total losses are deductible only to the extent that the total loss amount for the tax year exceeds 10% of Adjusted Gross Income.

2. It is possible that a financial gain can occur as a result of a casualty loss. For example, the reimbursement obtained from an insurance company can be greater than the actual fair market value of a loss. This is very rare, but if it happens, and the casualty gain(s) exceed the loss(es), the gain is reported on Schedule D as either short-term or long-term gain, depending on the holding period. No further entry is required on Form 4684. Claim Casualty and Theft Losses on Line 20, Schedule A, Form 1040.

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Job Expenses and Other Miscellaneous Deductions There is another category of expenses called miscellaneous itemized deductions, many of which are subject to the 2% AGI floor. This means that taxpayers are only entitled to a Schedule A deduction insofar as the total amount of these kinds of deductions are more than 2% of their adjusted gross income. There are numerous possible deductions that can fall under this category. We will briefly explain the more common ones, and where appropriate, any special rules for claiming the particular deduction. (260) Generally, the taxpayer applies the 2% limit after he or she applies any other deduction limit. For example, the taxpayer applies the 50% (or 80%) limit on business-related meals and entertainment before he or she applies the 2% limit. Deductions subject to the 2% limit generally fall into the following three categories: (261)

Unreimbursed employee expenses (Schedule A (Form 1040), line 21 or Schedule A (Form 1040NR), line 7). Tax preparation fees (Schedule A (Form 1040), line 22 or Schedule A (Form 1040NR), line 8). Other expenses (Schedule A (Form 1040), line 23 or Schedule A (Form 1040NR), line 9).

Unreimbursed Employee Expenses As an employee, a person may incur various expenses on behalf of his or her employer. Typical examples are expenses for travel, entertainment, meals, lodging, union dues, and job education. In some cases, the employee may be able to deduct these expenses on Schedule A. If an employee is reimbursed by the employer for the expense under an employer's reimbursement plan (an accountable plan), the amount of the reimbursement will not show up on the employee’s W-2 statement for the year and the employee does not have to include the amount of reimbursement in his or her income. However, if the expense is unreimbursed, the employee may be able to deduct the unreimbursed expense as a miscellaneous itemized deduction subject to the 2% AGI rule. If required, the employee must attach Form 2106 - Employee Business Expenses or Form 2106-EZ - Unreimbursed Employee Business Expenses to claim these expenses. Some of the unreimbursed employee expenses which may be tax deductible on the tax return and are subject to the 2% floor are: (261)

Business bad debt of an employee. Business liability insurance premiums. Damages paid to a former employer for breach of an employment contract. Depreciation on a computer an employer requires the taxpayer to use at work. Dues to a chamber of commerce if membership helps the taxpayer do his or her job. Dues to professional societies. Home office or part of the home used regularly and exclusively for work. Job search expenses in a taxpayer’s present occupation. Laboratory breakage fees. Legal fees related to a taxpayer’s job. Licenses and regulatory fees. Malpractice insurance premiums. Medical examinations required by an employer. Occupational taxes. Passport for a business trip. Repayment of an income aid payment received under an employer's plan. Research expenses of a college professor. Rural mail carriers' vehicle expenses. Subscriptions to professional journals and trade magazines related to work. Tools and supplies used at work. Travel, transportation, meals, entertainment, gifts, and local lodging related to work. Union dues and expenses. Work clothes and uniforms if required and not suitable for everyday use. Work-related education.

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Miscellaneous itemized deductions that are not subject to the 2% limit include: (261)

Amortizable premium on taxable bonds. Casualty and theft losses from income-producing property. Federal estate tax on income in respect of a decedent. Gambling losses up to the amount of gambling winnings. Impairment-related work expenses of persons with disabilities. Loss from other activities from Schedule K-1 (Form 1065-B), box 2. Losses from Ponzi-type investment schemes. Repayments of more than $3,000 under a claim of right. Unrecovered investment in an annuity.

Business Bad Debt A business bad debt is a loss from a debt created or acquired in the taxpayer’s trade or business. Any other worthless debt is a business bad debt only if there is a very close relationship between the debt and his or her trade or business when the debt becomes worthless. A debt has a very close relationship to the taxpayer’s trade or business of being an employee if the main motive for incurring the debt is a business reason. Transportation Expenses There are ordinary and necessary expenses that persons incur going from one work place to another in the course of their employment, when not traveling away from home. These include airfare, rail, bus, taxis, and even the cost of driving their own car. However, an employee may never deduct the cost of commuting to work or parking fees at the employee’s work location. Commuting expenses are nondeductible personal expenses. However, if the employee has one or more regular places of business and commutes to a temporary work location, the employee can deduct the expenses of the daily round trip transportation between the employee’s home and the temporary job site. If an employee is required to use his or her car for work, the employee can deduct proper car expenses. For 2017, the standard mileage rate is 53.5 cents per mile for business miles driven, down from 54 cents in 2016. (262) If the taxpayer wants to use the standard mileage rate for a car he or she owns, he or she must choose to use it in the first year the car is available for use in his or her business. Then, in later years, he or she can choose to use either the standard mileage rate or actual expenses. The taxpayer cannot use the standard mileage rate if he or she: (263)

Uses five or more cars at the same time (such as in fleet operations). Claimed a depreciation deduction for the car using any method other than straight line, for example, MACRS. Claimed a section 179 deduction on the car. Claimed the special depreciation allowance on the car. Claimed actual car expenses after 1997 for a car he or she leased. Is a rural mail carrier who received a qualified reimbursement.

The taxpayer can elect to use the standard mileage rate if he or she used a car for hire (such as a taxi) unless the standard mileage rate is otherwise not allowed, as discussed above. Also, there is no required percentage of business miles driven to qualify for the standard mileage rate.

Business Travel Expenses Travel expenses are the ordinary and necessary expenses of traveling away from home for the taxpayer’s business, profession, or job. Generally, employees deduct these expenses using Form 2106 - Employee Business Expenses or Form 2106-EZ - Unreimbursed Employee Business Expenses and on Form 1040, Schedule A. The taxpayer cannot deduct expenses that are lavish or extravagant or that are for personal purposes. The taxpayer is traveling away from home if his or her duties require him or her to be away from the general area of his or her tax home for a period substantially longer than an ordinary day's work, and he or she needs to get sleep or rest to meet the demands of his or her work while away. Generally, the taxpayer’s tax home is the entire city or general area where the taxpayer’s main place of business or work is located, regardless of where he or she maintains his or her family home. For example, the taxpayer lives with his or her family in Chicago but works in Milwaukee where he or she stays in a hotel and eats in restaurants. The taxpayer returns

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to Chicago every weekend. He or she may not deduct any of his or her travel, meals, or lodging in Milwaukee because that is his or her tax home. The taxpayer’s travel on weekends to his or her family home in Chicago is not for his or her work, so these expenses are also not deductible. If the taxpayer regularly works in more than one place, his or her tax home is the general area where his or her main place of business or work is located. In determining the taxpayer’s main place of business, take into account the length of time he or she is normally required to spend at each location for business purposes, the degree of business activity in each area, and the relative significance of the financial return from each area. However, the most important consideration is the length of time spent at each location. Here is a list of the common expenses that can be deducted as travel expenses while away from home: (264)

Travel by airplane, train, bus, or car between home and business destination. Using a car while at the business destination. A taxpayer can deduct actual expenses or the standard mileage

rate, as well as business-related tolls and parking fees. If he or she rents a car, the taxpayer can deduct only the business-use portion for the expenses.

Fares for taxis or other types of transportation between the airport or train station and the hotel, the hotel and the work location, and from one customer to another, or from one place of business to another.

Meals and lodging. Tips for services related to any of these expenses. Dry cleaning and laundry. Business calls while on the business trip (This includes business communications by fax machine or other

communication devices). Other similar ordinary and necessary expenses related to business travel (These expenses might include

transportation to and from a business meal, public stenographer's fees, computer rental fees, and operating and maintaining a house trailer).

Shipping of baggage, and sample or display material between regular and temporary work locations. If a trip was primarily for business, all of the taxpayer’s expenses can be deducted. If the primary purpose of the trip was for pleasure or other personal reason, then none of the expenses are deductible, even though the person may have transacted some business at the destination. However, business expenses incurred at the destination are deductible. In the case of conventions, a taxpayer can deduct the entire cost of attending a business convention if the taxpayer can show that his or her attendance benefited the individual’s trade or business. This does not include the costs of taking the taxpayer’s family along to the convention. However, if the convention is for investment, political, social or other purposes unrelated to the taxpayer’s trade or business, the taxpayer cannot deduct the cost. If the taxpayer traveled outside the United States, and the entire time was spent on business, all of the expenses are deductible. If part of the time was spent on personal activities, even though the trip was primarily for business, the taxpayer has to reduce the amount of deductible travel expenses by the percent of time spent on non-business pursuits. If the trip outside the country was primarily for non-business reasons, like travel within the U.S., none of the travel expenses are deductible. (218) Meals and Entertainment Meals and entertainment expenses are generally subject to the 50% Limit. Items that a taxpayer can only deduct 50% of business-related meal and entertainment include: (218)

Taxes and tips relating to a business meal or entertainment activity. Cover charges for admission to a nightclub. Rent paid for a room in which the taxpayer holds a dinner or cocktail party. Amounts paid for parking at a sports arena.

However, the cost of transportation to and from a business meal or a business-related entertainment activity is not subject to the 50% limit.

The taxpayer can deduct entertainment expenses only if they are both ordinary and necessary and meet one of the following tests: (263)

Directly-related test. Associated test.

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To meet the directly-related test for entertainment expenses (including entertainment-related meals), the taxpayer must show that: (263)

The main purpose of the combined business and entertainment was the active conduct of business. He or she did engage in business with the person during the entertainment period. He or she had more than a general expectation of getting income or some other specific business benefit at some

future time. Business is generally not considered to be the main purpose when business and entertainment are combined on hunting or fishing trips, or on yachts or other pleasure boats. Even if the taxpayer shows that business was the main purpose, he or she generally cannot deduct the expenses for the use of an entertainment facility. To meet the associated test for entertainment expenses (including entertainment-related meals), the taxpayer must show that the entertainment is: (263)

Associated with the active conduct of the trade or business. Directly before or after a substantial business discussion.

If the entertainment is held on the same day as the business discussion, it is considered to be held directly before or after the business discussion. If the entertainment and the business discussion are not held on the same day, the taxpayer must consider the facts of each case to see if the associated test is met. Among the facts to consider are the place, the date, and the duration of the business discussion. If the taxpayer or his or her business associates are from out of town, he or she must also consider the dates of arrival and departure, and the reasons the entertainment and the discussion did not take place on the same day. The taxpayer cannot deduct dues (including initiation fees) for membership in any club organized for: (263)

Business. Pleasure. Recreation. Other social purpose.

This rule applies to any membership organization if one of its principal purposes is either:

To conduct entertainment activities for members or their guests. To provide members or their guests with access to entertainment facilities.

The purposes and activities of a club, not its name, will determine whether or not the taxpayer can deduct the dues. He or she cannot deduct dues paid to:

Country clubs. Golf and athletic clubs. Airline clubs. Hotel clubs. Clubs operated to provide meals under circumstances generally considered to be conducive to business

discussions. Generally, the taxpayer cannot deduct any expense for the use of an entertainment facility. This includes expenses for depreciation and operating costs such as rent, utilities, maintenance, and protection. The taxpayer generally cannot deduct the cost of entertainment for his or her spouse or for the spouse of a customer. However, the taxpayer can deduct these costs if he or she can show he or she had a clear business purpose, rather than a personal or social purpose, for providing the entertainment. Also, generally, the taxpayer cannot deduct more than the face value of an entertainment ticket, even if he or she paid a higher price. For example, the taxpayer cannot deduct service fees he or she pays to ticket agencies or brokers or any amount over the face value of the tickets he or she pay to scalpers.

Lesson 13 - Itemized Deductions

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Business Educational Expenses Business education expenses may be deductible if they either: (265)

Are required by the employee’s employer or the law to maintain the employee’s salary or job status. Maintain or improve the employee’s required existing job skills.

Educational expenses are not deductible, even though they may meet the above two requirements, if the education either:

Is needed to meet the minimum educational requirements of the person’s present trade or business. Is part of a program of study that qualifies the person for a new trade or business. It does not matter that the

person neither intends to enter nor actually does enter a new business, only that the education enables the person to do so.

A taxpayer can deduct the costs of qualifying work-related education as a business expense even if the education could lead to a degree.

If work-related education meets the requirements described above, generally the following education expenses can be deducted as business expenses: (265)

Tuition, books, supplies, lab fees, and similar items. Certain transportation and travel costs. Other education expenses, such as costs of research and typing when writing a paper as part of an educational

program.

Other Employee Deductions Some examples of some further employee expenses that may be itemized are: (260)

Uniforms. Union dues. Tools. Subscriptions to professional and trade journals. Dues to professional organizations. Fees paid to employment agencies.

The cost of uniforms is deductible only if they are required by the worker’s employment and are not suitable as regular clothing (that is, for everyday use). Ordinary work clothes (such as khakis or overalls) are not deductible. If special clothing is deductible, the cost of laundering or dry cleaning is also allowed. Special protective clothing (such as safety helmets and safety shoes, work gloves, rubber boots) is usually deductible. The cost of armed forces uniforms is deductible only by reservists not on active duty. Job Search Expense A taxpayer can deduct certain expenses he or she incurs in looking for a new job in the taxpayer’s present occupation, even if the individual does not get a new job. A taxpayer cannot deduct job-hunting expenses if: (260)

Taxpayer is looking for a job in a new trade or occupation. Taxpayer had a long period of unemployment prior to working again. The person is seeking employment for the first time.

Investment and Tax Assistance The following investment and tax assistance expenses may be itemized:

Investment counsel fees and other related expenses. Investment services.

Lesson 13 - Itemized Deductions

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Safe-deposit box rent (if used to store stocks and bonds and other documents relating to income-producing property).

Fee for preparation of tax returns. Costs of defending or initiating a legal action or claim in connection with the determination, collection, or refund of

any tax. Appraisal fees relating to tax planning. Trustee's fees for the client's IRA, if such fees were separately billed and paid by the taxpayer.

Investment and tax assistance expenses will generally be included with the miscellaneous itemized deductions subject to the 2% of AGI floor. Other Miscellaneous Deductions Line 28 of Schedule A, Form 1040 allows the taxpayer to list certain other deductions that are miscellaneous deductions, but are not subject to the 2% AGI rule. Common deductions taken here include: (266)

Amortizable premium on taxable bonds. Casualty and theft losses from income-producing property. Federal estate tax on income in respect of a decedent. Gambling losses up to the amount of gambling winnings. Impairment-related work expenses of persons with disabilities. Loss from other activities from Schedule K-1 (Form 1065-B), box 2. Losses from Ponzi-type investment schemes. Repayments of more than $3,000 under a claim of right. Unrecovered investment in an annuity.

Amortizable Premium on Taxable Bonds In general, if the amount the taxpayer pays for a bond is greater than its stated principal amount, the excess is bond premium. The taxpayer can elect to amortize the premium on taxable bonds. The amortization of the premium is generally an offset to interest income on the bond rather than a separate deduction item. (266)

Pre-1998 election to amortize bond premium - Generally, if the taxpayer first elected to amortize bond premium before 1998, the above treatment of the premium does not apply to bonds acquired before 1988.

Bonds acquired after October 22, 1986, and before 1988 - The amortization of the premium on these bonds is investment interest expense subject to the investment interest limit, unless the taxpayer choses to treat it as an offset to interest income on the bond.

Bonds acquired before October 23, 1986 - The amortization of the premium on these bonds is a miscellaneous itemized deduction not subject to the 2% limit.

On certain bonds (such as bonds that pay a variable rate of interest or that provide for an interest-free period), the amount of bond premium allocable to a period may exceed the amount of stated interest allocable to the period. If this occurs, treat the excess as a miscellaneous itemized deduction that is not subject to the 2% limit. However, the amount deductible is limited to the amount by which the total interest inclusions on the bond in prior periods exceed the total amount the taxpayer treated as a bond premium deduction on the bond in prior periods. If any of the excess bond premium cannot be deducted because of the limit, this amount is carried forward to the next period and is treated as bond premium allocable to that period. (266) Casualty and Theft Losses of Income-Producing Property The taxpayer can deduct a casualty or theft loss as a miscellaneous itemized deduction not subject to the 2% limit if the damaged or stolen property was income-producing property (property held for investment, such as stocks, notes, bonds, gold, silver, vacant lots, and works of art). First report the loss in Section B of Form 4684 - Casualties and Thefts. The taxpayer may also have to include the loss on Form 4797 - Sales of Business Property, if he or she is otherwise required to file that form. To figure the deduction, add all casualty or theft losses from this type of property included on Form 4684, lines 32 and 38b, or Form 4797, line 18a. (266)

Lesson 13 - Itemized Deductions

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Federal Estate Tax on Income in Respect of a Decedent The taxpayer can deduct the Federal estate tax attributable to income in respect of a decedent that he or she as a beneficiary include in his or her gross income. Income in respect of the decedent is gross income that the decedent would have received had death not occurred and that was not properly includible in the decedent's final income tax return. (266) Gambling Losses Up to the Amount of Gambling Winnings The taxpayer must report the full amount of gambling winnings for the year on Form 1040, line 21. He or she deducts gambling losses for the year on Schedule A (Form 1040), line 28. The taxpayer cannot deduct gambling losses that are more than winnings. Generally, nonresident aliens cannot deduct gambling losses on Schedule A (Form 1040NR).

The taxpayer cannot reduce gambling winnings by gambling losses and report the difference. He or she must report the full amount of winnings as income and claim losses (up to the amount of winnings) as an itemized deduction. Therefore, the taxpayer’s records should show winnings separately from losses. The taxpayer must keep an accurate diary or similar record of losses and winnings. (266)

The diary should contain at least the following information: (266)

The date and type of the specific wager or wagering activity. The name and address or location of the gambling establishment. The names of other persons present with the taxpayer at the gambling establishment. The amount(s) the taxpayer won or lost.

In addition to the diary, the taxpayer should also have other documentation. He or she can generally prove winnings and losses through Form W-2G - Certain Gambling Winnings, Form 5754 - Statement by Person(s) Receiving Gambling Winnings, wagering tickets, canceled checks, substitute checks, credit records, bank withdrawals, and statements of actual winnings or payment slips provided to the taxpayer by the gambling establishment. Impairment-Related Work Expenses If the taxpayer has a physical or mental disability that limits him or her being employed, or substantially limits one or more of his or her major life activities, such as performing manual tasks, walking, speaking, breathing, learning, and working, the taxpayer can deduct the impairment-related work expenses. Impairment-related work expenses are ordinary and necessary business expenses for attendant care services at the taxpayer’s place of work and other expenses in connection with the taxpayer’s place of work that are necessary for him or her to be able to work. (266) Loss From Other Activities From Schedule K-1 If the amount reported in Schedule K-1- Beneficiary’s Share of Income, Deductions, Credits (Form 1065-B), box 2, is a loss, report it on Schedule A (Form 1040), line 28, or Schedule A (Form 1040NR), line 14 (only if effectively connected with a U.S. trade or business). It is not subject to the passive activity limitations. (266) Losses From Ponzi-type Investment Schemes If the taxpayer had a loss from a Ponzi-type investment scheme, refer to the following revenue ruling to determine qualification: (259)

Revenue Ruling 2009-9, 2009-14 I.R.B. 735 Revenue Procedure 2009-20, 2009-14 I.R.B. 749 Revenue Procedure 2011-58, 2011-50 I.R.B. 849

If the taxpayer qualifies to use Revenue Procedure 2009-20, as modified by Revenue Procedure 2011-58, and he or she chooses to follow the procedures in the guidance, first fill out Section C of Form 4684 - Casualties and Thefts to determine the amount to enter on Section B, line 28. Skip lines 19 to 27. Section C of Form 4684 replaces Appendix A in Revenue Procedure 2009-20. The taxpayer does not need to complete Appendix A. For more information, see the above revenue ruling and revenue procedures, and the Instructions for Form 4684. If the taxpayer chooses not to use the procedures in Revenue Procedure 2009-20, he or she may claim his or her theft loss by filling out Section B of Form 4684, lines 19 to 39, as appropriate.

Lesson 13 - Itemized Deductions

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Repayments Under Claim of Right If the taxpayer had to repay more than $3,000 that he or she included in income in an earlier year because at the time he or she thought they had an unrestricted right to it, the taxpayer may be able to deduct the amount he or she repaid, or take a credit against the tax. (266) Unrecovered Investment in Annuity A retiree who contributed to the cost of an annuity can exclude from income a part of each payment received as a tax-free return of the retiree's investment. If the retiree dies before the entire investment is recovered tax free, any unrecovered investment can be deducted on the retiree's final income tax return. (266) Investment Interest If the taxpayer uses the cash method of accounting, he or she must pay the interest before it can be deducted. If the taxpayer uses an accrual method of accounting, he or she can deduct interest over the period it accrues, regardless of when he or she pays it. Other Expenses The taxpayer can deduct certain other expenses as miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income limit. On Schedule A, he or she can deduct the ordinary and necessary expenses paid:

1. To produce or collect income that must be included in the taxpayer’s gross income. 2. To manage, conserve, or maintain property held for producing such income. 3. To determine, contest, pay, or claim a refund of any tax.

The taxpayer can deduct expenses he or she pays for the purposes in (1) and (2) above only if they are reasonable and closely related to these purposes. These other expenses include the following items:

Appraisal fees for a casualty loss or charitable contribution. Casualty and theft losses from property used in performing services as an employee. Clerical help and office rent in caring for investments. Depreciation on home computers used for investments. Excess deductions (including administrative expenses) allowed a beneficiary on termination of an estate or trust. Fees to collect interest and dividends. Hobby expenses, but generally not more than hobby income. Indirect miscellaneous deductions from pass-through entities. Investment fees and expenses. Legal fees related to producing or collecting taxable income or getting tax advice. Loss on deposits in an insolvent or bankrupt financial institution. Loss on traditional IRAs or Roth IRAs, when all amounts have been distributed to the taxpayer. Repayments of income. Repayments of Social Security benefits. Safe deposit box rental, except for storing jewelry and other personal effects. Service charges on dividend reinvestment plans. Tax advice fees. Trustee's fees for the taxpayer’s IRA, if separately billed and paid.

Expenses of Producing Income The taxpayer can deduct investment expenses (other than interest expenses) as miscellaneous itemized deductions on Schedule A (Form 1040). To be deductible, these expenses must be ordinary and necessary expenses paid or incurred: (267)

To produce or collect income. To manage property held for producing income.

Lesson 13 - Itemized Deductions

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The expenses must be directly related to the income or income-producing property, and the income must be taxable to the taxpayer. The deduction for most income-producing expenses is subject to a 2% limit that also applies to certain other miscellaneous itemized deductions. The amount deductible is limited to the total of these miscellaneous deductions that is more than 2% of adjusted gross income. The taxpayer can deduct fees he or she pays to a broker, bank, trustee, or similar agent to collect investment income, such as taxable bond or mortgage interest, or dividends on shares of stock. The taxpayer cannot deduct a fee he or she pays to a broker to acquire investment property, such as stocks or bonds. The taxpayer must add the fee to the cost of the property. Also, the taxpayer cannot deduct any broker's fees, commissions, or option premiums he or she pays (or that were netted out) in connection with the sale of investment property. They can be used only to figure gain or loss from the sale. Nondeductible Expenses Some expenses that the taxpayer incurs as an investor are not deductible. Some examples are: (132)

Transportation and other expenses the taxpayer pays to attend stockholders' meetings of companies in which he or she has no interest other than owning stock.

Interest on money the taxpayer borrows to buy or carry a single-premium life insurance, endowment, or annuity contract.

Interest on money the taxpayer borrows to buy or carry a life insurance, endowment, or annuity contract if he or she plans to systematically borrow part or all of the increases in the cash value of the contract.

Expenses the taxpayer incurs to produce tax-exempt income. Interest on money the taxpayer borrows to buy tax-exempt securities or shares in a mutual fund or other regulated

investment company that distributes only exempt-interest dividends. The taxpayer may have expenses that are for both tax-exempt and taxable income. If he or she cannot specifically identify what part of the expenses is for each type of income, he or she can divide the expenses, using reasonable proportions based on facts and circumstances. The taxpayer must attach a statement to the return showing how he or she divided the expenses and stating that each deduction claimed is not based on tax-exempt income. One accepted method for dividing expenses is to do it in the same proportion that each type of income is to the total income. If the expenses relate in part to capital gains and losses, include the gains, but not the losses, in figuring this proportion. To find the part of the expenses that is for the tax-exempt income, divide the tax-exempt income by the total income and multiply the expenses by the result. Additionally, the taxpayer cannot deduct the following expenses: (261)

Adoption expenses. Broker's commissions. Burial or funeral expenses, including the cost of a cemetery lot. Campaign expenses. Capital expenses. Check-writing fees. Club dues. Commuting expenses. Fees and licenses, such as car licenses, marriage licenses, and dog tags. Fines and penalties, such as parking tickets. Health spa expenses. Hobby losses. Home repairs, insurance, and rent. Home security system. Illegal bribes and kickbacks. Investment-related seminars. Life insurance premiums. Lobbying expenses. Losses from the sale of a home, furniture, personal car, etc. Lost or misplaced cash or property. Lunches with co-workers.

Lesson 13 - Itemized Deductions

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Meals while working late. Medical expenses as business expenses other than medical examinations required by the employer. Personal disability insurance premiums. Personal legal expenses. Personal, living, or family expenses. Political contributions. Professional accreditation fees. Professional reputation, expenses to improve. Relief fund contributions. Residential telephone line. Stockholders' meeting, expenses of attending. Tax-exempt income, expenses of earning or collecting. The value of wages never received or lost vacation time. Travel expenses for another individual. Voluntary unemployment benefit fund contributions. Wristwatches.

Lost or Mislaid Cash or Property The taxpayer cannot deduct a loss based on the mere disappearance of money or property. However, an accidental loss or disappearance of property can qualify as a casualty if it results from an identifiable event that is sudden, unexpected, or unusual. Gift Expenses The taxpayer can deduct no more than $25 for business gifts he or she gives directly or indirectly to each person during the tax year. A gift to a company that is intended for the eventual personal use or benefit of a particular person or a limited class of people will be considered an indirect gift to that particular person or to the individuals within that class of people who receive the gift. If the taxpayer gives a gift to a member of a customer's family, the gift is generally considered to be an indirect gift to the customer. This rule does not apply if the taxpayer has a bona fide, independent business connection with that family member and the gift is not intended for the customer's eventual use. If the taxpayer and his or her spouse both give gifts, both the taxpayer and his or her spouse are treated as one taxpayer. It does not matter whether they separate businesses, are separately employed, or whether each of them has an independent connection with the recipient. If a partnership gives gifts, the partnership and the partners are treated as one taxpayer. Incidental costs, such as engraving on jewelry, or packaging, insuring, and mailing, are generally not included in determining the cost of a gift for purposes of the $25 limit. A cost is incidental only if it does not add substantial value to the gift. For example, the cost of gift wrapping is an incidental cost. However, the purchase of an ornamental basket for packaging fruit is not an incidental cost if the value of the basket is substantial compared to the value of the fruit. The following items are not considered gifts for purposes of the $25 limit.

1. An item that costs $4 or less and: 2. Has the taxpayer’s name clearly and permanently imprinted on the gift, and 3. Is one of a number of identical items the taxpayer widely distributes. Examples include pens, desk sets, and plastic

bags and cases. 4. Signs, display racks, or other promotional material to be used on the business premises of the recipient.

The IRS provides detailed guidance on these types of expenses in IRS Publication 463 - Travel, Entertainment, Gift, and Car Expenses. (263) Total Itemized Deductions After completing all of the sections that apply to a given taxpayer, enter the total on Line 29 of Schedule A, Form 1040.

Lesson 13 - Itemized Deductions

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This is the total of all itemized deductions. If the taxpayer elects to itemize for state tax or other purposes even though the itemized deductions are less than the standard deduction, check the box on line 30. Limitation of Itemized Deductions (Pease)

The Limitation on Itemized Deductions (Pease) reduced the amount of itemized deductions and personal exemptions a taxpayer can take by 3% when adjusted gross income exceeded a specific threshold. In 2010, however, those income limits were repealed, and the recent tax relief act extended the elimination of Pease for

two more years, through 2012. The American Taxpayer Relief Act of 2012 revives the limitation on itemized deduction for tax year 2013 and later. For 2017, the higher threshold will be applicable under the tax law for taxpayers with income of: (268)

$313,800 for married couples, filing jointly and surviving spouses. $261,500 for single taxpayers. $287,650 for head of household taxpayers. $156,900 for married filing separately individuals.

The total amount of a taxpayer’s affected itemized deductions is reduced by 3% of the amount by which his or her AGI exceeds the threshold. However, the reduction cannot exceed 80% of the total affected deductions.

Lesson 13 - Itemized Deductions

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

Review Questions Answers appear in Review Feedback 1. All of the following are nondeductible expenses except:

A. Payments for food B. Life insurance premiums paid by the insured C. Ordinary and necessary business expenses D. Rent and insurance premiums paid for the taxpayer’s own dwelling

2. Which of the following events is a casualty loss that is deductible?

A. Damage to a building from a fire which was intentionally set by a competitor of the taxpayer B. Decline in value of a home due to mudslides which damaged only neighboring homes C. Loss of a seawall from the waves continually striking it D. Damage to a house from wood rotting

3. Susan traveled from Seattle to Portland on a business trip for her employer. She is not reimbursed for the travel

expenses. Susan spends two days in business meetings and one day on vacation. Her meals cost $120 ($40 per day), lodging costs $390 ($130 per day), and train fare costs $75. What is the total deductible amount of Susan's business-related travel expense?

A. $335 B. $375 C. $415 D. $585

4. In general, a taxpayer can deduct only what percentage of business-related meal and entertainment expenses?

A. 10% B. 15% C. 25% D. 50%

5. Which of the following common expenses can be deducted as travel expenses while away from home?

A. Dry cleaning and laundry B. Business telephone calls C. Tips D. All of the above

6. For the purposes of deductible mortgage interest, if the taxpayer rents a second home to others, he or she must use

the home during the year for more than the greater of how many days or 10% of the number of days it is rented, for the interest to qualify as qualified residence interest?

A. 5 days B. 10 days C. 14 days D. 15 days

Lesson 13 - Itemized Deductions

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7. When deducting a casualty, each casualty loss is subject to a $100 floor, and total losses are deductible only to the extent that the total loss amount for the tax year exceeds what percentage of adjusted gross income?

A. 2% B. 5% C. 7.5% D. 10%

8. Which of the following are examples of employee expenses that may be itemized?

A. Union dues B. Tools C. Dues to professional organizations D. All of the above

9. Which of the following can a taxpayer list as a miscellaneous deduction that is not subject to the 2% AGI rule?

A. Broker's commissions B. Investment-related seminars C. Amortizable premium on taxable bonds D. Lobbying expenses

10. Incidental costs are generally not included in determining the cost of a gift for purposes of the $25 limit. Incidental

costs generally include all of the following items except: A. Engraving on jewelry B. Mailing a gift C. Insuring a gift D. Purchasing an ornamental basket for packaging a gift where the value of the basket is substantial compared

to the value of the gift

Lesson 13 - Itemized Deductions

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Review Feedback Return to Review Questions Question 1 - C. Ordinary and necessary business expenses Among other nondeductible expenses, a taxpayer cannot deduct payments for food, life insurance premiums paid by the insured or rent and insurance premiums paid for the taxpayer’s own dwelling. Question 2 - A. Damage to a building from a fire which was intentionally set by a competitor of the taxpayer A casualty is defined as the complete or partial destruction of property from a sudden, unexpected, or unusual cause. A fire is a sudden and unexpected event causing damage to a building. It does not matter that the fire was intentionally set as long as it was not intentionally set by the taxpayer incurring the loss. Question 3 - B. $375 Allowable business-related travel expenses include: $75 train cost, $260 for two days lodging (two of the three days were for business), $40 after applying 50% limitation of the meal expenses for the two business days. $75 + $260 + $40 = $375. Question 4 - D. 50% Meals and entertainment expenses are generally subject to the 50% Limit. Items that a taxpayer can only deduct 50% of business-related meal and entertainment include taxes and tips relating to a business meal or entertainment activity, cover charges for admission to a nightclub, rent paid for a room in which the taxpayer holds a dinner or cocktail party or amounts paid for parking at a sports arena. However, the cost of transportation to and from a business meal or a business-related entertainment activity is not subject to the 50% limit. Question 5 - D. All of the above A taxpayer can deduct ordinary and necessary expenses when traveling away from home on business. Some of the deductible expenses include taxi, commuter bus, airport limousine, baggage, shipping, dry cleaning, laundry, business calls, tips and other similar ordinary and necessary expenses related to business travel. These expenses might include transportation to or from a business meal, public stenographer's fees, computer rental fees, and operating and maintaining a house trailer. Question 6 - C. 14 days A second home can include any other residence the taxpayer owns and treats as a second home. The taxpayer does not have to use the home during the year. However, if he or she rents it to others, the taxpayer must also use it as a home during the year for more than the greater of 14 days or 10% of the number of days it is rented, for the interest to qualify as qualified residence interest. Question 7 - D. 10% Each casualty loss is subject to a $100 floor, and total losses are deductible only to the extent that the total loss amount for the tax year exceeds 10% of Adjusted Gross Income. Question 8 - D. All of the above Some examples of employee expenses that may be itemized are uniforms, union dues, tools, subscriptions to professional and trade journals, dues to professional organizations and fees paid to employment agencies. Question 9 - C. Amortizable premium on taxable bonds Line 28 of Schedule A, Form 1040 allows the taxpayer to list certain other deductions that are miscellaneous deductions, but are not subject to the 2% AGI rule. Common deductions taken here include amortizable premium on taxable bonds, casualty and theft losses from income-producing property, Federal estate tax on income in respect of a decedent, gambling losses up to the amount of gambling winnings, impairment-related work expenses of persons with disabilities, loss from other activities from Schedule K-1 (Form 1065-B), box 2, losses from Ponzi-type investment schemes, repayments of more than $3,000 under a claim of right and unrecovered investment in an annuity. Question 10 - D. Purchasing an ornamental basket for packaging a gift where the value of the basket is substantial compared to the value of the gift Incidental costs, such as engraving on jewelry, or packaging, insuring, and mailing, are generally not included in determining the cost of a gift for purposes of the $25 limit. A cost is incidental only if it does not add substantial value to the gift. For example, the cost of gift wrapping is an incidental cost. However, the purchase of an ornamental basket for packaging fruit is not an incidental cost if the value of the basket is substantial compared to the value of the fruit.

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

Earned Income Tax Credit Child and Dependent Care Credit Child Tax Credit Additional Child Tax Credit Credits for Higher Education Affordable Care Act Tax Credits Adoption Credit Other Tax Credits

A tax credit reduces the amount of tax for which a taxpayer is liable. Unlike a deduction, which reduces the amount of income subject to tax, a tax credit directly reduces tax liability. This means that a $500 tax credit actually takes $500 off the taxpayer’s tax balance due. A tax deduction, on the other hand, reduces his or her taxable income and is equal to the percentage of his or her marginal tax bracket. Nonrefundable Tax Credits Most of the tax credits are referred to as nonrefundable credits. A nonrefundable credit is subtracted from the taxpayer’s income tax liability, up to the total amount he or she owes. But unlike a refundable tax credit, a nonrefundable credit cannot reduce his or her tax balance beyond zero. Any unused portion of a nonrefundable tax credit will expire in the year the credit is claimed and cannot be carried over. Examples of nonrefundable tax credits include:

Child and Dependent Care Credit. Education credits. Credit for the Elderly or Disabled. Child Tax Credit. Foreign Income Tax Credit. Residential Energy Credits. Adoption Credit (As of 2012, no longer refundable). Credit to Holders of Tax Credit Bonds. Mortgage Interest Credit. Nonrefundable Credit for Prior Year Minimum Tax. Retirement Savings Contributions Credit (Saver's Credit).

Refundable Tax Credits Refundable credits are the most versatile type of tax credit. These credits are treated just like tax payments that the taxpayer makes to the IRS, such as income taxes withheld paychecks or estimated tax payments made throughout the year. A refundable tax credit can reduce tax liability below zero. It is possible to receive a tax refund from this type of credit. Examples of refundable tax credits include:

Earned Income Tax Credit. Excess Social Security Credit. Additional Child Tax Credit. Premium Tax Credit. American Opportunity Tax Credit (up to $1,000 is refundable). Credit for Tax on Undistributed Capital Gain.

Lesson 14 - Credits

© 2018 Golden State Tax Training Institute, Inc. 14-2

Eight Tax Benefits for Parents Taxpayer’s children may help qualify the taxpayer for valuable tax benefits, such as certain credits and deductions. If the taxpayer is a parent, here are eight benefits he or she can use when filing taxes this year.

1. Dependents - In most cases, a taxpayer can claim a child as a dependent even if the child was born anytime in 2017. For more information, see IRS Publication 501 - Exemptions, Standard Deduction and Filing Information.

2. Child Tax Credit – The taxpayer may be able to claim the Child Tax Credit for each of his or her children that were under age 17 at the end of 2017. If the taxpayer does not benefit from the full amount of the credit, he or she may be eligible for the Additional Child Tax Credit. For more information, see the instructions for Schedule 8812 - Child Tax Credit, and Publication 972 - Child Tax Credit.

3. Child and Dependent Care Credit – The taxpayer may be able to claim this credit if he or she paid someone to care for his or her child or children under age 13, so that he or she could work or look for work. See IRS Publication 503 - Child and Dependent Care Expenses.

4. Earned Income Tax Credit - If the taxpayer worked but earned less than $53,930 in 2017, he or she may qualify for EITC. If the taxpayer has qualifying children, he or she may get up to $6,318 in 2017 back when he or she files a return and claims it. See Publication 596 - Earned Income Tax Credit.

5. Adoption Credit – The taxpayer may be able to take a tax credit for certain expenses he or she incurred to adopt a child. For details about this credit, see the instructions for IRS Form 8839 - Qualified Adoption Expenses.

6. Higher education credits - If the taxpayer paid higher education costs for him or herself or another student who is an immediate family member, he or she may qualify for either the American Opportunity Tax Credit or the Lifetime Learning Credit. Both credits may reduce the amount of tax owed. See IRS Publication 970 - Tax Benefits for Education.

7. Student loan interest – The taxpayer may be able to deduct interest he or she paid on a qualified student loan, even if the taxpayer does not itemize his or her deductions. For more information, see IRS Publication 970 - Tax Benefits for Education.

8. Self-employed health insurance deduction - If the taxpayer was self-employed and paid for health insurance, he or she may be able to deduct premiums paid to cover a child. It applies to children under age 27 at the end of the year, even if not the taxpayer’s dependent.

Here are five credits the IRS wants the taxpayer to consider before filing the Federal income tax return: (269)

1. The Earned Income Tax Credit is a refundable credit for people who work and do not earn a lot of money. The maximum credit for 2017 returns is $6,318 for workers with three or more children. Eligibility is determined based on earnings, filing status and eligible children. Workers without children may be eligible for a smaller credit. If the taxpayer worked and earned less than $53,930 in 2017, use the EITC Assistant tool on IRS.gov to see if he or she qualifies. For more information, see Publication 596 - Earned Income Tax Credit.

2. The Child and Dependent Care Credit is for expenses the taxpayer paid for the care of qualifying children under age 13, or for a disabled spouse or dependent. The care must enable the taxpayer to work or look for work. For more information, see Publication 503 - Child and Dependent Care Expenses.

3. The Child Tax Credit may apply to the taxpayer if he or she has a qualifying child under age 17. The credit may help reduce the Federal income tax by up to $1,000 for each qualifying child claimed on the return. The taxpayer may be required to file the new Schedule 8812 - Child Tax Credit, with the tax return to claim the credit. See Publication 972 - Child Tax Credit, for more information.

4. The Retirement Savings Contributions Credit (Saver’s Credit) helps low-to-moderate income workers save for retirement. The taxpayer may qualify if his or her income is below a certain limit and he or she contributes to an IRA or a retirement plan at work. The credit is in addition to any other tax savings that apply to retirement plans. For more information, see Publication 590 - Individual Retirement Arrangements (IRAs).

5. The American Opportunity Tax Credit helps offset some of the costs that the taxpayer pays for higher education. The AOTC applies to the first four years of post-secondary education. The maximum credit is $2,500 per eligible student. 40% of the credit, up to $1,000, is refundable. The taxpayer must file Form 8863 - Education Credits, to claim it if he or she qualifies. For more information, see Publication 970 - Tax Benefits for Education.

Earned Income Tax Credit Due Diligence Requirements Due to changes in the tax law, the paid tax return preparer Earned Income Tax Credit (EITC) due diligence requirements

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have been expanded to also cover the American Opportunity Tax Credit (AOTC), the Child Tax Credit (CTC) and/or the Additional Child Tax Credit (ACTC). Form 8867 - Paid Preparer’s Due Diligence Checklist, has been modified to account for these changes. In addition, Form 8867 has been streamlined. Completing the form is not a substitute for actually performing the necessary due diligence and completing all required forms and schedules when preparing the return. (270) The due diligence requirement, enacted by Congress over a decade ago, was designed to reduce errors on returns claiming the EITC, most of which are prepared by tax professionals. The IRS created Form 8867 to help preparers meet the requirement by obtaining eligibility information from their clients. Preparers have been required to keep copies of the form, or comparable documentation, which is subject to review by the IRS. (270) To help ensure compliance with the law and that eligible taxpayers receive the right credit amount, the new regulations require preparers, effective January 1, 2012, to file the Form 8867 with each return claiming the EITC. Further details can be found in Treasury Decision 9570, published in the Federal Register. (270)

The paid tax return preparer due diligence penalty under IRC section 6695(h) is now indexed for inflation. Therefore, the penalty for failure to meet the due diligence requirements with respect to returns and claims for refund filed in 2017 is $510 per credit per return.

To meet the due diligence requirements a paid tax return preparer must complete the four following steps:

1. Completion of Eligibility Checklist - Prepare form 8867, the paid preparer Earned Income Tax Credit Checklist. The paid tax return preparer must ask and explain to his or her clients all the questions in Part I and all the questions that apply in Part II and III. He or she must personally answer the due diligence questions in Part IV.

2. Computation of the Credit - Complete the EITC worksheet, which is available in most tax preparation software programs.

3. Knowledge - For the knowledge requirement, the paid tax return preparer must not know or have reason to know that the information used to compute the EITC is incorrect. If there is any doubt, he or she must ask his or her client additional questions. A knowledgeable tax return preparer should be able to conclude if the information given seems incorrect, inconsistent or incomplete.

4. Record Retention - The paid tax return preparer must keep the 8867, the EITC worksheet and a record of how he or she received the information used to prepare the return for three years from June 30 following the date he or she presented the return to his or her client to sign. The paid tax return preparer can keep these records in either paper or electronic format. It is a good idea to keep a back-up of these records at an off-site, secure location.

Completing the Form 8867 Form 8867 covers the EITC, the AOTC, and the CTC/ACTC. A tax preparer should only complete columns corresponding to credits actually claimed on the taxpayer’s return that he or she prepared. Only paid tax return preparers should complete Form 8867. Form 8867 is divided into questions that relate to all three credits and questions that are specifically related to EITC only, Child Tax Credit only, and the American Opportunity Tax Credit only. Due Diligence Questions for Returns Claiming EITC A paid tax return preparer must exercise due diligence to determine whether a taxpayer meets all of the eligibility requirements for the EITC. Although lines 9a and 9b of Form 8867only ask two specific questions about ETIC eligibility related to claiming a qualifying child, the tax preparer’s client must meet all of the eligibility requirements for claiming the EITC. Therefore, the tax preparer’s client cannot claim the EITC if all of the eligibility requirements for the EITC are not satisfied, even if the tax preparer answers “yes” to 9a and 9b. Credit Eligibility Certification The tax preparer must certify that all of the answers on Form 8867 are, to the best of his or her knowledge, true, correct and complete. Failure to meet due diligence requirements with respect to claiming the EITC, the AOTC, and the CTC/ACTC could result in a $510 penalty for each failure. For example, if a paid tax return preparer prepares a return claiming the EITC, the AOTC and the CTC/ACTC and he or she failed to meet the due diligence requirements for all of these credits, the tax preparer could be subject to a penalty of $1,530.

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Document Retention To meet the due diligence requirements for the EITC, the AOTC, and the CTC/ACTC, you must keep all of the following records: (271)

1. A copy of Form 8867. 2. The applicable worksheet(s) or your own worksheet(s) for any credits claimed specified in Due Diligence

Requirements. 3. Copies of any taxpayer documents you may have relied upon to determine eligibility for and the amount of the

credit(s). 4. A record of how, when, and from whom the information used to prepare Form 8867 and worksheet(s) was

obtained. 5. A record of any additional questions you may have asked to determine eligibility for and amount of the credits,

and the taxpayer’s answers. You must keep those records for three years from the latest of the following dates: (271)

The due date of the tax return (not including extensions). The date the return was filed (if you are a signing tax return preparer electronically filing the return). The date the return was presented to the taxpayer for signature (if you are a signing tax return preparer not electronically filing the return). The date you submitted to the signing tax return preparer the part of the return for which you were responsible (if

you are a nonsigning tax return preparer). These records may be kept on paper or electronically in the manner described in Revenue Procedure 97-22 (or later update). (272) Consequences of Filing EITC Returns Incorrectly People who come to you, a tax return preparer, expect you to know the tax law and prepare an accurate return. Also, if you are paid and prepare ETIC claims, you must meet EITC due diligence requirements. If the IRS examines your client's return and denies all or a part of EITC, your client: (273)

Must pay back the amount in error with interest. May need to file the Form 8862 - Information to Claim Earned Income Tax Credit after Disallowance. May be banned from claiming ETIC for the next two years if the IRS finds the error is because of reckless or

intentional disregard of the rules. May be banned from claiming EITC for the next ten years if the IRS finds the error is because of fraud.

If the IRS examines the EITC claims you prepared and finds you did not meet all four due diligence requirements, you can get: (273)

A $510 penalty for each failure to comply with EITC due diligence requirements. The penalty amounts are covered in IRC Section 6695(g). (The IRS adjusted the penalty for taxable year returns beginning in 2015 for cost of living.)

A minimum penalty of $1,000 if you prepare a client return and IRS finds any part of the amount of taxes owed is due to an, unreasonable position (For reference see IRC Section 6694(a)).

A minimum penalty of $5,000 if you prepare a client return and IRS finds any part of the amount of taxes owed is due to your reckless or intentional disregard of rules or regulations (For reference see IRC Section 6694(b)).

The IRS can also penalize an employer or employing firm if an employee fails to comply with the EITC due diligence requirements.

However, there are only specific circumstances when an employer is subject to the due diligence penalty: (274)

Management participated in or, prior to the time the return was filed, knew of the failure to comply with the due diligence requirements.

The firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements.

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The firm establishes appropriate compliance procedures but disregards those procedures through willfulness, recklessness, or gross indifference, including ignoring facts that would lead a person of reasonable prudence and competence to investigate or figure out the employee was not complying.

Earned Income Tax Credit Low- and moderate-income workers may be eligible for the Earned Income Tax Credit (EITC). For 2009 through 2017, the EITC amount had been temporarily increased for those with three (or more) children and the EITC marriage penalty had been reduced by increasing the income phase-out range by $5,000 (indexed for inflation) for those who are married and filing jointly. The Protecting Americans from Tax Hikes Act of 2015 made these provisions permanent. The provision also provided additional time for the IRS to review refund claims based on the EITC in order to reduce fraud and improper payments. Use Publication 596 - Earned Income Tax Credit (EITC) to determine eligibility. To qualify for the credit adjusted gross income (AGI) must be below a certain amount and the taxpayer must: (275)

Have a valid Social Security Number (if the taxpayer is filing a joint return, his or her spouse also must have a valid Social Security Number).

Have earned income from employment or from self-employment. Have a filing status other than married filing separately. Be a U.S. citizen or resident alien all year, or a nonresident alien married to a U.S. citizen or resident alien and

filing a joint return. Not be a qualifying child of another person (if the taxpayer is filing a joint return, his or her spouse also cannot be

a qualifying child of another person). Not have investment income over a certain amount. Not file Form 2555 - Foreign Earned Income or Form 2555-EZ - Foreign Earned Income Exclusion (related to

foreign earned income). Have a qualifying child who meets four tests (the Age, Relationship, Residency and Joint Return tests) OR:

o Be age 25 but under 65 at the end of the year. o Live in the United States for more than half the year. o Not qualify as a dependent of another person.

If the taxpayer qualifies, the amount of EITC will depend on filing status, whether the taxpayer has children, the number of children, and the amount of wages and income for the tax year. When EITC exceeds the amount of taxes owed, it results in a tax refund to those who claim and qualify for the credit.

Earned Income Tax Credit (EITC) Limitations Previous legislation increased the Earned Income Tax Credit for families with three or more qualifying children and allowed married joint-filing couples to earn more without having their credits reduced. The Protecting Americans from Tax Hikes Act of 2015 made these provisions permanent. Credit percentages and phase-out percentages are provided for taxpayers who have one qualifying child, two or more qualifying children, and no children.

Earned Income Tax Credit Limitations 2017

No Children One Child Two Children 3 or more children

Maximum Amount of Credit $510 $3,400 $5,616 $6,318 Earned Income and Adjusted Gross Income (AGI) must be less than for Single, Surviving Spouse or Head of Household

$15,010 $39,617 $45,007 $48,340

Earned Income and Adjusted Gross Income (AGI) must be less for Married Filing Jointly

$20,600 $45,207 $50,597 $53,930

Table 14-1 - Various Tax Benefits Increase Due to Inflation Adjustments (2017)

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Disqualified Income The Earned Income Tax Credit may not be claimed by taxpayers whose investment income is in excess of $3,450 in 2017. Disqualified income includes an individual’s capital gain net income and net passive income in addition to interest, dividends, tax-exempt interest and non-business rents or royalties. (276)

Qualifying Child The Earned Income Tax Credit adopts the uniform definition of a qualifying child as enacted by the Working Families Tax Relief Act of 2004. For purposes of claiming the Earned Income Tax Credit, a qualifying child is defined without regard to the support test. A qualifying child must meet a relationship, residency, and age test. Additionally, the taxpayer claiming the qualifying child must satisfy an identification requirement. The qualifying child must have one of the following relationships with the taxpayer to satisfy the relationship test: (277)

A son, daughter, stepchild, or a descendent of such child. A brother or sister (including by half-blood), a step-sibling or a descendant of such individual. An adopted child. An eligible foster child that has been placed by an authorized agency.

A qualifying child does not include a child who is married unless the taxpayer is entitled to claim an exemption for them.

For the residency test, the child must have the same principal place of abode, which must be located within the United States, for more than one-half of the year. For the age test, the child must be either under the age of 19 at the end of the calendar year, or a full-time student under the age of 24 at the end of the calendar year, or permanently and totally disabled at any time during the tax year. Finally, to satisfy the identification test, the taxpayer must specify the name and age of each qualifying child as well as the taxpayer identification number of a qualifying child on their return. The rules for determining among several taxpayers who may claim a child as a qualifying child for purposes of the Earned Income Tax Credit have been simplified. In the event that two or more taxpayers claim the same child(ren) in the same calendar year, the child(ren) will be the qualifying child(ren) for the parents first and then for a taxpayer, other than the parents, with highest adjusted gross income. If both qualifying child’s parents seek to claim the credit, but do not file jointly, then the parent who is claiming the child as a dependent may claim the child as an eligible child for Earned Income Tax Credit determination. For more information on whether a child qualifies for the EITC, see Publication 596 - Chapter 2, Rules If You Have a Qualifying Child. No Qualifying Child An individual who does not have a qualifying child may be eligible for this credit if:

1. The principal residence of such individual is in the United States for more than one-half of the tax year. 2. The individual (or the spouse of the individual) is at least age 25 and under age 65 before the close of the tax

year. 3. The individual is not claimed as a dependent by another. 4. The individual is not a qualifying child of another taxpayer.

Restrictions on Claiming the Credit The credit is denied to taxpayers who are not eligible to work in the United States. A nonresident alien (unless married to a U.S. citizen and filing a joint return) usually cannot claim an Earned Income Tax Credit. Filing Requirements Married persons must file a joint return in order to claim this credit. However, a married person living apart from a spouse under certain circumstances need not file a joint return to claim the credit. Also, the credit may be claimed only for a full 12-month tax year, except in the case of death. Earned Income The credit is based on earned income, which includes all wages, salaries, tips, and other employee compensation, plus

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the amount of the taxpayer’s net earnings from self-employment (determined with regard to the deduction for one-half of self-employment taxes). Earned income is determined without regard to community property laws. Earned income does not include: (278)

Interest and dividends. Welfare benefits. Veterans’ benefits. Pensions or annuities. Alimony and child support. Social Security benefits. Workers’ compensation. Unemployment compensation. Taxable scholarships or fellowships that are not reported on Form W-2.

How To Claim the Credit Taxpayers should use Form 1040, Schedule EITC, or Form 1040A, Schedule EITC, or Form 1040EZ to determine whether they are eligible for the credit. The IRS publishes the Earned Income Tax Credit (EITC) Table at the beginning of each year's tax season. Claim the Earned Income Tax Credit on Line 66a Form 1040, or Line 42a Form 1040A, or Line 8a Form 1040EZ.

As a reminder, paid preparers must complete Form 8867 - Paid Preparer’s Due Diligence Checklist when filing Federal income tax returns or claims for refund involving the EITC. Paid preparers must meet due diligence requirements in determining the taxpayer's eligibility for, and the amount of, the EITC. Failure to do so could result in a $510 penalty for each failure.

Child and Dependent Care Credit The taxpayer may be able to claim the Child and Dependent Care Credit if he or she paid work-related expenses for the care of a qualifying individual. The credit is generally a percentage of the amount of work-related expenses he or she paid to a care provider for the care of a qualifying individual. The percentage depends on the taxpayer’s adjusted gross income. Work-related expenses qualifying for the credit are those paid for the care of a qualifying individual to enable the taxpayer to work or actively look for work. Expenses are considered work-related only if both of the following are true:

1. They allow the taxpayer (and his or her spouse if filing jointly) to work or look for work. 2. They are for a qualifying person's care.

The cost of sending a child to an overnight camp is not considered a work-related expense. However, the cost of sending a child to a day camp may be a work-related expense, even if the camp specializes in a particular activity, such as computers or soccer.

A nonrefundable credit is allowed for a portion of qualifying child or dependent care expenses paid for the purpose of allowing the taxpayer to be gainfully employed. If a taxpayer paid someone to care for a child, spouse, or dependent in 2017, he or she may be able to claim the Child and Dependent Care Credit on the Federal income tax return. (279)

Below are 10 things the IRS wants taxpayers to know about claiming a credit for child and dependent care expenses: (279)

1. The care must have been provided for one or more qualifying persons. A qualifying person is the taxpayer’s dependent under the age of 13 when the care was provided. Additionally, the taxpayer’s spouse and certain other individuals who are physically or mentally incapable of self-care may also be qualifying persons. The taxpayer must identify each qualifying person on the tax return.

2. The care must have been provided so the taxpayer – and his or her spouse if married filing jointly – could work or look for work.

3. If the taxpayer and his or her spouse file jointly, they must have earned income from wages, salaries, tips, other taxable employee compensation or net earnings from self-employment. One spouse may be considered as having earned income if they were a full-time student or were physically or mentally unable to care for themselves.

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4. The payments for care cannot be paid to the taxpayer’s spouse, to the parent of the qualifying person, to someone the taxpayer can claim as a dependent on the return, or to a child who will not be age 19 or older by the end of the year even if he or she is not a dependent. The taxpayer must identify the care provider(s) on the tax return.

5. The taxpayer’s filing status must be single, married filing jointly, head of household or qualifying widow(er) with a dependent child.

6. The qualifying person must have lived with the taxpayer for more than half of 2017. There are exceptions for the birth or death of a qualifying person, or a child of divorced or separated parents. See Publication 503 - Child and Dependent Care Expenses.

7. The credit can be up to 35% of qualifying expenses, depending upon adjusted gross income. 8. The taxpayer may use up to $3,000 of expenses paid in a year for one qualifying individual or $6,000 for two or

more qualifying individuals to figure the credit. 9. The qualifying expenses must be reduced by the amount of any dependent care benefits provided by the

taxpayer’s employer that he or she deducts or excludes from income. 10. If the taxpayer pays someone to come to the home and care for the dependent or spouse, he or she may be a

household employer and may have to withhold and pay Social Security and Medicare tax and pay Federal unemployment tax. See Publication 926 - Household Employer's Tax Guide.

The custodial parent is the parent with whom the child lived for the greater number of nights in 2018. If the child was with each parent for an equal number of nights, the custodial parent is the parent with the higher adjusted gross income. The noncustodial parent cannot treat the child as a qualifying person even if that parent is entitled to claim the child as a dependent under the special rules for a child of divorced or separated parents. In the case of a child of divorced or separated parents living apart, only the custodial parent may claim the credit. The qualifying person must reside with the taxpayer for more than half the year to qualify for the child and dependent care credit and must be unable to care for themselves for more than half of the year. In determining whether a person is a qualifying person, treat someone who was born or who died during the tax year as having lived with the taxpayer for the entire tax year only if the taxpayer's home was the person's home the entire time he or she was alive. A spouse is never a dependent of the other spouse; but can qualify for the Child and Dependent Care Credit provided the conditions are met. One requirement for a spouse that is incapable of self-care is that the spouse must have the same principal place of abode as the taxpayer for more than half of the year. For more information on the Child and Dependent Care Credit, see Publication 503 - Child and Dependent Care Expenses. Qualifying Individual A qualifying individual for the Child and Dependent Care Credit is: (280)

The taxpayer’s dependent qualifying child who is under age 13 when the care is provided. The taxpayer’s spouse who is physically or mentally incapable of self-care and lived with the taxpayer for more than

half the year. A person who is physically or mentally incapable of self-care, lived with the taxpayer for more than half the year and

either: o Is his or her dependent o Could have been his or her dependent except that he or she is over the gross income limit or files a joint

return, or the taxpayer (or his or her spouse, if filing jointly) could have been claimed on another taxpayer’s income tax return.

An individual is physically or mentally incapable of self-care if, as a result of a physical or mental defect, the individual is incapable of caring for his or her hygiene or nutritional needs, or requires the full-time attention of another person for the individual's own safety or the safety of others. Amount of Credit The credit amount is equal to the applicable percentage, as determined by the taxpayer’s adjusted gross income (AGI), times the qualified employment expenses paid. In tax year 2017, taxpayers with an AGI of $15,000 or less use the highest applicable percentage of 35%. For taxpayers with adjusted gross income over $15,000, the credit is reduced by one percentage point for each $2,000 of adjusted gross income (or fraction thereof) over $15,000. The minimum applicable percentage of 20% is used by taxpayers with AGIs greater than $43,000. Thus, the maximum dependent care credit amount for one qualifying dependent is $1,050 and $2,100 for two or more qualifying dependents.

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If the taxpayer received dependent care benefits that he or she exclude or deduct from his or her income, the taxpayer must subtract that amount from the dollar limit that applies to him or her.

The following Child and Dependent Credit adjusted gross income (AGI) limits table are shown as a reference to determine the correct percentage rate for tax year 2017. (280)

2017 Adjusted Gross Income AGI PERCENTAGE

OVER BUT NOT OVER PERCENTAGE OVER BUT NOT

OVER PERCENTAGE

$0 $15,000 35% $29,000 $31,000 27% $15,000 $17,000 34% $31,000 $33,000 26% $17,000 $19,000 33% $33,000 $35,000 25% $19,000 $21,000 32% $35,000 $37,000 24% $21,000 $23,000 31% $37,000 $39,000 23%

$23,000 $25,000 30% $39,000 $41,000 22%

$25,000 $27,000 29% $41,000 $43,000 21%

$27,000 $29,000 28% $43,000 --- 20%

Table 14-2 - Publication 503 – Amount of Credit (2017)

Dependent care benefits include: (280)

1. Amounts the taxpayer’s employer paid directly to either him or her or the care provider for the care of the taxpayer’s qualifying person while he or she works.

2. The fair market value of care in a daycare facility provided or sponsored by the taxpayer’s employer. 3. Pre-tax contributions the taxpayer made under a dependent care flexible spending arrangement.

Qualifying employment-related expenses are considered in determining the credit only to the extent of earned income: wages, salary, remuneration for personal services, net self-employment income, etc. For married taxpayers, expenses are limited to the earned income of the lower-earning spouse. Generally, if one spouse is not working, no credit is allowed. However, if the non-working spouse is physically or mentally incapable of caring for himself or is a full-time student at an educational institution for at least five calendar months during the year, the law assumes an earned income, for each month of disability or school attendance, of $250 if there is one qualifying child or dependent or of $500 if there are two or more. Generally, a married taxpayer must file a joint return to claim the credit. However, a married person living apart from his or her spouse under certain circumstances is considered unmarried for this purpose, except that the spouse must not have been a member of the household during the last six months of the tax year. Also, a divorced or legally separated taxpayer having custody of a disabled or under the age-of-13 child is entitled to the credit even though he or she has released the right to a dependency exemption for the child. Taxpayers must provide each dependent’s taxpayer identification number and the identifying number of the service provider in order to claim the credit. The Child and Dependent Care Expenses are computed on Form 2441 - Child and Dependent Care Expenses.

Child Tax Credit The Child Tax Credit (CTC) is a $1,000 credit. To the extent the CTC exceeds the taxpayer’s tax liability, the taxpayer is eligible for a refundable credit (the Additional Child Tax Credit) equal to 15% of earned income in excess of a threshold dollar amount (the “earned income” formula). Until 2009, the threshold dollar amount was $10,000 indexed for inflation from 2001 (which would be roughly $14,000 in 2015). Since 2009, however, this threshold amount has been set at an unindexed $3,000 and was scheduled to expire at the end of 2017, returning to the $10,000 (indexed for inflation) amount. The Protecting Americans from Tax Hikes Act of 2015

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permanently set the threshold amount at an unindexed $3,000. The provision also provided additional time for the IRS to review refund claims based on refundable portion of the Child Tax Credit in order to reduce fraud and improper payments. Due to changes in the tax law, the paid tax return preparer Earned Income Tax Credit (EITC) due diligence requirements have been expanded to also cover the American Opportunity Tax Credit (AOTC), the Child Tax Credit (CTC) and/or the Additional Child Tax Credit (ACTC). Form 8867 - Paid Preparer’s Due Diligence Checklist, has been modified to account for these changes. In addition, Form 8867 has been streamlined. Completing the form is not a substitute for actually performing the necessary due diligence and completing all required forms and schedules when preparing the return. A paid tax return preparer must exercise due diligence to determine whether a taxpayer meets all of the eligibility requirements for the CTC and/or ACTC. Lines 10a, 10b, and 10c of Form 8867 only ask three specific questions about CTC and ACTC eligibility. However, the tax preparer’s client must meet all of the eligibility requirements for claiming the CTC and/or ACTC. Therefore, the tax preparer’s client cannot claim the CTC and/or ACTC if all of the eligibility requirements for these credits are not satisfied, regardless of the answers to questions on line 10. Here are 10 important facts from the IRS about this credit: (281)

1. Amount - With the Child Tax Credit, the taxpayer may be able to reduce the taxpayer’s Federal income tax by up to $1,000 for each qualifying child under the age of 17.

2. Qualification - A qualifying child for this credit is someone who meets the qualifying criteria of six tests: age, relationship, support, dependent, citizenship, and residence.

3. Age Test - To qualify, a child must have been under age 17 – age 16 or younger – at the end of 2017. 4. Relationship Test - To claim a child for purposes of the Child Tax Credit, they must either be the taxpayer’s son,

daughter, stepchild, foster child, brother, sister, stepbrother, stepsister or a descendant of any of these individuals, which includes a grandchild, niece or nephew. An adopted child is always treated as the taxpayer’s own child. An adopted child includes a child lawfully placed with the taxpayer for legal adoption.

5. Support Test - In order to claim a child for this credit, the child must not have provided more than half of their own support.

6. Dependent Test - The taxpayer must claim the child as a dependent on his or her Federal tax return. 7. Citizenship Test - To meet the citizenship test, the child must be a U.S. citizen, U.S. national, or U.S. resident

alien. 8. Residence Test - The child must have lived with the taxpayer for more than half of 2017. There are some

exceptions to the residence test, which can be found in IRS Publication 972 - Child Tax Credit. 9. Limitations - The credit phases out $50 for each $1,000 of modified AGI (rounded up to the next $1,000 increment)

over certain amounts. The amount at which this phase-out begins varies depending on filing status. For married taxpayers filing a joint return, the phase-out begins at $110,000. For married taxpayers filing a separate return, it begins at $55,000. For all other taxpayers, the phase-out begins at $75,000. In addition, the Child Tax Credit is generally limited by the amount of the income tax the taxpayer owes as well as any alternative minimum tax he or she owes.

10. Additional Child Tax Credit - If the amount of the Child Tax Credit is greater than the amount of income tax the taxpayer owes, he or she may be able to claim the Additional Child Tax Credit.

To claim the child tax credit, the taxpayer must file Form 1040 or Form 1040A. He or she cannot claim the Child Tax Credit on Form 1040EZ. The taxpayer must provide the name and identification number (usually a social security number) on his or her tax return for each qualifying child. If the taxpayer claims the Child Tax Credit with a child identified by an ITIN, he or she must also file Schedule 8812. Even if the taxpayer cannot claim his or her child as a dependent, the dependent is treated as the taxpayer’s qualifying person if:

1. The child was under age 13 or was not physically or mentally able to care for himself or herself. 2. The child received over half of his or her support during the calendar year from one or both parents who are

divorced or legally separated under a decree of divorce or separate maintenance, are separated under a written separation agreement, or lived apart at all times during the last 6 months of the calendar year.

3. The child was in the custody of one or both parents for more than half the year. 4. The taxpayer was the child's custodial parent.

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Qualifying Child A qualifying child for purposes of the child tax credit is a child who: (282)

Is a son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, or a descendant of any of them (for example, a grandchild, niece, or nephew).

Was under age 17 at the end of 2017. Did not provide over half of his or her own support for 2017. Lived with the taxpayer for more than half of 2017. Is claimed as a dependent on the return. Does not file a joint return for the year (or files it only as a claim for refund). Was a U.S. citizen, a U.S. national, or a U.S. resident alien.

In general, to be a qualifying child for purposes of the child tax credit and additional child tax credit, the child must be a citizen, national, or resident of the United States. Use Part I of Schedule 8812 – Child Tax Credit to document that any child for whom an IRS Individual Taxpayer Identification Number (ITIN) was issued meets the substantial presence test and is not otherwise treated as a nonresident alien.

To meet the substantial presence test, a child identified with an ITIN generally must be physically present in the United States on at least: (283)

1. 31 days during 2017, and 2. 183 days during the 3-year period that includes 2017, 2016, and 2015, counting:

a. All the days the child was present in 2017, and b. 1/3 of the days the child was present in 2016, and c. 1/6 of the days the child was present in 2015.

To figure the taxpayer’s credit, first review the Child Tax Credit Worksheet in his or her Form 1040 or 1040A instructions. If the taxpayer is instructed to use Publication 972, he or she may not use the worksheet in his or her tax return instructions; instead, he or she must use Publication 972 to figure the credit. If the taxpayer is not instructed to use Publication 972, he or she may use the Child Tax Credit Worksheet in his or her Form 1040 or 1040A instructions or Publication 972 to figure the credit

For 2017, the value used to determine the amount of credit that may be refundable is $3,000 (the credit amount has not changed). The taxpayer should remember that this is the value of the expenses used to determine the credit and not the actual amount of the credit.

Limitation of Child Tax Credit The Child Tax Credit begins to phase out when modified adjusted gross income (MAGI) reaches $110,000 for joint filers, $55,000 for married taxpayers filing separately and $75,000 for single taxpayers. The credit is reduced by $50 for each $1,000, or fraction thereof, of modified AGI above these threshold amounts.

Additional Child Tax Credit The Child Tax Credit (CTC) is a $1,000 credit. To the extent the CTC exceeds the taxpayer’s tax liability, the taxpayer is eligible for a refundable credit (the Additional Child Tax Credit) equal to 15% of earned income in excess of a threshold dollar amount (the “earned income” formula). Until 2009, the threshold dollar amount was $10,000 indexed for inflation from 2001. Since 2009, however, this threshold amount has been set at an unindexed $3,000 and was scheduled to expire at the end of 2017, returning to the $10,000 (indexed for inflation) amount.

The Protecting Americans from Tax Hikes Act of 2015 permanently set the threshold amount at an unindexed $3,000. The provision also provided additional time for the IRS to review refund claims based on refundable portion of the Child Tax Credit in order to reduce fraud and improper payments.

The Additional Child Tax Credit is a refundable tax credit for people who have a qualifying child and did not receive the full amount of the Child Tax Credit.

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The Additional Child Tax Credit is equal to the lesser of: (284)

The unclaimed portion of the nonrefundable Child Tax Credit amount. 15% of the person’s earned income over $3,000. For taxpayers with three or more qualifying children, the excess of the taxpayer’s Social Security taxes for the tax

year over his or her Earned income tax credit for the year.

For more information on the Additional Child Tax Credit, see Schedule 8812 - Child Tax Credit. Tax Liability Limitation The total amount of child tax credit claimed by the taxpayer cannot exceed the sum of their regular income tax liability and their alternative minimum tax liability, over the sum of the nonrefundable personal credits allowed to the taxpayer (other than the adoption credit, the retirement savings contribution credit, child tax credit, the residential energy efficient property credit, and beginning with year 2009 the foreign tax credit). No further carryover of the credit is allowed if the credit exceeds these limits.

Credits and Deductions for Higher Education Tuition and Related Expenses A taxpayer may be able to deduct qualified tuition and related expenses even if the taxpayer does not itemize deductions on Schedule A, Form 1040. This deduction may be beneficial to him or her if he or she cannot take either the American Opportunity or Lifetime Learning tax credit because income is too high.

Student Loan Interest Deduction Interest paid during the tax year on any qualified education loan is deductible from gross income in arriving at adjusted gross income on Form 1040 or Form 1040A. The debt must be incurred by the taxpayer solely to pay qualified higher education expenses. The original loan and all refinancing of the loan are treated as one loan for this purpose. The maximum deductible amount of interest for tax year 2017 is $2,500.

For 2017, the amount of the student loan interest deduction is phased out (gradually reduced) if the taxpayer’s filing status is married filing jointly and modified adjusted gross income (MAGI) is between $135,000 and $165,000. The taxpayer cannot take the deduction if modified AGI is $165,000 or more. If the taxpayer’s filing status is married filing separately, he or she does not qualify for the deduction. For all other filing statuses, the

student loan interest deduction is phased out if modified AGI is between $65,000 and $80,000. The taxpayer cannot take a deduction if modified AGI is $80,000 or more. The IRS provides a Student Loan Interest Deduction worksheet. For more information, see Publication 970 -Tax Benefits for Education. For purposes of the student loan interest deduction, these expenses are the total costs of attending an eligible educational institution, including graduate school. They include amounts paid for the following items:

Tuition and fees. Room and board. Books, supplies, and equipment. Other necessary expenses (such as transportation).

The cost of room and board qualifies only to the extent that it is not more than the greater of:

The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for Federal financial aid purposes) for a particular academic period and living arrangement of the student.

The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

Loan Origination Fee In general, a loan origination fee is a one-time fee charged by the lender when a loan is made. To be deductible as interest,

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a loan origination fee must be for the use of money rather than for property or services (such as commitment fees or processing costs) provided by the lender. A loan origination fee is treated as interest accrues over the term of the loan. Loan origination fees were not required to be reported on Form 1098-E - Student Loan Interest Statement, for loans made before September 1, 2004. If loan origination fees are not included in the amount reported on the taxpayer’s Form 1098-E, he or she can use any reasonable method to allocate the loan origination fees over the term of the loan. One acceptable method allocates equal portions of the loan origination fee to each payment required under the terms of the loan. A method that results in the double deduction of the same portion of a loan origination fee would not be reasonable. Voluntary Interest Payments These are payments made on a qualified student loan during a period when interest payments are not required, such as when the borrower has been granted a deferment or the loan has not yet entered repayment status. Capitalized Interest This is unpaid interest on a student loan that is added by the lender to the outstanding principal balance of the loan. Capitalized interest is treated as interest for tax purposes and is deductible as payments of principal are made on the loan. No deduction for capitalized interest is allowed in a year in which no loan payments were made. Student Loan Cancellations and Repayment Assistance Generally, if the taxpayer is responsible for making loan payments, and the loan is canceled (forgiven), he or she must include the amount that was forgiven in his or her gross income for tax purposes. However, if the taxpayer fulfills certain requirements, student loan cancellation and student loan repayment assistance may be tax free. If the taxpayer’s student loan is canceled, he or she may not have to include any amount in income. To qualify for tax-free treatment, for the cancellation of the taxpayer’s loan, the loan must have been made by a qualified lender to assist him of her in attending an eligible educational institution and contain a provision that all or part of the debt will be canceled if the taxpayer works: (285)

1. For a certain period of time. 2. In certain professions. 3. For any of a broad class of employers.

The cancellation of the taxpayer’s loan will not qualify for tax-free treatment if it is cancelled because of services he or she performed for the educational institution that made the loan or other organization that provided the funds.

If the taxpayer refinanced a student loan with another loan from an eligible educational institution or a tax-exempt organization, that loan may also be considered as made by a qualified lender. The refinanced loan is considered made by a qualified lender if it is made under a program of the refinancing organization that is designed to encourage students to serve in occupations with unmet needs or in areas with unmet needs where the services required of the students are for or under the direction of a governmental unit or a tax-exempt section 501(c)(3) organization. Student loan repayments made to the taxpayer are tax free if he or she received them for any of the following: (285)

The National Health Service Corps (NHSC) Loan Repayment Program (NHSC Loan Repayment Program). A state education loan repayment program eligible for funds under the Public Health Service Act. Any other state loan repayment or loan forgiveness program that is intended to provide for the increased

availability of health services in underserved or health professional shortage areas (as determined by such state). The taxpayer cannot deduct the interest he or she paid on a student loan to the extent payments were made through his or her participation in the above programs. Tuition and Fees Deduction The Bipartisan Budget Act of 2018 extended through 2017 the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction is capped at $4,000 for an individual whose adjusted gross income (AGI) does not exceed $65,000 ($130,000 for joint filers) or $2,000 for an individual whose AGI does not exceed $80,000 ($160,000 for joint filers). The Tuition and Fees Deduction was not renewed by the Tax Cuts and Jobs Act.

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American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit American Opportunity Tax Credit (AOTC) Due to changes in the tax law, the paid tax return preparer Earned Income Tax Credit (EITC) due diligence requirements have been expanded to also cover the American Opportunity Tax Credit (AOTC), the Child Tax Credit (CTC) and/or the Additional Child Tax Credit (ACTC). Form 8867 - Paid Preparer’s Due Diligence Checklist, has been modified to account for these changes. In addition, Form 8867 has been streamlined. Completing the form is not a substitute for actually performing the necessary due diligence and completing all required forms and schedules when preparing the return. A paid tax return preparer must exercise due diligence to determine whether a taxpayer meets all of the eligibility requirements for the AOTC. Although line 11 of Form 8867 only asks about substantiation of qualified tuition and related expenses, the tax preparer’s client must meet all of the eligibility requirements for claiming the AOTC. Therefore, the tax preparer’s client cannot claim the AOTC if all of the eligibility requirements for the AOTC are not satisfied, even if the tax preparer answers “yes” on line 11.

The American Opportunity Tax Credit expanded and renamed the already-existing Hope Scholarship Credit. The maximum amount of the American Opportunity Tax Credit (AOTC) is $2,500 per student $2,500 of the cost of tuition, fees and course materials paid during the taxable year. Also, 40% of the credit (up to $1,000) is refundable. This means the taxpayer can get the credit even if he or she owes no tax. The credit can be claimed

for claimed for expenses for the first four years of post-secondary education. The Protecting Americans from Tax Hikes Act of 2015 made the AOTC provisions permanent. The amount of the American Opportunity Tax Credit is comprised of:

100% of the first $2,000 in qualifying education expenses, plus 25% of the next $2,000 in qualifying expenses.

Thus, the taxpayer’s maximum credit could be $2,500 based on $4,000 in qualifying expenses. Generally, 40% of the AOTC is now a refundable credit for most taxpayers, which means that the taxpayer can receive up to $1,000 even if he or she owes no taxes. The term qualified tuition and related expenses has been expanded to include expenditures for course materials. For this purpose, the term “course materials” means books, supplies, and equipment needed for a course of study whether or not the materials must be purchased from the educational institution as a condition of enrollment or attendance. For more information, see Chapter 2 of Publication 970 – Tax Benefits for Education. Generally, the taxpayer can claim the American Opportunity Tax Credit if all three of the following requirements are met: (222)

1. He or she pays qualified education expenses of higher education. 2. He or she pays the education expenses for an eligible student. 3. The eligible student is either him or herself, his or her spouse, or a dependent for whom he or she claims an

exemption on his or her tax return.

Qualified Education Expenses For purposes of the American Opportunity Tax Credit, qualified education expenses are tuition and certain related expenses required for enrollment or attendance at an eligible educational institution. Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. However, expenses for books, supplies, and equipment needed for a course of study are included in qualified education expenses whether or not the materials are purchased from the educational institution. Qualified education expenses do not include amounts paid for:

Insurance. Medical expenses (including student health fees). Room and board.

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Transportation. Similar personal, living, or family expenses.

This is true even if the amount must be paid to the institution as a condition of enrollment or attendance. Lifetime Learning Credit The Lifetime Learning Credit is a tax credit for any person who takes college classes. It provides a tax credit of 20% of tuition expenses, with a maximum of $2,000 in tax credits on the first $10,000 of college tuition expenses. The taxpayer can claim the Lifetime Learning Credit on the tax return if the taxpayer, his or her spouse, or his or her dependents are enrolled at an eligible educational institution and the taxpayer was responsible for paying college expenses. Unlike the American Opportunity Tax Credit, the student need not be in the first four years of undergraduate classes. Even if the student took only one class, he or she may take advantage of the Lifetime Learning Credit. (286) Income Limitations on Lifetime Learning Credit The amount of the Lifetime Learning Credit is limited over a phase-out range. If adjusted gross income is below the phase-out, the credit is not reduced. If income is in the middle of the phase-out range, the credit will be reduced. If income exceeds the phase-out range, the taxpayer is not eligible to claim the Lifetime Learning Credit. The income phase-out range for 2017 is:

$56,000 to $66,000 - Single, Head of Household, or Qualifying Widow(er). $112,000 to $132,000 - Married Filing Jointly.

If a taxpayer is eligible to claim the Lifetime Learning Credit and the American Opportunity Tax Credit for the same student in the same year, he or she can choose to claim either credit, but not both.

Eligible Educational Institutions All accredited colleges and universities are eligible educational institutions. Additionally, vocational schools and other post-secondary institutions are also eligible. Basically, if the institution is eligible to participate in Federal student aid programs through the U.S. Department of Education, then the taxpayer may use tuition paid to the school for claiming the Lifetime Learning Credit. Qualifying Expenses Qualifying expenses include amounts paid for tuition and any required fees such as registration and student body fees. Student-activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution for enrollment or attendance. Qualified education expenses do not include amounts paid for: (286)

Insurance. Medical expenses (including student health fees). Room and board. Transportation Similar personal, living, or family expenses.

This is true even if the amount must be paid to the institution as a condition of enrollment or attendance. Also, qualified education expenses generally do not include expenses that relate to any course of instruction or other education that involves sports, games or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student's degree program, these expenses can qualify. The taxpayer must be responsible for paying the college tuition and fees. The taxpayer also needs to reduce qualifying expenses when figuring the tax credit by the amount of financial assistance received from grants, scholarships, or reimbursements from an employer. The taxpayer does not need to reduce qualifying expenses, however, if he or she paid for college tuition using borrowed funds, including student loans, or by using gifts from family members.

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Who Can Claim the Education Credits? If the taxpayer’s son or daughter is going to college and the taxpayer claims him or her as a dependent, then the taxpayer can claim the education credits on the tax return. If the taxpayer’s son or daughter is no longer a dependent, then he or she should claim any education credits on his or her own tax return. If the taxpayer pays the college expenses for someone who is not a dependent, he or she cannot claim the tax credit. Coordination with Other Provisions Taxpayers may now elect not to claim a tax credit should the taxpayer desire to take full advantage of the exclusion available for distributions from Coverdell educational saving accounts and/or qualified tuition plans. Thus, eligible educational expenses are first reduced by excludable scholarships or fellowships, veterans’ educational assistance allowance, employer-provided educational assistance that is excludable from income, and any other educational assistance other than gifts, bequests, devises, or inheritances that is excludable from gross income. Taxpayers are then permitted to elect to claim either the AOTC or the Lifetime Learning Credit for a student in any tax year. The expenses used to claim an educational credit reduce the amount of eligible expenses available to exclude distributions from educational savings accounts or qualified tuition plans. Since any excess distributions from an educational savings account or a qualified tuition plan over the eligible educational expenses is includible in gross income and subject to a 10% additional tax, waiving the claiming of an educational credit may result in a lower tax liability. However, taxpayers should be aware that the 10% additional tax for excess distributions from educational savings accounts or qualified tuition plans is waived if the excess is caused by the claiming of an educational credit. Taxpayers who receive distributions in excess of eligible expense from both an educational savings account and a qualified tuition plan in the same year must allocate the expenses between the two distributions. Finally, only after eligible expenses are reduced by an educational credit and distributions from educational savings accounts or qualified tuition plans, the remaining expenses may be used to determine the exclusion amount for Series EE United States Savings Bonds. The 10% additional tax does not apply to distributions: (287)

Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary.

Made because the designated beneficiary is disabled. A person is considered to be disabled if he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition. A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration.

Included in income because the designated beneficiary received: o A tax-free scholarship or fellowship. o Veterans' educational assistance. o Employer-provided educational assistance. o Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational

assistance. Made on account of the attendance of the designated beneficiary at a U.S. military academy (such as the USNA

at Annapolis). This exception applies only to the extent that the amount of the distribution does not exceed the costs of advanced education (as defined in Section 2005(d)(3) of title 10 of the U.S. Code) attributable to such attendance.

Included in income only because the qualified education expenses were taken into account in determining the American opportunity or lifetime learning credit.

Both the AOTC and the Lifetime Learning Credit (Education Credits) are supported by attaching Form 8863 – Education Credits, and entered on Line 50 of the Federal Form 1040, or Line 33 Form 1040A. Credit Recapture If any tax-free educational assistance for the qualified education expenses paid in 2017, or any refund of a taxpayer’s qualified education expenses paid in 2017, is received after he or she files the 2017 income tax return, the taxpayer must recapture (repay) any excess credit.

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The taxpayer does this by refiguring the amount of the adjusted qualified education expenses for 2017 by reducing the expenses by the amount of the refund or tax-free educational assistance. He or she then refigures the education credit(s) for 2017 and figure the amount by which the 2017 tax liability would have increased if he or she had claimed the refigured credit(s). The taxpayer should include that amount as an additional tax for the year the refund or tax-free assistance was received.

Affordable Care Act Tax Credits Premium Tax Credit Individuals and families may be eligible for the refundable Premium Tax Credit (PTC) to help them afford health insurance coverage purchased through an Affordable Insurance Exchange. Exchanges will operate in every state and the District of Columbia. This tax credit can help make the cost of purchasing health insurance coverage more affordable for individuals and families with low to moderate incomes. Additionally, the premium tax credit is refundable so taxpayers who have little or no income tax liability can still benefit. The credit also can be paid in advance to a taxpayer’s insurance company to help cover the cost of premiums. In general, the taxpayer may be eligible for the credit if he or she meets all of the following: (288)

1. Purchases coverage through the Marketplace. 2. Has household income that falls within a certain range. 3. Is not able to get affordable coverage through an eligible employer plan that provides minimum value. 4. Is not eligible for coverage through a government program, like Medicaid, Medicare, CHIP or TRICARE. 5. Does not file a Married Filing Separately tax return (unless he or she meet the criteria in section 1.36B-2T(b)(2)

of the Temporary Income Tax Regulations, which allows certain victims of domestic abuse and spousal abandonment to claim the Premium Tax Credit using the Married Filing Separately filing status).

6. Cannot be claimed as a dependent by another person. The Premium Tax Credit has both minimum and maximum income limits. In general, individuals and families whose household income for the year is between 100% and 400% of the Federal poverty line for their family size may be eligible for the Premium Tax Credit. An individual who meets these income requirements must also meet the other eligibility criteria described above. Thus, if the taxpayer has household income between 100% and 400% of the Federal poverty line, but is eligible for coverage through his or her state’s Medicaid program (for example, because his or her state provides Medicaid to individuals with household income up to 133% of the Federal poverty line), the taxpayer is not eligible for the Premium Tax Credit.

The tax credit for 2017 will be based on the 2016 guidelines. The taxpayer should use the 2016 Federal Poverty Guidelines (FPL) to determine 2017 Premium Tax Credit eligibility.

Federal Poverty Level (FPL) Guidelines 2016 - Continental U.S.

Persons in Household 1 2 3 4 5

100% $11,880 $16,020 $20,160 $24,300 $28,440

400% $47,520 $64,080 $80,640 $97,200 $113,760

Federal Poverty Guidelines are different in Hawaii and Alaska.

Table 14-3 - 2016 Federal Poverty Level (FPL) Guidelines (2017)

For purposes of the Premium Tax Credit, the taxpayer’s household income is his or her modified adjusted gross income plus that of every other individual in his or her family for whom he or she can properly claim a personal exemption deduction and who is required to file a Federal income tax return. Modified adjusted gross income is the adjusted gross income on the taxpayer’s Federal income tax return plus any excluded foreign income, nontaxable Social Security benefits (including tier 1 railroad retirement benefits), and tax-exempt interest received or accrued during the taxable year. It does not include Supplemental Security Income (SSI).

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If the taxpayer is eligible for the credit, he or she can choose to either:

Claim It Now - have all or some of the credit paid in advance directly to his or her insurance company to lower what he or she pays out-of-pocket for his or her monthly premiums during 2017. Then when the taxpayer files he is or her tax return, he or she will subtract the total advance credit payments he or she received during the year from the amount of the Premium Tax Credit calculated on his or her tax return. If the Premium Tax Credit computed on the return is more than the advance payments made on the taxpayer’s behalf during the year, the difference will increase his or her refund or lower the amount of tax he or she owes. If the advance credit payments are more than the premium tax credit, the difference will increase the amount the taxpayer owes and result in either a smaller refund or a balance due.

Claim It Later - wait to claim the full amount of the Premium Tax Credit when he or she files his or her 2017 tax return in 2018. This will either increase the taxpayer’s refund or lower his or her balance due.

Whether the taxpayer chooses to claim the Premium Tax Credit now at the Marketplace or claim it later, he or she must file a Federal income tax return. To claim the credit, the taxpayer must get insurance through the Marketplace. During enrollment through the Marketplace, using information the taxpayer provides about his or her projected income and family composition for 2017, the Marketplace will estimate the amount of the Premium Tax Credit he or she will be able to claim for the 2017 tax year that he or she will file in 2018. The taxpayer will then decide whether he or she wants to have all, some or none of the estimated credit paid in advance directly to his or her insurance company.

The taxpayer should report income and family size changes to the Marketplace throughout the year. Reporting changes, increases or decreases, will help the taxpayer get the proper type and amount of financial assistance and will help him or her avoid getting too much or too little in advance.

For example, if the taxpayer does not report income or family size changes to the Marketplace when they happen in 2017, the advance payments may not match his or her actual qualified credit amount on his or her Federal tax return that he or she will file in 2017. This might result in a smaller refund or balance due. If the taxpayer or a family member enrolled in health insurance through the Marketplace and advance payments of the Premium Tax Credit were made to his or her insurance company to reduce his or her monthly premium payment, the taxpayer must attach Form 8962 - Premium Tax Credit (PTC) to his or her income tax return to reconcile (compare) the advance payments with his or her Premium Tax Credit for the year. The Marketplace is required to send Form 1095-A by January 31, 2017, listing the advance payments and other information the taxpayer needs to complete Form 8962. The taxpayer will need Form 1095-A from the Marketplace in order to complete Form 8962 and to claim the credit and to reconcile his or her advance credit payments. The taxpayer should include Form 8962 with his or her 1040, 1040A, or 1040NR. (Do not include Form 1095-A). If the taxpayer chooses to claim the Premium Tax Credit now, when he or she files his or her 2017 tax return in 2018, he or she will subtract the total advance payments he or she received during the year from the amount of the Premium Tax Credit calculated on his or her tax return. If the Premium Tax Credit computed on the return is more than the advance credit paid on the taxpayer’s behalf during the year, the difference will increase his or her refund or lower the amount of tax he or she owes. If the advance credit payments are more than the Premium Tax Credit, the difference will increase the amount the taxpayer owes and result in either a smaller refund or a balance due. If the taxpayer chooses to claim the Premium Tax Credit later, he or she will claim the full amount of the Premium Tax Credit when he or she files his or her 2017 tax return in 2018. This will either increase his or her refund or lower his or her balance due. The taxpayer should use Form 8962 - Premium Tax Credit (PTC) to figure the amount of his or her Premium Tax credit and to reconcile any advance payments of the Premium Tax Credit. (288) Health Coverage Tax Credit (HCTC) The Trade Preferences Extension Act of 2015 extended and modified the expired Health Coverage Tax Credit (HCTC). Previously, those eligible for the HCTC could claim the credit against the premiums they paid for certain health insurance coverage through 2013. The HCTC can now be claimed for coverage through 2019. The taxpayer should use Form 8885 - Health Coverage Tax Credit to elect and figure the amount, if any, of his or her HCTC.

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The Health Coverage Tax Credit (HCTC) is a tax credit that pays 72.5% of qualified health insurance premiums for eligible individuals and their families. A taxpayer may only elect to take the HCTC if he or she is one of the following:

An eligible trade adjustment assistance (TAA) recipient, alternative (ATAA) recipient, reemployment (RTAA) recipient.

An eligible Pension Benefit Guaranty Corporation (PBGC) pension payee. The family member of a TAA, ATAA, or RTAA recipient or PBGC pension payee who is deceased or who finalized

a divorce with him or her. The taxpayer is not eligible if he or she could have been claimed as a dependent on another person’s Federal income tax return. All plans that were previously qualified for the HCTC qualify for the HCTC through 2019. This includes individual - private and non-group - health insurance that the taxpayer purchases for him or herself or his or her family from an insurance company, agent, or broker. There are several types of health insurance that qualify for the HCTC. However, contributions by the taxpayer’s employer or his or her spouse’s employer may limit qualification. Types of health insurance qualify for the HCTC include:

1. Coverage under a COBRA continuation provision. 2. Coverage under a group health plan available through the employment of the taxpayer’s spouse. 3. Coverage under an employee benefit plan funded by a voluntary employees’ beneficiary association (VEBA) that

was established through the bankruptcy of the taxpayer’s former employer. 4. Coverage obtained in the non-group (individual) health insurance market other than coverage offered through the

Health Insurance Marketplace. 5. Coverage under certain state-qualified health plans established prior to January 1, 2014.

A qualified health insurance plan does not include a flexible spending or similar arrangement and any insurance if substantially all of its coverage is of excepted benefits described in section 9832(c) of the Internal Revenue Code. For example, dental or vision benefits purchased separately aren’t part of a qualified health insurance plan for the HCTC. But, premiums paid for a comprehensive package that includes dental or vision benefits may be eligible for the HCTC if the dental or vision benefits don’t represent substantially all of its coverage. For 2014 and 2015 only, qualified coverage includes qualified health plans offered through a federally facilitated or a state-based Health Insurance Marketplace. For 2016 and beyond, Health Insurance Marketplace coverage will no longer be qualified coverage for the HCTC. The taxpayer cannot claim the HCTC for any month that, on the first day of the month, he or she was covered under an employer-sponsored health insurance plan (including any employer-sponsored health insurance plan of a spouse) and the employer paid 50% or more of the cost of coverage. Also, if the taxpayer is an Alternative Trade Adjustment Assistance (ATAA) or Reemployment Trade Adjustment Assistance (RTAA) recipient, he or she cannot claim the HCTC for any month that, on the first day of the month, he or she was eligible for certain kinds of coverage (including any employer-sponsored health insurance plan of the taxpayers spouse) where the employer would have paid 50% or more of the cost of the coverage or he or she was covered under certain kinds of coverage (including any employer-sponsored health insurance plan of the taxpayer’s spouse) where the employer paid any part of the cost of coverage.

Advance payments of the HCTC are planned to begin July 2016. The taxpayer may choose Marketplace coverage for the first part of 2016 to receive advance payments of the Premium Tax Credit (PTC) even though Marketplace coverage is not eligible for the HCTC in 2016. The taxpayer may then switch coverage into an HCTC-eligible plan after advance payments of the HCTC begin. The election required to claim the HCTC can be made for any coverage month and does not prevent the taxpayer from claiming the PTC in earlier months

in the year. Once the taxpayer makes the election to take the HCTC for an eligible coverage month, he or she cannot take the Premium Tax Credit (PTC) for the same coverage in that coverage month and for all subsequent eligible coverage months during his or her tax year in which he or she is eligible to take the HCTC.

Small Business Health Care Tax Credit The Small Business Health Care Tax Credit helps small businesses and small tax-exempt organizations afford the cost of covering their employees and is specifically targeted for those with low- and moderate-income workers. The credit is designed to encourage small employers to provide health insurance coverage for the first time or maintain coverage they

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already have. In general, the credit is available to small employers that pay at least half the cost of single coverage for their employees. The Small Business Health Care Tax Credit benefits employers that: (289)

Have fewer than 25 full-time equivalent employees. Pay an average wage of less than $50,000 a year. Pay at least half of employee health insurance premiums.

To be eligible for this credit, the taxpayer must have purchased coverage through the Small Business Health Options Program, also known as the SHOP marketplace. For tax years beginning in 2014 or later, there are changes to the credit: (289)

The maximum credit increases to 50% of premiums paid for small business employers and 35% of premiums paid for small tax-exempt employers.

To be eligible for the credit, a small employer must pay premiums on behalf of employees enrolled in a qualified health plan offered through a Small Business Health Options Program (SHOP) Marketplace or qualify for an exception to this requirement.

The credit is available to eligible employers for two consecutive taxable years. Even if the taxpayer is a small business employer who did not owe tax during the year, he or she can carry the credit back or forward to other tax years. Also, since the amount of the health insurance premium payments is more than the total credit, eligible small businesses can still claim a business expense deduction for the premiums in excess of the credit. The credit is refundable, so even if the taxpayer has no taxable income, he or she may be eligible to receive the credit as a refund so long as it does not exceed his or her income tax withholding and Medicare tax liability. Refund payments issued to small tax-exempt employers claiming the refundable portion of credit are subject to sequestration. The taxpayer must use Form 8941 - Credit for Small Employer Health Insurance Premiums to calculate the credit. Under the Small Business Health Care Tax Credit, the maximum credit is phased out based on the employer’s number of full-time equivalent employees in excess of 10 and the employer’s average annual wages in excess of $26,200 for tax year 2017, up from $25,900 for 2016.

Adoption Credit The maximum credit and the exclusion for employer-provided benefits are both $13,570 per eligible child in 2017. This amount begins to phase out if the taxpayer has modified adjusted gross income (MAGI) in excess of $203,540 and is completely phased out for modified adjusted gross income (MAGI) of $243,540 or more. Qualified adoption expenses are reasonable and necessary expenses directly related to, and whose principal purpose is for, the legal adoption of an eligible child. These expenses include:

Adoption fees. Court costs. Attorney fees. Travel expenses (including meals and lodging) while away from home. Re-adoption expenses to adopt a foreign child.

