The IRS has announced a significant increase in enforcement actions for syndicated conservation easement transactions. This is a "priority compliance area" for the agency.

The IRS has announced a significant increase in enforcement actions for syndicated conservation easement transactions. This is a "priority compliance area" for the agency.

Throughout the IRS, coordinated examinations are being conducted in the Small Business and Self-Employed (SB/SE) Division, Large Business and International (LB&I) Division, and Tax Exempt and Government Entities (TE/GE) Division. The IRS Criminal Investigation (CI) Division has also been initiating investigations. The audits and investigations cover billions of dollars of potentially inflated deductions, as well as hundreds of partnerships and thousands of investors.

"We will not stop in our pursuit of everyone involved in the creation, marketing, promotion and wrongful acquisition of artificial, highly inflated deductions based on these aggressive transactions. Every available enforcement option will be considered, including civil penalties and, where appropriate, criminal investigations that could lead to a criminal prosecution," said IRS Commissioner Charles "Chuck" Rettig. "Our innovation labs are continually developing new, more extensive enforcement tools that employ advanced techniques. If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options. It is always worthwhile to take advantage of various methods of getting back into compliance by correcting your tax returns before you hear from the IRS. Our continued use of ever-changing technologies would suggest that waiting is not a viable option for most taxpayers," he added.

Syndicated Conservation Easements

The IRS issued Notice 2017-10, I.R.B. 2017-4, 544, in 2016, which designated certain syndicated conservation easements as listed transactions. In these types of transactions, investors in pass-through entities receive promotional material which offer the possibility of a charitable contribution deduction worth at least two-and-a-half times their investment. The deduction taken in many transactions has been significantly higher than 250 percent of the investment.

Syndicated conservation easements were included on the IRS’s 2019 "Dirty Dozen" list of tax scams to avoid.

Not only do these transactions grossly overstate the value of the easement that was purportedly donated to charity, they often also fail to comply with the basic requirements for claiming a charitable deduction for a donated easement.

Taxpayers may avoid the imposition of penalties for improper contribution deductions if they fully remove the improper contribution and related tax benefits from their returns by timely filing a qualified amended return or timely administrative adjustment request.

Enforcement Actions

The IRS has prevailed in many cases involving the charitable deduction basic requirements, and has established a body of law that it believes supports disallowance of the deduction in a significant number of pending conservation easement cases. The IRS will soon be moving the Tax Court to invalidate the claimed deductions in all cases where the transactions fail to comply with the basic requirements, leaving only the final penalty amount to be determined.

In addition to auditing participants in syndicated conservation easement transactions, the IRS is pursuing investigations of promoters, appraisers, tax return preparers and others, and is evaluating numerous referrals of practitioners to the IRS Office of Professional Responsibility. The IRS will develop and assert all appropriate penalties, including:

• penalties for participants (40 percent accuracy-related penalty);
• penalties for appraisers (penalty for substantial and gross valuation misstatements attributable to incorrect appraisals);
• penalties for promoters, material advisors, and accommodating entities (penalty for promoting abusive tax shelters, and penalty for aiding and abetting understatement of tax liability); and
• penalties for return preparers (penalty for understatement of taxpayer’s liability by a tax return preparer).

Rettig, Desmond Highlight Heightened Focus

Rettig and IRS Chief Counsel Michael J. Desmond have each highlighted the IRS’s heightened, agency-wide focus on syndicated conservations easements.

While speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C., Rettig and Desmond both separately underscored the IRS’s increased enforcement efforts toward abuses of certain tax-advantaged land transactions under Code Sec. 170(h).

"We appreciate the value of conservation easements," Rettig said. "We do not appreciate the activities that have gone on with respect to the syndicated conservation easements—there are some artificial appraisals there… some fatal flaws."

Reiterating the IRS’s tough stance on the matter, Rettig said that the IRS is not going to "stand down." The information in IR-2019-182 issued on November 12 was "fair warning," Rettig said.

Likewise, Desmond stressed that the challenges surrounding syndicated conservation easements are an "institutional concern" for the IRS, "one that we will be responding to," he emphasized.

Treasury and the IRS are expected to release proposed rules in "early 2020" that would clarify certain limitations on the carried interest tax break, according to David Kautter, Treasury’s assistant secretary for tax policy. Kautter briefly addressed the proposed regulations’ timeline while speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C.

Treasury and the IRS are expected to release proposed rules in "early 2020" that would clarify certain limitations on the carried interest tax break, according to David Kautter, Treasury’s assistant secretary for tax policy. Kautter briefly addressed the proposed regulations’ timeline while speaking at the American Institute of CPAs (AICPA) 2019 National Tax Conference in Washington, D.C.

Carried Interest Limitation

The forthcoming