Qualified adoption expenses do not include expenses:

For which the taxpayer received funds under any state, local, or Federal program. That violate state or Federal law. For carrying out a surrogate parenting arrangement. For the adoption of the taxpayer’s spouse's child. Reimbursed by the taxpayer’s employer or otherwise. Allowed as a credit or deduction under any other provision of Federal income tax law.

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An eligible child is an individual who has not attained the age of 18 at the time of the adoption or who is physically or mentally incapable of caring for him or herself. Generally, the credit and exclusion are allowable whether the adoption is domestic or foreign. A domestic adoption is the adoption of a U.S. child (an eligible child who is a citizen or resident of the U.S. or its possessions before the adoption effort began). A foreign adoption is the adoption of an eligible child who was not a citizen or resident of the U.S. or its possessions before the adoption effort began. The tax years for which the taxpayer can claim the credit depend on when the expenses are paid, whether the adoption is domestic or foreign, and whether the adoption has been finalized. In domestic adoptions, qualified adoption expenses paid before the year the adoption becomes final are allowable for the tax year following the year of payment (and the credit is allowable even if the adoption is never finalized). For a foreign adoption, however, the credit and exclusion are allowable only if the adoption is finalized. Qualified adoption expenses paid before and during the year of finality of a foreign adoption are allowable for the year of finality. Once an adoption becomes final, expenses paid during or after the year of finality are allowable for the year of payment, whether the adoption is foreign or domestic. (290) Special Needs Child In the case of an adoption of a U.S. child that a state has determined has special needs, the taxpayer may be eligible for the maximum amount of credit or exclusion for the year of finality, even if he or she paid no qualified adoption expenses. A child is considered special needs for purposes of the adoption credit if all of the following conditions are met: (290)

1. The child was a U.S. citizen or resident when the adoption effort began. 2. A state determines that the child cannot or should not be returned to his or her parent's home. 3. A state determines that the child probably will not be adopted unless assistance is provided to the adoptive family.

The adoption credit’s definition of children with special needs is narrower than the definitions of special needs for other purposes. For purposes of the adoption credit, foreign children are not considered special needs. Additionally, many U.S. children who have disabilities are not considered special needs for the purposes of the adoption credit. Generally, special needs adoptions are the adoptions of children whom the state's child welfare agency considers difficult to place for adoption, and most foster care adoptions are special needs adoptions, but few other adoptions are special needs adoptions.

If the taxpayer is filing Form 8839 - Qualified Adoption Expenses, he or she cannot file the income tax return and Form 8839 electronically. The taxpayer must file a paper return. Mail the return to the address listed in the tax return instructions. (291)

Credit for the Elderly or the Permanently and Totally Disabled The Elderly and Disabled Tax Credit is a nonrefundable credit for low-income taxpayers over age 65 or those who are retired on permanent and total disability and received taxable disability income during the tax year. To qualify for the elderly and disabled tax credit, individual taxpayers must have income less than $17,500 ($25,000 for married filing jointly) and nontaxable income (nontaxable Social Security, pension, annuities, or disability income) of less than $5,000 ($7,500 for married filing jointly). The tax credit can be as high as $500. The tax credit for the elderly or the permanently and totally disabled applies to citizens or residents who are a U.S. citizen or resident alien, and either of the following applies: (292)

The taxpayer was age 65 or older at the end of 2017. The taxpayer was under age 65 at the end of 2017 and all three of the following statements are true:

1. The taxpayer retired on permanent and total disability. 2. The taxpayer received taxable disability income for 2017. 3. On January 1, 2017, the taxpayer had not reached mandatory retirement age.

Married taxpayers must file a joint return to claim the credit, unless the spouses live apart throughout the tax year. The credit is computed on Schedule R - Credit for the Elderly or the Disabled Form 1040. The credit for the elderly or the disabled is entered on Line 49 Form 1040, or Line 32 Form 1040A. The 2017 initial credits amounts are shown below. For individuals age 65 or older, the initial amount of allowable credit varies with filing status, as follows:

Lesson 14 - Credits

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2017 Initial Credit Amounts

IF the taxpayer’s filing status is… THEN enter on line 10 of Schedule R…

Single, Head of Household, or Qualifying Widow(er) and by the end of 2017 the taxpayer was:

• 65 or older $5,000 • under 65 and retired on permanent and total disability1 $5,000

Married filing a joint return and by the end of 2017: • both of taxpayers were 65 or older $7,500 • both of the taxpayers were under 65 and one of them retired on permanent

and total disability1 $5,000

• both of the taxpayers were under 65 and both of them retired on permanent and total disability2 $7,500

• one of the taxpayers was 65 or older, and the other was under 65 and retired on permanent and total disability3 $7,500

• one of the taxpayers was 65 or older, and the other was under 65 and not retired on permanent and total disability $5,000

Married filing a separate return and the taxpayer did not live with his or her spouse at any time during the year and, by the end of 2017, he or she was:

• 65 or older $3,750 • under 65 and retired on permanent and total disability1 $3,750

1 Amount cannot be more than the taxable disability income. 2 Amount cannot be more than your combined taxable disability income. 3 Amount is $5,000 plus the taxable disability income of the spouse under age 65, but not more than $7,500.

Table 14-4 - Publication 524 – Table 2 – Initial Amount (2017)

This initial amount is then reduced by amounts received as pension, annuity or disability benefits that are excludable from gross income and are payable under the Social Security Act, the Railroad Retirement Act of 1974, or a Veterans Administration program. No reduction is made for pension, annuity or disability benefits for personal injuries or sickness. The maximum amount determined above is further reduced by one-half of the excess of the adjusted gross income over the following levels, based on filing status. The 2017 adjusted gross income (AGI) limits are shown below.

2017 Adjusted Gross Income (AGI) Limits

If the taxpayer’s filing status is… THEN, even if he or she qualifies, he or she cannot take the credit if...

His or her adjusted gross income (AGI)* is equal to or more than…

OR the total of his or her nontaxable social security and other nontaxable pension(s), annuities, or disability income is equal to or more than...

Single, head of household, or qualifying widow(er) $17,500 $5,000

Individuals, joint return one spouse is a qualified individual $20,000 $5,000

Married Individuals, joint return, both spouses are qualified individuals $25,000 $7,500

Married filing separately and the taxpayer lived apart from his or her spouse for all of 2017

$12,500 $3,750

* AGI is the amount on Form 1040A or Form 1040.

Table 14-5 Publication 524 – Table 1 – Income Limits (2017)

Lesson 14 - Credits

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For permanently and totally disabled individuals under age 65, the applicable initial amount noted may not exceed the amount of disability income. A person is permanently and totally disabled if he or she cannot engage in any substantial gainful activity because of a physical or mental condition and a physician determines that the disability has lasted or can be expected to last continuously for at least a year or can lead to death. Substantial gainful activity

is the performance of significant duties over a reasonable period of time while working for pay or profit, or in work generally done for pay or profit. Full-time work (or part-time work done at the employer's convenience) in a competitive work situation for at least the minimum wage conclusively shows that the taxpayer is able to engage in substantial gainful activity. Substantial gainful activity is not work a taxpayer does to take care of him or herself or his or her home. It is not unpaid work on hobbies, institutional therapy or training, school attendance, clubs, social programs, and similar activities. However, doing this kind of work may show that the taxpayer is able to engage in substantial gainful activity. The fact that the taxpayer has not worked for some time is not, of itself, conclusive evidence that he or she cannot engage in substantial gainful activity.

Retirement Savings Contribution Credit (Saver’s Credit) For 2017, taxpayers with a low to moderate income may be able to claim a nonrefundable Saver’s Credit if he or she, or his or her spouse if filing jointly, made: (293)

Contributions (other than rollover contributions) to a traditional or Roth IRA. Elective deferrals to a 401(k), 403(b), governmental 457, SEP, or SIMPLE plan. Voluntary employee contributions to a qualified retirement plan as defined in Section 4974(c) (including the

Federal Thrift Savings Plan). Contributions to a Section 501(c)(18)(D) plan.

A taxpayer can claim the credit for 50%, 20% or 10% of the first $2,000 ($4,000 if married filing jointly) contributed during the year to a retirement account. Therefore, the maximum credit amounts that can be claimed are $1,000, $400 or $200 per person. The maximum credit a married couple filing jointly can claim together is $2,000. The applicable percentage is determined by the taxpayer’s filing status and adjusted gross income (AGI). The credit may be used against the taxpayer’s regular and alternative minimum tax liability. For 2017, the maximum applicable percentage is 50%, which is completely phased out when AGI exceeds $62,000 for joint filers, $46,500 for head of household filers, and $31,00 for single and married filing separately filers. The applicable percentage is the percentage as determined in accordance with the following table: (294)

2017 Saver’s Credit AGI Thresholds

Joint Return Head of Household Single or Married Filing Separately

Credit Rate

Over Not Over Over Not Over Over Not Over

$0 $37,000 $0 $27,750 $0 $18,500 50% $37,000 $40,000 $27,750 $30,000 $18,500 $20,000 20% $40,000 $62,000 $30,000 $46,500 $20,000 $31,000 10% $62,000 ----- $46,500 ------ $31,000 ---- 0%

Table 14-6 - Retirement Savings Contributions Credit (Saver’s Credit) (2017)

To be eligible for the credit, the individual making the contribution to a qualified retirement savings plan must be at least 18 years of age as of the close of the tax year, must not be claimed as a dependent on someone else’s tax return, and must not be a full-time student. A person enrolled as a full-time student during any part of 5 calendar months during the year is considered a student. The Saver’s Credit can be taken for the taxpayer’s contributions to a traditional or Roth IRA; his or her 401(k), SIMPLE IRA, SARSEP, 403(b), 501(c)(18) or governmental 457(b) plan; and his or her voluntary after-tax employee contributions to his or her qualified retirement and 403(b) plans. Rollover contributions (money that the taxpayer moved from another

Lesson 14 - Credits

© 2018 Golden State Tax Training Institute, Inc. 14-24

retirement plan or IRA) are not eligible for the Saver’s Credit. Also, the taxpayer’s eligible contributions may be reduced by any recent distributions he or she received from a retirement plan or IRA. Form 8880 – Credit for Qualified Retirement Savings Contributions is used to figure the dollar amount of this credit, which is claimed on Line 51 Form 1040, or Line 34 Form 1040A.

Other Tax Credits Foreign Tax Credit (FTC) The Foreign Tax Credit is intended to relieve the taxpayer of a double tax burden when his or her foreign source income is taxed by both the United States and the foreign country. In most cases, if the foreign tax rate is higher than the U.S. rate, there will be no U.S. tax on the foreign income. If the foreign tax rate is lower than the U.S. rate, U.S. tax on the foreign income will be limited to the difference between the rates. The foreign tax credit can only reduce U.S. taxes on foreign source income; it cannot reduce U.S. taxes on U.S. source income. Although no one rule covers all situations, in most cases it is better to take a credit for qualified foreign taxes than to deduct them as an itemized deduction. This is because:

1. A credit reduces the taxpayer’s actual U.S. income tax on a dollar-for-dollar basis, while a deduction reduces only his or her income subject to tax.

2. The taxpayer can choose to take the foreign tax credit even if he or she does not itemize his or her deductions. The taxpayer then is allowed the standard deduction in addition to the credit.

3. If the taxpayer chooses to take the Foreign Tax Credit, and the taxes paid or accrued exceed the credit limit for the tax year, he or she may be able to carry over or carry back the excess to another tax year.

A taxpayer may either deduct foreign income taxes paid or accrued as an itemized deduction on Schedule A of Form 1040 or may apply them as a credit against his or her U.S. income tax liability. The Foreign Tax Credit (FTC) is claimed on Form 1116 – Foreign Tax Credit, unless the total foreign taxes paid are less than $300 for single filers ($600 for married filing jointly). The credit may be claimed directly on Form 1040 if all filing requirements are satisfied. (295) Generally, the following four tests must be met for any foreign tax to qualify for the credit: (296)

The tax must be imposed on the taxpayer. The taxpayer must have paid or accrued the tax. The tax must be the legal and actual foreign tax liability. The tax must be an income tax (or a tax in lieu of an income tax).

The taxpayer can claim a foreign tax credit only for foreign taxes on income, war profits, excess profits or certain other taxes. In addition, there is a limit on the amount of the credit that the taxpayer can claim. The taxpayer figures this limit and the credit on Form 1116 - Foreign Tax Credit. The credit is the amount of foreign tax he or she paid or accrued or, if smaller, the limit. The limitation is the proportion of the taxpayer’s tentative U.S. income tax (before the Foreign Tax Credit) that taxpayer’s foreign source taxable income bears to his or her worldwide taxable income for the year. The maximum amount of tax that may be credited is computed using the following formula: FTC = U.S. income tax X Foreign source taxable income Worldwide taxable income The limit must be applied separately to nonbusiness interest income and all other income. Also, the amount used for taxable income in the numerator and the denominator is regular taxable income with adjustments. For example, the taxpayer must add back person exemptions.

If the taxpayer has foreign taxes available for credit but cannot use them because of the limit, he or she may be able to carry them back 1 tax year and forward to the next 10 tax years.

The taxpayer will not be subject to the above limit and will be able to claim the credit without using Form 1116 if the following requirements are met:

Lesson 14 - Credits

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Only foreign source gross income for the tax year is passive category income. For purposes of this rule, high taxed income and export financing interest are also passive category income.

Qualified foreign taxes for the tax year are not more than $300 ($600 if married filing a joint return). All of gross foreign income and the foreign taxes are reported to the taxpayer on a payee statement (such as a

Form 1099-DIV or 1099-INT). The taxpayer elects the exemption from foreign tax credit limit for the tax year.

If the taxpayer makes this election, he or she cannot carry back or carry over any unused foreign tax to or from the current tax year. Mortgage Interest Credit The taxpayer can claim the Mortgage Interest Credit only if he or she was issued a qualified Mortgage Credit Certificate (MCC) by a state or local governmental unit or agency under a qualified mortgage credit certificate program. The home to which the certificate relates must be the taxpayer’s main home and also must be located in the jurisdiction of the governmental unit that issued the certificate. If the interest on the mortgage was paid to a related person, the taxpayer cannot claim the credit. Also, if two or more persons (other than a married couple filing a joint return) hold an interest in the home to which the MCC relates, the credit must be divided based on the interest held by each person The taxpayer may have an unused credit to carry forward to the next 3 tax years or until used, whichever comes first. The current year credit is used first and then the prior year credits, beginning with the earliest prior year. If the taxpayer is subject to the $2,000 credit limit because the certificate credit rate is more than 20%, no amount over the $2,000 limit (or his or her prorated share of the $2,000 if he or she must allocate the credit) may be carried forward for use in a later year. For more information, see Form 8396 - Mortgage Interest Credit. Credit for Excess Social Security Tax or Railroad Retirement Tax Withheld Most employers must withhold Social Security tax from a taxpayer’s wages. If he or she works for a railroad employer, that employer must withhold tier 1 railroad retirement (RRTA) tax and tier 2 RRTA tax. If a taxpayer worked for more than one employer during 2017 and had more than $7,886.40 in Social Security and Tier 1 RRTA tax withheld, he or she should claim the excess on the appropriate line of Form 1040, Form 1040A, or Form 1040NR. If an employee had total wages and compensation over the wage base limit in Tier 2 RRTA tax withheld from more than one employer, the employee should claim a refund on Form 843 - Claim for Refund and Request for Abatement. If the taxpayer overpaid the tax, he or she may claim a credit for the overpayment on line 71 of Form 1040. The IRS will issue a full reimbursement of the overpayment, as long as the taxpayer does not owe any income tax. If the taxpayer does owe current year or previous year taxes, the IRS applies the overpayment to that amount first, then issues any balance to the taxpayer. If only one employer withheld too much Social Security or RRTA tax, the taxpayer cannot claim the excess as a credit against his or her income tax. The taxpayer’s employer should make an adjustment of the excess. If the employer does not make an adjustment, the taxpayer can use Form 843 - Claim for Refund and Request for Abatement, to claim a refund. Residential Energy Credits Residential Energy Efficient Property Credit (Part I) - The taxpayer may be able to take the Residential Energy Efficient Property Credit if he or she made energy saving improvements to his or her home located in the United States. The credit currently applies to solar electric property, solar water heating property, geothermal systems and windmills and is available for property placed in service through December 31, 2021, based on an applicable percentage. The applicable percentages are:

In the case of property placed in service after December 31, 2016, and before January 1, 2020, 30%. In the case of property placed in service after December 31, 2019, and before January 1, 2021, 26%. In the case of property placed in service after December 31, 2020, and before January 1, 2022, 22%.

Nonbusiness Energy Property Credit (Part II) - The Bipartisan Budget Act extends through 2017 the credit for purchases of nonbusiness energy property. The provision allows a credit of 10% of the amount paid or incurred by the taxpayer for qualified energy improvements (installing insulation, storm windows, etc.), up to $500. The credit for nonbusiness energy property was not renewed by the Tax Cuts and Jobs Act. The taxpayer uses Form 5695 - Residential Energy Credits to figure his or her Residential Energy Credits. The taxpayer also uses Form 5695 to carry the unused portion of the credit to 2018.

Lesson 14 - Credits

© 2018 Golden State Tax Training Institute, Inc. 14-26

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

Review Questions Answers appear in Review Feedback 1. Jerry and Heather are married, both are employed, and they have three children all under the age of 9. The two youngest

children are in preschool and the oldest child is in grade school. They claim their children as dependents and file a joint return. Their adjusted gross income (AGI) is $37,000. Heather earned $30,000 and Jerry earned $7,000. During the year, they paid $2,500 each for the two children to attend preschool. They also paid Jerry's mother $4,000 to watch the oldest child after school. How much of their childcare payments are eligible to calculate the Child and Dependent Care Credit on their return?

A. $4,000 B. $5,000 C. $6,000 D. $6,500

2. What type of contribution is excluded from the Credit for Qualified Retirement Savings Contributions?

A. Rollover contribution B. Traditional IRA contribution C. Roth IRA contribution D. 401(k) contribution

3. Jill, who works at a retail store, is married and earned $30,000 in 2017. Jill’s husband was unemployed in 2017 and did

not have any earnings. Jill contributed $1,000 to her IRA in 2017. After deducting her IRA contribution, the adjusted gross income shown on her joint return is $29,000. Jill may claim what amount for the Retirement Savings Contributions Credit (Saver’s Credit) for her $1,000 IRA contribution?

A. $0 B. $200 C. $500 D. $1,000

4. When determining earned income, which of the following qualifies for the Earned Income Tax Credit (EITC)?

A. Wages B. Welfare benefits C. Veterans’ benefits D. Interest and Dividends

5. Which of the following expenses are qualified adoption expenses?

A. Necessary adoption fees B. Court costs C. Attorney fees D. All of the above

6. A student must take at least how many classes in order to take advantage of the Lifetime Learning Credit?

A. One class B. Two classes C. Three classes D. Four class

Lesson 14 - Credits

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7. Which of the following is a refundable tax credit? A. Child and Dependent Care Credit B. Credit for the Elderly or Disabled C. Child Tax Credit D. Earned Income Tax Credit

Lesson 14 - Credits

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Review Feedback Return to Review Questions Question 1 - C. $6,000 A taxpayer may include up to $6,000 of expenses paid for the care of two or more qualifying persons to figure the child and dependent care credit, provided the amount of expenses claimed does not exceed the gross earnings of the lower earning taxpayer. A taxpayer should combine the total qualifying expenses for all qualifying persons. In this case combine the amounts paid for the two preschool children of $5,000 and the amount paid for after school care of $4,000. However, the total of $9,000 exceeds the maximum of $6,000 therefore they may only use $6,000 of the child care expenses to calculate the child and dependent care credit. Question 2 - A. Rollover contribution For tax year 2017, taxpayers with a low to moderate income may be able to claim a nonrefundable Saver’s Credit if he or she, or his or her spouse if filing jointly, made:

• Contributions (other than rollover contributions) to a traditional or Roth IRA. • Elective deferrals to a 401(k), 403(b), governmental 457, SEP, or SIMPLE plan. • Voluntary employee contributions to a qualified retirement plan as defined in section 4974(c) (including the Federal

Thrift Savings Plan). • Contributions to a section 501(c)(18)(D) plan.

Question 3 - C. $500 The amount of the Retirement Savings Contributions Credit (Saver’s Credit) is 50%, 20% or 10% of the taxpayer’s retirement plan or IRA contributions up to $2,000 ($4,000 if married filing jointly), depending on his or her adjusted gross income (reported on his or her Form 1040 or 1040A). Since the adjusted gross income shown on Jill’s joint return is $29,000. Jill may claim a 50% credit, $500, for her $1,000 IRA contribution. Question 4 - A. Wages Earned income generally means wages, salaries, tips, other taxable employee pay, and net earnings from self-employment. Employee pay is earned income only if it is taxable. Nontaxable employee pay, such as certain dependent care benefits and adoption benefits, is not earned income. Other examples of items that are not earned income include interest and dividends, pensions and annuities, Social Security and railroad retirement benefits (including disability benefits), alimony and child support, welfare benefits, workers' compensation benefits, unemployment compensation (insurance), nontaxable foster care payments, and veterans' benefits, including VA rehabilitation payments. Question 5 - D. All of the above Qualified adoption expenses are reasonable and necessary expenses directly related to the legal adoption of the child who is under 18 years old, or physically or mentally incapable of caring for him or herself. These expenses may include adoption fees, court costs, attorney fees and travel expenses. Question 6 - A. One class Unlike the American Opportunity Tax Credit, the student need not be in the first four years of undergraduate classes. Even if the student took only one class, he or she may take advantage of the Lifetime Learning Credit. Question 7 - D. Earned Income Tax Credit A refundable tax credit is a tax credit that can reduce tax liability below zero. It is possible to receive a tax refund from this type of credit. Some examples of refundable tax credits include:

• Earned Income Tax Credit • Excess Social Security Credit • Additional Child Tax Credit

Some examples of nonrefundable tax credits include:

• Child Tax Credit • Child and Dependent Care Credit • Credit for the Elderly or Disabled

© 2018 Golden State Tax Training Institute, Inc. 15-1

Additional Taxes At the conclusion of this lesson you should have a basic knowledge of:

Alternative Minimum Tax Affordable Care Act Taxes Kiddie Tax Estate Tax Gift Tax Household Employment Tax

Alternative Minimum Tax Alternative Minimum Tax (AMT) rules have been devised to ensure that at least a minimum amount of income tax is paid by higher-income taxpayers who reap large tax savings by making generous use of certain tax deductions, exemptions, losses and credits. Without AMT some of these taxpayers might be able to escape income taxation entirely. In essence, the AMT functions as a recapture mechanism, reclaiming some of the tax breaks primarily available to higher-income taxpayers, and represents an attempt to maintain tax equity. The exemption amounts for the AMT were permanently indexed for inflation by the American Taxpayer Relief Act of 2012. A taxpayer’s AMT for a tax year is the excess of the taxpayer’s tentative minimum tax over his or her regular tax and must be paid in addition to his or her regular tax liability. Form 6251 - Alternative Minimum Tax is used by individuals to compute the AMT. The starting point for AMT is line 41 of the Form 1040, which is the taxpayer’s AGI after deducting his or her standard deduction or itemized deductions, but before subtracting personal exemptions. This amount (from line 41) is then increased by the taxpayer’s total tax benefit items (i.e., tax preferences and adjustments) as calculated on Form 6251. The result is the taxpayer’s alternative minimum taxable income (AMTI). Amount Excluded from Minimum Taxation A specified amount of AMTI, Alternative Minimum Taxable Income, is exempt from alternative minimum taxation. The amount varies according to the taxpayer’s filing status and the tax year at hand. The exemption is subtracted from the taxpayer’s AMTI to determine the amount of his or her AMTI that is subject to tax at the AMT rates. For 2017 returns, the AMT exemption amounts are: (297)

$84,500 for married individuals filing a joint return and surviving spouses. $54,300 for a single individual (who is not a surviving spouse) and head of household. $42,250 for married individuals filing separate returns. $24,100 for estates and trusts.

AMT Exemption for Certain Children For children under age 24 the AMT exemption amount is limited to the amount of earned income plus $7,500 in 2017 if any of the following conditions apply: (298)

The taxpayer was under age 18 at the end of 2017. The taxpayer was age 18 at the end of 2017 and did not have earned income that was more than half of his or

her support. The taxpayer was a full-time student over age 18 and under age 24 at the end of 2017 and did not have earned

income that was more than half of his or her support.

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Ordinarily, single individuals can subtract a $54,300 exemption amount from their AMT taxable income. However, a child who files Form 8615 - Tax for Certain Children Who Have Unearned Income has a limited exemption amount. The child's exemption amount for 2017 is limited to the child's earned income plus $7,500.

AMT Exemption Phase-out The taxpayer’s exemption phases out if his or her AMTI exceeds the thresholds indicated below. More specifically, the exemption is reduced by 25% of the amount by which his or her AMTI exceeds the applicable threshold for his or her filing status. The AMTI exemption phase-out thresholds for 2017 begin at: (297)

$160,900, for married individuals filing a joint return, and surviving spouses. $120,700, for unmarried individuals (other than surviving spouses). $80,450 for married filing separately and estates and trusts.

The patch applied by Congress each year to allow bigger AMT exemptions and to allow various personal tax credits to offset the AMT was made permanent by The American Taxpayer Relief Act of 2012.

AMT is computed at rates of 26% and 28%. In 2017, the 26% rate applies to the first $187,800 ($93,900, in the case of married individuals filing separately) of AMT income in excess of the applicable exemption amount. The 28% rate applies to any additional AMT income. However, special rates apply to net long-term capital gain and qualified dividends. After subtracting the exemption amount from the taxpayer’s AMTI, multiply the remainder by the applicable AMT rate of 26% or 28%. Generally, the resulting figure is his or her tentative minimum tax (TMT). Compare the taxpayer’s TMT with his or her regular income tax. If the regular tax is higher, the taxpayer does not owe any AMT. But if the regular tax is lower, the difference between the two taxes is the amount of AMT he or she must pay in addition to his or her regular tax (if any). Credit for Prior Year Alternative Minimum Tax If a taxpayer is not liable for AMT this year, but he or she paid AMT in one or more previous years, he or she may be eligible to take a special minimum tax credit against his or her regular tax this year. The AMT is caused by two types of adjustments and preferences - deferral items and exclusion items. Deferral items (for example, depreciation) generally do not cause a permanent difference in taxable income over time. Exclusion items (for example, the standard deduction), on the other hand, do cause a permanent difference. The minimum tax credit is allowed only for the AMT caused by deferral items. The taxpayer should use Form 8801 - Credit for Prior Year Minimum Tax - Individuals, Estates, and Trusts if he or she is an individual, estate, or trust to figure the current year nonrefundable credit, if any, for alternative minimum tax (AMT) he or she incurred in prior tax years and to figure any credit carryforward to 2017. Complete Form 8801 if the taxpayer is an individual, estate, or trust that for 2015 had:

An AMT liability and adjustments or preferences other than exclusion items. A credit carryforward to 2017 (on 2016 Form 8801, line 26). An unallowed qualified electric vehicle credit.

Preferences and Adjustments Positive and negative AMT adjustments are added or subtracted from regular taxable income to determine the "taxable income after AMT adjustments". Tax preference items are then added to get the taxpayer’s AMTI. The following is a list of AMT adjustments:

Standard deduction and personal exemptions. Certain itemized deductions. Mortgage interest. Taxes. Medical expenses. Miscellaneous deductions.

Lesson 15 - Additional Taxes

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Investment interest. MACRS depreciation. Basis adjustment affects AMT gain or loss. Incentive stock options (ISO). Mining exploration and development costs. Circulation costs. Long-term contracts. Research and experimental procedures. Passive tax-shelter farm losses. Passive losses from non-farming activities.

Certain tax preference items must be added back into taxable income after AMT adjustments to determine the AMTI. These primary items include the following AMT preference items:

Tax-exempt interest on private-activity municipal bonds Percentage Depletion / Excess intangible drilling costs (IDC) Depreciation (ACRS/MACRS) Exercise of an Incentive Stock Option (Bargain Element)

Exclusion Items versus Deferral Items Tax preference and adjustments to AMT are broken down into two categories; exclusion items and deferral items. Exclusion items are adjustments that cause a permanent difference in income for regular tax versus AMT purposes, they include the following AMT adjustments/preferences that are exclusion items:

Personal exemption. Standard deduction. Itemized deduction. Percentage depletion. Tax-exempt interest. Exclusion of gain from qualified small business stock.

Deferral items do not cause a permanent difference in taxable income over time. AMT adjustments/preference that are deferral items are any adjustment/preference item that is not an exclusion item from the list above. Alternative Minimum Taxable Income (AMTI) The AMT is calculated based on the alternative minimum taxable income (AMTI) that includes all of the income under the regular tax system plus some income that is tax exempt under the regular tax system. The following common items are not deductible under the AMT system:

Personal exemptions. State and local taxes. Miscellaneous itemized deductions.

The only way to determine AMT liability is to calculate taxable income using standard procedures and then using the AMT procedures on Form 6251 - Alternative Minimum Tax for Individuals. The end result of the AMT calculation is a tentative AMT tax from which the regular tax is subtracted. If the result is positive, then this AMT tax is added to the regular tax on Form 1040; if the result is negative, then there is no AMT. Example Don’s regular income tax is $50,000. When he calculates his tax using the AMT rules, he comes up with $62,000. Therefore, Don must pay $12,000 of AMT in addition to the $50,000 of regular income tax.

Lesson 15 - Additional Taxes

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Affordable Care Act Tax Provisions The Affordable Care Act contains comprehensive health insurance reforms and includes tax provisions that affect individuals, families, businesses, insurers, tax-exempt organizations and government entities. These tax provisions contain important changes, including how individuals and families file their taxes. The law also contains benefits and responsibilities for other organizations and employers. President Trump signed an executive order giving the Department of Health and Human Services and “other executive departments and agencies” the authority and discretion to roll back certain aspects of the Affordable Care Act (ACA). It was unclear at the time what that might mean for the Internal Revenue Service (IRS) which has been tasked by Congress with enforcement of several key components of ACA, including the individual mandate of minimum essential coverage. Now it appears the IRS is relaxing enforcement of the mandate. Under the ACA, a taxpayer is required to demonstrate that he or she has "minimum essential coverage." The taxpayer is considered covered if he or she has insurance through the government, including Medicare, Medicaid or VA health coverage; private insurance that he or she purchased on his or her own including COBRA coverage and coverage obtained through the Health Insurance Marketplace; or provided by his or her employer (even if the taxpayer did not pay anything for the coverage). Most taxpayers will report coverage. Those that do not have coverage must claim a waiver or exemption (typically based on hardship) or be subject to a penalty called the shared individual responsibility payment. For the 2017 tax year, that penalty is equal to 2.5% of your adjusted gross income (AGI), or $695 per adult and $347.50 per child, up to a maximum of $2,085, whichever is higher. The amount is figured and reported on your 2017 tax return, payable by April 17, 2018. The easiest way for most taxpayers to indicate that they have coverage is to check the box on line 61 on page 2 of their individual income tax return. In past years, failure to check the box could have resulted in a rejection of the tax return. However, the IRS has indicated that for 2017, it will accept and process tax returns where a taxpayer does not declare coverage. What this should mean is that taxpayers may leave line 61 blank and still have their tax returns processed. Nevertheless, during last filing season, the IRS advised that line 61 could not be left blank if no form 8965 was attached so it's not unlikely that some software systems and tax preparers may still insist on checking the box. Nearly everyone is affected by the Affordable Care Act and will need to do something new when filing their taxes this year. The following chart will help the taxpayer better understand how the health care law affects him or her and his or her tax return.

Health Care Law's Effect on the Taxpayer If the taxpayer… Then the taxpayer… Is U.S. citizens or are non-U.S. citizens living in the United States

Must have qualifying health care coverage, qualify for a health coverage exemption, or make a payment when he or she files his or her tax return.

Has health coverage through an employer or under a government program such as Medicare, Medicaid and coverage for veterans for the entire year

Just has to check a box on his or her Form 1040 series return and do not read any further.

Does not have coverage for any month of the year Should check the instructions to Form 8965 - Health Coverage Exemptions to see if he or she is eligible for an exemption.

Is eligible for an exemption from coverage for a month Is not responsible for making an Individual Shared Responsibility payment for that month, and must claim the exemption or report an exemption already obtained from the Marketplace by completing Form 8965 - Health Coverage Exemptions, and submitting it with his or her tax return.

Does not have coverage and is not eligible for an exemption from coverage for any month of the year

Is responsible for making an individual shared responsibility payment when he or she files his or her return.

Is responsible for making an individual shared responsibility payment

Will report it on his or her tax return and make the payment with his or her taxes.

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Received the benefit of more advance payments of the Premium Tax Credit than the amount of credit for which he or she qualifies

Will repay the amount in excess of the credit he or she is allowed subject to a repayment cap

Needs qualifying health care coverage for 2017 Can enroll in health insurance through the Health Insurance Marketplace (Marketplace) during the open enrollment period that runs through January 31, 2017; once open enrollment ends, individuals can enroll only if he or she qualifies under special enrollment provisions

Enrolls in health insurance through the Marketplace for him or herself or someone else on his or her tax return

Might be eligible for the Premium Tax Credit.

Did not enroll in health insurance from the Marketplace for him or herself or anyone else on his or her tax return

Cannot claim the Premium Tax Credit.

Or another person on his or her tax return who is enrolled in coverage through the Marketplace is not eligible for health care coverage through his or her employer or under a government program

Might be eligible for the Premium Tax Credit.

Is eligible for the Premium Tax Credit Can choose to get premium assistance now to lower his or her monthly payments or get all the benefit of the credit when he or she claims it on his or her tax return.

Chooses to get premium assistance now Will have payments sent on his or her behalf to his or her insurance provider. These payments are called advance payments of the Premium Tax Credit.

Gets the benefit of advance payments of the Premium Tax Credit and experiences a significant life change, such as a change in income or marital status

Reports these changes in circumstances to the Marketplace when they happen.

Gets the benefit of advance payments of the premium tax credit

Will report the payments on his or her tax return and reconciles the amount of the payments with the amount of credit for which he or she is eligible.

Table 15-1 - HCTT-2015-06 - The Health Care Law's Effect on You (2017)

Minimum Essential Coverage Minimum Essential Coverage is the type of coverage a taxpayer needs to avoid the fee for not having insurance under the Affordable Care Act. In order to be in compliance with the law the taxpayer must maintain minimum essential coverage throughout the year or pay a fee for each month he or she goes without it (although the taxpayer is allowed up to three months in a row each year without coverage, due to a coverage gap exemption). Minimum essential coverage includes the following types of health insurance:

Employer-sponsored coverage (including COBRA coverage and retiree coverage). Coverage purchased in the individual market, including a qualified health plan offered by the Health Insurance

Marketplace (also known as an Affordable Insurance Exchange). Medicare Part A coverage and Medicare Advantage plans. Most Medicaid coverage. Children’s Health Insurance Program (CHIP) coverage. Certain types of veterans health coverage administered by the Veterans Administration. TRICARE. Coverage provided to Peace Corps volunteers. Coverage under the Non-appropriated Fund Health Benefit Program. Refugee Medical Assistance supported by the Administration for Children and Families. Self-funded health coverage offered to students by universities for plan or policy years that began on or before

December 31, 2014 (for later plan or policy years, sponsors of these programs may apply to HHS to be recognized as minimum essential coverage).

State high risk pools for plan or policy years that began on or before December 31, 2014 (for later plan or policy years, sponsors of these programs may apply to HHS to be recognized as minimum essential coverage).

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Minimum essential coverage does not include coverage providing only limited benefits, such as coverage only for vision care or dental care, and Medicaid covering only certain benefits such as family planning, workers’ compensation, or disability policies. Also, a taxpayer cannot claim the Premium Tax Credit (PTC) for any

individual in his or her tax family for any month when that individual is eligible for minimum essential coverage, except for coverage purchased through the individual market. Individual Shared Responsibility Provision Under the Affordable Care Act, the Federal government, state governments, insurers, employers and individuals are given shared responsibility to reform and improve the availability, quality and affordability of health insurance coverage in the United States. As of 2014, the individual shared responsibility provision calls for each individual to have minimum essential health coverage (known as minimum essential coverage) for each month, qualify for an exemption, or make a payment when filing his or her Federal income tax return. Most individuals in the United States have health coverage today that will count as minimum essential coverage and will not need to do anything more than continue the coverage that they have. For those who do not have coverage, who anticipate discontinuing the coverage they have currently, or who want to explore whether more affordable options are available, the Health Insurance Marketplace will open for every state and the District of Columbia in October of each year. The Health Insurance Marketplace will help qualified individuals find minimum essential coverage that fits their budget and potentially financial assistance to help with the costs of coverage. The Health Insurance Marketplace will also be able to assess whether applicants are eligible for Medicaid or the Children’s Health Insurance Program (CHIP). For those who will become eligible for Medicare during 2017, enrolling for Medicare will also ensure that the taxpayer has minimum essential coverage for 2018. Since January 2014, the taxpayer and his or her family have been required to have health care coverage, have an exemption from coverage, or make a payment when he or she files the 2017 tax return in 2018. Most people already have qualifying health care coverage and will not need to do anything more than maintain that coverage throughout 2017. The taxpayer may be exempt from the requirement to maintain qualifying health insurance coverage, called minimum essential coverage, and may not have to make a shared responsibility payment when he or she files his or her next Federal income tax return. The taxpayer may be exempt if he or she:

Has no affordable coverage options because the minimum amount he or she must pay for the annual premiums is more than 8% of his or her household income.

Has a gap in coverage for less than three consecutive months. Qualifies for an exemption for one of several other reasons, including having a hardship that prevents him or her

from obtaining coverage or belonging to a group explicitly exempt from the requirement.

For Tax Year 2017, the IRS will not consider a return complete and accurate if the taxpayer does not report full-year coverage, claim a coverage exemption, or report a shared responsibility payment on the tax return. Most taxpayers have qualifying health coverage for all 12 months in the year, and will check the "Full-year coverage"

box on their tax return. Taxpayers who do not have full-year coverage will indicate whether they qualify for a coverage exemption or owe a shared responsibility payment. Executive Order 13765 was issued on January 20, 2017, and directed Federal agencies to exercise authority and discretion available to them to reduce potential burden. However, legislative provisions of the ACA are still in force until changed by the Congress, and taxpayers remain obligated to follow the law and pay what they may owe. Taxpayers should continue to file their tax returns as they normally would. Change in Circumstances If the taxpayer is receiving advance payments of the premium tax credit to help pay for his or her insurance coverage, he or she must report changes such as income or family size to his or her marketplace. Reporting changes will help to make sure the taxpayer is receiving the proper amount of assistance. Fees Since 2014, most people have been required to have health coverage. If they do not have coverage, they may be required to pay a fee. The fee is sometimes called the individual shared responsibility provision or penalty. The penalty in 2017 is

Lesson 15 - Additional Taxes

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calculated based on income and is either a percentage or a flat fee. An individual will pay whichever of these amounts is higher:

1. 2.5% of his or her yearly household income (to determine payment using the income formula, subtract filing threshold from household income). The maximum penalty is the national average yearly premium for a bronze plan.

2. $695 per person for the year ($347.50 per child under 18). The maximum penalty per family using this method is $2,085.

The fee increases every year as it is adjusted for inflation. If an individual is uninsured for just part of the year, 1/12 of the yearly penalty applies to each month he or she uninsured. If the individual is uninsured for less than 3 months, he or she does not have a make a payment. The taxpayer will pay the fee on his or her Federal income tax return. The following types of health plans that do not meet minimum essential coverage do not qualify as coverage in 2017. If the individual only has these types of coverage, he or she may have to pay the fee. Examples include:

Coverage only for vision care or dental care. Workers' compensation. Coverage only for a specific disease or condition. Plans that offer only discounts on medical services.

Health Coverage Exemptions As of 2014, taxpayers must have health care coverage, have a health coverage exemption, or make a shared responsibility payment with their tax return. Taxpayers use Form 8965 - Health Coverage Exemptions to report a coverage exemption granted by the Marketplace (also called the “Exchange”) or to claim a coverage exemption on his or her tax return. In addition, if for any month the taxpayer or another member of his or her tax household had neither health care coverage nor a coverage exemption, the instructions for Form 8965 provide the information the taxpayer will need to calculate his or her shared responsibility payment. Some exemptions must be obtained through the Marketplace (an individual must have applied and received their exemption certificate number before they file their return). Certain exemptions can only be requested at the time the Federal return is filed, while others can be requested through the Marketplace or when filing their Federal return. Exemptions that can only be obtained from the Marketplace are as follows: (299)

Members of certain religious sects - the taxpayer is a member of a recognized religious sect. Determined ineligible for Medicaid in a state that did not expand Medicaid coverage - the taxpayer was determined

ineligible for Medicaid solely because the state in which he or she resided did not participate in Medicaid expansion under the Affordable Care Act.

General hardship - the taxpayer experienced a hardship that prevented him or her from obtaining coverage under a qualified health plan.

Coverage considered unaffordable based on projected income - the taxpayer did not have access to coverage that is considered affordable based on his or her projected household income.

Unable to renew existing coverage - the taxpayer was notified that his or her health insurance policy was not renewable and he or she considered the other plans available unaffordable.

Certain Medicaid programs that are not minimum essential coverage - The Marketplace determined that the taxpayer was (1) enrolled in Medicaid coverage provided to a pregnant woman that is not recognized as minimum essential coverage; (2) enrolled in Medicaid coverage provided to a medically needy individual (also known as Spend-down Medicaid or Share-of-Cost Medicaid) that is not recognized as minimum essential coverage; or (3) enrolled in Medicaid coverage provided to a medically needy individual and were without coverage for other months because the spend-down had not been met.

Examples of some of the exemptions that may only be requested by filing Form 8965 with a Federal return: (299)

Income below the filing threshold - the taxpayer’s gross income or his or her household income was less than his or her applicable minimum threshold for filing a tax return.

Coverage considered unaffordable - The minimum amount the taxpayer would have paid for premiums is more than 8.16% for tax year 2017 of his or her household income.

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Short coverage gap - the taxpayer went without coverage for less than 3 consecutive months during the year. Citizens living abroad and certain noncitizens - the taxpayer was:

o A U.S. citizen or resident who spent at least 330 full days outside of the U.S. during a 12-month period; o A U.S. citizen who was a bona fide resident of a foreign country or U.S. territory; o A resident alien who was a citizen of a foreign country with which the U.S. has an income tax treaty with

a nondiscrimination clause, and he or she was a bona fide resident of a foreign country for the tax year; o Not a U.S. citizen, not a U.S. national, and not an individual lawfully present in the U.S; or o A nonresident alien, including (1) a dual-status alien in the first year of U.S. residency and (2) a

nonresident alien or dual-status alien who elects to file a joint return with a U.S. spouse. This exemption does not apply if the taxpayer is a nonresident alien for 2017, but met certain presence requirements and elected to be treated as a resident alien.

Members of a health care sharing ministry - the taxpayer was a member of a health care sharing ministry. Members of Indian tribes - the taxpayer was either a member of a Federally-recognized Indian tribe, including an

Alaska Native Claims Settlement Act (ANCSA) Corporation Shareholder (regional or village), or he or she was otherwise eligible for services through an Indian health care provider or the Indian Health Service.

Incarceration - the taxpayer was in a jail, prison, or similar penal institution or correctional facility after the disposition of charges.

Aggregate self-only coverage considered unaffordable - Two or more family members' aggregate cost of self-only employer-sponsored coverage was more than 8.16% of household income for the 2017 tax year, as was the cost of any available employer-sponsored coverage for the entire family.

Resident of a state that did not expand Medicaid - the taxpayer’s household income was below 138% of the Federal poverty line for his or her family size and at any time during the tax year he or she resided in a state that didn't participate in the Medicaid expansion under the Affordable Care Act.

Eligible for Health Coverage Tax Credit (HCTC) - the taxpayer was eligible for the health coverage tax credit in the month. (For this purpose, he or she is considered eligible for the HCTC if he or she would have been eligible had he or she enrolled in HCTC-qualifying coverage.) This exemption was available only for July through December of 2016.

Member of tax household born or adopted during the year - The months before and including the month that an individual was added to the taxpayer’s tax household by birth or adoption. The taxpayer should claim this exemption only if he or she is also claiming another exemption on his or her Form 8965.

Member of tax household died during the year - The months after the month that a member of the taxpayer’s tax household died during the year. The taxpayer should claim this exemption only if he or she is also claiming another exemption on his or her Form 8965.

If a taxpayer is eligible for an exemption from having health insurance for 2017, they must complete Form 8965 (Health Coverage Exemptions) to avoid owing a penalty (shared responsibility payment) for 2017.

As of September 1, 2016, the coverage exemptions for members of health care sharing ministries, members of Indian tribes, and those who are incarcerated are no longer granted by the Marketplace, except in Connecticut. Taxpayers who have an ECN issued by the Marketplace for one or more of these three exemptions may report

the ECN on a Form 8965 filed with their income tax return for 2017. Taxpayers who qualify for one or more of these exemptions but who do not have an ECN issued by the Marketplace may claim these exemptions on Part III of Form 8965. Minimum Value Standards The Minimum Value (MV) standards will be used to determine whether employees eligible for employer-sponsored health care coverage can obtain subsidized coverage on an exchange. If the employee is qualified for an employer’s plan but the plan does not provide minimum value of at least 60%, then depending on the employee’s household income, he or she may be eligible for subsidized health care coverage on an exchange.

To meet the minimum value standards the plan must pay at least 60% of the covered benefits and services. Participant cost-sharing must be limited to no more than 40%.

Employees who are not provided access to a plan that meets this minimum value threshold and who have a household income of less than 400% of the Federal poverty level are eligible for premium subsidies, which are delivered in the form of tax credits for coverage through the Health Insurance Exchanges (Under a separate provision, employees in this income level may also be eligible for premium subsidies if the employer’s plan is not affordable according to government standards).

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The IRS has proposed three ways for employers to calculate whether their group health plans meets the standard for minimum value:

1. AV and MV Calculators - Calculators made available by the Department of Health and Human Services (HHS) and the Department of the Treasury. To use the calculator, employers input information about their plan benefits and the percent of cost sharing with employees. The calculator uses claims data from self-funded and large group fully-insured plans to determine whether an employer’s plan provides the minimum value. The calculator alone cannot be used for plans that include what the IRS calls non-standard features, such as limits on physician visits. These can complicate the calculation of the actuarial value.

2. Actuarial Certification - Employers sponsoring plans with non-standard features can use a combination of the calculator and an actuarial certification. The employer would use the calculator as explained above, and then have an actuary assess the impact of the non-standard features and adjust the plan’s actuarial value accordingly.

3. Safe Harbor Checklist - Instead of using the calculation or actuarial certification, employers can choose alternately to use a safe harbor checklist. This lists the four core benefits and the minimum cost-sharing levels the employer can use to reach a 60% actuarial value. If the cost-sharing level for any of these core benefits exceeds the allowable amount on the safe harbor checklist, the employer’s plan would not reach the required minimum value. Employers cannot choose this option if their plans include non-standard features or do not cover all of the core benefits.

Employer-sponsored plan designs meeting the following specifications are proposed as safe harbors for determining Minimum Value (MV) if the plans cover all of the benefits included in the Minimum Value (MV) Calculator. Deductible

(Single Coverage) Cost-Sharing Out-of-Pocket

Limit (Single Coverage)

Employer HSA Contributions

Plan 1 $3,500 integrated medical/drugs 80% $6,000 None required

Plan 2 $4,500 integrated medical/drugs 70% $6,400** $500

Plan 3 $3,500 medical/$0 drugs

60% medical/ 75% drugs with $10/$20/$50 copays for first three tiers and 75% coinsurance for specialty drugs

$6,400 None required

** Note that for 2017, the out-of-pocket maximum limit for HSA-eligible plans is $6,550 for an individual. Deductibles for HSA-eligible plans must be at least $1,300 for individual coverage and $2,600 for family coverage.

Table 15-2 - Internal Revenue Bulletin 2013-23: Minimum Value of an Employer-Sponsored Health Plan (2013)

An employer-sponsored plan provides minimum value if the plan covers at least 60% of the expected total allowed costs for covered services. The taxpayer’s employer will give him or her a document called a Summary of Benefits and Coverage. That document will provide the taxpayer with information about the benefits and coverage under the taxpayer’s employer-sponsored plan, including whether the plan provides minimum value. Also, under the Fair Labor Standards Act, most employers will make available to employees a notice about their options in the Marketplace and their potential eligibility for a premium tax credit. This one-time notice will include information about whether the employer has a plan that provides minimum value. Large Employer Health Coverage Excise Tax Large employers, generally those with 50 or more full-time employees in the prior calendar year, that do not offer coverage for all its full-time employees, offer minimum essential coverage that is unaffordable (employee contribution is more than 9.5% of the employee's household income), or offer minimum essential coverage where the plan's share of the total allowed cost of benefits is less than 60% are required to pay a penalty if any of its full-time employees were certified to the employer as having purchased health insurance through a state exchange and qualified for either tax credits or a cost-sharing subsidy.

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Individual reporting requires health insurers and employers sponsoring self-funded group health plans to annually report to the IRS and responsible individuals (i.e., the enrolled employees and other primary insureds) whether the group health plan coverage constitutes minimum essential coverage under Health Care Reform. This reporting requirement will assist the IRS to enforce the individual mandate penalty. Form 1095-B - Health Coverage is used to complete the individual mandate reporting requirement with respect to responsible individuals and the IRS. Information to be provided includes the responsible individual's name, address and Social Security number. Identifying information concerning the employer-plan sponsor and issuer-coverage provider must be supplied, along with a list of the responsible individual's enrolled family members and the months during the year when they had coverage. When submitting Form 1095-B to the IRS, the reporting entity must also submit IRS Form 1094-B - Transmittal of Health Coverage Information Returns. Form 1094-B is a "transmittal" form that provides information about the reporting entity and the number of Form 1095-B submitted. Applicable Large Employers (ALE) with 50 or more full-time and full-time equivalent employees are required to report to the IRS and full-time employees for two purposes:

1. To assist the IRS to enforce the Employer Shared Responsibility provisions. 2. To assist full-time employees to determine their eligibility for the Premium Tax Credit.

Applicable Large Employers (ALE) should use IRS Form 1095-C - Employer-Provided Health Insurance Offer and Coverage to complete the reporting requirement with respect to full-time employees and the IRS. Similar to the individual mandate reporting requirement, when submitting Form 1095-C to the IRS, large employers must also submit Form 1094-C - Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns. Form 1094-C is also a "transmittal" form that provides the IRS with a summary of the information contained in Form 1095-C. If an employer is part of a "controlled group" of commonly-owned entities, information regarding the other employers must be included. Cadillac Tax Starting in 2020, the Affordable Care Act (ACA) will impose a permanent, annual 40% excise tax on the portion of high-cost employer-sponsored health coverage (excluding dental and vision). For planning purposes, the thresholds for high-cost plans are currently $10,200 for individual coverage, and $27,500 for family coverage. However, these thresholds will be updated before the tax takes effect in 2020 and indexed for inflation in future years. The cost of coverage includes the total contributions paid by both the employer and employees, but not cost-sharing amounts such as deductibles, coinsurance and copays when care is received. The tax has been dubbed a “Cadillac” tax because it hits only high-end “gold”, “platinum”, and high-end health care plans not purchased on the exchange. Also, while the tax was originally not tax deductible, the December 2015 changes made it tax deductible for employers who pay it. Employer Not Offering a Health Care Plan Penalty An applicable large employer would be liable for the penalty (figured monthly) if the employer:

1. Fails to offer to its full-time employees (and their dependents) the opportunity to enroll in “minimum essential coverage” under an “eligible employer-sponsored plan” for that month; and

2. At least one full-time employee has been certified to the employer as having enrolled for that month in a qualified health plan for which a premium tax credit or cost-sharing reduction is allowed or paid with respect to the employee.

The excise tax penalty for any month would be $167 ($2,000/12) times the number of full-time employees in excess of 30. Employees Qualify for Premium Tax Credits or Cost-Sharing Assistance Penalty An applicable large employer would be liable for the penalty (figured monthly) if the employer:

1. Offers to its full-time employees (and their dependents) the opportunity to enroll in “minimum essential coverage” under an “eligible employer-sponsored plan” for that month; and

2. At least one full-time employee has been certified to the employer as having enrolled for that month in a qualified health plan for which a Premium Tax Credit or cost-sharing reduction is allowed or paid with respect to the employee.

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The excise tax penalty for any month would be $250 ($3,000/12) times the number of full-time employees that receive premium tax credit or cost-sharing reductions through an Exchange but not to exceed the penalty imposed had the employer not offered health care insurance. Individual reporting requires health insurers and employers sponsoring self-funded group health plans to annually report to the IRS and responsible individuals (i.e., the enrolled employees and other primary insureds) whether the group health plan coverage constitutes minimum essential coverage under Health Care Reform. This reporting requirement will assist the IRS to enforce the individual mandate penalty. Form 1095-B - Health Coverage is used to complete the individual mandate reporting requirement with respect to responsible individuals and the IRS. Information to be provided includes the responsible individual's name, address and Social Security number. Identifying information concerning the employer-plan sponsor and issuer-coverage provider must be supplied, along with a list of the responsible individual's enrolled family members and the months during the year when they had coverage. When submitting Form 1095-B to the IRS, the reporting entity must also submit IRS Form 1094-B - Transmittal of Health Coverage Information Returns. Form 1094-B is a "transmittal" form that provides information about the reporting entity and the number of Form 1095-B submitted. Applicable Large Employers (ALE) with 50 or more full-time and full-time equivalent employees are required to report to the IRS and full-time employees for two purposes:

1. To assist the IRS enforce the Employer Shared Responsibility provisions. 2. To assist full-time employees determine their eligibility for the Premium Tax Credit.

Applicable Large Employers (ALE) should use IRS Form 1095-C - Employer-Provided Health Insurance Offer and Coverage to complete the reporting requirement with respect to full-time employees and the IRS. Similar to the individual mandate reporting requirement, when submitting Form 1095-C to the IRS, large employers must also submit Form 1094-C - Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns. Form 1094-C is also a "transmittal" form that provides the IRS with a summary of the information contained in Form 1095-C. If an employer is part of a "controlled group" of commonly-owned entities, information regarding the other employers must be included. Tax Benefit to Health Professionals Working in Underserved Areas The Affordable Care Act included a change in the law, effective in 2009, that expands a tax exclusion for amounts received by health professionals under loan repayment and forgiveness programs. Prior to the new law, only amounts received under the National Health Service Corps Loan Repayment Program or certain state loan repayment programs eligible for funding under the Public Health Service Act qualified for a tax exclusion. The Affordable Care Act expands this tax exclusion to include any state loan repayment or loan forgiveness programs intended to increase the availability of health care services in underserved areas or health professional shortage areas and makes this exclusion retroactive to the 2009 tax year. Health care professionals participating in these programs who have reported income from repaid or forgiven loan amounts on their 2009 returns, possibly after receiving a Form W-2 - Wage and Tax Statement, or Form 1099, may be due refunds. Those who believe they qualify for this relief may want to consult their state loan program offices to determine whether the program is covered by the new law. Health care professionals may request an employer or other issuer to provide a Form W-2C - Corrected Wage and Tax Statement, or 1099 and may attach the corrected form to the Form 1040X. However, the Form 1040X may also be filed without attaching a corrected form. Excise Tax on Indoor Tanning Services Beginning July 1, 2010, many businesses providing indoor tanning services are required to collect a 10% excise tax on the indoor tanning services they provide. The provider must pay the excise tax to the government, quarterly, along with IRS Form 720 - Quarterly Federal Excise Tax Return. The tax does not apply to spray-on tanning services, topical creams and lotions or to phototherapy services performed by a licensed medical professional on his or her premises. There is also an exemption for qualified physical fitness facilities that meet specific criteria and provide tanning as an incidental service to members without a separately identifiable fee. (300)

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Health Coverage for Older Children Employees who have children who will not have reached age 27 by the end of the year are eligible for the new tax benefit from March 30, 2010 and on if the children are already covered under the employer’s plan or are added to the employer’s plan at any time. For this purpose, a child includes a son, daughter, stepchild, adopted child or eligible foster child. This new age 27 standard replaces the lower age limits that applied under prior tax law, as well as the requirement that a child generally qualify as a dependent for tax purposes. Employers with cafeteria plans may permit employees to immediately make pre-tax salary reduction contributions to provide coverage for children under age 27, even if the cafeteria plan has not yet been amended to cover these individuals. Plan sponsors then have until the end of 2010 to amend their cafeteria plan language to incorporate this change. In addition to changing these tax rules, the Affordable Care Act also requires plans that provide dependent coverage of children to continue to make the coverage available for an adult child until the child turns age 26. The extended coverage must be provided not later than plan years beginning on or after September 23, 2010.

This also applies to self-employed individuals who qualify for the self-employed health insurance deduction on their Federal income tax return.

Increased Tax on Non-qualifying HSA or Archer MSA Distributions The additional tax for HSA withdrawals for other than qualified medical expenses before age 65 are increased from 10% to 20%, and the additional tax for Archer MSA withdrawals for other than qualified medical expenses is increased from 15% to 20%. Distributions after age 65 are not subject to the penalty. Simple Cafeteria Plans for Small Businesses For years beginning after December 31, 2010, an eligible small employer that employed an average of 100 or fewer employees on business days during either of the two preceding years may provide employees with a simple cafeteria plan. If the employer was not in existence during the prior year, the determination is based on the average number of employees who are reasonably expected to be employed on business days during the current year. A Simple Cafeteria Plan allows employees to use pretax funds to pay their portion of the health, vision, dental, and other employer-sponsored welfare premiums. The employer contribution must equal a uniform percentage (not less than 2%) of the employee’s compensation for the plan year, or equal a 200% match of the employee contributions up to 6% of the employee’s compensation for the plan year. The rate of match for highly compensated employees cannot exceed the rate of match for non-highly compensated employees. Medical Loss Ratio (MLR) As of 2011, insurance companies are required to spend a specified percentage of premium dollars on medical care and quality improvement activities, meeting a medical loss ratio (MLR) standard. Insurance companies that are not meeting the MLR standard will be required to provide rebates to their consumers as of 2012. If a taxpayer purchased and paid premiums for a health insurance policy for him or herself in 2011 and does not deduct the premium payments on his 2011 Form 1040 and does not receive any reimbursement or subsidy for the premiums; the MLR rebate is not subject to Federal income tax. If the taxpayer deducts the premium payments on Schedule A of his or her 2011 Form 1040 the rebate is subject to the Federal income tax. (301) Health Flexible Spending Arrangements Effective January 1, 2011, the cost of an over-the-counter medicine or drug cannot be reimbursed from Flexible Spending Arrangements (FSAs) or health reimbursement arrangements unless a prescription is obtained. The change does not affect insulin, even if purchased without a prescription, or other health care expenses such as medical devices, eye glasses, contact lenses, co-pays and deductibles. This standard applies only to purchases made on or after January 1, 2011. A similar rule went into effect on January 1, 2011, for Health Savings Accounts (HSAs), and Archer Medical Savings Accounts (Archer MSAs). Employers and employees should take these changes into account as they make health benefit decisions. Employer Health Flexible Spending Accounts Contributions Limited For plan years beginning after December 31, 2012, a cafeteria plan may not allow an employee to request salary reduction

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contributions for a health FSA in excess of $2,500. A cafeteria plan providing a health FSA must be amended to specify the $2,500 limit (or any lower limit set by the employer). While cafeteria plans generally must be amended on a prospective basis, an amendment that is adopted on or before December 31, 2014, could be made effective retroactively, provided that in operation the cafeteria plan meets the limit for plan years beginning after December 31, 2012. A cafeteria plan that does not limit health FSA contributions to $2,500 is not a cafeteria plan and all benefits provided under the plan are includible in the employees' gross income. (302) Net Investment Income Tax The Net Investment Income Tax is imposed by section 1411 of the Internal Revenue Code (IRC) and took effect on January 1, 2013. The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts. In general, investment income includes, but is not limited to interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer. (303)

The amount subject to the 3.8% tax is the lesser of the taxpayer’s net investment income or the amount by which modified adjusted gross (MAGI) exceeds the applicable threshold. Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds: (303)

Filing Status Threshold Amount* Married filing jointly $250,000 Married filing separately $125,000 Single $200,000 Head of household (with qualifying person) $200,000 Qualifying widow(er) with dependent child $250,000 *Taxpayers should be aware that these threshold amounts are not indexed for inflation. These amounts will stay the same from year to year, unless Congress specifically changes these amounts through new legislation.

Table 15-3 - IRS.GOV Net Investment Income Tax FAQs (2017)

If an individual is exempt from Medicare taxes, he or she still may be subject to the Net Investment Income Tax if he or she has Net Investment Income and also has modified adjusted gross income over the applicable thresholds.

Nonresident Aliens (NRAs) are not subject to the Net Investment Income Tax. If an NRA is married to a U.S. citizen or resident and has made, or is planning to make, an election under IRC section 6013(g) to be treated as a resident alien for purposes of filing as Married Filing Jointly, the proposed regulations provide these couples special rules and a corresponding IRC section 6013(g) election for the NIIT. Estates and Trusts will be subject to the Net Investment Income Tax if they have undistributed Net Investment Income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year. Generally, the threshold amount for the upcoming year is updated by the IRS each fall in a revenue procedure. For tax year 2017, the highest regular income tax bracket for trusts and estates (39.6%) begins with taxable income in excess of $12,500. The taxpayer should be aware that there are special computational rules for certain unique types of trusts, such as Charitable Remainder Trusts and Electing Small Business Trusts. The following trusts are not subject to the Net Investment Income Tax:

1. Trusts that are exempt from income taxes imposed by Subtitle A of the Internal Revenue Code (e.g., charitable trusts and qualified retirement plan trusts exempt from tax under IRC section 501, and Charitable Remainder Trusts exempt from tax under IRC section 664).

2. A trust in which all of the unexpired interests are devoted to one or more of the purposes described in IRC section 170(c)(2)(B).

3. Trusts that are classified as grantor trusts under IRC sections 671-679. 4. Trusts that are not classified as trusts for Federal income tax purposes (e.g., Real Estate Investment Trusts and

Common Trust Funds).

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In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer (within the meaning of IRC section 469). To the extent that gains are not otherwise offset by capital losses, the following gains are common examples of items taken into account in computing Net Investment Income:

Gains from the sale of stocks, bonds, and mutual funds. Capital gain distributions from mutual funds. Gain from the sale of investment real estate (including gain from the sale of a second home that is not a primary

residence). Gains from the sale of interests in partnerships and S corporations (to the extent the taxpayer was a passive

owner). The Net Investment Income Tax will not be applicable to any amount of gain that is excluded from gross income for regular income tax purposes. The pre-existing statutory exclusion in IRC section 121 exempts the first $250,000 ($500,000 in the case of a married couple) of gain recognized on the sale of a principal residence from gross income for regular income tax purposes and, therefore, from the NIIT. Wages, unemployment compensation; operating income from a non-passive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income, Alaska Permanent Fund Dividends and distributions from certain Qualified Plans are some common types of income that are not investment income. In order to arrive at Net Investment Income, Gross Investment Income is reduced by deductions that are properly allocable to items of Gross Investment Income. Examples of properly allocable deductions include investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in Net Investment Income. Taxpayers will determine any applicable Medicare tax on the new Form 8960 - Net Investment Income Tax - Individuals, Estates and Trusts, when they file their income tax return. Taxpayers whose AGI may exceed the threshold amounts and who have investment income may need to adjust their withholding or make estimated tax payments to ensure the new Medicare tax on investment income does not prompt a balance due when filing taxes next year. Additional Medicare Tax Effective January 2013, Additional Medicare Tax applies to an individual’s Medicare wages that surpass a threshold amount based on the taxpayer’s filing status. All wages that are currently subject to Medicare Tax are subject to Additional Medicare Tax if they are paid in excess of the applicable threshold for an individual’s filing status. Employers are responsible for withholding the 0.9% Additional Medicare Tax on an individual’s wages paid in excess of $200,000 in a calendar year. An employer is obligated to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax. (226) An individual is responsible for Additional Medicare Tax if the individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) surpass the threshold amount for the individual’s filing status. Filing Status Threshold Amount Married filing jointly $250,000 Married filing separately $125,000 Single $200,000 Head of household (with qualifying person) $200,000 Qualifying widow(er) with dependent child $200,000

Table 15-4 - Questions and Answers for the Additional Medicare Tax (2017)

The Additional Medicare Tax statute mandates an employer to withhold Additional Medicare Tax on wages it pays to an employee in excess of $200,000 in a calendar year. An employer has this withholding obligation even though an employee

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may not be liable for Additional Medicare Tax because, for example, the employee’s wages together with that of his or her spouse do not exceed the $250,000 threshold for joint return filers. Any withheld Additional Medicare Tax will be credited against the total tax liability shown on the individual’s income tax return (Form 1040). An employee who foresees liability for Additional Medicare Tax may ask that his or her employer withhold an additional amount of income tax withholding on Form W-4 - Employee's Withholding Allowance Certificate. This additional income tax withholding will be applied against all taxes shown on the individual’s income tax return (Form 1040), including any Additional Medicare Tax liability. Changes to Itemized Deduction for Medical Expenses

Under the Tax Cuts and Jobs Act, the medical expense deduction is retroactively returned to 7.5% for 2017 and will remain in place with a lower floor of 7.5% for 2018.

Medical Device Excise Tax The End the Shutdown Act of 2018, signed into law on January 22, 2018 included a two-year delay on the 2.3% medical device excise tax imposed by Internal Revenue Code section 4191 which was originally included in the Affordable Care Act to help pay for the law’s health insurance subsidies. The first payments would have been due to the Treasury Department by January 29, 2018, but the spending deal language retroactively delayed the tax beginning on December 31, 2017. The tax will now go into effect on January 1, 2020. (304) Generally, under the final regulations, a taxable medical device is a device that is listed as a device with the FDA under section 510(j) of the Federal Food, Drug and Cosmetic Act, and 21 CFR Part 807, pursuant to FDA requirements. If a device is not listed as a device with the FDA but the FDA determines that the device should have been listed as a device, the device will be deemed to be listed as a device with the FDA as of the date the FDA notifies the manufacturer or importer in writing that corrective action with respect to listing is required. (304) The tax does not apply to sales of eyeglasses, contact lenses, and hearing aids. The new tax also does not apply to the sale of any other devices that are of a type generally purchased by the general public at retail for individual use (the retail exemption). (304)

Generally, no action is required by individual consumers. Because the tax is imposed upon the sale of a taxable medical device by the manufacturer or importer, the manufacturer or importer is responsible for reporting and paying the tax. (305)

American Health Benefit Exchanges The Affordable Care Act (ACA) required that health insurance exchanges were established in every state by January 1, 2014. The central purpose of these new Marketplaces is to enable low and moderate income individuals, and small employers to obtain affordable health coverage. Individuals and small business will be able to purchase private health insurance through a variety of insurance Marketplace models throughout the United States. This document reflects information and guidance issued through statute, rule or communications from the Federal government concerning the activities and options as they relate to the development of health insurance marketplaces. Plans provided through an exchange must provide essential health benefits, limit cost sharing and provide specified accrual benefits. Out-of-pocket deductibles are set for Health Savings Account caps and further limited to $2,000 ($4,000 for families) in the small market group. Tax-Exempt 501(c)(29) Qualified Nonprofit Health Insurance Issuers The Affordable Care Act requires the Department of Health and Human Services (HHS) to establish the Consumer Operated and Oriented Plan program (CO-OP program). It also provides for tax exemption for recipients of CO-OP program grants and loans that meet additional requirements under section 501(c)(29). (306) Medicare Part D Coverage Gap “Donut Hole” Rebate The Affordable Care Act provides a one-time $250 rebate in 2010 to assist Medicare Part D recipients who have reached their Medicare drug plan’s coverage gap. This payment is not taxable. This payment is not made by the IRS. (306)

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Limitation on Deduction for Compensation Paid by Certain Health Insurance Providers The Affordable Care Act amended section 162(m) of the Code to limit the compensation deduction available to certain health insurance providers. The amendment goes into effect for taxable years beginning after December 31, 2012, but may affect deferred compensation attributable to services performed in a taxable year beginning after December 31, 2009. Initial guidance on the application of this provision can be found in Notice 2011-2. (306) Retiree Drug Subsidies Under 26 USC section 139A of the Internal Revenue Code, certain special subsidy payments for retiree drug coverage made under the Social Security Act are not included in the gross income of plan sponsors. Plan sponsors receive these retiree drug subsidy payments based on the allowable retiree costs for certain qualified retiree prescription drug plans. For taxable years beginning on or after January 1, 2013, new statutory rules affect the ability of plan sponsors to deduct costs that are reimbursed through these subsidies. (306) Generally, taxpayers may not deduct costs that are reimbursed, for which they have a right of reimbursement, or that relate to income on which the taxpayers were not taxed (excluded income). However, for taxable years beginning on or before December 31, 2012, 26 USC section 139A provides an exception that allows plan sponsors to disregard the excluded income for purposes of determining the deductibility of their costs for the plan year for which they received the subsidy. This exception generally results in a greater deductible amount than if the exception did not apply. (307) For taxable years beginning after December 31, 2012, 26 USC section 139A has been amended to remove the language that allows plan sponsors to disregard the excluded income for purposes of determining whether a deduction is allowable for subsidized costs. Accordingly, plan sponsors may continue to exclude the RDS payments from gross income, but will be subject to the normal rules disallowing a deduction for expenses for which the sponsors are reimbursed, have a right of reimbursement, or relate to excluded income. (307) Online Resources The IRS has launched an Affordable Care Act Tax Provisions website at irs.gov/aca to educate individuals and businesses on how the health care law may affect them. The new home page has three sections, which explain the tax benefits and responsibilities for individuals and families, employers, and other organizations, with links and information for each group. The site provides information about tax provisions that are in effect now and those that went into effect in 2014 and beyond. Topics include premium tax credits for individuals, new benefits and responsibilities for employers, and tax provisions for insurers, tax-exempt organizations and certain other business types. Visitors to the site will find information about the law and its provisions, legal guidance, the latest news, frequently asked questions and links to additional resources. Several other Federal agencies have a role in implementing the health care law, including the Department of Health and Human Services, which has primary responsibility. To help locate additional online resources from the Department of Health and Human Services, the Department of Labor and the Small Business Administration, the IRS has issued a new Web-based flyer - Publication 5093 - Healthcare Law Online Resources. Effect on Taxpayer’s Return The Affordable Care Act contains tax provisions that affect the 2017 income tax return the taxpayer files in 2018. Almost everyone is affected by the individual shared responsibility provision while only people who purchased coverage through the Marketplace are affected by the Premium Tax Credit. The following chart will help the taxpayer better understand what he or she needs to do on his or her tax return.

Health Care Law's Effect on the Taxpayer’s Tax Return If the taxpayer… Then the taxpayer…

And everyone in his or her tax household had health coverage for the entire year

Will simply check the box on line 61 of Form 1040, line 38 of Form 1040-A, or line 11 of Form 1040-EZ.

Enrolled in health insurance through the Marketplace Should receive a Form 1095-A - Health Insurance Marketplace Statement from the Marketplace.

Received a Form 1095-A - Health Insurance Marketplace Statement, showing he or she received the benefit of advance payments of the Premium Tax Credit in 2017

Must file a tax return in 2018 and reconcile the advance payments with the amount of the Premium Tax Credit allowed on his or her return.

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Needs to reconcile the advance payments of the credit with the credit allowed

Makes the calculations using IRS Form 8962 - Premium Tax Credit (PTC).

Must repay any excess advance payments of the Premium Tax Credit

Must report the information on line 46 Form 1040 or line 29 of Form1040-A, and cannot file Form 1040-EZ.

Is claiming the premium tax credit and did not benefit from advance payments of the Premium Tax Credit

Must file a tax return and IRS Form 8962 - Premium Tax Credit (PTC).

Did not receive a Form 1095-A - Health Insurance Marketplace Statement from the Marketplace

Should contact the state or Federal Marketplace through which he or she enrolled.

Is claiming an exemption from the requirement to have health coverage for anyone on his or her tax return

Will complete Form 8965 - Health Coverage Exemptions, and submit it with his or her tax return.

Still needs to obtain a religious conscience exemption or a hardship exemption that can only be granted by the Marketplace

Should file an application with the Marketplace and follow the instructions below about how to report exemptions from the Marketplace on his or her return.

Obtained an exemption from the Marketplace, and received his or her unique Exemption Certificate Number

Will enter the Exemption Certificate Number in Part I of Form 8965 and submit the form with his or her return.

Applied for an exemption from the Marketplace, but do not currently have an Exemption Certificate Number

Will enter ‘PENDING’ in Part I of Form 8965 and submit the form with his or her return.

Is claiming an exemption that can be granted only from the IRS

Will not need an Exemption Certificate Number, but will complete Parts II and III of Form 8965 and submit the form with his or her return.

Is able to obtain the exemption from either the IRS or the Marketplace

Should obtain the exemption from the IRS by completing Part II and III of Form 8965 and attach this form to his or her Federal tax return when he or she files.

Is making a shared responsibility payment because he or she did not have health coverage or qualify for an exemption for any month in 2017

Will enter the payment amount on line 61 of Form 1040, line 38 of Form 1040-A, or line 11 of Form 1040-EZ.

Table 15-5 - HCTT-2015-05 - The Health Care Law's Effect on Your Tax Return (2017)

Other Taxes Estate Tax If the taxpayer inherited property from a decedent, except those who died in 2010, the basis in property he or she inherits from a decedent is generally one of the following: (244)

The Fair Market Value (FMV) of the property at the date of the decedent's death. The FMV on the alternate valuation date if the personal representative for the estate elects to use alternate

valuation. The value under the special-use valuation method for real property used in farming or a closely held business if

elected for estate tax purposes. The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a

qualified conservation easement. If a Federal estate tax return does not have to be filed, the basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes. The Estate Tax is a tax on the right to transfer property at the time of a person’s death. It consists of an accounting of everything he or she owns or has certain interests in on the date of death. The fair market value of these items is used, not necessarily what the taxpayer paid for them or what their values were when acquired. The total of all of these items is the gross estate. The gross estate includes the value of all property to the extent of the decedent’s interest in the property at the time of death. Unpaid interest that has accrued on savings from the date of the last interest payment to the date of death is included in the gross estate. Outstanding dividends declared to shareholders of record on or before the date of death are included in the gross estate. The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets. (245)

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A taxpayer’s gross estate also includes the following: (213)

Life insurance proceeds payable to the estate or, if the taxpayer owned the policy, to his or her heirs. The value of certain annuities payable to the estate or the heirs. The value of certain property transferred within 3 years before the decedent’s death.

Once the taxpayer has accounted for the Gross Estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at the taxable estate. These deductions may include mortgages and other debts, estate administration expenses, property that passes to surviving spouses and qualified charities. The value of some operating business interests or farms may be reduced for estates that qualify. (245) The allowable deductions used in determining the taxable estate include: (213)

Funeral expenses paid out of the estate. Debts owed at the time of death. The marital deduction (generally, the value of the property that passes from the estate to the surviving spouse). The charitable deduction (generally, the value of the property that passes from the estate to the United States,

any state, a political subdivision of a state, the District of Columbia, or to a qualifying charity for exclusively charitable purposes).

The state death tax deduction (generally any estate, inheritance, legacy, or succession taxes paid as the result of the decedent's death to any state or the District of Columbia).

The generation-skipping transfer tax is imposed as a separate tax, in addition to the gift and estate taxes, on generation-skipping transfers that are taxable distributions or terminations with respect to a generation skipping trust or direct skips. See Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return.

After the net amount is computed, the value of lifetime taxable gifts (beginning with gifts made in 1977) is added to this number and the tax is computed. The tax is then reduced by the available unified credit. The unified credit applies to both the gift tax and the estate tax and it equals the tax on the applicable exclusion amount. A taxpayer must subtract the unified credit from any gift or estate tax that he or she owes. Any unified credit the taxpayer uses against gift tax in one year reduces the amount of credit that he or she can use against gift or estate taxes in a later year. (213) As of 2011, the amount of unified credit available to a person will equal the tax on the basic exclusion amount plus the tax on any deceased spousal unused exclusion (DSUE) amount. The DSUE is only available if an election was made on the deceased spouse's Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return. The applicable exclusion amount consists of the basic exclusion amount ($5,490,000 in 2017) and, in the case of a surviving spouse, any unused exclusion amount of the last deceased spouse (who died after December 31, 2010). The executor of the predeceased spouse's estate must have elected on a timely and complete Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return to allow the donor to use the predeceased spouse's unused exclusion amount.

Estates of decedents who die during 2017 have a basic exclusion amount of $5,490,000, up from a total of $5,450,000 for estates of decedents who died in 2016.

Most relatively simple estates (cash, publicly traded securities, small amounts of other easily valued assets, and no special deductions or elections, or jointly held property) do not require the filing of an estate tax return. A filing is required for estates with combined gross assets and prior taxable gifts exceeding the following amounts:

Decedents dying in: Estate Tax Exemption Amount Tax Rate 2012 $5,120,000 35% 2013 $5,250,000 40% 2014 $5,340,000 40% 2015 $5,430,000 40% 2016 $5,450,000 40%

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2017 $5,490,000 40%

* An executor of the estate of a decedent dying in 2010 could opt out of the estate tax in exchange for Modified Carryover Basis.

Table 15-6 - IRS Estate and Gift Tax (2017)

Gift Tax The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not. The gift tax applies to the transfer by gift of any property. The taxpayer makes a gift if he or she gives property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. The basis of property received as a gift is the donor's carry-over basis (adjusted basis). If a taxpayer sells something at less than its full value or if he or she makes an interest-free or reduced-interest loan, it may be a gift. (308) The annual gift exclusion for 2017 remains at $14,000. For gifts made to spouses who are not U.S. citizens, the annual exclusion has increased to $149,000 for 2017. The top rate for gifts and generation-skipping transfers has increased to 40%. The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. Generally, the following gifts are not taxable gifts:

Gifts, excluding gifts of future interest, that are not more than the annual exclusion for the calendar year. For 2017, a taxpayer generally can give gifts valued up to $14,000 per person, to any number of people, and none of the gifts will be taxable.

Tuition or medical expenses paid directly to an educational or medical institution for someone else. Gifts to the taxpayer’s spouse. Gifts to a political organization for its use. Gifts to charities.

If the taxpayer or his or her spouse makes a gift to a third party, the gift can be considered as made one-half by the taxpayer and one-half by the spouse. This is known as gift splitting. Both the taxpayer and the spouse must agree to split the gift. For 2017, gift splitting allows married couples to give up to $28,000 to a person without making a taxable gift. (213) Use Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return to report the following: (247)

Transfers subject to the Federal gift and certain generation-skipping transfer (GST) taxes and to figure the tax due, if any, on those transfers, and

Allocation of the lifetime GST exemption to property transferred during the transferor's lifetime. (For more details, Regulations Section 26.2632-1).

In general, if the taxpayer is a citizen or resident of the United States, he or she must file a gift tax return (whether or not any tax is ultimately due) in the following situations: (247)

If he or she gave gifts to someone in 2017 totaling more than $14,000 (other than to his or he spouse), he or she probably must file Form 709.

Certain gifts, called future interests, are not subject to the $14,000 annual exclusion and the taxpayer must file Form 709 even if the gift was under $14,000.

A husband and wife may not file a joint gift tax return. Each individual is responsible for his or her own Form 709. The taxpayer must file a gift tax return to split gifts with his or her spouse (regardless of their amount). If a gift is of community property, it is considered made one-half by each spouse. For example, a gift of $100,000

of community property is considered a gift of $50,000 made by each spouse, and each spouse must file a gift tax return.

Likewise, each spouse must file a gift tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety.

Only individuals are required to file gift tax returns. If a trust, estate, partnership, or corporation makes a gift, the individual beneficiaries, partners, or stockholders are considered donors and may be liable for the gift and GST taxes.

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The donor is responsible for paying the gift tax. However, if the donor does not pay the tax, the person receiving the gift may have to pay the tax.

If a donor dies before filing a return, the donor's executor must file the return. If the taxpayer meets all of the following requirements, he or she is not required to file Form 709: (247)

1. He or she made no gifts during the year to his or her spouse. 2. He or she did not give more than $14,000 to any one person. 3. All the gifts he or she made were of present interests.

If the only gifts a taxpayer made during the year are deductible as gifts to charities, he or she does not need to file a return as long as he or she transferred the entire interest in the property to qualifying charities. If the taxpayer transferred only a partial interest, or transferred part of the interest to someone other than a charity, he or she must still file a return and report all of his or her gifts to charities. Unreported Social Security and Medicare Tax Use Form 4137 - Social Security and Medicare Tax on Unreported Tip Income only to figure the Social Security and Medicare tax owed on tips the taxpayer did not report to an employer, including any allocated tips shown on the Form(s) W-2 that he or she must report as income. (248) Use Form 8919 - Uncollected Social Security and Medicare Tax on Wages to figure and report the taxpayer’s share of the uncollected Social Security and Medicare taxes due on his or her compensation if the taxpayer was an employee but was treated as an independent contractor by his or her employer. An Individual can file Form SS-8 - Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding if he or she wants the IRS to determine whether the taxpayer is an independent contractor or an employee. Complete a separate line for each firm. If the taxpayer worked as an employee for more than five firms in 2017, attach additional Form(s) 8919 with lines 1 through 5 completed. Complete lines 6 through 13 on only one Form 8919. The line 6 amount on that Form 8919 should be the combined totals of all lines 1 through 5 of all the Forms 8919. Unearned Income of a Minor Child (Kiddie Tax) The transfer or shifting of income from a parent’s higher tax bracket over to the parent’s child who has a lower tax bracket in order for the parents to save money on their income tax is greatly limited before the child reaches age 14 (prior to 2006 year). The limit was increased to age 18 for the 2006 and subsequent tax years as amended by the Tax Increase Prevention and Reconciliation Act of 2005. Since the Dependent Standard Deduction is $1,050 for tax year 2017, the child’s unearned income between $1,050 and $2,100 is taxed at the child’s rate; and, the remaining unearned income of the child over $2,100 for tax year 2017 is taxed at the parents’ highest tax rate.

Kiddie Tax Tax Bracket Tax $0 to $1,050 0% Earned income > $1,050 Child’s tax rate Unearned income > $1,050 ≤ $2,100 Child’s tax rate Unearned income > $2,100 Generally, the parent’s highest marginal tax rate

Table 15-7 - Various Tax Benefits Increase Due to Inflation Adjustments (2017)

The tax is computed on Form 8615 - Tax for Certain Children Who Have Unearned Income. If the child’s parents file their returns as married filing separately the parent with the highest marginal tax rate is the rate to be used. However, for tax year 2017, the parent of a child under age 19 may elect to include the gross income of the child in excess of $2,100 into the parents’ income which can be accommodated by filing Form 8814 - Parents' Election To Report Child's Interest and Dividends. A parent can make this election if his or her child meets all of the following conditions: (249)

The child was under age 19 (or under age 24 if a full-time student) at the end of 2017. The child’s only income was from interest and dividends, including capital gain distributions and Alaska Permanent

Fund dividends.

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The child’s gross income for 2017 was less than $10,500. The child is required to file a 2017 return. The child does not file a joint return for 2017. There were no estimated tax payments for the child for 2017 (including any overpayment of tax from his or her

2016 return applied to 2017 estimated tax). There was no Federal income tax withheld from the child’s income.

Examples of unearned income that may be subject to income tax include Social Security benefits, dividends from stocks given as a gift, payments from trusts or annuities and taxable interest. Example Sara is 18 and single. Her parents can claim an exemption for her on their income tax return. She received $1,700 of taxable interest and dividend income. She did not work during the year. She must file a tax return because she has unearned income only and her total income is more than $1,050. The same $1,050 amount is used to determine whether a parent may elect to include a child's gross income in the parent's gross income and to calculate the "kiddie tax". For example, in 2017 one of the requirements for the parental election is that a child's gross income must be more than $1,050 but less than 10 times that amount which is $10,500.

If a child’s earned income represents not more than one half of support needs, the kiddie tax generally also applies to unearned income of children who have not attained age 19 by the close of the year, and children who are full-time students and have not attained age 24 as of the close of the year.

Household Employment Taxes A taxpayer has a household employee if he or she hired someone to do household work and that worker is the taxpayer’s employee. The worker is the taxpayer’s employee if he or she can control not only what work is done, but how it is done. If the worker is the taxpayer’s employee, it does not matter whether the work is full-time or part-time or that he or she hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether the taxpayer pays the worker on an hourly, daily, or weekly basis, or by the job. Some examples of workers who do household work are: (163)

Babysitters Caretakers House cleaning workers Domestic workers Drivers Health aides Housekeepers Maids Nannies Private nurses Yard workers

The household employment taxes that the taxpayer may have to account for on Schedule H cover the same three taxes that are withheld from all employment wages: the 12.4% Social Security tax, a 2.9% Medicare tax and the 6% Federal unemployment tax, or FUTA. If the taxpayer also pays state unemployment insurance taxes, Schedule H gives him or her credit for the taxes by reducing the FUTA rate. The taxpayer is responsible for paying all of FUTA – employees do not make contributions through withholding. The taxpayer also must pay half of each household employee's Social Security and Medicare tax liability; the employee pays the other half through amounts he or she withholds from her wages. If the taxpayer has to pay these taxes to the Internal Revenue Service, Schedule H calculates the precise amount that he or she should have withheld, as well as the portion he or she owes. (164)

Lesson 15 - Additional Taxes

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Employment Tax Requirements

If the taxpayer: Then he or she needs to: Pays cash wages of $2,000 or more in 2017 to any one household employee.

Withhold and pay Social Security and Medicare taxes.

• The taxes are 15.3%1 of cash wages. • The employee's share is 7.65%1. • The taxpayer’s share is 7.65%

Pays total cash wages of $1,000 or more in any calendar quarter of 2017 or 2017 to household employees.

Pay Federal unemployment tax.

• The tax is 6% of cash wages. • Wages over $7,000 a year per employee are not

taxed. • The taxpayer may also owe state unemployment tax.

1In addition to withholding Medicare tax at 1.45%, an employer must withhold a 0.9% Additional Medicare Tax from wages he or she pays to an employee in excess of $200,000 in a calendar year. The employer is required to begin withholding Additional Medicare Tax in the pay period in which he or she pays wages in excess of $200,000 to an employee and continue to withhold it each pay period until the end of the calendar year. Additional Medicare Tax is only imposed on the employee. There is no employer share of Additional Medicare Tax. All wages that are subject to Medicare tax are subject to Additional Medicare Tax withholding if paid in excess of the $200,000 withholding threshold.

Table 15-8 - Publication 926 - Table 1-Do You Need To Pay Employment Taxes? (2017)

Social Security and Medicare Taxes (Federal Insurance Contributions Act – FICA) If your client pays a household employee cash wages of more than the amount specified by law in a tax year ($2,000 for 2017), he or she generally must withhold Social Security and Medicare taxes from all cash wages paid to that employee. (Cash wages include wages paid by check, money order, etc.) Unless the taxpayer prefers to pay the employee's share of Social Security and Medicare taxes from his or her own funds, the taxpayer should withhold 7.65% from each payment of cash wages made. In addition, Additional Medicare Tax applies to an individual’s Medicare wages that exceed a threshold amount based on the taxpayer’s filing status. Employers are responsible for withholding the 0.9% Additional Medicare Tax on an individual’s wages paid in excess of $200,000 in a calendar year. An employer is required to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax. (309) The specified dollar amounts and percentages can be found Publication 926 - Household Employer's Tax Guide. The taxpayer should pay the amount he or she withholds to the IRS with an additional 7.65% for his or her share of the taxes. If the taxpayer pays the employee's share of Social Security and Medicare taxes from his or her own funds, the amounts the taxpayer pays for the employee counts as wages for purposes of the employees' income tax. However, they are not counted as Social Security and Medicare wages or as wages for Federal unemployment tax. (309) Do not withhold or pay Social Security and Medicare taxes from wages the taxpayer pays to: (309)

His or her spouse. His or her child who is under age 21. His or her parent, unless an exception is met. An employee who is under age 18 at any time during the year, unless performing household work is the employee's

principal occupation. If the employee is a student, providing household work is not considered to be his or her principal occupation.

Federal Income Tax Withholding The taxpayer is not required to withhold Federal income tax from wages he or she pays to a household employee. However, if the employee asks the taxpayer to withhold Federal income tax and he or she agrees, the taxpayer will need a completed Form W-4 - Employee's Withholding Allowance Certificate from the employee. See Publication 15 - (Circular E) - Employer's Tax Guide, which has tax withholding tables that are updated each year. (309)

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Form W-2 - Wage and Tax Statement If the taxpayer must withhold and pay Social Security and Medicare taxes, or if the taxpayer withholds Federal income tax, he or she will need to complete Form W-2 - Wage and Tax Statement, for each employee. The taxpayer will also need a Form W-3 - Transmittal of Wage and Tax Statement. To complete Form W-2 the taxpayer will need an employer identification number (EIN) and the employees' Social Security numbers. If the taxpayer does not already have an (EIN), he or she can apply for one using the online EIN application on the IRS website. (309) Federal Unemployment Tax Act (FUTA) If the taxpayer paid cash wages to household employees totaling more than $1,000 in any calendar quarter during the calendar year or the prior year, he or she generally must pay Federal unemployment tax (FUTA) tax on the first $7,000 of cash wages paid to each household employee. However, do not count wages paid to his or her spouse, his or her child who is under the age of 21, or his or her parent. The amounts the taxpayer pays to these individuals are also not considered wages subject to FUTA tax. Generally, the taxpayer can take a credit against the FUTA tax liability for amounts paid into state unemployment funds. A state that has not repaid money it borrowed from the Federal government to pay unemployment benefits is a "credit reduction state." If the taxpayer paid wages that are subject to the unemployment compensation laws of a credit reduction state, the FUTA tax credit may be reduced. See the instructions for Form 1040, Schedule H - Household Employment Taxes, or the IRS.gov website for more information. (309)

The FUTA tax is 6.0% of an employee's FUTA wages. However, the taxpayer may be able to take a credit of up to 5.4% against the FUTA tax, resulting in a net tax rate of 0.6%. The taxpayer’s credit for 2017 is limited unless he or she pays all the required contributions for 2017 to his or her state unemployment fund by April 17, 2018. The credit

the taxpayer can take for any contributions for 2017 that he or she pays after April 17, 2018, is limited to 90% of the credit that would have been allowable if the contributions were paid by April 17, 2018. Schedule H - Household Employment Taxes If the taxpayer pays wages subject to FICA tax, FUTA tax, or if he or she withholds Federal income tax from and employee's wages, he or she will need to file a Form 1040, Schedule H - Household Employment Taxes. Attach Schedule H to the individual income tax return. If the taxpayer is not required to file a return, he or she must still file Schedule H to report household employment taxes. However, a sole proprietor who must file Form 940 - Employer's Annual Federal Unemployment (FUTA) Tax Return, and Form 941 - Employer's QUARTERLY Federal Tax Return, or Form 944 - Employer's ANNUAL Federal Tax Return, for business employees, or Form 943 - Employer's Annual Federal Tax Return for Agricultural Employees, for farm employees, may report household employee tax information on these forms instead of on Schedule H. If the taxpayer chooses to report the wages for a household employee on the forms shown above, be sure to pay any taxes due by the date required based on the form, making Federal tax deposits if required. Additional information is available in the instructions for the form. Estimated Tax Payments If your client files Form 1040, Schedule H, he or she can avoid owing taxes with the return if he or she pays enough tax before filing the return to cover both the employment taxes for the household employee and the income tax. If the taxpayer is employed, he or she can ask the employer to withhold more Federal income tax from wages during the year. The taxpayer can also make estimated tax payments to the IRS during the year using Form 1040-ES - Estimated Tax for Individuals.

Voluntary Classification Settlement Program (VCSP) The Voluntary Classification Settlement Program (VCSP) is a voluntary program that provides an opportunity for taxpayers to reclassify their workers as employees for employment tax purposes for future tax periods with partial relief from Federal employment taxes. To participate in this voluntary program, the taxpayer must meet certain eligibility requirements and apply to participate in the VCSP by filing Form 8952 - Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS. The VCSP allows eligible taxpayers to obtain relief similar to that currently available through the Classification Settlement Program for taxpayers under examination. (310) The VCSP, originally released in Announcement 2011-64, has been modified in Announcement 2012-45 to: (310)

Permit a taxpayer under IRS audit, other than an employment tax audit, to be eligible to participate in the VCSP.

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Clarify the current eligibility requirement that a taxpayer who is a member of an affiliated group within the meaning of section 1504(a) is not eligible to participate in the VCSP if any member of the affiliated group is under employment tax audit.

Clarify that a taxpayer is not eligible to participate if the taxpayer is contesting in court the classification of the class or classes of workers from a previous audit by the IRS or Department of Labor.

Eliminate the requirement that a taxpayer agree to extend the period of limitations on assessment of employment taxes as part of the VCSP closing agreement with the IRS.

VCSP Agreements A taxpayer participating in the VCSP will agree to prospectively treat the class or classes of workers as employees for future tax periods. In exchange, the taxpayer will: (310)

Pay 10% of the employment tax liability that would have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of section 3509(a) of the Internal Revenue Code. See Instructions to Form 8952 for more information.

Not be liable for any interest and penalties on the amount. Not be subject to an employment tax audit with respect to the worker classification of the workers being reclassified

under the VCSP for prior years. Applying for VCSP To participate in the VCSP, a taxpayer must apply using Form 8952 - Application for Voluntary Classification Settlement Program. The application should be filed at least 60 days prior to the date the taxpayer wants to begin treating its workers as employees. The IRS will make every effort to process Form 8952 with sufficient time to allow for the voluntary reclassification on the requested date. Along with the application, the taxpayer may provide the name of a contact or an authorized representative with a valid Power of Attorney (Form 2848). However, the taxpayer, and not the taxpayer's representative, is required to sign Form 8952. The IRS will contact the taxpayer or authorized representative to complete the process after reviewing the application and verifying the taxpayer’s eligibility. Eligible taxpayers accepted into the VCSP will enter into a closing agreement with the IRS to finalize the terms of the VCSP, and will simultaneously make full and complete payment of any amount due under the closing agreement.

Lesson 15 - Additional Taxes

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

Review Questions Answers appear in Review Feedback 1. Steve’s regular income tax is $40,000. When he calculates his tax using the alternative minimum tax (AMT) rules, he

comes up with $53,000. Therefore, Steve must pay what amount of AMT in addition to the $40,000 of regular income tax?

A. $0 B. $6,500 C. $10,000 D. $13,000

2. When all conditions are met for certain children under age 24, the AMT exemption amount is limited to the amount of

earned income plus what amount in 2017? A. $5,950 B. $6,350 C. $7,000 D. $7,500

3. What is the maximum amount of AMT income that married individuals filing a joint return can earn before their AMT

exemption begins to phase out by 25 cents for each $1 above the threshold amount in 2017? A. $119,200 B. $125,000 C. $153,900 D. $160,900

4. The 2.3% medical device excise tax will apply to the sales of which, if any, of the following?

A. Eyeglasses B. Contact lenses C. Hearing aids D. None of above

5. Estates of decedents who die during 2017 have a basic exclusion amount of what amount?

A. $5,000,000 B. $5,490,000 C. $5,500,000 D. $5,580,000

6. If a taxpayer paid cash wages to household employees totaling more than $1,000 in any calendar quarter during the

calendar year or the prior year, he or she generally must pay Federal unemployment tax (FUTA) tax on cash wages of up to what amount paid to each household employee?

A. $7,000 B. $8,000 C. $9,000 D. $9,500

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Review Feedback Return to Review Questions Question 1 - D. $13,000 After subtracting the exemption amount from the taxpayer’s AMTI, multiply the remainder by the applicable AMT rate of 26% or 28%. Generally, the resulting figure is his or her tentative minimum tax (TMT). Compare the taxpayer’s TMT with his or her regular income tax. If the regular tax is higher, the taxpayer does not owe any AMT. But if the regular tax is lower, the difference between the two taxes is the amount of AMT he or she must pay in addition to his or her regular tax (if any). Question 2 - D. $7,500 Ordinarily, single individuals can subtract a $54,300 exemption amount from their AMT taxable income. However, a child who files Form 8615 has a limited exemption amount. The child's exemption amount for 2017 is limited to the child's earned income plus $7,500. Question 3 - D. $160,900 The 2012 Tax Relief Act not only permanently increased the AMT exemption, but it also indexed the exemption for inflation for the first time. For 2017, the AMT exemption increases from $83,800 to $84,500 for married couples filing jointly and from $53,900 to $54,300 for single filers. The AMT exemption is reduced by 25% of the amount by which alternative minimum taxable income exceeds $160,900 for married couples filing jointly ($120,700 for single taxpayers). Question 4 - D. None of above The new tax does not apply to sales of eyeglasses, contact lenses, and hearing aids. The new tax also does not apply to the sale of any other devices that are of a type generally purchased by the general public at retail for individual use (the retail exemption). Question 5 - B. $5,490,000 Estates of decedents who die during 2017 have a basic exclusion amount of $5,490,000, up from a total of $5,450,000 for estates of decedents who died in 2016. Question 6 - A. $7,000 If a taxpayer paid cash wages to household employees totaling more than $1,000 in any calendar quarter during the calendar year or the prior year, he or she generally must pay Federal unemployment tax (FUTA) tax on the first $7,000 of cash wages paid to each household employee. However, do not count wages paid to his or her spouse, his or her child who is under the age of 21, or his or her parent. The amounts the taxpayer pays to these individuals are also not considered wages subject to FUTA tax. Generally, the taxpayer can take a credit against the FUTA tax liability for amounts paid into state unemployment funds.

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

Taxpayer Civil Penalties Taxpayer Criminal Penalties

Civil Penalties Federal law provides Civil Penalties for failure to file income tax returns or pay income taxes as required. The failure-to-file penalty is generally more than the failure-to-pay penalty. So, the taxpayer should still file the tax return on time and pay as much as he or she can then explore other payment options. The IRS will work with the taxpayer. The following are examples of penalties a taxpayer may face for failing to file or filing late. (311)

Failure to File Generally, April 15 is the deadline for most people to file their individual income tax returns and pay any tax owed. During its processing, the IRS checks for mathematical accuracy on the taxpayer’s return. When processing is complete, if the taxpayer owes any tax, penalty, or interest, he or she will receive a bill. Generally, interest accrues on any unpaid tax from the due date of the return until the date of payment in full. The interest rate is determined quarterly and is the Federal short-term rate plus 3%. Interest compounds daily. Filing Late

If a taxpayer does not file his or her return by the due date (including extensions) he or she may have to pay a failure-to-file penalty. The failure to file penalty is usually 5% of the tax owed for each month, or part of a month that the taxpayer’s return is late, up to a maximum of 25%. For the 2017 tax year, the amount of the additional tax payable for failure to file a tax return within 60 days of the due date shall not be less than the lesser of $210 or 100% of the amount required to be shown as tax on the return. (up from $205 for 2016). (312)

Paying Late If the taxpayer files a return but does not t pay all tax owed on time, he or she will generally have to pay a late payment penalty. The failure to pay penalty is usually ½ of 1% of any tax, or part of a month, up to a maximum of 25% of the amount of tax that remains unpaid from the due date of the return until the tax is paid in full. The ½ of 1% rate increases to 1% if the tax remains unpaid 10 days after the IRS issues a notice of intent to levy property. This penalty does not apply during the automatic 6-month extension of time to file period if he or she paid at least 90% of his or her actual tax liability on or before the due date of his or her return and pay the balance when he or she files the return If the taxpayer files his or her return by its due date and requests an installment agreement, the ½ of 1% rate decreases to ¼ of 1% for any month in which an installment agreement is in effect. Be aware that the IRS applies payments to the tax first, then any penalty, then to interest. Any penalty amount that appears on the taxpayer’s bill is generally the total amount of the penalty up to the date of the notice, not the penalty amount charged each month. If a notice of intent to levy is issued, the rate will increase to 1% at the start of the first month beginning at least 10 days after the day that the notice is issued. If a notice and demand for immediate payment is issued, the rate will increase to 1% at the start of the first month beginning after the day that the notice and demand is issued. The late payment penalty is usually ½ of 1% of any tax (other than estimated tax) not paid by the filing due date. It is charged for each month or part of a month the tax is unpaid. The maximum penalty is 25%. (313)

Lesson 16 - Penalties

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Failure to File and Failure to Pay If a combination of the failure-to-file penalty and the failure-to-pay penalty apply in any month, the 5% failure-to-file penalty is reduced by the failure-to-pay penalty. However, if the return is filed more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $210 or 100% of the unpaid tax. (314)

A taxpayer will not have to pay a penalty if the taxpayer shows he or she failed to file or pay on time because of reasonable cause and not because of willful neglect. The taxpayer must also show that he or she acted in good faith. (314)

Estimated Tax-Related Penalties Employees have taxes withheld from their paychecks by their employer. When a taxpayer has income that is not subject to withholding he or she may have to make estimated tax payments during the year. This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes, and awards. The taxpayer may also have to pay estimated tax if the amount being withheld from his or her salary, pension, or other income is not enough to pay the tax liability. (315) Estimated tax payments are used to pay income tax and self-employment tax, as well as other taxes and amounts reported on the tax return. If the taxpayer does not pay enough through withholding or estimated tax payments, he or she may have to pay a penalty. If the taxpayer does not pay enough by the due date of each payment period, he or she may be charged a penalty even if the taxpayer is due a refund when he or she files the tax return. (316)

Accuracy The two most common accuracy related penalties are the substantial understatement penalty and the negligence or disregard of the rules or regulations penalty. However, the taxpayer may have to pay an accuracy-related penalty if he or she underpays his or her tax because:

He or she shows negligence or disregard of the rules or regulations. He or she substantially understates his or her income tax. He or she claims tax benefits for a transaction that lacks economic substance. He or she fails to disclose a foreign financial asset.

The penalty is equal to 20% of the underpayment. The penalty is 40% of any portion of the underpayment that is attributable to an undisclosed noneconomic substance transaction or an undisclosed foreign financial asset transaction. The penalty will not be figured on any part of an underpayment on which the fraud penalty is charged. The term “negligence” includes a failure to make a reasonable attempt to comply with the tax law or to exercise ordinary and reasonable care in preparing a return. Negligence also includes failure to keep adequate books and records. The taxpayer will not have to pay a negligence penalty if he or she has a reasonable basis for a position he or she took. The term “disregard” includes any careless, reckless, or intentional disregard. (315) Substantial Understatement The understatement is substantial if it is more than 10% of the correct tax or $5,000. To properly disclose the position, complete and attach IRS Form 8275 - Disclosure Statement to the tax return and disclose all relevant facts. As of December 31, 2015, if the taxpayer fails to report a substantial amount of income, then the IRS has 6 years (instead of 3 years) to create an audit assessment. In this case, the taxpayer must have failed to report 25% or more of his or her total income. (315) The taxpayer may avoid the substantial understatement penalty if he or she has substantial authority for his or her tax treatment of the item or through adequate disclosure. To avoid the substantial understatement penalty by adequate disclosure, the taxpayer must properly disclose the position on the tax return and there must at least be a reasonable basis for the position. To properly disclose the position, the taxpayer completes and attaches IRS Form 8275 - Disclosure Statement to his or her tax return and discloses all relevant facts. A reasonable basis is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper. The position must be more than just merely arguable or merely a colorable claim. The position must be reasonably based on authority supporting the position.

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Negligence or Disregard of the Rules Negligence includes (but is not limited to) any failure to: (315)

Make a reasonable attempt to comply with the internal revenue laws. Exercise ordinary and reasonable care in preparation of a tax return. Keep adequate books and records or to substantiate items properly.

This penalty may be asserted if the taxpayer carelessly, recklessly or intentionally disregards IRS rules and regulations - by taking a position on his or her return with little or no effort to determine whether the position is correct or knowingly taking a position that is incorrect. The taxpayer will not have to pay a negligence penalty if there was a reasonable cause for a position he or she took and he or she acted in good faith. Negligence includes any failure to make reasonable attempts to comply with the tax code. The understatement of tax is considered substantial if the taxpayer understates his or her income by more than 10% or $5,000.00.

Fraud If a taxpayer’s failure to file is due to fraud, the penalty is imposed at the rate of 15% for each month, up to 75% of the portion of any underpayment that is attributable to fraud. If a taxpayer’s underpayment is due to fraud, a penalty of 75% of the underpayment due to fraud will be added to the tax. (315) Joint Return

The fraud penalty on a joint return does not apply to a spouse unless some part of the underpayment is due to the fraud of that spouse. Negligence or ignorance of the law does not constitute fraud.

Failure to Supply Social Security Number (SSN) If the taxpayer does not include his or her SSN or the SSN of another person where required on a return, statement, or other document, he or she will be subject to a penalty of $50 for each failure. The taxpayer will also be subject to a penalty of $50 if he or she does not give his or her SSN to another person when it is required on a return, statement, or other document. Frivolous Tax Return A taxpayer may have to pay a penalty of $5,000 if he or she files a frivolous return. A frivolous return is one that does not include enough information to figure the correct tax or that contains information clearly showing that the tax reported is substantially incorrect. A taxpayer will have to pay the penalty if he or she filed this kind of return because of a frivolous position on the taxpayer’s part or a desire to delay or interfere with the administration of Federal income tax laws. This includes altering or striking out the preprinted language above the space provided for the taxpayer’s signature. (315) Bounced Checks If a taxpayer’s check used to pay taxes is returned for insufficient funds (bounces), the IRS may impose a penalty. The penalty is either 2% of the amount of the check - unless the check is under $1,250, in which case the penalty is the amount of the check or $25, whichever is less. (315)

Criminal Prosecution A taxpayer may be subject to Criminal Prosecution (brought to trial) for actions such as:

Tax evasion. Willful failure to file a return, supply information, or pay any tax due. Fraud and false statements. Preparing and filing a fraudulent return.

Lesson 16 - Penalties

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Identity Theft Identity theft occurs when someone uses a taxpayer’s personal information such as his or her name, Social Security Number (SSN), or other identifying information, without his or her permission, to commit fraud or other crimes. An identity thief may use the taxpayer’s SSN to get a job or may file a tax return using his or her SSN to receive a refund. To reduce his or her risk of identity theft, a taxpayer should:

1. Protect his or her SSN. 2. Ensure his or her employer is protecting his or her SSN. 3. Be careful when choosing a tax preparer.

If an individual’s tax records are affected by identity theft and he or she receives a notice from the IRS, the individual respond right away to the name and phone number printed on the IRS notice or letter. Abusive Tax Schemes Investors of abusive tax schemes that try to escape their legal tax responsibilities are still liable for taxes, interest, and civil penalties. Violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty or criminal prosecution. Civil fraud can include a penalty of up to 75% of the underpayment of tax attributable to fraud, in addition to the taxes owed. Criminal convictions of promoters and investors of abusive tax schemes may result in fines up to $250,000 and up to five years in prison. (317) Common Abusive Tax Schemes Tax evasion using foreign jurisdictions is accomplished using many different methods. Some can be as simple as taking unreported cash receipts and personally traveling to a tax haven country and depositing the cash into a bank account. Others are more elaborate involving numerous domestic and foreign trusts, partnerships, nominees, etc. The following schemes are not all-inclusive, but just a sample of abusive tax schemes. (318) Abusive Foreign Trust Schemes The foreign trust schemes usually start off as a series of domestic trusts layered upon one another. This set up is used to give the appearance that the taxpayer has turned his/her business and assets over to a trust and is no longer in control of the business or its assets. Once transferred to the domestic trust, the income and expenses are passed to one or more foreign trusts, typically in tax haven countries. As an example, a taxpayer's business is split into two trusts. One trust would be the business trust that is in charge of the daily operations. The other trust is an equipment trust formed to hold the business's equipment that is leased back to the business trust at inflated rates to nullify any income reported on the business trust tax return (Form 1041). Next the income from the equipment trust is distributed to foreign trust-one, again, which nullifies any tax due on the equipment trust tax return. Foreign trust-one then distributes all or most of its income to foreign trust-two. Since all of foreign trust-two's income is foreign based there is no filing requirement. Once the assets are in foreign trust-two, a bank account is opened either under the trust name or an International Business Corporation (IBC). The trust documentation and business records of this scheme all make it appear that the taxpayer is no longer in control of his/her business or its assets. The reality is that nothing ever changed. The taxpayer still exercises full control over his or her business and assets. There can be many different variations to the scheme. (318) International Business Corporations (IBC) The taxpayer establishes an IBC with the exact name as that of his/her business. The IBC also has a bank account in the foreign country. As the taxpayer receives checks from customers, he sends them to the bank in the foreign country. The foreign bank then uses its correspondent account to process the checks so that it never would appear to the customer, upon reviewing the canceled check that the payment was sent offshore. Once the checks clear, the taxpayer's IBC account is credited for the check payments. Here the taxpayer has, again, transferred the unreported income offshore to a tax haven jurisdiction. (318) False Billing Schemes A taxpayer sets up an International Business Corporation (IBC) in a tax haven country with a nominee as the owner (usually the promoter). A bank account is then opened under the IBC. On the bank's records the taxpayer would be listed

Lesson 16 - Penalties

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as a signatory on the account. The promoter then issues invoices to the taxpayer's business for goods allegedly purchased by the taxpayer. The taxpayer then sends payment to the IBC that gets deposited into the joint account held by the IBC and taxpayer. The taxpayer takes a business deduction for the payment to the IBC thereby reducing his or her taxable income and has safely placed the unreported income into the foreign bank account. (318) Fixing America’s Surface Transportation (FAST) Act The Fixing America’s Surface Transportation (FAST) Act was signed into law in December 2015. The purpose of the FAST Act was to provide long-term funding for transportation projects, including new highways. Also included in the bill was a new tax law that requires the Department of State to deny a passport (or renewal of a passport) to a seriously delinquent taxpayer or revoke any passport previously issued to a seriously delinquent taxpayer. For purposes of the law, a “seriously delinquent tax debt” is defined as “an unpaid, legally enforceable Federal tax liability” when a debt greater than $50,000, including interest and penalties, has been assessed and a notice of lien or a notice of levy has been filed. The $50,000 limit is adjusted each year for inflation and cost of living and for 2017, it remains at $50,000.

Lesson 16 - Penalties

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

Review Questions Answers appear in Review Feedback 1. If a taxpayer’s failure to file is due to fraud, what is the penalty imposed?

A. 10% for each month, up to 50% B. 15% for each month, up to 75% C. 20% for each month, up to 80% D. 25% for each month, up to 85%

2. If a taxpayer files a return by the due date (including extensions) but does not make a full payment, what is usually the

late payment penalty for unpaid taxes? A. ½ of 1% for each month, but not more than 25% B. 1% for each month, but not more than 30% C. 2% for each month, but not more than 40% D. 3% for each month, but not more than 50%

3. If a taxpayer’s check used to pay taxes is returned for insufficient funds (bounces), the IRS may impose a penalty. If

the check amount is more than $1,250 the penalty is what percentage of the amount of the check? A. 2% B. 5% C. 7,5% D. 10%

4. A taxpayer may be subject to criminal prosecution (brought to trial) for which of the following actions?

A. Tax evasion B. Willful failure to file a return C. Fraud and false statements D. All of the above

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Review Feedback Return to Review Questions Question 1 - B. 15% for each month, up to 75% If the taxpayer’s failure to file is due to fraud, the penalty is 15% for each month or part of a month that the return is late, up to a maximum of 75%. Question 2 - A. ½ of 1% for each month, but not more than 25% The late payment penalty is usually ½ of 1% of any tax (other than estimated tax) not paid by the filing due date. It is charged for each month or part of a month the tax is unpaid. The maximum penalty is 25%. Question 3 - A. 2% If a taxpayer’s check used to pay taxes is returned for insufficient funds (bounces), the IRS may impose a penalty. The penalty is either 2% of the amount of the check - unless the check is under $1,250, in which case the penalty is the amount of the check or $25, whichever is less. Question 4 - D. All of the above A taxpayer may be subject to criminal prosecution (brought to trial) for actions such as tax evasion, willful failure to file a return, supply information, or pay any tax due, fraud and false statements and preparing and filing a fraudulent return.

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Professional Responsibilities, Ethics, Penalties At the conclusion of this lesson you should have a basic knowledge of:

Treasury Department Circular 230 Office of Professional Responsibility Current Continuing Professional Education Requirements Paid Tax Preparer Penalties

Federal tax law starts with the Internal Revenue Code (IRC), enacted by Congress in Title 26 of the United States Code (26 U.S.C.). Formally called the Internal Revenue Code of 1986, the IRC is the domestic portion of Federal statutory tax law in the United States. It is organized topically, into subtitles and sections, covering income tax, payroll taxes, estate taxes, gift taxes, and excise taxes; as well as procedure and administration. Treasury regulations (26 C.F.R.), also referred to as Federal tax regulations, begin where the Internal Revenue Code (IRC) leaves off by providing the official interpretation of the IRC by the U.S. Department of the Treasury. Revenue Rulings are public administrative rulings by the Internal Revenue Service (IRS) in the United States Department of the Treasury of the United States Federal government that apply the law to particular factual situations. A Revenue Ruling can be relied upon as precedent by all taxpayers. The Office of Professional Responsibility (OPR) and the Return Preparer Office (RPO) generally are responsible for administering and enforcing the regulations governing practice before the IRS. The OPR generally has responsibility for matters related to practitioner conduct and exclusive responsibility for discipline, including disciplinary proceedings and sanctions. The Return Preparer Office is responsible for matters related to the authority to practice, including acting on applications for enrollment and administering competency testing and continuing professional education. OPR continuously investigates cases involving tax professionals not in compliance with their ethical obligations. Recently, OPR disbarred a former CPA and former attorney in Massachusetts. He was disbarred for having his CPA license revoked and for falsely claiming to be a CPA on power of attorney forms submitted to the IRS. In an Initial Decision and Order, the ALJ determined that Edgar’s “conduct demonstrates he does not have the integrity or character to be trusted representing taxpayers before the IRS.” The Decision further stated: “The only appropriate sanction therefore is disbarment.” The Treasury Appellate Authority concurred finding the disciplinary proceeding was brought within the statute of limitations; that Edgar had given false and misleading information to a Treasury employee during the IRS examination process; and, that submitting false powers of attorney to the IRS was a “serious violation[s] that warrants a severe sanction.” (319)

Also, an Enrolled Agent (EA) was disbarred for stealing a client's tax payments and for preparing tax returns with false deductions for multiple clients. In a Final Agency Decision, the Administrative Law Judge disbarred the EA for misappropriating client payments intended for the IRS in furtherance of an offer in compromise, and for preparing multiple returns containing Schedule C deductions for which she could not produce substantiation on audit. The EA was engaged to represent a taxpayer in a collection matter. The client gave the EA two money orders totaling $1,500 to forward to the IRS along with an offer in compromise for delinquent taxes. It was found by the ALJ that the EA altered, endorsed and cashed the money orders for her own personal use, which are acts of willful incompetent and disreputable conduct under Circular 230. The ALJ also found that the EA prepared Forms 1040 for seven clients claiming Schedule C deductions that were unsubstantiated and unsupportable. It was found that the EA failed to exercise due diligence in preparing the Schedule C’s, thereby violating multiple due diligence provisions contained in Circular 230. The EA also failed to respond to the administrative complaint and the motion for default judgment. The ALJ determined that because the EA failed to respond either to the complaint or to the motion for default judgment, she was deemed to admit all the allegations in the complaint, and to not oppose the default motion. (320) In another case, a tax preparer based in California was been convicted of filing tax returns that claimed more than $53 million in fraudulent returns. The tax practitioner’s firm filed more than 12,000 bogus tax returns over an 18-month period in 2011 and 2012. The government said on at least five occasions employees told the tax practitioner identity and W-2

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documents looked suspicious and the IRS sent hundreds of warning notices. But the tax practitioner instructed his employees to continue filing the returns. Co-conspirators provided phony identification documents that the tax practitioner would use to obtain Individual Taxpayer Identification Number (ITINs) to file three years' of income tax returns based on information from fabricated W-2s. The tax practitioner was convicted after a two-week jury trial for bilking the government by utilizing fake ITINs. (320)

Practice Before the IRS Practice before the Internal Revenue Service includes presenting to the IRS or any of its officers or employees all matter relating to a client’s rights, privileges or liabilities. Practice before the IRS covers all matters relating to any of the following: (321)

Communicating with the IRS for a taxpayer regarding the taxpayer's rights, privileges, or liabilities under laws and regulations administered by the IRS.

Representing a taxpayer at conferences, hearings, or meetings with the IRS. Preparing and filing documents, including tax returns, with the IRS for a taxpayer. Providing a client with written advice which has a potential for tax avoidance or evasion.

Furnishing information at the request of the IRS or appearing as a witness for the taxpayer is not practice before the IRS. Some examinations are handled entirely by mail. Examinations not handled by mail can take place in the taxpayer’s home, his or her place of business, an Internal Revenue office, or the office of his or her authorized representative. If the time, place, or method is not convenient for the taxpayer, the examiner will try to work out something more suitable. However, the IRS makes the final determination of when, where, and how the examination will take place. Throughout the examination, the taxpayer can act on his or her own behalf or have someone represent him or her or accompany him or her. If the taxpayer filed a joint return, either he or she or his or her spouse, or both, can meet with the IRS. The person representing the taxpayer can be any Federally authorized practitioner, including an attorney, a certified public accountant, an enrolled agent (a person enrolled to practice before the IRS), an enrolled actuary, or the person who prepared the return and signed it as the preparer. If the taxpayer wants someone to represent him or her in his or her absence, he or she must furnish that person with proper written authorization. The taxpayer can use Form 2848 - Power of Attorney and Declaration of Representative or any other properly written authorization. If the taxpayer wants to consult with an attorney, a certified public accountant, an enrolled agent, or any other person permitted to represent a taxpayer during an interview for examining a tax return or collecting tax, he or she should make arrangements with that person to be available for the interview. The following individuals are subject to the Regulations contained in Circular 230. However, any individual who is recognized to practice (a recognized representative) must be designated as the taxpayer's representative and file a written declaration with the IRS stating that he or she is authorized and qualified to represent a particular taxpayer. Form 2848 - Power of Attorney and Declaration of Representative can be used for this purpose. Appraisers - Any individual who prepares appraisals supporting the valuation of assets in connection with one or more Federal tax matters is subject to the regulations contained in Circular 230. Appraisers have no representation rights but may appear as witnesses on behalf of taxpayers. Attorneys - Any attorney who is not currently under suspension or disbarment from practice before the Internal Revenue Service may practice before the Internal Revenue Service by filing with the Internal Revenue Service a written declaration that the attorney is currently qualified as an attorney and is authorized to represent the party or parties. Notwithstanding the preceding sentence, attorneys who are not currently under suspension or disbarment from practice before the Internal Revenue Service are not required to file a written declaration with the IRS before rendering written advice covered under Circular 230 Section 10.37, but their rendering of this advice is practice before the Internal Revenue Service. Certified public accountants (CPAs) - Any CPA who is not currently under suspension or disbarment from practice before the IRS and who is duly qualified to practice as a CPA in any state, possession, territory, commonwealth, or the District of Columbia may practice before the Internal Revenue Service by filing with the Internal Revenue Service a written declaration that the certified public accountant is currently qualified as a certified public accountant and is authorized to represent the party or parties. Notwithstanding the preceding sentence, certified public accountants who are not currently

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under suspension or disbarment from practice before the Internal Revenue Service are not required to file a written declaration with the IRS before rendering written advice covered under Circular 230 Section 10.37, but their rendering of this advice is practice before the Internal Revenue Service. Enrolled agents - Any enrolled agent in active status who is not currently under suspension or disbarment from practice before the IRS may practice before the IRS. Enrolled retirement plan agents - Any enrolled retirement plan agent in active status who is not currently under suspension or disbarment from practice before the IRS may practice before the IRS. The practice of enrolled retirement plan agents is limited to certain Internal Revenue Code sections that relate to their area of expertise, principally those sections governing employee retirement plans. Enrolled actuaries - Any individual who is enrolled as an actuary by the Joint Board for the Enrollment of Actuaries who is not currently under suspension or disbarment from practice before the IRS may practice before the IRS. The practice of enrolled actuaries is limited to certain Internal Revenue Code sections that relate to their area of expertise, principally those sections governing employee retirement plans. Others - Any individual qualifying under Circular 230 Section 10.5(e) or Section 10.7 is eligible to practice before the Internal Revenue Service to the extent provided in those sections. Low Income Taxpayer Clinic Student Interns - Under certain circumstances, a student who is supervised by a practitioner may request permission to represent another person before the IRS. Unenrolled return preparers - An unenrolled return preparer is an individual other than an attorney, CPA, enrolled agent, enrolled retirement plan agent, or enrolled actuary who prepares and signs a taxpayer's return as the paid preparer, or who prepares a return but is not required (by the instructions to the return or regulations) to sign the return. Unenrolled return preparers may represent taxpayers only before revenue agents, customer service representatives, or similar officers and employees of the Internal Revenue Service (including the Taxpayer Advocate Service) and only during an examination of the tax returns they prepared and signed prior to December 31, 2015. Unenrolled return preparers may not represent taxpayers before appeals officers, revenue officers, counsel or similar officers or employees of the Internal Revenue Service or the Department of Treasury. Unenrolled return preparers may not execute closing agreements, extend the statutory period for tax assessments or collection of tax, execute waivers, or sign any document on behalf of a taxpayer. As of January 1, 2016, only unenrolled return preparers who hold an Annual Filing Season Program (AFSP) Record of Completion for both the tax return year (2015 or thereafter) under examination and the year the examination is conducted may represent under the following conditions:

Unenrolled return preparers may represent taxpayers only before revenue agents, customer service representatives, or similar officers and employees of the Internal Revenue Service (including the Taxpayer Advocate Service) and only during an examination of the taxable year or period covered by the tax returns they prepared and signed.

Unenrolled return preparers may not represent taxpayers, regardless of the circumstances requiring representation, before appeals officers, revenue officers, counsel or similar officers or employees of the Internal Revenue Service or the Department of Treasury.

Unenrolled return preparers may not execute closing agreements, extend the statutory period for tax assessments or collection of tax, execute waivers, or sign any document on behalf of a taxpayer.

If an unenrolled return preparer does not meet the requirements for limited representation, the taxpayer may authorize the unenrolled return preparer to inspect and/or request his or her tax information by filing Form 8821 - Tax Information Authorization. Completing Form 8821 will not authorize the unenrolled return preparer to represent the taxpayer before the IRS. Other individuals who may serve as representatives - Because of their special relationship with a taxpayer, the following individuals can represent the specified taxpayers before the IRS, provided they present satisfactory identification and, except in the case of an individual described below, proof of authority to represent the taxpayer: (321)

An individual. An individual can represent himself or herself before the IRS and does not have to file a written declaration of qualification and authority.

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A family member. An individual can represent members of his or her immediate family. Immediate family includes a spouse, child, parent, brother, or sister of the individual.

An officer. A bona fide officer of a corporation (including a parent, subsidiary, or other affiliated corporation), association, or organized group can represent the corporation, association, or organized group. An officer of a governmental unit, agency, or authority, in the course of his or her official duties, can represent the organization before the IRS.

A partner. A general partner may represent the partnership before the IRS. An employee. A regular full-time employee can represent his or her employer. An employer can be, but is not

limited to, an individual, partnership, corporation (including a parent, subsidiary, or other affiliated corporation), association, trust, receivership, guardianship, estate, organized group, governmental unit, agency, or authority.

A fiduciary. A fiduciary (trustee, executor, personal representative, administrator, receiver, or guardian) stands in the position of a taxpayer and acts as the taxpayer, not as a representative.

Restrictions Practitioners are restricted from engaging in certain practices: (322)

A practitioner must not unreasonably delay the prompt disposition of any matter before the IRS. A practitioner must not knowingly, directly or indirectly:

o Accept assistance from, or assist, any person who is under disbarment or suspension from practice before the IRS if the assistance relates to matters considered practice before the IRS.

o Accept assistance from any former government employee where provisions of Circular 230 or any Federal law would be violated.

A practitioner who is a notary public and is employed as counsel, attorney, or agent in a matter before the IRS, or has a material interest in the matter, cannot engage in any notary activities related to that matter.

Practitioners must not endorse or otherwise negotiate (cash) any refund check (including directing or accepting payment by any means, electronic or otherwise, in an account owned or controlled by the practitioner or any firm or other entity with whom the practitioner is associated) issued to the taxpayer.

Generally, individuals lose their eligibility to practice before the IRS in the following ways: (321)

Not meeting the requirements for renewal of enrollment (such as continuing professional education). Requesting to be placed in inactive retirement status. Being suspended or disbarred by the Office of Professional Responsibility for violating the regulations governing

practice before the IRS. Any practitioner or unenrolled return preparer may be disbarred, censured or suspended from practice before the IRS for incompetence or disreputable conduct. The following list contains examples of conduct that is considered disreputable:

Being convicted of any criminal offense under the revenue laws or of any offense involving dishonesty or breach of trust.

Knowingly giving false or misleading information in connection with Federal tax matters, or participating in such activity.

Soliciting employment by prohibited means as discussed in Section 10.30 of Circular 230. Willfully failing to file a Federal tax return, evading or attempting to evade any Federal tax or payment, or

participating in such actions. Misappropriating, or failing to properly and promptly remit, funds received from clients for payment of taxes or

other obligations due the United States. Directly or indirectly attempting to influence the official action of IRS employees by the use of threats, false

accusations, duress, or coercion, or by providing gifts, favors, or any special inducements. Being disbarred or suspended from practice as an attorney, CPA, public accountant, or actuary, by the District of

Columbia or any state, possession, territory, commonwealth, or any Federal court, or any Federal agency, body, or board.

Knowingly aiding and abetting another person to practice before the IRS during a period of suspension, disbarment, or ineligibility of that other person.

Using abusive language, making false accusations and statements knowing them to be false, circulating or publishing malicious or libelous matter, or engaging in any contemptuous conduct in connection with practice before the IRS.

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Giving a false opinion knowingly, recklessly, or through gross incompetence; or following a pattern of providing incompetent opinions in questions arising under the Federal tax laws.

The Office of Professional Responsibility may censure or institute proceedings to censure, suspend or disbar any attorney, CPA, or enrolled agent who has violated Circular 230. A practitioner will be given the opportunity to demonstrate compliance with the rules before any disciplinary action is taken. Unenrolled return preparers may only represent taxpayers before revenue agents, customer service representatives, or similar officers and employees of the Internal Revenue Service (including the Taxpayer Advocate Service) during an examination of the taxable year or period covered by the tax return they prepared and signed. Unenrolled return preparers cannot represent taxpayers, regardless of the circumstances requiring representation, before appeals officers, revenue officers, counsel or similar officers or employees of the Internal Revenue Service or the Department of Treasury. Unenrolled return preparers cannot execute closing agreements, extend the statutory period for tax assessments or collection of tax, execute waivers, execute claims for refund, or sign any document on behalf of a taxpayer.

The Return Preparer Office can grant enrollment to practice before the IRS to an applicant who demonstrates special competence in tax matters by passing a written examination administered by the IRS. Enrollment also can be granted to an applicant who qualifies because of past service and technical experience in the IRS. In either case, certain application forms must be filed. Additionally, an applicant must not have engaged in any conduct that would justify suspension or disbarment from practice before the IRS. Applicants can apply to take the special enrollment examination by filing Form 2587- Application for Special Enrollment Examination. Form 2587 can be filed online, by mail, or by fax. Individuals who have passed the examination or are applying on the basis of past service and technical experience with the IRS can apply for enrollment by filing Form 23 - Application for Enrollment to Practice Before the Internal Revenue Service, or Form 23-EP - Application for Enrollment to Practice Before the Internal Revenue Service as an Enrolled Retirement Plan Agent. The application must include a check or money order in the amount of the fee shown on Form 23 or Form 23-EP. Alternatively, payment may be made electronically pursuant to instructions on the forms. An individual may apply as an enrolled actuary on the basis of past employment with the IRS and technical experience by filing Form 5434 - Application for Enrollment, with the Joint Board for the Enrollment of Actuaries. The application must include a check or money order in the amount of the fee shown on Form 5434. An enrollment card will be issued to each individual whose enrollment application is approved. The individual is enrolled until the expiration date shown on the enrollment card or certificate. To continue practicing beyond the expiration date, the individual must request renewal of the enrollment by filing Form 8554 - Application for Renewal of Enrollment to Practice Before the Internal Revenue Service, or Form 8554-EP - Application for Renewal of Enrollment to Practice Before the Internal Revenue Service as an Enrolled Retirement Plan Agent (ERPA). Limited Practice Based on Relationship to the Taxpayer An individual may represent himself/herself before the IRS by presenting satisfactory identification. The individual does not have to file a written declaration of authority. Because of their special relationship with a taxpayer, unenrolled individuals can represent the specified taxpayers before the IRS without having actually prepared the tax return in question. The following must provide satisfactory identification and documented authority (e.g., Form 2848 - Power of Attorney and Declaration of Representative) to represent the taxpayer: (323)

A family member - an individual may represent members of his or her immediate family. Immediate family generally means a spouse, child, parent, brother or sister of the individual. In other cases, the determination of whether an individual is a member of a taxpayer’s immediate family can be complex, and the Office of Associate Chief Counsel (General Legal Services) or the Office of Associate Chief Counsel (Procedure and Administration) should be consulted.

An officer - a bona fide officer of a corporation (including a parent subsidiary or other affiliated corporation), association or organized group may represent the corporation, association or organized group. An officer of a governmental unit, agency, or authority in the course of his or her official duties, may represent the organization before the IRS.

A partner - a general partner may represent the partnership before the IRS.

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An employee - a regular full-time employee may represent his or her employer. An employer may be, but is not limited to, an individual, partnership, corporation (including a parent, subsidiary, or other affiliated corporation), association, trust, receivership, guardianship, estate, organized group, governmental unit, agency, or authority.

A fiduciary (trustee, executor, administrator, receiver, or guardian) - a fiduciary stands in the position of a taxpayer and acts as the taxpayer, not as a representative.

Power of Attorney The taxpayer has the right to represent him or herself or have someone represent him or her before the IRS in connection with a Federal tax matter. The taxpayer’s representative must be an individual authorized to practice before the IRS. If the taxpayer wants someone to represent him or her before the IRS, he or she must submit a power of attorney with the IRS office where he or she wants the representative to act for him or her. The Form 2848 - Power of Attorney and Declaration of Representative, can be used for this purpose. The taxpayer’s signature on Form 2848 allows the individual or individuals named to represent him or her before the IRS and to receive his or her tax information for the matter(s) and tax year(s)/period(s) specified on the Form 2848. Except as specified in other IRS guidance, the power attorney authorizes the listed representative(s) to receive and inspect confidential tax information and to perform all acts (that is, sign agreements, consents, waivers or other documents) that a taxpayer can perform with respect to matters described in the power of attorney. However, this authorization does not include the power to receive a check issued in connection with any liability for tax or any act specifically excluded in the power of the attorney. A power of attorney is not required when the third party is not dealing with the IRS as the taxpayer’s representative. The following situations do not require a power of attorney: (321)

Providing information to the IRS. Authorizing the disclosure of tax return information through Form 8821 - Tax Information Authorization, or other

written or oral disclosure consent. Allowing the IRS to discuss return information with a third party via the checkbox provided on a tax return or other

document. Allowing a tax matters partner or person (TMP) to perform acts for the partnership. Allowing the IRS to discuss return information with a fiduciary.

The IRS will accept a power of attorney other than Form 2848 provided the document satisfies the requirements for a power of attorney. Practice Before the Department Per USC Section 330, Practice before the Department, subject to Section 500 of Title 5, the Secretary of the Treasury may:

1. Regulate the practice of representatives of persons before the Department of the Treasury; and 2. Before admitting a representative to practice, require that the representative demonstrate:

a. Good character. b. Good reputation. c. Necessary qualifications to enable the representative to provide to persons valuable service. d. Competency to advise and assist persons in presenting their cases.

After notice and opportunity for a proceeding, the Secretary may reprimand, suspend or disbar from practice before the Department, or censure, a representative who:

1. Is incompetent. 2. Is disreputable. 3. Violates regulations prescribed under this section. 4. With intent to defraud, willfully and knowingly misleads or threatens the person being represented or a prospective

person to be represented. The Secretary may impose a monetary penalty on any representative described in the preceding sentence. If the representative was acting on behalf of an employer or any firm or other entity in connection with the conduct giving rise to

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such penalty, the Secretary may impose a monetary penalty on such employer, firm, or entity if it knew, or reasonably should have known, of such conduct. Such penalty shall not exceed the gross income derived (or to be derived) from the conduct giving rise to the penalty and may be in addition to, or in lieu of, any suspension, disbarment, or censure of the representative. After notice and opportunity for a hearing to any appraiser, the Secretary may:

1. Provide that appraisals by such appraiser shall not have any probative effect in any administrative proceeding before the Department of the Treasury or the Internal Revenue Service.

2. Bar such appraiser from presenting evidence or testimony in any such proceeding. Confidentiality Privileges With the introduction of the Federal tax practitioner privilege under Internal Revenue Code (IRC) Section 7525, the attorney-client privilege has become of major importance to accountants, enrolled agents and other tax practitioners because the IRC Section 7525 privilege is, to the extent it applies, coextensive with the attorney-client privilege and has the same limitations. Generally, with respect to tax advice, the same common law protections of confidentiality which apply to a communication between a taxpayer and an attorney shall also apply to a communication between a taxpayer and any “Federally authorized tax practitioner” to the extent the communication would be considered a privileged communication if it were between a taxpayer and an attorney. The privilege may only be asserted in any noncriminal tax matter before the Internal Revenue Service and any noncriminal tax proceeding in Federal court brought by or against the United States. The term “Federally authorized tax practitioner” means any individual who is authorized under Federal law to practice before the Internal Revenue Service if such practice is subject to Federal regulation under Section 330 of title 31, United States Code. The term “tax advice” means advice given by an individual with respect to a matter which is within the scope of the individual's authority to practice. The privilege shall not apply to any written communication which is between a “Federally authorized tax practitioner” and any person, any director, officer, employee, agent, or representative of the person, or any other person holding a capital or profits interest in the person in connection with the promotion of the direct or indirect participation of the person in any tax shelter.

Sarbanes-Oxley Act of 2002 On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, which he characterized as "the most far reaching reforms of American business practices since the time of Franklin Delano Roosevelt." The Act mandated a number of reforms to enhance corporate responsibility, enhance financial disclosures and combat corporate and accounting fraud, and created the Public Company Accounting Oversight Board (PCAOB) to oversee the activities of the auditing profession. The Sarbanes-Oxley Act requires that auditors of U.S. public companies be subject to external and independent oversight. Previously the profession was self-regulated. The PCAOB is a non-profit corporation established by Congress to oversee the audits of public companies to protect investors and the public interest by promoting accurate, independent audit reports. The PCAOB also monitors the audits of brokers and dealers, including compliance reports filed pursuant to Federal securities laws. The U.S. Securities and Exchange Commission (SEC) has authority over the PCAOB, including its rules, standards and budget. (324)

Rules for Tax Preparers – Circular 230 This section is designed to help you understand your ethical obligations as a paid tax preparer. Because tax preparers are trusted by their clients to comply with tax laws, tax preparers are required to comply with the ethical standards of Treasury Department Circular 230 – Rules for Tax Preparers. (325) Who exactly is a tax return preparer? Under USC Section 7701(a)(36), a tax return preparer is any person who prepares for compensation, or employs others to prepare for compensation, all or a substantial portion of any tax return or claim for refund under the IRC. The IRS recognizes attorneys, CPAs, enrolled actuaries, enrolled retirement plan agents, enrolled agents and all others paid to prepare returns as paid tax return preparers subject to the ethics rules.

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However, a person shall not be a tax return preparer merely because such he or she: (326)

Furnishes typing, reproducing, or other mechanical assistance. Prepares a return or claim for refund of the employer (or of an officer or employee of the employer) by whom he

is regularly and continuously employed. Prepares as a fiduciary a return or claim for refund for any person. Prepares a claim for refund for a taxpayer in response to any notice of deficiency issued to such taxpayer or in

response to any waiver of restriction after the commencement of an audit of such taxpayer or another taxpayer if a determination in such audit of such other taxpayer directly or indirectly affects the tax liability of such taxpayer.

Enforcement of the rules is administered by the Office of Professional Responsibility (OPR) within the IRS. OPR’s organizational structure includes three major segments: Office of the Director, Legal Analysis Branch, and Operations Management Branch. These branches of the OPR are committed to: (327)

Independent, fair and equitable treatment of all tax practitioners consistent with their Title 31 authority and principles of due process.

Rendering fair and independent determinations regarding alleged misconduct in violation of Circular 230 - Regulations Governing Practice before the Internal Revenue Service.

Educating/maintaining tax professionals’ knowledge of relevant Circular 230 provisions. Providing guidance and feedback to field/agency sources regarding essential referral criteria for each relevant

Circular 230 provision. Strengthening partnerships with other parts of the IRS and with external practitioner organizations. Developing procedures that ensure timely case resolution. Developing policies and regulations that ensure fair and equitable disposition of Circular 230 cases. Developing and implementing proactive strategies for identifying violations of Circular 230.

Examples of misconduct typically referred to OPR include, but are not limited to:

Inaccurate or unreasonable entries/omissions on tax returns, financial statements and other documents. A lack of due diligence exercised by the practitioner. A willful attempt by the practitioner to evade the payment/assessment of any Federal tax. Cashing, diverting or splitting a taxpayer’s refund by any means, electronic or otherwise. Patterns of misconduct involving multiple years, multiple clients or inappropriate/unprofessional conduct

demonstrated to multiple IRS employees. Potential conflict of interest situations, such as representation of both spouses who have a joint liability or when

representation is affected by competing interests of the practitioner. Any willful violation of Circular 230 provisions.

The Treasury Department Circular 230 contains ethics rules governing the recognition of attorneys, certified public accountants, enrolled agents, enrolled retirement plan agents, registered tax return preparers, and other persons representing taxpayers before the Internal Revenue Service. The Circular 230 is divided into five distinct subparts:

Subpart A - sets forth rules relating to the authority to practice before the Internal Revenue Service. Subpart B - prescribes the duties and restrictions relating to such practice. Subpart C - prescribes the sanctions for violating the regulations. Subpart D - contains the rules applicable to disciplinary proceedings. Subpart E - contains general provisions relating to official records.

The Office of Professional Responsibility shall generally have responsibility for matters related to practitioner conduct and shall have exclusive responsibility for discipline, including disciplinary proceedings and sanctions.

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Subpart A Rules Governing Authority to Practice Subpart A contains rules governing attorneys, certified public accountants, enrolled agents, enrolled retirement plan agents, registered tax return preparers, and other persons representing taxpayers before the IRS. Subpart A also outlines the requirements for annual continuing professional education. Eligibility In order to be eligible to become an enrolled agent or enrolled retirement plan agent, the applicant must:

Be 18 years of age or older. Demonstrate competence in tax matters. Possess a current preparer tax identification number (PTIN). Has not engaged in any conduct justifying suspension or disbarment.

Application In order to become an enrolled agent or enrolled retirement plan agent, the applicant must:

Submit an application to the IRS. Pay a non-refundable registration fee. Pass an examination. Pass certain suitability checks.

Suitability checks include verification on filing personal and/or business tax returns, payment of any tax liabilities and inquiry regarding any conduct which would justify suspension or disbarment from practice. Upon application completion and approval, the IRS will issue an enrollment registration card or certificate. This will include a preparer tax identification number (PTIN) which must be included next to your signature on all returns that you prepare. It is your IRS license to prepare taxes. If the applicant does not pass the tax compliance or suitability check, the applicant will not be issued an enrollment card or certificate. The applicant will be informed in writing as to the reason(s) for any denial of an application. The applicant may, within 30 days after receipt of the notice of denial of the application, file a written protest of the denial as prescribed by the Internal Revenue Service in forms, guidance, or other appropriate guidance. Attorneys People with this credential are licensed by state courts or their designees, such as the state bar. Generally, requirements include completion of a degree in law, passage of an ethics and bar exam and on-going continuing professional education. Attorneys can offer a range of services; some attorneys specialize in tax preparation and planning. Enrolled Agents People with this credential are licensed by the IRS and specifically trained in Federal tax planning, preparation and representation. Enrolled agents hold the most expansive license the IRS grants and must pass a suitability check, as well as a three-part Special Enrollment Examination, a comprehensive exam that covers individual tax, business tax and representation issues. An individual should follow these steps to become an enrolled agent:

1. Obtain a Preparer Tax Identification Number (PTIN). 2. Apply to take the Special Enrollment Examination (SEE). 3. Achieve passing scores on all 3 parts of the SEE:

a. Review old SEE questions and answers. b. Review the SEE Candidate Information Bulletin.

4. Apply for enrollment and pay enrollment fee electronically at Pay.gov or by downloading Form 23 - Application for Enrollment to Practice Before the Internal Revenue Service and mailing the completed form and a check to the IRS.

5. Pass a tax compliance check to ensure that he or she has filed all necessary tax returns and there are no outstanding tax liabilities. This check is conducted on the individual’s behalf after submission of Form 23.

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Enrolled agents must obtain 72 hours of continuing professional education (CPE) every three years. A minimum of 16 hours must be earned per year, two of which must be on ethics. Enrolled agents must use an IRS approved CE provider.

Former IRS employees may be granted enrollment based on past service and technical experience in the IRS without having to take the SEE.

Term and Renewal Anyone who prepares or assists in preparing Federal tax returns for compensation must have a valid preparer tax identification number (PTIN) before preparing returns. All enrolled agents must also have a PTIN. PTINs must be renewed by December 31st. Additionally, enrolled agents must renew their credentials with the IRS between November 1 and January 31 of every subsequent third year according to the last number of the individual’s Social Security number. Enrolled retirement plan agents must renew their status between April 1 and June 30 of every third year subsequent to their enrollment. Upon renewal and payment of a renewal fee, a new card or certificate will be issued. Changes of address must be reported to the IRS within 60 days of the address change. Failure to receive renewal notification from the IRS does not justify the practitioner failure to satisfy renewal requirements. Forms for renewal are available by written request, published bulletins and on the IRS webpage (www.irs.gov/for-Tax-Pros).

On June 1, 2017, the United States District court for the District of Columbia upheld the Internal Revenue Service’s authority to require the use of a Preparer Tax Identification Number (PTIN), but enjoined the IRS from charging a user fee for the issuance and renewal of PTINs.

An Enrolled Agent will be automatically classified as "inactive" if he or she fails to:

Meet the CPE requirements for his or her EA license renewal. Submit his or her enrolled agent license renewal by the due date. Meet any other condition of renewal.

The Office of Professional Responsibility will notify the EA by first class mail. The notice will describe the reason for denial of renewal. An EA will have 60 days from the date of the notice to reply and provide information for reconsideration. An enrolled individual will be placed on the roster of inactive enrolled individuals for a period of three years, if he or she:

Fails to respond timely to the notice of noncompliance with the renewal requirements. Fails to file timely the application for renewal. Does not satisfy the requirements of eligibility for renewal.

The enrolled individual must file an application for renewal and satisfy all requirements for renewal after being placed in inactive status. Otherwise, at the conclusion of the next renewal cycle, he or she will be removed from the roster and the enrollment status will be terminated. An EA can request to be placed on inactive retirement status when he or she fills out his or her renewal Form 8554 - Application for Renewal of Enrollment to Practice Before the Internal Revenue Service. Specifically, he or she marks a checkbox in Part 1 of the Application for Renewal of Enrollment. The checkbox states “I want approval to remain or be placed into Inactive Retirement status.” The cost to become inactive or remain on inactive status is the same as the cost to be on active status. An inactive EA must still pay the renewal fee every 3 years however no CPE is required while in inactive status. Enrolled individuals who request to be placed in an inactive retirement status will be ineligible to practice before the IRS. They must continue to adhere to all renewal requirements. They can be reinstated to active enrollment status by filing an application for renewal and providing evidence that they have completed the required continuing professional education hours for the enrollment cycle or registration year. Generally speaking, there is no advantage to selecting inactive status unless the enrolled individual plans to remain inactive for 6 or more years. If he or she decides to return to active status say after 4 year, he or she has to complete 72 hours to reactivate. Then in 2 years the individual has to submit 72 hours to renew his or her license. So the enrolled individual has to remain inactive for more than 6 years in order to skip a cycle of CPE requirements.

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Certified Public Accountants People with this credential are licensed by state boards of accountancy, the District of Columbia, and U.S. territories, and have passed the Uniform CPA Examination. They also must meet education, experience, and good character requirements established by their boards of accountancy. In addition, CPAs must comply with ethical requirements as well as complete specified levels of continuing professional education in order to maintain an active CPA license. CPAs can offer a range of services; some CPAs specialize in tax preparation and planning. Generally, an individual has three requirements for licensure: (328)

1. Education. 2. Exam or Uniform Certified Public Accountant Examination. 3. Experience.

To obtain the required body of knowledge and to develop the skills and abilities needed to be successful CPAs, students should complete 150 semester hours of education. Many states/jurisdictions now require or will require 150 semester hours of education for obtaining the CPA certification. Colleges and universities in these states/jurisdictions determine the curriculum for pre-licensure education of CPAs; it typically features a good balance of accounting, business, and general education. In general, state boards require the following:

A total of 150 semester credits from a college or university whose accreditation is accepted by the state (Colleges and universities typically offer a curriculum designed to meet the 150-credit requirement).

A minimum of a bachelor's degree. A specified number of accounting course. A specified number of business courses.

The uniform CPA examination is a computer based format consisting of four sections: (328)

Auditing and Attestation (AUD). Business Environment and Concepts (BEC). Financial Accounting and Reporting (FAR). Regulation (REG).

The exam is the same regardless of location taken. The passing score is 75 on a 0-99 scale. The question types include multiple choice, simulation and written communication. Eligibility to sit for the exam depends on state requirements. Many states require a candidate to have one to two years of experience under a CPA. Additional requirements vary based on the candidate’s education, employer(s) and type of work. CPA licenses give the individual the right to practice public accounting. Some states require an Ethics exam and the individual must comply with rules of professional conduct. Continuing Professional Education Requirement - CPA To maintain his or her license, a CPA typically must complete 40 hours (varies by state) of continuing professional education (CPE) per year. Types of eligible CPE hours vary based on jurisdiction. Subjects also vary on type or license and area of employment. Many jurisdictions may require ethics training and compliance. The National Association of State Boards of Accountancy (NASBA) Regulatory Compliance Services division offers several programs that assist state boards and their licensees by determining high quality CPE providers. For more information about the state board of accountancy in each of the 55 jurisdictions visit the NASBA website. Documentation of CPE is not required but should be maintained. The member is responsible for retaining any documentation that may be required. The reporting period begins the calendar year after joining the American Institute of Certified Public Accounts (AICPA). There is a two-month grace period immediately following the reporting period. Hours credited toward a deficiency may not be counted toward the reporting period in which they are taken. Qualifying programs are those programs which contribute to the member's professional competence and are formal programs. No specific subject areas are required. Examples of qualifying programs are in-house training courses, trade association conferences, self-study programs or college and university classes. Members bear primary responsibility of documenting compliance with CPE requirements.

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For each program the member should be able to document the following: (329)

Sponsor. Title and description of content. Date(s). Location. Number of CPE contact hours.

AICPA members in the following categories are automatically exempted from AICPA CPE Requirements: (329)

Retired and do not hold themselves out as CPAs to third parties. Temporarily Left the Work Force and do not hold themselves out as CPAs to third parties. Unemployed and do not hold themselves out as CPAs to third parties. Members who have formally placed their CPA certificate/license in 'inactive' status with the State Board of

Accountancy and do not hold themselves out as CPAs to third parties. AICPA members may request a waiver for AICPA membership CPE requirements if the member is unable to comply due to unique circumstances such as: (329)

Health. Military Service. Extreme natural disasters (in circumstances where the State Board grants any exemption, reduction or other

adjustment with regard to CPE requirements). Other similar circumstances that might prevent a member from complying with the CPE requirements.

For more information see the Statement on Standards for Continuing Professional Education (CPE) Programs. Members who place their licenses/certificate on inactive status with their state board of accountancy AND do not hold themselves out as CPAs are exempt from the AICPA's CPE requirement as long as their state board does not require CPE while on inactive status. If a CPA is short of the required 40 CPE hours in the first year, he or she may be penalized with a citation and receive a fine. The individual would also be required to make up the hours to reach a minimum of 80 for the two-year reporting period. Penalties and fines vary and are determined by the individual’s state board of accountancy. For more information about the state board of accountancy in each of the 55 jurisdictions visit the NASBA website. Continuing Professional Education Requirement - EA For an enrolled agent or enrolled retirement plan agent, during a three year enrollment cycle, 72 hours of continuing professional education, including 6 hours of ethics or professional conduct is required. At a minimum, 16 hours, including two hours of ethics or professional conduct, must be completed in any one year of the three year enrollment cycle. When an enrolled agent is newly enrolled in the middle of an enrollment cycle, the individual must complete two hours of qualified continuing professional education for each month enrolled during the enrollment cycle. Two hours of qualified ethics or professional conduct is required for every year an enrolled agent becomes enrolled during an enrollment cycle. Practitioner’s records of completed continuing professional education must be retained for four years subsequent to the renewal date. If a practitioner did not complete his or her continuing professional education requirements, he or she must fill out Form 14392 - Continuing Education Waiver Request and submit it to the IRS. The IRS states that all waiver requests will be processed within 90 days. Once the waiver is approved, the practitioner still has to make up the hours in 2017 that he or she missed in 2016. However, the practitioner will still be able to have a valid PTIN and prepare taxes this year. He or she will not have problems with his or her PTIN renewal until 2017. Reasons for requesting a waiver include:

Health, which prevented, or will prevent, compliance with the continuing professional education requirements (supporting documentation such as medical certificate must be provided with request).

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Extended active military duty (supporting documentation such as military orders must be provided with request). Absence from the United States for an extended period of time due to employment or other reasons provided the

individual does not practice before the Internal Revenue Service during such absence. Other compelling reasons, which will be considered on a case-by-case basis.

Rules for Qualified Continuing Professional Education

For Certified Public Accountants, CPE is required for CPAs to maintain their professional competence and provide quality professional services. CPAs are responsible for complying with all applicable CPE requirements, rules and regulations of state boards of accountancy, as well as those of membership associations and other professional organizations.

For enrolled agents, the course must be a qualifying continuing professional education program in Federal tax and must be consistent with IRC and tax administration.

For enrolled retirement plan agents, the course must be a qualifying continuing professional education program designed to enhance professional knowledge in qualified retirement plan matters and be a qualifying continuing professional education program consistent with the Internal Revenue Code and effective tax administration.

Annual Filing Season Program (AFSP), this program aims to recognize the efforts of non-credentialed return preparers who aspire to a higher level of professionalism. Tax practitioners meet the AFSP requirements by obtaining 18 hours of continuing education, including a six-hour Annual Federal Tax Refresher (AFTR) course with a comprehensive exam. Upon completion, the practitioner will receive an Annual Filing Season Program – Record of Completion from the IRS.

Formal qualified continuing professional education programs must require attendance and provide each attendee with a certificate of attendance, taught by a qualified instructor, include a written outline or educational materials, and it must satisfy the requirements established for a qualified continuing professional education program. Self-study programs are allowed provided that they require registration of the participants, measure the successful completion of the program by the participants with issuance of a certificate, provide educational materials, and satisfy the requirements established for a qualified continuing professional education program. Continuing professional education providers and educational programs also must comply with specific requirements. Providers must be an accredited educational institution, must be licensed for continuing professional education, and be recognized by the IRS as an approved provider. Educational program offerings must be current, taught by qualified instructors, and include a means of evaluating content. Additionally, the provider must issue certificates to participants upon completion of the courses. The provider is also subject to record retention rules. Golden State Tax Training Institute, Inc. is an approved education provider for the California Tax Education Council (CTEC). Our provider number is 2040 and can be verified at www.CTEC.org. Our IRS provider number is P619F and can be verified at the IRS list of Approved Continuing Education Providers. Category IRS CPE Requirement Credit Breakdown

Annual Filing Season Program (AFSP)

18 Hours per year - Voluntary

6 hours Annual Federal Tax Refresher (AFTR) Course 2 hours of Ethics 10 hours of Federal Tax Law

Enrolled Agent 72 Hours (over 3-year enrollment cycle)

Minimum of 16 hours per year (2 of which must be on ethics)

Enrolled Retirement Plan Agent 72 Hours (over 3-year enrollment cycle)

Minimum of 16 hours per year (2 of which must be on ethics)

Table 17-1- IRS CE Requirements for Tax Professionals (2017)

Annual Filing Season Program (AFSP) AFSP participants will also be included in a public database of return preparers on the IRS website. The Directory of Federal Tax Return Preparers with Credentials and Select Qualifications will include the name, city, state, zip code, and credentials of all attorneys, CPAs, enrolled agents, enrolled retirement plan agents and enrolled actuaries with a valid PTIN, as well as all AFSP – Record of Completion holders.

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Anyone who passed the Registered Tax Return Preparer test offered between November 2011 and January 2013 only needs to meet their original 15 hour continuing education requirement each year to obtain an AFSP – Record of Completion. Those who passed the RTRP test and certain other recognized national and state tests (including California and Oregon) are exempt from the six-hour Annual Federal Tax Refresher (AFTR) course with test. The AFSP is voluntary. Anyone with a preparer tax identification number (PTIN) can prepare tax returns for compensation, but continuing professional education is encouraged for all tax return preparers. To obtain an AFSP – Record of Completion a tax preparer must:

1. Take 18 hours of continuing education from IRS-Approved CE Providers, including: a. A six (6) hour Annual Federal Tax Refresher (AFTR) course that covers filing season issues and tax law

updates, as well as a knowledge-based comprehension test administered at the end of the course by the CE Provider;

b. Ten (10) hours of other federal tax law topics; and c. Two (2) hours of ethics.

2. Have an active preparer tax identification number (PTIN). 3. Consent to adhere to specific practice obligations outlined in Subpart B and section 10.51 of Treasury Department

Circular No. 230. In addition to being included in the public directory of tax return preparers, the AFSP – Record of Completion differentiates tax practitioners who have completed the program in the marketplace. The IRS launched a public education campaign encouraging taxpayers to select return preparers carefully and seek those with professional credentials or other select qualifications. After PTIN renewal season began in October of 2016, a Record of Completion was generated to the tax preparer once all requirements have been met, including renewal of his or her PTIN for 2017 and consent to the Circular 230 obligations. If the tax preparer has an online PTIN account, he or she will receive an e-mail from TaxPro_PTIN@irs.gov with instructions on how to sign the Circular 230 consent and receive his or her certificate in his or her online secure mailbox. If the tax preparer does not have an online PTIN account, he or she will receive a letter with instructions for completing the application process and obtaining his or her certificate.

The consent to certain Circular 230 requirements for the Annual Filing Season Program Record of Completion for 2017 is especially important for those who want to continue to have limited representation rights for clients whose returns they prepare after December 31, 2016.

Also, in 2016, there were changes to the representation rights of return preparers. Attorneys, CPAs, and enrolled agents will continue to be the only tax professionals with unlimited representation rights, meaning they can represent their clients on any matters including audits, payment/collection issues, and appeals. However, AFSP participants will have limited representation rights, meaning they can represent clients whose returns they prepared and signed, but only before revenue agents, customer service representatives, and similar IRS employees, including the Taxpayer Advocate Service. PTIN holders without an AFSP – Record of Completion or other professional credential will only be permitted to prepare tax returns. They will not be allowed to represent clients before the IRS. The following tax return preparers who have successfully completed one of the following national or state tests are exempt from taking the Annual Federal Tax Refresher (AFTR) course:

Anyone who passed the Registered Tax Return Preparer test administered by the IRS between November 2011 and January 2013.

Established state-based return preparer program participants with current testing requirements such as return preparers who are active members of the Oregon Board of Tax Practitioners, California Tax Education Council, and/or Maryland State Board of Individual Tax Preparers. For example, The IRS has exempted California Registered Tax Preparers (CRTP) from having to take the Annual Federal Tax Refresher (AFTR) course and passing the course’s competency examination to obtain a Record of Completion because they have already demonstrated their competency by passing a 60-hour qualifying education course and annually maintaining their continuing professional education. In addition, their California Tax Education Council (CTEC) education requirements will meet the IRS requirements. Therefore, a CRTP in good standing will have already met all of the IRS requirements of the AFSP and will have a simplified process to obtain a Record of Completion. Also, a CRTP

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was granted the authority to represent, before the IRS, clients whose returns the CRTP prepared, as long as the CRTP is properly registered with CTEC for both the year the tax return was prepared as well as the year the review takes place.

SEE Part I Test-Passers: Tax practitioners who have passed the Special Enrollment Exam Part I within the past two years as of the first day of the upcoming filing season.

VITA volunteers: Quality reviewers and instructors with active PTINs. Other accredited tax-focused credential-holders: The Accreditation Council for Accountancy and Taxation’s

Accredited Business Accountant/Advisor (ABA) and Accredited Tax Preparer (ATP) programs. To be eligible for an AFSP – Record of Completion, a return preparer must complete and pass the AFTR course and obtain their other CPE by December 31 prior to the start of the tax season. As AFTR courses are offered by CPE providers, return preparers are subject to the schedule of courses offered by these providers. In no circumstance will the AFSP – Record of Completion be issued before a return preparer has registered or renewed their PTIN for the upcoming year. Instructors It is possible to earn continuing professional education credits by serving as the instructor or discussion leader of a qualified continuing professional education program. One hour of continuing professional education credit will be awarded for each contact hour completed as an instructor, discussion leader, or speaker at an educational program. Only four hours annually can be earned from instructing by a tax return preparer. Additionally, only six hours annually can be earned from instructing by an enrolled agent or an enrolled retirement agent. A CPA who serves as an instructor, speaker or discussion leader of an approved course will be allowed CPE course credit for actual presentation time, plus actual preparation time of up to 2 hours for each hour of presentation. The maximum continuing professional education credits a CPA can earn annually for instructing a course varies by state. The program must meet all the requirements of a qualified continuing professional educational program as discussed above. Measurement All continuing professional education programs will be measured in terms of contact hours. The shortest recognized program will be one contact hour. A contact hour is 50 minutes of continuous participation in a program. Credit is granted only for a full contact hour, which is 50 minutes or multiples thereof. For example, a program lasting more than 50 minutes but less than 100 minutes will count as only one contact hour. Individual segments at continuous conferences, conventions and the like will be considered one total program. For example, two 90-minute segments (180 minutes) at a continuous conference will count as three contact hours. For university or college courses, each semester hour credit will equal 15 contact hours and a quarter hour credit will equal 10 contact hours.

Waiver from the continuing professional education requirements may be allowed for health issues, active military duty, absence from the United States and other case-by-case reasons. A request for waiver must be accompanied by documentation and can be filed no later than last day of the renewal period.

The IRS will provide notice to any person who fails to complete the continuing professional education and fee requirements. Individuals must reply within 60 days of notice to be considered for renewal. If reply is not attempted or the IRS denies renewal the individual may be placed on a roster of inactive enrolled or registered individuals. While on the inactive roster, the individual is not eligible to practice before the IRS. The individual may, within 30 days after receipt of the notice of denial of renewal, file a written protest of the denial as prescribed by the Internal Revenue Service in forms, instructions, or other appropriate guidance. A protest under Section 10.6 of Circular 230 is not governed by subpart D of Circular 230. Individuals placed in inactive status and individuals ineligible to practice before the Internal Revenue Service may not state or imply that they are eligible to practice before the Internal Revenue Service, or use the terms enrolled agent, enrolled retirement plan agent, or registered tax return preparer, the designations EA or ERPA or other form of reference to eligibility to practice before the Internal Revenue Service. An individual placed in inactive status may be reinstated to an active status by filing an application for renewal and providing evidence of the completion of all required continuing professional education hours for the enrollment cycle or registration year. An individual placed in inactive status must file an application for renewal and satisfy the requirements for renewal as set forth in this section within three years of being placed in inactive status. Otherwise, the name of such individual will be

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removed from the inactive status roster and the individual’s status as an enrolled agent, enrolled retirement plan agent, or registered tax return preparer will terminate. Future eligibility for active status must then be reestablished by the individual. An individual who no longer practices before the Internal Revenue Service may request to be placed in an inactive retirement status at any time and such individual will be placed in an inactive retirement status. The individual will be ineligible to practice before the Internal Revenue Service. An individual who is placed in an inactive retirement status may be reinstated to an active status by filing an application for renewal and providing evidence of the completion of the required continuing professional education hours for the enrollment cycle or registration year. Inactive retirement status is not available to an individual who is ineligible to practice before the Internal Revenue Service or an individual who is the subject of a pending disciplinary matter under this part. Recordkeeping Each individual applying for renewal must retain for a period of four years following the date of renewal the information required with regard to qualifying continuing professional education credit hours. Such information includes: (330)

The name of the CPE Provider organization. The location of the program. The title of the program, approval number received for the program, and copy of the program content. Written outlines, course syllabi, textbook, and/or electronic materials provided or required for the program. The date(s) attended. The credit hours claimed. The name(s) of the instructor(s), discussion leader(s), or speaker(s), if appropriate. The certificate of completion and/or signed statement of the hours of attendance obtained from the continuing

professional education provider. Continuing Professional Education Providers Continuing professional education providers must be accredited educational institutions recognized by the IRS as a professional organization, society or business. Each continuing professional education provider is required to obtain a provider number and pay applicable user fees. Requirements for qualified continuing professional education programs include:

Development by qualified individual. Current subject matter. Qualified instructors, discussion leaders and speakers. Evaluation of technical content and presentation. Certificate of completion. Maintenance of participant attendance and completion for four years.

To qualify for continuing professional education credit the course of learning must:

1. Be a qualifying continuing professional education program designed to enhance professional knowledge in Federal taxation or Federal tax related matters (programs comprised of current subject matter in Federal taxation or Federal tax related matters, including accounting, tax return preparation software, taxation, or ethics).

2. Be a qualifying continuing professional education program consistent with the Internal Revenue Code and effective tax administration.

Qualifying programs include formal and correspondence or individual self-study programs. A formal program qualifies as a continuing professional education program if it:

1. Requires attendance and provides each attendee with a certificate of attendance. 2. Is conducted by a qualified instructor, discussion leader, or speaker (in other words, a person whose background,

training, education, and experience is appropriate for instructing or leading a discussion on the subject matter of the particular program).

3. Provides or requires a written outline, textbook, or suitable electronic educational materials. 4. Satisfies the requirements established for a qualified continuing professional education program pursuant to

Section 10.9 of Circular 230.

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Qualifying continuing professional education programs include correspondence or individual self-study programs that are conducted by continuing professional education providers and completed on an individual basis by the enrolled individual. The allowable credit hours for such programs will be measured on a basis comparable to the measurement of a seminar or course for credit in an accredited educational institution. Such programs qualify as continuing professional education programs only if they:

1. Require registration of the participants by the continuing professional education provider. 2. Provide a means for measuring successful completion by the participants (for example, a written examination),

including the issuance of a certificate of completion by the continuing professional education provider. 3. Provide a written outline, textbook, or suitable electronic educational materials. 4. Satisfy the requirements established for a qualified continuing professional education program pursuant to Section

10.9 of Circular 230. Representing Oneself and Limited Practice Upon presentation of satisfactory identification, an individual may appear on their own behalf before the IRS. Additionally, subject to the limitations, an individual who is not a practitioner may represent a taxpayer before the Internal Revenue Service under the following circumstances:

An individual may represent a member of his or her immediate family. A regular full-time employee of an individual employer may represent the employer. A general partner or a regular full-time employee of a partnership may represent the partnership. A bona fide officer or a regular full-time employee of a corporation (including a parent, subsidiary, or other affiliated

corporation), association, or organized group may represent the corporation, association, or organized group. A regular full-time employee of a trust, receivership, guardianship, or estate may represent the trust, receivership,

guardianship, or estate. An officer or a regular employee of a governmental unit, agency, or authority may represent the governmental

unit, agency, or authority in the course of his or her official duties. An individual may represent any individual or entity, who is outside the United States, before personnel of the

Internal Revenue Service when such representation takes place outside the United States. An individual who is under suspension or disbarment from practice before the IRS may not participate in limited practice. Additionally, after notice, a delegate of the IRS may also deny eligibility for an individual to engage in limited practice. Return Preparation Any person that prepares or assists in preparing Federal tax returns for compensation must have a valid preparer tax identification number (PTIN) before preparing returns. Also, all enrolled agents must also have a PTIN. All PTINs expire on December 31 of each year. PTIN renewal begins approximately October 16th each year for the following year. Options for renewal include logging into your PTIN online account or by submitting a paper Form W-12 - IRS Paid Preparer Tax Identification Number (PTIN) Application with the “Renewal” box checked. If a tax preparer fails to meet the December 31st deadline his or her PTIN may be placed on inactive status. (331) As a reminder, in February 2013, the United States District Court for the District of Columbia modified its order from January 18, 2013 to clarify that the order does not affect the requirement for all paid tax return preparers to obtain a preparer tax identification number (PTIN). Consistent with this modification, the IRS has opened the online PTIN system. (332)

Subpart B Duties and Restrictions Relating to Practice Before the IRS Subpart B covers relationships between the practitioner and the IRS and the practitioner and the client. There are 19 specific rules about the relationships between the IRS and the client. In basic terms, a practitioner must submit information to the IRS if requested and must advise a client of any known omissions or errors in any filings with the IRS. Additionally, a practitioner must be diligent in their work to prevent mistakes in representations to the IRS. The fees charged by a practitioner must be reasonable. Also, a practitioner cannot withhold client records that prevent the client from complying

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with IRS filing rules. There cannot be any conflicts of interest between the client and the practitioner and in relation to conflicts of interest rules, a practitioner that prepares tax returns cannot endorse or negotiate checks issued to a client in settlement of a tax liability. (325) Information Furnished to the IRS

Information requested by the IRS is to be promptly submitted unless the practitioner has good reason to believe the information is subject to attorney/client privilege. Unreasonable delays by a practitioner are not permitted in matters before the IRS. If the requested records are not in the possession or control of the practitioner or client, the IRS must be informed and any information regarding the whereabouts of the records must be provided to the IRS.

The practitioner must make reasonable inquiries of the client regarding location of the records, but the practitioner does not have to make inquiries of any other person or verify any information provided by the client. The practitioner must also provide any information and/or testify concerning any alleged violations when questioned by a duly authorized representative of the IRS, unless the practitioner believes in good faith that the information is privileged. To the Internal Revenue Service a practitioner must:

1. On a proper and lawful request by a duly authorized officer or employee of the Internal Revenue Service, promptly submit records or information in any matter before the Internal Revenue Service unless the practitioner believes in good faith and on reasonable grounds that the records or information are privileged.

2. Where the requested records or information are not in the possession of, or subject to the control of, the practitioner or the practitioner’s client, the practitioner must promptly notify the requesting Internal Revenue Service officer or employee and the practitioner must provide any information that the practitioner has regarding the identity of any person who the practitioner believes may have possession or control of the requested records or information. The practitioner must make reasonable inquiry of his or her client regarding the identity of any person who may have possession or control of the requested records or information, but the practitioner is not required to make inquiry of any other person or independently verify any information provided by the practitioner’s client regarding the identity of such persons.

3. When a proper and lawful request is made by a duly authorized officer or employee of the Internal Revenue Service, concerning an inquiry into an alleged violation of the regulations in this part, a practitioner must provide any information the practitioner has concerning the alleged violation and testify regarding this information in any proceeding instituted under this part, unless the practitioner believes in good faith and on reasonable grounds that the information is privileged.

A practitioner may not interfere, or attempt to interfere, with any proper and lawful effort by the Internal Revenue Service, its officers or employees, to obtain any record or information unless the practitioner believes in good faith and on reasonable grounds that the record or information is privileged. Client Omissions If a practitioner knows that a client has made an error or has omitted information from any return, document, affidavit, or other submitted documents, the practitioner must promptly advise the client of the omission or error and the consequences. Due diligence must be exercised by the practitioner in preparing documents and oral and/or written representations to be submitted to the IRS. When relying on the work of others, it is presumed that the practitioner has exercised due care in the oversight of the work of others. Accuracy A practitioner must apply due diligence to assure accuracy when:

Preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters.

Determining the correctness of oral or written representations made by the practitioner to the Department of the Treasury.

Determining the correctness of oral or written representations made by the practitioner to clients with reference to any matter administered by the Internal Revenue Service.

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A practitioner will be presumed (except for certain circumstances) to have exercised due diligence for purposes of Section 10.22 of Circular 230 if the practitioner relies on the work product of another person and the practitioner used reasonable care in engaging, supervising, training, and evaluating the person, taking proper account of the nature of the relationship between the practitioner and the person. A practitioner who knows that his or her client has not complied with the revenue laws or has made an error or omission in any return, document, affidavit, or other required paper, has the responsibility to advise the client promptly of the noncompliance, error, or omission. The practitioner also must advise the client of any consequences as provided under the IRC and regulations of such noncompliance, error, or omission. Under Circular 230, the practitioner is not required to notify the IRS. Prompt Disposition of Pending Matters A practitioner may not unreasonably delay the prompt disposition of any matter before the Internal Revenue Service. Disbarred/Suspended, Former IRS Employees Practitioners cannot accept any help or provide assistance to other practitioners that are disbarred or suspended from practice before the IRS. Assistance from former IRS employees is not allowed when Federal law will be violated or when rules regarding practice by former government employees, their partners and their associates will be violated. Former Government Employees Former government employees are limited in their practice to ensure that no conflicts or undue influence arise. Specifically, former government employees:

Cannot represent or assist, in any particular matter, any person who is or was a specific party to that particular matter in which the practitioner participated while a government employee.

Cannot represent anyone in any matter before the IRS if the representation would violate the law. Who had official responsibility during the last year of government employment for a particular matter involving

specific parties may not represent in that particular matter any person who is or was a specific party to that particular matter within two years subsequent to employment.

Cannot, within one year subsequent to employment, influence any employee of the Treasury Department regarding rules of the Treasury Department for which the former employee had responsibility.

When the former government employee is a member of a firm which represent clients before the IRS, the former government employee must be isolated from matters in which he or she participated in while a government employee. Notaries A practitioner cannot perform any official act as a notary in regards to any matter overseen by the IRS. A notary is also excluded from acting as a notary for any matter for which he or she is employed as counsel, attorney or agent. Fees A practitioner’s fee must be reasonable in matters before the IRS. Contingent fees are only allowed when the IRS is examining or challenging an original tax return; an amended return, claim for a refund or credit where the amended return or claim was filed within 120 days of taxpayer receipt of an IRS examination notice. Contingent fees are also allowed for services to a client in connection with the determination of interest or penalties assessed by the Service and for services provided with any judicial proceeding arising under the IRC. Return of Client’s Records Upon request, a practitioner must promptly return any and all client records required for Federal tax obligation compliance (unless applicable state law provides otherwise). The practitioner may keep copies of the returned records. IRC Section 6107(b) requires a practitioner to retain a copy or list of a return or claim for the period ending 3 years after the close of the return.

The existence of a fee dispute generally does not relieve the practitioner of the responsibility to return client records.

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Conflict of Interest According to Circular 230, a conflict of interest exists if:

1. The representation of one client will be directly adverse to another client. 2. There is a significant risk that the representation of one or more clients will be materially limited by the practitioner’s

responsibilities to another client, a former client or a third person, or by a personal interest of the practitioner. However, if a practitioner believes a competent representation that is not prohibited by law is reasonable, each of the affected clients can waive the conflict of interest and give informed consent, confirmed in writing, at the time the existence of the conflict of interest is known by the practitioner. The confirmation may be made within a reasonable period of time after the informed consent, but in no event later than 30 days.

Copies of the written consents must be retained by the practitioner for at least 36 months from the date of the conclusion of the representation of the affected clients, and the written consents must be provided to any officer or employee of the Internal Revenue Service on request.

Solicitation There are several rules regarding advertising and solicitation of business. In general, an advertisement or solicitation cannot be false, fraudulent, coercive, misleading or deceptive. An example of a business name that is misleading is “Pay Less Tax Service.” Additionally, enrolled agents cannot use the term certified or give the impression of an employee relationship with the IRS. Allowed fee arrangements used in solicitations include: fixed fees, hourly rates, a range of fees for services, fees charged for an initial consultation. The method of communicating the fee information must not be deceptive. A copy of direct mail and e-commerce communications must be retained by the practitioner for 36 months from the date of last use. Negotiation of Taxpayer Checks A practitioner who prepares tax returns may not endorse or otherwise negotiate any check (including directing or accepting payment by any means, electronic or otherwise into an account owned or controlled by the practitioner or any firm or other entity with whom the practitioner is associated) issued to a client by the government in respect to a Federal tax liability. Practice of Law Treasury Department Circular 230 should not be construed as an authorization for persons not members of the bar to practice law. Therefore, nothing in the regulations in the circular may be construed as authorizing persons not members of the bar to practice law. Best Practices Tax advisors should provide their clients with the highest quality representation concerning Federal tax issues by adhering to best practices in providing advice and in preparing or assisting in the preparation of a submission to the Internal Revenue Service. In addition to compliance with the standards of practice provided elsewhere in this part, best practices include the following: (333)

1. Communicating clearly with the client regarding the terms of the engagement. For example, the advisor should determine the client’s expected purpose for and use of the advice and should have a clear understanding with the client regarding the form and scope of the advice or assistance to be rendered.

2. Establishing the facts, determining which facts are relevant, evaluating the reasonableness of any assumptions or representations, relating applicable law (including potentially applicable judicial doctrines) to the relevant facts, and arriving at a conclusion supported by the law and the facts.

3. Advising the client regarding the import of the conclusions reached, including, for example, whether a taxpayer may avoid accuracy-related penalties under the Internal Revenue Code if a taxpayer acts in reliance on the advice.

4. Acting fairly and with integrity in practice before the Internal Revenue Service.

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Tax Returns and Documents Standards A tax preparer cannot willfully sign a tax return or advise a client knowing that the return, documentation, or other submitted papers lack a reasonable basis, or is an unreasonable position, or is a willful attempt to understate the tax liability or a reckless disregard of rules by the preparer. A practitioner may not advise a client to take a frivolous tax position on any document, affidavit or other submitted papers or to impede the administration of Federal tax law.

Any penalties that are likely to be applied must be communicated to the client by the practitioner if the practitioner advised the client with respect to the position, prepared or signed the tax return or any other document submitted to the IRS. The practitioner can rely on information provided by the client without verification, but the practitioner may not ignore implications of information furnished that appears to be incorrect or inconsistent with other factual assumptions. A practitioner advising a client to take a position on a tax return, document, affidavit or other paper submitted to the Internal Revenue Service, or preparing or signing a tax return as a preparer, generally may rely in good faith without verification upon information furnished by the client. The practitioner may not, however, ignore the implications of information furnished to, or actually known by, the practitioner, and must make reasonable inquiries if the information as furnished appears to be incorrect, inconsistent with an important fact or another factual assumption, or incomplete. Competence Section 10.35 previously titled Covered Opinions has been eliminated and a complete new section has been added. Tax practitioners will no longer need to follow a separate set of standards regarding covered opinions when providing written advice to their clients. Section 10.35 now states a practitioner must possess the necessary competence to engage in practice before the Internal Revenue Service. Competent practice requires the appropriate level of knowledge, skill, thoroughness and preparation necessary for the matter for which the practitioner is engaged. A practitioner may become competent for the matter for which the practitioner has been engaged through various methods, such as consulting with experts in the relevant area or studying the relevant law. Also, extensive changes to wording and terminology are reflected in Section 10.36 including the text that an individual who has the principal authority and responsibility for overseeing the firm’s practice must now take reasonable steps to ensure that adequate procedures are in place for all members, associates or employees of the firm to comply with Circular 230. The term “individual” has replaced the term practitioner.

Many individuals currently use a Circular 230 disclaimer at the conclusion of every e-mail or other writing to remove the communication from the covered opinion rules in former Section 10.35. In many instances, these disclaimers are inserted without regard to whether the disclaimer is necessary or appropriate. These types of disclaimers are routinely inserted in any written transmission, including writings that do not contain any tax

advice. The removal of former Section 10.35 eliminates the detailed provisions concerning covered opinions and disclosures in written opinions. Because amended Section 10.37 does not include the disclosure provisions in the current covered opinion rules, Treasury and the IRS expect that these amendments will eliminate the use of a Circular 230 disclaimer in e-mail and other writings. These rules do not, however, prohibit the use of an appropriate statement describing any reasonable and accurate limitations of the advice rendered to the client. Written Advice Section 10.37, requirements for written advice, has been extensively revised. Keys areas of change include a definition of a “Federal tax matter” as any matter concerning the application or interpretation of a revenue provision or law impacting a person’s obligation to comply with the Federal tax law in addition to the obligation to file Federal tax returns and comply with any other law or regulation under the IRS umbrella. A Federal tax matter, as used in Section 10.37, is any matter concerning the application or interpretation of:

1. A revenue provision as defined in Section 6110(i)(1)(B) of the Internal Revenue Code. 2. Any provision of law impacting a person’s obligations under the internal revenue laws and regulations, including

but not limited to the person’s liability to pay tax or obligation to file returns. 3. Any other law or regulation administered by the Internal Revenue Service.

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Final Section 10.37 replaces the covered opinion rules with principles to which all practitioners must adhere when rendering written advice. Specifically, Section 10.37 states affirmatively the standards to which a practitioner must adhere when providing written advice on a Federal tax matter.

Section 10.37 requires, among other things, that the practitioner:

1. Base the written advice on reasonable factual and legal assumptions (including assumptions as to future events). 2. Reasonably consider all relevant facts and circumstances that the practitioner knows or reasonably should know. 3. Use reasonable efforts to identify and ascertain the facts relevant to written advice on each Federal tax matter. 4. Not rely upon representations, statements, findings, or agreements (including projections, financial forecasts, or

appraisals) of the taxpayer or any other person if reliance on them would be unreasonable. 5. Relate applicable law and authorities to facts. 6. Not, in evaluating a Federal tax matter, take into account the possibility that a tax return will not be audited or that

a matter will not be raised on audit.

Also the revised Section 10.37 does not require that the practitioner describe in the written advice the relevant facts (including assumptions and representations), the application of the law to those facts, and the practitioner's conclusion with respect to the law and the facts. Rather, the scope of the engagement and the type and specificity of the advice sought by the client, in addition to all other appropriate facts and circumstances, are factors in determining the extent to which the relevant facts, application of the law to those facts, and the practitioner’s conclusion with respect to the law and the facts must be set forth in the written advice. Also, under the revised Section 10.37, the practitioner may consider these factors in determining the scope of the written advice. Further, the determination of whether a practitioner has failed to comply with the requirements of Section 10.37 will be based on all facts and circumstances, not on whether each requirement is addressed in the written advice. Additionally, a section on a Standard of Review has been included and states in evaluating whether a practitioner giving written advice concerning one or more Federal tax matters complied with the requirements of this section, the Commissioner, or delegate, will apply a reasonable practitioner standard, considering all facts and circumstances, including, but not limited to, the scope of the engagement and the type and specificity of the advice sought by the client. In the case of an opinion the practitioner knows or has reason to know will be used or referred to by a person other than the practitioner (or a person who is a member of, associated with, or employed by the practitioner's firm) in promoting, marketing, or recommending to one or more taxpayers a partnership or other entity, investment plan or arrangement a significant purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code, the Commissioner, or delegate, will apply a reasonable practitioner standard, considering all facts and circumstances, with emphasis given to the additional risk caused by the practitioner's lack of knowledge of the taxpayer's particular circumstances, when determining whether a practitioner has failed to comply with this section. Reliance Opinions Written advice is a reliance opinion if the advice concludes at a confidence level of “at least more likely than not” (a greater than 50% likelihood) that one or more significant Federal tax issues would be resolved in the taxpayer’s favor. Marketed Opinions Written advice is a marketed opinion if the practitioner knows or has reason to know that the written advice will be used or referred to by a person other than the practitioner (or a person who is a member of, associated with, or employed by the practitioner’s firm) in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to one or more taxpayer(s). Compliance In Section 10.36, the regulations impose demanding oversight responsibilities on those individuals with principal authority and responsibility for overseeing a firm’s practice governed by Circular 230 to manage Circular 230 compliance by all members, associates and employees. The final regulations specifically provide that the tax practice managers not only must ensure that the firm has adequate procedures in place but must ensure that those procedures are properly followed. Any such individual who has (or such individuals who have or share) principal authority as described above will be subject to discipline for failing to comply with the requirements of this section if: (333)

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The individual through willfulness, recklessness, or gross incompetence does not take reasonable steps to ensure that the firm has adequate procedures to comply with this part, as applicable, and one or more individuals who are members of, associated with, or employed by, the firm are, or have, engaged in a pattern or practice, in connection with their practice with the firm, of failing to comply with this part, as applicable.

The individual through willfulness, recklessness, or gross incompetence does not take reasonable steps to ensure that firm procedures in effect are properly followed, and one or more individuals who are members of, associated with, or employed by, the firm are, or have, engaged in a pattern or practice, in connection with their practice with the firm, of failing to comply with this part, as applicable.

The individual knows or should know that one or more individuals who are members of, associated with, or employed by, the firm are, or have, engaged in a pattern or practice, in connection with their practice with the firm, that does not comply with this part, as applicable, and the individual, through willfulness, recklessness, or gross incompetence fails to take prompt action to correct the noncompliance.

Although Circular 230 expressly applies only to those who practice before the IRS, the regulations advocate that the IRS is, at a minimum, encouraging firm management to oversee the tax compliance not just of its partners who practice before the IRS but of all of its members, associates and employees. In the absence of a firm designating responsibility for oversight to particular persons, the IRS may identify such person or persons. Advisory Committees To promote and maintain the public’s confidence in tax advisors, the Internal Revenue Service is authorized to establish one or more advisory committees composed of at least six individuals authorized to practice before the Internal Revenue Service. Membership of an advisory committee must be balanced among those who practice as attorneys, accountants, enrolled agents, enrolled actuaries, enrolled retirement plan agents and registered tax return preparers. Subpart C Sanctions for Violation of the Regulations The Secretary of the Treasury, or delegate, has the authority to disbar or censure a practitioner from practice before the IRS for violations of the rules or for misleading clients or potential clients. Additionally, the authority extends to imposing monetary penalties on the practitioner or on the practitioner’s employer if the employer was responsible for the infraction. The amount of any monetary penalty is not to be greater that the gross income derived from the conduct giving rise to the penalty. Examples of incompetence and disreputable conduct include: (333)

Conviction of any criminal offense under the Federal tax laws. Conviction of any criminal offense involving dishonesty or breach of trust. Conviction of any felony under Federal or State law for which the conduct involved renders the practitioner unfit

to practice before the Internal Revenue Service. Giving false or misleading information to the Department of the Treasury. The use of false or misleading representations with intent to deceive a client or prospective client in order to

procure employment. Willfully failing to make a Federal tax return in violation of the Federal tax laws. Willfully assisting, counseling, encouraging a client or prospective client in violating, or suggesting to a client or

prospective client to violate, any Federal tax law, or knowingly counseling or suggesting to a client or prospective client an illegal plan to evade Federal taxes or payment.

Misappropriation of, or failure properly or promptly to remit, funds received from a client for the purpose of payment of taxes or other obligations due the United States.

Directly or indirectly attempting to influence, or providing or agreeing to attempt to influence, the official action of any officer or employee of the Internal Revenue Service by the use of threats, false accusations, duress or coercion, by providing any special inducement or promise of an advantage or by the bestowing of any gift, favor or thing of value.

Disbarment or suspension from practice as an attorney, certified public accountant, public accountant, or actuary by any duly constituted authority of any State, territory, or possession of the United States.

Knowingly aiding and abetting another person to practice before the Internal Revenue Service during a period of suspension, disbarment or ineligibility of such other person.

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Contemptuous conduct in connection with practice before the Internal Revenue Service, including the use of abusive language, making false accusations or statements, knowing them to be false, or circulating or publishing malicious or libelous matter.

Giving a false opinion, knowingly, recklessly, or through gross incompetence, including an opinion which is intentionally or recklessly misleading, or engaging in a pattern of providing incompetent opinions on questions arising under the Federal tax laws.

Willfully failing to sign a tax return prepared by the practitioner when the practitioner’s signature is required by Federal tax laws unless the failure is due to reasonable cause and not due to willful neglect.

Willfully disclosing or otherwise using a tax return or tax return information in a manner not authorized by the Internal Revenue Code.

Willfully failing to file on magnetic or other electronic media a tax return prepared by the practitioner when the practitioner is required to do so by the Federal tax laws unless the failure is due to reasonable cause and not due to willful neglect.

Willfully preparing all or substantially all of, or signing, a tax return or claim for refund when the practitioner does not possess a current or otherwise valid preparer tax identification number or other prescribed identifying number.

Willfully representing a taxpayer before an officer or employee of the Internal Revenue Service unless the practitioner is authorized to do so pursuant to this part.

Disciplinary Proceedings “Practitioner” is Circular 230's collective term for individuals who are eligible to practice before the IRS: attorneys, certified public accountants, enrolled agents, enrolled actuaries, and enrolled retirement plan agents. Practitioners who fail to comply with any of Circular 230's regulations are subject to the sanctions of private reprimand, public censure, suspension or disbarment from practice before the IRS, and imposition of a monetary penalty. Appraisers are individuals who present evidence or testimony in administrative proceedings before the IRS or the Department of the Treasury. Appraisers who violate applicable Circular 230 rules are subject to disqualification from presenting testimony or evidence. Employers, firms, and other entities which knew or should have known that a practitioner acting on their behalf engaged in misconduct subject to discipline under Circular 230 are subject to a monetary penalty. (334) Receipt of Information Concerning Practitioner If an officer or employee of the Internal Revenue Service has reason to believe a practitioner has violated any provision of Circular 230, the officer or employee will promptly make a written report of the suspected violation to the Director of the Office of Professional Responsibility (OPR). The report will explain the facts and reasons upon which the officer’s or employee’s belief rests and must be submitted to the office(s) of the Internal Revenue Service responsible for administering or enforcing the action. Any person other than an officer or employee of the Internal Revenue Service having information of a violation of any provision of this part may make an oral or written report of the alleged violation to the office(s) of the Internal Revenue Service responsible for administering or enforcing the action or any officer or employee of the Internal Revenue Service. If the report is made to an officer or employee of the Internal Revenue Service, the officer or employee will make a written report of the suspected violation and submit the report to the office(s) of the Internal Revenue Service responsible for administering or enforcing Circular 230. No report described above shall be maintained unless retention of the report is permissible under the applicable records control schedule as approved by the National Archives and Records Administration and designated in the Internal Revenue Manual. Reports must be destroyed as soon as permissible under the applicable records control schedule. The destruction of any report will not bar any proceeding under subpart D of this part, but will preclude the use of a copy of the report in a proceeding under subpart D of Circular 230.

Please see the Internal Revenue Code, corresponding Treasury Regulations, and other related published guidance for additional information on each penalty section.

Institution of Proceeding Whenever it is determined that a practitioner (or employer, firm or other entity, if applicable) violated any provision of the

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laws governing practice before the Internal Revenue Service or the regulations in Subpart C, the practitioner may be reprimanded or, in accordance with Section 10.62 - Contents of Complaint, subject to a proceeding for sanctions. (333) Whenever a penalty has been assessed against an appraiser under the Internal Revenue Code and an appropriate officer or employee in an office established to enforce this part determines that the appraiser acted willfully, recklessly, or through gross incompetence with respect to the proscribed conduct, the appraiser may be reprimanded or, in accordance with Section 10.62 - Contents of Complaint, subject to a proceeding for disqualification. A proceeding for disqualification of an appraiser is instituted by the filing of a complaint, the contents of which are more fully described in Section 10.62 - Contents of Complaint. The proceeding for a violation of Circular 230 regulations is instituted when the IRS representative signs a complaint naming the attorney, CPA, registered tax return preparer, enrolled agent, or enrolled actuary, and files the complaint with the Administrative Law Judge (ALJ). Except as provided elsewhere, a proceeding will not be instituted under Circular 230 unless the proposed respondent previously has been advised in writing of the law, facts and conduct warranting such action and has been accorded an opportunity to dispute facts, assert additional facts, and make arguments. (333)

Subpart D Rules Applicable to Disciplinary Proceedings Subpart D of Circular 230 covers details of disciplinary hearings and their procedures. Once a complaint is made against a practitioner, a hearing is held to determine the merits of the compliant. This subpart of the circular outlines the contents of a compliant, how the compliant is processed and filed, and how the practitioner is to respond to the compliant. Ultimately, the compliant can be argued in front of an Administrative Law Judge with jurisdiction over these matters. The Office of Professional Responsibility (OPR) has exclusive authority for all matters related to practitioner discipline, including disciplinary proceedings and sanctions. (See Circular 230, Section 10.1 – Offices). OPR is committed to processing referrals and conducting investigations in a timely and fair manner. The investigative process and disciplinary proceedings follow established due process guidelines designed to ensure that practitioners receive notice of the allegations against them and an opportunity to present their side of the story at multiple stages. (335) OPR receives referrals about practitioners from a variety of sources. The majority of referrals come directly from IRS field personnel, such as Revenue Agents, Revenue Officers, Special Agents and Appeals/Settlement Officers. OPR also receives referrals from other government agencies, such as the Treasury Inspector General for Tax Administration (TIGTA), the Department of Justice and state licensing authorities. An OPR manager reviews all referrals when they arrive in OPR. If it appears that a violation of Circular 230 has occurred, the manager will assign the case to an attorney or paralegal for communication with the referred individual and for further investigation. (335) If it is determined a practitioner violated any laws governing practice before the IRS, the practitioner may be reprimanded or sanctioned. Whenever a penalty assessed against a practitioner demonstrates willful, reckless or gross incompetence, the practitioner may be subject to disqualification. A conference with the practitioner may occur concerning allegations of misconduct. Rather than proceeding, a practitioner may provide consent for sanction under Subpart C of the Circular 230. It is up to the discretion of the OPR delegate to accept or decline the voluntary sanction. (325) Complaint A complaint must be served by certified mail, first class mail, a private delivery service, in person or other means agreed to by the respondent. The complaint must provide the following contents to the practitioner:

Clear and concise description of the facts and law that constitute the proceeding. Specific sanction sought. Time for answering the complaint.

The time for answering a complaint cannot be less than 30 days from the date of service of the complaint and must include the address of the Administrative Law Judge and the name and address of the IRS representative. (325)

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Answer The practitioner’s answer must be filed with the Administrative Law Judge and served on the Internal Revenue Service within the time specified in the complaint. The answer must provide the following contents:

Grounds of Defense (general denials are not permitted). Admission or denial of each allegation. Acknowledging statement and signature.

Every allegation in the complaint that is not denied in the answer is deemed admitted and will be considered proved; no further evidence in respect of such allegation need be adduced at a hearing. Failure to file an answer within the time prescribed (or within the time for answer as extended by the Administrative Law Judge), constitutes an admission of the allegations of the complaint and a waiver of hearing, and the Administrative Law Judge may make the decision by default without a hearing or further procedure. OPR encourages the practitioner to submit any evidence that will aid in resolving the issue as early as possible in the investigative stage. If the matter proceeds to an administrative hearing, the judge does not have to admit evidence that is brought before the court at the last minute. (335) Hearing An evidentiary hearing must be held in all proceeding prior to the issuance of a decision. All hearings will be recorded and transcribed. The testimony of witnesses will be taken under oath or affirmation. Proceedings are conducted by an Administrative Law Judge (ALJ). The Administrative Law Judge (ALJ) has the authority to do the following: (325)

Administer oaths and affirmations. Make rulings on motions and requests, which rulings may not be appealed prior to the close of a hearing except

in extraordinary circumstances and at the discretion of the Administrative Law Judge (ALJ). Determine the time and place of the hearing and regulate its course and conduct. Adopt rules of procedure and modify the same from time to time as needed for the orderly disposition of

proceedings. Rule on offers of proof, receive relevant evidence, and examine witnesses. Take or authorize the taking of depositions or answers to requests for admission. Receive and consider oral or written argument on facts or law. Hold or provide for the holding of conferences for the settlement or simplification of the issues with the consent of

the parties. Perform such acts and take such measures as are necessary or appropriate to the efficient conduct of any

proceeding. Make decisions.

Decision Within 180 days after the conclusion of a hearing the Administrative Law Judge should enter a decision in the case. A copy of the decision will be provided to the Internal Revenue Service’s representative and to the respondent. In the absence of an appeal or further proceedings, after 30 days it becomes the decision of the agency. When the final decision in a case is against the respondent the following effects may apply: (325)

Disbarment - the practitioner will not be allowed to practice before the IRS unless and until authorized to do so. Suspension - the practitioner will not be allowed to practice before the IRS during the suspension period. Censure - the practitioner will be permitted to practice before the IRS but may be subject to conditions.

In general, a disbarred practitioner may petition for reinstatement five years following disbarment, suspension or disqualification (or immediately following the expiration of the suspension or disqualification period, if shorter than 5 years). Reinstatement will not be granted unless the Internal Revenue Service is satisfied that the petitioner is not likely to engage thereafter in conduct contrary to the regulations in this part, and that granting such reinstatement would not be contrary to the public interest. Suspension or Disbarment Under Section 10.79 of Circular 230, when a final agency decision results in suspension or disbarment of a

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practitioner/respondent or when the practitioner/respondent has provided his or her consent to suspension or disbarment and such consent has been accepted by the Director of OPR, the practitioner/respondent will not be permitted to practice before the IRS for the period of time imposed by the final agency decision or as agreed to by consent. A suspended or disbarred individual may not: (336)

1. Prepare or file documents (including tax returns) or other correspondence with the IRS. The restriction applies regardless of whether the individual signs the document or correspondence and regardless of whether the individual personally files, or directs another person to file, documents or correspondence with the IRS. Also, as a result of a suspension or disbarment, the individual will have any preparer tax identification number (PTIN) revoked.

2. Render written advice with respect to any entity, transaction, plan or arrangement, or other plan or arrangement having a potential for tax avoidance or evasion. The prohibition applies regardless of whether the written advice is a part of a larger document or a component of a set of documents and regardless of whether the individual signs the written advice.

3. Represent a client at conferences, hearings, and meetings. The prohibition applies to all forms of conferences, hearings, and meetings, including those conducted person-to-person or by telephone or by teleconferencing facilities. The prohibition bars the individual from representing the taxpayer, that is, from advocating, disputing, arguing, or otherwise negotiating on the taxpayer's behalf with respect to the taxpayer's rights, privileges, or liabilities under laws or regulations administered by the Internal Revenue Service, including provisions outside Title 26 which have been delegated to the Commissioner by the Treasury Secretary or Congress (e.g., foreign bank account reporting; health care insurance premium provisions). The prohibition applies regardless of whether the taxpayer is a paying client and also applies to all of the limited forms of practice defined in Section 10.7(c). The prohibition does not affect a taxpayer's right to the services of the individual as a witness or any right of the taxpayer to be accompanied by the individual to conferences, hearings, or meetings. However, OPR will consider any instances of the individual's advocating or negotiating on the taxpayer's behalf at conferences, hearings, or meetings, to be attempted practice in violation of the individual's suspended or disbarred status.

4. Execute waivers, consents, or closing agreements; receive a taxpayer's refund check; or sign a tax return on behalf of a taxpayer. Because these acts require the filing of a power of attorney authorizing the representative to perform these acts, they are considered to be practice before the IRS. See Section 601.504(a) of the IRS Conference and Practice Requirements, which are in 26 C.F.R. Sections 601.501 through 601.509 and are also in pamphlet form as Publication 216 - Conference and Practice Requirements.

5. File powers of attorney with the IRS. OPR will consider the filing of a power of attorney appointing an individual as a representative who is under suspension or disbarment to be an attempt to practice in violation of the individual's suspended or disbarred status. An individual who seeks to practice before the IRS must declare (usually on Form 2848 - Power of Attorney and Declaration of Representative) that he or she is not under suspension or disbarment from practice before the IRS. OPR will refer false declarations to the Treasury Inspector General for Tax Administration.

6. Accept assistance from another person (or request assistance) or assist another person (or offer assistance) if the assistance relates to a matter constituting practice before the IRS, or enlist another person for the purpose of aiding and abetting practice before the IRS. Sections 10.24(a) and 10.51(a)(11) prohibit individuals who are eligible to practice before the IRS from accepting assistance from, or assisting, or aiding or abetting a suspended or disbarred individual in matters constituting practice. OPR will consider both a suspended or disbarred individual and any other individual's/firm's participation in such relationships to be in violation of Sections 10.24(a) and 10.51(a)(11) and evidence of disreputable conduct under Section 10.51(a).

7. State or imply that he or she is eligible to practice before the IRS. OPR will consider such express or implied statements to be false, misleading, or deceptive, and to constitute a violation of Section 10.30. In addition, under Section 10.6(j)(4), individuals may not use the terms enrolled agent, enrolled retirement plan agent, or registered tax return preparer, the designation EA or ERPA, or other form of reference to eligibility to practice before the IRS while disbarred, suspended, or in inactive status. These prohibitions apply to business cards, business stationary, and websites.

A suspended or disbarred individual may: (336)

1. Represent him or herself with respect to any matter. Authorized under Section 10.7(a). 2. Appear before the IRS as a trustee, receiver, guardian, administrator, executor, or other fiduciary if duly

qualified/authorized under the law of the relevant jurisdiction. Authorized under Section 10.7(e). Fiduciaries should file Form 56 - Notice Concerning Fiduciary Relationship.

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3. Appear as a witness for the taxpayer. Authorized under Section 10.8(b) and Revenue Procedure 68-29, reprinted in pamphlet form as Publication 499. A witness is limited to providing factual information, and he or she may not advocate particular positions on issues or controversies arising during a tax examination.

4. Furnish information at the request of the IRS or any of its officers or employees. Authorized under Section 10.8(b). 5. Receive information concerning a taxpayer from the IRS pursuant to a valid tax information authorization. A

suspended or disbarred individual's appointment on Form 8821 - Tax Information Authorization, entitles him or her to receive taxpayer information but does not entitle him or her to practice before the IRS on behalf of that taxpayer.

Notice of Disbarment, Suspension, Censure, or Disqualification On the issuance of a final order censuring, suspending, or disbarring a practitioner or a final order disqualifying an appraiser, notification of the censure, suspension, disbarment or disqualification will be given to appropriate officers and employees of the Internal Revenue Service and interested departments and agencies of the Federal government. The Internal Revenue Service may determine the manner of giving notice to the proper authorities of the State by which the censured, suspended, or disbarred person was licensed to practice. Appeal from Administrative Decision Both OPR and the practitioner have the right to appeal the Initial Decision and Order of the ALJ to the Department of the Treasury within 30 days of being served. A specially designated senior attorney (called the Appellate Authority) within The Department of Treasury’s Office of Chief Counsel reviews the appeals and accompanying briefs and renders the Final Agency Decision in the case (See Circular 230, Section 10.77). Filing Suit in U.S. Federal District Court If the practitioner disagrees with the Appellate Authority’s Final Agency Decision, he or she may file a complaint against the OPR in U.S. Federal District Court in the district where he or she resides. The Administrative Procedure Act contains provisions governing that proceeding (See 5 USC Sections 551-559, 702). The proceeding will not be a new trial. Rather, the district court will review the entire administrative record already in existence in the case to determine if the agency’s action against the practitioner was arbitrary, capricious, contrary to law or otherwise an abuse of discretion. (335) Final Agency Decisions in Disciplinary Cases Final regulations issued under Circular 230 on September 26, 2007 allowed the Office of Professional Responsibility (OPR) to publish decisions on its cases, once they become final agency decision. A decision becomes the final agency decision at one of two points: (337)

1. After an Administrative Law Judge issues a decision and either party has not appealed the decision to the Secretary of the Treasury or his designee within 30 days.

2. After the Secretary of the Treasury or his designee has issued his or her decision. Although the practitioner may further appeal the decision of the Secretary of the Treasury to the Federal District Court, the decision may be made public, and the term of any suspension or disbarment will begin at that point.

Petition For Reinstatement In general, a practitioner disbarred or suspended under Section 10.60, or suspended under Section 10.82, or a disqualified appraiser may petition for reinstatement before the Internal Revenue Service after the expiration of 5 years following such disbarment, suspension, or disqualification (or immediately following the expiration of the suspension or disqualification period, if shorter than 5 years). Reinstatement will not be granted unless the Internal Revenue Service is satisfied that the petitioner is not likely to engage thereafter in conduct contrary to the regulations in this part, and that granting such reinstatement would not be contrary to the public interest. Expedited Suspension

Circular 230 Section 10.82 authorizes the immediate suspension of a practitioner engaged in certain prohibited conduct, but the revised final regulations extend the expedited disciplinary proceedings against practitioners who have “willfully failed to comply with their Federal tax filing obligations”.

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The regulations state that a pattern of willful disreputable conduct would be defined as failing to file an annual Federal tax return in four of the five tax years immediately before an expedited suspension proceeding or failing to file a return required more frequently than annually in five of seven tax periods immediately before a suspension proceeding. Also, Section 10.82 has been expanded as to the categories where an expedited proceeding would apply.

Subpart E General Provisions Subpart E contains general provisions relating to the availability of official records. The IRS maintains records for public inspection with various rosters which include:

Individuals (and employers, firms, or other entities, if applicable) censured, suspended, or disbarred from practice before the Internal Revenue Service or upon whom a monetary penalty was imposed.

Enrolled agents and inactive enrolled agents. Enrolled retirement plan agents and those in inactive status. Tax return preparers and those in inactive status. Disqualified appraisers. Qualified continuing professional education providers, including providers:

o Who have obtained a qualifying continuing professional education provider number. o Whose qualifying continuing professional education number has been revoked for failure to comply with

the requirements of this part of Circular 230. The Internal Revenue Service will also maintain and make available for public inspection in the time and manner prescribed by the Secretary, or delegate, other records of the Director of the Office of Professional Responsibility that may be disclosed upon specific request, in accordance with the applicable law. Saving Provision

Any proceeding instituted under Circular 230 prior to June 12, 2014, for which a final decision has not been reached or for which judicial review is still available is not affected by the Circular 230 revisions. Any proceeding based on conduct engaged in prior to June 12, 2014, which is instituted after that date, will apply subpart D and

E as revised, but the conduct engaged in prior to the effective date of these revisions will be judged by the regulations in effect at the time the conduct occurred.

Individual Income Tax Penalties Accuracy Related Penalties The 20% accuracy related penalty is imposed on the underpayment of tax due to:

1. Negligence or disregard of rules or regulations. 2. Substantial understatement of tax. 3. Substantial valuation misstatement (increased to 40% for gross valuation misstatement). 4. Transaction lacking economic substance (increased to 40% for undisclosed transaction lacking economic

substance). 5. Undisclosed foreign financial asset understatement (40% in all cases).

The two most common accuracy related penalties are the substantial understatement penalty and the negligence or disregard of the rules or regulations penalty. These penalties are calculated as a flat 20% of the net understatement of the tax. (315) Substantial Understatement The understatement is substantial if it is more than 10% of the correct tax or $5,000. To properly disclose the position, complete and attach IRS Form 8275 - Disclosure Statement to the tax return and disclose all relevant facts. As of December 31, 2015, if the taxpayer fails to report a substantial amount of income, then the IRS has 6 years (instead of 3 years) to create an audit assessment. In this case, the taxpayer must have failed to report 25% or more of his or her total income. (315)

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The taxpayer may avoid the substantial understatement penalty if he or she has substantial authority for his or her tax treatment of the item or through adequate disclosure. To avoid the substantial understatement penalty by adequate disclosure, the taxpayer must properly disclose the position on the tax return and there must at least be a reasonable basis for the position. To properly disclose the position, the taxpayer completes and attaches IRS Form 8275 - Disclosure Statement to his or her tax return and discloses all relevant facts. A reasonable basis is a relatively high standard of tax reporting, that is, significantly higher than not frivolous or not patently improper. The position must be more than just merely arguable or merely a colorable claim. The position must be reasonably based on authority supporting the position. Negligence or Disregard of the Rules Negligence includes (but is not limited to) any failure to: (315)

Make a reasonable attempt to comply with the internal revenue laws. Exercise ordinary and reasonable care in preparation of a tax return. Keep adequate books and records or to substantiate items properly.

This penalty may be asserted if the taxpayer carelessly, recklessly or intentionally disregards IRS rules and regulations - by taking a position on his or her return with little or no effort to determine whether the position is correct or knowingly taking a position that is incorrect. The taxpayer will not have to pay a negligence penalty if there was a reasonable cause for a position he or she took and he or she acted in good faith. Negligence includes any failure to make reasonable attempts to comply with the tax code. The understatement of tax is considered substantial if the taxpayer understates his or her income by more than 10% or $5,000.00. Failure to File Penalties The failure to file penalty is assessed for each month or partial month from the date the tax return is due. The penalty is 5% per month, up to a maximum of 25%. In almost all cases, the taxpayer will also be assessed, in addition to the failure to file penalty, a failure to pay penalty. For tax years beginning in 2017, the amount of the additional tax payable for failure to file a tax return within 60 days of the due date shall not be less than the lesser of $210 or 100% of the amount required to be shown as tax on the return. (up from $205 for 2016). Failure to Pay Penalty The failure to pay penalty is .05% for each month or partial month until the tax is paid. Note that an extension to file does not extend the time to pay tax. For example, if the tax return is due on April 15 and the taxpayer files an automatic six-month extension until October 15, he or she still must pay at least 90% of the tax shown on the return when filed or he or she will incur a failure to pay penalty. Civil Fraud Penalty Investors of abusive tax schemes that try to escape their legal tax responsibilities are still liable for taxes, interest, and civil penalties. Violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty or criminal prosecution. Civil fraud can include a penalty of up to 75% of the underpayment of tax attributable to fraud, in addition to the taxes owed. Criminal convictions of promoters and investors may result in fines up to $250,000 and up to five years in prison. Frivolous Tax Return Penalty A tax practitioner may not advise a taxpayer to take a position on a document that will be submitted to the IRS unless the position is not frivolous. If a taxpayer files a frivolous return, the penalty may be $5,000. Jointly file the return, and the taxpayer and his or her spouse may be liable for $5,000 each. This penalty is added to other penalties. Fixing America’s Surface Transportation (FAST) Act The Fixing America’s Surface Transportation (FAST) Act was signed into law in December 2015. The purpose of the FAST Act was to provide long-term funding for transportation projects, including new highways. Also included in the bill was a new tax law that requires the Department of State to deny a passport (or renewal of a passport) to a seriously delinquent

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taxpayer or revoke any passport previously issued to a seriously delinquent taxpayer. For purposes of the law, a “seriously delinquent tax debt” is defined as “an unpaid, legally enforceable Federal tax liability” when a debt greater than $50,000, including interest and penalties, has been assessed and a notice of lien or a notice of levy has been filed. The $50,000 limit is adjusted each year for inflation and cost of living and for 2017, it remains at $50,000.

Tax Return Preparer Penalties The IRS has penalty and injunctive authority to address improper tax return preparation, and abusive transaction promoters. The Internal Revenue Code (IRC) contains penalties to stop fraudulent, unscrupulous and/or incompetent tax return preparers, abusive transaction promoters, and material advisors whose failure to furnish information or maintain lists with respect to reportable transactions. Penalty assertion is one enforcement vehicle for noncompliant return preparers, promoters, and material advisors. Sanctionable Acts The Secretary of the Treasury may censure, suspend or disbar from practice before the IRS any attorney, CPA or enrolled agent who:

Is shown to be incompetent or disreputable. Fails to comply with any regulations relating to practice before the IRS. Willfully and knowingly, with intent to defraud, misleads or threatens any claimant or potential claimant.

Reporting Requirements for Tax Return Preparers Section 6060, Reporting Requirements for Tax Return Preparers, applies to any person who employs one or more income tax return preparers to prepare any return of tax under the IRC. The general rule states any person who employs a tax return preparer to prepare any return or claim for refund other than for such person at any time during a return period shall make a return setting forth the name, taxpayer identification number, and place of work of each tax return preparer employed by him at any time during such period. For purposes of this section, any individual who in acting as a tax return preparer is not the employee of another tax return preparer shall be treated as his own employer. The return required by this section shall be filed, in such manner as the Secretary may by regulations prescribe, on or before the first July 31 following the end of such return period. In lieu of the return required by subsection (a), the Secretary may approve an alternative reporting method if he determines that the necessary information is available to him from other sources. The term return period means the 12-month period beginning on July 1 of each year, except that the first return period shall be the 6-month period beginning on January 1, 1977, and ending on June 30, 1977. (338)

Paid Preparer’s Due Diligence Checklist Due to changes in the tax law, the paid tax return preparer Earned Income Tax Credit (EITC) due diligence requirements have been expanded to also cover the American Opportunity Tax Credit (AOTC), the Child Tax Credit (CTC) and/or the Additional Child Tax Credit (ACTC). Form 8867 - Paid Preparer’s Due Diligence Checklist, has been modified to account for these changes. In addition, Form 8867 has been streamlined. Completing the form is not a substitute for actually performing the necessary due diligence and completing all required forms and schedules when preparing the return.

Also, the paid tax return preparer due diligence penalty under IRC section 6695(h) is now indexed for inflation. Therefore, the penalty for failure to meet the due diligence requirements with respect to returns and claims for refund filed in 2017 is $510 per credit per return.

A paid tax return preparer is required to exercise due diligence when preparing any client’s return or claim for refund. As part of exercising due diligence, the tax preparer must interview the client, ask adequate questions, and obtain appropriate and sufficient information to determine correct reporting of income, claiming of tax benefits (such as deductions and credits), and compliance with the tax laws. A paid tax return preparer must meet specific due diligence requirements set forth in Treasury Regulations when he or she prepares returns and claims for refund involving the EITC, the AOTC and/or the CTC/ACTC. To meet these due diligence requirements, the tax preparer may need to ask additional questions and obtain additional information to determine eligibility for and the amount of the EITC, AOTC, and CTC/ACTC.

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A tax preparer has complied with the due diligence requirements set forth in Treasury Regulations with respect to the EITC, AOTC, and/or CTC/ACTC claimed on a return or claim for refund if he or she:

1. Completes Form 8867 truthfully and accurately and completes the actions described on Form 8867 for each credit claimed for which he or she is the paid tax return preparer.

2. Submits Form 8867 in the manner required. 3. Meets the knowledge requirement by interviewing the taxpayer, asking adequate questions, documenting the

taxpayer’s responses on the return or in his or her notes, reviewing adequate information to determine if the taxpayer is eligible to claim the credit(s) and in what amount(s), and

4. The tax preparer keeps all five of the following records for three years from lasts of the due date of the tax return (without extensions), the date the return was filed, the date the return was presented to the taxpayer for signature or the date the tax preparer submitted to the signing tax return preparer:

a. A copy of Form 8867. b. The applicable worksheet(s) or his or her own worksheet(s) for any credits claimed. c. Copies of any taxpayer documents you may have relied upon to determine eligibility for and the amount

of the credit(s). d. A record of how, when, and from whom the information used to prepare Form 8867 and worksheet(s) was

obtained. e. A record of any additional questions he or she may have asked to determine eligibility for and amount of

the credits, and the taxpayer’s answers. Completing Form 8867 Form 8867 covers the EITC, the AOTC, and the CTC/ACTC. A tax preparer should only complete columns corresponding to credits actually claimed on the taxpayer’s return that he or she prepared. Only paid tax return preparers should complete Form 8867. Form 8867 is divided into questions that relate to all three credits and questions that are specifically related to EITC only, Child Tax Credit only, and the American Opportunity Tax Credit only. Due Diligence Requirements The tax preparer completes the appropriate column for each credit for which he or she was the paid tax return preparer determining the taxpayer’s eligibility for and amount of the credit. Columns for credits for which he or she was not the paid tax return preparer should be left blank. Due Diligence Questions for Returns Claiming EITC A paid tax return preparer must exercise due diligence to determine whether a taxpayer meets all of the eligibility requirements for the EITC. Although lines 9a and 9b only ask two specific questions about EITC eligibility related to claiming a qualifying child, the tax preparer’s client must meet all of the eligibility requirements for claiming the EITC. Therefore, the tax preparer’s client cannot claim the EITC if all of the eligibility requirements for the EITC are not satisfied, even if the tax preparer answers “yes” to 9a and 9b. Due Diligence Questions for Returns Claiming CTC and/or ACTC A paid tax return preparer must exercise due diligence to determine whether a taxpayer meets all of the eligibility requirements for the CTC and/or ACTC. Lines 10a, 10b, and 10c only ask three specific questions about CTC and ACTC eligibility. However, the tax preparer’s client must meet all of the eligibility requirements for claiming the CTC and/or ACTC. Therefore, the tax preparer’s client cannot claim the CTC and/or ACTC if all of the eligibility requirements for these credits are not satisfied, regardless of the answers to questions on line 10. Due Diligence Questions for Returns Claiming AOTC A paid tax return preparer must exercise due diligence to determine whether a taxpayer meets all of the eligibility requirements for the AOTC. Although line 11 only asks about substantiation of qualified tuition and related expenses, the tax preparer’s client must meet all of the eligibility requirements for claiming the AOTC. Therefore, the tax preparer’s client cannot claim the AOTC if all of the eligibility requirements for the AOTC are not satisfied, even if the tax preparer answers “yes” on line 11.

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Credit Eligibility Certification The tax preparer must certify that all of the answers on Form 8867 are, to the best of his or her knowledge, true, correct and complete. Failure to meet due diligence requirements with respect to claiming the EITC, the AOTC, and the CTC/ACTC could result in a $510 penalty for each failure. For example, if a paid tax return preparer prepares a return claiming the EITC, the AOTC and the CTC/ACTC and he or she failed to meet the due diligence requirements for all of these credits, the tax preparer could be subject to a penalty of $1,530. Document Retention To meet the due diligence requirements for the EITC, the AOTC, and the CTC/ACTC, you must keep all of the following records: (271)

1. A copy of Form 8867. 2. The applicable worksheet(s) or your own worksheet(s) for any credits claimed specified in Due Diligence

Requirements. 3. Copies of any taxpayer documents you may have relied upon to determine eligibility for and the amount of the

credit(s). 4. A record of how, when, and from whom the information used to prepare Form 8867 and worksheet(s) was

obtained. 5. A record of any additional questions you may have asked to determine eligibility for and amount of the credits,

and the taxpayer’s answers. You must keep those records for three years from the latest of the following dates: (271)

The due date of the tax return (not including extensions). The date the return was filed (if you are a signing tax return preparer electronically filing the return). The date the return was presented to the taxpayer for signature (if you are a signing tax return preparer not electronically filing the return). The date you submitted to the signing tax return preparer the part of the return for which you were responsible (if

you are a nonsigning tax return preparer). These records may be kept on paper or electronically in the manner described in Revenue Procedure 97-22 (or later update). (339) Consequences of Filing EITC Returns Incorrectly People who come to you, a tax return preparer, expect you to know the tax law and prepare an accurate return. Also, if you are paid and prepare EITC claims, you must meet EITC due diligence requirements. If the IRS examines your client's return and denies all or a part of EITC, your client: (340)

Must pay back the amount in error with interest. May need to file the Form 8862 - Information to Claim Earned Income Tax Credit after Disallowance. May be banned from claiming EITC for the next two years if the IRS finds the error is because of reckless or

intentional disregard of the rules. May be banned from claiming EITC for the next ten years if the IRS finds the error is because of fraud.

If the IRS examines the EITC claims you prepared and finds you did not meet all four due diligence requirements, you can get: (340)

A $510 penalty for each failure to comply with EITC due diligence requirements. The penalty amounts are covered in IRC Section 6695(g). (The IRS adjusted the penalty for taxable year returns beginning in 2015 for cost of living.)

A minimum penalty of $1,000 if you prepare a client return and IRS finds any part of the amount of taxes owed is due to an unreasonable position (For reference see IRC Section 6694(a)).

A minimum penalty of $5,000 if you prepare a client return and IRS finds any part of the amount of taxes owed is due to your reckless or intentional disregard of rules or regulations (For reference see IRC Section 6694(b)).

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The IRS can also penalize an employer or employing firm if an employee fails to comply with the EITC due diligence requirements. However, there are only specific circumstances when an employer is subject to the due diligence penalty: (341)

Management participated in or, prior to the time the return was filed, knew of the failure to comply with the due diligence requirements.

The firm failed to establish reasonable and appropriate procedures to ensure compliance with the due diligence requirements.

The firm establishes appropriate compliance procedures but disregards those procedures through willfulness, recklessness, or gross indifference, including ignoring facts that would lead a person of reasonable prudence and competence to investigate or figure out the employee was not complying.

Additional Tax Return Preparer Penalties

Understatement of Taxpayer’s Liability Several potential penalties may be assessed against tax return preparers. Below is a summary of the Preparer Penalties under Title 26 of Internal Revenue Code, Sections 6694 and 6695. (342)

Due to unreasonable position – a first-tier penalty for an understatement due to unreasonable position is the greater of $1,000 or 50% of income derived with respect to the refund claim.

Due to willful or reckless conduct – a second-tier penalty for an understatement due to willful or reckless conduct is the greater of $5,000 or 75% of income derived with respect to the refund claim.

The Protecting Americans from Tax Hikes Act of 2015 expanded the penalty for tax preparers who engage in willful or reckless conduct, which was the greater of $5,000 or 50% of the preparer’s income with respect to the return, by increasing the 50% amount to 75% (IRC 6694(b)).

Failure to Follow Procedures Penalties assessable for failure to meet the requirements described previously, unless such failure is due to reasonable cause and not to willful neglect, are:

Failure to furnish copy to taxpayer - $50 for each failure to furnish a copy of a return or claim with a maximum penalty of $25,500 in a calendar year.

Failure to sign return - $50 for each failure to sign a return for refund with a maximum penalty of $25,500 in a calendar year.

Failure to furnish identifying number (PTIN) - $50 for each failure to furnish an identifying number on a return with a maximum penalty of $25,500 in a calendar year.

Failure to retain copy or list - $50 for each failure to comply with IRC Section 6107(b) to retain a copy or list of a return or claim for the period ending 3 years after the close of the return. There is a maximum penalty of $25,500 in a return period.

Failure to file correct information - $50 for each failure with a maximum penalty of $25,500 in a return period. Negotiation of Taxpayer Checks A $510 penalty may be imposed for a tax preparer who endorse or otherwise negotiate any check (including directing or accepting payment by any means, electronic or otherwise into an account owned or controlled by the practitioner or any firm or other entity with whom the practitioner is associated) issued to a client by the government in respect to a Federal tax liability. Promoting Abusive Tax Shelters The penalty for promoting abusive tax shelters is generally equal to $1,000 or, if lesser, 100% of income derived from each organization or sale of the abusive plan. IRS, the Office of Chief Counsel and Treasury issue formal guidance on certain tax avoidance transactions that are referred to as listed transactions. Taxpayers are required to disclose their participation in listed transactions.

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Aiding or Abetting in Tax Liability Understatement Tax return preparers also may be penalized $1,000 for aiding or abetting in an understatement of tax liability on a return. The penalty is $10,000 if conduct relates to a corporation’s tax return. Disclosure or Use of Information Internal Revenue Code Section 7216 is a criminal provision enacted by the U.S. Congress in 1971 that prohibits preparers of tax returns from knowingly or recklessly disclosing or using tax return information. Tax return information consists of all the information tax return preparers obtain from taxpayers or other sources in any form or manner that is used to prepare tax returns or is obtained in connection with the preparation of returns. Tax return information also includes all computations, worksheets, and printouts preparers create; correspondence from IRS during the preparation, filing and correction of returns; statistical compilations of tax return information; and tax return preparation software registration information.

Unauthorized disclosure - The penalty is $250 for each unauthorized disclosure or use of information furnished in connection with a taxpayer return with a maximum penalty of $10,000 per calendar year.

Knowing or reckless disclosure – Upon conviction of a misdemeanor a fine of up to $1,000 or imprisonment for up to one year or both along with the costs of prosecution.

Willful Preparation of a False or Fraudulent Return

Guilty of a felony – Upon conviction, the practitioner may face a fine of up to $100,000 or imprisonment for up to 3 years or both. The practitioner may also be responsible for costs of prosecution. A fine amount up to $500,000 may be imposed if fraud involves a corporation.

Guilty of a misdemeanor – Upon conviction, the practitioner may face a fine up to $10,000 or imprisonment of up to 1 year or both. A fine amount up to $50,000 may be imposed if fraud involves a corporation.

Please see the Internal Revenue Code, corresponding Treasury Regulations, and other related published guidance for additional information on each penalty section.

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

Review Questions Answers appear in Review Feedback.

1. Alex Smart recently passed the Special Enrollment Examination and is advertising for his business. Which of the

following presentations will violate the Circular 230 rules for advertising? A. Alex Smart, enrolled to practice before the Internal Revenue Service B. Alex Smart, Certified Enrolled Agent C. Alex Smart, enrolled to represent taxpayers before the Internal Revenue Service D. Alex Smart, admitted to practice before the Internal Revenue Service

2. Failure to file an answer to a complaint instituting a proceeding for disbarment by the original or extended deadline

constitutes which of the following? A. An error that can be corrected by filing the answer with the administrative law judge within one year of the

original (or extended) deadline B. Grounds for criminal sanctions C. An admission of the allegations in the complaint and a waiver of a hearing D. Legal estoppel against the practitioner

3. A notice of disbarment or suspension of a certified public accountant from practice before the Internal Revenue Service

is issued to which of the following? A. State authorities B. IRS employees C. Interested departments and agencies of the Federal government D. All of the above

4. Tax advisors should adhere to “best practices” in providing advice and in preparing a submission to the IRS. Best

practices include all of the following except: A. Clear communication B. Relevant facts C. Concise conclusions D. Establishing the facts, their relevancy, and arriving at a conclusion supported solely by the facts

5. All of the following are considered examples of disreputable conduct for which an enrolled agent can be censured or

suspended except: A. Directly or indirectly attempting to influence the official action of any employee of the Internal Revenue Service

by use of threats, false accusations, or by bestowing any gift, favor or thing of value B. Misappropriation or failure to remit funds received from a client for the purpose of payment of taxes or other

obligations due the United States C. Knowingly aiding and abetting another person to practice before the Internal Revenue Service during a period

of suspension or disbarment D. Failure to timely pay personal income taxes

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6. Contingent fees are only allowed when the IRS is examining or challenging an original tax return; an amended return, claim for a refund or credit where the amended return or claim was filed within how many days of taxpayer receipt of IRS examination notice?

A. 30 days B. 60 days C. 90 days D. 120 days

7. For how long must records of continuing professional education be retained subsequent to renewal date?

A. 1 year B. 2 years C. 3 years D. 4 years

8. Which of the following are compelling reasons for waiver of continuing professional education requirement?

A. Health B. Active military duty C. Absence from the United States for employment reasons D. All of the Above

9. For how many months from the last date of use must a practitioner retain copies of direct mail and e-commerce

communications regarding fee information? A. 12 months from date of last use B. 24 months from date of last use C. 36 months from date of last use D. 48 months from date of last use

10. For which of the following reasons, if any, can a tax preparer willfully sign a tax return?

A. Return lacks reasonable basis B. Return attempts to understate tax liability C. Return recklessly disregards tax rules D. None of the above

11. Which monetary penalty may be imposed against a return preparer for each tax return of refund claim that understates

the taxpayer’s liability due to an unreasonable position? A. $250 or 25% of income derived from refund B. $500 or 25% of income derived from refund C. $1,000 or 50% of income derived from refund D. $2,000 or 50% of income derived from refund

12. What is the penalty for failure to furnish the taxpayer with a copy of the prepared return?

A. $50 for each failure B. $100 for each failure C. $250 for each failure D. $500 for each failure

13. Which amount is generally the monetary penalty a tax preparer might receive for promoting abusive tax shelters?

A. $1,000 B. $2,000 C. $3,000 D. $4,000

14. If found guilty of a misdemeanor, tax preparers who willfully prepare a false or fraudulent individual taxpayer return

may be disciplined by which of the following penalties? A. $500 and 1 month in jail or both B. $1,000 and 3 months in jail or both C. $5,000 and 6 months in jail or both D. $10,000 and 1 year in jail or both

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15. If a sanction is sought against a practitioner, the practitioner has at least how many days to answer the specific complaint?

A. 5 days B. 10 days C. 20 days D. 30 days

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Review Feedback Return to Review Questions Question 1 - B. Alex Smart, Certified Enrolled Agent Section 10.301 of Treasury Department Circular 230 states a practitioner may not, with respect to any Internal Revenue Service matter, in any way use or participate in the use of any form of public communication or private solicitation containing a false, fraudulent, or coercive statement or claim; or a misleading or deceptive statement or claim. Enrolled agents, enrolled retirement plan agents, or registered tax return preparers, in describing their professional designation, may not utilize the term “certified” (Choice B) or imply an employer/employee relationship with the Internal Revenue Service. Examples of acceptable descriptions for enrolled agents are “enrolled to represent taxpayers before the Internal Revenue Service,” “enrolled to practice before the Internal Revenue Service,” and “admitted to practice before the Internal Revenue Service.” Similarly, examples of acceptable descriptions for enrolled retirement plan agents are “enrolled to represent taxpayers before the Internal Revenue Service as a retirement plan agent” and “enrolled to practice before the Internal Revenue Service as a retirement plan agent.” An example of an acceptable description for registered tax return preparers is “designated as a registered tax return preparer by the Internal Revenue Service.” Question 2 - C. An admission of the allegations in the complaint and a waiver of a hearing If a respondent fails to answer a complaint filed by the IRS for disbarment, the IRS and/or the Administrative Law Judge may treat the respondent as if he or she had admitted all allegations and waived a hearing. Every allegation in the complaint that is not denied in the answer is deemed admitted and will be considered proved; no further evidence in respect of such allegation need be adduced at a hearing. Therefore, Choices A, B and D are incorrect based on the regulation governing practice before the IRS contained in Circular 230 that failure to file an answer within the time prescribed (or within the time for answer as extended by the Administrative Law Judge), constitutes an admission of the allegations of the complaint and a waiver of hearing, and the Administrative Law Judge may make the decision by default without a hearing or further procedure. Question 3 - D. All of the above On the issuance of a final order censuring, suspending, or disbarring a practitioner or a final order disqualifying an appraiser, notification of the censure, suspension, disbarment or disqualification will be given to appropriate officers and employees of the Internal Revenue Service and interested departments and agencies of the Federal government. The Internal Revenue Service may determine the manner of giving notice to the proper authorities of the State by which the censured, suspended, or disbarred person was licensed to practice. Section 10.80 of Circular 230 outlines the parties that should receive notice of disbarment or suspension. The list includes IRS employees (Choice B), interested departments and agencies of the Federal government (Choice C), as well as the appropriate state authorities (Choice A). Therefore, based on the regulations governing practice before the IRS contained in Circular 230, Choice D is correct. Question 4 - D. Establishing the facts, their relevancy, and arriving at a conclusion supported solely by the facts According to Section10.33 of Circular 230, best practices should include the following:

1. Communicating clearly with the client regarding the terms of the engagement; 2. Establishing the facts, determining which facts are relevant, evaluating the reasonableness of any assumptions

or representations, relating applicable law to the relevant facts, and arriving at a conclusion supported by the law and the facts;

3. Advising the client regarding the importance of the conclusions reached; and 4. Acting fairly and with integrity in practice before the IRS.

The correct answer (Choice D) failed to include the applicable law as a basis of support for a conclusion.

Lesson 17 - Professional Responsibilities, Ethics, Penalties

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Question 5 - D. Failure to timely pay personal income taxes Section 10.51 of Circular 230 lists several examples of disreputable conduct for which a practitioner may be disbarred or suspended from practice before the Internal Revenue Service. The list includes directly or indirectly attempting to influence the official action of any employee of the Internal Revenue Service by use of threats, false accusations, or by bestowing any gift, favor or thing of value (Choice A), the misappropriation or failure to remit funds received from a client for the purpose of payment of taxes or other obligations due the United States (Choice B) and knowingly aiding and abetting another person to practice before the Internal Revenue Service during a period of suspension or disbarment (Choice C). Choice D, failure to timely pay personal income taxes is not disreputable conduct under Section 10.51 of Circular 230. Therefore, based on the regulations governing practice before the IRS contained in Circular 230, Choices A, B, and C would be incorrect. Question 6 - D. 120 days A practitioner’s fee must be reasonable in matters before the IRS. Contingent fees are only allowed when the IRS is examining or challenging an original tax return; an amended return, claim for a refund or credit where the amended return or claim was filed within 120 days of taxpayer receipt of IRS examination notice. Contingent fees are also allowed for services to a client in connection with the determination of interest or penalties assessed by the service and for services provided with any judicial proceeding arising under the IRC. Therefore, based on the regulations governing practice before the IRS contained in Circular 230, Choices A, B, and D would be incorrect. Question 7 - D. 4 years Each individual applying for renewal must retain for a period of four years following the date of renewal the information required with regards to qualifying continuing professional education credit hours. Such information includes, but not limited to, the name of the sponsoring organization, the location of the program, the title of the program, qualified program number, description of its content, dates attended, credit hours claimed etc. Question 8 - D. All of the above Waiver from the continuing professional education requirements for a given period may be granted for health issues, extended active military duty; absence from the United States due to employment or other compelling reasons considered on a case-by-case basis. A request for waiver must be accompanied by appropriate documentation. Additionally, a request for waiver must be filed no later than the last day of the renewal application period. Question 9 - C. 36 months from date of last use For communication of fee information in the form of direct mail and e-commerce communications, the practitioner must retain a copy of the actual communication, along with a list or other description of persons to whom the communication was mailed or otherwise distributed. The copy must be retained by the practitioner for a period of at least 36 months from the date of the last transmission or use. Question 10 - D. None of the above A practitioner may not willfully, recklessly, or through gross incompetence sign a tax return or claim for refund that lacks a reasonable basis, is an unreasonable position or is a willful attempt by the practitioner to understate the liability. Additionally, a practitioner cannot advise a client to take a position on a tax return or claim for refund, or prepare a portion of a tax return or claim for refund containing unreasonable basis or understatement. Question 11 - C. $1,000 or 50% of income derived from refund Per IRC section 6694(a) – If a tax return preparer understates the taxpayer’s liability due to an unreasonable position, the practitioner will receive a penalty which is the greater of $1,000 or 50% of the income derived by the tax return preparer with respect to the return or claim for refund. Question 12 - A. $50 for each failure Per IRC section 6695(a), the penalty for the failure to furnish a copy of the return to a taxpayer is $50 for each failure to comply with IRC section 6107 regarding furnishing a copy of a return or claim to a taxpayer. The maximum penalty imposed on any tax return preparer shall not exceed $25,500 in a calendar year. IRC section 6107 states a copy or list must be retained by an income tax return preparer, with respect to a return or claim for refund, for the period ending 3 years after the close of the return period. Question 13 - A. $1,000 Per IRC section 6700, for promoting abusive tax shelters the penalty is generally equal to $1,000 for each organization or sale of an abusive plan or arrangement (or, if lesser, 100% of the income derived from the activity).

Lesson 17 - Professional Responsibilities, Ethics, Penalties

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Question 14 - D. $10,000 and 1 year in jail or both Per IRC section 7207, upon conviction of a misdemeanor for fraudulent returns, statements, or other documents, the practitioner will receive a fine of not more than $10,000 ($50,000 in the case of a corporation), imprisonment of not more than one year, or both. Question 15 - D. 30 days The complaint must specify the sanction sought against the practitioner or appraiser. If the sanction sought is a suspension, the duration of the suspension sought must be specified. The respondent must be notified in the complaint or in a separate paper attached to the complaint of the time for answering the complaint, which may not be less than 30 days from the date of service of the complaint.

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2017 Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders At the conclusion of this lesson you should have a basic knowledge of:

Tax Law Administration Annual Filing Season Program Identity Theft 2017 Federal Tax Law Updates

Administration This course has taught you most of the up-to-date rules that you will need to know to prepare a client's return. However, every year Congress changes the tax laws, and part of being a tax professional is knowing where to look to find these changes. In its role in administering the tax laws enacted by the Congress, the IRS must take the specifics of these laws and translate them into detailed regulations, rules and procedures. The Office of Chief Counsel fills this crucial role by producing several different kinds of documents and publications that provide guidance to taxpayers, firms and charitable groups. The Internal Revenue Code The first place that any tax professional looks for answers is the Internal Revenue Code, or simply, "the Code." These are the tax laws as passed by Congress. The first real tax Code became law in 1939. It was rewritten fifteen years later in 1954, again in 1986, again in 1997, once more in 2001, and, recently, in both 2003 and 2004. In addition, every year Congress passes new tax laws, or amendments, which then become part of the existing Internal Revenue Code. Although the Code is the first place to look, it is not the only place to look. When you cannot find the answer in “the Code”, you then turn to the Regulations. Treasury Regulations

Treasury Regulations, which most tax professionals simply call "the Regs," are the IRS's interpretation of the Internal Revenue Code. Unfortunately, the Code is not always as clear as most tax practitioners would prefer. It is not uncommon for someone to look something up in the Code, and still not find the answer. At this point you turn to the Regs. They will often give, not only an explanation of the part of the Code that you may not

understand, but also examples of how the IRS sees the Code in various situations. Like the Code itself, the Regulations have the force of the law. Revenue Rulings Every year, the IRS issues numerous so-called Revenue Rulings. Just as the Regs are an interpretation of the Code, the Revenue Rulings are the IRS's interpretation of the Regs and the Code in very specific, factual situations. For example, they often start out with a hypothetical taxpayer problem. After going over the facts of the problem, the Ruling will then tell what the IRS thinks is the law used to solve the problem, and the conclusion that the IRS has come to regarding the hypothetical taxpayer. Revenue Rulings do not have the same force of law as the Code or Regulations. They are only the IRS's opinion about a given tax situation. However, they are quite useful in that they will tell taxpayers who might have the same or similar tax problem as the hypothetical taxpayer how the IRS will deal with that problem. Court Decisions Sooner or later, a taxpayer is going to disagree with the IRS. For example, the taxpayer may interpret the Code or Regs to say that he is allowed to take a particular deduction on his tax return. The IRS, on the other hand, may interpret the same Code section or Regulation to say that the taxpayer cannot. If the taxpayer and the IRS cannot settle the argument between themselves, the case may end up in a court of law. There are various courts to which taxpayers can go to resolve

Lesson 18 - Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

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a dispute with the IRS, including the United States Tax Court (if tax is unpaid), the local Federal District Court (if tax is paid), and the U.S. Court of Claims (if tax is paid). When these courts decide an IRS-taxpayer dispute, they give the reasons for their decisions in writing. These decisions are then published and made available to all taxpayers. If after looking at the Code, the Regs and Revenue Rulings, you still cannot find the answer to a question, there is a good chance that some court published an opinion on the same or similar questions. You may want to look at that case for guidance. Revenue Procedure A revenue procedure is an official statement of a procedure that affects the rights or duties of taxpayers or other members of the public under the Internal Revenue Code, related statutes, tax treaties and regulations and that should be a matter of public knowledge. It is also published in the Internal Revenue Bulletin. While a revenue ruling generally states an IRS position, a revenue procedure provides return filing or other instructions concerning an IRS position. For example, a revenue procedure might specify how those entitled to deduct certain automobile expenses should compute them by applying a certain mileage rate in lieu of calculating actual operating expenses. (343) Private Letter Ruling A private letter ruling, or PLR, is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer's specific set of facts. A PLR is issued to establish with certainty the Federal tax consequences of a particular transaction before the transaction is consummated or before the taxpayer's return is filed. A PLR is issued in response to a written request submitted by a taxpayer and is binding on the IRS if the taxpayer fully and accurately described the proposed transaction in the request and carries out the transaction as described. A PLR may not be relied on as precedent by other taxpayers or IRS personnel. PLRs are generally made public after all information has been removed that could identify the taxpayer to whom it was issued. (343) Technical Advice Memorandum A technical advice memorandum, or TAM, is guidance furnished by the Office of Chief Counsel upon the request of an IRS director or an area director or appeals, in response to technical or procedural questions that develop during a proceeding. A request for a TAM generally stems from an examination of a taxpayer's return, a consideration of a taxpayer's claim for a refund or credit, or any other matter involving a specific taxpayer under the jurisdiction of the territory manager or the area director, appeals. Technical Advice Memoranda are issued only on closed transactions and provide the interpretation of proper application of tax laws, tax treaties, regulations, revenue rulings or other precedents. The advice rendered represents a final determination of the position of the IRS, but only with respect to the specific issue in the specific case in which the advice is issued. Technical Advice Memoranda are generally made public after all information has been removed that could identify the taxpayer whose circumstances triggered a specific memorandum. (343) Notice A notice is a public pronouncement that may contain guidance that involves substantive interpretations of the Internal Revenue Code or other provisions of the law. For example, notices can be used to relate what regulations will say in situations where the regulations may not be published in the immediate future. (343) Announcement An announcement is a public pronouncement that has only immediate or short-term value. For example, announcements can be used to summarize the law or regulations without making any substantive interpretation; to state what regulations will say when they are certain to be published in the immediate future; or to notify taxpayers of the existence of an approaching deadline. (343)

Lesson 18 - Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

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2017 Federal Tax Legislation

What’s New Tax Cuts and Jobs Act Most of the provisions in the Tax Cuts and Jobs Act take effect on January 1, 2018 and are operative for income tax returns filed in 2019. The bill will NOT affect income tax returns prepared in 2018. Since this course covers the 2017 tax year for income tax returns filed in 2018 the new tax laws will not be reflected with the exception of the medical expense deduction that will remain in place with a lower floor of 7.5% for tax years 2017 and 2018. Due Date of Return The taxpayer should file Form 1040 by April 17, 2018. The due date is April 17, because April 15 is a Sunday and the Emancipation Day holiday in the District of Columbia is observed on April 16 - even if the taxpayer does not live in the District of Columbia. Childless Earned Income Tax Credit (EITC) If the taxpayer’s child meets the tests to be his or her qualifying child, but also meets the tests to be the qualifying child of another person, only one of the individuals can actually treat the child as a qualifying child to claim the EITC. If the other person can claim the child as a qualifying child, the taxpayer cannot claim the EITC as a taxpayer with a qualifying child unless he or she has another qualifying child. However, the taxpayer may be able to claim the EITC without a qualifying child. For more information, see IRS Publication 596 - Earned Income Tax Credit. Tuition and Fees Deduction Expired The Bipartisan Budget Act of 2018 extended through 2017 the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction is capped at $4,000 for an individual whose adjusted gross income (AGI) does not exceed $65,000 ($130,000 for joint filers) or $2,000 for an individual whose AGI does not exceed $80,000 ($160,000 for joint filers). The Tuition and Fees Deduction was not renewed by the Tax Cuts and Jobs Act. EIN Needed to Claim the American Opportunity Credit To claim the American Opportunity Credit, the taxpayer needs to have the employer identification number (EIN) of the institution to which his or her qualified expenses were paid. Medical and Dental Expenses The taxpayer can deduct the part of his or her medical and dental expenses that is more than 7.5% of his or her adjusted gross income (AGI). For more information see the Instructions for Schedule A. Tax Rate Schedules for 2017 A slightly higher annual consumer price index (CPI) means that brackets (not rates) will move upward. Together with increases in the standard deduction and exemption amounts, taxes should decrease for many taxpayers. The tax rates for 2017 are shown below. The tax rate of 39.6% is expected to affect singles whose income exceeds $418,400 ($470,700 for married taxpayers filing a joint return), up from $415,050 and $466,950 in 2016. The following are the tax rates schedules for tax year 2017 based on certain filing status. (344)

Unmarried Individuals (other than Surviving Spouses and Heads of Households) If Taxable Income Is: The Tax Is: Not over $9,325 10% of the taxable income Over $9,325 but not over $37,950 $932.50 plus 15% of the excess over $9,325 Over $37,950 but not over $91,900 $5,226.25 plus 25% of the excess over $37,950

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Over $91,900 but not over $191,650 $18,713.75 plus 28% of the excess over $91,900 Over $191,650 but not over $416,700 $46,643.75 plus 33% of the excess over $191,650 Over $416,700 not over $418,400 $120,910.25 plus 35% of the excess over $416,700 Over $418,400 $121,505.25 plus 39.6% of the excess over $418,400

Table 18-1 - Internal Revenue Bulletin (2017)

Married Individuals Filing Joint Returns and Surviving Spouses If Taxable Income Is: The Tax Is: Not over $18,650 10% of the taxable income Over $18,650 but not over $75,900 $1,865 plus 15% of the excess over $18,650 Over $75,900 but not over $153,100 $10,452.50 plus 25% of the excess over $75,900 Over $153,100 but not over $233,350 $29,752.50 plus 28% of the excess over $153,100 Over $233,350 but not over $416,700 $52,222.50 plus 33% of the excess over $233,350 Over $416,700 but not over $470,700 $112,728 plus 35% of the excess over $416,700 Over $470,700 $131,628 plus 39.6% of the excess over $470,700

Table 18-2 - Internal Revenue Bulletin (2017)

Married Individuals Filing Separate Returns If Taxable Income Is: The Tax Is: Not over $9,325 10% of the taxable income Over $9,325 but not over $37,950 $932.50 plus 15% of the excess over $9,325 Over $37,950 but not over $76,550 $5,226.25 plus 25% of the excess over $37,950 Over $76,550 but not over $116,675 $14,876.25 plus 28% of the excess over $76,550 Over $116,675 but not over $208,350 $26,111.25 plus 33% of the excess over $116,675 Over $208,350 not over $235,350 $56,364 plus 35% of the excess over $208,350 Over $235,350 $65,814 plus 39.6% of the excess over $235,350

Table 18-3 - Internal Revenue Bulletin (2017)

Heads of Household If Taxable Income Is: The Tax Is: Not over $13,350 10% of the taxable income Over $13,350 but not over $50,800 $1,335 plus 15% of the excess over $13,350 Over $50,800 but not over $131,200 $6,952.50 plus 25% of the excess over $50,800 Over $131,200 but not over $212,500 $27,052.50 plus 28% of the excess over $131,200 Over $212,500 but not over $416,700 $49,816.50 plus 33% of the excess over $212,500 Over $416,700 not over $444,500 $117,202.50 plus 35% of the excess over $416,700 Over $444,500 $126,950 plus 39.6% of the excess over $444,500

Table 18-4 - Internal Revenue Bulletin (2017)

Estates and Trusts If Taxable Income Is: The Tax Is: Not over $2,550 15% of the taxable income Over $2,550 but not over $6,000 $382.50 plus 25% of the excess over $2,550 Over $6,000 but not over $9,150 $1,245 plus 28% of the excess over $6,000 Over $9,150 but not over $12,500 $2,127 plus 33% of the excess over $9,150 Over $12,500 $3,232.50 plus 39.6% of the excess over $12,500

Table 18-5 - Internal Revenue Bulletin (2017)

Lesson 18 - Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

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Long Term Capital Gains and Qualified Dividends Tax Bracket Short-term Long-term 10%, 15% brackets Ordinary rate 0% 25%, 28%, 33%, 35% brackets Ordinary rate 15% 39.6% brackets Ordinary rate 20%

Table 18-6 - Internal Revenue Bulletin (2017)

An additional 3.8% Federal Net Investment Income Tax applies to individuals on the lesser of net investment income or modified AGI in excess of $200,000 (single) or $250,000 (married/filing jointly and qualifying widow(er)s). The tax also applies to any trust or estate on the lesser of undistributed net income or AGI in excess of the dollar amount at which the estate/trust pays income taxes at the highest rate.

Standard Mileage Rates The 2017 optional standard mileage rates are used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes. As of January 1, 2017, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) are: (345)

53.5 cents per mile for business miles driven, down from 54 cents for 2016. 17 cents per mile driven for medical or moving purposes, down from 19 cents for 2016. 14 cents per mile driven in service of charitable organizations.

The business mileage rate decreased .5 cents per mile and the medical and moving expense rates decreased 2 cents per mile from the 2016 rates. The charitable rate is based on statute. The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile, including depreciation, insurance, repairs, tires, maintenance, gas and oil. The rate for medical and moving purposes is based on the variable costs, such as gas and oil. The charitable rate is set by law. Taxpayers always have the option of claiming deductions based on the actual costs of using a vehicle rather than the standard mileage rates. A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle. In addition, the business standard mileage rate cannot be used for more than four vehicles used simultaneously.

If the taxpayer wants to use the standard mileage rate for a car he or she owns, the taxpayer must choose to use it in the first year the car is available for use in his or her business. Then in later years, the taxpayer can choose to use either the standard mileage rate or actual expenses.

Standard Deduction In 2017 the standard deduction will be $6,350 for singles and married persons filing separate returns and $12,700 for married couples filing jointly, up from $6,300 and $12,600 in 2016. The standard deduction for heads of household rises to $9,350, up from $9,300 in 2016. (344)

Standard Deductions 2017 Tax Year Filing Status Standard Deduction Amount

Single $6,350 Married Filing Jointly $12,700

Married Filing Separately $6,350 Heads of Household $9,350

Surviving Spouse $12,700

Table 18-7 - Publication 501 - Exemptions, Standard Deduction, and Filing Information (2017)

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For 2017, the additional standard deduction amount for the aged or the blind is $1,250. The additional standard deduction amount is increased to $1,550 if the individual is also unmarried and not a surviving spouse. For an individual who can be claimed as a dependent on another’s return, the basic standard deduction for 2017 will be $1,050 (same as for 2016) or $350 (same as for 2016) plus the individual’s earned income, whichever is greater. However, the standard deduction may not exceed the regular standard deduction for that individual. Elderly and/or Blind Taxpayers The standard deduction chart for people age 65 or older (shown below) lists the additional standard deduction for taxpayers who are age 65 or older and/or blind at the end of the tax year. The standard deduction is calculated by adding the person's standard deduction (based on their filing status), plus the additional amount. Additional standard deduction amounts for 2017 are $1,550 for single or head of household or $1,250 for married filing jointly, married filing separately, or qualifying widow. For example, if the taxpayer is married, filing a joint return and both he and his wife are 68 years of age, what would their standard deduction amount come to for 2017? The taxpayer would check off the box for him as being 65 or older, as well as the same box for his spouse. Two boxes are checked, and looking at the married filing joint return section, we see that their available standard deduction would be $15,200. If one was also blind, the standard deduction for 2017 would be $16,450 having three boxes checked. Partial blindness qualifies, with a certified statement from an eye doctor (ophthalmologist or optometrist) attesting that the vision in the taxpayer’s better eye is 20/200 or worse after being corrected with glasses or contact lenses or that the taxpayer’s field of vision is not more than 20 degrees. If the taxpayer’s eye condition is not likely to improve beyond these limits, the statement should include this fact. The taxpayer should keep the statement with his or her records. If the taxpayer is blind on the last day of the year, he or she is entitled to the higher standard deduction.

Standard Deduction Chart for People Age 65 or Older or Blind

Filing Status Number from the box on Line 39a of 1040 Standard Deduction for 2017

Single 1 2

$7,900 $9,450

Married filing jointly or qualifying widow(er)

1 2 3 4

$13,950 $15,200 $16,450 $17,700

Married filing separately*

1 2 3 4

$7,600 $8,850 $10,100 $11,350

Head of household 1 2

$10,900 $12,450

Caution: Do not use the number of exemptions from Line 6d

*The taxpayer can only have a value of 3 or 4 for the total in the box of Line 39a of Form 1040 if he or she is claiming an exemption for his or her spouse when using the Married Filing Separately status.

Table 18-8 - Publication 501 - Table 7 – Standard Deduction Chart for People who are 65 or Older or Who are Blind, (2017)

Itemized Deduction Phase-Out Higher income taxpayers are subject to the phase-out of itemized deductions. The adjusted gross income (AGI) thresholds are $261,500 (single filers who are not married and who are not surviving spouses or heads of households), $313,800

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(married joint-filing couples or surviving spouse), $287,650 (heads of households), and $156,900 (married filing separately). The phase-out limitation (Pease Limitations) on itemized deductions cuts the amount of deductions a taxpayer can take by 3% of adjusted gross income (AGI) above the specified thresholds but he or she cannot lose more than 80% of the itemized deductions. The following Schedule A (Form 1040) deductions are subject to the overall limit on itemized deductions: (346)

Taxes paid. Interest paid. Gifts to charity. Job expenses and certain miscellaneous deductions. Other miscellaneous deductions.

The following Schedule A (Form 1040) deductions are not subject to the overall limit on itemized deductions. However, they are still subject to other applicable limits: (346)

Medical and dental expenses. Investment interest expense. Casualty and theft losses of personal use property. Casualty and theft losses of income-producing property. Gambling losses.

Personal Exemption The personal exemption for tax year 2017 remains as it was for 2016: $4,050. However, the exemption is subject to a phase-out that begins with adjusted gross incomes of $261,500 ($313,800 for married couples filing jointly). It phases out completely at $384,000 ($436,300 for married couples filing jointly.)

Personal Exemption Phase-out Thresholds Filing Status Threshold Begins Threshold Ends Individual $261,500 $384,000 Married Filing Jointly $313,800 $436,300 Head of Household $287,650 $410,150 Married Filing Separately $156,900 $218,150

Table 18-9 - Publication 501 - Phaseout of Exemptions (2017)

A taxpayer must reduce the dollar amount of his or her exemptions by 2% for each $2,500, or part of $2,500 ($1,250 if he or she is married filing separately), that his or her adjusted gross income (AGI) exceeds the amount shown above for his or her filing status. If his or her AGI exceeds the amount shown above by more than $122,500 ($61,250 if married filing separately), the amount of the taxpayer’s deduction for exemptions is reduced to zero. (344) Alternative Minimum Tax (AMT) Exemption Amount Following the passage of the American Tax Relief Act (ATRA), the AMT patch legislation that Congress had to pass every year to ensure more taxpayers were not caught off-guard by the Alternative Minimum tax is no longer required. Instead the AMT exemption and associated thresholds based on filing status are now tied (or indexed) to inflation (CPI) and updated by the IRS every year. A specified amount of AMTI, Alternative Minimum Taxable Income, is exempt from alternative minimum taxation. The amount varies according to the taxpayer’s filing status and the tax year at hand. The exemption is subtracted from the taxpayer’s AMTI to determine the amount of his or her AMTI that is subject to tax at the AMT rates. Additionally, the taxpayer’s exemption phases out if his or her AMTI exceeds the thresholds indicated below. More specifically, the exemption is reduced by 25% of the amount by which his or her AMTI exceeds the applicable threshold for his or her filing status.

Lesson 18 - Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

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2017 Alternative Minimum Tax Exemption Information

Filing Status AMT Exemption Amount Excess Taxable Income (AMTI)*

AMT Phase-out Income Level

Joint Returns or Surviving Spouses $84,500 $187,800 $160,900

Singles $54,300 $187,800 $120,700 Married Individuals Filing Separate Returns $42,250 $93,900 $80,450

Estates and Trusts $24,100 $187,800 $80,450

* For tax year 2017, the 28% tax rate applies to taxpayers with taxable incomes above these thresholds.

Table 18-10 - Instructions for Form 6251 (2017)

If the taxpayer is not liable for AMT this year, but he or she paid AMT in one or more previous years, he or she may be eligible to take a special minimum tax credit against his or her regular tax this year. If eligible, the taxpayer should complete and attach Form 8801 - Credit for Prior Year Minimum Tax - Individuals, Estates, and Trusts, to claim the minimum tax credit. Children have a limited exemption amount regarding the alternative minimum tax. In 2017, the exemption amount is the lesser of $54,300 or the sum of the child's earned income plus $7,500. The instructions for Form 6251 - Alternative Minimum Tax - Individuals, include a worksheet for calculating the child's exemption amount. (347) Flexible Spending Accounts (FSA) A Flexible Spending Account (also known as a flexible spending arrangement) is a special account the taxpayer puts money into that he or she uses to pay for certain out-of-pocket health care costs. The taxpayer does not have to pay taxes on this money. This means he or she will save an amount equal to the taxes he or she would have paid on the money he or she sets aside. The taxpayer can use funds in his or her FSA to pay for certain medical and dental expenses, including copayments and deductibles. FSAs are available only with job-based health plans. Employers may make contributions to a taxpayer’s FSA. However, a taxpayer cannot spend FSA funds on insurance premiums. The annual dollar limit on contributions to employer-sponsored health care FSAs rises to $2,600 in 2017. Both employer and employee may contribute to an employee's health FSA, but contributions from all sources combined must not exceed the $2,600 annual limit for 2017. The statutory $2,600 limit under IRC Section 125(i) applies only to salary reduction contributions under a health FSA, and does not apply to certain employer non-elective contributions (sometimes called flex credits), to any types of contributions or amounts available for reimbursement under other types of FSAs, health savings accounts, or health reimbursement arrangements, or to salary reduction contributions to cafeteria plans that are used to pay an employee’s share of health coverage premiums (or the corresponding employee share under a self-insured employer-sponsored health plan).

The U.S. Treasury Department and the IRS altered the long-standing “use it or lose it” rule, allowing employers to offer a carryover of up to $500 in unused health FSA funds to the following year or to continue a grace period option giving employees a two-and-a-half-month extension to spend remaining FSA funds. FSAs cannot have both a carryover and a grace period option, and employers are not obligated to offer either extension.

Health Savings Accounts (HSA) 2017 offers individuals and families additional opportunities to save for current and future health care with a Health Savings Account (HSA):

HSA holders can choose to save up to $3,400 for an individual and $6,750 for a family (HSA holders 55 and older get to save an extra $1,000 which means $4,400 for an individual and $7,750 for a family) - and these contributions are 100% tax deductible from gross income.

Minimum annual deductibles are $1,300 for self-only coverage or $2,600 for family coverage.

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Annual out-of-pocket expenses (deductibles, copayments, and other amounts, but not premiums) cannot exceed $6,550 for self-only coverage and $13,100 for family coverage.

2017 HSA Contribution Limits, Deductibles, and Out-of-Pocket Expenses

Minimum Deductible Maximum Out-of-Pocket

Contribution Limit

55+ Contribution Limit

Single $1,300 $6,550 $3,400 $4,400 Family $2,600 $13,100 $6,750 $7,750

Table 18-11 - HSA Contribution Limits, Deductibles, and Out-of-Pocket Expenses (2017)

While the Affordable Care Act allows parents to add their adult children (up to age 26) to their health plans, the IRS definition of a qualified dependent (child or relative) who may be covered under an employee's HSA is different. For example, an employee whose 24-year-old child is covered on his HSA-qualified high-deductible health plan may not be eligible to use HSA funds to pay that child's medical bills (unless the child is a full-time student, and therefore a qualified dependent for tax purposes).

Those under age 65 (unless totally and permanently disabled) who use HSA funds for nonqualified medical expenses face a penalty of 20% of the funds used for such expenses. Funds spent for nonqualified purposes are also subject to income tax.

There are several important differences between FSAs and HSAs. Options such as the taxpayer’s flexibility in contributing, the ability to keep his or her unused balance and additional tax benefits can make HSAs the wisest choice if the taxpayer has the option. However, both accounts can potentially save the taxpayer money and make budgeting for medical costs easier.

Important Differences Between HSAs and FSAs

Health savings account (HSA) Flexible spending account (FSA)

Eligibility requirements Eligibility requirements include having a high-deductible health plan (HDHP).

No eligibility requirements.

Contribution limit 2017 contributions capped at $3,400 for individuals or $6,750 for families. 2017 contributions capped at $2,600.

Changing contribution amount The taxpayer can change how much he or she contributes to the account at any point during the year.

Contribution amounts can be adjusted only at open enrollment or with a change in employment or family status.

Rollover Unused balances roll over into the next year.

FSAs can allow an individual to carry over up to $500 per year to use in the following year.

Connection to employer The taxpayer’s HSA can follow him or her as he or she changes employment.

In most cases, the taxpayer will lose his or her FSA with a job change. One exception: if the taxpayer is eligible for FSA continuation through COBRA.

Effect on taxes

Contributions are tax-deductible, but can also be taken out of the taxpayer’s salary pretax. Growth and distributions are tax-free.

Contributions are pretax, and distributions are untaxed.

Table 18-12 - Using a Flexible Spending Account (FSA) - HealthCare.gov (2017)

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Pension Plan Limitations The Internal Revenue Service has set the cost‑of‑living adjustments affecting dollar limitations for pension plans and other retirement-related items for tax year 2017. Some of the pension plan limitations will change for 2017 because the increase in the cost-of-living index met the statutory thresholds that trigger their adjustment. However, other limitations will remain unchanged because the increase in the index did not meet the statutory thresholds that trigger their adjustment. (348) Elective Deferral (Contribution) Limits The elective deferral limit for employees who participate in 401(k), 403(b), most 457 plans, and the Federal government’s Thrift Savings Plan will remain at $18,000 in 2017. The catch-up contribution limit for employees aged 50 and over who participate in 401(k), 403(b), most 457 plans, and the Federal government’s Thrift Savings Plan is will also stay the same at $6,000 in 2017. If the taxpayer is self-employed, the total employer plus employee contributions to all defined contribution plans under Section 415(c)(1)(A) is increased in 2017 from $53,000 to $54,000. (349) Individual Retirement Arrangements (IRA) The contribution limit to a taxpayer’s traditional IRA for 2017 is the smaller of the following amounts: (350)

$5,500. The taxpayer’s taxable compensation for the year.

If the taxpayer was age 50 or older before 2017, the maximum amount that can be contributed to his or her traditional IRA for 2017 will be the smaller of the following amounts:

$6,500. The taxpayer’s taxable compensation for the year.

The income ranges for determining eligibility to make deductible contributions to traditional Individual Retirement Arrangements (IRAs), to contribute to Roth IRAs, and to claim the saver’s credit all increased for 2017. For 2017, if the taxpayer is covered by a retirement plan at work, his or her deduction for contributions to a traditional IRA is reduced (phased out) if modified AGI is: (350)

More than $99,000 but less than $119,000 for a married couple filing a joint return or a qualifying widow(er), More than $62,000 but less than $72,000 for a single individual or head of household, or Less than $10,000 for a married individual filing a separate return.

If the taxpayer either lives with his or her spouse or files a joint return, and his or her spouse is covered by a retirement plan at work, but the taxpayer is not, the taxpayer’s deduction is phased out if his or her modified AGI is more than $186,000 but less than $196,000. If the taxpayer’s modified AGI is $196,000 or more, he or she cannot take a deduction for contributions to a traditional IRA. The IRA contribution limit does not apply to:

Rollover contributions. Qualified reservist repayments.

If the taxpayer files a joint return, he or she may be able to contribute to an IRA even if he or she did not have taxable compensation as long as his or her spouse did. The amount of taxpayer’s combined contributions cannot be more than the taxable compensation reported on his or her joint return. Rollovers Most pre-retirement payments a taxpayer receives from a retirement plan or IRA can be “rolled over” by depositing the payment in another retirement plan or IRA within 60 days. He or she can also have his or her financial institution or plan directly transfer the payment to another plan or IRA.

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All of the following are methods to complete a rollover:

1. Direct rollover - If the taxpayer is getting a distribution from a retirement plan, he or she can ask the plan administrator to make the payment directly to another retirement plan or to an IRA. The taxpayer should contact the plan administrator for instructions. The administrator may issue the taxpayer’s distribution in the form of a check made payable to his or her new account. No taxes will be withheld from the transfer amount.

2. Trustee-to-trustee transfer - If the taxpayer is getting a distribution from an IRA, he or she can ask the financial institution holding the IRA to make the payment directly from his or her IRA to another IRA or to a retirement plan. No taxes will be withheld from the transfer amount.

3. 60-day rollover - If a distribution from an IRA or a retirement plan is paid directly to the taxpayer, he or she can deposit all or a portion of it in an IRA or a retirement plan within 60 days. Taxes will be withheld from a distribution from a retirement plan, so the taxpayer will have to use other funds to roll over the full amount of the distribution.

The taxpayer generally cannot make more than one rollover from the same IRA within a 1-year period. He or she also cannot make a rollover during this 1-year period from the IRA to which the distribution was rolled over. (351) If the taxpayer has not elected a direct rollover, in the case of a distribution from a retirement plan, or he or she has not elected out of withholding in the case of a distribution from an IRA, his or her plan administrator or IRA trustee will withhold taxes from the taxpayer’s distribution. If the taxpayer later rolls the distribution over within 60 days, he or she must use other funds to make up for the amount withheld. If the taxpayer decides not to roll over the entire amount of the distribution (including any amount withheld) he or she will report the difference as taxable income. The taxpayer must also pay the 10% additional tax on early distributions on the withheld amount unless he or she qualifies for an exception. If the taxpayer rolls over the full amount of any eligible rollover distribution, he or she receives the entire distribution would be tax-free and the taxpayer would avoid the 10% additional tax on early distributions.

In Revenue Procedure 2016-47, effective August 2016, the IRS has created a new “self-certification” procedure that allows someone who misses the 60-day deadline for rollovers to avoid the expense and delay of obtaining a private letter ruling. Instead, a taxpayer submits a model IRS letter to the new retirement account custodian, checking in that letter one of 11 acceptable excuses for missing the deadline.

A self-certification is not a waiver by the IRS of the 60-day rollover requirement. However, a taxpayer may report the contribution as a valid rollover unless later informed otherwise by the IRS. The IRS, in the course of an examination, may consider whether a taxpayer’s contribution meets the requirements for a waiver. The taxpayer must have missed the 60-day deadline because of his or her inability to complete a rollover due to one or more of the following reasons:

An error was committed by the financial institution receiving the contribution or making the distribution to which the contribution relates.

The distribution, having been made in the form of a check, was misplaced and never cashed. The distribution was deposited into and remained in an account that the taxpayer mistakenly thought was an

eligible retirement plan. The taxpayer’s principal residence was severely damaged. A member of the taxpayer’s family died. The taxpayer or a member of the taxpayer’s family was seriously ill. The taxpayer was incarcerated. Restrictions were imposed by a foreign country. A postal error occurred. The distribution was made on account of a levy under Section 6331 and the proceeds of the levy have been

returned to the taxpayer. The party making the distribution to which the rollover relates delayed providing information that the receiving plan

or IRA required to complete the rollover despite the taxpayer’s reasonable efforts to obtain the information. While the reasons are comprehensive, they only apply if the taxpayer was initially eligible to complete a 60-day rollover. As a result of a 2014 U.S. Tax Court decision, taxpayers may only perform one 60-day IRA rollover every 12 months, no matter how many IRAs they have.

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The contribution must be made to the plan or IRA as soon as practicable after the reason or reasons listed above no longer prevent the taxpayer from making the contribution. This requirement is deemed to be satisfied if the contribution is made within 30 days after the reason or reasons no longer prevent the taxpayer from making the contribution.

One reason the IRS will not allow is that the taxpayer was using his or her retirement money as a short-term loan for some non-retirement purpose, such as a down payment on a house, and missed the 60-day deadline because of a complication or delay.

IRA One-Rollover-Per-Year Rule Since January 1, 2015, a taxpayer can make only one rollover from a traditional IRA to another (or the same) traditional IRA in any 12-month period, regardless of the number of IRAs he or she owns. A similar limitation will apply to rollovers between Roth IRAs. The taxpayer can, however, continue to make as many trustee-to-trustee transfers between IRAs as he or she wants. Amounts transferred between traditional IRAs, either by rollover or trustee-to-trustee transfer, are excluded from the taxpayer’s gross income. The one-per year limit does not apply to: (351)

Rollovers from traditional IRAs to Roth IRAs (conversions). Trustee-to-trustee transfers to another IRA. IRA-to-plan rollovers. Plan-to-IRA rollovers. Plan-to-plan rollovers.

The tax consequences of the new rule are: (351)

1. The taxpayer must include in gross income any previously untaxed amounts distributed from an IRA if he or she made an IRA-to-IRA rollover (other than a rollover from a traditional IRA to a Roth IRA) in the preceding 12 months.

2. The taxpayer may be subject to the 10% early withdrawal tax on the amount he or she includes in gross income. If the taxpayer has not elected a direct rollover, in the case of a distribution from a retirement plan, or he or she has not elected out of withholding in the case of a distribution from an IRA, the plan administrator or IRA trustee will withhold taxes from the distribution. If the taxpayer later rolls the distribution over within 60 days, he or she must use other funds to make up for the amount withheld. If the taxpayer rolls over the full amount of any eligible rollover distribution he or she receives, the entire distribution would be tax-free and he or she would avoid the 10% additional tax on early distributions.

This change will not affect the taxpayer’s ability to transfer funds from one IRA trustee directly to another, because this type of transfer is not a rollover (Revenue Ruling 78-406, 1978-2 C.B. 157). The one-rollover-per-year rule of Internal Revenue Code Section 408(d)(3)(B) applies only to rollovers.

The IRS intends to follow the Tax Court’s interpretation of Internal Revenue Code Section 408(d)(3)(B). However, to give IRA owners and trustees time to adjust, the IRS delayed implementation until January 1, 2015. Proposed Treasury Regulation Section 1.408-4(b)(4)(ii) will be withdrawn and Publication 590-B - Distributions from Individual Retirement Arrangements (IRAs) has been revised to reflect the new interpretation. Qualified Reservist Repayments If the taxpayer was a member of a reserve component and he or she was ordered or called to active duty after September 11, 2001, he or she may be able to contribute (repay) to an IRA amounts equal to any qualified reservist distributions he or she received. The taxpayer can make these repayment contributions even if they would cause his or her total contributions to the IRA to be more than the general limit on contributions. To be eligible to make these repayment contributions, the taxpayer must have received a qualified reservist distribution from an IRA or from a Section 401(k) or 403(b) plan or a similar arrangement.

The qualified reservist repayments cannot be more than the qualified reservist distributions and the taxpayer cannot make these repayment contributions later than the date that is 2 years after his or her active duty period ends. Also, the taxpayer cannot deduct qualified reservist repayments.

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If the taxpayer repays a qualified reservist distribution, include the amount of the repayment with nondeductible contributions on line 1 of Form 8606 - Nondeductible IRAs. Roth IRA If contributions on the taxpayer’s behalf are made only to Roth IRAs, his or her contribution limit for 2017 will generally be the lesser of either: (350)

$5,500. The taxpayer’s taxable compensation for the year.

If the taxpayer was age 50 or older before 2018 and contributions on his or her behalf were completed only to Roth IRAs, the taxpayer’s contribution limit for 2017 will generally be the lesser of either of the following: (350)

$6,500. The taxpayer’s taxable compensation for the year.

For 2017, the taxpayer’s Roth IRA contribution limit is reduced (phased out) in the following situations: (350)

His or her filing status is married filing jointly or qualifying widow(er) and his or her modified AGI is at least $186,000. The taxpayer cannot make a Roth IRA contribution if his or her modified AGI is $196,000 or more.

His or her filing status is single, head of household, or married filing separately and he or she did not live with his or her spouse at any time in 2017 and his or her modified AGI is at least $119,000. The taxpayer cannot make a Roth IRA contribution if his or her modified AGI is $133,000 or more.

His or her filing status is married filing separately, he or she lived with his or her spouse at any time during the year, and his or her modified AGI is more than $0. The taxpayer cannot make a Roth IRA contribution if his or her modified AGI is $10,000 or more.

Regardless of the taxpayer’s age, he or she may be able to establish and make nondeductible contributions to a Roth IRA. The taxpayer does not report Roth IRA contributions on his or her return. Contribution Limits The Internal Revenue Service announced cost‑of‑living adjustments affecting dollar limitations for pension plans and other retirement-related items for tax year 2017. Some pension limitations such as those governing 401(k) plans and IRAs will remain unchanged because the increase in the Consumer Price Index did not meet the statutory thresholds for their adjustment. However, other pension plan limitations increased for 2017. Contribution Limits 2016 2017 IRA contributions under age 50 $5,500 $5,500 IRA contributions age 50 and over $6,500 $6,500 SIMPLE Contributions $12,500 $12,500

SEP, Keogh Maximum Dollar Allocations $53,000 $54,000

401(k), 403(b), Profit-Sharing Plans Elective deferrals $18,000 $18,000

Elective catch-ups SIMPLEs $3,000 $3,000 401(k), 403(b), 457 plans $6,000 $6,000

Table 18-13 - Pension Plan Limitations (2017)

Designated Roth Accounts - In-Plan Rollovers to Designated Roth Accounts A plan with a designated Roth program may allow participants to transfer eligible rollover distributions to a designated Roth account from another account in the same plan. The Roth contribution program must be in place before a plan can offer in-plan Roth rollovers. A Roth program cannot be set up solely to accept in-plan rollovers - it must also accept elective

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deferrals from participants. Not all pre-tax plan balances can be transferred to a designated Roth account. To be eligible for an in-plan rollover, the amount must be eligible for distribution to the participant under the terms of the plan and must be otherwise eligible for rollover (an eligible rollover distribution). 20% mandatory withholding does not apply to an in-plan Roth direct rollover. However, if the taxpayer receives his or her distribution in cash, 20% withholding will apply even if the amount is rolled over to a designated Roth account within 60 days. (352) Inherited IRAs Not Excludable In Bankruptcy In Clark v. Rameker. the U.S. Supreme Court unanimously ruled that inherited IRAs do not qualify under the “retirement funds” bankruptcy exemption. As a result, non-spouses inheriting an IRA may no longer protect the funds from creditors after filing bankruptcy and spouses have more incentive to roll over inherited IRA funds. The new decision does not leave those wishing to transfer IRAs on their death without options. Spouses inheriting IRAs retain the option to roll over the inherited IRA into their own or a new IRA. If a current IRA owner wishes to leave his or her IRA to a beneficiary upon the owner’s death, the best course of action is to leave the IRA to a trust for the benefit of the individual instead of directly to an individual. The My Retirement Account (myRA) The U.S. Department of the Treasury has decided to phase out the myRA retirement savings program and the program is no longer accepting new enrollments. However, existing accounts remain open and accessible at this time. The taxpayer’s account remains open and he or she can continue to manage his or her account. At this time, the taxpayer will be able to continue making deposits and his or her account will continue to earn interest. The funds in the account remain in an investment issued by the U.S. Department of the Treasury. The taxpayer can initiate a transfer of his or her full account balance to another Roth IRA at any time. Before initiating a direct rollover or transfer, the taxpayer will want to identify or open an account at the new Roth IRA provider where he or she will continue to save and invest. Then, by working with a new Roth IRA provider selected, the taxpayer can transfer his or her myRA balance to his or her new Roth IRA. By using a direct rollover or transfer to move the funds, the taxpayer avoids withholding and potential tax liabilities that may apply to earnings if funds paid directly to the taxpayer are not deposited within 60 days of a distribution to a new Roth IRA. If the taxpayer chooses not to transfer his or her balance to another Roth IRA, he or she can make a withdrawal for the amount of his or her myRA balance online by signing into his or her account. To maintain all of the benefits of a Roth IRA, the taxpayer must deposit funds paid to him or her (as well as any tax withholding) into another Roth IRA within 60 days of the distribution. Failure to do so may result in tax liability and penalties related to withdrawn earnings that would have been avoided by working with taxpayer’s new Roth IRA provider to transfer his or her account balance. Any myRA with a zero ($0) balance as of September 15, 2017 or later, will be subject to possible automatic closure beginning on September 18, 2017. If the taxpayer has a $0 balance and recently set up direct deposit with his or her employer, the U.S. Department of the Treasury recommends contacting the taxpayer’s employer to cancel his or her request as soon as possible. Employers may ask the taxpayer to follow their own paper or electronic process to cancel direct deposits.

Affordable Care Act Tax Provisions for Individuals In March 2010, President Obama signed comprehensive health reform, the Patient Protection and Affordable Care Act (ACA), into law. The law contains tax provisions that are currently in effect and more that will be implemented during the next few years. When the taxpayer files his or her 2017 tax return in 2018, he or she will need to either:

Indicate on his or her Federal income tax return that he or she, his or her spouse (if filing jointly), and his or her dependents had health care coverage throughout 2017.

Claim an exemption from the health care coverage requirement for some or all of 2017 and attach Form 8965 - Health Coverage Exemptions to his or her return.

Make a shared responsibility payment if, for any month in 2017, the taxpayer, his or her spouse (if filing jointly), or his or her dependents did not have coverage and do not qualify for a coverage exemption.

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The taxpayer may be eligible to claim the Premium Tax Credit if he or she, his or her spouse (if filing jointly), and his or her dependents enrolled in health insurance through the Health Insurance Marketplace. Advance payments of the Premium Tax Credit may have been made to a health insurer to help pay for the insurance coverage of the taxpayer, his or her spouse (if filing jointly), or his or her dependents. If advance payments of the Premium Tax Credit were made, the taxpayer must file a 2017 return and Form 8962 - Premium Tax Credit (PTC). If the taxpayer, his or her spouse (if filing jointly), or his or her dependents enrolled in health insurance through the Health Insurance Marketplace, the taxpayer should have received Form 1095-A - Health Insurance Marketplace Statement. If the taxpayer receives Form(s) 1095-A, he or she should save it. Form(s) 1095-A will help the taxpayer figure his or her Premium Tax Credit. If the taxpayer did not receive a Form 1095-A, he or she should contact the Marketplace. Premium Tax Credit (PTC) Since 2014, individuals and families have been able to claim the Premium Tax Credit (PTC) to help them afford health insurance coverage purchased through an Affordable Insurance Exchange. Exchanges will operate in every state and the District of Columbia. This tax credit can help make the cost of purchasing health insurance coverage more affordable for individuals and families with low to moderate incomes. Additionally, the Premium Tax Credit is refundable so taxpayers who have little or no income tax liability can still benefit. The credit also can be paid in advance to a taxpayer’s insurance company to help cover the cost of premiums. In general, the taxpayer may be eligible for the credit if he or she meets all of the following: (353)

1. Purchases coverage through the Marketplace. 2. Has household income that falls within a certain range. 3. Is not able to get affordable coverage through an eligible employer plan that provides minimum value. 4. Is not eligible for coverage through a government program, like Medicaid, Medicare, CHIP or TRICARE. 5. Files a joint return, if married. 6. Cannot be claimed as a dependent by another person.

In general, individuals and families whose household income for the year is between 100% and 400% of the Federal poverty line for their family size may be eligible for the Premium Tax Credit. An individual who meets these income requirements must also meet the other eligibility criteria. The taxpayer should use the 2016 Federal Poverty Guidelines (FPL) to determine 2017 Premium Tax Credit eligibility. For residents of one of the 48 contiguous states or Washington, D.C., the following illustrates some examples of when household income would be between 100% and 400% of the Federal poverty line: (353)

$11,880 (100%) up to $47,520 (400%) for one individual. $16,020 (100%) up to $64,080 (400%) for a family of two. $20,160 (100%) up to $80,640(400%) for a family of three. $24,300 (100%) up to $97,200 (400%) for a family of four.

If the taxpayer is eligible for the credit, he or she can choose to either: (353)

Claim It Now - have all or some of the credit paid in advance directly to his or her insurance company to lower what he or she pays out-of-pocket for his or her monthly premiums during 2017.

Claim It Later - wait to get all of the credit when he or she files his or her 2017 tax return in 2018. Whether the taxpayer chooses to claim the Premium Tax Credit now at the Marketplace or claim it later, he or she must file a Federal income tax return.

To claim the credit, the taxpayer must get insurance through the Marketplace. During enrollment through the Marketplace, using information the taxpayer provides about his or her projected income and family composition for 2017, the Marketplace will estimate the amount of the Premium Tax Credit he or she will be able to claim for the 2017 tax year that he or she will file in 2018. The taxpayer will then decide whether he or she wants to have all, some or none of the estimated credit paid in advance directly to his or her insurance company. The taxpayer should report income and family size changes to the Marketplace throughout the year. Reporting changes, increases or decreases, will help the taxpayer get the proper type and amount of financial assistance and will help him or her avoid getting too much or too little in advance.

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For example, if the taxpayer does not report income or family size changes to the Marketplace when they happen in 2017, the advance payments may not match his or her actual qualified credit amount on his or her Federal tax return that he or she will file in 2018. This might result in a smaller refund or balance due. If the taxpayer chooses to claim the Premium Tax Credit now, when he or she files his or her 2017 tax return in 2018, he or she will subtract the total advance payments he or she received during the year from the amount of the Premium Tax Credit calculated on his or her tax return. If the Premium Tax Credit computed on the return is more than the advance credit paid on the taxpayer’s behalf during the year, the difference will increase his or her refund or lower the amount of tax he or she owes. If the advance credit payments are more than the Premium Tax Credit, the difference will increase the amount the taxpayer owes and result in either a smaller refund or a balance due. If the taxpayer chooses to claim the Premium Tax Credit later, he or she will claim the full amount of the Premium Tax Credit when he or she files his or her 2017 tax return in 2018. This will either increase his or her refund or lower his or her balance due. If the taxpayer’s state runs its own Marketplace, he or she will use the state's website, not the Marketplace. (353) Individual Shared Responsibility Provision Under the Affordable Care Act, the Federal government, state governments, insurers, employers and individuals are given shared responsibility to reform and improve the availability, quality and affordability of health insurance coverage in the United States. The individual shared responsibility provision calls for each individual to have minimum essential health coverage (known as minimum essential coverage) for each month, qualify for an exemption, or make a payment when filing his or her Federal income tax return. Most individuals in the United States have health coverage today that will count as minimum essential coverage and will not need to do anything more than continue the coverage that they have. For those who do not have coverage, who anticipate discontinuing the coverage they have currently, or who want to explore whether more affordable options are available, the Health Insurance Marketplace opened for every state and the District of Columbia in October of 2013. The Health Insurance Marketplace helps qualified individuals find minimum essential coverage that fits their budget and potentially financial assistance to help with the costs of coverage. The Health Insurance Marketplace also assesses whether applicants are eligible for Medicaid or the Children’s Health Insurance Program (CHIP). For those who became eligible for Medicare during 2016, enrolling for Medicare will also ensure that the taxpayer has minimum essential coverage for 2017. The taxpayer and his or her family are required to have health care coverage, have an exemption from coverage, or make a payment when he or she files the 2017 tax return in 2018. Most people already have qualifying health care coverage and will not need to do anything more than maintain that coverage throughout 2017. The taxpayer may be exempt from the requirement to maintain qualifying health insurance coverage, called minimum essential coverage, and may not have to make a shared responsibility payment when he or she files his or her next Federal income tax return. The taxpayer may be exempt if he or she:

Has no affordable coverage options because the minimum amount he or she must pay for the annual premiums is more than 8% of his or her household income.

Has a gap in coverage for less than three consecutive months. Qualifies for an exemption for one of several other reasons, including having a hardship that prevents him or her

from obtaining coverage or belonging to a group explicitly exempt from the requirement.

For Tax Year 2017, the IRS will not consider a return complete and accurate if the taxpayer does not report full-year coverage, claim a coverage exemption, or report a shared responsibility payment on the tax return. Most taxpayers have qualifying health coverage for all 12 months in the year, and will check the "Full-year coverage"

box on their tax return. Taxpayers who do not have full-year coverage will indicate whether they qualify for a coverage exemption or owe a shared responsibility payment. Executive Order 13765 was issued on January 20, 2017, and directed Federal agencies to exercise authority and discretion available to them to reduce potential burden. However, legislative provisions of the ACA are still in force until changed by the Congress, and taxpayers remain obligated to follow the law and pay what they may owe. Taxpayers should continue to file their tax returns as they normally would.

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Change in Circumstances If the taxpayer is receiving advance payments of the premium tax credit to help pay for his or her insurance coverage, he or she must report changes such as income or family size to his or her marketplace. Reporting changes will help to make sure the taxpayer is receiving the proper amount of assistance. Individual Shared Responsibility Payment Most people are required to have health coverage. If they do not have coverage, they may be required to pay a fee. The fee is sometimes called the individual shared responsibility payment or penalty. The penalty in 2017 is calculated one of 2 ways. An individual will pay whichever of these amounts is higher:

1. 2.5% of his or her yearly household income (to determine payment using the income formula, subtract filing threshold from household income). The maximum penalty is the national average yearly premium for a bronze plan.

2. $695 per person for the year ($347.50 per child under 18). The maximum penalty per family using this method is $2,085.

The taxpayer’s payment amount is capped at the cost of the national average premium for a bronze level health plan available through the Marketplace. As a reference, for 2017, the annual national average premium for a bronze level health plan available through the Marketplace was $3,264 per year ($272 per month) for an individual and $16,320 per year ($1,360 per month) for a family with five or more members. The fee may increase every year as it is adjusted for inflation. If an individual is uninsured for just part of the year, 1/12 of the yearly penalty applies to each month he or she uninsured. If the individual is uninsured for less than 3 months, he or she does not have a make a payment. The taxpayer will pay the fee on his or her Federal income tax return. The following types of health plans that do not meet minimum essential coverage do not qualify as coverage in 2017. If the individual only has these types of coverage, he or she may have to pay the fee. Examples include:

Coverage only for vision care or dental care. Workers' compensation. Coverage only for a specific disease or condition. Plans that offer only discounts on medical services.

Health Coverage Exemptions Taxpayers must have health care coverage, have a health coverage exemption, or make a shared responsibility payment with their tax return. Taxpayers use Form 8965 - Health Coverage Exemptions to report a coverage exemption granted by the Marketplace (also called the “Exchange”) or to claim a coverage exemption on his or her tax return. In addition, if for any month the taxpayer or another member of his or her tax household had neither health care coverage nor a coverage exemption, the instructions for Form 8965 provide the information the taxpayer will need to calculate his or her shared responsibility payment. Some exemptions must be obtained through the Marketplace (an individual must have applied and received their exemption certificate number before they file their return). Certain exemptions can only be requested at the time the Federal return is filed, while others can be requested through the Marketplace or when filing their Federal return. Exemptions that can only be obtained from the Marketplace are as follows: (299)

Members of certain religious sects - the taxpayer is a member of a recognized religious sect. Determined ineligible for Medicaid in a state that did not expand Medicaid coverage - the taxpayer was determined

ineligible for Medicaid solely because the state in which he or she resided did not participate in Medicaid expansion under the Affordable Care Act.

General hardship - the taxpayer experienced a hardship that prevented him or her from obtaining coverage under a qualified health plan.

Coverage considered unaffordable based on projected income - the taxpayer did not have access to coverage that is considered affordable based on his or her projected household income.

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Unable to renew existing coverage - the taxpayer was notified that his or her health insurance policy was not renewable and he or she considered the other plans available unaffordable.

Certain Medicaid programs that are not minimum essential coverage - The Marketplace determined that the taxpayer was (1) enrolled in Medicaid coverage provided to a pregnant woman that is not recognized as minimum essential coverage; (2) enrolled in Medicaid coverage provided to a medically needy individual (also known as Spend-down Medicaid or Share-of-Cost Medicaid) that is not recognized as minimum essential coverage; or (3) enrolled in Medicaid coverage provided to a medically needy individual and were without coverage for other months because the spend-down had not been met.

Examples of some of the exemptions that may only be requested by filing Form 8965 with a Federal return: (299)

Income below the filing threshold - the taxpayer’s gross income or his or her household income was less than his or her applicable minimum threshold for filing a tax return.

Coverage considered unaffordable - The minimum amount the taxpayer would have paid for premiums is more than 8.16% for tax year 2017 of his or her household income.

Short coverage gap - the taxpayer went without coverage for less than 3 consecutive months during the year. Citizens living abroad and certain noncitizens - the taxpayer was:

o A U.S. citizen or resident who spent at least 330 full days outside of the U.S. during a 12-month period; o A U.S. citizen who was a bona fide resident of a foreign country or U.S. territory; o A resident alien who was a citizen of a foreign country with which the U.S. has an income tax treaty with

a nondiscrimination clause, and he or she was a bona fide resident of a foreign country for the tax year; o Not a U.S. citizen, not a U.S. national, and not an individual lawfully present in the U.S; or o A nonresident alien, including (1) a dual-status alien in the first year of U.S. residency and (2) a

nonresident alien or dual-status alien who elects to file a joint return with a U.S. spouse. This exemption does not apply if the taxpayer is a nonresident alien for 2017, but met certain presence requirements and elected to be treated as a resident alien.

Members of a health care sharing ministry - the taxpayer was a member of a health care sharing ministry. Members of Indian tribes - the taxpayer was either a member of a Federally-recognized Indian tribe, including an

Alaska Native Claims Settlement Act (ANCSA) Corporation Shareholder (regional or village), or he or she was otherwise eligible for services through an Indian health care provider or the Indian Health Service.

Incarceration - the taxpayer was in a jail, prison, or similar penal institution or correctional facility after the disposition of charges.

Aggregate self-only coverage considered unaffordable - Two or more family members' aggregate cost of self-only employer-sponsored coverage was more than 8.16% of household income for the 2017 tax year, as was the cost of any available employer-sponsored coverage for the entire family.

Resident of a state that did not expand Medicaid - the taxpayer’s household income was below 138% of the Federal poverty line for his or her family size and at any time during the tax year he or she resided in a state that didn't participate in the Medicaid expansion under the Affordable Care Act.

Eligible for Health Coverage Tax Credit (HCTC) - the taxpayer was eligible for the health coverage tax credit in the month. (For this purpose, he or she is considered eligible for the HCTC if he or she would have been eligible had he or she enrolled in HCTC-qualifying coverage.) This exemption was available only for July through December of 2016.

Member of tax household born or adopted during the year - The months before and including the month that an individual was added to the taxpayer’s tax household by birth or adoption. The taxpayer should claim this exemption only if he or she is also claiming another exemption on his or her Form 8965.

Member of tax household died during the year - The months after the month that a member of the taxpayer’s tax household died during the year. The taxpayer should claim this exemption only if he or she is also claiming another exemption on his or her Form 8965.

If a taxpayer is eligible for an exemption from having health insurance for 2017, they must complete Form 8965 - Health Coverage Exemptions to avoid owing a penalty (shared responsibility payment) for 2017.

As of September 1, 2016, the coverage exemptions for members of health care sharing ministries, members of Indian tribes, and those who are incarcerated are no longer granted by the Marketplace, except in Connecticut. Taxpayers who have an ECN issued by the Marketplace for one or more of these three exemptions may report

the ECN on a Form 8965 filed with their income tax return for 2017. Taxpayers who qualify for one or more of these exemptions but who do not have an ECN issued by the Marketplace may claim these exemptions on Part III of Form 8965.

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Health Coverage Tax Credit (HCTC) The Trade Preferences Extension Act of 2015 extended and modified the expired Health Coverage Tax Credit (HCTC). Previously, those eligible for the HCTC could claim the credit against the premiums they paid for certain health insurance coverage through 2013. The HCTC can now be claimed for coverage through 2019. The taxpayer should use Form 8885 - Health Coverage Tax Credit to elect and figure the amount, if any, of his or her HCTC. The Health Coverage Tax Credit (HCTC) is a tax credit that pays 72.5% of qualified health insurance premiums for eligible individuals and their families. A taxpayer may only elect to take the HCTC if he or she is one of the following:

An eligible trade adjustment assistance (TAA) recipient, alternative (ATAA) recipient, reemployment (RTAA) recipient.

An eligible Pension Benefit Guaranty Corporation (PBGC) pension payee. The family member of a TAA, ATAA, or RTAA recipient or PBGC pension payee who is deceased or who finalized

a divorce with him or her. The taxpayer is not eligible if he or she could have been claimed as a dependent on another person’s Federal income tax return. All plans that were previously qualified for the HCTC qualify for the HCTC through 2019. This includes individual - private and non-group - health insurance that the taxpayer purchases for him or herself or his or her family from an insurance company, agent, or broker. There are several types of health insurance that qualify for the HCTC. However, contributions by the taxpayer’s employer or his or her spouse’s employer may limit qualification. Types of health insurance qualify for the HCTC include:

1. Coverage under a COBRA continuation provision. 2. Coverage under a group health plan available through the employment of the taxpayer’s spouse. 3. Coverage under an employee benefit plan funded by a voluntary employees’ beneficiary association (VEBA) that

was established through the bankruptcy of the taxpayer’s former employer. 4. Coverage obtained in the non-group (individual) health insurance market other than coverage offered through the

Health Insurance Marketplace. 5. Coverage under certain state-qualified health plans established prior to January 1, 2014.

A qualified health insurance plan does not include a flexible spending or similar arrangement and any insurance if substantially all of its coverage is of excepted benefits described in section 9832(c) of the Internal Revenue Code. For example, dental or vision benefits purchased separately aren’t part of a qualified health insurance plan for the HCTC. But, premiums paid for a comprehensive package that includes dental or vision benefits may be eligible for the HCTC if the dental or vision benefits don’t represent substantially all of its coverage. For 2014 and 2015 only, qualified coverage included qualified health plans offered through a Federally facilitated or a state-based Health Insurance Marketplace. For 2016 and beyond, Health Insurance Marketplace coverage is no longer qualified coverage for the HCTC. The taxpayer cannot claim the HCTC for any month that, on the first day of the month, he or she was covered under an employer-sponsored health insurance plan (including any employer-sponsored health insurance plan of a spouse) and the employer paid 50% or more of the cost of coverage. Also, if the taxpayer is an Alternative Trade Adjustment Assistance (ATAA) or Reemployment Trade Adjustment Assistance (RTAA) recipient, he or she cannot claim the HCTC for any month that, on the first day of the month, he or she was eligible for certain kinds of coverage (including any employer-sponsored health insurance plan of the taxpayers spouse) where the employer would have paid 50% or more of the cost of the coverage or he or she was covered under certain kinds of coverage (including any employer-sponsored health insurance plan of the taxpayer’s spouse) where the employer paid any part of the cost of coverage.

Advance payments of the HCTC began July 2016. The taxpayer could choose Marketplace coverage for the first part of 2016 to receive advance payments of the Premium Tax Credit (PTC) even though Marketplace coverage was not eligible for the HCTC in 2016. The taxpayer may then switch coverage into an HCTC-eligible plan after advance payments of the HCTC begin. The election required to claim the HCTC can be made for any coverage month and does not prevent the taxpayer from claiming the PTC in earlier months in the year.

Once the taxpayer makes the election to take the HCTC for an eligible coverage month, he or she cannot take the Premium Tax Credit (PTC) for the same coverage in that coverage month and for all subsequent eligible coverage months during his or her tax year in which he or she is eligible to take the HCTC.

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Advance Payments of the Premium Tax Credit If the taxpayer or a family member enrolled in health insurance through the Marketplace and advance payments of the Premium Tax Credit were made to his or her insurance company to reduce his or her monthly premium payment, the taxpayer should attach Form 8962 to his or her return to reconcile (compare) the advance payments with his or her Premium Tax Credit for the year, which the taxpayer figures on Form 8962. The Marketplace is required to send Form 1095-A by January 31, 2018, listing the advance payments and other information the taxpayer needs to figure his or her Premium Tax Credit. The taxpayer should use Form 1095-A to complete Form 8962. Also, the taxpayer should attach Form 8962 to his or her return. The taxpayer does not attach Form 1095-A to the income tax return. Net Investment Income Tax The Net Investment Income Tax is imposed by Section 1411 of the Internal Revenue Code (IRC) that took effect on January 1, 2013. The NIIT applies at a rate of 3.8% to certain net investment income of individuals, estates and trusts that have income above the statutory threshold amounts. In general, investment income includes, but is not limited to interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer.

The amount subject to the 3.8% tax is the lesser of the taxpayer’s net investment income or the amount by which modified adjusted gross (MAGI) exceeds the applicable threshold. Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds: (354)

Filing Status Threshold Amount* Married filing jointly $250,000 Married filing separately $125,000 Single $200,000 Head of household (with qualifying person) $200,000 Qualifying widow(er) with dependent child $250,000 *Taxpayers should be aware that these threshold amounts are not indexed for inflation. These amounts will stay the same from year to year, unless Congress specifically changes these amounts through new legislation.

Table 18-14 - IRS.GOV Net Investment Income Tax FAQs (2017)

If an individual is exempt from Medicare taxes, he or she still may be subject to the Net Investment Income Tax if he or she has Net Investment Income and also has modified adjusted gross income over the applicable thresholds.

Nonresident Aliens (NRAs) are not subject to the Net Investment Income Tax. If an NRA is married to a U.S. citizen or resident and has made, or is planning to make, an election under IRC Section 6013(g) to be treated as a resident alien for purposes of filing as Married Filing Jointly, the proposed regulations provide these couples special rules and a corresponding IRC Section 6013(g) election for the NIIT. Estates and Trusts will be subject to the Net Investment Income Tax if they have undistributed Net Investment Income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year. Generally, the threshold amount for the upcoming year is updated by the IRS each fall in a revenue procedure. For tax year 2017, the threshold amount is $12,500. The taxpayer should be aware that there are special computational rules for certain unique types of trusts, such as Charitable Remainder Trusts and Electing Small Business Trusts. The following trusts are not subject to the Net Investment Income Tax:

1. Trusts that are exempt from income taxes imposed by Subtitle A of the Internal Revenue Code (e.g., charitable trusts and qualified retirement plan trusts exempt from tax under IRC Section 501, and Charitable Remainder Trusts exempt from tax under IRC Section 664).

2. A trust in which all of the unexpired interests are devoted to one or more of the purposes described in IRC Section 170(c)(2)(B).

3. Trusts that are classified as grantor trusts under IRC Sections 671-679. 4. Trusts that are not classified as trusts for Federal income tax purposes (e.g., Real Estate Investment Trusts and

Common Trust Funds).

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In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities, and businesses that are passive activities to the taxpayer (within the meaning of IRC Section 469). To the extent that gains are not otherwise offset by capital losses, the following gains are common examples of items taken into account in computing Net Investment Income:

Gains from the sale of stocks, bonds, and mutual funds. Capital gain distributions from mutual funds. Gain from the sale of investment real estate (including gain from the sale of a second home that is not a primary

residence). Gains from the sale of interests in partnerships and S corporations (to the extent the taxpayer was a passive

owner). The Net Investment Income Tax will not be applicable to any amount of gain that is excluded from gross income for regular income tax purposes. The pre-existing statutory exclusion in IRC Section 121 exempts the first $250,000 ($500,000 in the case of a married couple) of gain recognized on the sale of a principal residence from gross income for regular income tax purposes and, therefore, from the NIIT. Wages, unemployment compensation; operating income from a non-passive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income, Alaska Permanent Fund Dividends and distributions from certain Qualified Plans are some common types of income that are not investment income. In order to arrive at Net Investment Income, Gross Investment Income is reduced by deductions that are properly allocable to items of Gross Investment Income. Examples of properly allocable deductions include investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, and state and local income taxes properly allocable to items included in Net Investment Income. Taxpayers will determine any applicable NIIT on the new Form 8960 - Net Investment Income Tax - Individuals, Estates and Trusts, when they file their income tax return. Taxpayers whose AGI may exceed the threshold amounts and who have investment income may need to adjust their withholding or make estimated tax payments to ensure the new tax on investment income does not prompt a balance due when filing taxes next year. Additional Medicare Tax Effective January 2013, Additional Medicare Tax applies to an individual’s Medicare wages that surpass a threshold amount based on the taxpayer’s filing status. All wages that are currently subject to Medicare Tax are subject to Additional Medicare Tax if they are paid in excess of the applicable threshold for an individual’s filing status. Employers are responsible for withholding the 0.9% Additional Medicare Tax on an individual’s wages paid in excess of $200,000 in a calendar year. An employer is obligated to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax. (226) An individual is responsible for Additional Medicare Tax if the individual’s wages, compensation, or self-employment income (together with that of his or her spouse if filing a joint return) surpass the threshold amount for the individual’s filing status. Filing Status Threshold Amount Married filing jointly $250,000 Married filing separately $125,000 Single $200,000 Head of household (with qualifying person) $200,000 Qualifying widow(er) with dependent child $200,000

Table 18-15 - Questions and Answers for the Additional Medicare Tax (2017)

The Additional Medicare Tax statute mandates an employer to withhold Additional Medicare Tax on wages it pays to an employee in excess of $200,000 in a calendar year. An employer has this withholding obligation even though an employee may not be liable for Additional Medicare Tax because, for example, the employee’s wages together with that of his or her

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spouse do not exceed the $250,000 threshold for joint return filers. Any withheld Additional Medicare Tax will be credited against the total tax liability shown on the individual’s income tax return (Form 1040). An employee who foresees liability for Additional Medicare Tax may ask that his or her employer withhold an additional amount of income tax withholding on Form W-4 - Employee Withholding Allowance Certificate. This additional income tax withholding will be applied against all taxes shown on the individual’s income tax return (Form 1040), including any Additional Medicare Tax liability. Compensation subject to RRTA taxes and wages subject to FICA tax are not combined to determine Additional Medicare Tax liability. The threshold applicable to an individual’s filing status is applied separately to each of these categories of income. Changes to Itemized Deduction for Medical Expenses

Under the Tax Cuts and Jobs Act, the medical expense deduction is retroactively returned to 7.5% for 2017 and will remain in place with a lower floor of 7.5% for 2018.

Medical Device Excise Tax - Suspended The End the Shutdown Act of 2018, signed into law on January 22, 2018 included a two-year delay on the 2.3% medical device excise tax imposed by Internal Revenue Code section 4191 which was originally included in the Affordable Care Act to help pay for the law’s health insurance subsidies. The first payments would have been due to the Treasury Department by January 29, 2018, but the spending deal language retroactively delayed the tax beginning on December 31, 2017. The tax will now go into effect on January 1, 2020. Cadillac Tax The End the Shutdown Act of 2018 also includes a delay of the so-called "Cadillac Tax" on employer-provided health insurance for two years, until 2022. The Cadillac tax would apply a 40% excise tax to fully insured and self-funded employer health plans and would be levied on premium amounts higher than estimated thresholds of $10,800 for individual coverage and $29,100 for family coverage.

Affordable Care Act Tax Provisions Employers The Affordable Care Act (ACA), or health care law, includes many tax and other provisions for employers. The IRS will administer the tax provisions included in the law. Small Business Health Care Tax Credit The Small Business Health Care Tax Credit helps small businesses and small tax-exempt organizations afford the cost of covering their employees and is specifically targeted for those with low- and moderate-income workers. The credit is designed to encourage small employers to provide health insurance coverage for the first time or maintain coverage they already have. In general, the credit is available to small employers that pay at least half the cost of single coverage for their employees. For taxable years beginning in 2014 and forward:

The maximum credit is 50% of the employer’s premium payments made on behalf of its employees under a qualifying arrangement for a QHP offered through a SHOP Marketplace.

The maximum credit is 35% of the tax-exempt employer’s premium payments made on behalf of its employees under a qualifying arrangement for a QHP offered through a SHOP Marketplace.

To be eligible for the credit, a small employer must pay premiums on behalf of employees enrolled in a qualified health plan provided through a Small Business Health Options Program (SHOP) Marketplace.

The credit will be available to eligible employers for two consecutive taxable years. To be eligible, the small business must cover at least 50% of the cost of single (not family) health care coverage for each of the employees. The business must also have fewer than 25 full-time equivalent employees (FTEs). Those employees must have average wages of less than $50,000 (as adjusted for inflation beginning in 2014) per year.

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Also, the credit provides that the maximum credit is phased out based on the employer’s number of full-time equivalent employees in excess of 10 and the employer’s average annual wages in excess of $26,200 for tax year 2017, up from $25,900 for 2016. The small business taxpayer must use Form 8941 - Credit for Small Employer Health Insurance Premiums, to calculate the credit. A small business can include the amount as part of the general business credit on the income tax return. If the business is a tax-exempt organization, include the amount on line 44f of the Form 990-T - Exempt Organization Business Income Tax Return. The business must file the Form 990-T in order to claim the credit, even if they do not ordinarily do so.

A small business employer may be able to carry the credit back or forward. A tax-exempt employer may be eligible for a refundable credit.

Employer Shared Responsibility Provisions For 2016 and after, employers employing at least a certain number of employees (generally 50 full-time employees or a combination of full-time and part-time employees that is equivalent to 50 full-time employees) will be subject to the Employer Shared Responsibility provisions under Section 4980H of the Internal Revenue Code (added to the Code by the Affordable Care Act). As defined by the statute, a full-time employee is an individual employed on average at least 30 hours of service per week. An employer that meets the 50-full-time employee threshold is referred to as an applicable large employer (ALE). Under the Employer Shared Responsibility provisions, if these employers do not offer affordable health coverage that provides a minimum level of coverage to their full-time employees (and their dependents), the employer may be subject to an Employer Shared Responsibility payment if at least one of its full-time employees receives a premium tax credit for purchasing individual coverage on one of the new Affordable Insurance Exchanges, also called a Health Insurance Marketplace (Marketplace). Mid-size employers (i.e., employers with between 50 and 99 full-time employees and full-time equivalent employees) are not required to comply with the Employer Shared Responsibility provisions until the first day of the employer's 2017 plan year. Large Employer Health Coverage Excise Tax Large employers, generally those with 50 or more full-time employees in the prior calendar year, that:

Do not offer coverage for all its full-time employees. Offer minimum essential coverage that is unaffordable (employee contribution is more than 9.5% of the

employee's household income). Offer minimum essential coverage where the plan's share of the total allowed cost of benefits is less than 60%.

Will be required to pay a penalty if any of its full-time employees were certified to the employer as having purchased health insurance through a state exchange and qualified for either tax credits or a cost-sharing subsidy. Individual reporting requires health insurers and employers sponsoring self-funded group health plans to annually report to the IRS and responsible individuals (i.e., the enrolled employees and other primary insureds) whether the group health plan coverage constitutes minimum essential coverage under Health Care Reform. This reporting requirement will assist the IRS to enforce the individual mandate penalty. Form 1095-B - Health Coverage is used to complete the individual mandate reporting requirement with respect to responsible individuals and the IRS. Information to be provided includes the responsible individual's name, address and Social Security number. Identifying information concerning the employer-plan sponsor and issuer-coverage provider must be supplied, along with a list of the responsible individual's enrolled family members and the months during the year when they had coverage. When submitting Form 1095-B to the IRS, the reporting entity must also submit IRS Form 1094-B - Transmittal of Health Coverage Information Returns. Form 1094-B is a "transmittal" form that provides information about the reporting entity and the number of Form 1095-B submitted. Applicable Large Employers (ALE) with 50 or more full-time and full-time equivalent employees are required to report to the IRS and full-time employees for two purposes:

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1. To assist the IRS to enforce the Employer Shared Responsibility provisions. 2. To assist full-time employees to determine their eligibility for the Premium Tax Credit.

Applicable Large Employers (ALE) should use IRS Form 1095-C - Employer-Provided Health Insurance Offer and Coverage to complete the reporting requirement with respect to full-time employees and the IRS. Similar to the individual mandate reporting requirement, when submitting Form 1095-C to the IRS, large employers must also submit Form 1094-C - Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns. Form 1094-C is also a "transmittal" form that provides the IRS with a summary of the information contained in Form 1095-C. If an employer is part of a "controlled group" of commonly-owned entities, information regarding the other employers must be included.

Same-Sex Married Couples The U.S. Department of the Treasury and the Internal Revenue Service (IRS) ruled that same-sex couples, legally married in jurisdictions that recognize their marriages, will be treated as married for Federal tax purposes. The ruling applies regardless of whether the couple lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage. The ruling implements Federal tax aspects of the June 26 Supreme Court Obergefell v. Hodges decision invalidating a key provision of the 1996 Defense of Marriage Act. Under the ruling, same-sex couples will be treated as married for all Federal tax purposes, including income and gift and estate taxes. The ruling applies to all Federal tax provisions where marriage is a factor, including filing status, personal and dependency exemptions, the standard deduction, employee benefits, contributing to an IRA and the Earned Income Tax Credit or Child Tax Credit. (355)

Any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country will be covered by the ruling. However, the ruling does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law.

A taxpayer’s same-sex spouse cannot be a dependent of the taxpayer. For Federal tax purposes, the IRS has a general rule recognizing a marriage of same-sex individuals that was validly entered into in a domestic or foreign jurisdiction whose laws authorize the marriage of two individuals of the same sex even if the married couple resides in a domestic or foreign jurisdiction that does not recognize the validity of same-sex marriages. A same-sex spouse cannot file using head of household filing status. However, a married taxpayer may be considered unmarried and may use the head-of-household filing status if the taxpayer lives apart from his or her spouse for the last 6 months of the taxable year and provides more than half the cost of maintaining a household that is the principal place of abode of the taxpayer’s dependent child for more than half of the year. Also, if a taxpayer’s spouse itemized his or her deductions, the taxpayer cannot claim the standard deduction. Additionally, employees who purchased same-sex spouse health insurance coverage from their employers on an after-tax basis may treat the amounts paid for that coverage as pre-tax and excludable from income. Individuals who were in same-sex marriages may, but are not required to, file original or amended returns choosing to be treated as married for Federal tax purposes for one or more prior tax years still open under the statute of limitations. Taxpayers who wish to file a refund claim for income taxes should use Form 1040X - Amended U.S. Individual Income Tax Return. Taxpayers who wish to file a refund claim for gift or estate taxes should file Form 843 - Claim for Refund and Request for Abatement.

A taxpayer usually may file a claim for refund for three years from the date the return was filed or two years from the date the tax was paid, whichever is later. Also, some taxpayers may have special circumstances, such as signing an agreement with the IRS to keep the statute of limitations open, that permit them to file refund claims for earlier tax years.

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Other 2017 Tax Update Information Simplified Option for the Home Office Deduction The Internal Revenue Service has a simplified option that many owners of home-based businesses and some home-based workers may use to figure their deductions for the business use of their homes as they consider tax planning in 2017. The optional deduction is capped at $1,500 per year based on $5 a square foot for up to 300 square feet. This simplified option does not alter the criteria for who may claim a home office deduction. It only simplifies the calculation and recordkeeping requirements of the allowable deduction. Key points of the simplified option include: (356)

Standard deduction of $5 per square foot of home used for business (maximum 300 square feet). Allowable home-related itemized deductions claimed in full on Schedule A. (For example: Mortgage interest, real

estate taxes). No home depreciation deduction or later recapture of depreciation for the years the simplified option is used.

Comparison of Methods

Simplified Option Regular Method Deduction for home office use of a portion of a residence allowed only if that portion is exclusively used on a regular basis for business purposes

Same

Allowable square footage of home use for business (not to exceed 300 square feet)

Percentage of home used for business

Standard $5 per square foot used to determine home business deduction

Actual expenses determined and records maintained

Home-related itemized deductions claimed in full on Schedule A

Home-related itemized deductions apportioned between Schedule A and business schedule (Schedule C or Schedule F)

No depreciation deduction Depreciation deduction for portion of home used for business

No recapture of depreciation upon sale of home Recapture of depreciation on gain upon sale of home Deduction cannot exceed gross income from business use of home less business expenses

Same

Amount in excess of gross income limitation may not be carried over

Amount in excess of gross income limitation may be carried over

Loss carryover from use of regular method in prior year may not be claimed

Loss carryover from use of regular method in prior year may be claimed if gross income test is met in current year

Table 18-16 - Comparison of Methods (2017)

The taxpayer may elect to use either the simplified method or the regular method for any taxable year. He or she may also choose a method by using that method on his or her timely filed, original Federal income tax return for the taxable year. Once the taxpayer has selected a method for a taxable year, he or she cannot later change to the other method for that same year. If the taxpayer uses the simplified method for one year and uses the regular method for any subsequent year, he or she must calculate the depreciation deduction for the subsequent year using the appropriate optional depreciation table. This is true regardless of whether the taxpayer used an optional depreciation table for the first year the property was used in business. To determine allowable square footage under the simplified method when the qualified business use of the home is for less than the entire taxable year, or the portion of the home used in a qualified business use changes during the taxable year the taxpayer must determine the average of the monthly allowable square footage for the taxable year. For this purpose, no more than 300 square feet may be taken into account for any one month, and he or she only accounts for a month in which he or she had 15 or more days of a qualified business use of his or her home. The total allowable square footage is totaled and divided by 12 to determine the average of the monthly allowable square footage for the taxable year.

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Social Security and Medicare Tax The employee tax rate for Social Security in 2017 is 6.2%. The employer tax rate for Social Security remains unchanged at 6.2%. The Social Security wage base limit rises 7.3% to $127,200 for 2017. The new wage base translates into a maximum of $7,886.40 withheld from a highly paid employee’s 2017 paychecks. The Medicare tax rate is 1.45% each for the employee and employer, unchanged since 2012. There is no wage base limit for Medicare tax. If the taxpayer’s only income is from self-employment, the Social Security maximum is still in effect. That is, the Social Security portion of his or her self-employment tax is capped at the maximum profit of the company, depending on the maximum for that year. For 2017, the self-employment tax rate on net earnings is 15.3% (12.4% Social Security tax plus 2.9% Medicare tax). (357) Kiddie Tax The exemption from the kiddie tax for 2017 will be $2,100 (same as for 2016). Also, the threshold for the kiddie tax or the amount of unearned net income that a child can take home without paying any Federal income tax is $1,050. The same $1,050 amount is used to determine whether a parent may elect to include a child's gross income in the parent's gross income and to calculate the "kiddie tax". For example, in 2017 one of the requirements for the parental election is that a child's gross income must be more than $1,050 but less than 10 times that amount which is $10,500.

Kiddie Tax Tax Bracket Tax $0 to $1,050 0% Earned income > $1,050 Child’s tax rate Unearned income > $1,050 ≤ $2,100 Child’s tax rate Unearned income > $2,100 Generally, the parent’s highest marginal tax rate

Table 18-17 - Various Tax Benefits Increase Due to Inflation Adjustments (2017)

The AMT exemption for 2017 for a child subject to the kiddie tax will be the lesser of:

$7,500 (up from $7,400 in 2016) plus the child’s earned income, or $54,300 (up from $53,900 for 2016).

If a child’s earned income represents not more than one half of support needs, the kiddie tax generally also applies to unearned income of children who have not attained age 19 by the close of the year, and children who are full-time students and have not attained age 24 as of the close of the year.

The taxpayer should figure his or her child's tax on Form 8615 - Tax for Certain Children Who Have Unearned Income, and attach it to the child's tax return when:

1. The child's unearned income was more than $2,100. 2. The child meets one of the following age requirements:

a. The child was under age 18 at the end of the tax year. b. The child was age 18 but less than 19 at the end of the tax year and the child's earned income did not

exceed one-half of the child's own support for the year (excluding scholarships if the child was a full-time student).

c. The child was a full-time student who was at least 19 and under age 24 at the end of the tax year and the child's earned income did not exceed one-half of the child's own support for the year (excluding scholarships).

3. At least one of the child's parents was alive at the end of the tax year. 4. The child is required to file a tax return for the tax year. 5. The child does not file a joint return for the tax year.

Also, children have a limited exemption amount regarding the alternative minimum tax. In 2017, the exemption amount is the lesser of $54,300 or the sum of the child's earned income plus $7,500. The instructions for Form 6251 - Alternative Minimum Tax - Individuals, include a worksheet for calculating the child's exemption amount.

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Additionally, a child required to file Form 8615 may be subject to the Net Investment Income Tax (NIIT). NIIT is a 3.8% tax on the lesser of net investment income or the excess of the child's modified adjusted gross income (MAGI) over a threshold amount. Qualified Long-Term Care Insurance Premiums The amount of qualified long-term care insurance premiums a taxpayer can include is limited. He or she can include the following as medical expenses on Schedule A (Form 1040) as determined by age (as of the close of the tax year) of the taxpayer: Age Group 2017 Eligible Premium Amount Age 40 and under $410 Ages 41 through 50 $770 Ages 51 through 60 $1,530 Ages 61 through 70 $4,090 Age 71 and over $5,110 Note: The limit on premiums is for each person.

Table 18-18 - Publication 502 - Medical and Dental Expenses (2017)

Amounts received under a qualified long-term care insurance contract are generally excludible as amounts received for personal injuries and sickness, subject to a per diem limitation, which will be $360 in 2017 (up from $340 for 2016). Series EE and I Savings Bonds Income Exclusion For 2017, the exclusion under IRC Section 135, regarding income from United States Series EE and I Savings Bonds for taxpayers who pay qualified higher education expenses, begins to phase out for modified adjusted gross income (MAGI) above $117,250 for joint returns and $78,150 for all other returns. The exclusion phases out completely at MAGI levels of $147,250 for joint returns and $93,150 for other returns. Rates on Long-Term Gains and Dividends The tax rates on long-term capital gains and dividends will remain the same as last year for most taxpayers. However, the maximum rate for higher-income people increased to 20% (up from 15%). This change only affects single filers with taxable income above $418,400, married joint-filing couples with income above $470,700, heads of households with income above $444,500, and married individuals who file separate returns with income above $235,350.

These higher-income individuals can also face the new 3.8% Net Investment Income Tax, which can result in a maximum 23.8% Federal tax rate on long-term gains and dividends. Additionally, for short-term gains, the capital gains tax rate is the taxpayer’s ordinary tax rate, which could be in the 33% to 40% range if he or she is a high earner. (For most taxpayers, the rate will be 25% or 28%).

Transportation Fringe Benefits An employer can exclude the value of any de minimis transportation benefit he or she provides to an employee from the employee's wages. A de minimis transportation benefit is any local transportation benefit the employer provides to an employee if it has so little value (taking into account how frequently the employer provides transportation to his or her employees) that accounting for it would be unreasonable or administratively impracticable. For example, it applies to occasional transportation fare an employer gives an employee because the employee is working overtime if the benefit is reasonable and is not based on hours worked. This exclusion applies to the following benefits: (358)

A ride in a commuter highway vehicle between the employee's home and work place. A transit pass. Qualified parking. Qualified bicycle commuting reimbursement.

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The exclusion applies whether the employer provides only one or a combination of these benefits to his or her employees. However, the exclusion for qualified bicycle commuting reimbursement is not available in any month the employee receives any of the other qualified transportation benefits. An employer can generally exclude the value of transportation benefits that he or she provides to an employee during 2017 from the employee's wages up to the following limits: (358)

$255 per month for combined commuter highway vehicle transportation and transit passes. $255 per month for qualified parking. For a calendar year, $20 multiplied by the number of qualified bicycle commuting months during that year for

qualified bicycle commuting reimbursement of expenses incurred during the year.

If the value of a benefit for any month is more than its limit, the employer must include in the employee's wages the amount over the limit minus any amount the employee paid for the benefit. The employer cannot exclude the excess from the employee's wages as a de minimis transportation benefit.

Foreign Earned Income Exclusion If the taxpayer is a U.S. citizen or a resident alien of the United States and he or she lives abroad, the taxpayer is taxed on his or her worldwide income. However, the taxpayer may qualify to exclude from income up to an amount of his or her foreign earnings that is adjusted annually for inflation. The foreign earned income exclusion rises to $102,100 for tax year 2017, up from $101,300 for 2016. In addition to the foreign earned income exclusion, the taxpayer can also claim an exclusion or a deduction from gross income for his or her housing amount if his or her tax home is in a foreign country and he or she qualifies for the exclusions and deduction under either the bona fide residence test or the physical presence test. The housing exclusion applies only to amounts considered paid for with employer-provided amounts, which includes any amounts paid to the taxpayer or paid or incurred on his or her behalf by his or her employer that are taxable foreign earned income to the taxpayer for the year (without regard to the foreign earned income exclusion). The housing deduction applies only to amounts paid for with self-employment earnings. The taxpayer’s housing amount is the total of his or her housing expenses for the year minus the base housing amount. The computation of the base housing amount (line 32 of Form 2555) is tied to the maximum foreign earned income exclusion. The amount is 16% of the maximum exclusion amount (computed on a daily basis) multiplied by the number of days in the taxpayer’s qualifying period that fall within his or her tax year. The base amount for 2017 is $16,336 or $44.76 per day. To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction, the taxpayer must meet all three of the following requirements.

1. His or her tax home must be in a foreign country. 2. He or she must have foreign earned income. 3. He or she must be either:

a. A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,

b. A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or

c. A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

The taxpayer does not automatically acquire bona fide resident status merely by living in a foreign country or countries for 1 year. Also, the taxpayer cannot exclude income he or she receives after the end of the year following the year he or she does the work to earn it.

Expatriate Health Plans On June 10, 2016, the Treasury Department and Internal Revenue Service, the Department of Health and Human

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Services, and the Department of Labor (the Departments) issued proposed regulations that implement the Expatriate Health Coverage Clarification Act of 2014 (EHCCA). The EHCCA generally provides that most ACA provisions do not apply to expatriate health plans covering individuals traveling to or from the United States. More specifically, the EHCCA provides that the requirements of the ACA do not apply to expatriate health plans, expatriate health insurance issuers for coverage under expatriate health plans, and employers in their capacity as plan sponsors of expatriate health plans, except that: (353)

1. An expatriate health plan shall be treated as minimum essential coverage under section 5000A(f) of the Code and any other section of the Code that incorporates the definition of minimum essential coverage.

2. The employer shared responsibility provisions of section 4980H of the Code continue to apply. 3. The health care reporting provisions of sections 6055 and 6056 of the Code continue to apply but with certain

modifications relating to the use of electronic media for required statements to enrollees. 4. The excise tax provisions of section 4980I of the Code continue to apply with respect to coverage of certain

qualified expatriates who are assigned (rather than transferred) to work in the United States. 5. The annual health insurance providers fee imposed by section 9010 of the ACA takes into account expatriate

health insurance issuers for certain purposes for calendar years 2014 and 2015 only. The EHCCA proposed regulations provide that the market reform provisions enacted as part of the ACA generally do not apply to expatriate health plans, any employer solely in its capacity as a plan sponsor of an expatriate health plan, and any expatriate health insurance issuer with respect to coverage under an expatriate health plan. Further, the EHCCA proposed regulations define the benefit and administrative requirements for expatriate health issuers, expatriate health plans, and qualified expatriates, and provide clarification regarding the applicability of certain fee and reporting requirements. Home Affordable Modification Program (HAMP) The Home Affordable Modification Program (HAMP) is designed to help financially struggling homeowners avoid foreclosure by modifying loans to a level that is affordable for borrowers now and sustainable over the long term. The program provides clear and consistent loan modification guidelines that the entire mortgage industry can use. The Home Affordable Modification Program includes incentives for borrowers, servicers and investors. HAMP is designed specifically to help homeowners impacted by financial hardship. With HAMP, the taxpayer’s loan is modified to make his or her monthly mortgage payment no more than 31% of his or her gross (pre-tax) monthly income. If eligible, the modification permanently changes the original terms of his or her mortgage. The taxpayer may be eligible for HAMP if he or she meets the following criteria: (359)

He or she has a financial hardship. He or she obtained his or her mortgage on or before January 1, 2009. He or she owes up to $729,750 in 2016 tax year (the last year of the program) on his or her primary residence or

a one-to-four-unit rental property. He or she must not have been convicted within the last 10 years of felony larceny, theft, fraud or forgery, money

laundering or tax evasion, in connection with a mortgage or real estate transaction. The benefits of HAMP include:

Resolving the taxpayer’s delinquency status with his or her mortgage company immediately. Reducing the taxpayer’s monthly mortgage payments to a more affordable amount. Changing the original terms of his or her mortgage permanently, giving him or her a new start. Less damaging to the taxpayer’s credit score than a foreclosure. Ability to stay in his or her home and avoid foreclosure.

HAMP involves one or more of the following:

Changing the mortgage loan type (e.g., changing an Adjustable Rate Mortgage to a Fixed-Rate Mortgage). Extending the term of the mortgage (e.g., from a 30-year term to a 40-year term). Reducing the interest rate either temporarily or permanently. Adding any past-due amounts, such as interest and escrow, to the unpaid principal balance, which is then re-

amortized over a new term.

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HAMP provides incentives to borrowers and servicers for successful modifications and timely mortgage payments. Incentives accrue monthly and are awarded yearly. Borrowers who make timely payments on their modified first lien and the modified payment resulted in at least a 6% reduction from the monthly mortgage payment used to determine eligibility will receive a "Pay for Performance" incentive in the form of a principal reduction of up to $1,000 per year for five years. The guidance issued by the IRS provides that investor incentive payments made by the HAMP program administrator to mortgage loan holders are treated as payments on the mortgage loans by the United States government on behalf of the borrowers. These payments are generally not taxable to the borrowers under the general welfare doctrine. The IRS set forth the rules for taxpayers that make the election to defer recognizing cancellation of indebtedness income (COD Income) under newly-enacted Code Section 108(i). The election under Code Section 108(i) was added by the American Recovery and Reinvestment Tax Act of 2009. The new rules in Code Section 108(i) are effective for certain COD Income realized by taxpayers in connection with the "reacquisition" of the taxpayer's debt after December 31, 2008 and before January 1, 2011. COD Income realized by a taxpayer with respect to an eligible debt instrument is included in the taxpayer's gross income ratably over a five-taxable year, beginning with a taxpayer's fourth or fifth taxable year following the taxable year of the debt cancellation. Taxpayers making the Code Section 108(i) election will experience a significant deferral of COD Income by avoiding the recognition of COD income in 2009 or 2010 and by taking into account the deferred COD Income beginning with their 2014 taxable year. This election is particularly useful for taxpayers that are not eligible for one of the more common COD Income exclusions, such as the exclusion for COD Income of insolvent taxpayers or the exclusion of COD Income for certain real estate indebtedness where the taxpayer makes an election to reduce their basis in the real property by the amount of the excluded COD Income.

HAMP (and the entire MHA Program) expired December 31, 2016, the last day to submit applications, and the Modification Effective Date must be on or before September 30, 2017.

Direct Deposit Limits In an effort to combat fraud and identity theft, IRS procedures that took effect January 2015 limited the number of refunds electronically deposited into a single financial account or pre-paid debit card to three. The fourth and subsequent refunds automatically will convert to a paper refund check and be mailed to the taxpayer. Taxpayers also will receive a notice informing them that the account has exceeded the direct deposit limits and that they will receive a paper refund check in approximately four weeks if there are no other issues with the return. The vast majority of taxpayers will not be affected by this limitation, and the IRS would encourage taxpayers and tax preparers to continue to use direct deposit. It is the fastest, safest way for taxpayers to receive refunds. The direct deposit limit is intended to prevent criminals from easily obtaining multiple refunds. The limit applies to financial accounts, such as bank savings or checking accounts, and to prepaid, reloadable cards or debit cards. Virtual Currency In some environments, virtual currency (such as Bitcoin) operates like “real” currency (i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance) but it does not have legal tender status in any jurisdiction. For Federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency. A taxpayer who receives virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency was received. This also means that:

Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to Federal income tax withholding and payroll taxes.

Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply. Normally, payers must issue Form 1099.

The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

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If the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, the taxpayer has taxable gain. The taxpayer has a loss if the fair market value of the property received is less than the adjusted basis of the virtual currency.

Section 179 Deduction Essentially, Section 179 of the IRS tax code allows businesses to deduct the full purchase price of qualifying equipment and or software purchased or financed during the tax year. That means that if the taxpayer buys (or leases) a piece of qualifying equipment, he or she can deduct the full purchase price from his or her gross income. The deduction is an incentive created by the U.S. government to encourage businesses to buy equipment and invest in themselves. The maximum amount the taxpayer can elect to deduct for most Section 179 property he or she placed in service in tax years beginning in 2017 is $510,000. This limit is reduced by the amount by which the cost of Section 179 property placed in service during the tax year exceeds $2,030,000.

With the passage and signing into law of the Tax Cuts and Jobs Act, the deduction limit for Section 179 increases from $500,000 to $1,000,000 for 2018 and beyond. The limit on equipment purchases likewise has increased, from $2,000,0000 to $2,500,000. In addition, the deduction now includes any of the following improvements to existing nonresidential property (i.e., the improvement must be placed in service after the date the property itself

was first placed in service): roofs; heating, air-conditioning, and ventilation systems; fire protection, alarm, and security systems. Further, the bonus depreciation increases from 50% to 100%. This part is retroactive to September 27, 2017, and is good through 2022. The bonus depreciation also now includes used equipment. The total cost that can be deducted under Section 179 is also limited to the taxable income earned from the taxpayer's trade or business during the year. Taxable income (including salaries and wages paid to the taxpayer(s) from the business and reported as W-2 income) is figured without regard to any available Section 179 expense deduction. However, the amount of any disallowed deduction in this tax year can be carried over to next tax year and be added to the amount of qualified Section 179 property placed in service in that next tax year. To elect the Section 179 Deduction a taxpayer needs to fill out Part One of IRS Form 4562 - Depreciation and Amortization. The taxpayer should keep in mind that to qualify for the Section 179 Deduction, the equipment listed below must be purchased and put into use between January 1, 2017 and December 31, 2017:

Computers. Computer off-the-shelf software. Office furniture. Office equipment. Equipment (machines, etc) purchased for business use. Tangible personal property used in business. Business Vehicles with a gross vehicle weight in excess of 6,000lbs (Section 179 Vehicle Deductions). Property attached to the taxpayer’s building that is not a structural component of the building (i.e.: a printing press,

large manufacturing tools and equipment). Partial Business Use (equipment that is purchased for business use and personal use: generally, the taxpayer’s

deduction will be based on the percentage of time he or she uses the equipment). Off-the-shelf computer software put in service during the tax year is qualifying property for purposes of the Section 179 deduction. This includes computer software that is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially modified. It is any program designed to cause a computer to perform a desired function. However, a database or similar item is not considered computer software unless it is in the public domain and is incidental to the operation of otherwise qualifying software. For passenger vehicles, trucks, and vans (not meeting the guidelines below), that are used more than 50% in a qualified business use, the total deduction for depreciation including both the Section 179 expense deduction as well as Bonus Depreciation is limited to $11,160 for passenger cars and $11,560 for trucks and vans during 2017. For automobiles placed in service during 2017 but not eligible for bonus depreciation, the deduction limit is $3,160 for passenger cars and $3,560 for trucks and vans. The guidance will be published in the Internal Revenue Bulletin sometime after mid-year). For later years, the taxpayer must compute his or her depreciation on the car or truck using the usual methods. As long as the

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taxpayer continues to use the car more than 50% for business, he or she would multiply the business percentage of the car's cost by the percentage shown in the normal MACRS table for five-year property. Exceptions include the following vehicles:

Taxis, transport vans, and other vehicles used to specifically transport people or property for hire. Ambulance or hearse used specifically in a taxpayer’s business. Qualified non-personal use vehicles specifically modified for business (i.e. van without seating behind driver,

permanent shelving installed, and exterior painted with company’s name).

Certain vehicles (with a gross vehicle weight rating above 6,000lbs but no more than 14,000lbs) qualify for expensing up to $25,000 if the vehicle is financed and placed in service prior to December 31 and meets other conditions. Many vehicles that by their nature are not likely to be used for personal purposes qualify for full Section 179 deduction including the following vehicles:

1. Heavy non-SUV vehicles with a cargo area at least six feet in interior length (this area must not be easily accessible from the passenger area.).

2. Vehicles that can seat nine-plus passengers behind the driver's seat (i.e.: Hotel / Airport shuttle vans, etc.). 3. Vehicles with a fully-enclosed driver's compartment / cargo area, no seating at all behind the driver's seat, and no

part of the body Section protruding more than 30 inches ahead of the leading edge of the windshield. Some of the property and equipment that does not qualify for the Section 179 Deduction is:

Property used outside the United States generally does not qualify for the Section 179 Deduction. Property that is used to furnish lodging is generally not qualified for the Section 179 Deduction. Real Property does not qualify for the Section 179 Deduction. Real Property is typically defined as land, buildings,

permanent structures and the components of the permanent structures (including improvements). Other examples of property that would not qualify for the Section 179 Deduction include paved parking areas and fences.

Air conditioning and heating equipment is generally not eligible for the Section 179 Deduction. Property acquired by gift or inheritance, as well as property purchased from related parties does not qualify for

the Section 179 Deduction (No, a taxpayer cannot sell equipment to him or herself and qualify for Section 179). Any property that is not considered to be personal property, may not qualify for the Section 179 Deduction. Used Equipment (that is new to the taxpayer) qualifies for Section 179, however used equipment does not qualify

for Bonus Depreciation.

Bonus Depreciation Under the Tax Cuts and Jobs Act, the bonus depreciation increases from 50% to 100%. This provision is retroactive to September 27, 2017, and is good through 2022. The bonus depreciation also now includes used equipment. Bonus Depreciation is useful to very large businesses spending more than the Section 179 Spending Cap on new capital equipment. Also, businesses with a net loss are still qualified to deduct some of the cost of new equipment and carry-forward the loss. When applying these provisions, Section 179 is generally taken first, followed by Bonus Depreciation - unless the business had no taxable profit, because the unprofitable business is allowed to carry the loss forward to future years. Unrecovered Basis There are limits on the amount a taxpayer can deduct for depreciation of his or her car, truck, or van. The Section 179 deduction is treated as depreciation for purposes of the limits. The maximum amount a taxpayer can deduct each year depends on the year he or she puts the car in service. If the depreciation deductions for the taxpayer’s car are reduced, he or she will have unrecovered basis in his or her car at the end of the recovery period. If the taxpayer continues to use his or her car for business, he or she can deduct that unrecovered basis (subject to depreciation limits) after the recovery period ends. Unrecovered basis is the taxpayer’s cost or other basis in the car reduced by any clean-fuel vehicle deduction (for vehicles placed in service before January 1, 2006), alternative motor vehicle credit, electric vehicle credit, gas guzzler tax, and

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depreciation and Section 179 deductions that would have been allowable if the taxpayer had used the car 100% for business and investment use. For 5-year property, the taxpayer’s recovery period is 6 calendar years. A part year's depreciation is allowed in the first calendar year, a full year's depreciation is allowed in each of the next 4 calendar years, and a part year's depreciation is allowed in the 6th calendar year. Under MACRS, the taxpayer’s recovery period is the same whether he or she utilizes declining balance or straight line depreciation. The taxpayer determines his or her unrecovered basis in the 7th year after he or she placed the car in service. If the taxpayer continues to use his or her car for business after the recovery period, he or she is due a depreciation deduction in each succeeding tax year until he or she recovers the basis in the car. The maximum amount the taxpayer can deduct each year is determined by the date he or she placed the car in service and his or her business-use percentage. For example, no deduction is allowed for a year the taxpayer uses a car 100% for personal purposes. Per Revenue Procedure 2011-26 the IRS provides a safe harbor accounting method. This procedure provides guidance with respect to the 100% additional first year depreciation deduction under Section 168(k)(5) of the Code, and the extension of the 50% bonus depreciation deduction for qualified property placed in service in 2010. This procedure defines which property is eligible for the 100% bonus depreciation deduction and provides guidance regarding the time and manner for making certain elections under Sections 168(k)(2) and (5). The procedure also provides a safe harbor method of accounting for passenger automobiles that qualify for the 100% additional first year depreciation deduction and that are subject to first-year limitations under Section 280F. The taxpayer selects the safe harbor method by choosing it to deduct depreciation on a passenger car on the return of the year that follows the placed-in-service year of the car when the cost exceeded the first-year luxury auto limit and the 100% bonus depreciation deduction was claimed.

2017 Tax Credits and Deductions Updates

Child Tax Credit The American Taxpayer Relief Act made the Child Tax Credit permanent. The Child Tax Credit is an important tax credit that may be worth as much as $1,000 per qualifying child depending upon the taxpayer’s income. In general, to be a qualifying child for purposes of the child tax credit and additional child tax credit, the child must be a citizen, national, or resident of the United States. Use Part I of Schedule 8812 - Child Tax Credit to document that any child for whom an IRS Individual Taxpayer Identification Number (ITIN) was issued meets the substantial presence test and is not otherwise treated as a nonresident alien. To meet the substantial presence test, a child identified with an ITIN generally must be physically present in the United States on at least: (283)

1. 31 days during 2017, and 2. 183 days during the 3-year period that includes 2017, 2016, and 2015, counting:

a. All the days the child was present in 2017, and b. 1/3 of the days the child was present in 2016, and c. 1/6 of the days the child was present in 2014.

Here are 10 important facts from the IRS about the Child Tax Credit and how it may benefit a taxpayer’s family. (360)

1. Amount - With the Child Tax Credit, a taxpayer may be able to reduce his or her Federal income tax by up to $1,000 for each qualifying child under the age of 17.

2. Qualification - A qualifying child for this credit is someone who meets the qualifying criteria of six tests: age, relationship, support, dependent, citizenship, and residence.

3. Age Test - To qualify, a child must have been under age 17 – age 16 or younger – at the end of 2017. 4. Relationship Test - To claim a child for purposes of the Child Tax Credit, they must either be the taxpayer’s son,

daughter, stepchild, foster child, brother, sister, stepbrother, stepsister or a descendant of any of these individuals, which includes a grandchild, niece or nephew. An adopted child is always treated as a taxpayer’s own child. An adopted child includes a child lawfully placed with him or her for legal adoption.

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5. Support Test - In order to claim a child for this credit, the child must not have provided more than half of their own support.

6. Dependent Test – The taxpayer must claim the child as a dependent on the Federal tax return. 7. Citizenship Test - To meet the citizenship test, the child must be a U.S. citizen, U.S. national, or U.S. resident

alien. 8. Residence Test - The child must have lived with the taxpayer for more than half of 2017. There are some

exceptions to the residence test, which can be found in IRS Publication 972 - Child Tax Credit. 9. Limitations - The credit is limited if the taxpayer’s modified adjusted gross income is above a certain amount. The

amount at which this phase-out begins varies depending on the filing status. For married taxpayers filing a joint return, the phase-out begins at $110,000. For married taxpayers filing a separate return, it begins at $55,000. For all other taxpayers, the phase-out begins at $75,000. In addition, the Child Tax Credit is generally limited by the amount of the income tax the taxpayer owes as well as any alternative minimum tax he or she owes.

10. Additional Child Tax Credit - If the amount of the Child Tax Credit is greater than the amount of income tax the taxpayer owes, he or she may be able to claim the Additional Child Tax Credit.

Form 8812 is no longer available to figure the additional child tax credit. Instead, use Parts II through IV of Schedule 8812 (Form 1040A or 1040) to figure the additional child tax credit for 2017.

Additional Child Tax Credit A portion of the Child Tax Credit is refundable, if the credit exceeds the amount of taxes the family owes, a percentage of the remaining credit is given back to the family as a refund, and is officially called the Additional Child Tax Credit. A family can receive a refund worth 15% of earnings above $3,000, up to $1,000 per child. The Protecting Americans from Tax Hikes Act of 2015 permanently set the threshold amount for determining whether a taxpayer is eligible for the Additional Child Tax Credit at $3,000 (not indexed for inflation). The bill also adds a provision barring individuals from claiming the credit for 10 years if they fraudulently claimed the credit and for two years if they are found to have claimed the credit with reckless or intentional disregard of the rules. Families must have at least $3,000 in earned income to claim any portion of the credit. The refund formula means that families with one child become eligible for the full credit with incomes of $9,666 or more, families with two children when they have incomes of $16,333 or more, and for each additional child the minimum income to receive the full credit increases by $6,666. The credit begins to phase out when family income reaches $75,000 for a single filer and $110,000 for couples. The phase-out allows families to claim a portion of the credit, capped at 5% of their income over the phase-out threshold, so married couples making $130,000 ($95,000 for heads of household) with one child receive no credit at all, while families with two children are eligible for a partial payment with incomes up to $150,000 ($115,000 for heads of household) and families with more children are eligible at even higher income levels. Child and Dependent Care Credit The American Taxpayer Relief Act made the Child and Dependent Care Credit permanent. The Dependent Care credit is also an important tax credit that may be worth up to $1,050 or 35% of $3,000 of eligible expenses in 2017. For two or more qualifying dependents, the taxpayer can claim up to 35% of $6,000 (or $2,100) of eligible expenses. For higher income earners, the credit percentage is reduced, but not below 20%, regardless of the amount of adjusted gross income. A taxpayer’s child and dependent care expenses must be for the care of one or more qualifying persons. A qualifying person is: (361)

A taxpayer’s qualifying child who is his or her dependent and who was under age 13 when the care was provided. A spouse who was not physically or mentally able to care for himself or herself and lived with the taxpayer for

more than half the year. A person who was not physically or mentally able to care for himself or herself, lived with the taxpayer for more

than half the year, and either: o Was his or her dependent. o Would have been his or her dependent except that:

He or she received gross income of $4,050 or more. He or she filed a joint return. He or she, or his or her spouse if filing jointly, could be claimed as a dependent on someone

else's 2017 return.

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Adoption Credit and Exclusion The American Taxpayer Relief Act of 2012 (H.R.8) passed on January 2, 2013 permanently extended the Adoption Credit and the adoption assistance programs for tax years beginning after December 31, 2012. Tax benefits for adoption include both a tax credit for qualified adoption expenses paid to adopt an eligible child and an exclusion for employer-provided adoption assistance. The credit is nonrefundable, which means it is limited to the taxpayer’s tax liability for the year. The maximum amount (dollar limit) for 2017 is $13,570 per child. For both the credit and the exclusion, qualified adoption expenses, defined in section 23(d)(1) of the Code, include: (273)

Reasonable and necessary adoption fees, Court costs and attorney fees, Traveling expenses (including amounts spent for meals and lodging while away from home), and Other expenses that are directly related to and for the principal purpose of the legal adoption of an eligible child. An eligible child is an individual who is under the age of 18, or is physically or mentally incapable of self-care.

An eligible child is an individual who is under the age of 18, or is physically or mentally incapable of self-care. Qualified adoption expenses do not include: (273)

Expenses for which the taxpayer received funds under any state, local, or Federal program. Expenses that violate state or Federal law. Expenses for carrying out a surrogate parenting arrangement. Expenses for the adoption of a taxpayer’s spouse's child. Expenses paid or reimbursed by a taxpayer’s employer or any other person or organization. Expenses allowed as a credit or deduction under any other provision of Federal income tax law.

If the taxpayer is filing Form 8839 - Qualified Adoption Expenses, he or she cannot file the income tax return and Form 8839 electronically. The taxpayer must file a paper return. Mail the return to the address listed in the tax return instructions. (273) The credit and exclusion are each subject to an income limitation and a dollar limitation. The income limit on the adoption credit or exclusion is based on taxpayer’s modified adjusted gross income (MAGI). For tax year 2017, the MAGI phase-out begins at $203,540 and ends at $243,540. Thus, if the taxpayer’s MAGI amount is below $203,540 for 2017, his or her credit or exclusion will not be affected by the MAGI phase-out but if the taxpayer’s MAGI amount for 2017 is above $243,540, his or her credit or exclusion will be zero. The taxpayer should reduce the dollar limit for a particular year by the amount of qualified adoption expenses used in the previous years for the same adoption effort. Also, when computing the dollar limitation, qualified adoption expenses paid and claimed in connection with an unsuccessful domestic adoption effort must be combined with qualified adoption expenses paid in connection with a subsequent domestic adoption attempt, whether or not the subsequent attempt is successful. The dollar limitation applies separately to both the credit and the exclusion, and the taxpayer may be able to claim both the credit and the exclusion for qualified expenses. However, he or she must claim any allowable exclusion before claiming any allowable credit. Expenses used for the exclusion reduce the amount of qualified adoption expenses available for the credit. As a result, the taxpayer cannot claim both a credit and an exclusion for the same expenses.

Because the adoption credit is not refundable after 2011, the taxpayer may be able to carry-forward any unused credit amounts to future tax years. The 2017 Form 8839 and its instructions will have information on the credit carry-forward. (273)

Coverdell Education Savings Accounts The American Taxpayer Relief Act made permanent the $2,000 per year total contributions to a Coverdell ESA. There is no limit to the number of accounts that can be established for a beneficiary; however, the total contribution to all accounts on behalf of a beneficiary in any year cannot exceed $2,000. The taxpayer’s contribution limit may be reduced. If his or her modified adjusted gross income (MAGI) is between $95,000 and $110,000 (between $190,000 and $220,000 if filing a joint return), the $2,000 limit for each designated beneficiary is gradually reduced. If the taxpayer’s MAGI is $110,000 or more ($220,000 or more if filing a joint return), he or she cannot contribute to a Coverdell ESA.

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To figure the limit on the amount the taxpayer can contribute for each designated beneficiary, multiply $2,000 by a fraction. The numerator (top number) is the taxpayer’s MAGI minus $95,000 ($190,000 if filing a joint return). The denominator (bottom number) is $15,000 ($30,000 if filing a joint return). Subtract the result from $2,000. This is the amount the taxpayer can contribute for each beneficiary. The taxpayer can use Worksheet 7-2 - Coverdell ESA Contribution Limit in Publication 970 to figure the limit on contributions. Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed. The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution.

This benefit applies to qualified higher education expenses as well as to qualified elementary and secondary education expenses.

Amounts remaining in a CESA must be dispersed within 30 days after the beneficiary reaches age 30 or 30 days after the death of the beneficiary. One method a taxpayer can use to avoid taking an unwanted distribution is to take advantage of the rollover provision for Coverdell ESAs. Distributed amounts are not subject to Federal income taxes if they are rolled-over to another ESA for the benefit of the same beneficiary or a member of the beneficiary's family that is under the age of 30 including: (362)

Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them. Brother, sister, stepbrother, or stepsister. Father or mother or ancestor of either. Stepfather or stepmother. Son or daughter of a brother or sister. Brother or sister of father or mother. Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. The spouse of any individual listed above. First cousin.

An amount is rolled over if it is paid to another Coverdell ESA within 60 days after the date of the distribution. The age limit does not apply to beneficiaries with special needs. Student Loan Interest Deduction The American Taxpayer Relief Act made permanent the Student Loan Interest Deduction. Generally, the amount a taxpayer may deduct is the lesser of $2,500 or the amount of interest he or she actually paid. For purposes of the student loan interest deduction, these expenses are the total costs of attending an eligible educational institution, including graduate school. (363) The expenses include amounts paid for the following items: (364)

Tuition and fees. Room and board. Books, supplies and equipment. Other necessary expenses (such as transportation).

The cost of room and board qualifies only to the extent that it is not more than the greater of: (364)

The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for Federal financial aid purposes) for a particular academic period and living arrangement of the student.

The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

For 2017, the $2,500 maximum deduction for interest paid on student loans begins to phase out if the taxpayer’s modified adjusted gross income (MAGI) is between $65,000 and $80,000 ($135,000 and $165,000 if he or she files a joint return). The taxpayer cannot take a student loan interest deduction if his or her MAGI is $80,000 or more ($165,000 or more if he or she files a joint return). Generally, the taxpayer figures the deduction using the Student Loan Interest Deduction Worksheet in the Form 1040 or Form 1040A instructions.

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American Opportunity Tax Credit The American Opportunity Tax Credit (AOTC) modifies the existing Hope Scholarship Credit. The AOTC makes the Hope Credit available to a broader range of taxpayers, including many with higher incomes and those who owe no tax. It also adds required course materials to the list of qualifying expenses and allows the credit to be claimed for four post-secondary education years instead of two. Many of those eligible will qualify for the maximum annual credit of $2,500 per student.

The Protecting Americans from Tax Hikes Act of 2015 made the American Opportunity Tax Credit permanent. The bill also adds a provision barring individuals from claiming the credit for 10 years if they fraudulently claim the credit and for two years if they are found to have claimed the credit with reckless or intentional disregard of the rules.

The American Opportunity Tax Credit is a partially refundable tax credit for undergraduate college education expenses. This credit provides up to $2,500 in tax credits on the first $4,000 of qualifying educational expenses. The amount of the American Opportunity tax credit is comprised of:

100% of the first $2,000 in qualifying education expenses, plus 25% of the next $2,000 in qualifying expenses.

Thus, the taxpayer’s maximum credit could be $2,500 based on $4,000 in qualifying expenses. Also, a taxpayer’s modified adjusted gross income (AGI) in excess of $80,000 ($160,000 for a joint return) is used to determine a reduction in the amount of the American Opportunity Tax Credit. The credit is completely phased out and not available for taxpayers with AGI of $90,000 ($180,000 for joint filers). Up to 40% of the American Opportunity Tax Credit is refundable. Therefore, up to $1,000 of the American Opportunity Tax Credit can be refunded to a taxpayer, even if his or her tax liability is zero. This potential refund could make the American Opportunity Tax Credit more valuable than the Lifetime Learning Credit, which is non-refundable. Lifetime Learning Credit The Lifetime Learning Credit equals 20% of adjusted qualified education expenses, up to a maximum of $10,000 of adjusted qualified education expenses per return. Therefore, the maximum Lifetime Learning Credit the taxpayer can claim on his or her return for the year is $2,000, regardless of the number of students for whom he or she paid qualified education expenses. The amount of the taxpayer’s credit for 2017 is gradually reduced (phased out) if his or her modified adjusted gross income (MAGI) is between $56,000 and $66,000 ($112,000 and $132,000 if he or she files a joint return). The taxpayer cannot claim a credit if his or her MAGI is $66,000 or more ($132,000 or more if he or she files a joint return). The taxpayer cannot claim the Lifetime Learning Credit for any student if he or she claims the American Opportunity Tax Credit for that student for the same tax year. Tuition and Fees Deduction The Bipartisan Budget Act of 2018 extended through 2017 the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction is capped at $4,000 for an individual whose adjusted gross income (AGI) does not exceed $65,000 ($130,000 for joint filers) or $2,000 for an individual whose AGI does not exceed $80,000 ($160,000 for joint filers). The Tuition and Fees Deduction was not renewed by the Tax Cuts and Jobs Act. Deduction for Educator Expenses The Protecting Americans from Tax Hikes Act of 2015 made the above-the-line deduction for certain expenses of elementary and secondary school teachers permanent. If the taxpayer is an eligible educator, he or she can deduct up to $250 ($500 if married filing joint and both spouses are educators, but not more than $250 each) of any unreimbursed expenses (otherwise deductible as a trade or business expense) he or she paid or incurred for books, supplies, computer equipment (including related software and services), other equipment, and supplementary materials that he or she uses in the classroom. For courses in health and physical education, expenses for supplies are qualified expenses only if they are related to athletics. This deduction is for expenses paid or incurred during the tax year.

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The taxpayer is an eligible educator if, for the tax year, he or she meets the following requirements: (365)

1. He or she is a kindergarten through grade 12: a. Teacher b. Instructor c. Counselor d. Principal e. Aide

2. He or she works at least 900 hours a school year in a school that provides elementary or secondary education, as determined under state law.

Qualified expenses are deductible only to the extent the amount of such expenses exceed the following amounts for the tax year:

The interest on qualified U.S. savings bonds that the taxpayer excluded from income because he or she paid qualified higher education expenses.

Any distribution from a qualified tuition program that the taxpayer excluded from income. Any tax-free withdrawals from the taxpayer’s Coverdell Education Savings Account. Any reimbursed expenses not reported to the taxpayer on his or her Form W-2, box 1.

The taxpayer may be able to deduct certain expenses for professional development courses he or she has taken related to the curriculum he or she teaches or to the students he or she teaches. See the instructions for line 23 of Form 1040 for more information.

Retirement Savings Contributions Credit (Saver’s Credit) A taxpayer can claim the credit for 50%, 20% or 10% of the first $2,000 ($4,000 if married filing jointly) contributed during the year to a retirement account. Therefore, the maximum credit amounts that can be claimed are $1,000, $400 or $200 per person. The maximum credit a married couple filing jointly can claim together is $2,000. The applicable percentage is determined by the taxpayer’s filing status and adjusted gross

income (AGI). The credit may be used against the taxpayer’s regular and alternative minimum tax liability. For 2017, the maximum applicable percentage is 50%, which is completely phased out when AGI exceeds $62,000 for joint filers, $46,500 for head of household filers, and $31,00 for single and married filing separately filers. (294) The applicable percentage is the percentage as determined in accordance with the following table:

2017 Saver’s Credit AGI Thresholds

Joint Return Head of Household Single or Married Filing Separately

Credit Rate

Over Not Over Over Not Over Over Not Over $0 $37,000 $0 $27,750 $0 $18,500 50%

$37,000 $40,000 $27,750 $30,000 $18,500 $20,000 20% $40,000 $62,000 $30,000 $46,500 $20,000 $31,000 10% $62,000 ----- $46,500 ------ $31,000 ---- 0%

Table 18-19 - Retirement Savings Contributions Credit (Saver’s Credit) (2017)

Earned Income Tax Credit The Protecting Americans from Tax Hikes Act of 2015 made the Earned Income Tax Credit (EITC) permanent. The bill contained provisions that include an increased amount for families with three or more children and an increased phase-out range for married taxpayers filing jointly. The phase-out range is indexed for inflation for years after 2015. For tax year 2017, the maximum Earned Income Tax Credit (EITC) for low and moderate-income workers and working families rises to $6,318, up from $6,269 in 2016. The EITC is a refundable tax credit for certain people who work and have earned income under $53,930. The credit varies by family size, filing status and other factors, with the maximum credit going to joint filers with three or more qualifying children. The maximum amount of income a taxpayer can earn and still get the credit has increased: (366)

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Taxpayer has three or more qualifying children and he or she earned less than $48,340 ($53,930 if married filing jointly).

Taxpayer has two qualifying children and he or she earned less than $45,007 ($50,597 if married filing jointly). Taxpayer has one qualifying child and he or she earned less than $39,617 ($45,207 if married filing jointly). Taxpayer does not have a qualifying child and he or she earned less than $15,010 ($20,600 if married filing jointly).

For tax year 2017 the maximum Earned Income Tax Credit is: (366)

$6,318 with three or more qualifying children. $5,616 with two qualifying children. $3,400 with one qualifying child. $510 with no qualifying children.

The maximum amount of investment income a taxpayer can have and still get the credit has increased to $3,450. Use Publication 596 - Earned Income Tax Credit (EITC) to determine eligibility.

Paid preparers must complete Form 8867 - Paid Preparer’s Due Diligence Checklist when filing Federal income tax returns or claims for refund involving the EITC. Paid preparers must meet due diligence requirements in determining the taxpayer's eligibility for, and the amount of, the EITC. Failure to do so could result in a $510

penalty for each failure. The penalty was $500 per return, however, the IRS adjusted the penalty for taxable year returns beginning in 2015 for cost of living. Exclusion of Capital Gains Tax on Principal Residences Single homeowners are able exclude up to $250,000 of the gain (other than gain allocated to periods of nonqualified use) on the sale of his or her main home. A taxpayer may be able to exclude up to $500,000 of the gain (other than gain allocated to periods of nonqualified use) on the sale of his or her main home if he she or is married and file a joint return and meet the requirements listed in the special rules for joint returns in Publication 523 - Selling Your Home. A single taxpayer can exclude the gain on the sale of his or her main home if all of the following are true: (367)

1. Meet the ownership test. 2. Meet the use test. 3. During the 2-year period ending on the date of the sale, the taxpayer did not exclude gain from the sale of another

home. If the taxpayer sells his or her home at a loss, the money he or she receives is not taxable. However, the taxpayer cannot deduct the loss from other income. Use Publication 523 - Selling Your Home to figure the exclusion of capital gains on the tax return. Option to Deduct State and Local General Sales Taxes The Protecting Americans from Tax Hikes Act of 2015 made the option to deduct State and Local General Sales Taxes permanent. There are four types of deductible non-business taxes:

1. State, local and foreign income taxes. 2. State, local and foreign real estate taxes. 3. State and local personal property taxes. 4. State and local general sales taxes.

To be deductible, the tax must be imposed on the taxpayer and must have been paid during his or her tax year. Taxes may be claimed only as an itemized deduction on Form 1040, Schedule A - Itemized Deductions. State and local income taxes withheld from the taxpayer’s wages during the year appear on his or her Form W-2. The taxpayer can elect to deduct state and local general sales taxes instead of state and local income taxes, but he or she cannot deduct both. If the taxpayer elects to deduct state and local general sales taxes, he or she can use either his or her actual expenses or the optional sales tax tables. Refer to the Form 1040, Schedule A Instructions, for more information and for the optional sales tax tables.

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Residential Energy Credits Residential Energy Efficient Property Credit (Part I) - The taxpayer may be able to take the Residential Energy Efficient Property Credit if he or she made energy saving improvements to his or her home located in the United States. The credit currently applies to solar electric property, solar water heating property, geothermal systems and windmills and is available for property placed in service through December 31, 2021, based on an applicable percentage. The applicable percentages are: (368)

In the case of property placed in service after December 31, 2016, and before January 1, 2020, 30%. In the case of property placed in service after December 31, 2019, and before January 1, 2021, 26%. In the case of property placed in service after December 31, 2020, and before January 1, 2022, 22%.

Nonbusiness Energy Property Credit (Part II) - The Bipartisan Budget Act extends through 2017 the credit for purchases of nonbusiness energy property. The provision allows a credit of 10% of the amount paid or incurred by the taxpayer for qualified energy improvements (installing insulation, storm windows, etc.), up to $500. The credit for nonbusiness energy property was not renewed by the Tax Cuts and Jobs Act. The taxpayer uses Form 5695 - Residential Energy Credits to figure his or her Residential Energy Credits. The taxpayer also uses Form 5695 to carry the unused portion of the credit to 2018. Charitable Donations from IRAs The Protecting Americans from Tax Hikes Act of 2015 made permanent the tax exemption of distributions from individual retirement accounts for charitable purposes. Individuals age 70½ or over can exclude up to $100,000 from gross income for donations paid directly to a qualified charity from their IRA. Key points about qualified charitable contributions (QCDs) include:

Married individuals filing a joint return could exclude up to $100,000 donated from each spouse’s own IRA ($200,000 total).

The donation satisfies any IRA required minimum distributions for the year. The amount excluded from gross income is not deductible. Donations from an inherited IRA are eligible if the beneficiary is at least age 70½. Donations from a SEP or SIMPLE IRA are not eligible. Donations from a Roth IRA are eligible.

IRA owners reported charitable donations from an IRA on Form 1040. Work Opportunity Tax Credit The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) retroactively allows eligible employers to claim the Work Opportunity Tax Credit (WOTC) for all targeted group employee categories that were in effect prior to the enactment of the PATH Act, if the individual began or begins work for the employer after December 31, 2014 and before January 1, 2020. For tax-exempt employers, the PATH Act retroactively allows them to claim the WOTC for qualified veterans who begin work for the employer after December 31, 2014 and before January 1, 2020. The PATH Act also added a new targeted group category to include qualified long-term unemployment recipients. The credit is limited to the amount of the business income tax liability or Social Security tax owed. A taxable business may apply the credit against its business income tax liability, and the normal carry-back and carry-forward rules apply. For taxable employers, the WOTC may be claimed for hiring targeted group members, including qualified veterans, who began work before January 1, 2015. After the required certification is secured, taxable employers claim the tax credit as a general business credit against their income tax on Form 3800 - General Business Credit.

For qualified tax-exempt organizations, the credit is limited to the amount of employer social security tax owed on wages paid to all employees for the period the credit is claimed.

Gift and Estate Tax The American Taxpayer Relief Act of 2012 inhibits increases in gift, estate and generation-skipping transfer (GST) taxes. For an estate of any decedent dying during calendar year 2017, the basic exclusion from estate tax amount is $5,490,000,

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up from a total of $5,450,000 for estates of decedents who died in 2016. The Act also permanently increases the top gift and estate tax rate from 35% to 40%. The annual exclusion for gifts remains at $14,000.

Decedents dying in: Estate Tax Exemption Amount Tax Rate

2012 $5,120,000 35% 2013 $5,250,000 40% 2014 $5,340,000 40% 2015 $5,430,000 40% 2016 $5,450,000 40% 2017 $5,490,000 40%

* An executor of the estate of a decedent dying in 2010 could opt out of the estate tax in exchange for Modified Carryover Basis.

Table 18-20 - Estate Tax Exemption Amounts (2017)

The following is a list of gifts that are not considered "taxable gifts" and, therefore, do not count as part of the taxpayer’s $5,490,000 lifetime total:

Present-interest gift of $14,000 in 2017. "Present-interest" means that the person receiving the gift has an unrestricted right to use or enjoy the gift immediately. In 2017 the taxpayer could give amounts up to $14,000 to each person, gifting as many different people as he or she wants, without triggering the gift tax.

Charitable gift. Gifts to a political organization for its use. Gifts to the taxpayer’s spouse. Gifts to a spouse who is a U.S. citizen. Gifts to foreign spouses are subject to an annual limit of $149,000 in 2017.

This amount is indexed for inflation and can change each year. Gifts for educational expenses. To qualify for the unlimited exclusion for qualified education expenses, the

taxpayer must make a direct payment to the educational institution for tuition only. Books, supplies and living expenses do not qualify. If the taxpayer wants to pay for books, supplies and living expenses in addition to the unlimited education exclusion, he or she can make a 2017 gift of $14,000 to the student under the annual gift exclusion.

Gifts for medical expenses.

Charitable Gifts A taxpayer can only deduct gifts he or she gives to qualified charities. Gifts of money include those made in cash or by check, electronic funds transfer, credit card and payroll deduction. The taxpayer must have a bank record or a written statement from the charity to deduct any gift of money on his or her tax return. This is true regardless of the amount of the gift. The statement must show the name of the charity and the date and amount of the contribution. Bank records include canceled checks, or bank, credit union and credit card statements. If the taxpayer gives by payroll deductions, he or she should retain a pay stub, a Form W-2 wage statement or another document from his or her employer. It must show the total amount withheld for charity, along with the pledge card showing the name of the charity. Household items include furniture, furnishings, electronics, appliances and linens. If the taxpayer donates clothing and household items to charity they generally must be in at least good used condition to claim a tax deduction. If he or she claims a deduction of over $500 for an item it does not have to meet this standard if the taxpayer includes a qualified appraisal of the item with his or her tax return. The taxpayer must get an acknowledgment from a charity for each deductible donation (either money or property) of $250 or more. Additional rules apply to the statement for gifts of that amount. This statement is in addition to the records required for deducting cash gifts. However, one statement with all of the required information may meet both requirements. The taxpayer can deduct contributions in the year he or she makes them. If the taxpayer charges his or her gift to a credit card before the end of the year it will count for 2017. This is true even if he or she does not pay the credit card bill until 2018. Also, a check will count for 2017 as long as the taxpayer mails it in 2017. Use the following lists for a quick check of whether the taxpayer can deduct a contribution.

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Examples of Charitable Contributions

Deductible As Charitable Contributions

Not Deductible As Charitable Contributions

Money or property the taxpayer gives to: • Churches, synagogues, temples, mosques,

and other religious organizations. • Federal, state, and local governments, if the

taxpayer’s contribution is solely for public purposes (for example, a gift to reduce the public debt or maintain a public park).

• Nonprofit schools and hospitals. • The Salvation Army, American Red Cross,

CARE, Goodwill Industries, United Way, Boy Scouts of America, Girl Scouts of America, Boys and Girls Clubs of America, etc.

• War veterans' groups.

Money or property the taxpayer gives to: • Civic leagues, social and sports clubs, labor

unions, and chambers of commerce. • Foreign organizations (except certain Canadian,

Israeli, and Mexican charities). • Groups that are run for personal profit. • Groups whose purpose is to lobby for law

changes. • Homeowners' associations. • Individuals. • Political groups or candidates for public office.

Expenses paid for a student living with the taxpayer, sponsored by a qualified organization. Cost of raffle, bingo, or lottery tickets.

Out-of-pocket expenses when the taxpayer serves a qualified organization as a volunteer.

Dues, fees, or bills paid to country clubs, lodges, fraternal orders, or similar groups.

Tuition Value of the taxpayer’s time or services Value of blood given to a blood bank

Table 18-21 - Publication 526 - Table 1 - Examples of Charitable Contributions - A Quick Check (2017)

Portability Election of Unused Estate Tax Exemption The portability election allows estates of married taxpayers to pass along the unused part of their exclusion amount, normally $5,490,000 in 2017, to their surviving spouse. This provision eradicates the need for spouses to retitle property and create trusts solely to take full advantage of each spouse’s exclusion amount. The first estate tax returns for estates eligible to make the portability election (because the date of death is after December 31, 2010) were due as early as Monday, October 3, 2011. This date was the earliest eligible because the estate tax return is due nine months after the date of death. The IRS highlighted that estates of those who died before 2011 are not eligible to make this election. As a reminder, estates unable to meet the nine-month deadline can request an automatic six-month filing extension by filing Form 4768 - Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes. For example, assume Heidi’s husband dies in 2017 having made lifetime gifts to children, consuming $2 million of his exemption. At death, he leaves his remaining $3,490,000 estate to Heidi. The executor of Heidi’s husband’s estate may elect to permit her to use his unused $3.49 million exemption, giving Heidi an $8,980,000 exemption (her original $5,490,000 exemption for 2017, plus the deceased spouse’s $3,490,000 unused exemption). Although the portability of the estate tax exemption is designed to prevent married couples from wasting some or all their respective exemption amounts, trust planning for married couples may still provide meaningful benefits, such as eliminating estate taxes on post-mortem appreciation, and protecting the inheritance of heirs. Report of Foreign Bank and Financial Accounts (FBAR) The Financial Crimes Enforcement Network (FinCEN) distributed a rule that amends the Bank Secrecy Act (BSA) implementing regulations regarding the Report of Foreign Bank and Financial Accounts (FBAR). The FBAR form is utilized to report a financial interest in, or signature or other authority over, one or more financial accounts in foreign countries. A report is not mandatory if the aggregate value of the accounts does not exceed $10,000. Therefore, if a U.S. person who has a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account that exceeds $10,000 at any time during the calendar

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year, the Bank Secrecy Act may require him or her to report the account yearly to the Internal Revenue Service by filing a Report of Foreign Bank and Financial Accounts (FBAR).

FBARs must be electronically filed through the Bank Secrecy Act (BSA) E-Filing System using the electronic FinCEN Form 114 - Report of Foreign Bank and Financial Accounts (FBAR), which supersedes the now-obsolete paper Treasury Department Form 90-22.1. Starting after December 31, 2015, the due date of FinCEN

Report 114 (relating to Report of Foreign Bank and Financial Accounts) is April 15 with a maximum extension for a 6-month period ending on October 15 and with provision for an extension under rules similar to the rules in Treasury Regulation Section 1.6081–5. For any taxpayer required to file such Form for the first time, any penalty for failure to timely request for, or file, an extension, may be waived by the Secretary. United States persons are required to file an FBAR if both of the following apply: (369)

1. The United States person had a financial interest in or signature authority over at least one financial account located outside of the United States.

2. The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.

United States person includes U.S. citizens; U.S. residents; entities, including but not limited to, corporations, partnerships, or limited liability companies, created or organized in the United States or under the laws of the United States; and trusts or estates formed under the laws of the United States. The Federal tax treatment of an entity does not determine whether the entity has an FBAR filing requirement. For example, an entity that is disregarded for purposes of Title 26 of the United States Code must file an FBAR, if otherwise required to do so. Similarly, a trust for which the trust income, deductions, or credits are taken into account by another person for purposes of Title 26 of the United States Code must file an FBAR, if otherwise required to do so. A financial account contains, but is not limited to, securities, brokerage, savings, demand, checking, deposit, time deposit, or other account maintained with a financial institution (or other person performing the services of a financial institution). A financial account also is comprised of commodity futures or options account, an insurance policy with a cash value (such as a whole life insurance policy), an annuity policy with a cash value, and shares in a mutual fund or similarly pooled fund (i.e., a fund that is available to the general public with a regular net asset value determination and regular redemptions). A foreign financial account is a financial account located outside of the United States. For example, an account maintained with a branch of a United States bank that is physically located outside of the United States is a foreign financial account. An account maintained with a branch of a foreign bank that is physically located in the United States is not a foreign financial account. Exceptions to the FBAR reporting requirements are located in the FBAR instructions. There are filing exceptions for the following United States persons or foreign financial accounts:

Certain foreign financial accounts jointly owned by spouses. United States persons included in a consolidated FBAR. Correspondent/nostro accounts. Foreign financial accounts owned by a governmental entity. Foreign financial accounts owned by an international financial institution. IRA owners and beneficiaries. Participants in and beneficiaries of tax-qualified retirement plans. Certain individuals with signature authority over but no financial interest in a foreign financial account. Trust beneficiaries (but only if a U.S. person reports the account on an FBAR filed on behalf of the trust). Foreign financial accounts maintained on a United States military banking facility.

A U.S. person who has a foreign financial account may have a reporting obligation even though the account produces no taxable income. The reporting obligation is met by answering questions on a tax return about foreign accounts (for example, the questions about foreign accounts on Form 1040 Schedule B) and by filing an FBAR. The FBAR is a calendar year report, which must be filed with the Department of Treasury on or before April 15 of the year following the calendar year reported. Generally, extensions of time to file an FBAR are allowed. The law affords an extension of up to six months to be available to all taxpayers, which coincides with the October 15 extension due date for

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individual income tax returns. While the due dates for the FBAR and individual income tax returns now coincide, the method of filing FBARs has not changed. FBARs must be filed electronically through the FinCEN BSA E-Filing System. Those required to file an FBAR who fail to properly file a complete and correct FBAR may be subject to civil monetary penalties. For penalties that are assessed after August 1, 2016, whose associated violations occurred after November 2, 2015, the IRS may assess an inflation-adjusted civil penalty not to exceed $12,459 per violation for non-willful violations that are not due to reasonable cause. For willful violations, the inflation-adjusted penalty may be the greater of $124,588 or 50% of the balance in the account at the time of the violation, for each violation. Taxpayers with specified foreign financial assets that exceed $50,000 on the last day of the tax year or $75,000 at any time during the tax year (higher threshold amounts apply to married individuals filing jointly and individuals living abroad) must report those assets to the IRS on Form 8938 - Statement of Specified Foreign Financial Assets, which is filed with an income tax return. The new Form 8938 filing requirement is in addition to the FBAR filing requirement.

Tax Court Decisions Voss v. Commissioner A divided Ninth Circuit reversed the Tax Court decision in Voss v. Commissioner and allowed two unmarried co-owners of real property to each claim a home mortgage interest deduction. Now, the IRS has acquiesced in the decision, giving a bonus to unmarried individuals who buy property together. The IRS issued Action on Decision (AOD) 2016-31, acquiescing in the Ninth Circuit's decision in Voss v. Commissioner, which held that the Section 163(h)(3) limitations on the deductibility of mortgage interest ($1 million of acquisition indebtedness plus $100,000 of home equity indebtedness) are applied on a per-taxpayer basis (for a total of $2.2 of mortgage debt for unmarried couples), rather than on a per-residence basis (and thus limited to $1.1 of mortgage debt for married couples), as previously argued by the IRS and decided by the Tax Court. Bruce Voss and Charles Sophy, unmarried co-owners of the property, each claimed a home mortgage interest deduction under Tax Code Section 163(h)(3). The Code section allows taxpayers to deduct interest on up to $1,000,000 of home acquisition debt and $100,000 of home equity debt. The IRS said Voss and Sophy were jointly subject to Section 163(h)(3)’s debt limits, and therefore disallowed a substantial portion of their claimed deductions. Voss and Sophy claimed the provision applies on a per-taxpayer basis, so they were each entitled to deduct interest on up to $1.1 million. While the Ninth Circuit conceded the language of the Code is “anything but plain,” it agreed with the taxpayers. The decision of the IRS to acquiesce opens the door for unmarried couples outside the Ninth Circuit to claim the deductions subject to the increased limit, and adds an additional element to the marriage penalty under the Code.

Reminders Refunds Filed in Early 2017 The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) made several changes to the tax law to benefit taxpayers and their families. Section 201 of this new law mandates that no credit or refund for an overpayment for a taxable year shall be made to a taxpayer before February 15 if the taxpayer claimed the Earned Income Tax Credit (EITC) or Additional Child Tax Credit (ACTC) on his or her income tax return. This change begins January 1, 2017, and may affect some returns filed early in 2017. To comply with the law, the IRS will hold the refunds on EITC and ACTC-related returns until February 15. This allows additional time to help prevent revenue lost due to identity theft and refund fraud related to fabricated wages and withholdings. The IRS will hold the entire refund. Under the new law, the IRS cannot release the part of the refund that is not associated with the EITC and ACTC. Taxpayers should file as they normally do, and tax return preparers should also submit returns as they normally do. The IRS will begin accepting and processing tax returns once the filing season begins, as they do every year. That will not change. The IRS still expects to issue most refunds in less than 21 days, though IRS will hold refunds for EITC and ACTC-related tax returns filed early in 2017 until February 15 and then begin issuing them.

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Recent Tax Legislation A large number of expired tax provisions have been retroactively extended by the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act). Some tax breaks have been made permanent, some have been retroactively extended through 2019. Also, the Bipartisan Budget Act of 2018 retroactively extended other provisions through 2017. The following is a list of the key provisions. Tax provisions made permanent:

Child Tax Credit. American Opportunity Tax Credit. Earned Income Tax Credit. Above-the-line deduction for certain expenses of elementary and secondary school teachers. Deduction for state and local general sales taxes. Enhanced mass transit and parking pass benefits. Qualified charitable distributions from individual retirement plans. Research and Development Credit. Section 179 expensing. An exclusion of 100% of gain on certain small business stock. The S corporation recognition period for built-in gains tax to five years.

Tax provisions retroactively extended through 2019:

Bonus depreciation. First year bonus depreciation on automobiles. Work Opportunity Tax Credit. New Markets Tax Credit.

Tax provisions retroactively extended through 2017:

Above-the-line deduction for qualified tuition and related expenses. Nonbusiness Energy Property Credit. Cancellation of Debt (COD) principal residence exclusion. Mortgage insurance premiums treated as qualified residence interest. Credit for Two-wheeled Plug-in Electric Vehicles.

Tax Return Due Date The April 15 tax deadline is set by statute and will remain in place. If the due date falls on a Saturday, Sunday, or legal holiday, the due date is delayed until the next business day. The IRS reminds taxpayers that anyone can request an automatic six-month extension to file their tax return. The request is easily done with Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, which can be filed electronically or on paper. For 2017 tax returns the taxpayer should file Form 1040 by April 17, 2018. The due date is April 17, because April 15 is a Sunday and the Emancipation Day holiday in the District of Columbia is observed on April 16 - even if the taxpayer does not live in the District of Columbia. Annual Filing Season Program (AFSP) The IRS is offering a voluntary Annual Filing Season Program (AFSP) to return preparers. The AFSP is intended to recognize and encourage the voluntary efforts of non-credentialed tax return preparers to increase their knowledge and improve their filing season competency through continuing education. To obtain the voluntary certification, credentialed tax preparers (CPA, attorney, enrolled agent, etc.) or tax return preparers who have successfully completed a national or state test (RTRP, CTEC, OBTP, DLLR, Part 1 of the SEE, etc.) would need to have an active Preparer Tax Identification Number (PTIN) and complete 15 credit hours of continuing professional education annually through an IRS approved provider.

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Non-credentialed/non-exempt or unenrolled tax preparers must complete an 18-hour course consisting of 2 hours of Ethics and Professional Conduct, 10 hours of Federal taxation and 6 hours of Annual Federal Tax Refresher (AFTR) course that includes a 100-question comprehension test with a 3-hour time limit. Unenrolled return preparers can elect to voluntarily take continuing professional education each year in preparation for the filing season and receive an Annual Filing Season Program – Record of Completion. The program is important for a number of reasons. It encourages unregulated return preparers who do not have to meet continuing professional education requirements to stay up-to-date on tax laws and changes. It helps lessen the risk to taxpayers from preparers who have no education in Federal tax law or filing requirements. And it allows preparers without professional credentials to stand out from the competition by giving them a recognizable record of completion that they can show to their clients. Preparers who complete the AFSP will also be included in a public directory that will be added to IRS.gov each year for taxpayers to use in searching for qualified tax return preparers. The Directory of Federal Tax Return Preparers with Credentials and Select Qualifications will only include attorneys, certified public accountants (CPAs), enrolled agents, enrolled retirement plan agents (ERPAs), enrolled actuaries and individuals who have received an Annual Filing Season Program – Record of Completion. Also, as of 2016, there were changes to the representation rights of return preparers. Attorneys, CPAs, and enrolled agents will continue to be the only tax professionals with unlimited representation rights, meaning they can represent their clients on any matters including audits, payment/collection issues, and appeals. AFSP participants will have limited representation rights, meaning they can represent clients whose returns they prepared and signed, but only before revenue agents, customer service representatives, and similar IRS employees, including the Taxpayer Advocate Service. PTIN holders without an AFSP – Record of Completion or other professional credential will only be permitted to prepare tax returns. They will not be allowed to represent clients before the IRS. Established state-based return preparer program participants with current testing requirements such as return preparers who are active members of the Maryland State Board of Individual Tax Preparers, the Oregon Board of Tax Practitioners and/or the California Tax Education Council are exempt from taking the Annual Federal Tax Refresher (AFTR) course. For example, the IRS has exempted California Registered Tax Preparers (CRTP) from having to take the Annual Federal Tax Refresher (AFTR) course and passing the course’s competency examination to obtain a Record of Completion because they have already demonstrated their competency by passing a 60-hour qualifying education course and annually maintaining their continuing professional education. These exempt groups are still required to meet other program requirements, including 15 CPE credits (10 Federal Tax Law, 3 Federal Tax Law Updates, and 2 Ethics). Return preparers who can obtain the AFSP – Record of Completion without taking the AFTR course are:

Anyone who passed the Registered Tax Return Preparer test administered by the IRS between November 2011 and January 2013.

Established state-based return preparer program participants currently with testing requirements: Return preparers who are active registrants of the Oregon Board of Tax Practitioners, California Tax Education Council, and/or Maryland State Board of Individual Tax Preparers.

SEE Part I Test-Passers: Tax practitioners who have passed the Special Enrollment Exam Part I within the past two years as of the first day of the upcoming filing season.

VITA volunteers: Quality reviewers and instructors with active PTINs. Other accredited tax-focused credential-holders: The Accreditation Council for Accountancy and Taxation’s

Accredited Business Accountant/Advisor (ABA) and Accredited Tax Preparer (ATP) programs. California Tax Education Council (CTEC) education requirements will meet the IRS requirements. Therefore, a CRTP in good standing will have already met all of the IRS requirements of the new program and will have a simplified process to obtain a Record of Completion. Also, a CRTP was granted the authority to represent,

before the IRS, clients whose returns the CRTP prepared, as long as the CRTP is properly registered with CTEC for both the year the tax return was prepared as well as the year the review takes place. Preparer Tax Identification Number (PTIN) On January 18, 2013, the United States District Court for the District of Columbia enjoined the Internal Revenue Service

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from enforcing the regulatory requirements for registered tax return preparers. In accordance with this order, tax return preparers covered by this program are not required to complete competency testing or secure continuing education. The ruling does not affect the regulatory practice requirements for CPAs, attorneys, enrolled agents, enrolled retirement plan agents or enrolled actuaries or the continuing professional education requirements of individual states. On February 1, 2013, the court modified its order to clarify that the order does not affect the requirement for all paid tax return preparers to obtain a preparer tax identification number (PTIN). IRS regulations still require all paid tax return preparers (including attorneys, CPAs, and enrolled agents) to apply for a Preparer Tax Identification Number (PTIN) before preparing any future Federal tax returns. On June 1, 2017, the United States District court for the District of Columbia upheld the Internal Revenue Service’s authority to require the use of a Preparer Tax Identification Number (PTIN), but enjoined the IRS from charging a user fee for the issuance and renewal of PTINs. The PTIN application process may be completed online. Form W-12 - IRS Paid Preparer Tax Identification Number Application and Renewal, is available for paper applications and renewals, but takes four to six weeks to process. A tax preparer must renew his or her PTIN every year during the renewal season. The renewal season generally runs from mid-October to December 31. The renewal process can be completed online and only takes a few moments. Failure to have and use a valid PTIN may result in penalties. All enrolled agents, regardless of whether they prepare returns, must have a PTIN in order to maintain their status. Electronic Filing Identification Number (EFIN) The IRS assigns an EFIN to identify firms that have completed the IRS e-file Application to become an Authorized IRS e-file Provider. After the provider completes the application and passes a suitability check, the IRS sends an acceptance letter, including the EFIN, to the provider. Providers need the EFIN to electronically file tax returns. The firm owns the EFIN. The principals of the firm use either their Social Security Number or Employer Identification Number to apply for an EFIN. On their application, the firm's “Doing Business As” name and business address should be used, not a personal address. The IRS announced that effective October 1, 2012, they will no longer be accepting paper applications to become an IRS e-file provider and that all applications must be submitted online. Until October 1, 2012, the IRS has allowed tax professionals to fill out Form 8633 - Application to Participate in the IRS e-file Program. With all tax preparers now submitting their applications online, the IRS estimates that the online application process takes four to six weeks to complete and urges tax professionals not to delay. Authorized IRS e-file Providers do not have to reapply each year as long as they continue to e-file returns. However, if a Provider does not e-file returns for two consecutive years, the IRS will notify the Provider of removal from the IRS active Provider list. The IRS may reactivate a Provider if the Provider replies within sixty days and requests reactivation. Otherwise, the Provider will have to complete and submit a new application. Providers must update their application information within 30 days of the date of any changes to the information on their current application. Make all changes using the IRS e-file Application. See Changes to Your IRS e-file Application. The EFIN is not transferable and neither is the password. Even if an Authorized IRS e-file Provider transfers his or her business by sale, gift or other disposition, he or she may not transfer his or her EFIN. The Provider must protect his or her EFINS, Electronic Transmitter Identification Numbers (ETINs) and passwords from unauthorized use. Identity Theft Identity theft occurs when another person uses the taxpayer’s personal information such as his or her name, Social Security number (SSN) or other identifying information, without the taxpayer’s permission, to commit fraud or other crimes. Usually, an identity thief utilizes a legitimate taxpayer’s identity to fraudulently file a tax return and claim a refund. Generally, the identity thief will use a stolen SSN to file a forged tax return and try to get a fraudulent refund early in the filing season. The taxpayer may not be aware that an identity theft has happened to him or her until he or she files a return later in the filing season and discovers that two returns have been filed using the same SSN. The taxpayer should be alert to possible identity theft if he or she gets an IRS notice or letter stating: (370)

More than one tax return for the taxpayer was filed.

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The taxpayer has a balance due, refund offset or has had collection actions taken against him or her for a year he or she did not file a tax return.

IRS records indicate the taxpayer received wages from an employer unknown to him or her.

If the taxpayer receives a notice from the IRS, respond immediately. If he or she believes someone may have used his or her SSN fraudulently, the taxpayer should notify the IRS immediately by responding to the name and number printed on the notice or letter. The taxpayer will need to fill out the Form 14039 - Identity Theft Affidavit. Identity Protection Personal Identification Number (IP PIN) If a taxpayer received an IRS notice providing him or her with an Identity Protection Personal Identification Number (IP PIN), enter it in the IP PIN spaces provided below daytime phone number on the tax return form. The taxpayer must enter the IP PIN exactly as it is shown on the Notice CP01A. If the taxpayer did not receive a notice containing an IP PIN, leave these spaces blank. An IP PIN is a number the IRS gives to taxpayers who have: (369)

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

The IP PIN helps to prevent the misuse of a taxpayer's Social Security number or Taxpayer Identification Number on income tax returns. New IP PINs are issued every year. An IP PIN should be used only for the tax year it was issued. IP PINs for 2018 tax returns generally will be sent in December 2017. A new IP PIN will be issued every year for three years after the identity theft incident. If the taxpayer is filing a joint return and both

taxpayers receive an IP PIN, only the taxpayer whose Social Security number (SSN) appears first on the tax return should enter his or her IP PIN. Individual Taxpayer Identification Numbers (ITIN) In January of 2013 the IRS implemented new procedures that affect the Individual Taxpayer Identification Number (ITIN) application process. The information below highlights improvements to the ITIN program: (371)

If the taxpayer is applying directly to the IRS for an ITIN, they will only accept original identification documents or certified copies of these documents from the issuing agency along with a completed Form W-7 - Application for IRS Individual Taxpayer Identification Number and Federal tax return.

In addition to direct submission of documents to the IRS centralized site or use of Certifying Acceptance Agents (CAAs), ITIN applicants will have several other avenues for verification of key documents. These options include some key IRS Taxpayer Assistance Centers (TACs), U.S. Tax Attachés in London, Paris, Beijing and Frankfurt and at Low-Income Taxpayer Clinics (LITCs) and Volunteer Income Tax Assistance (VITA) Centers that use CAAs.

New ITINs will now be issued for a five-year period rather than an indefinite period. This change will help ensure that ITINs are being used for legitimate tax purposes.

There are four exceptions to this new documentation requirement. Applicants who are not impacted by these changes include:

o U.S. military spouses and U.S. military dependents. o Non-resident aliens applying for ITINs for the purpose of claiming tax treaty benefits. o Noncitizens that have approved TY 2011 extensions to file their tax returns. These are temporary ITINs. o Student Exchange Visitors Program (SEVP) participants.

The IRS issues ITINs to foreign nationals and others who have Federal tax reporting or filing requirements and do not qualify for SSNs. A non-resident alien individual not eligible for a SSN who is required to file a U.S. tax return only to claim a refund of tax under the provisions of a U.S. tax treaty needs an ITIN. Other examples of individuals who need ITINs include: (372)

A nonresident alien required to file a U.S. tax return. A U.S. resident alien (based on days present in the United States) filing a U.S. tax return. A dependent or spouse of a U.S. citizen/resident alien. A dependent or spouse of a nonresident alien visa holder.

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The IRS processes returns showing SSNs or ITINs in the blanks where tax forms request SSNs. IRS no longer accepts, and will not process, forms showing "SSA205c," "applied for," "NRA," blanks, etc.

All ITINs not used on a Federal tax return at least once in the last three years will no longer be valid for use on a tax return as of January 1, 2018. Additionally, all ITINs issued before 2013 began expiring in 2016. In 2017, ITINs with middle digits of 70, 71, 72 or 80 (Example: 9NN-70-NNNN) need to be renewed if the taxpayer will

have a filing requirement in 2018. No action is needed by ITIN holders who do not need to file a tax return next year. Also, there are new documentation requirements when applying for or renewing an ITIN for certain dependents. If taxpayers have an expired ITIN and do not renew before filing a tax return next year, they could face a refund delay and may be ineligible for certain tax credits, such as the Child Tax Credit and the American Opportunity Tax Credit, until the ITIN is renewed. The ITIN changes are required by the Protecting Americans from Tax Hikes (PATH) Act enacted by Congress in December 2015. The IRS emphasizes that no action is needed by ITIN holders if they do not need to file a tax return next year. Taxpayers with ITINs set to expire at the end of the year and who need to file a tax return in 2018 must submit a renewal application. Others do not need to take any action.

ITINs with middle digits 70, 71, 72, or 80 (For example: 9NN-70-NNNN) need to be renewed if the taxpayer will have a filing requirement in 2018.

Taxpayers whose ITINs expired due to lack of use should only renew their ITIN if they will have a filing requirement in 2018.

Taxpayers who are eligible for, or who have, a Social Security number (SSN) should not renew their ITIN, but should notify IRS both of their SSN and previous ITIN, so that their accounts can be merged.

Taxpayers whose ITINs have middle digits 78 or 79 that have expired should renew their ITIN if they will have a filing requirement in 2018.

A taxpayer whose ITIN has been deactivated and needs to file a U.S. return can reapply using Form W-7 - Application for IRS Individual Taxpayer Identification Number. As with any ITIN application, original documents, such as passports, or copies of documents certified by the issuing agency must be submitted with the form. IRS Direct Pay IRS Direct Pay is a payment application that allows individual taxpayers with a valid Social Security Number to make IRS payments directly from their checking or savings accounts. It is free, secure and provides an electronic payment confirmation while reducing processing costs. Only Form 1040 payments and associated penalties can be made through IRS Direct Pay.

The taxpayer must have a valid Social Security Number (SSN) to use this application. This application cannot accommodate Individual Taxpayer Identification Numbers (ITINs).

IRS Direct Pay currently accepts 1040 series payments, including the 4868 (1040 Extension) and the 1040-ES (1040 Estimated Tax). Direct Pay will also accept form 5329 payments and Shared Responsibility payments. Other form types may be added in the future. A taxpayer can make a tax payment towards a 1040 tax return for the last 20 years for most of the Reason for Payment options. There are two exceptions: Estimated Tax Payments and Requests for Extension of Time to File. Estimated Tax Payments are paid to the IRS in the current calendar year, while Requests for Extension of Time to File payments are generally for the current tax year. Taxpayers receive instant confirmation that the payment has been submitted, and the system is available 24 hours a day, 7 days a week. Bank account information is not retained in any IRS systems after payments are completed. IRS Direct Pay also offers 30-day advance payment scheduling, payment rescheduling or cancellations, and a payment status search. Future plans include an option for e-mailed payment confirmation, a Spanish version and one-time registration with a login and password to allow quick access on return visits. Installment Agreements The IRS has revised the user fee schedule for installment agreements. The new fee schedule applies to installment

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agreements entered into, restructured or reinstated on or after January 2, 2017. The final regulations increase the existing user fees (except for low-income taxpayers) and create two new types of online installment agreements, each subject to a separate fee. Five of these rates are based on the full cost of establishing and monitoring installment agreements, while the sixth rate is for low-income taxpayers. The new fees are:

1. A top rate of $225, up from $120, applies to taxpayers who enter into installment agreements in person, over the phone, by mail, or by filing Form 9465 - Installment Agreement Request, with the IRS. This includes taxpayers requesting installment agreements with their e-filed returns.

2. A reduced rate of $107, up from $52, applies to a direct debit agreement. 3. A taxpayer who sets up an installment agreement through IRS.gov and agrees to make payments either by mailing a

check or through the Electronic Federal Tax Payment System (EFTPS) will pay $149. 4. A taxpayer who sets up an installment agreement online and agrees to make automatic payments through direct debit

will pay a $31 fee. 5. The fee for a restructured/reinstated installment agreement is $89, up from $50. 6. A low-income taxpayer pays a $43 fee, the same as the current rate, when setting up any type of installment

agreement, other than a direct debit online payment agreement or when restructuring or reinstating any installment agreement.

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

Paid Preparer’s Due Diligence Checklist Due to changes in the tax law, the paid tax return preparer Earned Income Tax Credit (EITC) due diligence requirements have been expanded to also cover the American Opportunity Tax Credit (AOTC), the Child Tax Credit (CTC) and/or the Additional Child Tax Credit (ACTC). Form 8867 - Paid Preparer’s Due Diligence Checklist, has been modified to account for these changes. In addition, Form 8867 has been streamlined. Completing the form is not a substitute for actually performing the necessary due diligence and completing all required forms and schedules when preparing the return.

Also, the paid tax return preparer due diligence penalty under IRC section 6695(h) is now indexed for inflation. Therefore, the penalty for failure to meet the due diligence requirements with respect to returns and claims for refund filed in 2017 is $510 per credit per return.

A paid tax return preparer is required to exercise due diligence when preparing any client’s return or claim for refund. As part of exercising due diligence, the tax preparer must interview the client, ask adequate questions, and obtain appropriate and sufficient information to determine correct reporting of income, claiming of tax benefits (such as deductions and credits), and compliance with the tax laws. A paid tax return preparer must meet specific due diligence requirements set forth in Treasury Regulations when he or she prepares returns and claims for refund involving the EITC, the AOTC and/or the CTC/ACTC. To meet these due diligence requirements, the tax preparer may need to ask additional questions and obtain additional information to determine eligibility for and the amount of the EITC, AOTC, and CTC/ACTC.

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

Review Questions Answers appear in Review Feedback 1. Estates and Trusts will be subject to the Net Investment Income Tax if they have undistributed Net Investment Income

and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year. Generally, the threshold amount for the upcoming year is updated by the IRS each fall in a revenue procedure. For 2017, the threshold amount is what amount?

A. $11,950 B. $12,500 C. $13,000 D. $15,550

2. Which of the following is true regarding same-sex marriage tax returns?

A. A taxpayer’s same-sex spouse can be a dependent of the taxpayer B. A same-sex spouse files using head of household filing status C. A taxpayer who is married to a person of the same sex can claim the standard deduction if the taxpayer’s

spouse itemized deductions D. A taxpayer and his or her same-sex spouse can file a joint return if they were married in a state that recognizes

same-sex marriages but they live in a state that does not recognize their marriage

3. In general, a taxpayer may be eligible for the Premium Tax Credit if he or she meets which of the following criteria? A. He or she buys health insurance through the Marketplace B. He or she is eligible for coverage through an employer or government plan C. He or she is married and files a separate return D. He or she can be claimed as a dependent by another person

4. The Internal Revenue Service has a simplified option that many owners of home-based businesses and some home-

based workers may use to figure their deductions for the business use of their homes as they consider tax planning in 2017. All of the following are true regarding the simplified option except:

A. The standard deduction is $5 per square foot of home used for business B. The standard deduction is allowed on a maximum 300 square feet C. Allowable home-related itemized deductions are claimed in full on Schedule A D. Home depreciation deduction or later recapture of depreciation for the years is allowable if the simplified option

is used

5. Adam, a single filer, earns $210,000 in wages and sells his principal residence that he has owned and resided in for the last 10 years for $420,000. Adam’s cost basis in the home is $200,000. Adam’s realized gain on the sale is $220,000. Under IRC Section 121, Adam may exclude up to $250,000 of gain on the sale. What amount of this gain is included for purposes of determining Net Investment Income?

A. $0 B. $200,000 C. $210,000 D. $220,000

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6. For tax year 2017 Bill and Terry Willow are filing a joint return on Form 1040. Their adjusted gross income on line 38 is $325,500. Which of the following Schedule A itemized deductions is not subject to the overall limit on itemized deductions?

A. Taxes paid B. Interest paid C. Investment interest expense D. All of the above

7. When Leatrice, age 25, graduated from college last year she had $5,000 left in her Coverdell ESA. She wanted to give

this money to her younger sister, who was still in high school. Leatrice took a $5,000 distribution and contributed the same amount to her sister's Coverdell ESA within 60 days of the distribution. What amount of the distribution is taxable?

A. $0 B. $2,000 C. $2,500 D. $5,000

8. Hugo is a single taxpayer with $175,000 in salary and $100,000 in capital gains. His modified adjusted gross income is

$275,000 while his net investment income is $100,000. Hugo’s modified adjusted gross income exceeds the net investment income tax threshold by $75,000. What amount does Hugo owe for the net investment income tax?

A. $0 B. $2,850 C. $3,800 D. $5,225

9. In general, all of the following are included in net investment income except:

A. Interest B. Dividends C. Social Security Benefits D. Capital gains

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Review Feedback Return to Review Questions Question 1 - B. $12,500 Estates and Trusts will be subject to the Net Investment Income Tax if they have undistributed Net Investment Income and also have adjusted gross income over the dollar amount at which the highest tax bracket for an estate or trust begins for such taxable year. Generally, the threshold amount for the upcoming year is updated by the IRS each fall in a revenue procedure. For 2017, the threshold amount is $12,500. The taxpayer should be aware that there are special computational rules for certain unique types of trusts, such as Charitable Remainder Trusts and Electing Small Business Trusts. Question 2 - D. A taxpayer and his or her same-sex spouse can file a joint return if they were married in a state that recognizes same-sex marriages but they live in a state that does not recognize their marriage For Federal tax purposes, the IRS has a general rule recognizing a marriage of same-sex individuals that was validly entered into in a domestic or foreign jurisdiction whose laws authorize the marriage of two individuals of the same sex even if the married couple resides in a domestic or foreign jurisdiction that does not recognize the validity of same-sex marriages. Question 3 - A. He or she buys health insurance through the Marketplace In general, a taxpayer may be eligible for the Premium Tax Credit if he or she meets all of the following criteria:

• Buys health insurance through the Marketplace. • Is ineligible for coverage through an employer or government plan. • Is within certain income limits. • Files a joint return, if married. • Cannot be claimed as a dependent by another person.

Because the taxpayer buys health insurance through the Marketplace is one of the eligibility requirements choice A is correct. Choice B is incorrect because the eligibility requirement states the taxpayer must be ineligible for coverage through an employer or government plan. Choice C is incorrect because the eligibility requirement states the taxpayer must file a joint return if married. Choice D is incorrect because the eligibility requirement states the taxpayer cannot be claimed as a dependent by another person. Question 4 - D. Home depreciation deduction or later recapture of depreciation for the years is allowable if the simplified option is used Key points of the simplified option include:

• Standard deduction of $5 per square foot of home used for business (maximum 300 square feet). • Allowable home-related itemized deductions claimed in full on Schedule A. (For example: Mortgage interest, real

estate taxes). • No home depreciation deduction or later recapture of depreciation for the years the simplified option is used.

Choices A and B are true because they state that the standard deduction is $5 per square foot of home used for business (maximum 300 square feet). Choice C is true because allowable home-related itemized deductions are claimed in full on Schedule A. Thus choice D is false. It states home depreciation deduction or later recapture of depreciation for the years is allowable if the simplified option is used which is inaccurate. Question 5 - A. $0 Adam may exclude up to $250,000 of gain on the sale. Because this gain is excluded for regular income tax purposes, it is also excluded for purposes of determining Net Investment Income. In this example, the Net Investment Income Tax does not apply to the gain from the sale of Adam’s home thus choice A of $0 is the correct response. Any choice more than $0, including choices B, C and D is incorrect.

Lesson 18 - Federal Tax Legislation and Continuing Changes, Recent Tax Law Update Reminders

© 2018 Golden State Tax Training Institute, Inc. 18-54

Question 6 - C. Investment interest expense The following Schedule A (Form 1040) deductions are not subject to the overall limit on itemized deductions. However, they are still subject to other applicable limits:

• Medical and dental expenses. • Investment interest expense. • Casualty and theft losses of personal use property. • Casualty and theft losses of income-producing property. • Gambling losses.

Investment interest expense are Schedule A (Form 1040) deductions that are not subject to the overall limit on itemized deductions, thus choice C is correct. Taxes paid and interest paid are subject to the overall limit and therefore choices A, B and D are incorrect. Question 7 - A. $0 Any amount distributed from a Coverdell ESA is not taxable if it is rolled over to another Coverdell ESA for the benefit of the same beneficiary or a member of the beneficiary's family (including the beneficiary's spouse) who is under age 30. This age limitation does not apply if the new beneficiary is a special needs beneficiary. An amount is rolled over if it is paid to another Coverdell ESA within 60 days after the date of the distribution. Therefore, Choice A of $0 is the correct response. Any choice more than $0, including choices B, C and D is incorrect. Question 8 - B. $2,850 The tax applies on the lesser of modified adjusted gross income (MAGI) over the threshold or net investment income, so it applies to the $75,000 of MAGI over the threshold amount of $200,000 for a single taxpayer. Hugo owes the IRS $2,850 ($75,000 X 3.8%) for the tax. Question 9 - C. Social Security Benefits Wages, unemployment compensation; operating income from a non-passive business, Social Security Benefits, alimony, tax-exempt interest, self-employment income, Alaska Permanent Fund Dividends (see Revenue Ruling 90-56, 1990-2 CB 102) and distributions from certain Qualified Plans are some common types of income that are not Net Investment Income.

© 2018 Golden State Tax Training Institute, Inc. I

Bibliography

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[Online] http://www.irs.gov/taxtopics/tc152.html. 30. —. Publication 1 - Your Rights as a Taxpayer. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p1.pdf. 31. —. Six Facts on Tax Refunds and Offsets. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Six-Facts-on-Tax-Refunds-and-Offsets. 32. —. Topic 203 - Refund Offsets: For Unpaid Child Support, and Certain Federal, State and Unemployment Compensation Debts. irs.gov. [Online] http://www.irs.gov/taxtopics/tc203.html. 33. —. Topic 308 - Amended Returns. irs.gov. [Online] http://www.irs.gov/taxtopics/tc308.html. 34. —. Estimated Taxes. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estimated-Taxes. 35. —. Publication 505 - Tax Withholding and Estimated Tax. irs.gov. [Online] http://www.irs.gov/publications/p505/ch01.html. 36. —. EFTPS: The Electronic Federal Tax Payment System. irs.gov. [Online] http://www.irs.gov/uac/EFTPS:-The-Electronic-Federal-Tax-Payment-System. 37. —. Pay your Taxes by Debit or Credit Card. irs.gov. [Online] http://www.irs.gov/uac/Pay-Taxes-by-Credit-or-Debit-Card. 38. —. Pay by Check or Money Order. irs.gov. [Online] http://www.irs.gov/Individuals/Pay-by-Check-or-Money-Order. 39. —. Topic 202 - Tax Payment Options. irs.gov. [Online] http://www.irs.gov/taxtopics/tc202.html. 40. —. Offer in Compromise. irs.gov. [Online] http://www.irs.gov/Individuals/Offer-in-Compromise-1. 41. —. 1040EZ. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f1040ez.pdf. 42. —. Instructions Form 1040A. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040a.pdf. 43. —. Instructions Form 1040. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040.pdf. 44. —. Instructions Form 1040NR. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040nr.pdf. 45. —. Instructions for Form 1040NR-EZ. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040nre.pdf. 46. —. Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return . irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f4868.pdf. 47. —. Publication 17. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p17.pdf. 48. —. Instructions for Form 1040X. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040x.pdf. 49. —. Topic 203 - Refund Offsets: For Unpaid Child Support, and Certain Federal, State and Unemployment Compensation Debts. irs.gov. [Online] http://www.irs.gov/taxtopics/tc203.html. 50. —. Topic 753 - Form W-4 – Employee's Withholding Allowance Certificate. irs.gov. [Online] http://www.irs.gov/taxtopics/tc753.html. 51. —. Publication 919 - How Do I Adjust My Tax Withholding? irs.gov. [Online] http://www.irs.gov/publications/p919/. 52. —. Form W-4 - Employee's Withholding Allowance Certificate. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/fw4.pdf. 53. —. Withholding Exemptions - Personal Exemptions - Form W-4. irs.gov. [Online] http://www.irs.gov/Individuals/International-Taxpayers/Withholding-Exemptions---Personal-Exemptions---Form-W-4. 54. —. Publication 15 - (Circular E), Employer's Tax Guide. irs.gov. [Online] http://www.irs.gov/publications/p15/. 55. —. Topic 307 - Backup Withholding. irs.gov. [Online] http://www.irs.gov/taxtopics/tc307.html. 56. —. Publication 15-B - Employer's Tax Guide to Fringe Benefits. irs.gov. [Online] http://www.irs.gov/publications/p15b/.

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© 2018 Golden State Tax Training Institute, Inc. II

57. —. Form W-2, Wage and Tax Statement. irs.gov. [Online] http://www.irs.gov/uac/Form-W-2,-Wage-and-Tax-Statement. 58. —. What to Do If You Are Missing a W-2. irs.gov. [Online] http://www.irs.gov/uac/What-to-Do-If-You-Are-Missing-a-W-2. 59. —. General Instructions for Forms W-2 and W-3. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/iw2w3.pdf. 60. Cornell School of Law. 26 USC § 280G - Golden parachute payments. law.cornell.edu. [Online] http://www.law.cornell.edu/uscode/text/26/280G. 61. IRS. Publication 505 - Tax Withholding and Estimated Tax. irs.gov. [Online] http://www.irs.gov/publications/p505/ch01.html. 62. —. Topic 160 - Form 1099-A (Acquisition or Abandonment of Secured Property) and Form 1099-C (Cancellation of Debt). irs.gov. [Online] http://www.irs.gov/taxtopics/tc160.html. 63. —. Form 1099-MISC - Miscellaneous Income. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f1099msc.pdf. 64. —. Form 1099-DIV - Dividends and Distributions. irs.gov. 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Publication 501 - Exemptions, Standard Deduction, and Filing Information. irs.gov. [Online] http://www.irs.gov/publications/p501/. 89. —. Publication 519 - U.S. Tax Guide for Aliens. irs.gov. [Online] [Cited: ] 90. —. Taxation of Dual-Status Aliens. irs.gov. [Online] http://www.irs.gov/Individuals/International-Taxpayers/Taxation-of-Dual-Status-Aliens. 91. —. Publication 504 - Divorced or Separated Individuals. irs.gov. [Online] http://www.irs.gov/publications/p504/index.html. 92. —. Topic 205 - Innocent Spouse Relief (Including Separation of Liability and Equitable Relief). irs.gov. [Online] http://www.irs.gov/taxtopics/tc205.html. 93. —. Publication 17, Chapter 2 - Filing Status. irs.gov. [Online] http://www.irs.gov/publications/p17/ch02.html. 94. —. Answers to Frequently Asked Questions for Individuals of the Same Sex Who Are Married Under State Law. irs.gov. [Online] http://www.irs.gov/uac/Answers-to-Frequently-Asked-Questions-for-Same-Sex-Married-Couples. 95. —. Publication 3 - Armed Forces' Tax Guide. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/p3.pdf. 96. —. Taxation of Nonresident Aliens. irs.gov. [Online] http://www.irs.gov/Individuals/International-Taxpayers/Taxation-of-Nonresident-Aliens. 97. —. Publication 17, Standard Deduction . irs.gov. [Online] http://www.irs.gov/publications/p17/ch20.html#en_US_2011_publink1000173023. 98. —. Publication 501 - Exemptions, Standard Deduction, and Filing Information. irs.gov. [Online] http://www.irs.gov/publications/p501/. 99. —. Form 2120 - Multiple Support Declaration. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f2120.pdf. 100. Cornell University Law School. 26 USC § 61 - Gross income defined. law.cornell.edu. [Online] http://www.law.cornell.edu/uscode/text/26/61. 101. IRS. What is Earned Income? irs.gov. [Online] http://www.irs.gov/Individuals/What-is-Earned-Income%3F. 102. —. Taxable or Non-Taxable Income? irs.gov. [Online] http://www.irs.gov/uac/Taxable-or-Non-Taxable-Income%3F-1. 103. —. Instructions for Form 2555 - Foreign Earned Income. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i2555.pdf. 104. —. Publication 15-B - Employer's Tax Guide to Fringe Benefits. irs.gov. [Online] http://www.irs.gov/publications/p15b/. 105. —. Unemployment Compensation. irs.gov. [Online] http://www.irs.gov/Individuals/Employees/Unemployment-Compensation. 106. —. Publication 525 - Unemployment Benefits. irs.gov. [Online] http://www.irs.gov/publications/p525/. 107. —. Four Tax Tips about Your Unemployment Benefits. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Four-Tax-Tips-about-Your-Unemployment-Benefits. 108. —. Publication 17, Sickness and Injury Benefits. irs.gob. [Online] http://www.irs.gov/publications/p17/ch05.html#d0e25712. 109. —. Publication 17, Military and Government Disability Pensions. irs.gov. [Online] http://www.irs.gov/publications/p17/ch05.html#d0e25809. 110. —. Publication 525 - Sickness and Injury Benefits. irs.gov. [Online] http://www.irs.gov/publications/p525/ar02.html. 111. —. Publication 502 - Medical and Dental Expenses (Including the Health Coverage Tax Credit). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p502.pdf. 112. —. Publication 17, Chapter 12 - Other Income. irs.gov. [Online] http://www.irs.gov/publications/p17/ch12.html. 113. —. Publication 525 - Taxable and Nontaxable Income. irs.gov. [Online] http://www.irs.gov/publications/p525/. 114. —. Topic 419 - Gambling Income and Losses. IRS. [Online] http://www.irs.gov/taxtopics/tc419.html. 115. —. Topic 761 - Tips – Withholding and Reporting. irs.gov. [Online] http://www.irs.gov/taxtopics/tc761.html. 116. —. Publication 531 - Reporting Tip Income. irs.gov. [Online] http://www.irs.gov/publications/p531/. 117. —. Topic 420 - Bartering Income. irs.gov. [Online] http://www.irs.gov/taxtopics/tc420.html. 118. —. Four Things You Should Know if You Barter. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Four-Things-You-Should-Know-if-You-Barter. 119. —. Topic 431 - Canceled Debt – Is It Taxable or Not? irs.gov. [Online] http://www.irs.gov/taxtopics/tc431.html. 120. —. Life Insurance & Disability Insurance Proceeds. irs.gov. [Online] http://www.irs.gov/Help-&-Resources/Tools-&-FAQs/FAQs-for-Individuals/Frequently-Asked-Tax-Questions-&-Answers/Interest,-Dividends,-Other-Types-of-Income/Life-Insurance-&-Disability-Insurance-Proceeds/Life-Insurance-&-Disability-Insurance-

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© 2018 Golden State Tax Training Institute, Inc. III

Proceeds. 121. —. Publication 541 - Partnerships. irs.gov. [Online] http://www.irs.gov/publications/p541/. 122. —. Source of Income - Personal Service Income. irs.gov. [Online] http://www.irs.gov/Individuals/International-Taxpayers/Source-of-Income---Personal-Service-Income. 123. —. Form 1041 - U.S. Income Tax Return for Estates and Trusts. irs.gov. [Online] http://www.irs.gov/instructions/i1041/. 124. —. Source of Income - Personal Service Income. irs.gov. [Online] http://www.irs.gov/Individuals/International-Taxpayers/Source-of-Income---Personal-Service-Income. 125. —. Topic 421 - Scholarship and Fellowship Grants. irs.gov. [Online] http://www.irs.gov/taxtopics/tc421.html. 126. —. Topic 417 - Earnings for Clergy. irs.gov. [Online] http://www.irs.gov/taxtopics/tc417.html. 127. —. Tax Information for Members of the U.S. Armed Forces. irs.gov. [Online] http://www.irs.gov/uac/Tax-Information-for-Members-of-the-U.S.-Armed-Forces. 128. —. Passive Activity Loss ATG - Chapter 3, Passive Income. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Passive-Activity-Loss-ATG----Chapter-3,-Passive-Income. 129. —. Instructions for Form 8582 - Passive Activity Loss Limitations. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8582.pdf. 130. —. Topic 414 - Rental Income and Expenses. irs.gov. [Online] http://www.irs.gov/taxtopics/tc414.html. 131. —. Tax Topic 452 - Alimony Paid. irs.gov. [Online] http://www.irs.gov/taxtopics/tc452.html. 132. —. Publication 550, Chapter 1 - Investment Income. irs.gov. [Online] http://www.irs.gov/publications/p550/ch01.html. 133. —. Publication 17, Chapter 8 - Dividends and Other Distributions. irs.gov. [Online] http://www.irs.gov/publications/p17/ch08.html. 134. —. Stocks (Options, Splits, Traders). irs.gov. [Online] http://www.irs.gov/Help-&-Resources/Tools-&-FAQs/FAQs-for-Individuals/Frequently-Asked-Tax-Questions-&-Answers/Capital-Gains,-Losses,-Sale-of-Home/Stocks-(Options,-Splits,-Traders)/Stocks-(Options,-Splits,-Traders). 135. —. Topic 427 - Stock Options. irs.gov. [Online] http://www.irs.gov/taxtopics/tc427.html. 136. —. Publication 550, Chapter 1 - Investment Income. irs.gob. [Online] http://www.irs.gov/publications/p550/ch01.html. 137. —. Publication 550, Chapter 1 - Investment Income. irs.gob. [Online] http://www.irs.gov/publications/p550/ch01.html. 138. —. Publication 17 - Chapter 7 - Interest Income. irs.gov. [Online] http://www.irs.gov/publications/p17/ch07.html. 139. —. 1040SD - Capital Gains and Losses. irs.gov. [Online] http://www.irs.gov/instructions/i1040sd/ar01.html. 140. —. Instructions for Form 8949. irs.gov. [Online] http://www.irs.gov/instructions/i8949/. 141. —. Instructions for Schedule D. irs.gov. [Online] http://www.irs.gov/instructions/i1040sd/. 142. —. Form 6781 - Gains and Losses From Section 1256 Contracts and Straddles. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f6781.pdf. 143. —. Form 8824 - Like-Kind Exchanges(and section 1043 conflict-of-interest sales). irs.gov. [Online] http://www.irs.gov/uac/Form-8824,-Like-Kind-Exchanges(and-section-1043-conflict-of-interest-sales). 144. —. Publication 550, Chapter 4 - Sales and Trades of Investment Property. [Online] http://www.irs.gov/publications/p550/ch04.html. 145. —. Ten Facts about Capital Gains and Losses. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Ten-Facts-about-Capital-Gains-and-Losses. 146. —. Publication 550, Chapter 1 - Investment Income, Qualified Dividends. irs.gov. [Online] http://www.irs.gov/publications/p550/ch01.html. 147. —. Topic 453 - Bad Debt Deduction. irs.gov. [Online] http://www.irs.gov/taxtopics/tc453.html. 148. —. Publication 523 - Selling Your Home. irs.gov. [Online] http://www.irs.gov/publications/p523. 149. —. Topic 705 - Installment Sales. irs.gov. [Online] http://www.irs.gov/taxtopics/tc705.html. 150. —. Publication 544 - Sales and Other Dispositions of Assets. irs.gov. [Online] http://www.irs.gov/publications/p544/. 151. —. Like-Kind Exchanges Under IRC Code Section 1031. irs.gov. [Online] http://www.irs.gov/uac/Like-Kind-Exchanges-Under-IRC-Code-Section-1031. 152. —. Four Things You Should Know if You Barter. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Four-Things-You-Should-Know-if-You-Barter. 153. —. Should I File Schedule C or Schedule C-EZ? irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Should-I-File-Schedule-C-or-Schedule-C-EZ%3F. 154. —. Instructions for Schedule C. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040sc.pdf. 155. —. Publication 334 - Tax Guide for Small Business. irs.gov. [Online] http://www.irs.gov/publications/p334/. 156. —. Home Office Deduction. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Home-Office-Deduction. 157. —. Publication 535, Chapter 11 - Other Expenses. irs.gov. [Online] http://www.irs.gov/publications/p535/ch11.html. 158. —. Publication 587 - Business Use of Your Home. irs.gov. [Online] http://www.irs.gov/publications/p587/. 159. —. Simplified Option for Home Office Deduction. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Simplified-Option-for-Home-Office-Deduction. 160. —. Filing and Paying Business Taxes - Publication 334. irs.gov. [Online] http://www.irs.gov/publications/p334/ch01.html. 161. —. Publication 334 - Tax Guide for Small Business. irs.gov. [Online] http://www.irs.gov/publications/p334/. 162. —. Instructions for Schedule SE (Form 1040). irs.gov. [Online] http://www.irs.gov/instructions/i1040sse/. 163. —. Publication 926 - Household Employer's Tax Guide. irs.gov. [Online] http://www.irs.gov/publications/p926/. 164. —. Instructions for Schedule H (Form 1040). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1040sh.pdf. 165. —. Publication 542 - Corporations. irs.gov. [Online] http://www.irs.gov/publications/p542/index.html. 166. —. Publication 542 - Corporations. irs.gov. [Online] http://www.irs.gov/publications/p542/index.html. 167. —. Publication 541 - Partnerships. irs.gov. [Online] http://www.irs.gov/publications/p541/. 168. SBA. S Corporation. sba.gov. [Online] http://www.sba.gov/content/s-corporation. 169. IRS. Publication 550, Chapter 4 - Sales and Trades of Investment Property. [Online] http://www.irs.gov/publications/p550/ch04.html. 170. —. Publication 550, Chapter 1 - Investment Income. irs.gov. [Online] http://www.irs.gov/publications/p550/ch01.html. 171. —. Instruction for Form 1120S - U.S. Income Tax Return for an S Corporation. irs.gov. [Online] http://www.irs.gov/instructions/i1120s/. 172. —. Publication 3402 - Taxation of Limited Liability Companies. irs.gov. [Online] http://www.irs.gov/publications/p3402/. 173. —. Instructions for Form 1041 and Schedules A, B, G, J, and K-1. irs.gov. [Online] http://www.irs.gov/instructions/i1041/index.html. 174. —. Instructions for Form 1023-EZ. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i1023ez.pdf. 175. —. IRS Tax Tip 2013-41 - Ten Things to Know about Farm Income and Deductions. [Online] http://www.irs.gov/uac/Tax-Tips-for-2013-1. 176. —. Publication 225 - Farmer's Tax Guide. irs.gov. [Online] http://www.irs.gov/publications/p225/. 177. —. Publication 225 - Farmer's Tax Guide. irs.gov. [Online] http://www.irs.gov/publications/p225/. 178. —. Tips on Rental Real Estate Income, Deductions and Recordkeeping. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Tips-on-Rental-Real-Estate-Income,-Deductions-and-Recordkeeping. 179. —. Publication 334 - Tax Guide for Small Business. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p334.pdf. 180. —. A Brief Overview of Depreciation. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/A-Brief-Overview-of-Depreciation.

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181. —. Publication 946 - Figuring Depreciation Under MACRS. irs.gov. [Online] http://www.irs.gov/publications/p946/ch04.html. 182. —. Publication 946 - How To Depreciate Property. irs.gov. [Online] http://www.irs.gov/publications/p946/. 183. —. Topic 703 - Basis of Assets. irs.gov. [Online] http://www.irs.gov/taxtopics/tc703.html. 184. —. Publication 551 - Basis of Assets. irs.gov. [Online] http://www.irs.gov/publications/p551/. 185. —. Publication 4895 - Tax Treatment of Property Acquired From a Decedent Dying in 2010. irs.gov. [Online] http://www.irs.gov/publications/p4895/. 186. —. Publication 946 - Electing the Section 179 Deduction. irs.gov. [Online] http://www.irs.gov/publications/p946/ch02.html. 187. Section179.org. The Section 179 Deduction. www.section179.org. [Online] http://www.section179.org/. 188. IRS. Self-Employment Tax (Social Security and Medicare Taxes). irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Self-Employment-Tax-(Social-Security-and-Medicare-Taxes). 189. —. Questions and Answers for the Additional Medicare Tax. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Questions-and-Answers-for-the-Additional-Medicare-Tax. 190. —. Publication 17 - Chapter 11 - Social Security and Equivalent Railroad Retirement Benefits. irs.gov. [Online] http://www.irs.gov/publications/p17/ch11.html. 191. —. Publication 575 - Pension and Annuity Income. irs.gov. [Online] http://www.irs.gov/publications/p575/. 192. —. Topic 410 - Pensions and Annuities. irs.gov. [Online] http://www.irs.gov/taxtopics/tc410.html. 193. —. Topic 451 - Individual Retirement Arrangements (IRAs). irs.gov. [Online] http://www.irs.gov/taxtopics/tc451.html. 194. —. Retirement Topic - IRA Contribution Limits. irs.gov. [Online] http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-IRA-Contribution-Limits. 195. —. Instructions for Form 8606 - Nondeductible IRAs. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8606.pdf. 196. —. Publication 590, Chapter 1 - Traditional IRAs. irs.gov. [Online] http://www.irs.gov/publications/p590/ch01.html. 197. —. Retirement Plans FAQs regarding Substantially Equal Periodic Payments. irs.gov. [Online] http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Substantially-Equal-Periodic-Payments. 198. —. Publication 590, Chapter 2 - Roth IRAs. irs.gov. [Online] http://www.irs.gov/publications/p590/ch02.html. 199. —. Designated Roth Accounts - In-Plan Rollovers to Designated Roth Accounts. irs.gov. [Online] http://www.irs.gov/Retirement-Plans/Designated-Roth-Accounts---In-Plan-Rollovers-to-Designated-Roth-Accounts. 200. —. Choosing a Retirement Plan: SIMPLE IRA Plan. irs.gov. [Online] http://www.irs.gov/Retirement-Plans/Choosing-a-Retirement-Plan:-SIMPLE-IRA-Plan. 201. —. Retirement Topics - Catch-Up Contributions. irs.gov. [Online] http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics-Catch-Up-Contributions. 202. —. Publication 575 - Pension and Annuity Income. irs.gov. [Online] http://www.irs.gov/publications/p575/. 203. —. Tax Topic 413 - Rollovers from Retirement Plans. irs.gov. [Online] http://www.irs.gov/taxtopics/tc413.html. 204. —. Publication 560 - Retirement Plans for Small Business. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p560.pdf. 205. —. Retirement Plans - Defiinitions. irs.gov. [Online] http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Definitions. 206. —. Retirement Topics - Required Minimum Distributions (RMDs). irs.gov. [Online] http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics---Required-Minimum-Distributions-(RMDs). 207. —. Publication 525 - Taxable and Nontaxable Income. irs.gov. [Online] http://www.irs.gov/publications/p525/. 208. —. Publication 525 - Accident or Health Plan. irs.gov. [Online] http://www.irs.gov/publications/p525/ar02.html. 209. —. Publication 525 - Other Sickness and Injury Benefits. irs.gov. [Online] http://www.irs.gov/publications/p525/ar02.html. 210. —. Publication 525 - Group-Term Life Insurance. irs.gov. [Online] http://www.irs.gov/publications/p525/ar02.html. 211. Cornell University Law School. 26 CFR 1.101-1 - Exclusion from gross income of proceeds of life insurance contracts payable by reason of death. Legal Information Institute. [Online] http://www.law.cornell.edu/cfr/text/26/1.101-1. 212. IRS. Publication 915 - Social Security and Equivalent Railroad Retirement Benefits. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p915.pdf. 213. —. Publication 950 - Introduction to Estate and Gift Taxes. irs.gov. [Online] http://www.irs.gov/publications/p950/. 214. —. Publication 525 - Welfare and Other Public Assistance Benefits. irs.gov. [Online] http://www.irs.gov/publications/p525/. 215. —. Publication 525 - Scholarships and Fellowships. irs.gov. [Online] http://www.irs.gov/publications/p525/. 216. —. Publication 54 - Tax Guide for U.S. Citizens and Resident Aliens Abroad. irs.gov. [Online] http://www.irs.gov/publications/p54/index.html. 217. —. Publication 17, Chapter 26 - Car Expenses and Other Employee Business Expenses. irs.gov. [Online] http://www.irs.gov/publications/p17/ch26.html. 218. —. Publication 17, Chapter 26 - Car Expenses and Other Employee Business Expenses. irs.gov. [Online] http://www.irs.gov/publications/p17/ch26.html. 219. —. Topic 310 - Coverdell Education Savings Accounts. irs.gov. [Online] http://www.irs.gov/taxtopics/tc310.html. 220. —. Publication 970, Chapter 7 - Coverdell Education Savings Account (ESA). irs.gov. [Online] http://www.irs.gov/publications/p970/ch07.html. 221. —. Topic 313 - Qualified Tuition Programs (QTPs). irs.gov. [Online] http://www.irs.gov/taxtopics/tc313.html. 222. —. Tax Benefits for Education: Information Center. irs.gov. [Online] http://www.irs.gov/uac/Tax-Benefits-for-Education:-Information-Center. 223. —. Publication 970, Chapter 4 - Student Loan Interest Deduction. irs.gov. [Online] http://www.irs.gov/publications/p970/ch04.html. 224. —. Instructions for Form 8889 - Health Savings Accounts (HSAs). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8889.pdf. 225. —. Publication 969 - Health Savings Accounts and Other Tax-Favored Health Plans. irs.gov. [Online] http://www.irs.gov/publications/p969/. 226. —. Instructions for Form 8853 - Archer MSAs and Long-Term Care Insurance Contracts. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8853.pdf. 227. —. Publication 521 - Moving Expenses. irs.gov. [Online] http://www.irs.gov/publications/p521/. 228. Cornell University Law School. 26 CFR 1.123-1 - Exclusion of insurance proceeds for reimbursement of certain living expenses. [Online] http://www.law.cornell.edu/cfr/text/26/1.123-1. 229. IRS. Publication 535, Chapter 6 - Insurance. irs.gov. [Online] http://www.irs.gov/publications/p535/. 230. —. FAQs for government entities regarding Cafeteria Plans. irs.gov. [Online] http://www.irs.gov/Government-Entities/Federal,-State-&-Local-Governments/FAQs-for-government-entities-regarding-Cafeteria-Plans. 231. —. Publication 17, Chapter 13 - Basis of Property. irs.gov. [Online] http://www.irs.gov/publications/p17/ch13.html. 232. —. Publication 525 - Taxable and Nontaxable Income. irs.gov. [Online] http://www.irs.gov/publications/p525/. 233. —. Publication 503 - Child and Dependent Care Expenses. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p503.pdf. 234. —. Publication 17, Chapter 29 - Limit on Itemized Deductions. irs.gov. [Online] http://www.irs.gov/publications/p17/ch29.html. 235. —. Publication 17, Chapter 29 - Limit on Itemized Deductions. irs.gov. [Online] http://www.irs.gov/publications/p17/ch29.html. 236. —. Seven Important Tax Facts about Medical and Dental Expense. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Seven-Important-Tax-Facts-about-Medical-and-Dental-Expenses. 237. —. Publication 502 - Medical and Dental Expenses (Including the Health Coverage Tax Credit). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p502.pdf. 238. —. Topic 502 - Medical and Dental Expenses. irs.gov. [Online] http://www.irs.gov/taxtopics/tc502.html.

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239. —. Publication 17, Chapter 21 - Medical and Dental Expenses. irs.gov. [Online] http://www.irs.gov/publications/p17/ch21.html. 240. —. Publication 17, Chapter 22 - Taxes. irs.gov. [Online] http://www.irs.gov/publications/p17/ch22.html. 241. —. Excise Tax. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Excise-Tax. 242. —. IRS Tax Tip 2013-42 - Seven Tips for Taxpayers with Foreign Income. irs.gov. [Online] http://www.irs.gov/uac/Tax-Tips-for-2013-1. 243. —. Instructions for Form 5329 - Additional Taxes on Qualified Plans (Including IRAs). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i5329.pdf. 244. —. Publication 17 , Chapter 13 - Basis of Property. irs.gov. [Online] http://www.irs.gov/publications/p17/ch13.html. 245. —. Estate Tax. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estate-Tax. 246. —. Gift Tax. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Gift-Tax. 247. —. Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return. irs.gov. [Online] http://www.irs.gov/instructions/i709/. 248. —. Form 4137 - Social Security and Medicare Tax on Unreported Tip Income. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f4137.pdf. 249. —. Form 8814 - Parents' Election To Report Child's Interest and Dividends. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f8814.pdf. 250. —. Net Investment Income Tax FAQs. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs. 251. —. Topic 505 - Interest Expense. irs.gov. [Online] http://www.irs.gov/taxtopics/tc505.html. 252. —. Publication 17, Chapter 23 - Interest Expense. irs.gov. [Online] http://www.irs.gov/publications/p17/ch23.html. 253. —. Form 1098 - Mortgage Interest Statement. irs.gov. [Online] http://www.irs.gov/uac/Form-1098,-Mortgage-Interest-Statement. 254. —. Topic 504 - Home Mortgage Points. irs.gov. [Online] http://www.irs.gov/taxtopics/tc504.html. 255. —. Publication 17, Chapter 23 - Interest Expense. irs.gov. [Online] http://www.irs.gov/publications/p17/ch23.html. 256. —. Publication 17, Chapter 24 - Contributions. irs.gov. [Online] http://www.irs.gov/publications/p17/ch24.html. 257. —. Publication 526 - Charitable Contributions. irs.gob. [Online] http://www.irs.gov/pub/irs-pdf/p526.pdf. 258. —. Publication 547 - Casualties, Disasters, and Thefts. irs.gov. [Online] http://www.irs.gov/publications/p547. 259. —. Publication 17, Chapter 25 - Nonbusiness Casualty and Theft Losses. irs.gov. [Online] http://www.irs.gov/publications/p17/ch25.html. 260. —. Publication 17, Chapter 28 - Miscellaneous Deductions. irs.gov. [Online] 261. —. Publication 529 - Miscellaneous Deductions. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p529.pdf. 262. —. Topic 514 - Employee Business Expenses. irs.gov. [Online] http://www.irs.gov/taxtopics/tc514.html. 263. —. Publication 463 - Travel, Entertainment, Gift, and Car Expenses. irs.gov. [Online] http://www.irs.gov/publications/p463/. 264. —. Topic 511 - Business Travel Expenses. irs.gov. [Online] http://www.irs.gov/taxtopics/tc511.html. 265. —. Publication 17, Chapter 27 - Tax Benefits for Work-Related Education. irs.gov. [Online] http://www.irs.gov/publications/p17/ch27.html. 266. —. Publication 529 - Miscellaneous Deductions. irs.gov. [Online] http://www.irs.gov/publications/p529/. 267. —. Publication 550, Chapter 3 - Investment Expenses. irs.gov. [Online] http://www.irs.gov/publications/p550/ch03.html. 268. Tax Policy Center. Reinstate Personal Exemption Phaseout and Limitation on Itemized Deductions. http://www.taxpolicycenter.org. [Online] http://www.taxpolicycenter.org/taxtopics/2012-Budget-Reinstate-Personal-Exemption-Phaseout-and-Limitation-on-Itemized-Deductions.cfm. 269. IRS. Five Tax Credits that Can Reduce Your Taxes. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Five-Tax-Credits-that-Can-Reduce-Your-Taxes. 270. —. IR-2011-122. irs.gov. [Online] http://www.irs.gov/uac/Starting-Jan.-1:-Tax-Preparers-Need-to-File-Due-Diligence-Checklist-with-All-Earned-Income-Tax-Credit-Claims. 271. —. Instructions for Form 8867. irs.gov. [Online] https://www.irs.gov/pub/irs-pdf/i8867.pdf. 272. —. Instructions for Form 8867 - Paid Preparer's Due Diligence Checklist. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8867.pdf. 273. —. Consequences of Filing EITC Returns Incorrectly. eitc.irs.gov. [Online] http://www.eitc.irs.gov/rptoolkit/dd/consequences/. 274. —. Due Diligence FAQs. eitc.irs.gov. [Online] http://www.eitc.irs.gov/rptoolkit/faqs/duediligence/. 275. —. Topic 601 - Earned Income Tax Credit. irs.gov. [Online] http://www.irs.gov/taxtopics/tc601.html. 276. —. Preview of EITC Income Limits, Maximum Credit Amounts and Tax Law Updates. irs.gov. [Online] https://www.irs.gov/Credits-&-Deductions/Individuals/Earned-Income-Tax-Credit/EITC-Income-Limits-Maximum-Credit-Amounts-Next-Year. 277. —. Publication 596 - Rules If You Have a Qualifying Child. irs.gov. [Online] http://www.irs.gov/publications/p596/ch02.html. 278. —. Publication 596 - Earned Income Tax Credit (EITC) Rule 7. irs.gov. [Online] http://www.irs.gov/publications/p596/ch02.html. 279. —. Ten Things to Know About the Child and Dependent Care Credit. irs.gov. [Online] http://www.irs.gov/uac/Ten-Things-to-Know-About-the-Child-and-Dependent-Care-Credit. 280. —. Publication 503 - Child and Dependent Care Expenses. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p503.pdf. 281. —. Ten Facts about the Child Tax Credit. irs.gov. [Online] http://www.irs.gov/uac/Ten-Facts-about-the-Child-Tax-Credit. 282. —. Publilcation 972 - Child Tax Credit. irs.gov. [Online] http://www.irs.gov/publications/p972/. 283. —. Instructions for Schedule 8812. irs.gov. [Online] http://www.irs.gov/instructions/i1040s8/index.html. 284. —. Form 8812 - Additional Child Tax Credit. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f8812.pdf. 285. —. Publication 970 - Chapter 5 - Student Loan Cancellations and Repayment Assistance. irs.gov. [Online] http://www.irs.gov/publications/p970/ch05.html. 286. —. Publication 970, Chapter 3 - Lifetime Learning Credit. irs.gov. [Online] http://www.irs.gov/publications/p970/ch03.html. 287. —. Publication 970, Chapter 8 - Qualified Tuition Program (QTP). irs.gov. [Online] http://www.irs.gov/publications/p970/ch08.html. 288. —. Affordable Care Act Tax Provisions. irs.gov. [Online] http://www.irs.gov/uac/Affordable-Care-Act-Tax-Provisions. 289. —. Small Business Health Care Tax Credit and the SHOP Marketplace. irs.gov. [Online] https://www.irs.gov/Affordable-Care-Act/Employers/Small-Business-Health-Care-Tax-Credit-and-the-SHOP-Marketplace. 290. —. Topic 607 - Adoption Credit and Adoption Assistance Programs. irs.gov. [Online] http://www.irs.gov/taxtopics/tc607.html. 291. —. Instructions for Form 8839 - Qualified Adoption Expenses. irs. [Online] http://www.irs.gov/pub/irs-pdf/i8839.pdf. 292. —. Publication 524 - Credit for the Elderly or the Disabled. irs.gov. [Online] http://www.irs.gov/publications/p524/ar02.html. 293. —. Form 8880 - Credit for Qualified Retirement Savings Contributions. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f8880.pdf. 294. —. Plan Now to Get Full Benefit of Saver’s Credit; Tax Credit Helps Low- and Moderate-Income Workers Save for Retirement. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Plan-Now-to-Get-Full-Benefit-of-Saver%E2%80%99s-Credit;-Tax-Credit-Helps-Low-and-Moderate-Income-Workers-Save-for-Retirement. 295. —. Publication 514 - Foreign Tax Credit for Individuals. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p514.pdf. 296. —. What Foreign Taxes Qualify For The Foreign Tax Credit? irs.gov. [Online] http://www.irs.gov/Individuals/International-Taxpayers/What-Foreign-Taxes-Qualify-For-The-Foreign-Tax-Credit%3F. 297. —. Instructions for Form 6251. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i6251.pdf. 298. —. Instructions for Form 6251 - Alternative Minimum Tax—Individuals. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i6251.pdf. 299. —. Instructions for Form 8965. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8965.pdf.

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300. —. Indoor Tanning Services Tax Center. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Indoor-Tanning-Services-Tax-Center. 301. —. Medical Loss Ratio (MLR) FAQs. irs.gov. [Online] http://www.irs.gov/uac/Medical-Loss-Ratio-(MLR)-FAQs. 302. —. Publication 969 - Health Savings Accounts and Other Tax-Favored Health Plans. irs.gov. [Online] http://www.irs.gov/publications/p969/. 303. —. Net Investment Income Tax FAQs. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs. 304. —. Medical Device Excise Tax. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Medical-Device-Excise-Tax. 305. —. Medical Device Excise Tax: Frequently Asked Questions. irs.gov. [Online] http://www.irs.gov/uac/Medical-Device-Excise-Tax:-Frequently-Asked-Questions. 306. —. Affordable Care Act Tax Provisions. irs.gov. [Online] http://www.irs.gov/uac/Affordable-Care-Act-Tax-Provisions. 307. —. Frequently Asked Questions: Retiree Drug Subsidy. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Frequently-Asked-Questions:-Retiree-Drug-Subsidy. 308. —. Gift Tax. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Gift-Tax. 309. —. Topic 756 - Employment Taxes for Household Employees. irs.gov. [Online] http://www.irs.gov/taxtopics/tc756.html. 310. —. Voluntary Classification Settlement Program (VCSP). irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Voluntary-Classification-Settlement-Program. 311. —. Failure to File or Pay Penalties: Eight Facts. irs.gov. [Online] http://www.irs.gov/uac/Failure-to-File-or-Pay-Penalties:-Eight-Facts. 312. —. Topic 653 - IRS Notices and Bills, Penalties and Interest Charges. irs.gov. [Online] http://www.irs.gov/taxtopics/tc653.html. 313. —. Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return . irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/f4868.pdf. 314. —. Failure to File or Pay Penalties: Eight Facts. irs.gov. [Online] http://www.irs.gov/uac/Failure-to-File-or-Pay-Penalties:-Eight-Facts. 315. —. Avoiding Penalties and the Tax Gap. irs.gov. [Online] http://www.irs.gov/uac/Avoiding-Penalties-and-the-Tax-Gap. 316. —. Avoiding Penalties and the Tax Gap. irs.gov. [Online] http://www.irs.gov/uac/Avoiding-Penalties-and-the-Tax-Gap. 317. —. Civil and Criminal Penalties - Abusive Tax Schemes. irs.gov. [Online] http://www.irs.gov/uac/Civil-and-Criminal-Penalties---Abusive-Tax-Schemes. 318. —. Abusive Tax Schemes - Criminal Investigation (CI). irs.gov. [Online] http://www.irs.gov/uac/Abusive-Tax-Schemes-Criminal-Investigation-(CI). 319. —. CPA Disbarred for Stealing from Daughter’s Trust Fund. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/CPA-Disbarred-for-Stealing-from-Daughter%E2%80%99s-Trust-Fund. 320. —. Enrolled Agent Disbarred for Stealing a Client’s Tax Payments and Preparing Returns with False Deductions. irs.gov. [Online] http://www.irs.gov/uac/Enrolled-Agent-Disbarred-for-Stealing-a-Client%E2%80%99s-Tax-Payments-and-Preparing-Returns-with-False-Deductions. 321. —. Publication 947 - Practice Before the IRS and Power of Attorney. irs.gov. [Online] http://www.irs.gov/publications/p947/. 322. —. Publication 947 - Practice Before the IRS and Power of Attorney. irs.gov. [Online] http://www.irs.gov/publications/p947/. 323. —. Internal Revenue Manual (IRM) - Part 1. Organization, Finance and Management - Chapter 25. Practice Before the Service - Section 1. Rules Governing Practice Before the IRS. irs.gov. [Online] http://www.irs.gov/irm/part1/irm_01-025-001.html. 324. SEC. Sarbanes-Oxley Act. sec.gov. [Online] https://www.sec.gov/about/laws.shtml#sox2002. 325. IRS. Treasury Department Circular 230. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/pcir230.pdf. 326. U.S. Government Printing Office. Title 26 - INTERNAL REVENUE CODE - Subtitle F - Procedure and Administration - CHAPTER 79 - DEFINITIONS. gpo.gov. [Online] http://www.gpo.gov/fdsys/pkg/USCODE-2011-title26/html/USCODE-2011-title26-subtitleF-chap79-sec7701.htm. 327. IRS. The Office of Professional Responsibility (OPR) at a Glance. irs.gov. [Online] http://www.irs.gov/Tax-Professionals/Enrolled-Agents/The-Office-of-Professional-Responsibility-(OPR)-At-a-Glance-1. 328. AICPA. Become a CPA. aicpa.org. [Online] http://www.aicpa.org/becomeacpa/pages/becomeacpa.aspx. 329. —. AICPA Membership CPE Requirements . aicpa.org. [Online] http://www.aicpa.org/Membership/Requirements/Pages/membership-CPE-requirements.aspx. 330. IRS. FAQs: Enrolled Agent Continuing Education Requirements. irs.gov. [Online] http://www.irs.gov/Tax-Professionals/FAQs:-Enrolled-Agent-Continuing-Education-Requirements. 331. —. PTIN Application/Renewal Assistance. irs.gov. [Online] http://www.irs.gov/Tax-Professionals/Frequently-Asked-Questions:-PTIN-Application-Renewal-Assistance. 332. —. For Tax Pros. irs.gov. [Online] http://www.irs.gov/for-Tax-Pros. 333. —. Circular 230 - Regulations Governing Practice before the Internal Revenue Service. irs.gov. [Online] http://www.irs.gov/pub/irs-utl/pcir230.pdf. 334. —. Overview of Circular 230 Disciplinary Proceedings. irs.gov. [Online] http://www.irs.gov/Tax-Professionals/Enrolled-Agents/Overview-of-Circular-230-Disciplinary-Proceedings. 335. —. Rights and Responsibilities of Practitioners in Circular 230 Disciplinary Cases. irs.gov. [Online] http://www.irs.gov/pub/irs-utl/rightsandresponsibilitiesofpractitioners.pdf. 336. —. Guidance on Restrictions During Suspension or Disbarment from Practice Before the Internal Revenue Service. irs.gov. [Online] http://www.irs.gov/pub/irs-utl/guidance_on_restrictions_during_suspension_or_disbarment.pdf. 337. —. Final Agency Decisions in Disciplinary Cases. irs.gov. [Online] http://www.irs.gov/Tax-Professionals/Enrolled-Agents/Final-Agency-Decisions-in-Disciplinary-Cases. 338. Cornell University Law School. 26 USC § 6060 - Information returns of tax return preparers. law.cornell.edu. [Online] http://www.law.cornell.edu/uscode/text/26/6060. 339. IRS. Instructions for Form 8867 - Paid Preparer's Due Diligence Checklist. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8867.pdf. 340. —. Consequences of Filing EITC Returns Incorrectly. eitc.irs.gov. [Online] http://www.eitc.irs.gov/rptoolkit/dd/consequences/. 341. —. Due Diligence FAQs. eitc.irs.gov. [Online] http://www.eitc.irs.gov/rptoolkit/faqs/duediligence/. 342. —. Summary of Preparer Penalties under Title 26. irs.gov. [Online] http://www.irs.gov/Tax-Professionals/Summary-of-Preparer-Penalties-under-Title-26. 343. —. Understanding IRS Guidance - A Brief Primer. irs.gov. [Online] http://www.irs.gov/uac/Understanding-IRS-Guidance---A-Brief-Primer. 344. —. In 2017, Some Tax Benefits Increase Slightly Due to Inflation Adjustments, Others Are Unchanged. irs.gov. [Online] https://www.irs.gov/uac/newsroom/in-2017-some-tax-benefits-increase-slightly-due-to-inflation-adjustments-others-are-unchanged. 345. —. Standard Mileage Rates. irs.gov. [Online] http://www.irs.gov/uac/2013-Standard-Mileage-Rates-Up-1-Cent-per-Mile-for-Business,-Medical-and-Moving. 346. —. Publication 17, Chapter 29 - Limit on Itemized Deductions. irs.gov. [Online] http://www.irs.gov/publications/p17/ch29.html. 347. —. Instructions for Form 6251. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i6251.pdf. 348. —. IRS Announces Pension Plan Limitations. irs.gov. [Online] https://www.irs.gov/uac/newsroom/irs-announces-2017-pension-plan-limitations-401k-contribution-limit-remains-unchanged-at-18000-for-2017. 349. —. IRS Announces Pension Plan Limitations. irs.gov. [Online] https://www.irs.gov/uac/newsroom/irs-announces-2017-pension-plan-limitations-401k-contribution-limit-remains-unchanged-at-18000-for-2017.

Bibliography

© 2018 Golden State Tax Training Institute, Inc. VII

350. —. Publication 590-B - Distributions from Individual Retirement Arrangements (IRAs). irs.gov. [Online] https://www.irs.gov/publications/p590b/. 351. —. Rollovers of Retirement Plan and IRA Distributions. irs.gov. [Online] http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Rollovers-of-Retirement-Plan-and-IRA-Distributions. 352. —. Designated Roth Accounts - In-Plan Rollovers to Designated Roth Accounts. irs.gov. [Online] August 30, 2013. http://www.irs.gov/Retirement-Plans/Designated-Roth-Accounts---In-Plan-Rollovers-to-Designated-Roth-Accounts. 353. —. Affordable Care Act Tax Provisions. irs.gov. [Online] http://www.irs.gov/uac/Affordable-Care-Act-Tax-Provisions. 354. —. Net Investment Income Tax FAQs. irs.gov. [Online] http://www.irs.gov/uac/Newsroom/Net-Investment-Income-Tax-FAQs. 355. —. Treasury and IRS Announce That All Legal Same-Sex Marriages Will Be Recognized For Federal Tax Purposes; Ruling Provides Certainty, Benefits and Protections Under Federal Tax Law for Same-Sex Married Couples. irs.gov. [Online] https://www.irs.gov/uac/Newsroom/Treasury-and-IRS-Announce-That-All-Legal-Same-Sex-Marriages-Will-Be-Recognized-For-Federal-Tax-Purposes%3B-Ruling-Provides-Certainty,-Benefits-and-Protections-Under-Federal-Tax-Law-for-Same-Sex-Married-Couples. 356. —. Simplified Option for Home Office Deduction. irs.gov. [Online] http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Simplified-Option-for-Home-Office-Deduction. 357. —. Notice 1036 - Early Release Copies of the Percentage Method Tables for Income Tax Withholding. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/n1036.pdf. 358. —. Publication 15-B - Employer's Tax Guide to Fringe Benefits. irs.gov. [Online] http://www.irs.gov/publications/p15b/index.html. 359. Department of Housing and Urban Development. Home Affordable Modification Program. makinghomeaffordable.gov. [Online] http://www.makinghomeaffordable.gov/programs/lower-payments/Pages/hamp.aspx. 360. IRS. Ten Facts about the Child Tax Credit. irs.gov. [Online] http://www.irs.gov/uac/Ten-Facts-about-the-Child-Tax-Credit. 361. —. Publication 503 - Child and Dependent Care Expenses. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p503.pdf. 362. —. Instructions for Form 8867 - Paid Preparer's Due Diligence Checklist. irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/i8867.pdf. 363. —. Topic 456 - Student Loan Interest Deduction. irs.gov. [Online] http://www.irs.gov/taxtopics/tc456.html. 364. —. Tax Benefits for Education: Information Center. irs.gov. [Online] http://www.irs.gov/uac/Tax-Benefits-for-Education:-Information-Center. 365. —. Publication 529 - Miscellaneous Deductions. irs.gov. [Online] http://www.irs.gov/publications/p529/index.html. 366. —. Publication 596 - Earned Income Tax Credit (EITC). irs.gov. [Online] http://www.irs.gov/pub/irs-pdf/p596.pdf. 367. —. Publication 523 - Selling Your Home. irs.gov. [Online] http://www.irs.gov/publications/p523/ar02.html#en_US_2010_publink1000200709. 368. —. Tax Credits Available for Certain Energy-Efficient Home Improvements. irs.gov. [Online] http://www.irs.gov/uac/Tax-Credits-Available-for-Certain-Energy-Efficient-Home-Improvements. 369. —. Understanding Your LTR4868CS Letter. irs.gov. [Online] http://www.irs.gov/Individuals/Understanding-Your-LTR4868CS-Letter. 370. —. Taxpayer Guide to Identity Theft. irs.gov. [Online] http://www.irs.gov/uac/Taxpayer-Guide-to-Identity-Theft. 371. —. ITIN Policy Change Summary. irs.gov. [Online] http://www.irs.gov/Individuals/ITIN-Policy-Change-Summary-for-2013.. 372. —. General ITIN Information. irs.gov. [Online] http://www.irs.gov/Individuals/General-ITIN-Information.

© 2018 Golden State Tax Training Institute, Inc. VIII

Index

$ $200 Property ............................................................................ 10-16

1 12 Month Property .................................................................... 10-16

3 30% Limit Organization ............................................................. 13-16

5 50% Limit Organization ............................................................. 13-16 52-53-Week Tax Year .................................................................... 1-5 529 Plan ....................................................................................... 12-7

6 60-day Rollover ......................................................................... 18-11

A Abandoned Spouse ...................................................................... 3-21 Abusive Foreign Trust Schemes ................................................... 16-4 Abusive Tax Schemes .................................................................. 16-4 Accounting Methods ............................................................ 1-6, 9-37

Accrual Method ............................................................... 1-7, 9-37 Cash Method ................................................................... 1-6, 9-37 Excluded Entities ...................................................................... 1-6

Accounting Periods ........................................................................ 1-4 52-53-week Tax Year ................................................................ 1-5 Calendar Year ........................................................................... 1-5 Fiscal Year ................................................................................. 1-5 Short Tax Year .......................................................................... 1-5

Accuracy ............................................................................. 1-3, 17-18 Negligence ................................................................... 16-3, 17-30 Substantial Understatement ....................................... 16-2, 17-29

Acquired Components ............................................................... 10-16 ACRS (Accelerated Cost Recovery System) .................................. 10-4 Additional Child Tax Credit ........................................................ 14-11 Additional Medicare Tax............................... 8-13, 13-6, 15-14, 18-21 Adjusted Gross Income (AGI) ...................................................... 3-10

Deductions ............................................................................. 3-10 Administrative Law Judge .................................... 17-25, 17-26, 17-28 Adoption Credit .............................................................. 14-20, 18-35

Special Needs Child .............................................................. 14-21 Advance Credit Payments .......................................................... 14-18 Advance Payments ............................................................. 1-7, 18-20 Advance Reimbursement .............................................................. 5-6 Advertisements ......................................................................... 17-20 Advertising .................................................................................... 8-6 Advisory Committees ................................................................ 17-23 Affordable Care Act ... 5-4, 11-1, 14-17, 15-4, 15-6, 15-15, 15-16, 18-

14, 18-16 Affordable Insurance Exchange ...................................... 14-17, 18-15 Alien ............................................................................................... 1-2 Alimony ............................................................ 3-8, 3-10, 5-18, 12-11

Voluntary Payments ............................................................. 12-11 Allocated Tips ................................................................................ 5-9 Alternative Depreciation System (ADS) ....................................... 10-6 Alternative Minimum Tax (AMT) ........................................ 3-11, 15-1

Exemption .............................................................................. 15-1 Exemption Amount ................................................................ 18-7 Exemption for Certain Children .............................................. 15-1 Exemption Phase-out ............................................................. 15-2

Alternative Minimum Taxable Income (AMTI) .................... 15-1, 15-2 Amended Returns ................................................................. 1-27, 2-5 American Health Benefit Exchanges .......................................... 15-15 American Institute of Certified Public Accounts (AICPA) ........... 17-11 American Opportunity Tax Credit (AOTC) ................ 12-6, 14-14, 18-37 American Taxpayer Relief Act . 12-4, 13-30, 15-1, 15-2, 18-33, 18-34,

18-35, 18-36 Announcement ............................................................................. 18-2 Annual Federal Tax Refresher (AFTR) ............................. 17-13, 17-14 Annual Filing Season Program (AFSP) ............................. 17-13, 18-45 Annuities ...................................................................... 3-9, 7-15, 11-3 Annuity Withholding .................................................................... 2-15 Annulment ................................................................................... 3-15 Answer ....................................................................................... 17-26 Appeal

Administrative Decision ........................................................ 17-28 Appellate Authority ................................................................... 17-28 Applicable Financial Statement (AFS) ........................................ 10-15 Applicable Large Employers (ALE) ............ 15-10, 15-11, 18-23, 18-24 Application ................................................................................... 17-9 Assistance to Other Practitioners .............................................. 17-19 Athletic Scholarships .................................................................... 5-14 Attorneys ............................................................................ 17-2, 17-9 Auditing and Attestation (AUD) ................................................. 17-11 Authorized IRS e-file Provider ........................................... 1-13, 18-47 Auto-gratuities ............................................................................... 5-9

B Back Pay ......................................................................................... 3-5 Backup Withholding .................................................................... 2-13 Bank Secrecy Act (BSA) .............................................................. 18-43

E-Filing System .......................................................... 18-43, 18-44 Bargain Purchases ...................................................................... 12-13 Bartering ...................................................................... 5-10, 7-9, 7-16 Basic Housing Allowance (BHA) ................................................... 5-15 Basic Records ............................................................................... 1-18 Basis ............................................................................................... 7-3

Unrecovered Basis ..................................................... 10-13, 18-32 Basis of Inherited Property .......................................................... 10-3 Basis of Property .......................................................................... 10-2 Best Practices ............................................................................. 17-20 Bitcoin .......................................................................... 3-9, 7-9, 18-30 Bonus Depreciation ........................................................ 10-13, 18-32 Bonuses ......................................................................................... 3-5

Index

© 2018 Golden State Tax Training Institute, Inc. IX

Bounced Checks .......................................................................... 16-3 Breach of Trust .......................................................................... 17-23 Built-in Gains Tax ......................................................................... 9-18 Bureau of Fiscal Service (BFS) ............................................. 1-27, 2-10 Business Educational Expenses ................................................. 13-24 Business Environment and Concepts (BEC) ............................... 17-11 Business Travel Expenses .......................................................... 13-21

C Cadillac Tax ................................................................................ 15-10 Cafeteria Plans ......................................................... 5-3, 12-13, 15-12 Calendar Year ................................................................................ 1-5 Canceled Debts ............................................................................ 5-11 Cancelled Home Mortgage Debt ............................................... 13-15 Capital Asset ................................................................................... 7-4 Capital Gain Distributions .............................................................. 6-7 Capital Gain Property ................................................................ 13-16 Capital Gains

Calculation ............................................................................... 7-6 Personal Residences ................................................................. 7-9 Tax ............................................................................................ 7-7

Capital Gains and Losses ................................................................ 7-5 Capital Losses ................................................................................ 7-8

Deduction ................................................................................. 7-7 Capitalization and Repairs ......................................................... 10-14 Capitalized Interest.................................................................... 14-13 Car and Truck Expenses ................................................................. 8-6 Carry-over Basis .............................................................. 13-11, 15-19 Carryover of Non-allowed Expenses to Next Year ....................... 8-12 Casualty and Theft Losses.......................................................... 13-17

Reporting.............................................................................. 13-19 Catch-Up Contributions .................................................... 11-5, 11-12 Censure ..................................................................................... 17-26 Certified Public Accountants (CPA) ................................... 17-2, 17-11 Certifying Acceptance Agents (CAA) .......................................... 18-48 Changes of Address ................................................................... 17-10 Charitable Donations from IRAs ..................................... 11-16, 18-40 Charitable Gifts .......................................................................... 18-41 Charitable Remainder Trusts .......................................... 15-13, 18-20 Child and Dependent Care Credit ..................................... 14-7, 18-34

Amount .................................................................................. 14-8 Child Support .................................................................... 5-18, 12-11 Child Tax Credit .......................................................................... 18-33

Liability Limitations .............................................................. 14-12 Limits .................................................................................... 14-11

Children of Divorced Parents ......................................................... 4-9 Circular 230 ................................................................................. 17-7

Subpart A................................................................................ 17-9 Subpart B .............................................................................. 17-17 Subpart C .............................................................................. 17-23 Subpart D ............................................................................. 17-25 Subpart E .............................................................................. 17-29

Claim for Refund ............................................................................ 2-6 Clark v. Rameker ........................................................................ 18-14 Clergy ........................................................................................... 5-16 Client Omissions ........................................................................ 17-18 Client Records ............................................................................ 17-19 COD Income ............................................................................... 18-30 Combat Pay .................................................................... 12-12, 12-17 Combat Zone Exclusion ............................................................. 12-12

Combat Zone Service ................................................................... 3-25 Commissions .................................................................................. 3-5 Common Law Marriage ............................................................... 3-25 Community Income ............................................................ 3-21, 8-15 Community Property ................................................................... 3-21 Commuter Highway Vehicle ........................................... 12-15, 12-16 Company Car ............................................................................. 12-14 Compensation ................................................................................ 5-2

Company Car ........................................................................ 12-14 Fringe Benefits ...................................................................... 12-15 Prizes and Awards .................................................................... 5-7 Subject to the Tax ..................................................................... 5-2 Unemployment ........................................................................ 5-3

Competence .............................................................................. 17-21 Complaint .................................................................................. 17-25 Compliance ................................................................................ 17-22 Confidentiality Privileges ............................................................. 17-7 Conflict of Interest ..................................................................... 17-20 Consumables ............................................................................. 10-16 Contests ......................................................................................... 5-7 Contingent Fees ......................................................................... 17-19 Continuing Professional Education ...................... 17-11, 17-12, 17-13

Failure to Complete .............................................................. 17-15 Instructors ............................................................................ 17-15 Measurement ....................................................................... 17-15 Recordkeeping ...................................................................... 17-16 Records ................................................................................. 17-12 Requirements ............................................................ 17-11, 17-12 Rules ..................................................................................... 17-13 Self-study Programs ............................................................. 17-13 Waiver .................................................................................. 17-15

Continuing Professional Education Providers ................. 17-13, 17-16 Contract Labor ............................................................................... 8-7 Contributions

Cash ...................................................................................... 13-16 Contribution of a vehicle ...................................................... 13-17 Contribution Percentage Limitations ................................... 13-16 Non-cash charitable contributions ....................................... 13-17 Value of Services .................................................................. 13-17 Written Substantiation Required ......................................... 13-16

Conviction .................................................................................. 17-23 Corporate Preference Items .......................................................... 9-6 Corporations

Alternative Minimum Tax (AMT) .............................................. 9-9 Below-market Loans ................................................................. 9-7 Capital Losses ........................................................................... 9-8 Charitable Contributions .......................................................... 9-7 Closely Held .............................................................................. 9-2 Cost of Goods Sold ................................................................... 9-4 Costs of Going Into Business .................................................... 9-5 Distributions to Shareholders ................................................... 9-9 Dividends-received Deduction ................................................. 9-6 Employee-owners ..................................................................... 9-2 Extraordinary Dividends ........................................................... 9-7 Gross Rents ............................................................................... 9-4 Income ...................................................................................... 9-2 Interest ..................................................................................... 9-4 Net Operating Losses (NOL) ..................................................... 9-8 Personal Services ...................................................................... 9-1 Uniform Capitalization Rules .................................................... 9-5

Cost Basis ..................................................................................... 10-2

Index

© 2018 Golden State Tax Training Institute, Inc. X

Cost of Goods Sold ........................................................................ 8-5 Cost of Labor ................................................................................. 8-5 Court Decisions ............................................................................ 18-1 Coverdell Education Savings Account (CESA) .......... 12-4, 12-6, 18-35

Coordination with Other Education Benefits ......................... 12-6 Distributions ........................................................................... 12-6

Covered Opinions Written Advice ..................................................................... 17-21

Credit Recapture ....................................................................... 14-16 Credits

Adoption Credit ......................................................... 14-20, 18-35 American Opportunity Tax Credit (AOTC) ................. 14-14, 18-37 Child and Dependent Care Credit ................................ 14-7, 18-34 Child Tax Credit ........................................................... 14-9, 18-33 Credit for the Elderly or the Permanently or Totally Disabled . 14-

21 Earned Income Tax Credit (EITC) ................................. 14-2, 18-38 Education Credits ................................................................. 14-16 Foreign Tax Credit ................................................................ 14-24 Health Coverage Tax Credit (HCTC) ........................... 14-19, 18-19 Higher Education Credits ...................................................... 14-12 Hope Scholarship Credit ....................................................... 18-37 Lifetime Learning Credit ............................................ 14-15, 18-37 Mortgage Interest Credit ..................................................... 14-25 Nonbusiness Energy Property Credit (Part II) ............ 14-25, 18-40 Premium Tax Credit ............................... 14-17, 15-5, 15-16, 18-20 Residential Energy Efficient Property Credit (PartI) .. 14-25, 18-40 Retirement Savings Contribution Credit ................... 14-23, 18-38 Small Business Health Care Tax Credit ........... 14-19, 14-20, 18-22 Work Opportunity Tax Credit (WOTC) ................................. 18-40

Crops ................................................................................... 8-18, 13-7

D Damages ...................................................................................... 8-20 Daycares ...................................................................................... 8-11 De Minimis Safe Harbor Election ............................................... 10-14 De minimis Transportation ........................................................ 18-27 Debit or Credit Card ..................................................................... 1-30 Deceased Spousal Unused Exclusion (DSUE) .................. 13-10, 15-18 Decedent Issues ........................................................................... 3-24 Declaration Control Number (DCN) ............................................. 1-15 Deductions

Adjusted Gross Income (AGI) ................................................. 3-10 Alimony ................................................................................ 12-11 Business Education Expenses ............................................... 13-24 Business Taxes ........................................................................ 13-5 Certain Business Expenses of Fee Based Government Officials 12-

4 Certain Business Expenses of Performing Artists ................... 12-4 Contributions ....................................................................... 13-15 Direct Donations of IRAs to Charity ...................................... 13-17 Donation of Vehicles ............................................................ 13-17 Educator Expenses ............................................................... 18-37 Employee Deductions .......................................................... 13-24 Foreign Income Taxes ............................................................ 13-8 Health Savings Accounts ........................................................ 12-8 Home Equity Loan ................................................................ 13-14 Home Office Business Expenses ............................................. 8-10 Home Office Deduction Rule .................................................. 8-10 Individual Retirement Arrangements (IRAs) ........................... 11-4

Interest ................................................................................. 13-13 Investment and Tax Assistance ............................................ 13-24 IRA Phase-out Range .............................................................. 11-5 Job Expenses ........................................................................ 13-20 Job Search Expense .............................................................. 13-24 Limitation of Itemized Deductions (Pease) ........................... 13-30 Meals and Entertainment ..................................................... 13-22 Medical Expenses ............................................. 13-2, 15-15, 18-22 Miscellaneous ............................................................ 13-20, 13-25 Mortgage Interest ................................................................ 13-14 Moving Expenses .................................................................... 12-9 Nondeductible Taxes .............................................................. 13-8 Penalty On Early Withdrawal Of Savings .............................. 12-11 Penalty-Free Withdrawals from IRAs ..................................... 11-9 Qualified Long-term Care ....................................................... 13-3 Real Estate Taxes .................................................................... 13-7 Rental Property ............................................................. 8-19, 9-48 Self-employed Health Insurance .......................................... 12-10 Self-employment Tax ............................................................ 12-10 Standard ................................................................................. 3-11 State, Local and Foreign Income Taxes ................................... 13-6 Student Loan Interest ........................................................... 14-12 Taxes ....................................................................................... 13-4 Teachers’ Classroom Expenses ............................................... 12-4 Transportation Expenses ...................................................... 13-21 Tuition and Fees ............................................. 12-12, 14-13, 18-37 Utilities ................................................................................... 8-11

Deferred Exchange ...................................................................... 7-14 Defined Benefit Plans ....................................................... 9-34, 11-16 Defined Contribution Plans ............................................... 9-34, 11-16 Department of Veterans Affairs (VA) ........................................... 5-15 Depletion ....................................................................................... 8-7 Depreciation

ACRS ....................................................................................... 10-4 Business Use of the Home ...................................................... 8-12 MARCS .................................................................................... 10-4 Methods of ............................................................................. 10-4 Recovery Periods .................................................................... 10-4 Rental Property ...................................................................... 10-8 Straight Line............................................................................ 10-4

Determining and Paying the Tax Checklist ................................................................................. 1-10

Direct Deposit Limits .................................................................. 18-30 Direct Rollovers .............................................................. 11-15, 18-11 Disability Payments ....................................................................... 5-5 Disability Pension ........................................................................... 5-5 Disaster Area Losses .................................................................... 9-44 Disbarment ..................................................................... 17-23, 17-26 Disciplinary Hearings ................................................................. 17-25

Answer.................................................................................. 17-26 Complaint ............................................................................. 17-25 Decision ................................................................................ 17-26 Evidentiary Hearing .............................................................. 17-26

Disciplinary Proceedings ............................................................ 17-24 Disclosure or Use of Information ............................................... 17-35 Disqualification .......................................................................... 17-25 Disreputable Conduct ....................................................... 17-4, 17-23 Distributable Net Income (DNI) ................................................... 9-27 Distributive Share ........................................................................ 5-12 Dividends ..................................................................... 3-6, 6-1, 18-27

Holding Period .......................................................................... 6-3

Index

© 2018 Golden State Tax Training Institute, Inc. XI

Non-dividend Distributions ...................................................... 6-4 Ordinary ................................................................................... 6-2 Ordinary and Qualified ............................................................. 6-2 Qualified ................................................................................... 6-2 Subject to the Tax .................................................................... 6-2

Divorce .................................................................... 3-22, 5-18, 12-11 Document Retention ........................................................ 14-4, 17-33 Documentary Evidence ................................................................. 9-49 Dual Status Aliens ................................................................. 1-2, 3-20 Due Diligence .................................................................... 14-2, 17-31

E Earned Income .............................................................................. 5-1 Earned Income Tax Credit

Age Test .................................................................................. 14-6 Claim ...................................................................................... 14-7 Disqualified income ................................................................ 14-6 Earned Income ....................................................................... 14-6 Filing Requirements ............................................................... 14-6 Identification Test .................................................................. 14-6 Limitations .............................................................................. 14-5 Qualifying Child ...................................................................... 14-6 Residency Test ........................................................................ 14-6 Restrictions ............................................................................ 14-6

e-Commerce Communications .................................................. 17-20 Education Savings Bond Program .................................................. 6-8 e-File ............................................................................ 1-3, 1-12, 1-14

Rejected Electronic Returns ................................................... 1-24 Rules and Requirements ........................................................ 1-14

Elected Farm Income (EFI) ........................................................... 9-45 Electing Small Business Trusts ........................................ 15-13, 18-20 Elective Contribution Limits ...................................................... 18-10 Electronic Federal Tax Payment System (EFTPS) .............. 1-30, 18-50 Electronic Filing Identification Number (EFIN) 1-13, 1-14, 1-15, 18-47 Electronic Funds Withdrawal ....................................................... 1-28 Electronic Return Originator (ERO) ..................................... 1-14, 1-22

Advertising ............................................................................. 1-15 Fees ........................................................................................ 1-15 Recordkeeping and Documentation Requirements ............... 1-16

Electronic Storage Systems ......................................................... 1-17 Eligibility ...................................................................................... 17-9 Employee Achievement Awards .................................................... 5-8 Employee Benefit Programs .......................................................... 8-7 Employee Stock Purchase Plan (ESPP) ........................................... 6-4 Employer Identification Number (EIN) ......................................... 15-23 Employer Shared Responsibility ................................................ 18-23 Employer-provided Child or Dependent Care Services ............. 12-16 Employment Taxes ...................................................................... 1-11 Energy-efficient Commercial Building Property Deduction ........... 9-5 Enrolled Actuaries ....................................................................... 17-3 Enrolled Agents .................................................................. 17-3, 17-9 Enrolled Retirement Plan Agents ................................................ 17-3 Entertainment ........................................................................... 13-22 Equitable Relief .................................................................. 1-20, 3-24 e-Services Account ...................................................................... 1-12 Estate Tax ............................................ 1-10, 9-25, 13-9, 15-17, 18-40 Estates ......................................................................................... 5-13 Estimated Tax Payments .................................................... 2-12, 3-13 Estimated Taxes .................................................................. 1-28, 9-29 Excess Net Passive Income Tax .................................................... 9-19

Exchange of Principal Residence ........................................... 3-6, 7-10 Excise Taxes ............................................................... 1-11, 9-45, 13-8 Excluded Interest ........................................................................... 6-7 Exclusions .................................................................................... 12-1

Adoption Expenses ............................................................... 18-35 Annual Gift Tax ....................................................................... 12-2 Capital Gains Tax on Principal Residences ............................ 18-39 Combat Zone ........................................................................ 12-12 Food and Lodging Provided by Employer ............................. 12-17 Intergovernmental Relations .................................................. 12-3 Living Expense Reimbursements .......................................... 12-10 Related to Age ........................................................................ 12-2 Related to Death .................................................................... 12-2 Related to Education .............................................................. 12-3 Related to Foreign-Earned Income ......................................... 12-3 Related to Illness .................................................................... 12-1

Exclusive Use Test ......................................................................... 8-11 Executor ....................................................................................... 9-28 Exempt Organizations .................................................................. 9-31 Exemption Certificate Number .................................................. 15-17 Exemption from Withholding ...................................................... 2-11 Exemptions

AMT ........................................................................................ 15-1 Expatriate Health Plans .............................................................. 18-28 Expedited Suspension ................................................................ 17-28 Expenses

Gifts ...................................................................................... 13-29 Nondeductible ...................................................................... 13-28 Producing Income ................................................................. 13-27

Extensions ...................................................................................... 2-4 Extraordinary Dividends ................................................................ 9-7

F Failure to File Correct Information ............................................ 17-34 Failure to Furnish Copy to Taxpayer .......................................... 17-34 Failure to Furnish Identifying Number ....................................... 17-34 Failure to Retain Copy or List ..................................................... 17-34 Failure to Sign Return ................................................................ 17-34 False Billing Schemes ................................................................... 16-4 Family Partnership ....................................................................... 9-14 Farm Employment Taxes ............................................................. 9-45 Farm Expenses ............................................................................. 8-19 Farm Inventory ............................................................................ 9-42 Farms ........................................................................................... 9-36

Conservation Expenses ........................................................... 9-40 Crop Shares ............................................................................ 9-39 Depreciation ........................................................................... 9-43 Dispositions of Property ......................................................... 9-41 Elected Farm Income (EFI) ...................................................... 9-45 Farm Employment Taxes ........................................................ 9-45 Inventory ................................................................................ 9-42 Inventory Valuation Methods................................................. 9-43 Livestock ................................................................................. 9-38 Prepaid Farm Supplies ............................................................ 9-40 Rents....................................................................................... 9-39 Sales Caused by Weather-Related Conditions ........................ 9-39 Special Estimated Tax Rules ................................................... 9-46

Federal Insurance Contributions Act (FICA) ........................... 1-11, 13-6 Federal Poverty Guidelines (FPL) .................................... 14-17, 18-15 Federal Tax Legislation ................................................................ 18-3

Index

© 2018 Golden State Tax Training Institute, Inc. XII

Federal Tax Matter .................................................................... 17-21 Federal Unemployment Tax Act (FUTA) .................... 1-12, 13-5, 15-23 Federally Authorized Tax Practitioner ......................................... 17-7 Fees

Contingent Fees ................................................................... 17-19 Practitioner .......................................................................... 17-19

Fellowships .................................................................................. 5-13 Fiduciary ...................................................................................... 9-28 Filing

Extensions ................................................................................ 2-4 Filing Due Dates .................................................................. 1-8, 18-45 Filing Status

Head of Household ........................................................ 2-12, 3-17 Married, filing a joint return ................................................... 3-15 Married, Filing Separately ...................................................... 3-16 Qualifying Widow(er) With Dependent Child......................... 3-16 Single ...................................................................................... 3-14

Financial Accounting and Reporting (FAR) ................................ 17-11 Financial Privacy Rule .................................................................. 1-21 Fiscal Year ...................................................................................... 1-5 Fishing Crew Member ................................................................. 8-14 Fixed Amortization Method .......................................................... 11-8 Fixed Annuitization Method .......................................................... 11-8 Fixing America’s Surface Transportation (FAST) Act ......... 16-5, 17-30 Flexible Spending Accounts (FSA) ................................................ 18-8 Flexible Spending Arrangements ................................................. 18-8 Flow-through Entities .................................................................... 3-8 Foreclosures ................................................................................ 7-16 Foreign Bank and Financial Accounts (FBAR) ............................ 18-42 Foreign Earned Income ................................................................. 5-2 Foreign Earned Income Exclusion ....................................... 12-3, 18-28 Foreign Employer ........................................................................ 5-16 Foreign Housing Exclusion ............................................................ 12-3 Foreign Tax Credit ..................................................................... 14-24 Former Government Employees ............................................... 17-19 Former IRS Employees ............................................................... 17-19 Forms

FinCEN Form 114 - Report of Foreign Bank and Financial Accounts (FBAR) ..................................................... 13-8, 18-43

Form 1023 - Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code ............... 9-30

Form 1023-EZ - Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code .................................................................................. 9-30

Form 1024 - Application for Recognition of Exemption Under Section 501(a) ................................................................... 9-31

Form 1040 ................................................................................ 2-2 Form 1040A .............................................................................. 2-2 Form 1040-C - U.S. Departing Alien Income Tax Return ........ 3-27 Form 1040-ES - Estimated Tax for Individuals . 1-29, 2-12, 3-14, 5-

6, 15-23 Form 1040EZ ............................................................................ 2-1 Form 1040NR ......................................... 2-3, 3-26, 3-27, 5-9, 9-25 Form 1040NR-EZ ............................................. 2-3, 3-26, 3-27, 5-9 Form 1040-PR ........................................................................... 5-9 Form 1040-SS ........................................................................... 5-9 Form 1040V - Payment Voucher ............................................ 1-32 Form 1040X - Amended U.S. Individual Income Tax Return . 1-28,

2-5, 2-17, 7-8, 11-7 Form 1041 - U.S. Income Tax Return for Estates and Trusts .. 5-13 Form 1065 - U.S. Return of Partnership Income3-6, 9-11, 9-12, 9-

23 Form 1065-B - U.S. Return of Income for Electing Large

Partnerships ...................................................................... 9-11 Form 1066 - U.S. Real Estate Mortgage Investment Conduit

(REMIC) Income Tax Return .............................................. 9-11 Form 1094-B - Transmittal of Health Coverage Information

Returns ...................................................... 15-10, 15-11, 18-23 Form 1094-C - Transmittal of Employer-Provided Health

Insurance Offer and Coverage Information Returns 15-10, 15-11, 18-24

Form 1095-A - Health Insurance Marketplace Statement ... 15-16, 18-15

Form 1095-B - Health Coverage ..................... 15-10, 15-11, 18-23 Form 1095-C - Employer-Provided Health Insurance Offer and

Coverage ................................................... 15-10, 15-11, 18-24 Form 1098 - Mortgage Interest Statement .......................... 13-14 Form 1098-C Contributions of Motor Vehicles, Boats, and

Airplanes ......................................................................... 13-17 Form 1098-E - Student Loan Interest Statement .................. 14-13 Form 1099-A - Acquisition or Abandonment of Secured Property

................................................................................. 2-22, 2-23 Form 1099-B - Proceeds From Broker and Barter Exchange

Transactions ............................................................. 2-22, 5-10 Form 1099-C - Cancellation of Debt ..................... 2-22, 2-23, 7-16 Form 1099-DIV - Dividends and Distributions 2-22, 2-24, 6-2, 6-3,

6-11 Form 1099-G - Certain Government Payments .. 2-22, 3-9, 5-4, 5-

12 Form 1099-INT - Interest Income ........................... 2-22, 2-24, 6-5 Form 1099-K - Payment Card and Third Party Network

Transactions ...................................................................... 2-22 Form 1099-MISC - Miscellaneous Income ..................... 2-22, 2-23 Form 1099-OID - Original Issue Discount ............................... 2-22 Form 1099-PATR - Taxable Distributions Received From

Cooperatives ..................................................................... 2-22 Form 1099-Q - Payments From Qualified Education Programs

(Under sections 529 and 530) ........................................... 2-22 Form 1099-R - Distributions From Pensions, Annuities,

Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. ................... 1-16, 2-17, 2-23, 2-24, 11-4, 11-13

Form 1099-S - Proceeds From Real Estate Transactions ........ 13-7 Form 1116 - Foreign Tax Credit ............................................ 14-24 Form 1120 - U.S. Corporation Income Tax Return ... 3-6, 9-2, 9-11,

9-24 Form 1120S - U.S. Income Tax Return for an S Corporation .. 9-19,

9-24 Form 1120X - Amended U.S. Corporation Income Tax Return . 9-8 Form 1125-A - Cost of Goods Sold ............................................ 9-4 Form 1139 - Corporation Application for Tentative Refund ..... 9-8 Form 13711 - Request for Appeal of Offer in Compromise .... 1-33 Form 14039 - Identity Theft Affidavit .......................... 1-22, 18-48 Form 14392 - Continuing Education Waiver Request ........... 17-12 Form 2063 - U.S. Departing Alien Income Tax Statement ...... 3-27 Form 2106 - Employee Business Expenses ....... 12-4, 13-20, 13-21 Form 2106-EZ - Unreimbursed Employee Business Expenses .. 12-

4, 13-20, 13-21 Form 2120 - Multiple Support Declaration ............................... 4-9 Form 2210 - Underpayment of Estimated Tax by ................... 1-30 Form 2210-F - Underpayment of Estimated Tax by Farmers and

Fishermen ................................................................ 1-30, 9-47 Form 23 - Application for Enrollment to Practice Before the

Index

© 2018 Golden State Tax Training Institute, Inc. XIII

Internal Revenue Service ......................................... 17-5, 17-9 Form 2350 - Application for Extension of Time to File U.S.

Income Tax Return for Citizens and Resident Aliens Abroad Who Expect to Qualify for Special Tax Treatment ............ 1-28

Form 23-EP - Application for Enrollment to Practice Before the Internal Revenue Service as an Enrolled Retirement Plan Agent ................................................................................. 17-5

Form 2439 - Notice to Shareholder of Undistributed Long-Term Capital Gains ....................................................................... 7-2

Form 2441 - Child and Dependent Care Expenses ................. 14-9 Form 2553 - Election by a Small Business Corporation 9-17, 9-22,

9-24 Form 2555 - Foreign Earned Income ............................. 12-3, 14-5 Form 2555-EZ - Foreign Earned Income Exclusion ................. 14-5 Form 2587- Application for Special Enrollment Examination . 17-5 Form 2848 - Power of Attorney and Declaration of

Representative ..................................... 17-2, 17-5, 17-6, 17-27 Form 3115 - Application for Change in Accounting Method ... 1-8,

10-16 Form 3520-A - Annual Information Return of Foreign Trust With

a U.S. Owner ..................................................................... 9-26 Form 3800 - General Business Credit ................................... 18-40 Form 3903 - Moving Expenses ............................................... 12-9 Form 4136 - Credit for Federal Tax Paid on Fuels .................. 8-19 Form 4137 - Social Security and Medicare Tax on Unreported Tip

Income .......................................................... 5-9, 13-12, 15-20 Form 433-A (OIC) -Collection Information Statement for Wage

Earners and Self-Employed Individuals ............................. 1-33 Form 433-B (OIC) - Collection Information Statement for

Businesses ......................................................................... 1-33 Form 4562 - Depreciation and Amortization 3-8, 5-18, 8-4, 8-7, 9-

48, 10-6, 10-12, 18-31 Form 4626 - Alternative Minimum Tax - Corporations ............ 9-9 Form 4684 - Casualties and Thefts .......... 7-2, 13-19, 13-25, 13-26 Form 4768 - Application for Extension of Time To File a Return

and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes ............................................................................... 18-42

Form 4797 - Sales of Business Property 3-6, 7-2, 8-19, 8-20, 8-21, 9-37, 9-41, 13-25

Form 4852 - Substitute for Form W-2, Wage and Tax Statement ................................................................................. 1-16, 2-17

Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return .................. 2-4, 3-27, 18-45

Form 4952 - Investment Interest Expense Deduction .......... 13-14 Form 4972 - Tax on Lump-Sum Distributions ....................... 11-13 Form 5329 - Additional Taxes on Qualified Plans (Including IRAs)

and Other Tax-Favored Accounts ........................... 11-17, 13-9 Form 5434 - Application for Enrollment ................................. 17-5 Form 5500 - Annual Return/Report of Employee Benefit Plan .. 1-

24, 8-8 Form 5500-EZ - Annual Return of One-Participant (Owners and

Their Spouses) Retirement Plan .......................................... 8-8 Form 5500-SF - . Short Form Annual Return/Report of Small

Employee Benefit Plan ........................................................ 8-8 Form 56 - Notice Concerning Fiduciary Relationship ........... 17-27 Form 5695 - Residential Energy Credits .................... 14-25, 18-40 Form 5754 - Statement by Person(s) Receiving Gambling

Winnings ......................................................................... 13-26 Form 6251 - Alternative Minimum Tax - Individuals ..... 15-1, 15-3 Form 6252 - Installment Sale Income ............................ 7-12, 7-13 Form 6478 - Alcohol and Cellulosic Biofuel Fuels Credit . 9-4, 9-13

Form 656 - Offer Income Compromise ................................... 1-33 Form 6781 - Gains and Losses From Section 1256 Contracts and

Straddles ............................................................................. 7-2 Form 7004 - Application for Automatic Extension of Time To File

Certain Business Income Tax, Information, and Other Returns .......................................................................................... 9-10

Form 706 - United States Estate (and Generation-Skipping Transfer) Tax Return ................ 1-10, 9-27, 10-3, 13-10, 15-18

Form 709 - United States Gift (and Generation-Skipping Transfer) Tax Return ..................... 13-10, 13-11, 15-18, 15-19

Form 720 - Quarterly Federal Excise Tax Return .................. 15-11 Form 8027 - Employer's Annual Information Return of Tip

Income and Allocated Tips ....................................... 2-19, 5-10 Form 8275 - Disclosure Statement ................... 16-2, 17-29, 17-30 Form 8283 – Noncash Charitable Contributions .................. 13-17 Form 8332 - Release/Revocation of Release of Claim to

Exemption for Child by Custodial Parent .......................... 4-10 Form 8379 - Injured Spouse Allocation ......................... 1-26, 1-27 Form 8396 - Mortgage Interest Credit ...................... 13-14, 14-25 Form 843 - Claim for Refund and Request for Abatement ... 14-25 Form 8453 - U.S. Individual Income Tax Transmittal for an IRS e-

file Return ......................................................................... 1-16 Form 8453-C - U.S. Corporation Income Tax Declaration ....... 1-23 Form 8453-EO - Exempt Organization Declaration and Signature

for Electronic Filing............................................................ 1-23 Form 8453-PE - U.S. Partnership Declaration ......................... 1-23 Form 8508 - Request for Waiver From Filing Information Returns

Electronically ..................................................................... 2-16 Form 8554 - Application for Renewal of Enrollment to Practice

Before the Internal Revenue Service ...................... 17-5, 17-10 Form 8554-EP - Application for Renewal of Enrollment to

Practice Before the Internal Revenue Service as an Enrolled Retirement Plan Agent (ERPA) .......................................... 17-5

Form 8582 - Passive Activity Loss Limitations ............... 5-17, 9-18 Form 8606 - Nondeductible IRAs ................................. 11-7, 18-13 Form 8615 - Tax for Certain Children Who Have Unearned

Income ............................................ 13-12, 15-2, 15-20, 18-26 Form 8621 - Information Return by a Shareholder of a Passive

Foreign Investment Company or Qualified Electing Fund ... 9-5 Form 8633 - Application to Participate in the IRS e-file Program

............................................................................... 1-13, 18-47 Form 8655 - Reporting Agent Authorization .......................... 1-13 Form 8689 - Allocation of Individual Income Tax to the U.S.

Virgin Islands ....................................................................... 2-9 Form 8801 - Credit for Prior Year Minimum Tax - Individuals,

Estates, and Trusts ............................................................ 18-8 Form 8809 - Application for Extension of Time to File

Information Returns .......................................................... 2-17 Form 8814 - Parents' Election To Report Child's Interest and

Dividends .............................................................. 13-12, 15-20 Form 8815 - Exclusion of Interest From Series EE and I U.S.

Savings Bonds Issued After 1989 ................................ 6-9, 12-8 Form 8821 - Tax Information Authorization ....... 17-3, 17-6, 17-28 Form 8824 - Like-Kind Exchanges ............................................. 7-2 Form 8829 - Expenses for Business Use of Your Home . 8-10, 8-12 Form 8832 - Entity Classification Election . 3-6, 5-12, 9-1, 9-23, 9-

24 Form 8839 - Qualified Adoption Expenses ....... 14-2, 14-21, 18-35 Form 8855 - Election To Treat a Qualified Revocable Trust as

Part of an Estate ................................................................ 9-27 Form 8857 - Request for Innocent Spouse Relief . 1-20, 3-15, 3-23

Index

© 2018 Golden State Tax Training Institute, Inc. XIV

Form 8862 - Information to Claim Earned Income Tax Credit after Disallowance ................................................. 14-4, 17-33

Form 8863 - Education Credits .................................... 14-2, 14-16 Form 8864 - Biodiesel and Renewable Diesel Fuels Credit . 9-4, 9-

13 Form 8867 - Paid Preparer’s Due Diligence Checklist .. 14-3, 14-7,

14-10, 14-14, 17-31, 18-39, 18-50 Form 8879 - IRS e-file Signature Authorization ...................... 1-22 Form 8879-C - IRS e-file Signature Authorization for Form 11201-

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

Organization ..................................................................... 1-23 Form 8879-PE - IRS e-file Signature Authorization for Form 1065

.......................................................................................... 1-23 Form 8880 - Credit for Qualified Retirement Savings

Contributions ......................................................... 11-4, 14-24 Form 8885 - Health Coverage Tax Credit .................. 14-18, 18-19 Form 8888 - Allocation of Refund (Including Savings Bond

Purchases) ......................................................................... 1-26 Form 8889 -Health Saving Accounts (HSAs) ........................... 12-8 Form 8919 - Uncollected Social Security and Medicare Tax on

Wages .................................................................. 13-12, 15-20 Form 8925 - Report of Employer-Owned Life Insurance

Contracts ............................................................................. 9-4 Form 8938 - Statement of Specified Foreign Financial Assets . 13-

8, 18-44 Form 8941 - Credit for Small Employer Health Insurance

Premiums ............................................................. 14-20, 18-23 Form 8944 - Preparer e-file Hardship Waiver Request .......... 1-12 Form 8948 - Preparer Explanation for Not Filing Electronically . 1-

25 Form 8949 - Sales and Other Dispositions of Capital Assets 3-6, 7-

1, 7-5, 7-6, 7-9, 9-15 Form 8952 - Application for Voluntary Classification Settlement

Program .......................................................................... 15-23 Form 8958 - Allocation of Tax Amounts Between Certain

Individuals in Community Property States ........................ 3-22 Form 8959 - Additional Medicare Tax .................................... 8-13 Form 8960 - Net Investment Income Tax - Individuals, Estates

and Trusts ............................................................ 15-14, 18-21 Form 8962 - Premium Tax Credit (PTC) .......... 14-18, 15-17, 18-15 Form 8965 - Health Coverage Exemptions .. 15-4, 15-7, 15-17, 18-

14, 18-17, 18-18 Form 90-22.1 ........................................................................ 18-43 Form 940 - Employer's Annual Federal Unemployment (FUTA) 1-

19, 15-23 Form 941 - Employer's QUARTERLY Federal Tax Return . 1-19, 15-

23 Form 943 - Employer's Annual Federal Tax Return for

Agricultural Employees .......................................... 1-19, 15-23 Form 944 - Employer's ANNUAL Federal Tax Return .. 1-19, 15-23 Form 9465 - Installment Agreement Request ............. 1-32, 18-50 Form 982 - Reduction of Tax Attributes Due to Discharge of

Indebtedness .................................................................... 2-23 Form 990 - Return of Organization Exempt From Income Tax ... 1-

23 Form 990-EZ - Short Form Return of Organization Exempt From

Income Tax ........................................................................ 1-24 Form 990-PF - Return of Private Foundation ......................... 1-24 Form 990-T - Exempt Organization Business Income Tax Return

............................................................................... 9-32, 18-23

Form I-551 - Green Card ......................................................... 3-20 Form RRB-1099 - Payments by the Railroad Retirement Board11-

2 Form SS-5 - Application for a Social Security Card .................. 1-20 Form SS-8 - Determination of Worker Status for Purposes of

Federal Employment Taxes and Income Tax Withholding . 8-3, 13-12, 15-20

Form SSA-1099 - Social Security Benefit Statement ..... 2-23, 2-24, 11-2

Form W-12 - IRS Paid Preparer Tax Identification Number (PTIN) Application and Renewal ...................................... 17-17, 18-47

Form W-2 - Wage and Tax Statement ... 2-16, 2-22, 3-12, 5-2, 12-10, 15-11, 15-23

Form W-2C - Corrected Wage and Tax Statement ...... 2-17, 15-11 Form W-2G - Certain Gambling Winnings ..................... 5-8, 13-26 Form W-3 - Transmittal of Wage and Tax Statements 2-22, 15-23 Form W-4 - Employee's Withholding Allowance Certificate .. 2-10,

3-13, 15-15, 15-22, 18-22 Form W-4P - Withholding Certificate for Pension or Annuity

Payments .................................................................. 2-15, 11-4 Form W-4S - Request for Federal Income Tax Withholding From

Sick Pay................................................................................ 5-6 Form W-4V - Voluntary Withholding Request .......................... 5-5 Form W-7 - Application for IRS Individual Taxpayer Identification

Number ................................................................ 18-48, 18-49 Form W-8IMY - Certificate of Foreign Intermediary, Foreign

Flow-Through Entity, or Certain U.S.Branches for United States Tax Withholding ....................................................... 3-8

Form W-9 - Request for Taxpayer Identification Number and Certification .............................................................. 2-14, 2-15

Fraud ............................................................................................ 16-3 Failure to File .......................................................................... 16-3 Joint Return ............................................................................ 16-3 Underpayment ....................................................................... 16-3

Fraudulent Return Guilty of a Felony .................................................................. 17-35 Guilty of a Misdemeanor ...................................................... 17-35

Fringe Benefits .................................................................. 2-16, 12-15 Transportation ...................................................................... 18-27

Frivolous Return ................................................................ 16-3, 17-30 Frivolous Tax Position ................................................................ 17-21 Frozen Deposits ............................................................................. 6-9 Fulbright Grants ........................................................................... 5-14

G Gambling Income ........................................................................... 5-8 Gambling Losses ................................................................. 5-8, 13-26 Gambling Withholding ................................................................. 2-14 General Depreciation System (GDS) ............................................ 10-6 General Provisions ..................................................................... 17-29 General Rule ................................................................................ 11-3 General Welfare Doctrine .......................................................... 18-30 Gift Splitting ............................................................ 12-2, 13-11, 15-19 Gift Tax .............................................. 1-11, 12-2, 13-11, 15-19, 18-40 Government Disability Pensions .................................................... 5-7 Gramm-Leach-Bliley Act .............................................................. 1-21 Grantor Trusts ........................................................ 9-26, 15-13, 18-20 Grants .......................................................................................... 5-13 Green Card ................................................................................... 3-20 Gross Estate ...................................................................... 13-9, 15-17

Index

© 2018 Golden State Tax Training Institute, Inc. XV

Gross Income ............................................................................... 3-10 Adjustments ........................................................................... 3-10

Group-term Life Insurance .......................................................... 12-2 Guaranteed Payments ................................................................. 9-14

H H.R. 4453 - S Corporation Permanent Tax Relief Act of 2014 ...... 9-19 Health Coverage for Older Children .......................................... 15-12 Health Coverage Tax Credit (HCTC) ................................ 14-18, 18-19 Health Flexible Spending Arrangement (FSA) ..................... 5-3, 15-12 Health Savings Accounts ............................................ 12-1, 12-8, 18-8

Contributions ......................................................................... 12-8 Healthcare Marketplace ................................................. 14-18, 18-15 Hearing ...................................................................................... 17-26 High Deductible Health Insurance ............................................... 12-8 Highly Compensated Employee ................................................... 9-36 Hobby Income ............................................................................... 8-3 Holding Periods

Assets ....................................................................................... 7-6 Stock ......................................................................................... 7-7

Hollingsworth v. Perry ................................................................. 3-25 Home Acquisition Debt ............................................................. 13-14 Home Affordable Modification Program (HAMP) ..................... 18-29 Home Equity Loan ..................................................................... 13-14 Home Offices ................................................................................ 8-11

Business Use ........................................................................... 8-10 Daycare .................................................................................. 8-11 Deductions ............................................................................. 8-10 Depreciation ........................................................................... 8-12 Simplified Option ................................................................... 8-12

Hope Scholarship Credit ............................................................ 14-14 Household Employment .................... 1-19, 8-17, 15-21, 15-22, 15-23 HSAs vs. MSAs ............................................................................. 12-8 Husband and Wife Businesses ....................................................... 8-2

I Identity Protection Personal Identification Number (IP PIN) . 1-4, 18-

48 Identity Theft .................................................................... 1-21, 18-47 Illegal Alien .................................................................................... 1-3 Immigrant ...................................................................................... 1-2 In Respect of a Decedent (IRD) .................................................... 9-27 Incentive Stock Option (ISO) .......................................................... 6-4 Incidental Costs ......................................................................... 13-29 Income .................................................................................... 5-1, 8-4

Alimony ........................................................................... 3-8, 5-18 Business.................................................................................... 3-5 Child Support .......................................................................... 5-18 Gambling .................................................................................. 5-8 Gross ...................................................................................... 3-10 Interest .............................................................................. 3-5, 6-5 Property Settlements ............................................................. 5-19 Rental ............................................................ 3-7, 5-17, 8-19, 9-48 Royalties ................................................................................. 5-10 Separation or Divorce ............................................................ 5-18 Social Security ........................................................................ 11-1 Tips ........................................................................................... 5-9 Veterans' Benefits .................................................................. 5-15

Incompetence ............................................................................ 17-23

Individual Income Tax Penalties Accuracy ...................................................................... 16-2, 17-29 Civil Fraud .................................................................... 16-3, 17-30 Failure to File ............................................................... 16-2, 17-30 Failure to Pay ............................................................... 16-2, 17-30 Frivolous Tax Return .................................................... 16-3, 17-30

Individual Retirement Arrangements .......................................... 11-4 Individual Shared Responsibility Payment ................................. 18-17 Individual Shared Responsibility Provision ............ 15-6, 18-16, 18-17

Change in Circumstances ...................................................... 18-17 Health Coverage Exemptions ............................................... 18-17

Individual Taxpayer Identification Number (ITIN) .......................... 1-4 Individual Taxpayer Identification Numbers (ITIN) .................... 18-48 Information Furnished to the IRS .............................................. 17-18 Inherited Property ....................................................................... 10-3 Injured Spouse ............................................................................. 1-20 Innocent Spouse Relief ....................................................... 1-20, 3-23 Installment Agreements ................................................... 1-32, 18-49 Installment Sale Payments ............................................................. 6-7 Installment Sales .......................................................................... 7-12 Institution of Proceeding ........................................................... 17-24 Insurance ....................................................................................... 8-8 Insurance Policies ........................................................................ 7-15 Insurance Premiums .................................................................... 13-3 Interest ......................................................................... 2-6, 6-5, 13-13

Education Savings Bond ............................................................ 6-8 Excluded ................................................................................... 6-7 Income ...................................................................................... 6-5 Subject to the Tax ..................................................................... 6-5

Interest Allocation Rules ................................................................ 8-8 Interest on Insurance Dividends .................................................... 6-6 Internal Revenue Code (IRC) ............................................... 17-1, 18-1 International Business Corporations (IBC) ................................... 16-4 Inventory ....................................................................... 1-8, 8-4, 8-11 Inventory Valuation Methods ...................................................... 9-43 Involuntary Conversions .............................................................. 7-16 IRA Penalty-free Withdrawals

First-time Homebuyer ............................................................ 11-9 Medical Insurance Premiums ................................................. 11-8 Qualified Higher Education ..................................................... 11-9 Qualified Reservist Distributions ............................................ 11-9 Unreimbursed Medical Expenses ........................................... 11-8

IRAs ............................................................................ 6-8, 11-4, 18-10 Annuity ................................................................................... 11-8 Catch-up Contributions ............................................... 11-5, 11-12 Contribution Limits ...................................................... 11-5, 18-13 Contributions ........................................................................ 18-10 Contributions Age ................................................................... 11-5 Early Distributions .................................................................. 11-7 Inherited IRAs Not Excludable In Bankruptcy ....................... 18-14 Lump-sum Distributions ....................................................... 11-13 One-Rollover-Per-Year Rule ....................................... 11-14, 18-12 Phase-out Range ..................................................................... 11-5 Required Minimum Distributions (RMD) .............................. 11-17 Rollovers .................................................................... 11-11, 11-13 Roth IRA ................................................................................ 11-10

IRS Direct Pay ............................................................................. 18-49 IRS Letters .................................................................................... 1-33 IRS Notices ................................................................................... 1-33 Itemized Deductions .................................................................... 13-1

Medical Expenses ...................................................... 15-15, 18-22

Index

© 2018 Golden State Tax Training Institute, Inc. XVI

Phase-out ............................................................................... 18-6

J Joint and Several Liability ............................................................ 1-20

K Kay Bailey Hutchison Spousal IRA Limit ....................................... 11-6 Kickbacks ..................................................................................... 8-20 Kiddie Tax ............................................................ 13-12, 15-20, 18-26 Knowing or Reckless Disclosure ................................................. 17-35

L Large Employer Health Coverage Excise Tax .................... 15-9, 18-23 Lawful Permanent Resident ........................................................ 3-20 Leave and Earning Statements .................................................... 1-16 Legal Analysis Branch .................................................................. 17-8 Legal and Professional Services ..................................................... 8-8 Life Insurance Proceeds ........................................... 5-11, 13-9, 15-18 Lifetime Learning Credit .......................................... 12-6, 14-15, 18-37

Limitations ............................................................................ 14-15 Like-kind Exchanges ..................................................................... 7-13

Deferred Exchange ................................................................. 7-14 Like-kind Properties ............................................................... 7-14 Qualifying Property ................................................................ 7-13 Section 1031 Exchange........................................................... 7-14

Limited Liability Company (LLC) ................................................... 9-22 Classifications ......................................................................... 9-23 Classified as Corporations ...................................................... 9-24 Classified as Disregarded Entities ........................................... 9-23 Classified as Partnerships ....................................................... 9-23 Effective Date of Election ....................................................... 9-24 Subsequent Elections ............................................................. 9-25

Limited Practice ................................................................ 17-5, 17-17 Line of Credit Loan ..................................................................... 13-14 Listed Transactions .................................................................... 17-34 Livestock ............................................................................. 8-18, 9-38 Loan ............................................................................................... 5-6 Loan Origination Fee ................................................................. 14-12 Lock-in-Letter .............................................................................. 2-10 Lodging ...................................................................................... 12-17 Long-term Asset ..................................................................... 7-5, 7-7 Long-term Gains ........................................................................ 18-27 Long-term Loss .............................................................................. 7-8 Lost Income Payments ................................................................ 8-20 Low Income Certification .............................................................. 1-33

M MACRS (Modified Accelerated Cost Recovery System) ............... 10-4

Depreciation ......................................................................... 10-10 Recovery Periods .................................................................... 10-4

Mandatory Contributions ............................................................ 13-6 Marketed Opinions .................................................................... 17-22 Married Dependents ..................................................................... 4-8 Materials and Supplies .................................................................. 8-5 Materials and Supplies Costs ..................................................... 10-16 Meals .............................................................................. 12-17, 13-22 Medical Care ................................................................................ 13-3

Medical Device Excise Tax .............................................. 15-15, 18-22 Medical Expenses ........................................................................ 13-3 Medical Loss Ratio (MLR) ........................................................... 15-12 Medical Pensions ......................................................................... 12-1 Medicare Part D Coverage Gap Rebate ..................................... 15-15 Military Disability Pensions ............................................................ 5-7 Military Personnel ....................................................................... 5-16 Minimum Essential Coverage ...................................................... 15-5 Minimum Income Requirements ................................................... 3-4 Minimum Value Standards .......................................................... 15-8 Miscellaneous Itemized Deductions .......................................... 13-20 Misconduct ....................................................................... 17-8, 17-25 Money Market Funds .................................................................... 6-7 Money Purchase Pension plans ................................................... 9-34 Mortgage ................................................................................... 13-14 Mortgage Credit Certificate (MCC) ............................................ 14-25 Mortgage Insurance Premiums ................................................. 13-15 Mortgage Interest ...................................................................... 13-14 Moving Expenses ................................................................ 3-10, 12-9

Automobile ............................................................................. 12-9 Nondeductible Expenses ........................................................ 12-9 Reimbursement .................................................................... 12-10 Time Test ................................................................................ 12-9

Multiple-support Agreements ....................................................... 4-8 Municipal Bonds ............................................................................ 6-8 Mutual Funds ................................................................................. 7-6

N Name Change .............................................................................. 1-20 Nationality ..................................................................................... 1-1 Natural Resources ........................................................................ 13-7 Negotiation of Taxpayer Checks ..................................... 17-20, 17-34 Net Capital Gain ............................................................................. 7-7 Net Investment Income Tax (NIIT) ................ 1-29, 13-13, 15-13, 18-20 Net Tax Liability ........................................................................... 3-11 Net Taxable Income ..................................................................... 3-11 Netting Process ............................................................................... 7-6 No-Additional-Cost Services ...................................................... 12-15 Nonbusiness Bad Debt ................................................................... 7-8 Nondeductible IRAs ..................................................................... 11-6 Nondividend Distributions ............................................................. 6-4 Non-elective Contribution Formula ........................................... 11-12 Nonimmigrant Visa ........................................................................ 1-3 Non-qualified Dividends ................................................................ 6-2 Nonrefundable Tax Credits .......................................................... 14-1 Nonresident Alien ...................................................... 2-12, 3-19, 3-26 Nonstatutory Stock Option ............................................................ 6-4 Notary Public .................................................................... 8-14, 17-19 Notice 2011-2 ............................................................................ 15-16 Notices ......................................................................................... 18-2

O Obergefell v. Hodges ................................................................... 3-25 Offer in Compromise ................................................................... 1-32 Office Expense ............................................................................... 8-8 Office of Professional Responsibility ....................... 17-1, 17-8, 17-25 Old-age, Survivors, and Disability Insurance Benefits (OASDI) ........ 1-12 Omnibus Budget Reconciliation Act ............................................... 12-2 Operations Management Branch ................................................ 17-8

Index

© 2018 Golden State Tax Training Institute, Inc. XVII

Ordinary Dividends ........................................................................ 6-2 Schedule B ................................................................................ 6-2

Other Employee Compensation ................................................ 12-13 Overpayment ............................................................................... 1-27

P Paid Preparer’s Due Diligence Checklist ......................... 17-31, 18-50 Partial Rollovers ......................................................................... 11-15 Partnership Interests ................................................................... 7-15 Partnerships ....................................................................... 5-12, 9-11

Bad Debts ............................................................................... 9-15 Deductions ............................................................................. 9-13 Distributions ........................................................................... 9-15 Family ..................................................................................... 9-14 Other Income ......................................................................... 9-13 Passive Activity Limitations .................................................... 9-12 Repairs and Maintenance ...................................................... 9-15 Self-employed Health Insurance Premiums ........................... 9-15 Taxes and Licenses ................................................................. 9-15

Passive Activities ......................................................................... 9-18 Passive Income ............................................................................ 5-16 Patient Protection and Affordable Care Act ................................ 11-1 Payment Voucher ......................................................................... 1-32 Pease Limitations ............................................................. 13-30, 18-7 Pell Grants ................................................................................... 5-15 Penalties ............................................................................... 2-6, 16-1

Accuracy ...................................................................... 16-2, 17-29 Combination ........................................................................... 16-2 Failure to File ........................................................................... 16-1 Fraud ...................................................................................... 16-3 Frivolous Return ..................................................................... 16-3 Late Payment ......................................................................... 16-1

Penalty for Underpayment .......................................................... 1-29 Penalty-free Withdrawals from IRAs ........................................... 11-7 Pension and Profit Sharing Plans ................................................... 8-8 Pension Plan Limitations ........................................................... 18-10

Contribution Limits ............................................................... 18-13 Pension Withholding ................................................................... 2-15 Pensions .................................................................... 3-9, 11-3, 11-16 Period of Limitations ................................................................... 1-19 Perjury ......................................................................................... 1-22 Personal Exemption .............................................................. 4-4, 18-7

Amount of Deduction ............................................................... 4-4 Citizen or Resident Test ............................................................ 4-7 Dependent ............................................................................... 4-5 Support Test ............................................................................. 4-7

Personal Service Corporation ........................................................ 9-1 Personal Services ........................................................................... 9-2 Personal Use of Company Car ................................................... 12-14 Petition For Reinstatement ....................................................... 17-28 Points ......................................................................................... 13-13 Portability .................................................................................. 18-42 Power of Attorney ....................................................................... 17-6 Practice Before the Department ................................................. 17-6 Practice Before the IRS ................................................................ 17-2 Practice of Law .......................................................................... 17-20 Practitioner ................................................................................ 17-24 Premium Tax Credit ........................................................ 14-17, 18-15 Prepaid Farm Supplies ................................................................. 9-40 Prepaid Insurance Premiums ......................................................... 6-6

Preparer Tax Identification Number (PTIN) . 1-4, 17-10, 17-17, 18-47 Presidential Election Campaign Fund ................................. 1-34, 3-14 Principal Place of Business

Home Offices ........................................................................... 8-11 Part of Your Home Used for Business ..................................... 8-11 Separate Building ................................................................... 8-11

Principal Residences .................................................................. 18-39 Private Letter Ruling (PLR) ........................................................... 18-2 Prizes and Awards .......................................................................... 5-7 Produce ........................................................................................ 8-18 Product Samples .......................................................................... 8-11 Profit or Loss From Business .......................................................... 8-4 Profit-sharing Plans ...................................................................... 9-34 Prohibited Transactions ............................................................... 9-35 Promissory Notes ......................................................................... 8-20 Prompt Disposition .................................................................... 17-19 Proof of Payment ......................................................................... 1-18 Property Inherited During 2010 ................................................... 10-4 Property Settlements ........................................................ 5-19, 12-12 Property Tax ................................................................................. 1-11 Protecting Americans from Tax Hikes Act of 2015 (PATH) .... 5-11, 11-

16, 12-4, 13-6, 13-17, 14-5, 14-9, 14-10, 14-14, 17-34, 18-45 Public Company Accounting Oversight Board (PCAOB) ............... 17-7 Publication 17

Chapter 10 - Retirement Plans, Pensions, and Annuities ......... 3-9 Chapter 15 - Selling Your Home ................................................ 3-6 Chapter 18 - Alimony ................................................................ 3-9 Chapter 2 - Filing Status .......................................................... 3-14 Chapter 20 - Standard Deduction ............................................. 4-1 Chapter 3 - Personal Exemptions and Dependents .................. 4-4 Chapter 4 - Tax Withholding and Estimated Tax ........... 3-13, 3-14 Chapter 7 - Interest Income ..................................................... 3-5 Chapter 8 - Dividends and Other Distributions......................... 3-7 Part Six - Figuring Your Taxes and Credits .............................. 3-12

Publications Publication 1345 - Handbook for Authorized IRS e-file Providers

of Individual Income Tax Returns ...................................... 1-14 Publication 1346 - Electronic Return File Specifications for

Individual Income Tax Returns .......................................... 1-22 Publication 15 - (Circular E) - Employer's Tax Guide .... 2-13, 15-22 Publication 216 - Conference and Practice Requirements ... 17-27 Publication 225 - Farmer's Tax Guide ..................................... 9-36 Publication 334 - Tax Guide for Small Business ...................... 8-16 Publication 3402 - Taxation of Limited Liability Companies ..... 9-1 Publication 4557 - Safeguarding Taxpayer Data ..................... 1-21 Publication 4591- Small Business Federal Tax Responsibilities .. 1-

20 Publication 4600 - Safeguarding Taxpayer Information ......... 1-21 Publication 463 - Travel, Entertainment, Gift and Car Expenses 8-

9, 13-29 Publication 4895 - Tax Treatment of Property Acquired From a

Decedent Dying in 2010 ............................................... 3-6, 7-6 Publication 501 - Exemptions, Standard Deduction and Filing

Information ....................................................... 2-12, 4-5, 14-2 Publication 502 - Medical and Dental Expenses ..................... 13-3 Publication 503 - Child and Dependent Care Expenses 3-16, 14-2,

14-8 Publication 505 - Tax Withholding and Estimated Tax ........... 2-12 Publication 5093 - Healthcare Law Online Resources .......... 15-16 Publication 519 - U.S. Tax Guide for Aliens .............................. 1-2 Publication 523 - Selling Your Home .................................... 18-39

Index

© 2018 Golden State Tax Training Institute, Inc. XVIII

Publication 527 - Residential Rental Property ................. 3-8, 5-18 Publication 534 - Depreciating Property Placed in Service Before

1987 .................................................................................. 8-12 Publication 535 - Business Expenses. ....................................... 8-7 Publication 54 - Tax Guide for U.S. Citizens and Resident Aliens

Abroad .............................................................................. 13-9 Publication 550 - Investment Income and Expenses ....... 7-5, 10-2 Publication 551 - Basis of Assets ............................................ 10-2 Publication 556 - Examination of Returns, Appeal Rights, and

Claims for Refund .............................................................. 1-27 Publication 560 - Retirement Plans for Small Business ............ 8-9 Publication 587 - Business Use of Your Home ........................ 8-12 Publication 590 - Individual Retirement Arrangements (IRAs) . 11-

4, 14-2 Publication 590-B - Distributions from Individual Retirement

Arrangements (IRAs) ....................................................... 18-12 Publication 594 - The IRS Collection Process .......................... 1-34 Publication 596 - Earned Income Tax Credit (EITC) 14-2, 14-5, 14-

6, 18-39 Publication 926 - Household Employer's Tax Guide .... 14-8, 15-22 Publication 946 - How To Depreciate Property ............... 8-7, 8-12 Publication 970 - Tax Benefits for Education .............. 14-2, 14-12 Publication 971 - Innocent Spouse Relief ...................... 3-15, 3-24 Publication 972 - Child Tax Credit .................... 14-2, 14-10, 18-34

Punitive Damages ........................................................................ 8-20

Q Qualified Charitable Contributions (QCD) ...................... 11-16, 18-40 Qualified Dividends ....................................................................... 6-2 Qualified Dividends and Capital Gain Tax Worksheet ................... 7-7 Qualified Joint Ventures ................................................................ 8-2 Qualified Long-term Care Insurance Premiums ........................ 18-27 Qualified Moving Expense Reimbursement ................................. 12-15 Qualified Nonprofit Health Insurance Issuers ........................... 15-15 Qualified Physical Fitness Facilities ........................................... 15-11 Qualified Plans ............................................................................. 9-33 Qualified Principal Residence Indebtedness ............................... 5-11 Qualified Refinery Property ........................................................... 9-5 Qualified Rent-to-Own Property ................................................. 10-6 Qualified Reservist Repayments ................................................ 18-12 Qualified Retirement Plans ............................................... 11-16, 13-9 Qualified Revocable Trust (QRT) ................................................. 9-27 Qualified Tuition Program (QTP) ................................................. 12-7 Qualified Tuition Reduction ......................................................... 5-15 Qualifying Child ....................................... 3-18, 4-5, 4-10, 14-6, 14-11 Qualifying Relative ................................................................ 3-18, 4-6 Qualifying Shipping Activities ........................................................ 9-5

R Real Estate Investment Trusts (REITs) ........................................... 6-7 Real Estate Taxes

Not Deductible ....................................................................... 13-7 Real Property ............................................................................... 10-2 Reasonable Cause ...................................................... 2-4, 16-2, 17-24 Receipt of Information .............................................................. 17-24 Recharacterize .............................................................................. 11-7 Record of Completion..................................................... 17-13, 17-14 Recordkeeping ........................................................... 1-16, 1-17, 11-7

Documentation Requirements ............................................... 1-16

Records Public Inspection .................................................................. 17-29

Recovery ............................................................................. 5-11, 8-20 Reduced Refund .......................................................................... 2-10 Refund ......................................................................................... 1-26

Filing a Claim ............................................................................. 2-6 Refund Anticipation Loan (RAL) ................................................... 1-14 Refund Offsets ............................................................................. 1-27 Refundable Tax Credits ................................................................ 14-1 Refunds ...................................................................................... 18-44 Regulation (REG) ........................................................................ 17-11 Rejected Electronic Return .......................................................... 1-24 Relationship to the Taxpayer ....................................................... 17-5 Reliance Opinions ...................................................................... 17-22 Renewal ..................................................................................... 17-10 Rent ..................................................................................... 8-19, 9-48 Rental Expenses and Improvements............................................ 8-19 Rental Income ..................................................................... 5-17, 9-47 Rental Property ............................................................................ 10-8 Rentals

Improvements ............................................................... 8-19, 9-48 Income ........................................................... 3-7, 5-17, 8-19, 9-48 Repair ............................................................................ 8-19, 9-48

Repayment Assistance ............................................................... 14-13 Repayments ................................................................................. 5-12 Reporting Agent Authorization .................................................... 1-13 Repossessions .............................................................................. 7-16 Representing Oneself ................................................................ 17-17 Required Minimum Distribution Method ...................................... 11-8 Required Minimum Distributions (RMD) ................................... 11-17 Reserve Component ..................................................................... 11-9 Residential Energy Credits .............................................. 14-25, 18-40 Residential Telephone ................................................................. 8-11 Restricted Property ...................................................................... 8-19 Restrictions .................................................................................. 17-4 Retiree Drug Subsidies ............................................................... 15-16 Return of Client’s Records ......................................................... 17-19 Return Preparation .................................................................... 17-17 Return Preparer Office (RPO) ............................................. 17-1, 17-5 Returns and Allowances ................................................................ 8-5 Revenue Procedure ...................................................................... 18-2 Revenue Procedure 2007-40 - e-file Providers of Individual Income

Tax Returns ............................................................................. 1-14 Revenue Procedure 2009-20 ..................................................... 13-26 Revenue Procedure 2011-26 .......................................... 10-13, 18-33 Revenue Procedure 2011-58 ..................................................... 13-26 Revenue Ruling 2009-9 .............................................................. 13-26 Revenue Ruling 2013-17 .............................................................. 3-25 Revenue Rulings ................................................................. 17-1, 18-1 Rollovers .................................................................................... 18-10 Roth IRAs ........................................................................ 11-10, 18-13 Royalties ...................................................................................... 5-10 Rules for Tax Preparers ................................................................ 17-7

S S Corporations .................................................................... 5-13, 9-17

Built-in Gains Tax .................................................................... 9-18 Compensation ........................................................................ 9-19 Distributions ........................................................................... 9-18 Excess Net Passive Income Tax ............................................... 9-19

Index

© 2018 Golden State Tax Training Institute, Inc. XIX

Returns ................................................................................... 9-19 Stock and Debt Basis Shareholder Loss Limitations ............... 9-20 Taxes ...................................................................................... 9-18 Termination of Election .......................................................... 9-22

Safe Harbor Accounting Method .................................... 10-13, 18-33 Safe Harbor Checklist .................................................................. 15-9 Safe Harbor Rule .......................................................................... 7-11 Safeguards Rule ........................................................................... 1-21 Sale of Principal Residence ................................................... 3-6, 7-10 Sales Tax ........................................................................... 1-11, 18-39 Sales Tax Deduction Calculator ................................................... 13-7 Same-sex Married Couples ............................................... 3-25, 18-24 Sanctionable Acts ...................................................................... 17-31 Sanctions for Violation of the Regulations ................................ 17-23 Sarbanes-Oxley Act of 2002......................................................... 17-7 Saver’s Credit .................................................................. 14-23, 18-38 Saving Provision ......................................................................... 17-29 Savings Incentive Match Plans (SIMPLE) ..................................... 9-33 Schedule A Deductions ................................................................ 13-1 Schedules

Schedule 8812 - Child Tax Credit ........... 14-2, 14-11, 14-12, 18-33 Schedule A .. 5-8, 8-4, 11-8, 12-4, 13-1, 13-4, 13-20, 13-26, 13-27,

14-24, 18-7, 18-27 Schedule B - Interest and Ordinary Dividends .......... 2-2, 6-3, 13-8 Schedule C .................... 3-6, 5-9, 5-10, 8-4, 8-12, 8-13, 8-18, 9-23 Schedule C-EZ ........................................... 3-6, 5-9, 5-10, 8-4, 9-23 Schedule D - Capital Gains and Losses . 3-6, 7-1, 7-2, 7-3, 7-5, 7-6,

7-7 Schedule E - Supplemental Income and Loss .. 5-10, 5-17, 8-15, 8-

19, 9-23, 9-39, 9-48 Schedule EITC - Earned Income Tax Credit ............................. 14-7 Schedule F - Profit or Loss From Farming ... 8-18, 9-23, 9-36, 9-38,

9-42 Schedule H - Household Employment Taxes . 1-19, 2-22, 8-18, 15-

23 Schedule J - Income Averaging for Farmers and Fishermen 9-4, 9-

45 Schedule K-1 (Form 1041) - Beneficiary’s Share of Income,

Deductions, Credits, etc .................................................... 5-13 Schedule K-1 (Form 1065) - Partner's Share of Income,

Deductions, Credits, etc. ................................................... 9-15 Schedule K-1 (Form 1120S) - Shareholder’s Share of Income,

Deductions, Credits, etc. ................................................... 9-18 Schedule K-1- Beneficiary’s Share of Income, Deductions,

Credits, etc ............................................................. 8-15, 13-26 Schedule R - Credit for the Elderly/Disabled ........................ 14-21 Schedule SE ..................................................................... 2-3, 8-13

Scholarships ................................................................................. 5-13 Second Mortgage ...................................................................... 13-14 Secretary of the Treasury ...................................... 17-6, 17-23, 17-28 Section 1231 Transactions ........................................................... 9-41 Section 1245 Property ................................................................. 9-41 Section 179 Election .................................................................. 10-10

Deduction Limits ....................................................... 10-12, 18-31 Property ............................................................................... 10-10 Selection ............................................................................... 10-10

Self-employment Tax ............................................... 1-11, 8-13, 12-10 Separation .......................................................................... 3-22, 5-18 Separation of Liability Relief ............................................... 1-20, 3-23 SEP-IRA Deduction ..................................................................... 11-15 Series E Bonds ............................................................................... 6-5

Series EE Bonds .............................................................................. 6-5 Series H Bonds ............................................................................... 6-5 Series HH Bonds ............................................................................. 6-5 Series I Bonds ................................................................................. 6-6 Service Academy Cadets .............................................................. 5-15 Short Sales ................................................................................... 7-16 Short Tax Year ................................................................................ 1-5 Short-term Asset ..................................................................... 7-5, 7-6 Short-term Loss ............................................................................. 7-8 Sick Pay .......................................................................................... 5-6 Sickness and Injury Benefits .......................................................... 5-5 Simple Cafeteria Plans ............................................................... 15-12 SIMPLE IRA ................................................................................. 11-11 Simplified Employee Pension Plans (SEP) ......................... 9-32, 11-15 Simplified Method ....................................................................... 11-3 Simplified Option for Home Office Deduction .................. 8-12, 18-25 Sin Tax .......................................................................................... 1-11 Small Business Health Care Tax Credit ............................ 14-19, 18-22 Small Business Health Options Program (SHOP) ........................ 14-20 Social Security

Joint Return ............................................................................ 11-2 Repayments ............................................................................ 11-2 Taxation .................................................................................. 11-1

Social Security and Medicare Taxes .................................. 11-1, 18-26 Social Security Benefits ................................................................ 12-2

Maximum Taxable Part ........................................................... 11-1 Social Security Benefits Worksheet ............................................. 11-2 Social Security Equivalent Benefit (SSEB) .................................... 11-1 Social Security Number .................................................................. 1-4

Ex-spouse ............................................................................... 5-19 Sole Proprietors .............................................................. 8-1, 8-4, 8-13 Solicitation ................................................................................. 17-20 Special Enrollment Examination (SEE) ......................................... 17-9 Spousal IRA .................................................................................. 11-5 Spousal Support ........................................................................... 5-18 Standard Deduction .............................................................. 3-11, 4-1

Dependents of Other Taxpayers ............................................... 4-3 Elderly and/or Blind Taxpayers ........................................ 4-1, 18-6 Eligibility ................................................................................... 4-2

Standard Mileage Rates ............................................................... 18-5 State Tax Liability ......................................................................... 2-10 Statement on Standards for Continuing Professional Education

(CPE) Programs ..................................................................... 17-12 Statute of Limitations .................................................................. 1-13 Statutory Stock Option .................................................................. 6-4 Stock Dividends.............................................................. 3-7, 6-1, 9-10 Stock Options ................................................................... 3-7, 6-1, 6-4 Stock Rights ............................................................................ 3-7, 6-1 Stock Spilt ...................................................................................... 6-3 Student Loan Cancellations ....................................................... 14-13 Student Loan Interest Deduction ...................................... 3-10, 18-36 Substantial Gainful Activity .......................................................... 14-23 Suitability Checks ......................................................................... 17-9 Summary of Benefits and Coverage ............................................. 15-9 Supplies ......................................................................................... 8-9 Suspension ................................................................................. 17-26

T Tangible Property ......................................................................... 10-4 Tangible Property Regulations ................................................... 10-14

Index

© 2018 Golden State Tax Training Institute, Inc. XX

Tax Computation Worksheet ................................................ 1-10, 2-4 Tax Credits ................................................................................... 3-12 Tax Exempt Bonds ......................................................................... 6-8 Tax Exempt Organizations ........................................................... 9-30 Tax Home .................................................................................. 13-21 Tax Payments .............................................................................. 3-12 Tax Rates .............................................................................. 3-2, 18-3 Tax Return Preparer Penalties ................................................... 17-31

Aiding or Abetting ................................................................ 17-35 Failure to File Correct Information ....................................... 17-34 Failure to Follow Procedures................................................ 17-34 False or Fraudulent Return................................................... 17-35 Knowing or Reckless Disclosure ........................................... 17-35 Negotiation of Taxpayer Checks ........................................... 17-34 Promoting Abusive Tax Shelters ........................................... 17-34 Unauthorized Disclosure or Use of Information .................. 17-35 Understatement of Taxpayer’s Liability ............................... 17-34

Tax Returns and Documents Standards ..................................... 17-21 Tax Table ........................................................................................ 2-4 Tax Treaties ................................................................................... 1-2 Tax Withholding ...................................................... 2-10, 3-13, 15-22 Taxable Estate ................................................................ 13-10, 15-18 Taxable Medical Device ............................................................. 15-15 Taxes

Employment ........................................................................... 1-11 Foreign Income ...................................................................... 13-8 Household Employment ....................................................... 15-21 Maximum Capital Gain Rates ................................................... 7-7 Qualified Retirement Plan ...................................................... 13-9 Self-employment ............................................................. 2-3, 8-13

Taxpayer Advocate Service ........................................................ 18-46 Taxpayer Assistance Center (TAC) ...................................... 2-17, 2-27 Taxpayer Identification Numbers .................................................. 1-4 Technical Advice Memorandum (TAM) ....................................... 18-2 Temporary Assistance for Needy Families (TANF) ....................... 3-17 Term and Renewal ..................................................................... 17-10 The $100 Rule ............................................................................ 13-19 The 10% Rule ............................................................................. 13-19 The 2% AGI Rule ............................................................. 13-20, 13-25 The 2% Floor .............................................................................. 13-16 The 50% Limit ............................................................................ 13-22 Tips .......................................................................... 5-9, 13-12, 15-20

Withholding............................................................................ 2-15 Trade Preferences Extension Act of 2015 ....................... 14-18, 18-19 Transportation Expenses ........................................................... 13-21 Transportation Fringe Benefits ....................................... 12-16, 18-27 Treasury Offset Program .................................................... 1-27, 2-10 Treasury Regulations .......................................................... 17-1, 18-1 Trustee ........................................................................................ 9-28 Trustee-to-trustee Transfer ....................................................... 18-11 Trusts ............................................................ 5-13, 9-26, 15-13, 18-20 Tuition Reduction ........................................................................ 5-15

U U.S. Citizen ..................................................................................... 1-1 U.S. Federal District Court ......................................................... 17-28 U.S. National .................................................................................. 1-2 U.S. Obligations ............................................................................. 6-7 U.S. Savings Bonds ......................................................................... 6-5

Electronic Series EE Bonds ........................................................ 6-5 Series E Bonds .......................................................................... 6-5 Series EE Bonds ........................................................................ 6-5 Series H Bonds .......................................................................... 6-5 Series HH Bonds ....................................................................... 6-5 Series I Bonds ........................................................................... 6-6

U.S. Treasury Bills .......................................................................... 6-7 U.S. Treasury Notes or Bonds ...................................................... 7-15 Unauthorized Disclosure............................................................ 17-35 Understatement of Taxpayer's Liability

Due to Unreasonable Position .............................................. 17-34 Due to Willful or Reckless Conduct ...................................... 17-34

Unemployment Compensation ...................................................... 5-4 Unenrolled Return Preparers ....................................................... 17-3 Unified Credit .................................................................. 13-10, 15-18 Uniform Capitalization Rules ......................................................... 9-5 Uniform Certified Public Accountant Examination .................... 17-11 Uniform Lifetime Table .............................................................. 11-17 United States v. Windsor ............................................................. 3-25 Unrecovered Basis .......................................................... 10-13, 18-32 Unreimbursed Employee Expenses ........................................... 13-20 Unreimbursed Medical Expenses ................................................ 11-8 Unrelated Business Taxable Income (UBTI) ................................. 9-32 Utilities......................................................................................... 8-10

V Veterans' Benefits ........................................................................ 5-15 Virtual Currency ........................................................... 3-9, 7-9, 18-30 Visa Waiver Program ..................................................................... 1-3 Voluntary Classification Settlement Program (VCSP) ................ 15-23 Voluntary Employees’ Beneficiary Association (VEBA) ... 14-19, 18-19 Voluntary Interest Payments ..................................................... 14-13 Voss v. Commissioner ................................................................ 18-44

W Wages .. 2-2, 3-22, 5-2, 7-7, 8-4, 8-12, 8-13, 10-12, 11-1, 11-5, 11-16,

11-20, 12-9, 12-17, 13-6, 14-6, 14-9, 14-28, 18-31 Willfully Sign .............................................................................. 17-21 Work Opportunity Tax Credit .................................................... 18-40 Workers' Compensation ....................................................... 5-5, 12-1 Working Condition Benefits ....................................................... 12-17 Working Families Tax Relief Act of 2004 ........................................ 14-6 Work-related Expenses ................................................................ 14-7 Worthless Securities ...................................................................... 7-8 Written Advice ........................................................................... 17-21

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© 2018 Golden State Tax Training Institute, Inc. RP-1

Tax Return Preparation Instructions

The following pages contain several Federal tax return scenarios that are designed to help you learn the material you have just studied. Tax return preparation questions are for instructional use only and you will not be graded on these questions. We also provide you the answers to each question and an explanation or feedback as to how we arrived at each answer. You should use the information provided in the 2017 tax tables in the appendix at the back of the course and on the 2017 tax forms included with each scenario to complete each return exercise. For the tax return preparation scenarios, best practice suggests that you should try to answer the questions on your own first, and only then refer to the answer key and feedback to see how well you did in terms of learning the material.

2017 tax year forms are provided following each of the scenarios. All the tax forms provided may not be necessary for the particular scenario. As part of the return preparation, you will need to determine which forms to use for each unique situation. You can also access IRS forms that you can populate and complete online by clicking the links below:

Form 1040 - U.S. Individual Income Tax Return Schedule A - Itemized Deductions Schedule B - Interest and Ordinary Dividends Schedule C - Profit or Loss From Business Schedule D - Capital Gains and Losses Schedule SE - Self-Employment Tax Form 8839 - Qualified Adoption Expenses Form 8949 - Sales and Other Dispositions of Capital Assets

Scenario 1 Robin Wright is a 30-year-old single taxpayer with annual earnings of $35,979 which is reported to her on a Form W-2 - Wage and Tax Statement. Robin does not have children or other dependents. Additionally, she cannot be claimed as a dependent on someone else’s tax return. $3,600 was withheld from her wages for Federal taxes. She owns her own home and paid $11,000 of mortgage interest and $2,200 in property taxes. Robin’s Social Security number is 132-45-6789 and her address is 141 Sunset Blvd, Hollywood, CA, 90038. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Robin.

Scenario 1 Questions Answers appear in Scenario 1 Feedback 1. What form would Robin receive that shows how much interest she paid on her mortgage during the year?

A. Form 1099-MISC B. Form 1099-INT C. Form 1098 D. Form 1097

2. What form or schedule could Robin use to report her income if she did not own a home?

A. Form 1040EZ B. Form 1040A C. Schedule C D. Schedule D

3. Filing status declaration is found on page 1 of Robin’s Form 1040.

A. True B. False

Tax Return Preparation - Scenario 1

© 2018 Golden State Tax Training Institute, Inc. RP-2

4. Based on the information provided Robin should: A. Use the standard deduction B. Itemize her deductions C. File for an extension with the IRS D. Not worry about filing a return

5. If Robin did not own a home her standard deduction would be what amount?

A. $5,950 B. $6,350 C. $9,350 D. $12,700

6. What is Robin’s adjusted gross income shown on the return?

A. $22,800 B. $25,000 C. $33,800 D. $35,979

7. What dollar amount would Robin show for her exemptions on line 42?

A. $0 B. $1,950 C. $3,800 D. $4,050

8. What is Robin’s taxable income (Line 43)?

A. $0 B. $4,050 C. $18,729 D. $22,779

9. After completing the tax return, Robin would show an amount owed on line 78.

A. True B. False

10. Robin is due a refund from the IRS for what amount?

A. $0, Robin owes additional taxes B. $500 C. $1,257 D. $3,600

11. If Robin had a dependent she would still itemize her deductions.

A. True B. False

12. If Robin got married and filed a joint return she would still itemize her deductions.

A. True B. False

Tax Return Preparation - Scenario 1

© 2018 Golden State Tax Training Institute, Inc. RP-3

Scenario 1 Feedback Return to Scenario 1 Questions Question 1 - C. Form 1098 Robin would receive Form 1098. Form 1098 - Mortgage Interest Statement is the statement the taxpayer’s mortgage lender sends him or her to let him or her know how much mortgage interest or points he or she paid during the year. Refer to Lesson 13 in the Federal tax law course for more information about Form 1098. Question 2 - A. Form 1040EZ Robin could use Form 1040EZ if she did not own a home. A taxpayer can use Form 1040EZ if he or she does not claim any adjustments to income, such as a deduction for home mortgage interest, points, IRA contributions, a student loan interest deduction, or an educator expenses deduction, etc. Refer to Lesson 2 in the Federal tax law course for more information about Form 1040EZ. Question 3 - A. True The filing status section is found on page 1 of the Form 1040. The taxpayer should check only one box based on citizenship status, marital status, spouse's year of death (if applicable) and the percentage of the costs that the taxpayer’s household members paid towards keeping up a home. Refer to Lesson 3 in the Federal tax law course for more information about filing status. Question 4 - B. Itemize her deductions When filing a Federal income tax return, taxpayers can choose to either take the standard deduction or to itemize their deductions. The taxpayer should use the deduction method that gives him or her the lowest tax bill. In this scenario if Robin itemizes her taxes she qualifies for a deduction of $13,200. If she chose to take the standard deduction she would only qualify for $6,350 as a single filing taxpayer. In future years, Robin can claim the standard deduction or itemize her deductions again. Again, she should use the deduction method that gives her the lowest tax bill. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and itemized deductions. Question 4 - B. $6,350 The standard deduction remains the same at $6,350 ($12,700 for married couples filing jointly) for 2017. Robin would claim the standard deduction if she did not own a home as she would not need to use Schedule A and itemize her deductions. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction. Question 6 - D. $35,979 Robin’s adjusted gross income (AGI) is her entire annual earnings of $35,979 as she does not qualify for any above-the-line deductions for the tax year. Refer to Lesson 3 in the Federal tax law course for more information about adjusted gross income (AGI). Question 7 - D. $4,050 Robin can claim one personal exemption for herself. The personal exemption remains at $4,050. However, in 2017, the exemption is subject to a phase-out that begins with adjusted gross incomes of $261,500 ($313,800 for married couples filing jointly). It phases out completely at $384,000 ($436,300 for married couples filing jointly.) Robin’s adjusted gross income is below $261,500 and not subject to the phase out. Refer to Lesson 4 in the Federal tax law course for more information about the personal exemptions. Question 8 - C. $18,729 Robin’s total taxable income on line 43 is equal to her adjusted gross income ($35,979) less her itemized deductions ($13,200) less her exemptions ($4,050) for a total of $18,779. Refer to Lesson 3 in the Federal tax law course for more information about taxable income. Question 9 - B. False Robin’s total tax from line 63 is $2,343 and her total payments are $3,600 from line 74. Robin will receive a $1,257 refund. Refer to Lesson 1 in the Federal tax law course for more information about refunds.

Tax Return Preparation - Scenario 1

© 2018 Golden State Tax Training Institute, Inc. RP-4

Question 10 - C. $1,257 As mentioned above, Robin’s total tax from line 63 is $2,343 and her total payments are $3,600 from line 74. Robin will receive a $1,257 refund. Refer to Lesson 1 in the Federal tax law course for more information about refunds. Question 11 - A. True If Robin had a dependent she may qualify for the head of household filing status. However, the head of household standard deduction is only $9,350 which is considerably less than her itemized deductions of $13,200. Robin would still itemize her deductions. Refer to Lesson 3 in the Federal tax law course for more information about filing status and Lesson 4 for more information about the standard deduction. Question 12 - A. True If Robin got married and decided to file a joint return her standard deduction would be $12,700. This amount is still less than her itemized deductions of $13,200. Robin would still itemize her deductions. Refer to Lesson 3 for more information about filing status and Lesson 4 in the Federal tax law course for more information about the standard deduction.

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© 2018 Golden State Tax Training Institute, Inc. RP-5

Tax Return Preparation

Scenario 2 Steve Tyler is a 36-year-old single taxpayer. He lives in Washington state but earned $33,989 for services performed in California which was reported on Form W-2 - Wage and Tax Statement. His Form W-2 also showed that $3,300 was withheld for Federal income taxes and $1,000 withheld for California income taxes. Steve did not have any other wages or salaries during the year. Steve does not have children or other dependents. Additionally, he cannot be claimed as a dependent on someone else’s tax return. He lives in an apartment with annual rent of $10,800. He has his savings invested in fixed income securities issued by the WA Trust Company which paid him $400 in ordinary dividends and $1,550 in taxable interest. Steve’s Social Security number is 589-64-1458 and his address is 8332 Winslow Way, Bainbridge Island, WA, 98110. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Steve.

Scenario 2 Questions Answers appear in Scenario 2 Feedback 1. What form would Steve receive that shows him the amount of interest he received during the year?

A. Form 1099-MISC B. Form 1099-INT C. Form 1098 D. Form 1097

2. What form would Steve receive that shows him the amount of dividends he received during the year?

A. Form 1099-DIV B. Form 1099-INT C. Form 1099-MISC D. Form 1099-OID

3. Exemption totals are found on page 1 of Steve’s Form 1040.

A. True B. False

4. If Steve did not receive any dividends what is the maximum amount of interest he can report and still be allowed to use

Form 1040EZ? A. $0 B. $1,000 C. $1,500 D. $2,000

5. On what line of Form 1040 would Steve show the amount of tax that is withheld from his paychecks for Federal income

taxes? A. Line 37 B. Line 64 C. Line 72 D. Line 76

6. Steve would want to use the standard deduction on this return.

A. True B. False

Tax Return Preparation - Scenario 2

© 2018 Golden State Tax Training Institute, Inc. RP-6

7. What is Steve’s total income shown on line 22 of this return? A. $33,989 B. $34,389 C. $35,539 D. $35,939

8. What is the outcome of Steve’s return?

A. Steve will receive a $63 refund B. Steve owes a $63 tax C. Steve will receive a $163 refund D. Steve owes a $163 tax

9. If Steve owned a condo and paid $8,000 of interest and $2,800 of property tax instead of renting he would itemize his

deductions. A. True B. False

10. Steve should ask his employer for a Form W-4 - Employee's Withholding Allowance Certificate to change his

withholding. A. True B. False

Tax Return Preparation - Scenario 2

© 2018 Golden State Tax Training Institute, Inc. RP-7

Scenario 2 Feedback Return to Scenario 2 Questions Question 1 - B. Form 1099-INT The IRS requires payments of interest income of at least $10 be reported on Form 1099-INT - Interest Income by the person or entity that makes the payments. This entity is most commonly a bank, other financial institution or government agency. When Steve files his taxes, he does not need to attach copies of the 1099-INT forms he receives, but he does need to report the information from the forms on the tax return. Refer to Lesson 2 in the Federal tax law course for more information about Form 1099-INT. Question 2 - A. Form 1099-DIV Form 1099-DIV - Dividends and Distributions is used by banks and other financial institutions to report dividends and other distributions to taxpayers and to the IRS. Refer to Lesson 2 in the Federal tax law course for more information about Form 1099-DIV. Question 3 - A. True The exemptions section is found on page 1 of the Form 1040. A taxpayer generally can take one for him or herself and, if he or she is married, one for his or her spouse. Also, the taxpayer generally can take an exemption for each of his or her dependents. A dependent is the taxpayer’s qualifying child or qualifying relative. If the taxpayer is entitled to claim an exemption for a dependent, that dependent cannot claim a personal exemption on his or her own tax return. Refer to Lesson 4 in the Federal tax law course for more information about the personal exemptions. Question 4 - C. $1,500 A taxpayer may use Form 1040EZ if he or she has only wages, salaries, tips, taxable scholarship and fellowship grants, unemployment compensation, or Alaska Permanent Fund dividends, and his or her taxable interest was not over $1,500. Refer to Lesson 2 in the Federal tax law course for more information about Form 1040EZ. Question 5 - B. Line 64 On Form 1040 in the payments category, use line 64 to show Federal income tax withheld from Forms W-2 and 1099. Refer to Lesson 2 in the Federal tax law course for more information about Form 1040 and Form W-2. Question 6 - A. True When filing a Federal income tax return, taxpayers can choose to either take the standard deduction or to itemize their deductions. The taxpayer may generally deduct the total itemized deduction amount or the standard deduction amount, whichever is greater. Because rent is not deductible, Steve does not have any deductions that make using Schedule A and itemizing deductions a greater amount than the standard deduction. He should use the standard deduction of $6,350. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and Lesson 13 for more information about itemized deductions. Question 7 - D. $35,939 Steve is required to attach Schedule B - Interest and Ordinary Dividends. He would include the $1,550 in Part I - Interest and $400 in Part II - Dividends on lines 8a and 9a of his Form 1040. His total income is the total of his earnings ($33,989), interest ($1,550) and his ordinary dividends ($400) or $35,939. Refer to Lesson 6 in the Federal tax law course for more information about Schedule B. Question 8 - B. Steve owes a $63 tax Steve’s total tax from line 63 of his Form 1040 is $3,363. His total payments from line 74 equal $3,300. Subtract line 74 from line 63 to determine the amount Steve owes. Enter $63 on line 78. Refer to Lesson 1 in the Federal tax law course for more information about paying the tax. Question 9 - A. True If Steve owed a condo he could include interest and property taxes in his itemized deductions. The itemized deductions would amount to $10,800 which is considerably more than his standard deduction for a single taxpayer of $6,350. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and Lesson 13 for more information about itemized deductions.

Tax Return Preparation - Scenario 2

© 2018 Golden State Tax Training Institute, Inc. RP-8

Question 10 - B. False Steve’s employer deducts taxes from his paycheck based on the number of allowances he claims on his Form W-4 - Employee's Withholding Allowance Certificate. If Steve has too much money withheld from his paychecks, he may end up giving Uncle Sam an interest-free loan (and getting a tax refund). However, there may be better ways for him to use his money. Conversely, if Steve is having too little withheld from his paycheck this could mean an unexpected tax bill or even a penalty for underpayment. For Steve’s current tax return, he only owes a tax of $63 so he has the correct amount of deductions on his existing Form W-4. Refer to Lesson 2 in the Federal tax law course for more information about Form W-4.

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© 2018 Golden State Tax Training Institute, Inc. RP-9

Tax Return Preparation

Scenario 3 Vera Wang is a 28-year-old unmarried taxpayer with a 6-year-old son, Tim. She earned $47,990 last year which was reported on Form W-2 - Wage and Tax Statement. Her Form W-2 also showed that $4,000 was withheld for Federal income taxes. Tim lives with Vera in her home that she rents. She provides over 50% of the cost of his support. Vera received alimony of $100 per month and child support of $75 per month from her son’s father for all twelve months of the year. She also collected taxable interest income of $475. Vera’s Social Security number is 078-92-4258 and her address is 15348 49th Ave SW, Walnut Creek, CA, 94507. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Vera.

Scenario 3 Questions Answers appear in Scenario 3 Feedback 1. What is Vera’s taxable income on line 43 of her Form 1040?

A. $32,215 B. $39,050 C. $44,000 D. $48,000

2. If Tim lived with his father who paid more than 50% of household expenses and support in what way would Vera’s total

tax change? A. Vera’s total tax would not change B. Vera’s total tax would decrease C. Vera’s total tax would increase D. Vera would need to file a tax return

3. What amount appears on line 63 on Form 1040 and shows total tax?

A. $946 B. $1,000 C. $3,166 D. $4,054

4. Vera no longer receives a Child Tax Credit after Tim reaches what age?

A. 13 years old B. 14 years old C. 15 years old D. 17 years old

5. On what line on Form 1040 should Vera show the Child Tax Credit?

A. Line 49 B. Line 50 C. Line 51 D. Line 52

6. What amount would the Child Tax Credit be on Vera’s Form 1040?

A. $0 B. $500 C. $750 D. $1,000

Tax Return Preparation - Scenario 3

© 2018 Golden State Tax Training Institute, Inc. RP-10

7. How many exemptions would Vera show on her return? A. 0 B. 1 C. 2 D. 3

8. What is the outcome of Vera’s return?

A. Vera will receive a $834 refund B. Vera owes a $834 tax C. Vera will receive a $1,834 refund D. Vera owes a $1,834 tax

9. Vera should have itemized her deduction rather than using the standard deduction.

A. True B. False

10. If Vera owned her home and paid mortgage interest of $6,500 and $2,000 of property tax she would want to itemize.

A. True B. False

Tax Return Preparation - Scenario 3

© 2018 Golden State Tax Training Institute, Inc. RP-11

Scenario 3 Feedback Return to Scenario 3 Questions Question 1 - A. $32,215 Vera can use the head of household standard deduction of $9,350 on line 40. She can claim two exemptions for her and her son for $8,100 on line 42. She can subtract both of these amounts from her adjusted gross income of $49,665 to arrive at $32,215. Refer to Lesson 3 in the Federal tax law course for more information about taxable income and filing status. Question 2 - C. Vera’s total tax would increase If Tim lived with his father who paid more than 50% of household expenses and support Vera would not be able to use the head of household standard deduction of $9,350. She would most likely use a single filer’s deduction of $6,350. She also could only use one exemption instead of two thus only having $4,050 in exemptions. Therefore, Vera’s taxable income would be higher as would her total tax. Refer to Lesson 3 in the Federal tax law course for more information about filing status and Lesson 4 for more information about personal exemptions. Question 3 - C. $3,166 Vera’s tax from the 2017 tax table is $4,166 based on taxable income on $32,215 and the head of household filing status. She qualifies for a $1,000 Child Tax Credit bringing her total tax on line 63 to $3,166. Refer to Lesson 3 for more information about tax liability and Lesson 14 in the Federal tax law course for more information about the Child Tax Credit. Question 4 - D. 17 years old For the Child Tax Credit, a taxpayer may be able to reduce his or her Federal income tax by up to $1,000 for each qualifying child under the age of 17. Refer to Lesson 14 in the Federal tax law course for more information about the Child Tax Credit. Question 5 - D. Line 52 In the Tax and Credits section of Form 1040, the Child Tax Credit amount appears on line 52. Refer to Lesson 2 in the Federal tax law course for more information about Form 1040. Question 6 - D. $1,000 Vera meets all the requirements, including Age, Relationship, Support and Residence tests for the Child Tax Credit. The credit is limited if a taxpayer’s modified adjusted gross income is above a certain amount. For married taxpayers filing a joint return, the phase-out begins at $110,000. For married taxpayers filing a separate return, it begins at $55,000. For all other taxpayers, the phase-out begins at $75,000. In addition, the Child Tax Credit is generally limited by the amount of the income tax and any alternative minimum tax (AMT) a taxpayer owes. Vera’s modified adjusted gross income does not exceed $75,000 and she does not owe AMT. She qualifies for the entire $1,000 credit. Refer to Lesson 14 in the Federal tax law course for more information about the Child Tax Credit. Question 7 - C. 2 Vera can claim herself and Tim, her qualifying child, as exemptions on her Form 1040, in the exemptions section on page 1. Refer to Lesson 4 in the Federal tax law course for more information about personal exemptions. Question 8 - A. Vera will receive a $834 refund Vera’s total tax from line 63 of her Form 1040 is $3,166. Her total payments from line 74 equal $4,000. Subtract line 63 from line 74 to determine Vera’s refund amount. Enter $834 on line 75. Refer to Lesson 1 in the Federal tax law course for more information about refunds. Question 9 - B. False When filing his or her Federal income tax return, taxpayers can choose to either take the standard deduction or to itemize their deductions. Whether to itemize deductions on the tax return depends on how much the taxpayer spent on certain expenses last year. Money paid for medical care, mortgage interest, taxes, charitable contributions, casualty losses and miscellaneous deductions can reduce his or her taxes. If the total amount spent on those categories is more than the standard deduction, the taxpayer can usually benefit by itemizing. In Vera’s case her expenses are not more than her head of household standard deduction of $9,350. Refer to Lesson 4 for more information about the standard deduction and Lesson 13 in the Federal tax law course for more information about itemized deductions.

Tax Return Preparation - Scenario 3

© 2018 Golden State Tax Training Institute, Inc. RP-12

Question 10 - B. False If Vera owed her home she could include mortgage interest and property taxes in her itemized deductions. The itemized deductions would amount to $8,500 which is less than her standard deduction of $9,350 for a head of household. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and Lesson 13 for more information about itemized deductions.

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© 2018 Golden State Tax Training Institute, Inc. RP-13

Tax Return Preparation

Scenario 4 Gwen and Andy Smith are both 50 years old. They are married and filing a joint Federal tax return. Gwen earned $43,974 last year and Andy earned $40,000 reported to them on Form W-2 - Wage and Tax Statement from which $4,400 and $4,000 respectively was withheld for Federal income taxes. The Smiths do not have children or other dependents. Additionally, they cannot be claimed as dependents on someone else’s tax return. They own their own home and paid $15,000 of mortgage interest, $3,000 of property tax and $800 for homeowners insurance. They also had $250 they paid for preparation of their tax return. Gwen’s Social Security number is 345-67-8999. Andy’s Social Security number is 123-45-6789. Their address is 5617 Main St, Bakersfield, CA, 93203. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for the Smiths.

Scenario 4 Questions Answers appear in Scenario 4 Feedback 1. What is the total amount of itemized deductions allowed on the Smiths return?

A. $3,000 B. $15,000 C. $18,000 D. $18,800

2. What line on Form 1040 would show the total itemized deductions or the standard deduction amount?

A. Line 40 B. Line 41 C. Line 42 D. Line 44

3. If the interest paid on their mortgage was $8,000 the Smiths would still want to itemize their deductions.

A. True B. False

4. What is the Smiths adjusted gross income on line 37 of their Form 1040?

A. $69,000 B. $81,000 C. $83,200 D. $83,974

5. What is the Smiths taxable income on line 43 of their Form 1040?

A. $57,874 B. $65,974 C. $76,200 D. $83,974

6. All of the following are nondeductible expenses that may be included in the taxpayer’s house payment except:

A. Fire insurance premiums B. Homeowner’s insurance premiums C. An amount applied to reduce the principal of the mortgage D. Home mortgage interest

7. What is the Smiths total tax from Line 63 of their Form 1040?

A. $7,749 B. $7,849 C. $9,059 D. $10,485

Tax Return Preparation - Scenario 4

© 2018 Golden State Tax Training Institute, Inc. RP-14

8. What is the outcome of the Smiths tax return? A. They will receive a $651 refund B. They owe a $651 tax C. They will receive a $1,651 refund D. They owe a $1,651 tax

9. Assuming the same amount of property tax, what is the least amount of mortgage interest the Smiths would pay and

still itemize? A. $9,701 B. $9,750 C. $9,801 D. $9,850

10. If the Smiths had a dependent what would their exemption amount be on line 42 of their Form 1040?

A. $8,100 B. $8,300 C. $10,700 D. $12,150

Tax Return Preparation - Scenario 4

© 2018 Golden State Tax Training Institute, Inc. RP-15

Scenario 4 Feedback Return to Scenario 4 Questions Question 1 - C. $18,000 The Smiths total itemized deductions include $15,000 of mortgage interest and $3,000 of property tax. The $800 for homeowners insurance is not deductible. The $250 in tax preparation fees are not allowed as an itemized deduction because the amount does not exceed the 2% AGI floor. Refer to Lesson 13 in the Federal tax law course for more information about itemized deductions. Question 2 - A. Line 40 Line 40 of the Tax and Credits section of Form 1040 shows the taxpayer’s itemized deductions amount or the standard deduction amount. Refer to Lesson 2 in the Federal tax law course for more information about Form 1040. Question 3 - B. False If the interest paid on the Smiths mortgage was $8,000 their total itemized deductions would be $11,000. As a married couple filing jointly their standard deduction would be $12,700 so it is more advantageous for the Smiths to take the standard deduction. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and Lesson 13 for more information about itemized deductions. Question 4 - D. $83,974 The Smiths adjusted gross income (AGI) is their entire annual earnings of $83,974 ($43,974 + $40,000) as they do not qualify for any above-the-line deductions for the tax year. Refer to Lesson 3 in the Federal tax law course for more information about adjusted gross income (AGI). Question 5 - A. $57,874 The Smiths can subtract the $18,000 for itemized deductions on Line 40 and $8,100 for two exemptions on line 42 from their adjusted gross income of $83,974 to arrive at taxable income of $57,874. Refer to Lesson 3 in the Federal tax law course for more information about taxable income. Question 6 - D. Home mortgage interest If the taxpayer took out a mortgage (loan) to finance the purchase of his or her home, he or she probably has to make monthly house payments. The taxpayer’s house payment may include several costs of owning a home. The only costs a taxpayer can deduct are real estate taxes actually paid to the taxing authority, interest that qualifies as home mortgage interest, and mortgage insurance premiums. Some nondeductible expenses that may be included in the taxpayer’s house payment include fire or homeowner's insurance premiums and the amount applied to reduce the principal of the mortgage. Refer to Lesson 13 in the Federal tax law course for more information about nondeductible expenses. Question 7 - A. $7,749 Based on total taxable income of $57,874 and their married, filing jointly status, the Smiths total tax from the 2017 tax table is $7,749. This amount appears on line 63. Refer to Lesson 3 in the Federal tax law course for more information about tax liability. Question 8 - A. They will receive a $651 refund The Smiths total tax from line 63 of their Form 1040 is $7,749. Their total payments from line 74 equal $8,400. Subtract line 63 from line 74 to determine the Smiths refund amount. Enter $651 on line 75. Refer to Lesson 1 in the Federal tax law course for more information about refunds. Question 9 - A. $9,701 If the Smiths paid $9,701 their itemized deduction would be more than the standard deduction of $12,700 for a couple filing jointly. If they paid any amount less than $9,701 they would use the standard deduction as this amount would be greater than (or equal to) the Smiths itemized deductions. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction and Lesson 13 for more information about itemized deductions. Question 10 - D. $12,150 Taxpayers are entitled to claim a $4,050 personal exemption for themselves and any dependents they support. If the Smiths had a dependent they could claim three exemptions for a total of $12,150 on line 42 of their Form 1040. Refer to Lesson 4 in the Federal tax law course for more information about personal exemptions.

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© 2018 Golden State Tax Training Institute, Inc. RP-16

Tax Return Preparation

Scenario 5 Mike Jordan is a 53-year-old self-employed contractor who remodels houses. During the tax year, he had total revenues of $125,000, paid wages of $25,000 and spent $25,000 for supplies. He made estimated tax payments to the IRS of $5,000 for each quarter. He is single and has no other income. Mike is a calendar year taxpayer and does not have children or other dependents. Additionally, he cannot be claimed as dependents on someone else’s tax return. Mike’s Social Security number is 987-65-4321. Mike rents his house and his address is 83 12th St, Sacramento, CA, 94203. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Mike.

Scenario 5 Questions Answers appear in Scenario 5 Feedback 1. What is Mike’s self-employment income for the year?

A. $25,000 B. $75,000 C. $100,000 D. $125,000

2. What amount is Mike’s self-employment tax for the year?

A. $0 B. $5,299 C. $10,597 D. $10,860

3. What amount of Mike’s self-employment tax is deductible?

A. $0 B. $2,649 C. $5,299 D. $10,597

4. What amount is Mike’s adjusted gross income from line 37 of his Form 1040?

A. $59,701 B. $63,601 C. $69,701 D. $75,000

5. What amount of estimated tax payment Mike made for the year shows on line 65 of Form 1040?

A. $5,000 B. $10,000 C. $15,000 D. $20,000

6. What is Mike’s total tax that appears on line 63 of his Form 1040?

A. $5,299 B. $10,597 C. $10,860 D. $21,167

Tax Return Preparation - Scenario 5

© 2018 Golden State Tax Training Institute, Inc. RP-17

7. What is the outcome of Mike’s tax return? A. Mike will receive a $167 refund B. Mike owes a $167 tax C. Mike will receive a $1,167 refund D. Mike owes a $1,167 tax

8. What form would Mike use to submit his estimated payments?

A. Form 1040 B. Form 1040A C. Form 1040ES D. Form 1040X

9. All four quarterly estimated tax payments must be remitted before the end of the calendar year.

A. True B. False

10. Mike is required to use Section B, Long Schedule SE, when completing his tax return because he calculated more than $50,000 of net profit on his Schedule C.

A. True B. False

Tax Return Preparation - Scenario 5

© 2018 Golden State Tax Training Institute, Inc. RP-18

Scenario 5 Feedback Return to Scenario 5 Questions Question 1 - B. $75,000 Use Schedule C - Profit or Loss From Business to determine Mike’s self-employment income. Mike’s gross income on line 7 is $125,000. From that amount subtract $25,000 for supplies on line 22 and $25,000 for wages on line 26. Mike does not deduct expenses for business use of his home so his net profit on line 30 is $75,000. Refer to Lesson 8 in the Federal tax law course for more information about Schedule C. Question 2 - C. $10,597 Mike’s self-employment tax is figured on Schedule SE by entering his net profit from Schedule C, line 31 onto Schedule SE line 2. Combine line 1a, 1b and 2 of Schedule SE for a total of $75,000 on line 3. Then multiply line 3 by 92.35% (.9235) for a total of $69,263 on line 4. Because the amount on line 4 is less than $127,200 multiply $69,263 by 15.3% (.153) for a total self-employment tax of $10,597 on line 5. Refer to Lesson 8 in the Federal tax law course for more information about self-employment tax. Question 3 - C. $5,299 Mike can deduct one-half of his self-employment tax. This deduction is calculated on Schedule SE - Self-Employment Tax. Multiply line 5 by 50% (.50) and enter the result on line 6. Refer to Lesson 8 in the Federal tax law course for more information about Schedule SE. Question 4 - C. $69,701 Mike figures adjusted gross income (AGI) on page 1 of his Form 1040. He can deduct the $5,299 of self-employment tax from his Schedule SE from his business income of $75,000 for a total adjusted gross income of $69,701. Refer to Lesson 3 in the Federal tax law course for more information about adjusted gross income (AGI). Question 5 - D. $20,000 Mike made estimated tax payments to the IRS of $5,000 for each quarter. The total estimated tax payments in the amount of $20,000 appear on line 65. Refer to Lesson 3 in the Federal tax law course for more information about estimated tax payments. Question 6 - D. $21,167 Mike’s figured his tax on line 44 of $10,570 from the 2017 tax table based on his taxable income of $59,301. Mike adds his self-employment tax of $10,597 and reports a total tax of $21,167 on line 63. Refer to Lesson 3 for more information about tax liability and Lesson 8 in the Federal tax law course for more information about Schedule SE. Question 7 - D. Mike owes a $1,167 tax Mike’s total tax from line 63 of his Form 1040 is $21,167. His total payments from line 74 equal $20,000. Subtract line 74 from line 63 to determine Mike’s tax owed. Enter $1,167 on line 78. Refer to Lesson 1 in the Federal tax law course for more information about paying the tax. Question 8 - C. Form 1040ES Estimated tax is the method used to pay tax on income that is not subject to withholding (for example, earnings from self-employment, interest, dividends, rents, alimony, etc.). In addition, if the taxpayer does not elect voluntary withholding, he or she should make estimated tax payments on other taxable income, such as unemployment compensation and the taxable part of his or her Social Security benefits. Mike should use Form 1040ES to figure and pay his estimated tax. Refer to Lesson 1 in the Federal tax law course for more information about estimated taxes.

Tax Return Preparation - Scenario 5

© 2018 Golden State Tax Training Institute, Inc. RP-19

Question 9 - B. False A taxpayer can pay all of his or her estimated tax by April 15 of the current year, or in four equal amounts by the following dates:

• 1st payment - April 15 • 2nd payment - June 15 • 3rd payment - September 15 • 4th payment - January 15 (of the following year)

The taxpayer does not have to make the payment due January 15 if he or she files his or her tax return by February 2 and pays the entire balance due with the return. Refer to Lesson 1 in the Federal tax law course for more information about estimated taxes. Question 10 - B. False Using the flowchart on page 1 of Schedule SE Mike determines he can use Section A, Short Schedule SE. Generally, the taxpayer will only be required to complete Section B, Long Schedule SE, if he or she:

• Received tips subject to Social Security or Medicare tax that he or she did not report to his or her employer. • Was minister, member of a religious order, or Christian Science practitioner who received IRS approval not to be

taxed on earnings from these sources, but he or she owed self-employment tax on other earnings. • Was using one of the optional methods to figure his or her net earnings. • Received church employee income reported on Form W-2 of $108.28 or more.

Refer to Lesson 8 in the Federal tax law course for more information about Schedule SE and figuring net earnings from self-employment.

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© 2018 Golden State Tax Training Institute, Inc. RP-20

Tax Return Preparation

Scenario 6 James Garfield is a 38-year-old married taxpayer with income of $74,989 reported to him on Form W-2 - Wage and Tax Statement. His Form W-2 also showed that $3,000 was withheld from his paychecks during the year for Federal income taxes. In March he and his wife Gina, also 38-years-old, adopted a daughter, 1-year-old Jane, from the United States for whom they paid $5,000 of qualified domestic adoption expenses. The Garfields do not have any other children or other dependents. Additionally, they cannot be claimed as dependents on someone else’s tax return. The Garfields own a home and paid $2,500 interest on their home mortgage and $500 property tax. James’ Social Security number is 928-56-1234. Gina’s Social Security number is 789-56-4321. Their address is 383 College Drive, Chico, CA, 95926. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for the Garfields.

Scenario 6 Questions Answers appear in Scenario 6 Feedback 1. What form or schedule would James and Gina use to calculate the credit for qualified adoption expenses?

A. Form 1040 B. Schedule A C. Schedule B D. Form 8839

2. What is the total amount of credits shown on line 55 of the Garfield’s Form 1040?

A. $0 B. $1,000 C. $5,000 D. $6,000

3. If James and Gina pay for additional qualified adoption expenses next year they can file for an additional tax credit.

A. True B. False

4. James and Gina should complete Schedule A and itemize their deductions because they paid home mortgage interest and personal property tax.

A. True B. False

5. What is the exemption amount the Garfields can claim on line 42 of their Form 1040?

A. $0 B. $4,050 C. $8,100 D. $12,150

6. What is the Garfield’s taxable income on line 43 of their Form 1040?

A. $50,139 B. $62,389 C. $63,300 D. $74,989

7. What amount is the Garfield’s total tax on line 63 of their Form 1040?

A. $586 B. $2,224 C. $6,000 D. $6,776

Tax Return Preparation - Scenario 6

© 2018 Golden State Tax Training Institute, Inc. RP-21

8. What is the outcome of the Garfield’s tax return? A. They will receive a $1,414 refund B. They owe a $1,414 tax C. They will receive a $2,414 refund D. They owe a $2,414 tax

9. The adoption credit for qualified adoption expenses can only be taken after the adoption is final.

A. True B. False

10. For how many years can the Garfields carry forward unused credit for their qualified adoption expenses?

A. Two years B. Three years C. Four years D. Five years

Tax Return Preparation - Scenario 6

© 2018 Golden State Tax Training Institute, Inc. RP-22

Scenario 6 Feedback Return to Scenario 6 Questions Question 1 - D. Form 8839 A taxpayer uses Form 8839 - Qualified Adoption Expenses to figure his or her Adoption Credit and any employer-provided adoption benefits he or she can exclude from his or her income. The taxpayer can claim both the exclusion and the credit for expenses of adopting an eligible child. For example, depending on the cost of the adoption, the taxpayer may be able to exclude up to $13,570 from his or her income and also be able to claim a credit of up to $13,570. But, the taxpayer cannot claim both a credit and exclusion for the same expenses. Refer to Lesson 14 in the Federal tax law course for more information about Form 8839. Question 2 - D. $6,000 The Garfields are eligible to claim $1,000 for the Child Tax Credit on Line 52 and $5,000 from Form 8839 for qualified adoption expenses on line 54. Total credits of $6,000 appear on line 55. Refer to Lesson 14 in the Federal tax law course for more information about the Child Tax Credit and the Adoption Credit. Question 3 - A. True If Form 8839, line 15 is smaller than line 14, the taxpayer may have an unused credit to carry forward to the next 5 years or until used, whichever comes first. The taxpayer uses the Adoption Credit Carryforward Worksheet to figure the amount of his or her credit carryforward. If the taxpayer has any unused credit to carry forward to future tax years, be sure he or she keeps the worksheet. The taxpayer will need it to figure his or her credit for future tax years. Refer to Lesson 14 in the Federal tax law course for more information about Form 8839. Question 4 - B. False When filing a Federal income tax return, taxpayers can choose to either take the standard deduction or to itemize their deductions. In this case the Garfields should choose the standard deduction rather than itemizing their deductions because the total amount they spent on medical care, mortgage interest, taxes, charitable contributions, casualty losses and miscellaneous deductions is less than the standard deduction for married taxpayers filing jointly. Refer to Lesson 4 in the Federal tax law course for more information about the standard deduction. Question 5 - D. $12,150 An adopted child is always treated as the taxpayer’s own child. The term “adopted child” includes a child who was lawfully placed with him or her for legal adoption. Therefore, the Garfields can claim three exemptions totaling $12,150. Refer to Lesson 4 in the Federal tax law course for more information about personal exemptions. Question 6 - A. $50,139 The Garfields taxable income is equal to their adjusted gross income of $74,989 less their standard deduction of $12,700 from line 40. They also subtract $12,150 for three exemptions on line 42 to arrive at a total of $50,139. Refer to Lesson 3 in the Federal tax law course for more information about taxable income. Question 7 - A. $586 Using the 2017 tax table, the Garfields figured their tax on line 46 is $6,586. They can claim the Child Tax Credit and adoption expenses from Form 8839 for a total of $6,000 entered on line 55. By subtracting line 55 from line 47 they arrive at a total tax on line 63 of $586. Refer to Lesson 3 in the Federal tax law course for more information about tax liability. Question 8 - C. They will receive a $2,414 refund The Garfield’s total tax from line 63 of their Form 1040 is $586. Their total payments from line 74 equal $3,000. Subtract line 63 from line 74 to determine the Garfields’ refund amount. Enter $2,414 on line 75. Refer to Lesson 1 in the Federal tax law course for more information about refunds. Question 9 - B. False The tax years for which a taxpayer can claim the credit depend on when the expenses are paid, whether the adoption is domestic or foreign, and whether the adoption has been finalized. Generally, the credit is allowable whether the adoption is domestic or foreign. In the Garfield’s case for their domestic adoptions, qualified adoption expenses paid before the year the adoption becomes final are allowable as a credit for the tax year following the year of payment (and the credit is allowable even if the adoption is never finalized). Refer to Lesson 14 in the Federal tax law course for more information about the Adoption Credit.

Tax Return Preparation - Scenario 6

© 2018 Golden State Tax Training Institute, Inc. RP-23

Question 10 - D. Five years A taxpayer may have an unused credit to carry forward to the next 5 years or until used, whichever comes first. Refer to Lesson 14 in the Federal tax law course for more information about the Adoption Credit.

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© 2018 Golden State Tax Training Institute, Inc. RP-24

Tax Return Preparation

Scenario 7 Thomas Jefferson, age 35, is a self-employed real estate agent. He had gross income of $70,000. Tom is a calendar year taxpayer. During the current tax year he paid $1500 for advertising, $200 for his real estate license and $100 per month for a cell phone which he uses 60% for business. He owns a car that he used to travel 800 miles for personal use and 2,000 miles for business that are documented in his mileage log book. He uses actual expenses of $1,413 instead of the standard mileage deduction method for the vehicle. He made estimated tax payments of $4,000 for each quarter. He does not take a deduction for a home office. His wife, Maureen, who is 30-years-old earned $40,000 for which she received a Form W-2 - Wage and Tax Statement that also showed $4,000 had been withheld for Federal income taxes. They own their own home and paid $15,000 for mortgage interest, $3,500 for property taxes and $900 for homeowners insurance. Maureen contributed $3,000 to a traditional IRA during the year. Mr. and Mrs. Jefferson do not have any children or other dependents. Additionally, they cannot be claimed as dependents on someone else’s tax return. Thomas’ Social Security number is 369-25-8147. Maureen’s Social Security number is 741-85-2963. Their address is 1914 Mountain View Drive, South Lake Tahoe, CA 96150. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Mr. and Mrs. Jefferson.

Scenario 7 Questions Answers appear in Scenario 7 Feedback 1. What are Thomas’ total business expenses from Part II of Schedule C - Profit or Loss From Business?

A. $1,500 B. $2,913 C. $3,113 D. $3,833

2. What is the Jefferson’s total income on line 22 for this return?

A. $40,000 B. $66,167 C. $98,492 D. $106,167

3. What amount of Thomas’ self-employment tax is deductible?

A. $0 B. $4,675 C. $9,349 D. $9,934

4. What is the Jefferson’s adjusted gross income shown on line 37 of Form 1040?

A. $40,000 B. $66,167 C. $98,492 D. $106,167

5. What amount is Thomas’ self-employment tax for the year?

A. $0 B. $4,675 C. $9,349 D. $9,934

6. What amount is the Jefferson’s total tax on line 63 of their Form 1040?

A. $9,641 B. $9,349 C. $9,934 D. $19,198

Tax Return Preparation - Scenario 7

© 2018 Golden State Tax Training Institute, Inc. RP-25

7. What is the outcome of the Jefferson’s tax return? A. They will receive a $802 refund B. They owe a $802 tax C. They will receive a $1,802 refund D. They owe a $1,802 tax

8. What is the maximum amount Maureen can contribute to a traditional IRA?

A. $0 B. $5,000 C. $5,500 D. $6,500

9. Both Thomas and Maureen can contribute to an IRA.

A. True B. False

Tax Return Preparation - Scenario 7

© 2018 Golden State Tax Training Institute, Inc. RP-26

Scenario 7 Feedback Return to Scenario 7 Questions Question 1 - D. $3,833 Thomas can claim $1,500 for advertising expenses, $1,413 for car expenses, $720 for his cell phone under utilities expense and $200 for his real estate license for total expenses of $3,883. Refer to Lesson 8 in the Federal tax law course for more information about Schedule C - Profit or Loss From Business. Question 2 - D. $106,167 To calculate total income on line 22 of page 1 of the Form 1040 combine all income including wages of $40,000 and business income from Schedule C of $66,167. The result is $106,167. Refer to Lesson 5 for more information about earned income and Lesson 8 in the Federal tax law course for more information about Schedule C. Question 3 - B. $4,675 Thomas can deduct one-half of his self-employment tax. This deduction is calculated on Schedule SE - Self-Employment Tax. Multiply line 5 by 50% (.50) and enter the result on line 6. Refer to Lesson 8 in the Federal tax law course for more information about Schedule SE. Question 4 - C. $98,492 When figuring the Jefferson’s adjusted gross income include a deduction $4,675 for one-half of the self-employment tax from Schedule SE and a $3,000 deduction for contributions to the IRA. Enter $7,675 on line 36. Subtract this amount from total income of $106,167 to arrive at $98,492. Enter this amount in line 37. Refer to Lesson 3 in the Federal tax law course for more information about adjusted gross income (AGI). Question 5 - C. $9,349 Thomas’ self-employment tax is figured on Schedule SE by entering his net profit from Schedule C, line 31 on line 2. Combine line 1a, 1b and 2 for a total of $66,167 on line 3. Then multiply line 3 by 92.35% (.9235) for a total of $61,105 on line 4. Because the amount on line 4 is less than $127,200 multiply $61,105 by 15.3% (.153) for a total self-employment tax of $9,349 on line 5. Refer to Lesson 8 in the Federal tax law course for more information about self-employment tax. Question 6 - D. $19,198 Using the 2017 tax table, the Mr. and Mrs. Jefferson figured their tax on line 44 is $9,849. They cannot claim additional credits. They include Thomas’ self-employment tax of $9,349 from Schedule SE for a total tax on line 63 of $19,198. Refer to Lesson 3 in the Federal tax law course for more information about tax liability. Question 7 - A. They will receive a $802 refund The Jefferson’s total tax from line 63 of their Form 1040 is $19,198. Their total payments from line 74 equal $20,000. Subtract line 63 from line 74 to determine the Jeffersons refund amount. Enter $802 on line 75. Refer to Lesson 1 in the Federal tax law course for more information about refunds. Question 8 - C. $5,500 For 2017, the maximum a taxpayer can contribute to all of his or her traditional and Roth IRAs is the smaller of $5,500 ($6,500 if you’re age 50 or older), or his or her taxable compensation for the year. Because Maureen is filing jointly she may be eligible to contribute $5,500. The deduction is limited if the taxpayer or his or her spouse is covered by a retirement plan at work and his or her income exceeds certain levels. Refer to Lesson 11 in the Federal tax law course for more information about IRAs. Question 9 - A. True If a taxpayer files a joint return, he or she and his or her spouse can each make IRA contributions even if only one of them has taxable compensation. The amount of the taxpayer’s combined contributions cannot be more than the taxable compensation reported on his or her joint return. It does not matter which spouse earned the compensation. The deduction is also limited if the taxpayer or his or her spouse is covered by a retirement plan at work and his or her income exceeds certain levels. Refer to Lesson 11 in the Federal tax law course for more information about IRAs.

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© 2018 Golden State Tax Training Institute, Inc. RP-27

Tax Return Preparation

Scenario 8 Margaret Paz is a 35-year-old unmarried taxpayer who has a daughter, Margie, age 6, who lives with her. Margaret provides over 50% of the cost of Margie’s support. Margaret owns her own home and paid $13,000 in mortgage interest and $2,500 in property taxes. She earned $34,000 that was reported on Form W-2 - Wage and Tax Statement which also showed that $3,000 had been withheld for Federal income taxes. Margaret is a calendar year taxpayer who also has a small bookkeeping business that had gross revenue of $25,000. She spent $500 on supplies, $200 on software, $150 on meals with clients and $100 per month for a cell phone used 50% for business. She made estimated tax payments of $1,500 for each quarter. She bought 100 shares of common stock in ABC Company with a cost of $2,000 that she held for exactly 4 months and sold for $2,500 on December 1. She received $150 in ordinary dividends during the holding period. She also received $1,000 in interest on fixed income securities. She contributed $3,000 to an IRA and made a charitable contribution in cash of $300. She had $6,000 in unreimbursed, allowable medical expenses. Margaret’s Social Security number is 852-74-9631. Her address is 37 Ocean Terrace, Laguna Beach, CA 92607. Using the tax tables in the back of the course and the forms immediately following the scenario, prepare a Federal tax return for Margaret.

Scenario 8 Questions Answers appear in Scenario 8 Feedback 1. To complete her tax return, Margaret will need to use which of the following schedules?

A. Schedule A B. Schedule C C. Schedule D D. All of the above

2. What is the amount of business income Margaret reported on line 12 of her Form 1040 from Schedule C -Profit or Loss

From Business? A. $23,625 B. $34,000 C. $35,000 D. $59,275

3. What is Margaret’s adjusted gross income shown on line 37 of Form 1040?

A. $54,606 B. $57,606 C. $57,625 D. $59,275

4. What is the amount of Margaret’s itemized deductions on line 40 of her Form 1040?

A. $3,039 B. $13,000 C. $16,039 D. $17,705

5. What amount of self-employment tax does Margaret owe?

A. $0 B. $1,669 C. $3,338 D. $21,818

6. What amount is Margaret’s total tax on line 63 of her Form 1040?

A. $2,884 B. $3,338 C. $3,884 D. $5,994

Tax Return Preparation - Scenario 8

© 2018 Golden State Tax Training Institute, Inc. RP-28

7. What is the outcome of Margaret’s tax return? A. She will receive a $1,006 refund B. She owes a $1,006 tax C. She will receive a $3,006 refund D. She owes a $3,006 tax

8. If Margaret also had a short-term loss carryover of $5,300 what would be the impact on her return?

A. No Change B. She can show a $3,000 loss on line 13 of her Form 1040 C. She can show a $5,300 loss on line 13 of her Form 1040 D. She can show a $3,000 gain on line 13 of her Form 1040

9. Margaret can deduct what part of her $6,000 in medical expenses on her Schedule A - Itemized Deductions?

A. $0 B. $1,905 C. $4,095 D. $6,000

10. Because Margaret itemizes her deductions the outcome of her return will not change based on her filing status. A. True B. False

Tax Return Preparation - Scenario 8

© 2018 Golden State Tax Training Institute, Inc. RP-29

Scenario 8 Feedback Return to Scenario 8 Questions Question 1 - D. All of the above Margaret will use Schedule A - Itemized Deductions because her itemized deductions are greater than the standard deduction for her filing status. She will also use Schedule C - Profit or Loss From Business to determine the net profit (loss) from her bookkeeping business. And lastly, she will need to complete Schedule D - Capital Gains and Losses to figure the capital gains (losses) for the common stock she sold. Refer to Lesson 13 in the Federal tax law course for more information about Schedule A. Refer to Lesson 8 in the Federal tax law course for more information about Schedule C. Refer to Lesson 7 in the Federal tax law course for more information about Schedule D. Question 2 - A. $23,625 Margaret uses Schedule C to calculate her business income. She had $25,000 of gross income and was able to deduct $1,375 of expenses for a total of $23,625. She enters this amount on line 12 of her Form 1040. Her expenses include $500 for supplies and $200 for software. She also had $75 for meals (she can deduct only 50% of her business-related meal and entertainment expenses) and $600 for her cell phone which she used 50% of the time for business. Refer to Lesson 8 in the Federal tax law course for more information about Schedule C. Question 3 - A. $54,606 When figuring Margaret’s adjusted gross income (AGI) include a deduction of $1,669 for one-half of the self-employment tax from Schedule SE - Self-Employment Tax and a $3,000 deduction for contributions to the IRA. Enter $4,669 on line 36. Subtract this amount from total income of $59,275 to arrive at $54,606. Enter this amount in line 37. Refer to Lesson 3 in the Federal tax law course for more information about adjusted gross income (AGI). Question 4 - D. $17,705 Margaret uses Schedule A to calculate her itemized deduction. Since Margaret is under age 65, she can deduct only the amount of unreimbursed allowable medical and dental expenses that is more than 7.5% of her adjusted gross income (AGI). This amount is $1,905 ($6,000 - $4,095). She can also deduct $2,500 for property taxes and $13,000 for home mortgage interest on her Schedule A. Additionally, she can deduct $300 for her charitable contribution bringing her total itemized deductions on Schedule A to $17,705. Refer to Lesson 13 in the Federal tax law course for more information about Schedule A. Question 5 - C. $3,338 Margaret uses Schedule SE to determine her self-employment tax. She multiplies $23,625 from Schedule C by 92.35% (.9235) to arrive at $21,818. Because this amount is less than $127,200 she multiplies $21,818 by 15.3% (.153). She enters self-employment tax of $3,338 on line 5. Refer to Lesson 8 in the Federal tax law course for more information about Schedule SE. Question 6 - D. $5,994 Using the 2017 tax table, Margaret figured her tax on line 47 is $3,656. She can claim $1,000 credit for the Child Tax Credit and enters $2,656 on line 56. She includes her self-employment tax of $3,338 from Schedule SE for a total tax on line 63 of $5,994. Refer to Lesson 3 in the Federal tax law course for more information about tax liability. Question 7 - C. She will receive a $3,006 refund Margaret’s total tax from line 63 of her Form 1040 is $5,994. Her total payments from line 74 equal $9,000. Subtract line 63 from line 74 to determine Margaret’s refund amount. Enter $3,006 on line 75. Refer to Lesson 1 in the Federal tax law course for more information about refunds. Question 8 - B. She can show a $3,000 loss on line 13 of her Form 1040 On her Schedule D, Margaret would enter her $5,300 short-term loss carryover on line 6. After combining all gain and loss her net short-term gain on line 7 would show ($4,800). Since Margaret’s capital losses exceed her capital gains, the amount of the excess loss that can be claimed is the lesser of $3,000, ($1,500 if married filing separately) or her total net loss. Since her net capital loss is more than $3,000 she can only enter $3,000 on line 13 of her Form 1040. She can carry the remaining loss forward to later years. Refer to Lesson 7 in the Federal tax law course for more information about capital gains and losses.

Tax Return Preparation - Scenario 8

© 2018 Golden State Tax Training Institute, Inc. RP-30

Question 9 - B. $1,905 Since Margaret is under age 65, she can deduct on Schedule A - Itemized Deductions only the amount of her unreimbursed allowable medical and dental expenses that is more than 7.5% of her adjusted gross income (AGI) from Form 1040, line 38 which is $4,095. Margaret’s $6,000 medical expenses would be limited to a $1,905 itemized deduction ($6,000 - $4,095). Refer to Lesson 13 in the Federal tax law course for more information about medical expenses. Question 10 - B. False Margaret qualifies for and should use the head of household filing status. Because she qualifies to file as head of household, her tax rate will be lower than the rates for single or married filing separately. She would also receive a higher standard deduction than if she filed as single or married filing separately. In this scenario, even though Margaret itemized her deductions, by choosing the head of household filing status Margaret’s tax rate from the 2017 tax table is lower ($3,656) than it would be if she used the single filing status ($3,858). Refer to Lesson 3 in the Federal tax law course for more information about filing status.

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© 2018 Golden State Tax Training Institute, Inc. EX-1

Examination Instructions - 60 Hour Qualifying Education

Passing the Qualifying Exam (QE) from a self-study course is contingent upon scoring 70% or higher on the exam questions related to the course material. This final examination covering Federal tax law consists of 280 multiple-choice questions, meaning you must correctly answer 196 in order to pass. The exam has no time limit, and is open book, so you are allowed to look up answers in the text we provide. You do not need to finish the exam in one continuous sitting as all of the answers you enter online are automatically saved. After you submit the online exam to us you will receive a pass/fail message. If you should fail the exam on your first attempt, you will have the option to re-take the exam at no additional cost. If you score less than 70%, a message will be displayed at the bottom of the page along with a list of incorrect questions. You have unlimited attempts to pass an exam. Upon successful completion of the full 60-Hour QE course, we will e-mail you a Certificate of Completion. Additionally, we notify the California Tax Education Council (CTEC) that you passed the Qualifying Education (QE) allowing you to apply for your CRTP registration online at www.CTEC.org. We wish you every success and thank you for choosing Golden State Tax Training Institute, Inc. Submit your exam:

How To: • Log into www.GSTTI.com • Enter your email address and your password • Click link to take online exam • Answer questions (There is no time limit) • Submit answers (The exam does not need to be

completed in one sitting) • Get certificate by email within 24 hours • We electronically notify CTEC that you earned

Qualifying Education (QE) course credits

IMPORTANT: Just because you successfully completed the 60-hour qualifying education (QE) course does not mean you can prepare tax returns in the state of California. You must also complete the registration process with the California Tax Education Council (CTEC). You have 18 months from the completion date listed on the 60-hour qualifying education (QE) completion certificate provided by your education provider to register with CTEC. If you do not register with CTEC within the allowed 18 months, you will be required to complete another 60-hour qualifying education course before being able to register. CTEC registration MUST be completed online at https://www.ctec.org/Preparer/.

© 2018 Golden State Tax Training Institute, Inc. EX-2

Examination Questions - 45 Hour Federal Tax Law

All questions pertain to Tax Year 2017 unless noted.

Lesson 1 1. Some returns are not eligible for the Internal Revenue Service electronic filing program. Which item listed below is

generally eligible to be filed through the Internal Revenue Service electronic filing program? A. Form 1040A B. Form 990T C. Tax returns for prior years D. Amended tax returns

2. Federal law requires paid tax return preparers to electronically file Federal income tax returns if they file how

many combined 1040, 1040A, 1040EZ and 1041 returns during the year? A. 5 or more B. 7 or more C. 9 or more D. 11 or more

3. All of the following are true regarding the Preparer Tax Identification Number (PTIN) except:

A. New regulations require all paid tax return preparers and enrolled agents to obtain a Preparer Tax Identification Number (PTIN) before preparing any Federal tax returns

B. A tax preparer must renew his or her PTIN every year during the renewal season C. Failure to have a current PTIN could result in the imposition of Internal Revenue Code section 6695

penalties, injunction, and/or disciplinary action by the IRS Office of Professional Responsibility D. The PTIN is not required for CPAs if they prepare for compensation all or substantially all of a Federal

tax return or claim for refund

4. As a tax preparer you work with a client named Mary on her 2017 tax return and there are no issues. However, during that process you realize Mary was due a refund in 2016 but did not file a return. Which of the following statements applies to Mary with respect to her 2016 refund?

A. Mary cannot apply for a refund for the year 2016 as it is too late B. Mary has up to three years from the date the tax return was due to file a 2016 return to obtain her refund C. Mary has up to four years from the date the tax return was due to file a 2016 return to obtain her refund D. Mary has up to five years from the date the tax return was due to file a 2016 return to obtain her refund

5. In working with a client named Fred, you realize that he did not report income that he should have on a return. Fred

reported $10,000 of income on the return but should have reported $13,500. What is Fred’s obligation going forward regarding this incident?

A. Fred must maintain records for 5 years from the year the return was filed B. Fred must maintain records for 6 years from the year the return was filed C. Fred must maintain records for 8 years from the year the return was filed D. Fred must maintain records for 10 years from the year the return was filed

6. Under the cash method, a taxpayer includes in his or her gross income all items of income actually or constructively

received during the tax year. If he or she receives property and services, the taxpayer must include what amount in income?

A. Fair market value (FMV) B. Purchase price C. Cost D. Adjusted basis

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-3

7. Agnes Green was a single, calendar year taxpayer. She died on March 6, 2017. Her final income tax return must be filed by which date (not including weekends or holidays)?

A. April 15, 2017 B. January 1, 2018 C. March 6, 2018 D. April 15, 2018

8. Taxpayers can make payments by electronic funds withdrawal (EFW) for all of the following except:

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

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

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

9. For the 2017 tax year, Michael had wages of $52,000. What amount will be withheld from his earnings for the

Federal Insurance Contributions Act (FICA)? A. $3,224 B. $3,978 C. $5,408 D. $6,448

10. Captain Margaret Jones entered Afghanistan on December 1, 2015. She remained there through March 31, 2017,

when she departed for the United States. She was not injured and did not return to the combat zone. What date is her 2017 tax return due if she does not file Form 4868?

A. January 1, 2018 B. April 15, 2018 C. June 15, 2018 D. October 15, 2018

11. If an individual taxpayer files on a fiscal year basis (a year ending on the last day of any month except December),

and his or her fiscal year ends June 30. What is the due date of the tax return? A. September 1 B. October 1 C. October 15 D. December 31

12. When a taxpayer is using a debit or credit card for payment all of the following are true except:

A. If the taxpayer made an overpayment, IRS will refund it after the return is processed B. The taxpayer can make Federal tax deposits with a debit or credit card C. Making an electronic payment eliminates the need to use a voucher D. High balance payments of $100,000 or greater may require special coordination with the service provider

chosen

13. For which of the following unpaid debts may the Bureau of Fiscal Service (BFS) apply part or all of a tax refund to pay that debt?

A. Past-due child support B. Federal agency non-tax debts C. State income tax obligations D. All of the above

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-4

14. The taxpayer is considered to have reasonable cause for the period covered by an automatic extension if at least what percentage of the actual tax liability is paid before the regular due date of the return through withholding, estimated tax payments, or payments made with Form 4868 - Application for Automatic Extension of Time To File U.S. Individual Income Tax Return?

A. 75% B. 80% C. 85% D. 90%

15. To figure whether she should pay estimated tax for 2017, Jane determines her expected adjusted gross income

(AGI) for 2017 will be $82,800. Her AGI for 2016 was $73,700. Her total tax on her 2015 return (Form 1040, line 61) was $9,001. Using the 2017 Estimated Tax Worksheet she figures her total 2017 estimated tax to be $11,015. Her tax expected to be withheld in 2017 is $10,000. She will file as head of household and expects no refundable credits in 2017. All of the following are true regarding Jane’s estimated taxes except:

A. She expects to owe at least $1,000 for 2017 after subtracting her withholding from her expected total tax B. She expects her income tax withholding to be at least 90% of the tax to be shown on her 2017 return C. Jane does not need to pay estimated tax D. Jane will need to pay estimated tax

16. The taxpayer will owe a penalty for any 2017 payment period for which his or her estimated tax payment plus his

or her withholding for the period and overpayments for previous periods was less than what percent of his or her 2016 tax?

A. 20% B. 21% C. 22.5% D. 25%

17. The taxpayer does not owe a penalty for underpayment of the estimated tax if the total tax shown on his or her

return minus the amount he or she paid through withholding (including excess Social Security and tier 1 railroad retirement (RRTA) tax withholding) is less than what amount?

A. $500 B. $1,000 C. $1,500 D. $2,000

18. Using the short method in Part III of Form 2210, Alvaro determines his total underpayment of his estimated taxes

for 2017 was $2,000. If he meets all other conditions and the entire amount was paid on or after April 15, 2018, what is the amount of his underpayment penalty?

A. $0 B. $53 C. $55 D. $65

19. If the taxpayer thinks he or she owes the estimated tax penalty, but does not want to figure it when he or she files

the tax return, the taxpayer may not have to. Generally, the IRS will figure the penalty for him or her and send a bill. The taxpayer only needs to figure his or her penalty in which of the following situations?

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

actually withheld D. All of the above

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-5

20. Ray, who is single and 22 years old, was unemployed for a few months during 2016. He earned $6,700 in wages before he was laid off, and he received $1,400 in unemployment compensation afterwards. He had no other income. Even though he had gross income of $8,100, he did not have to pay income tax because his gross income was less than the filing requirement for a single person under age 65. He filed a return only to have his withheld income tax refunded to him. In 2017, Ray began regular work as an independent contractor and earned $28,000. Ray made no estimated tax payments in 2017 and he did owe tax at the end of the year. What amount does Ray owe for the underpayment penalty in 2017?

A. $0 B. $555 C. $558 D. $630

21. The payment transaction limit for which a taxpayer can use a debit or credit card to make a payment for a Form

1040 tax return, for the current tax year, is how many times per year? A. 1 time per year B. 2 times per year C. 3 times per year D. 4 times per year

22. What is the user fee when a taxpayer applies by phone, mail, or in-person and enters into a standard long-term

installment agreement or a payroll deduction agreement with the IRS allowing for periodic partial payments of taxes owed?

A. $50 B. $125 C. $225 D. $300

23. If a taxpayer files a claim for a loss from worthless securities or bad debt deduction, he or she must keep records

that support items shown for how many years after the return was filed? A. 5 years B. 7 years C. 8 years D. No limit

Lesson 2 24. Which of the following Federal tax forms could a single filing taxpayer use if his or her taxable income is $175,000?

A. Form 1040EZ B. Form 1040A C. Form 1040 D. All of the above

25. An individual can use Form 1040NR-EZ instead of Form 1040NR if all of the following items apply except:

A. The taxpayer does not claim any dependents B. The taxpayer cannot be claimed as a dependent on another person's U.S. tax return C. The taxpayer does not claim any tax credits D. If the taxpayer was married, he or she claims an exemption for his or her spouse

26. Emily Smith files her tax return on the basis of a fiscal year. Her records show that she received income in

November 2016 and February 2017 from which there was backup withholding ($100 and $50, respectively). Emily takes credit for what amount of backup withholding on her tax return for the fiscal year ending September 30, 2017?

A. $0 B. $50 C. $100 D. $150

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-6

27. Andy originally reported $21,000 as his adjusted gross income on his 2016 Form 1040. He received another Form W-2 for $500 after he filed his return. Which of the following is true?

A. Andy should file another Form 1040 for 2016 B. Andy should re-file Form 1040 for 2016 C. Andy should include the $500 on his 2017 Form 1040 D. Andy should use Form 1040X - Amended U.S. Individual Income Tax Return to correct the 2016 Form

1040 28. As a wage earner, the taxpayer pays Federal income tax by having it withheld from his or her pay during the year.

The withholding is based on the number of allowances he or she claims when filing Form W-4 - Employee's Withholding Allowance Certificate, with an employer. All of the following are true regarding the completion of Form W-4 except:

A. A taxpayer can claim any number of allowances B. If the taxpayer has not changed jobs, he or she generally does not have to give his or her employer a new

Form W-4 each year C. The taxpayer should try to have his or her withholding match his or her actual tax liability D. If an employer cannot withhold enough additional tax from the taxpayer’s wages, he or she may need to

make estimated tax payments 29. Meg Green works in a store and earns $46,000 a year. Her husband, John, works full-time in manufacturing and

earns $68,000 a year. In 2017, they will also have $184 in taxable interest and $1,000 of other taxable income. They expect to file a joint income tax return. Meg and John complete Worksheets 1, 4, and 7 of Form W-4. Line 5 of Worksheet 7 shows that they will owe an additional $4,459 after subtracting their withholding for the year. All of the following are true regarding their new Form W-4 except:

A. They can divide the $4,459 any way they want B. They can enter an additional amount on either of their Forms W-4 C. They can divide the additional amount between them D. They must apply the additional withholding amount to Meg’s taxable income

30. Which of the following statements regarding tip income is true?

A. If the taxpayer is an indirectly tipped employee (for example, a busser or bartender) he or she is not required to report tips to an employer

B. Any tips the taxpayer reported to an employer are to be included in the wages in box 1 (Wages, tips, other compensation) of his or her Form W-2

C. If the only tips a taxpayer receives in a month are charged tips (for example, credit and debit card charges) distributed to him or her by an employer, he or she not required to report these tips to the employer

D. If the only tips a taxpayer receives in a month are cash tips, he or she is not required to report these tips to the employer

31. Every employer engaged in a trade or business who pays remuneration, including noncash payments of what

amount or more for the year for services performed by an employee must file a Form W-2 - Wage and Tax Statement for each employee (assuming no income, Social Security, or Medicare tax was withheld)?

A. $500 B. $600 C. $700 D. $800

32. In certain situations, the taxpayer will receive two W-2 forms in place of the original incorrect form. This will happen

for which of the following reasons? A. The taxpayer’s identification number is wrong or missing B. The taxpayer’s name and address are wrong C. The taxpayer received the wrong type of form D. All of the above

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-7

33. Company ABC provides a dependent care assistance flexible spending arrangement to its employees through a cafeteria plan. In addition, it provides occasional on-site dependent care to its employees at no cost. Emily, a single filing taxpayer and an employee of Company ABC, had $4,500 deducted from her pay for the dependent care flexible spending arrangement. In addition, Emily used the on-site dependent care several times. The fair market value of the on-site care was $700. Emily's Form W-2 should report $5,200 of dependent care assistance in Box 10. If all other conditions are met, what is the maximum amount excludable from gross income for the dependent care expenses Emily can report on her tax return?

A. $700 B. $2,500 C. $4,500 D. $5,000

34. All of the following are true regarding the 1099 series forms except:

A. If the taxpayer received the types of income reported on some forms in the 1099 series, he or she may not be able to use Form 1040A or Form 1040EZ

B. Most forms in the 1099 series should be furnished to the taxpayer by January 31 C. The requirement to file 1099 series forms is mandated by the Internal Revenue Service D. Estates and trusts that make reportable transactions during the calendar year are not required to file 1099

series forms

Lesson 3 35. Randall lived apart from his spouse from July 10 to December 31, but he was not divorced or legally separated at

the end of the year. Of the following choices, which filing status is Randall eligible to use on his income tax return? A. Single B. Head of Household C. Married, filing separately D. None of the above

36. If the taxpayer is a U.S. citizen or resident, whether he or she must file a return depends on which of the following

factors? A. Gross income B. Filing status C. Age D. All of the above

37. Eduardo, who is 64 years of age and single, received wages of $15,000, interest income of $3,000, dividends of

$2,000, municipal bond interest of $7,000 and state unemployment compensation of $3,000. What is Eduardo’s Federal gross income?

A. $15,000 B. $18,000 C. $23,000 D. $27,000

38. All of the following are requirements to claim head of household filing status except:

A. The taxpayer’s parent must live in his or her home at least 6 months B. The taxpayer is unmarried or considered unmarried on the last day of the year C. A qualifying person lived with the taxpayer over half the year D. The taxpayer’s spouse did not live in his or her home during the last 6 months of the tax year

39. During 2017, which of the following can be considered as an adjustment to Federal Gross Income? A. Interest paid on delinquent credit card bills B. Interest on a personal loan C. Interest from car payments D. Moving expenses

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-8

40. If the taxpayer files a separate return in a community property state, he or she and his or her spouse must each report half of their combined community income and deductions in addition to their separate income and deductions. Each of the taxpayers must complete and attach which form to the Form 1040 showing how he or she figured the amount he or she is reporting on the return?

A. Form 8889 B. Form 8917 C. Form 8949 D. Form 8958

41. Mike is unmarried. His dependent daughter, Sara, lived with him all year. Property taxes of $1,000 and mortgage

interest of $4,000 on the home where he and Sara live are divided equally with his ex-wife. Mike paid the utilities of $100 per month. What portion of the yearly household expenses allows him to qualify for head of household filing status?

A. $1,000 B. $2,500 C. $3,700 D. $5,600

42. During the current year, Tom Jackson, who is 50 years old and single, maintained his home in which he and his

widowed father, age 75, resided. His father had $2,650 interest income from a savings account and also received $3,000 from Social Security during the current year. Tom provided 60% of his father’s total support for the current year. What is Tom’s filing status for the current year, and how many exemptions should he claim on his tax return?

A. Head of household and two exemptions B. Head of household and one exemption C. Single and two exemptions D. Single and one exemption

43. Mrs. Walter’s husband died in 2015. She has not remarried and has maintained a home for herself and her

dependent son, whose personal exemption she can claim. In the summer of 2017, the son was killed in an automobile accident. What is Mrs. Walter’s filing status for 2017?

A. Married filing separately B. Single C. Qualifying widow with dependent child D. Head of household

44. It is important to use the correct filing status when filing the taxpayer’s income tax return. It can impact the tax

benefits he or she receives, the amount of his or her standard deduction and the amount of taxes he or she pays. All of the following statements regarding filing status are true except:

A. If more than one filing status fits the taxpayer, he or she should choose the one that allows him or her to pay the lowest taxes

B. If a married couple decides to file their returns separately, each person’s filing status would generally be Married Filing Separately

C. The Head of Household status generally applies if the taxpayer is not married and has paid more than half the cost of maintaining a home for him or herself and claims an exemption for a qualifying person

D. Qualifying Widow(er) with Dependent Child status only applies for the year the taxpayer’s spouse passes away and the taxpayer must have a dependent child and meet certain other conditions

45. Henry Wright retired this year after 30 years of civil service. He and his wife were domiciled in a community

property state during the past 15 years. If Mr. Wright receives $1,000 a month in retirement pay, what amount of the retirement pay is considered community income?

A. $0 B. $100 C. $500 D. $1,000

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-9

46. Herb and Wanda timely filed their 2015 joint income tax return on April 15, 2016. Herb died in March 2017, and the executor of Herb's will transferred all of the estate's assets to Wanda. In August 2017, the IRS assessed a deficiency for the 2015 return. The items causing the deficiency belong to Herb. All of the following are true regarding the tax deficiency except:

A. Wanda is solely liable for the deficiency as the spouse of the decedent B. Wanda is relieved of the deficiency under the innocent spouse relief provisions C. Herb's estate remains solely liable for the deficiency D. The IRS may collect the deficiency from Wanda to the extent permitted under Federal transferee liability

47. At the time Sherry signed her joint return, she knew that her spouse did not report $5,000 of gambling winnings.

The IRS examined the tax return several months after she filed it and determined that her spouse's unreported gambling winnings were actually $25,000. Sherry established that she did not know about, and had no reason to know about, the additional $20,000 because of the way her spouse handled gambling winnings. If Sherry meets the other requirements, what amount of the understated income will qualify for innocent spouse relief?

A. $2,500 B. $5,000 C. $10,000 D. $20,000

48. Jeff and Riley were married for 35 years when Riley died in July of 2017. The couple have two children who are 6

and 10 years old. Which of the following applies to Jeff regarding filing status? A. Jeff can file using any status he wants for the next 3 years B. Since Jeff’s spouse died during the year, he may be entitled to the special qualifying widower with

dependent child benefits for tax year 2018 and 2019 C. Since Jeff’s spouse died during the year, he may be entitled to the special qualifying widower with

dependent child benefits for tax year 2017 only D. Since Jeff’s spouse died during the year, he may be entitled to the special qualifying widower with

dependent child benefits for tax year 2018 only 49. Aidan is unmarried. His mother, for whom he can claim an exemption, lived in an apartment by herself. She died

on September 2, 2017. The cost of the upkeep of her apartment for the year until her death was $6,000. Aidan and his brother both paid support and their mother had no income. Aidan would qualify to file as head of household if he paid what amount of his mother’s support?

A. $1,000 B. $1,500 C. $2,000 D. $4,000

Lesson 4 50. The taxpayer is generally allowed one exemption for him or herself. If married, he or she may be allowed an

exemption for his or her spouse if which of the following is true? A. His or her spouse is considered the taxpayer’s dependent B. The taxpayer and his or her spouse are filing a joint return C. Another taxpayer is entitled to claim his or her spouse as a dependent D. The taxpayer and his or her spouse file a separate return and his or her spouse had gross income less

than $5,000 51. Charlie and Marianne are both over 65. Their adjusted gross income is $100,000. During the year their 35-year-

old single son, Lenny, lived with them while attending college and earned $4,500. Charlie’s mother, Elizabeth, lived with them until June 1 when she was placed in a nursing home for an indefinite period of time to receive medical care. Elizabeth received no income and was supported solely by Charlie and Marianne. Determine the number of exemptions Charlie and Marianne can claim on their joint return.

A. 1 B. 2 C. 3 D. 4

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-10

52. In meeting the gross income test for claiming his father as a dependent, James must consider the income received by his father. This income included gross rents of $3,000 (expenses were $2,000), municipal bond interest of $1,000, dividends of $1,500, and Social Security of $4,000. What is James' father's gross income for the qualifying relative test purposes?

A. $1,500 B. $3,000 C. $4,500 D. $5,500

53. Sally is trying to determine if her sister Heather, for whom she provided more than half of the support in 2017,

meets the qualifying relative test. Heather is 35 years old and earned $3,500. Which statement determines if Heather meets the qualifying relative test?

A. Heather meets the qualifying relative test because she is under the age of 65 B. Heather meets the qualifying relative test because she earned less than $4,050 C. Heather fails the qualifying relative test because she is over the age of 24 D. Heather fails the qualifying relative test because she earned $3,500

54. Drew gets married in January of 2017 and provides support for his stepdaughter Melissa who is 26 years old.

Melissa does not earn any income in 2017 since she is a full-time graduate student. Which of the following is true regarding Melissa as a qualifying relative?

A. Melissa qualifies based on her age of 26 B. Melissa qualifies based on her earned income C. Melissa qualified because there is no age limit on qualifying relatives D. Both B and C are correct

55. Rick and Tina are married and filing a joint tax return for 2017. Their two children (Sarah, age 13 and Mike, age

10) and Tina’s mother lived with them all year. During 2017, Rick and Tina provided all the support for their children and more than half of the support for Tina's mother. The children each had interest income of less than $400. Tina's mother received $3,500 from a taxable pension, $2,500 of dividends, and $2,000 of interest income. How many exemptions can Rick and Tina claim on their 2017 income tax return?

A. 3 B. 4 C. 5 D. 6

56. A taxpayer can claim an exemption for a person who files a joint return if that person and his or her spouse file the

joint return only to claim which of the following? A. American Opportunity Credit B. Lifetime Learning Credit C. Estimated tax paid D. Interest paid

57. Rubén and Jeanette’s 18-year-old son and his 17-year-old wife had $800 of wages from part-time jobs and no

other income. Neither is required to file a tax return. They do not have a child and they meet all other tests. Taxes were taken out of their pay so they file a joint return only to get a refund of the withheld taxes. Additionally, Rubén and Jeanette provide more than half of the support for their son and daughter-in-law. How many exemptions can Ruben and Jeanette claim on their 2017 income tax return?

A. 1 B. 2 C. 3 D. 4

58. A taxpayer can claim a person as a dependent if the person meets all other tests and is a resident of which

country? A. Mexico B. Honduras C. Panama D. Guatemala

Examination Questions - 45 Hour Federal Tax Law

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59. A taxpayer can generally claim all of the following persons as a dependent except: A. U.S. citizen B. U.S. resident alien C. U.S. national D. Foreign student brought to the U.S. under a qualified international education exchange program

60. A group can enter into a multiple-support agreement if no one person in the group contributes over what

percentage of the dependent's support? A. 30% B. 40% C. 45% D. 50%

61. Ken and his brother, Wes, each provide 20% of their mother's support for the year. The remaining 60% of her

support is provided equally by two persons who are not related to her. She does not live with either of these two people. Who can claim the exemption for Ken and Wes’ mother?

A. Ken B. Wes C. Ken and Wes D. No one can claim the exemption

62. A child is treated as a qualifying child or a qualifying relative of the noncustodial parent if all other criteria are met

and the noncustodial parent provides at least what amount for the child’s support during the year? A. $250 B. $400 C. $500 D. $600

63. Tim and Gail are divorced. In 2017, their child lived with Tim 190 nights and with Gail 165 nights. Their child also

spent ten nights with Tim’s parents during the summer. Who is the custodial parent? A. Tim B. Gail C. Both Tim and Gail D. Neither Tim nor Gail

64. If a child is a qualifying child of two persons, only one person can actually treat the child as a qualifying child and

take all of the following tax benefits (provided the person is eligible for each benefit) except: A. The exemption for the child B. The Additional Child Tax Credit C. The Child Tax Credit D. The Credit for Child and Dependent Care Expenses

65. Lisa and her 2-year-old daughter, Courtney, lived with Lisa’s mother all year. Lisa is 25 years old and unmarried.

Her mother's AGI is $18,000. Courtney's father did not live with Lisa or her daughter and she has not signed Form 8832 (or a similar statement) to release the child's exemption to the noncustodial parent. If Lisa does not claim Courtney as a qualifying child, her mother can treat her as a qualifying child to claim certain tax benefits unless Lisa has an adjusted gross income (AGI) of what amount?

A. $5,000 B. $7,500 C. $10,000 D. $20,000

Examination Questions - 45 Hour Federal Tax Law

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66. Veronica has adjusted gross income of $312,650 in 2017 and she files as head of household and claims two personal exemptions: one for herself plus one for her daughter. For 2017, Veronica's personal exemptions are reduced by what amount?

A. $0 B. $800 C. $1,620 D. $2,100

67. Sean and Dianne are a married couple filing jointly. For 2017, their adjusted gross income (AGI) is $452,000. For

2017, Sean and Dianne’s personal exemptions total what amount? A. $0 B. $5,200 C. $7,300 D. $8,000

68. Larry, 46, and Donna, 33, are filing a joint return for 2017. Neither is blind, and neither can be claimed as a

dependent. They decide not to itemize their deductions. Their standard deduction is what amount? A. $9,350 B. $12,700 C. $13,600 D. $14,800

69. Terry, age 67, and his wife, Diana, age 61, are planning to file a joint return for 2017. Neither is blind nor can be

claimed as a dependent. If they do not itemize deductions their standard deduction is what amount? A. $9,100 B. $12,700 C. $13,950 D. $14,800

70. What is the amount of the 2017 standard deduction for a head of household taxpayer, who is 72 years old and

completely blind? A. $12,450 B. $12,700 C. $13,600 D. $14,800

71. Matt is 46 years old and has a certified statement from his optometrist on December 1, 2017, that confirms he can

see no better than 20/250. For tax year 2017, which is correct? A. Matt is not eligible for the higher standard deduction for blindness as he is only partially blind B. Matt is eligible for the higher standard deduction for blindness in 2017 C. Matt is eligible for the higher standard deduction for blindness in 2018, the first full year of his blindness D. Matt is not eligible for the higher standard deduction for blindness as he can see better than 20/300

72. When determining the standard deduction for an individual who can be claimed as a dependent on another

person's tax return earned income is defined as all of the following except: A. Wages B. Tips C. Interest D. Fellowship grant that the taxpayer must include in his or her gross income

73. Michael is single. His parents can claim an exemption for him on their 2017 tax return. He has interest income of $780 and wages of $150. He has no itemized deductions. What is Michael’s standard deduction?

A. $150 B. $350 C. $500 D. $1,050

Examination Questions - 45 Hour Federal Tax Law

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74. Danielle and her 3-year-old daughter Kyra lived with her mother all year. Danielle is 25 years old, unmarried, and her adjusted gross income (AGI) is $18,000. Danielle’s mother's AGI is $15,000. Kyra's father did not live with Danielle or her daughter. Also, Danielle has not signed Form 8832 (or a similar statement) to release the child's exemption to the noncustodial parent. Because Danielle’s mother's AGI is not higher than hers she cannot claim Kyra as a qualifying child on her income tax return. Only can Danielle can claim Kyra as a qualifying child and is entitled, if additional eligibility requirements are met, to which of the following tax benefit?

A. The Child Tax Credit B. The Credit for Child and Dependent Care Expenses C. Head of household filing status D. All of the above

75. Jody, age 42, is married filing separately. Her husband, Eric, age 45, itemizes deductions on his return. What is

Jody’s standard deduction? A. $0 B. $6,350 C. $9,350 D. $12,700

Lesson 5 76. Taxable earned income includes which of the following?

A. Interest and dividends B. Unemployment benefits C. Alimony D. Tips

77. While on vacation in Las Vegas Jennifer, who is from Utah, wins a progressive jackpot playing cards worth $15,875

at the Casino Royale. What implication does she encounter when she goes to collect her prize? A. The State of Utah withholds 25% of her winnings B. The Casino Royale withholds 15% of her winnings when she collects her prize C. The Casino Royale withholds 25% of her winnings when she collects her prize D. The Casino Royale withholds 30% of her winnings when she collects her prize

78. Anne is a full-time student at UCLA buts works part-time as a waitress at a diner near her dormitory. She earns

an hourly wage but also receives tips as part of her compensation. Last month she collected $51 in tips while working night shifts in the diner. What obligation does she have regarding these tips?

A. Anne must report the tips to her employer because they exceeded $20 for the month B. Anne does not have to report the tips to her employer because they did not exceed $100 for the month C. Anne must report the tips to her employer because they exceeded $50 for the month D. Anne’s employer is responsible for keeping track of tips

79. Which of the following is canceled debt that qualifies for exception to inclusion in gross income?

A. Cancellation of qualified farm indebtedness B. Debt canceled during insolvency C. Cancellation of qualified real property business indebtedness D. A qualified purchase price reduction given by a seller

80. A trust’s fiduciary (or one of the joint fiduciaries) must file Form 1041 for a domestic trust taxable under Section

641 that has a gross income for the tax year of what amount? A. Gross income of $600 or more B. Gross income of $700 or more C. Gross income of $800 or more D. Gross income of $900 or more

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-14

81. The IRS defines sick pay as any amount paid under a plan for employees because of an employee’s temporary absence from work due to injury, sickness or disability. The sick pay may be paid by either the employer or by a third party, such as an insurance company. Based on this definition, the IRS classifies which of the following benefits paid to employees as sick pay?

A. Long-Term Disability Insurance (LTD) B. Short-Term Disability Insurance (STD) C. State Disability Insurance (SDI) D. All of the above

82. A taxpayer must include in his or her income sick pay benefits received from all of the following payers except:

A. A welfare fund B. A state sickness or disability fund C. An association of employers or employees D. An insurance company, if the taxpayer paid the premiums on the accident or health insurance policy

83. Paul Casey retired from the U.S. Navy in 2011. He receives a military pension based on his years of service. On

August 3, 2017, he received a determination of service-connected disability retroactive to 2011. Which of the following is true regarding Paul’s claim for a refund for taxes paid on his pension?

A. Paul cannot file a claim a refund for the taxes paid on his pension for any year B. Under the special limitation period, Paul can file a claim for a refund for taxes paid on his pension for 2013

as long as he files the claim by August 3, 2018 C. Paul can file a claim for a refund for taxes paid on his pension for 2011 and 2012 D. Paul can only file a claim for a refund for taxes paid on his pension for 2016

84. Sally receives $300 each month for sick pay from her employer for the three months she is on sick leave. What

amount will she need to include as income on her tax return? A. $0 B. $300 C. $600 D. $900

85. Herman is covered by a cafeteria plan by his employer. His adjusted gross income (AGI) is $100,000. He paid

unreimbursed medical premiums in the amount of $10,500 and he itemizes deductions. What amount will Herman be able to deduct for his medical insurance premium expenses?

A. $500 B. $1,000 C. $3,000 D. $5,250

86. Carol pays $500 a month for the premiums on her health insurance policy and receives a monthly reimbursement

of the same amount from her employer and is required to use it for those premiums. What amount of the reimbursement is considered taxable income?

A. $0 B. $100 C. $250 D. $275

87. Ben Green received three employee achievement awards during the year: a nonqualified plan award of a watch

valued at $250, and two qualified plan awards of a stereo valued at $1,000 and a set of golf clubs valued at $500. Assuming that the requirements for qualified plan awards are otherwise satisfied, Ben must include what amount in his income?

A. $0 B. $150 C. $1,600 D. $1,750

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-15

88. Penelope Summers received certain income benefits in 2017. She received $1,400 of state unemployment insurance benefits, $2,000 from a Federal Unemployment Trust Fund and $3,700 workers’ compensation received for an occupational injury. What amount of the compensation must Penelope include in her income?

A. $1,400 B. $3,400 C. $3,700 D. $5,700

89. Perry returns to work after qualifying for workers' compensation. He receives $1,000 a month for performing light

duties. What percentage of his salary payments is taxable? A. 0% B. 50% C. 75% D. 100%

90. Lana receives a $3,000 disability payment from an accident insurance plan paid for by her employer. What amount

will she need to include as income on her tax return? A. $0 B. $1,000 C. $2,000 D. $3,000

91. A minister performing ministerial services is taxed on wages, offerings, and on any fees received for performing

which of the following services? A. Marriages B. Baptisms C. Funerals D. All of the above

92. Under what circumstance would a taxpayer not include any amounts he or she receives for his or her disability

from a health or accident insurance plan as income on his or her tax return? A. The accident or health insurance plan was paid for entirely by his or her employer B. He or she pays the entire cost of a health or accident insurance plan C. Both the taxpayer and his or her employer have paid the premiums for the plan D. He or she pays the premiums of a health or accident insurance plan through a cafeteria plan at his or her

place of employment, and the amount of the premium was not included as taxable income to the taxpayer 93. Jim has a primary residence that he uses as his home. Twice a year he rents it out for local sporting events for a

total of 7 days in each instance. How is Jim’s home treated for tax purposes given these circumstances? A. Jim must treat his home as a rental because he rents it for more than 10 days a year B. Jim must treat his home as a rental because he rents it for more than 12 days a year C. Jim must treat his home as a rental because he rents it for at least 14 days a year D. Jim uses the dwelling as a home and rents it for less than 15 days during the year so Jim may treat the

home as his main home and there is no tax implication

94. Which of the following are examples of expenses that may be deducted from total rental income? A. Fixing leaks in the plumbing B. Putting a recreation room in an unfinished basement C. Paneling a den that previously had wallpaper D. Adding a bathroom or a spare bedroom

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-16

95. On April 6, 2017 Ben purchased a house to use as residential rental property. He made extensive repairs to the house and had it ready for rent on July 5, 2017. He began to advertise the house for rent in July and actually rented it beginning September 1, 2017. When is the house considered to be placed in service for the purposes of rental expenses?

A. January 1, 2017 B. April 6, 2017 C. July 5, 2017 D. September 1, 2017

Lesson 6 96. What form of income is not specified by contract and is not necessarily paid at regular intervals, but depends upon

the decision of the corporate directors to make a distribution? A. Interest B. Dividends C. Commissions D. Salaries

97. Mike owns Big Box Co. common stock, which he bought in 1985. He was paid a dividend of $500 for the year.

These qualified dividends are generally taxed at what tax rate? A. Individual tax rate B. Long-term capital gains tax rates C. Corporate tax rates D. All of the above

98. Some dividends may not be qualified dividends even if they are shown in box 1b of Form 1099-DIV. Which of the

following is a qualified dividend? A. Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building

and loan associations, U.S. savings and loan associations, Federal savings and loan associations, and similar financial institutions

B. Dividends from a corporation that is a tax-exempt organization or farmer's cooperative during the corporation's tax year in which the dividends were paid or during the corporation's previous tax year

C. Dividends paid from a stock held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date

D. Dividends paid by a corporation on employer securities held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation

99. If a taxpayer uses the cash basis method, when would he or she report interest income? A. In the year received B. The year it is earned C. When the funds are withdrawn D. When entered in passbook

100. On September 1, 2015, Steve loaned Brett $2,000 at 12% interest compounded annually. Steve is not in the

business of lending money. The note stated that principal and interest would be due on August 31, 2017. In 2017, Steve received $2,508.80 ($2,000 principal and $508.80 interest). Steve uses the cash method of accounting. What amount must Steve include in income on his income tax return?

A. $0 B. $508.80 C. $1,254.40 D. $2,508.80

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-17

101. Hillary deposited $5,000 with a bank and borrowed $5,000 from the bank to make up the $10,000 minimum deposit required to buy a 6-month certificate of deposit. The certificate earned $575 at maturity in 2016, but she only received $265, which represented the $575 she earned minus $310 interest charged on the $5,000 loan. The bank gives Hillary a Form 1099-INT for 2017 showing the $575 interest she earned. The bank also gives her a statement showing that she paid $310 interest for 2017. What amount must Hillary include in her income?

A. $0 B. $265 C. $310 D. $575

102. Which of the following, if any, are dividends that are qualified dividends?

A. Capital gain distributions B. Dividends paid on deposits from a credit union C. Dividends paid by a corporation on employer securities held on the date of record by an employee stock

ownership plan (ESOP) maintained by that corporation D. None of the above

103. Allison opens a savings account at her local bank and deposits $800. The account earns $20 interest. She also

receives a $15 calculator. No other interest is credited to her account during the year and the Form 1099-INT she receives shows $35 interest for the year. What amount of interest income must Allison report on her tax return?

A. $0 B. $10 C. $15 D. $35

104. Sylvia bought stock in 2004 for $100. In 2007, she received a non-dividend distribution of $80. She did not include

this amount in her income, but she reduced the basis of her stock to $20. She received a non-dividend distribution of $30 in 2017. What amount must Sylvia report as a long-term capital gain for 2017?

A. $10 B. $20 C. $30 D. $80

105. Interest income can be excluded on qualified U.S. Savings Bonds, either a series EE bond issued after 1989 or

a series I bond, redeemed for which of the following reasons? A. Qualified higher education expenses B. Transfer to a trust C. Ownership transfer D. Distribution from a retirement or profit-sharing plan

106. Money market funds are offered by nonbank financial institutions such as mutual funds and stock brokerage

houses. Generally, amounts a taxpayer receives from money market funds should be reported as which of the following?

A. Interest B. Dividends C. Short-term capital gain D. Long-term capital gain

107. The taxpayer generally must include interest in his or her income when he or she actually receives it for a

certificate of deposit or any other deferred interest account that pays interest in a single payment at maturity and matures in how many year(s) or less?

A. One year B. Two years C. Three years D. Four years

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-18

108. The discount on which of the following discounted debt instruments is generally not taxable? A. U.S. Treasury bonds B. Corporate bonds C. Municipal bonds D. Certificates of deposit

109. The interest on which of the following dividends is generally not taxable?

A. Exempt-interest dividends from a mutual fund B. Cooperative banks dividends C. Credit unions dividends D. Federal savings and loan associations dividends

110. Nonresident aliens are not taxed on certain kinds of interest income provided that such interest income arises

from which of the following sources? A. U.S. savings and loan association B. U.S. credit union C. U.S. insurance company D. All of the above

111. Interest on a state or local government obligation may be tax exempt for all of the following except:

A. Interest on a debt evidenced only by an ordinary written agreement of purchase and sale B. Interest paid by an insurer on default by the state C. Interest paid by an insurer on default by a political subdivision D. Interest paid on Federally guaranteed state obligations

112. $100 of interest was credited on Linda’s frozen deposit during the year. She withdrew $80 but could not withdraw

any more as of the end of the year. Linda must include what amount in her income for the current tax year? A. $0 B. $20 C. $80 D. $100

113. Which of the following is correct regarding a payor who is required to file Form 1099-DIV - Dividends and

Distributions? A. A payor is not required to file Form 1099-DIV - Dividends and Distributions unless he or she has paid

dividends (including capital gain dividends and exempt-interest dividends) and other distributions on stock of more than $5000 to one person

B. A payor is not required file Form 1099-DIV - Dividends and Distributions unless he or she has withheld and paid foreign tax on dividends and other distributions on stock of more than $5000 to one person

C. A payor is not required to file Form 1099-DIV - Dividends and Distributions unless he or she has withheld Federal income tax on dividends under the backup withholding rules of more than $5000 to one person

D. None of the above

Lesson 7 114. Laura sold her house. Her amount realized after selling expenses was $385,000. At the time of the sale, the

adjusted basis for the house was $300,000. If all of other conditions are met, what is the gain on the sale of her house?

A. $0 B. $42,500 C. $85,000 D. $300,000

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-19

115. Which of the following statements is false regarding Form 8949 - Sales and Other Dispositions of Capital Assets? A. The taxpayer uses Form 8949 to report sales and exchanges of capital assets B. Form 8949 allows the taxpayer and the IRS to reconcile amounts that were reported to him or her and the

IRS on Form 1099-B or 1099-S (or substitute statement) with the amounts he or she reports on his or her income tax return

C. If all Forms 1099-B the taxpayer received (and all substitute statements) show basis was reported to the IRS and if no correction or adjustment is needed, the taxpayer must always file Form 8949 and attach a statement of these transactions

D. Corporations and partnerships use Form 8949 to report undistributed long-term capital gains from Form 2439

116. The individual taxpayer uses Schedule D for all of the following except: A. To report nonbusiness bad debts B. To figure the overall gain or loss from transactions reported on Form 8949 C. To report a gain from Form 2439 D. To report a gain or loss from Form 4684

117. The taxpayer should keep accurate records that show the basis of a property and, if applicable, the adjusted

basis of the property should show which of the following? A. The purchase price B. The cost of improvements C. Depreciation D. All of the above

118. Mateo bought machinery on December 4, 2016. On June 4, 2017, he traded this machinery for other machinery

in a nontaxable exchange. On December 6, 2017, Mateo sold the machinery he got in the exchange. His holding period for this machinery began on which date?

A. December 4, 2016 B. December 5, 2016 C. June 4, 2017 D. June 5, 2017

119. Which of the following is considered a taxpayer’s capital asset?

A. Taxpayer’s house B. Real estate used in the trade or business C. Depreciable property used in the trade or business D. Supplies regularly used in the trade or business

120. The taxpayer can elect to treat musical compositions and copyrights in musical works as capital assets when he

or she sells or exchange them if certain conditions apply. The taxpayer must make the election within what time period of the due date (including extensions) of the income tax return for the tax year of the sale or exchange?

A. On or before the due date B. 30 days after the due date of the return C. 90 days after the due date of the return D. 6 months after the due date of the return

121. In 2012 Lois purchased a painting for $5,000 at a local art gallery. She decided to sell the painting in 2017 and

finds a buyer willing to pay $12,000. What is the maximum capital gains rate and maximum amount she may owe? A. 22% capital gains rate and $1,540 owed B. 24% capital gains rate and $1,680 owed C. 26% capital gains rate and $1,820 owed D. 28% capital gains rate and $1,960 owed

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-20

122. Gwen inherited 100 shares of SuperShoes stock when her mother died on October 21, 2015; the fair market value of the stock was $20 per share. Her mother paid $200 per share when she purchased the stock March 1, 2006. If Gwen sells all 100 shares for $50 per share on July 3, 2017, how should she report the sale on her income tax return?

A. $3,000 long-term capital gain B. $3,000 short-term capital gain C. $12,000 long-term capital gain D. $15,000 short-term capital loss

123. John and Jill Jones sold stock that resulted in a short-term capital loss of $5,000. They had no other capital

transactions during the year. Their taxable income was $10,000. How much of the capital loss is deductible on their joint return and how much must be carried over to the next year?

A. $0 loss; $5,000 carryover B. $1,500 loss; $1,500 carryover C. $3,000 loss; $0 carryover D. $3,000 loss; $2,000 carryover

124. Brandt exchanged his collection of stamp albums for a tractor from Virgil in September 2017. The fair market

value of the stamp albums is $3,000. The tractor has the same $3,000 fair market value. The collection of stamps cost Brandt $2,000 over the years to assemble. How should Brandt report this transaction on his income tax return?

A. He reports it as a capital transaction with a $0 gain B. He is not required to report it because it is not taxable C. He attaches a statement to his return explaining that the exchange was for something of equal value D. He reports a $1,000 capital gain

125. On a joint return in most situations, what is the maximum amount of gain a taxpayer could exclude from the sale

of his or her home? A. $200,000 B. $300,000 C. $400,000 D. $500,000

126. Christian owns two homes, one in Oregon and one in New Hampshire. In 2013 and 2014, he lived in the Oregon

home. In 2015 and 2016, he lived in the New Hampshire home. In 2017, he lived again in the Oregon home. Which of the following statements is true regarding Christian’s eligibility to exclude the gain on the sale of both of his homes in 2017?

A. He would be eligible to partially exclude the gain from the sale of the Oregon home in 2017 B. He would not be eligible to exclude the gain from the sale of the New Hampshire home in 2017 C. He would not be eligible to exclude the gain from the sale of the Oregon home in 2017 D. He would be eligible to exclude the gain from the sale of either home in 2017

127. Naomi bought and moved into a house in July 2013. She lived there for 13 months and then moved in with a

friend. She moved back into her own house in 2016 and lived there for 12 months until she sold it in July 2017. Which of the following is true regarding Naomi’s exclusion for the sale of her home?

A. Naomi meets the ownership test but not the use test B. Naomi meets the use test but not the ownership test C. Naomi meets both the ownership and use tests D. Naomi does not qualify for a partial or the entire exclusion

128. Greg bought a home on May 5, 2012. After living in it for 6 months, he moved out. He never lived in the home

again and sold it at a gain on June 28, 2017. Greg did not sell the home because of change of employment, health issues, or any unforeseeable event. Based on the ownership and use tests which of the following is true regarding Greg’s exclusion of the gain on the sale of his home?

A. He is entitled to claim the entire maximum exclusion of gain from the sale B. He is entitled to claim a reduced exclusion of gain from the sale C. He cannot exclude any part of his gain on the sale D. The sale of Greg’s home is considered a like-kind exchange.

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-21

129. The total gain on an installment method is generally the amount by which the selling price of the property sold exceeds adjusted basis in that property. The selling price includes all of the following except:

A. The money and the fair market value of property received for the sale of the property B. Any selling expenses C. Existing debt encumbering the property that the buyer assumes D. Unstated interest

Lesson 8 130. The income earned from a sole proprietorship is subject to Medicare and Social Security contributions. What is

the wage base limit for the 2.9% Medicare tax in 2017? A. $55,050 B. $118,500 C. $127,200 D. No Limitation

131. Which of the following statements about taxation of a sole proprietorship is correct?

A. Any income to the business is treated as income to the business owner B. It may be possible to defer income and therefore income tax to a different tax year C. They are not required to make quarterly payments of estimated tax liability, to both the state and to the

Federal government D. The income earned from a sole proprietorship is not subject to income and self-employment tax

132. In which of the following situations does a taxpayer have to recapture the depreciation deduction (meaning he or

she includes in income part or all of the depreciation he or she deducted in previous years)? A. If his or her business use of listed property falls to 50% or less in a tax year after the tax year, he or she

placed the property in service B. If he or she takes a Section 179 deduction for an asset and before the end of the asset's recovery period

the percentage of business use drops to 50% or less C. If he or she sells or exchanges depreciable property at a gain D. All of the above

133. When determining whether an individual is an independent contractor or an employee, which of the following can

be used to make this determination? A. If the individual is compensated for services provided then they are an employee B. If the individual is compensated for services provided then they are an independent contractor C. If the individual withholds taxes on a payment for services then the individual is an independent contractor D. If an employer withholds income taxes, withholds and pays Social Security and Medicare taxes, and pays

unemployment tax on wages paid, then the individual is an employee

134. Generally, if the taxpayer is an independent contractor he or she is considered self-employed, and should report income (nonemployee compensation) on which form?

A. Schedule A (Form 1040) B. Schedule B (Form 1040) C. Schedule C (Form 1040) D. Schedule D (Form 1040)

135. When considering whether an activity is a hobby or a business, which of the following is correct?

A. A hobby is defined as an activity done regularly in one's leisure time for pleasure and does not result in a profit

B. Schedule C can be used to report income derived from a hobby C. An activity is a business if it makes a profit during at least three of the last five tax years, including the

current year D. All of the above

Examination Questions - 45 Hour Federal Tax Law

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136. Dustin is a sole-proprietor who owns a small business that makes business cards for other companies. He started the company in 2017 and had $4,800 in total business expenses for the year. Which of the following applies to Dustin’s small business?

A. Dustin must use Schedule C when filing the business return B. Dustin can use Schedule C-EZ because he had less than $5,000 of expenses C. Dustin can use Schedule A because he had less than $5,000 of expenses D. Dustin does not have to file a Schedule C or C-EZ because his business had less than $5,000 in expenses

137. Which of the following statements is correct regarding Schedule C and C-EZ?

A. Small businesses with business expenses of $7,000 or less may be able to file Schedule C-EZ instead of Schedule C

B. Schedule C is used only to report profit from a business C. Schedule C is used to report profit or loss from a business D. Small businesses with less than 10 employees should use Schedule C-EZ

138. Kirk decides to use the simplified option for his home office deduction on his 2017 income tax return. He figures

he uses 200 square feet of his home for business. What is his allowable home office deduction? A. $0 B. $600 C. $1,000 D. $2,000

139. Liberty is calculating her cost of goods sold to enter on her Schedule C. Her inventory at the beginning of the

year amounted to $50,000. Her cost for labor and materials was $20,000. She had no other costs. Her inventory at the end of the year totaled $58,000. What amount for cost of goods sold will Liberty enter on her Schedule C?

A. $12,000 B. $20,000 C. $25,000 D. $50,000

140. A taxpayer can generally deduct premiums he or she pays for all of the following kinds of insurance related to

business except: A. Medical and dental insurance for him or herself and his or her family B. Liability insurance C. Insurance to secure a loan D. Workers’ Compensation insurance

141. In 2017, Noelle, a self-employed landscaper who uses the cash method of accounting, signed a 3-year health

insurance contract. She paid premiums of $500 for 2017, $550 for 2018, and $600 for 2019 when she signed the contract. What amount can she deduct for the premiums on her 2017 income tax return?

A. $0 B. $250 C. $500 D. $1,050

142. The general rule is that taxpayers who use a part of the home for legitimate business purposes can deduct

expenses allocable to that portion of the home used for those business purposes. To meet this qualification all of the following must apply except:

A. Part of the home is exclusively used on a regular basis as the principal place of business for any of the trades or businesses

B. Part of the home is exclusively used on a regular basis as a place of business used by patients, clients or customers to meet or deal with the taxpayer in the normal course of the trade or business

C. Part of the home is exclusively used on a regular basis in connection with the trade or business if it is a separate structure that is not attached to the home

D. Part of the home is used on a regular basis as a home office and family room used by the rest of the family for entertainment

Examination Questions - 45 Hour Federal Tax Law

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143. Travel expenses are the ordinary and necessary expenses of traveling away from home for business. Which of the following kinds of travel expenses are not applicable for deduction on Schedule C or C-EZ?

A. Cost of a hotel stay in the general area in which the taxpayer’s business is located B. Cost of travel by car between the taxpayer’s tax home and the out-of-town business destination C. Cost of business calls while on the business trip D. Costs of dry cleaning and laundry while on the business trip

144. The taxpayer can deduct any expenses paid or incurred for a membership at all of the following organizations

except: A. Civic or public service organizations B. Airline and hotel clubs C. Professional organizations (such as bar and medical associations) D. Trade associations

145. Alicia’s home is used as a daycare Monday through Friday for 12 hours per day for 250 days during the year. It

is also used on 50 Saturdays for 8 hours per day. What is the total number of hours that the house was used for daycare during the year that Alicia can include on Form 8829 - Expenses for Business Use of Your Home?

A. 0 hours B. 1,700 hours C. 3,000 hours D. 3,400 hours

146. Mona is self-employed working as a fortune teller. Her net income from this activity was $250 in 2017. Which of

the following is true regarding her self-employment (SE) tax for the year? A. She has SE tax because she was self-employed B. She has SE tax because net income was earned C. She has no SE tax since net income was less than $400 D. She has no SE tax because net income was less than $1,000

147. All of the following are true when reporting car and truck expenses on Schedule C except:

A. Placing the company logo, displays, or advertisements on a vehicle changes the use from personal to business use

B. If the taxpayer owns or leases five or more cars that are used for business at the same time, he or she must use the actual expense method

C. If the taxpayer takes the standard mileage rate, multiply the number of business miles driven by 54 cents D. If the taxpayer takes the standard mileage rate, add to the total amount any amounts for parking fees and

tolls

148. Harvey is the sole proprietor of a flower shop. He drove his van 20,000 miles during the year. 16,000 miles were for delivering flowers to customers and 4,000 miles were for personal use. Instead of figuring actual expenses, Harvey decides to use the standard mileage rate to figure the deductible costs of operating his van. What amount can Harvey claim as the cost of operating his van as a business expense in 2017?

A. $0 B. $4,600 C. $8,560 D. $9,820

149. Carl, a single filer, has $145,000 in self-employment income and $130,000 in wages. Carl’s employer did not

withhold Additional Medicare Tax. Therefore, Carl is liable to pay Additional Medicare Tax on what amount of self-employment income?

A. $0 B. $75,000 C. $130,000 D. $145,000

Examination Questions - 45 Hour Federal Tax Law

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150. When determining earnings subject to SE tax, the taxpayer may want to use one of the optional methods whether they have a small net profit or loss and which of the following conditions applies?

A. They are eligible to receive the Additional Child Tax Credit B. They can claim a Credit for Dependent or Child Care Expenses C. Taxpayer wants to receive a Credit for Social Security Benefit Coverage D. All of the above

151. Victor has a farm that he operates. He also derives $7,000 per year in income from nonfarm activities. What

method or methods can Victor use to report the income from his nonfarm activities? A. Victor can use the farm and nonfarm methods whichever is most beneficial to him B. Victor must use the farm-only method for all income earned C. Victor must use the nonfarm method for all income earned D. Victor can use the nonfarm optional method for earnings that do not come from farming activities and only

if he has used this method less than 5 years 152. Which of the following business expenses related to advertising is not allowed as a deductible expense?

A. Promoting a business through paid advertisements on the internet B. Business cards C. Promotional items D. Advertising with the intention of influencing political legislation

Lesson 9 153. Jessica paid $1,500 for electricity during the tax year. She used one-third of the electricity for personal purposes

and two-thirds for farming. Under these circumstances, Jessica can deduct what amount of her electricity expense as a farm business expense?

A. $0 B. $500 C. $750 D. $1,000

154. Phil used his rental property for personal use for 7 days and rented it for 63 days. In most cases, what percentage

of his expenses are not rental expenses and cannot be deducted on Schedule E? A. 10% B. 20% C. 50% D. 90%

155. Kai signs a 10-year lease to rent a property. In the first year, he receives $5,000 for the first year's rent and

$5,000 as rent for the last year of the lease. What amount must Kai include in income in the first year? A. $0 B. $2,500 C. $5,000 D. $10,000

156. Larry rents his townhouse to Sue for $1,400 a month. At the beginning of the lease he asked for a $2,000 security

deposit. When Sue moved out at the end of the lease Larry used $1,400 of the security deposit for the last month’s rent. What amount of the security deposit will Larry need to include in rental income on his tax return?

A. $0 B. $1,000 C. $1,400 D. $2,000

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-25

157. Wendy is a single taxpayer with adjusted gross income of $92,300 for tax year 2017. She has rental income of $55,000 and rental expenses of $80,000. What can Wendy report on her tax return given this situation?

A. She can deduct $10,000 because her rental expenses exceeded her rental income B. She can deduct $15,000 because her rental expenses exceeded her rental income C. She can deduct $25,000 because her rental expenses exceeded her rental income D. She can deduct $30,000 because her rental expenses exceeded her rental income

158. A taxpayer should keep adequate records to prove his or her expenses or have sufficient evidence that will

support his or her own statement. This documentary evidence ordinarily will be considered adequate if it shows all of the following except:

A. The amount of the expense B. The date C. The place D. The method of payment

Lesson 10 159. A taxpayer can depreciate property under all of the following circumstances except:

A. He or she made a down payment to purchase rental property and assumed the previous owner's mortgage B. He or she bought a new van that he or she will use only for his or her courier business and he or she will

be making payments on the van over the next 5 years C. He or she bears the burden of exhaustion of the capital investment in a leased property D. He or she leases property from someone to use in his or her trade or business or for the production of

income

160. To figure the basis of property a taxpayer receives as a gift, it is necessary to have which of the following? A. Adjusted basis to the donor just before it was given to the taxpayer B. The Fair Market Value (FMV) at the time it was given to the taxpayer C. Any gift tax paid on the property D. All of the above

161. Alyssa is an attorney. She maintains a library for use in her profession. She also buys technical books and

journals for use in her business. Which of the following is true regarding Alyssa’s depreciable property? A. She can depreciate any books and journals that have a useful life that extends substantially beyond the

year she placed them in service B. She cannot depreciate her library C. She can depreciate all of her technical books and journals regardless of useful life D. She can depreciate her library but none of her technical books and journals

162. Dave buys a building for $20,000 cash and assumes a mortgage of $80,000 on it, what is his basis in the

property? A. $0 B. $20,000 C. $80,000 D. $100,000

163. Under final regulations, a self-employed taxpayer may elect to apply a de minimis safe harbor to amounts he or

she paid to acquire or produce tangible property to the extent such amounts are deducted by him or her for financial accounting purposes or in keeping his or her books and records. For taxable years beginning on or after January 1, 2016, the Internal Revenue Service increased the de minimis safe harbor threshold to what amount per invoice or item for self-employed taxpayers without applicable financial statements?

A. $500 B. $1,000 C. $2,000 D. $2,500

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-26

164. Ken Larch is a tailor. He bought two industrial sewing machines from his father. He placed both machines in service in the same year he bought them. All of the following are true except:

A. The sewing machines do not qualify as Section 179 property B. Ken cannot claim a Section 179 deduction for the cost of these machines C. Ken can claim a partial Section 179 deduction D. The asset must be used at least 50% of the time for business in the first year it is placed in service to

qualify for a Section 179 deduction

Lesson 11

165. Sandy is a single taxpayer who collected Social Security benefits of $22,000. The Social Security benefits were her only income for the tax year. What is the amount of taxes she will owe when she files her income tax return?

A. $0 B. $2,200 C. $5,500 D. $11,000

166. In 2016, Joelle received $3,000 in Social Security benefits, and in 2017 she received $2,700. In March 2017, the

Social Security Administration (SSA) notified her that she should have received only $2,500 in benefits in 2016. During 2017, she repaid $500 to SSA. The Form SSA-1099 she received for 2017 shows what amount for her net benefits?

A. $500 B. $2,200 C. $2,500 D. $2,700

167. George, who is 34 years old and single, earns $24,000 in 2017. His IRA contributions for 2017 are limited to what

amount? A. $0 B. $1,000 C. $3,500 D. $5,500

168. Danny, an unmarried college student working part-time, earns $3,500 in 2017. His IRA contributions for 2017 are

limited to what amount? A. $0 B. $1,000 C. $3,500 D. $5,500

169. Wayne, age 53, and Janet, age 51, are married and file a joint return. Wayne is covered by an employer

retirement plan. In 2017, Wayne had compensation of $50,000 and Janet had compensation of $175,000. Their modified adjusted gross income (MAGI) was $200,000. What is the amount of the deductible contribution that can be made for Janet to her traditional IRA for 2017?

A. $0 B. $2,500 C. $3,000 D. $5,000

170. The pension or annuity payments that a taxpayer receives are fully taxable if he or she has no cost in the contract

because of which of the following situations? A. The taxpayer did not pay anything or is not considered to have paid anything for the pension or annuity.

Amounts withheld from his or her pay on a tax-deferred basis are not considered part of the cost of the pension or annuity payment

B. The taxpayer’s employer did not withhold contributions from his or her salary C. The taxpayer received all of his or her contributions tax free in prior years D. All of the above

Examination Questions - 45 Hour Federal Tax Law

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171. Sarah, age 52, is married with no taxable compensation for 2017. She and her husband reported taxable compensation of $60,000 on their 2017 joint income tax return. Sarah may contribute what amount to her IRA for 2017?

A. $0 B. $1,000 C. $5,500 D. $6,500

172. Elizabeth works for the Rockland Quarry Company, a small business with 50 employees. Rockland has decided

to establish a SIMPLE IRA plan for its employees and will match its employees’ contributions dollar-for-dollar up to 3% of each employee’s compensation. Elizabeth has a yearly compensation of $50,000 and contributes 5% of her compensation to her SIMPLE IRA. What is the total contribution to Elizabeth’s SIMPLE IRA for 2017?

A. $0 B. $2,000 C. $2,500 D. $4,000

173. Joe is 57 years old and unemployed. He decides to take an early withdrawal or distribution from his IRA to make

ends meet. Which of the following apply to Joe as a result of this transaction? A. Joe incurs a 10% Federal penalty because he withdrew funds for an unqualified purpose before he was 59½

years old B. Joe incurs a 15% Federal penalty because he withdrew funds for an unqualified purpose before he was 59½

years old C. Joe incurs a 20% Federal penalty because he withdrew funds for an unqualified purpose before he was 59½

years old D. Joe does not incur a penalty because he is over the age of 55

174. Peter is 38 years old and has just purchased his first home. In order to come up with the down payment he

withdraws $10,000 from a traditional IRA account he set up when he was 18. Which of the following applies to Peter as a result of this transaction?

A. He incurs a 10% Federal penalty for withdrawing funds before he is 59 ½ years old B. He incurs no penalty since he is a first-time homebuyer, used the funds for this purpose, and did not

exceed the maximum withdrawal amount of $10,000 C. He incurs a 15% Federal penalty for withdrawing funds before he was 59 ½ years old D. He incurs a 20% Federal penalty for withdrawing funds before he was 59 ½ years old

175. Lori and Mike, both 42 years old, have been married for 20 years and have two children ages 14 and 17. Mike

has worked at Computer Corp. while Lori stayed home taking care of the kids. Once both the kids entered high school Lori decided she wanted to go back to college and finish her degree. Mike uses his IRA funds to pay for the tuition, books, supplies and associated fees for Lori to return to college. Which of the following apply as a result of this transaction?

A. Mike incurs a 10% Federal penalty for withdrawing funds before 59 ½ years old B. Mike incurs a 15% Federal penalty for withdrawing funds before 59 ½ years old C. Mike incurs a 20% Federal penalty for withdrawing funds before 59 ½ years old D. Mike incurs no penalty since the funds were used for a qualified higher educational expense and Lori is

Mike’s spouse

176. For a Roth IRA, a payment or distribution is not a qualified distribution if it is made less than how many tax years from the first tax year in which the individual made a contribution?

A. 2 years B. 3 years C. 4 years D. 5 years

Examination Questions - 45 Hour Federal Tax Law

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177. Francisco, age 57, is a married, filing jointly taxpayer. His modified adjusted gross income (MAGI) for 2017 was $220,500. What is the maximum annual nondeductible contribution he can make to a Roth IRA in 2017?

A. $0 B. $1,000 C. $2,500 D. $5,500

178. Which of the following a false statement regarding a direct rollover option distribution to another qualified

retirement plan? A. To be a direct eligible rollover, the taxpayer must pay withholding tax on the amount being rolled over B. On a direct eligible rollover, no tax will be withheld from any part of the distribution C. The taxpayer may choose to have any part or all of an eligible rollover distribution paid directly to another

retirement plan D. If an eligible rollover distribution is paid from an employer-sponsored retirement plan to the taxpayer generally

there will be tax withheld 179. The IRA one-rollover-per-year rule applies to which of the following?

A. Rollovers from a traditional IRA to a Roth IRA (conversions) B. Rollovers from a traditional IRA to another traditional IRA C. Trustee-to-trustee transfers to another IRA D. IRA-to-plan rollovers

Lesson 12 180. An exclusion is provided for premiums paid by an employer for "group-term" life insurance, up to what amount

for each employee? A. $25,000 B. $30,000 C. $40,000 D. $50,000

181. Connie and her spouse, Mark, (both over 65) are filing a joint return for 2017. They both received Social Security

benefits during the year. In January 2018, Connie received a Form SSA-1099 showing net benefits of $7,500 in box 5. Mark received a Form SSA-1099 showing net benefits of $3,500 in box 5. Connie also received a taxable pension of $22,000 and interest income of $500. She did not have any tax-exempt interest income. What amount of Connie’s Social Security benefits is taxable for 2017?

A. $0 B. $500 C. $3,750 D. $7,500

182. Heidi received a scholarship of $2,500. The scholarship was not received under either the National Health Service

Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program. As a condition for receiving the scholarship, Heidi must serve as a part-time teaching assistant. Of the $2,500 scholarship, $1,000 represents payment for teaching. The provider of her scholarship gives Heidi a Form W-2 showing $1,000 as income. Her qualified education expenses were $2,000. Assuming that all other conditions are met, what portion of Heidi’s scholarship is taxable?

A. $0 B. $500 C. $1,000 D. $2,000

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-29

183. Wayne was a bona fide resident of Brazil for all of 2016 and 2017. He reports his income on the cash basis. In 2016, he was paid $86,300 for work he did in Brazil during that year. He excluded all of the $86,300 from his income in 2016. In 2017, Wayne was paid $117,300 for his work in Brazil. $18,800 was for work he did in 2016 and $98,500 was for work he did in 2017. What amount of the 2016 income received in 2017 can Wayne exclude from his 2017 income tax return?

A. $0 B. $10,900 C. $15,000 D. $18,800

184. An employer can exclude the value of lodging he or she furnishes to an employee from the employee's wages

for all of the following reasons except: A. It is furnished on the business premises B. It is furnished for the employer’s convenience C. The employee must accept it as a condition of employment D. The employer will allow the employee to choose to receive additional pay instead of lodging

185. What is the maximum amount excludable from gross income for a dependent care assistance program for an

employee who is married filing jointly? A. $5,000 B. $6,000 C. $7,000 D. $8,000

186. Chad is employed as a flight attendant for a company that owns both an airline and a hotel chain. His employer

allows him to take personal flights (if there is an unoccupied seat) and stay in any one of their hotels (if there is an unoccupied room) at no cost to him. What amounts must Chad include in his income?

A. The value of the flight B. The value of the hotel room C. Both the value of the flight and the hotel room D. Neither the value of the flight nor the hotel room

187. An employer cannot exclude from the wages of a highly compensated employee any part of the value of a

discount that is not available on the same terms to all employees. For this exclusion, a highly compensated employee for 2017 is an employee who was a 5% owner at any time during the year or the preceding year or received more than what amount in pay for the preceding year?

A. $100,000 B. $120,000 C. $125,000 D. $145,000

188. In addition to the annual exclusion of $14,000, a taxpayer also can give which of the following without triggering

the gift tax? A. Gifts to a political organization for its use B. Gifts to cover educational expenses C. Gifts used to pay for medical expenses D. All of the above

189. When Aaron, age 25, graduated from college last year he had $5,000 left in his Coverdell ESA. He wanted to

give this money to his younger sister, who was still in high school. Aaron contributed the same $5,000 distribution from his Coverdell ESA to his sister's Coverdell ESA within 60 days of the distribution. What amount of the distribution is taxable?

A. $0 B. $1,000 C. $2,500 D. $5,000

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-30

190. In 2017, employers may reimburse bicycle commuters up to what amount per month tax free for each qualified bicycle commuting month a bicycle is used for transportation between the employee's home and place of employment?

A. $10 B. $15 C. $20 D. $25

191. If the taxpayer’s employer provides him or her with a product or service and the cost of it is so small that it would

be unreasonable for the employer to account for it, the value is not included in the taxpayer’s income. In most cases, this de minimis fringe benefit includes the value of all of the following except:

A. Cab fares home when working overtime B. Discounts at company cafeterias C. Holiday gifts that can easily be exchanged for cash D. Company picnics

192. Marisela has family health insurance coverage in 2017. The annual deductible for the family plan is $3,500. This

plan also has an individual deductible of $1,500 for each family member. The plan does not qualify as an HDHP because the deductible for an individual family member is less than the minimum annual deductible of what amount for family coverage?

A. $1,300 B. $1,500 C. $2,600 D. $6,650

193. Using a company car for business purposes is not considered a fringe benefit, while personal use is a taxable

fringe benefit. Personal use includes all of the following except: A. Commuting to and from work B. Running errands C. Allowing a family member who is not a company employee to use the vehicle D. Making company deliveries

194. Marco and Leigh Ann Green (husband and wife) moved from New Jersey to Oregon on May 1, 2017. Leigh Ann

immediately found a job as a part-time substitute teacher, but only worked 23 weeks during the year. Marco, a self-employed solar heating unit salesman, could not continue in the same line of work after the move. In Oregon he held one full-time job for 20 weeks, then at another full-time job for 6 more weeks during 2017. Marco expects that he will start a new full-time job as an employee of a landscaping company in January of 2018. Can Marco and Leigh Ann claim a deduction for moving expenses on their 2017 jointly filed income tax return?

A. They cannot because Marco did not meet the 39-week test in 2017 B. They can because Leigh Ann worked 23 weeks and Marco worked 26 weeks for a total of 49 weeks C. They can because Marco expects to meet the 39-week test in 2018 D. They cannot because both Leigh Ann and Marco have to meet the 39-week test individually

195. Rich’s divorce decree calls for him to pay his former spouse $200 a month as child support and $150 a month

as alimony. If he pays the full amount of $4,200 during the year, Jeanna, his former spouse, can exclude what amount from her income?

A. $150 B. $200 C. $1,800 D. $2,400

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-31

196. Camilo is a self-employed roofer. He reported a profit of $30,000 on his Schedule C. He had other taxable income of $5,000. He paid $3,000 for hospitalization insurance. His self-employment tax was $4,656. He paid his former wife $4,000 in court-ordered alimony and $4,000 in child support. What is the amount Camilo can deduct in arriving at adjusted gross income (AGI)?

A. $5,328 B. $9,328 C. $13,656 D. $15,656

197. Trent and Kim divorced on September 1, 2017. As part of the divorce decree, beginning in September, Trent was

to make payments to Kim of $1,000 a month for the balance of the year for recent medical expenses; child support payments of $1,000 per month, and $1,500 a month for the mortgage payment on a jointly-owned home. Kim and the children will continue to live in the home. What is the amount that Trent can deduct as alimony for 2017?

A. $1,000 B. $4,000 C. $7,000 D. $10,000

198. Generally, no gain or loss is recognized on a transfer of property from the taxpayer to (or in trust for the benefit

of) his or her former spouse if the transfer is incident to their divorce. This rule applies even if the transfer was in exchange for all of the following except:

A. Cash B. The release of marital rights C. The assumption of liabilities D. Certain transfers in trust

199. If a separation decree says a taxpayer is to pay $2,000 a month, and he or she pays $2,200 a month, what is the

amount that is deductible as alimony per month? A. $1,000 B. $1,100 C. $2,000 D. $2,200

200. The taxpayer can deduct alimony he or she paid, whether or not he or she itemizes deductions on the return. If

the taxpayer does not provide the spouse's Social Security number, the deduction may be disallowed and he or she may have to pay a penalty for what amount?

A. $50 B. $100 C. $150 D. $200

201. In tax year 2017, employers can generally exclude a maximum of what amount per month from the employee's

wages for combined commuter highway vehicle transportation and transit passes? A. $255 B. $275 C. $300 D. $345

202. Participants in a cafeteria plan must be permitted to choose among at least how many taxable benefits (such as

cash) and at least one qualified benefit? A. One B. Two C. Three D. Four

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-32

203. Hal had previously worked in Dallas, TX for Tasty Chip Inc. but in 2017 he takes a new job 95 miles away at Luby’s in Waco, TX. Which of the following is true regarding the moving expense exclusion?

A. Hal is not eligible since the move is not more than 150 miles from his previous location B. Hal is not eligible since the move is not more than 100 miles from his previous location C. Hal is eligible since the move is greater than 50 miles from his previous location D. Hal is eligible since the move required him to change companies

204. Chloe lived in Portland and accepted a job in Atlanta. Under an accountable plan, her employer reimbursed her

for her actual traveling expenses from Portland to Atlanta and the cost of moving her furniture to Atlanta. Chloe’s employer included $3,200 on her Form W-2, box 12, with Code P. However, Chloe’s allowable moving expenses were $3,900. What amount can she deduct as moving expenses on Form 3903 - Moving Expenses?

A. $0 B. $350 C. $700 D. $3,200

205. Generally, the amount a taxpayer may deduct for the Student Loan Interest Deduction is the lesser of what

amount or the amount of interest he or she actually paid? A. $1,000 B. $1,500 C. $2,000 D. $2,500

206. Renee works at Indigo Inc. and attends school part-time as part of her company’s educational assistance

program. In 2017 her company reimbursed her a total of $6,250 for tuition, books, supplies, fees, etc. related to her schooling. How much of this amount can Renee exclude from her gross income?

A. $0, this is a company sponsored benefit and does affect the individual’s return B. $5,250, the maximum exclusion allowed under an employer’s educational assistance program C. $5,750 the maximum exclusion allowed under an employer’s educational assistance program D. $6,250 the maximum exclusion allowed under an employer’s educational assistance program

Lesson 13 207. Stan figured his adjusted gross income for 2017 was $40,000. He paid medical expenses of $2,500. What amount

of his medical expenses can he deduct on his tax return? A. $0 B. $500 C. $1,500 D. $4,000

208. In 2017, Bill Jones drove 3,800 miles for medical reasons. He spent $500 for gas, $30 for oil, and $100 for tolls

and parking. Using either actual expenses or standard mileage rate, what is the largest amount he can include for car expenses in his medical expenses on his tax return?

A. $630 B. $658 C. $688 D. $746

209. Which of the following expenses are not deductible as medical expenses?

A. Insulin used for diabetes B. Wig, purchased upon the advice of a physician for the mental health of a patient who has lost all of his or

her hair from disease C. Swimming lessons, recommended by a doctor for improvement of general health D. Acupuncture used for migraines

Examination Questions - 45 Hour Federal Tax Law

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210. Susan is a 45-year-old single filing taxpayer. What is the maximum amount of qualified long-term care insurance premiums she is allowed to include as medical expenses on Schedule A (Form 1040) in 2017?

A. $410 B. $770 C. $1,530 D. $4,090

211. Which of the following items, generally, is deductible as a real estate tax?

A. Property tax paid through an escrow account attached to a mortgage loan B. Taxes for local benefits, such as assessments for streets C. Itemized charges for services D. Transfer taxes

212. Generally, the proceeds for all of the following transactions must be reported on Form 1099-S - Proceeds From

Real Estate Transactions except: A. A burial plot or vault B. Improved or unimproved land, including air space C. Inherently permanent structures, including any residential, commercial, or industrial building D. A condominium unit and its appurtenant fixtures and common elements, including land

213. Ron pays $25 each quarter for a state property tax based only on the value of his boat. What amount of this

personal property tax is deductible on his Federal tax return? A. $0 B. $25 C. $50 D. $100

214. John and Peggy Harris sold their home on May 7. Through April 30, they made home mortgage interest payments

of $1,220. The settlement sheet for the sale of the home showed $50 interest for the 6-day period in May up to, but not including, the date of sale. What is the amount of their mortgage interest deduction?

A. $0 B. $610 C. $1,220 D. $1,270

215. Mia pays $65 for a ticket to a dinner-dance at a church. Her entire $65 payment goes to the church. The ticket to

the dinner-dance has a fair market value of $25. When Mia buys the ticket, she knows its value is less than her payment. What amount can Mia deduct as a charitable contribution to the church?

A. $0 B. $25 C. $40 D. $65

216. Melissa is blind. She is self-employed and must use a reader to do her work. She uses the reader both during

her regular working hours at her place of work and outside her regular working hours away from her place of work. The reader's services are only for her work. Which of the following is true regarding Melissa’s work-related expenses?

A. She cannot deduct her expenses for the reader because the expense is not for attendant care services at her place of work

B. She cannot deduct her expenses for the reader because she is self-employed C. She cannot deduct her expenses for the reader because she uses it away from her place of work D. She can deduct her expenses for the reader as an impairment-related work expense because it is an

expense in connection with her place of work that is necessary for her to be able to work

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-34

217. Jennifer received $6,000 interest; $4,800 was tax-exempt and $1,200 was taxable. In earning this income, she had $500 of expenses. Jennifer cannot specifically identify the amount of each expense item that is for each income item. What amount of interest expenses can Jennifer deduct from her tax return?

A. $0 B. $100 C. $400 D. $500

218. Which of the following expenses that the taxpayer incurs as an investor is deductible?

A. Fees the taxpayer pays to a broker, bank, trustee, or similar agent to collect investment income, such as taxable bond or mortgage interest

B. Transportation and other expenses the taxpayer pays to attend stockholders' meetings of companies in which he or she has no interest other than owning stock

C. Interest on money the taxpayer borrows to buy or carry a single-premium life insurance, endowment, or annuity contract

D. Interest on money the taxpayer borrows to buy or carry a life insurance, endowment, or annuity contract if he or she plans to systematically borrow part or all of the increases in the cash value of the contract

219. If a taxpayer claimed an itemized deduction for a given year for qualified foreign taxes, he or she can choose

instead to claim a foreign tax credit that will result in a refund for that year by filing an amended return on Form 1040X within how many years from the original due date of his or her return?

A. Three years B. Five years C. Seven years D. Ten years

220. All of the following are true regarding the deduction for qualified foreign taxes except:

A. Generally, a taxpayer can take either a deduction or a credit for income taxes imposed by a foreign country B. A deduction or credit can also be taken for foreign income taxes paid on income that is exempt from U.S.

tax under the foreign earned income exclusion or the foreign housing exclusion C. A taxpayer can change his or her choice between a deduction or a credit for each year's taxes D. A taxpayer can figure his or her tax claiming the credit and claiming the deduction then fill out his or her

return the way that benefits him or her the most 221. Charitable contributions of what amount or more must be substantiated by a written acknowledgment from a

qualified organization? A. $250 B. $300 C. $350 D. $400

222. Bill donated $100 to the American Red Cross, $200 to the Boy Scouts of America, and $300 to his neighbor

whose home was destroyed by an earthquake. How much is Bill's deduction for charitable contributions? A. $100 B. $300 C. $400 D. $500

223. Anita donates a used car to a qualified organization. She bought it 3 years ago for $9,000. A used car guide

shows the fair market value for this type of car is $6,000. However, Anita gets a Form 1098-C from the organization showing the car was sold for $2,900. The vehicle was neither used nor improved by the organization given nor sold to a needy individual. If Anita itemizes her deductions, what amount can she deduct for her donation?

A. $0 B. $500 C. $2,900 D. $6,000

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-35

224. A taxpayer contributing a qualified vehicle valued at over what amount must obtain from the charity a Form 1098-C Contributions of Motor Vehicles, Boats, and Airplanes?

A. $500 B. $750 C. $1,000 D. $1,500

225. After an individual has figured the casualty or theft loss on personal-use property, he or she must reduce that

loss by what amount when figuring the deduction limits for personal-use property? A. $100 B. $150 C. $200 D. $250

226. In June, Alvaro discovered his house had been burglarized. His loss after insurance reimbursement was $2,000.

His adjusted gross income for the year he discovered the theft is $29,500. What amount can Alvaro claim as a theft loss deduction?

A. $0 B. $100 C. $1,790 D. $1,900

227. A hailstorm damages Royce’s home and his car. He determines the amount of loss to his home is $4,000 and

$600 to his car. Since the losses are due to a single event, Royce combines the losses and reduces the combined total by what amount (prior to reducing the total of the loss by 10% of his adjusted gross income)?

A. $0 B. $100 C. $200 D. $500

228. Which of the following miscellaneous expenses, which may be tax deductible on the tax return, is subject to the

2% floor? A. Union dues and expenses B. Amortizable premium on taxable bonds C. Casualty and theft losses from income-producing property D. Federal estate tax on income in respect of a decedent

229. Which of the following fees (all of which are not ordinary and necessary expenses of a business or income

producing activity) is deductible for Federal income tax purposes? A. Driver’s license B. Hunting license C. Marriage license D. Motor boat registration

230. Cindy’s state charges a yearly motor vehicle registration tax of 1% of value plus 50 cents per hundredweight.

She paid $167 based on the value ($15,000) and weight (3,400 lbs.) of her car. What amount can she deduct as a personal property tax?

A. $0 B. $150 C. $160 D. $167

231. A taxpayer must keep an accurate diary or similar record of wagering losses and winnings. The diary should

contain all of the following information except: A. The date and type of the specific wager or wagering activity B. The name and address or location of the gambling establishment C. The names of other persons present with the taxpayer at the gambling establishment D. The number of days of wagering activity

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-36

232. Shannon won $1,000 in a poker tournament she entered in May. In July and September, she lost $600 and $700 in two other tournaments. She reported $1,000 of gambling winnings on Form 1040. What amount can Shannon deduct as gambling losses for the year on Schedule A?

A. $600 B. $700 C. $1,000 D. $1,300

233. Pablo borrowed $1,000 for a bona fide business loan on August 31, 2017, payable in 90 days at 12% interest.

On November 30, 2017, he paid this with a new note for $1,030, due on March 1, 2018. If he uses the cash method of accounting, what amount of interest can he deduct on his 2017 income tax return?

A. $0 B. $10 C. $20 D. $25

234. A taxpayer’s new puppy causes $1,000 damage to his or her antique rug before it was housebroken. What

amount of the damages are deductible as a casualty loss? A. $0 B. $100 C. $500 D. $1,000

235. A car door is accidentally slammed on Muriel’s hand, breaking the setting of her diamond ring. The diamond falls

from the ring and is never found. Which of the following is true regarding the loss of the diamond? A. She can deduct the loss based on the mere disappearance of money or property B. The loss of the diamond is a casualty because it resulted from an identifiable event that was sudden,

unexpected, or unusual C. The loss of the diamond is not a casualty because it resulted from an identifiable event that was sudden,

unexpected, or unusual D. Deductible casualty losses cannot result from an unusual event that is not a day-to-day occurrence

236. Deductible ordinary and necessary expenses that a taxpayer incurs going from one work place to another in the

course of their employment, when not traveling away from home include which of the following? A. Taxi between home office and work place B. Cost of commuting to work C. Parking fees at work D. All of the above

237. Henry is a teacher who has satisfied the minimum requirements for teaching. His employer requires him to take

an additional college course each year to keep his teaching job. The courses will not qualify Henry for a new trade or business. All of the following are true regarding work-related education except:

A. The courses are qualifying work-related education even if Henry eventually receives a master's degree B. The courses are qualifying work-related education even if Henry eventually receives an increase in salary

because of this extra education C. The course requirement serves a bona fide business purpose of his employer D. The courses are not qualifying work-related education because they are not part of a program that will

qualify Henry for a new trade or business

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-37

238. Debra Smith is employed as a salesperson. She is not a statutory employee. Her adjusted gross income is $40,000, and she did not receive any reimbursement for her expenses. She has the following qualifying miscellaneous deductions:

• Entertainment expenses $500 • Transportation expenses $500 • Home office expenses $1,100 • Tax return preparation $200 • Investment counseling $300

Compute the amount of her allowable deduction she can take on her Form 2106-EZ for business expenses. A. $200 B. $800 C. $1,300 D. $1,850

239. Lucy decided to itemize on her return. She has the following receipts:

• Federal income tax $10,000 • State income tax $1,000 • County real estate tax $2,000 • Fee for her car inspection that she uses only personally $275 • Homeowners' association fees on her personal home $500

Compute the amount of the deduction she can take on her Schedule A, Itemized Deductions. A. $3,000 B. $3,275 C. $4,000 D. $12,000

Lesson 14 240. Failure to meet due diligence requirements by a paid tax preparer in determining the taxpayer's eligibility for, and

the amount of, the Earned Income Tax Credit (EITC) could result in a penalty of what amount? A. $100 for each failure B. $250 for each failure C. $300 for each failure D. $510 for each failure

241. A tax practitioner must keep the records described in Part IV of the due diligence checklist at the bottom of Form

8867. He or she must keep those records for 3 years from the latest of all of the following dates except: A. Due date of the tax return B. Due date of the tax return including extensions C. Date the return was filed (if the tax practitioner is a signing tax return preparer electronically filing the

return) D. Date the return was presented to the taxpayer for signature (if the tax practitioner is a signing tax return

preparer not electronically filing the return)

242. Brent is a single taxpayer who has one qualifying child. His adjusted gross income (AGI) is $57,550. His investment income for 2017 is $2,100. Which of the following statements is true regarding Brent’s ability to claim the Earned Income Tax Credit (EITC)?

A. He cannot claim the EITC because his investment income is not less than $2,000 B. He cannot claim the EITC because his adjusted gross income (AGI) is not less than $39,617 C. He cannot claim the EITC because he only has one qualifying child D. He cannot claim the EITC because he is not married, filing jointly

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-38

243. When determining earned income, which of the following does not qualify for the Earned Income Tax Credit? A. Wages B. Salaries C. Tips D. Unemployment compensation

244. For purposes of the Earned Income Tax Credit (EITC), which of the following is a requirement for a qualifying

child? A. Is over age 24 at the end of 2017 and not permanently and totally disabled B. Has lived with the taxpayer in the United States for at least 12 months C. Is filing a joint return D. Meets the relationship test

245. All of the following child and dependent care expenses may qualify as work-related expenses for the Child and

Dependent Care Credit except: A. Expenses for a child in nursery school, preschool, or similar programs for children below the level of

kindergarten B. Expenses that allow the taxpayer to work or look for work C. The cost of sending a child to a day camp specializing in computer technology D. The cost of sending a child to an overnight camp

246. Kevin and Jenny, who are both working full-time, have three children all under the age of ten. The two youngest

children, who are three and five years old, attended Eastside Pre-School for a total cost of $3,000. Ervin, who is nine, attended Big Kid Daycare after school at a cost of $2,000. Jenny has earned income of $15,000 and Kevin earns $14,000. What amount of childcare expenses should be used to determine the Child and Dependent Care Credit?

A. $3,000 B. $5,000 C. $14,000 D. $15,000

247. Gina works 3 days a week. While she works, her 6-year-old child attends a dependent care center, which

complies with all state and local regulations. Gina can pay the center $150 for any 3 days a week or $250 for 5 days a week. Her child attends the center 5 days a week. For the purposes of the Child and Dependent Care Credit, what are Gina’s work-related expenses for the center per week?

A. $0 B. $75 C. $150 D. $250

248. A married taxpayer, filing jointly must reduce his or her Child Tax Credit if his or her modified adjusted gross

income (MAGI) is above what amount? A. $80,000 B. $90,000 C. $100,000 D. $110,000

249. Rob’s 10-year-old nephew lives in Mexico and qualifies as his dependent. However, his nephew is not a U.S.

citizen, U.S. national, or U.S. resident alien. Which of the following is true regarding the Child Tax Credit? A. Rob’s nephew is a qualifying child for the Child Tax Credit B. Rob’s nephew is not a qualifying child for the Child Tax Credit C. Rob’s nephew only qualifies for the Additional Child Tax Credit D. Rob’s nephew qualifies for a partial Child Tax Credit

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-39

250. George Alexander pays $9,300 in tuition and fees in December 2017, and his child began college in January 2018. He filed his 2017 tax return on February 14, 2018, and claimed a Lifetime Learning Credit of $1,860. He claimed no other tax credits. After he filed his return, his child withdrew from two courses and George received a refund of $2,900. He must refigure his 2017 Lifetime Learning Credit using $6,400 of qualified education expenses instead of $9,300. After George refigures the credit he determines his tax liability increased by what amount?

A. $0 B. $580 C. $1,280 D. $1,860

251. For the purposes of the Lifetime Learning Credit, which of the following is not a qualifying student?

A. A student who claims the American Opportunity Credit in the same year B. A part-time student C. A student in a graduate program D. A student in a vocational program

252. Sandy is a sophomore at the University of California. She paid $2,000 in tuition, $300 for books, and $150 for

student fees. She also paid room and board of $2,500. For the calculation of the American Opportunity Credit, what is the total qualifying educational expense for Sandy?

A. $2,000 B. $2,150 C. $2,450 D. $4,500

253. Small businesses that have fewer than how many full-time equivalent employees and provide healthcare

coverage may be eligible for the Small Business Health Care Tax Credit? A. 25 B. 35 C. 45 D. 55

254. Mary is a single taxpayer and has modified adjusted gross income of $80,000, what is the maximum Adoption

Credit she can claim on her 2017 income tax return? A. $12,650 per eligible child B. $13,190 per eligible child C. $13,570 per eligible child D. $14,500 per eligible child

255. Miranda and Tony adopted a child, not determined to have special needs, in the current year. During the year

their qualified adoption expenses were $17,000 and they had a modified adjusted gross income (MAGI) of $283,500. What is the amount of Miranda and Tony’s Adoption Credit?

A. $0 B. $6,700 C. $13,570 D. $26,800

256. Jason had two employers during the year. Both employers withheld Social Security tax from his wages in the

amounts of $4,035.05 and $4,200.35. What amount can Jason claim as a credit against his income tax when he files his income tax return?

A. $0 B. $349 C. $1,186 D. $8,235

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-40

257. The taxpayer cannot claim the excess as a credit against his or her income tax if how many employer(s) withheld too much Social Security or RRTA tax?

A. One B. Two C. Three D. Four

258. If a taxpayer has foreign taxes available for credit but cannot use them because of the limit, he or she may be

able to carry them back how many tax year(s)? A. 1 tax year B. 2 tax years C. 3 tax years D. 4 tax years

259. Jake receives a qualified mortgage credit certificate (MCC) from California. This year, his regular tax liability is

$1,100, he owes no alternative minimum tax, and his Mortgage Interest Credit is $1,700. Additionally, Jake claims no other credits. What amount of Jake’s unused Mortgage Interest Credit for this year can he carry forward to the next 3 years or until used, whichever comes first?

A. $0 B. $600 C. $1,100 D. $1,700

Lesson 15 260. Tim enrolls in health insurance with Ace Insurance Company in January 2017. Tim fails to pay his premiums for

November and December 2017 and January 2018. Ace sends Tim a Form 1095-B on January 31, 2018, reporting coverage for every month in 2017. On February 1, 2018, Ace cancels Tim’s coverage effective November 1, 2017. Additionally, Ace filed Tim’s Form 1095-B with the IRS. Regarding Tim’s corrected Form 1095-B, Ace must complete which of the following actions?

A. Ace Insurance Company must send Tim a corrected Form 1095-B reporting that Tim was covered only for January through October 2017

B. Ace Insurance Company must file a corrected Form 1095-B with the IRS reporting coverage only for January through October

C. No action is required by Ace Insurance Company D. Both A and B

261. At the end of 2017 Sandy was 22 years old and a full-time student. She earned $2,000 working at the Muffin

Break after school. Her parents provided her with $10,000 of support for the year. What is Sandy’s AMT exemption amount for 2017?

A. $2,000 B. $7,500 C. $9,500 D. $10,000

262. The parent of a child under age 18 may elect to include the child’s income on their tax return if the child’s interest

and dividend income (including capital gain distributions) for 2017 was less than what amount? A. $7,150 B. $8,500 C. $9,500 D. $10,500

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-41

Lesson 16 263. If a taxpayer fails to file a return and it is no more than 60 days past the due date (including extensions), what is

usually the penalty for failure to file? A. 5% for each month, but not more than 25% B. 10% for each month, but not more than 30% C. 15 % for each month, but not more than 35% D. 20% for each month, but not more than 40%

264. What is the penalty for a tax return filed with an accuracy error based on either substantial understatement or

negligence? A. A flat 10 % of the net understatement of the tax B. A flat 15 % of the net understatement of the tax C. A flat 20 % of the net understatement of the tax D. A flat 25 % of the net understatement of the tax

265. Abusive tax schemes have evolved from simple structuring of abusive domestic and foreign trust arrangements

into sophisticated strategies that take advantage of the financial secrecy laws of some foreign jurisdictions and the availability of credit/debit cards issued from offshore financial institutions. Generally, these schemes are characterized by the use of all of the following flow-through entities except:

A. International Business Companies B. Foreign Trusts C. Qualified Intermediaries D. Foreign Partnerships

266. Section 6662(d)(1) generally defines "substantial understatement" of income tax to be an understatement for the

taxable year that exceeds the greater of what percentage of the correct tax required to be shown on the return or $5,000?

A. 10% B. 20% C. 25% D. 30%

267. If a taxpayer alters or strikes out the preprinted language above the space provided for the taxpayer’s signature

on Form 1040, he or she may have to pay a frivolous return penalty in which amount? A. $1,000 B. $2,500 C. $5,000 D. $7,500

Lesson 17 268. Which of the following is true regarding Treasury Circular 230?

A. The circular contains the rules regarding eligibility to become an enrolled agent and renewal of enrollment B. The circular contains rules of conduct applicable to enrolled agents, enrolled retirement plan agents,

registered tax return preparers, and enrolled actuaries, but not attorneys or certified public accountants C. The circular contains rules regarding disciplinary actions for tax return preparers who are not enrolled

agents, registered tax return preparers, CPAs, or attorneys D. The circular contains rules of conduct applicable to attorneys or certified public accountants, but not

enrolled agents, enrolled retirement plan agents, registered tax return preparers, and enrolled actuaries

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-42

269. Generally, each tax practitioner who applies for renewal to practice before the Internal Revenue Service must retain the information required with regard to qualifying continuing professional education hours. How long must records of completed continuing professional education (CPE) be retained?

A. The individual is not required to retain the information if the continuing professional education sponsor has agreed to retain it

B. For a period of 1 year following the date of renewal of enrollment C. For a period of 4 years following the date of renewal of enrollment D. For a period of 5 years if it is an initial enrollment

270. Identify the individual below who is not eligible to practice before the IRS. None of the individuals are under

suspension or disbarment. A. Certified financial planner B. Attorney C. Enrolled agent D. Enrolled actuary, with respect to specified statutory issues

271. Jim Brown, a tax practitioner, received a complaint from the IRS for disreputable conduct. Which of the following

items was not required to be listed in the complaint? A. The unit and employee of the Internal Revenue Service that recommended the action against Jim B. Clear and concise description of the facts that constitute the proceeding C. Clear and concise description of the law that constitute the proceeding D. Specific sanction sought

272. Which of the following statements is correct with respect to a client’s request for records of the client that are

necessary for the client to comply with his or her Federal tax obligations? A. The practitioner may never return records of the client to the client even if the client requests prompt return

of the records B. The existence of a dispute over fees always relieves the practitioner of his or her responsibility to return

records of the client to the client C. The practitioner must, at the request of the client, promptly return the records of the client to the client

unless applicable state law provides otherwise D. The practitioner must, at the request of the client, return the records of the client to the client within three

months of receiving the request 273. How is a proceeding for violation of the regulations in Circular 230 instituted against a tax practitioner?

A. An aggrieved taxpayer files a petition with the United States Tax Court stating a claim against the attorney, certified public accountant, registered tax return preparer, enrolled agent, enrolled retirement plan agent, or enrolled actuary

B. The IRS representative signs a complaint naming the tax practitioner and files the complaint with the Administrative Law Judge (ALJ)

C. The Secretary of the Treasury files a complaint against the attorney, certified public accountant, registered tax return preparer, enrolled agent, enrolled retirement plan agent, or enrolled actuary in the United States District Court for the District of Columbia

D. The Commissioner of the IRS files a complaint against the attorney, certified public accountant, registered tax return preparer, enrolled agent, enrolled retirement plan agent, or enrolled actuary with the United States Tax Court

274. If an IRS examiner believes that a tax practitioner filed a return that contains a frivolous position, to whom does

he report his concern? A. To the practitioner B. To the practitioner’s supervisor C. To the Director of the Office of Professional Responsibility D. To the Secretary of the Treasury

Examination Questions - 45 Hour Federal Tax Law

© 2018 Golden State Tax Training Institute, Inc. EX-43

275. The Office of Professional Responsibility can censure, suspend or disbar a practitioner from practice before the Internal Revenue Service for incompetence and/or disreputable conduct. Which of the following is considered disreputable conduct?

A. Conviction of any criminal offense under the revenue laws of the United States B. Conviction of any criminal offense involving dishonesty or breach of trust C. Giving false or misleading information or participating in any way in the giving of false or misleading

information to the Department of the Treasury or any officer or employee thereof D. All of the above

276. Jenny James is a CPA who is representing Steve and Ashley O’Brien before the Wage and Investment Division

of the Internal Revenue Service. The IRS is questioning Steve and Ashley on contributions that were listed on page 2 of their 2016 Form 1040. While reviewing the documentation provided by Steve and Ashley, Jenny discovers contributions that were made to a non-qualified organization. What is the appropriate action for Jenny to take?

A. Jenny must advise Steve and Ashley on how to keep the inaccuracy from being discovered by the IRS B. Jenny must notify the Internal Revenue Service that she is no longer representing Steve and Ashley by

withdrawing her Form 2848 C. Jenny must advise Steve and Ashley promptly of the inaccuracy and the consequences provided by the

Internal Revenue Code and Regulations for such an inaccuracy D. Jenny must immediately advise the Internal Revenue Service examiner of the non-qualified contributions

277. With regards to negotiating a taxpayer’s refund check, a tax preparer that is also a financial institution, but has

not made a loan to the taxpayer on the basis of the taxpayer’s anticipated refund, may complete all of the following transactions except:

A. Cash a refund check and remit all of the cash to the taxpayer B. Endorse a taxpayer’s refund check and electronically direct payment into an account owned and

controlled by the practitioner for an income tax return the practitioner prepared C. Accept a refund check for deposit in full to a taxpayer’s account provided the bank does not initially

endorse or negotiate the check D. Endorse a refund check for deposit in full to a taxpayer’s account pursuant to a written authorization of

the taxpayer

Lesson 18 278. Which of the following statements is false regarding a taxpayer’s eligibility to qualify for the Premium Tax Credit?

A. If a taxpayer enrolls in an employer-sponsored plan, including retiree coverage, he or she is eligible for the Premium Tax Credit

B. If a taxpayer is not eligible for coverage through a government program, like Medicaid, Medicare, CHIP or TRICARE he or she is eligible for the Premium Tax Credit

C. A taxpayer is eligible for the Premium Tax Credit if he or she cannot be claimed as a dependent by another person

D. A taxpayer is eligible for the Premium Tax Credit if he or she purchases coverage through the Marketplace

279. The statutory $2,600 limit for Health Flexible Spending Arrangements (FSAs) under 26 USC Section 125(i) only applies to which of the following?

A. Salary reduction contributions under a health FSA B. Certain employer non-elective contributions (sometimes called flex credits) C. Health savings accounts D. All of the above

280. Individual Taxpayer Identification Numbers (ITINs) not used on a Federal income tax return in the last how many

years will no longer be valid to use on a tax return as of January 1, 2017? A. Three years B. Four years C. Five years D. Ten years

© 2018 Golden State Tax Training Institute, Inc. CE-1

GOLDEN STATE TAX TRAINING INSTITUTE, INC.

IRS Provider Number: P619F CTEC Provider Number: 2040

60 Hour California Tax Education Council (CTEC) Qualifying Education Course Evaluation

CTEC Course Number: 2040-QE-0003

Instructions: Please comment on all of the following evaluation points for this course and select a number grade, using the 1-5 scale, with 5 being the highest. Were the stated learning objectives met?........................................................... 5 4 3 2 1 Were the course materials accurate and relevant, and did they contribute to the achievement of the learning objectives?.................................................... 5 4 3 2 1 Was the time allocated to learning adequate?..................................................... 5 4 3 2 1 Were the facilities/equipment appropriate (if applicable)?.................................... 5 4 3 2 1 Was the course syllabus or handout materials satisfactory?................................ 5 4 3 2 1 Were the audio and visual materials effective (if applicable)?.............................. 5 4 3 2 1 If applicable, were individual instructors knowledgeable and effective? Instructor (enter name) ..................................................................................... 5 4 3 2 1 Instructor (enter name) ..................................................................................... 5 4 3 2 1 Number of Hours/Minutes it took you to study and complete course. Additional comments: ____________________________________________________________________________________________ ____________________________________________________________________________________________ Part of the course you found most beneficial: ____________________________________________________________________________________________ ____________________________________________________________________________________________ Part of the course you found least beneficial: ____________________________________________________________________________________________ ____________________________________________________________________________________________ Would you like us to contact you about your comments after the course? YES NO Name: _____________________________________________ Phone: __________________________________ Please complete and include with exam at the conclusion of the course.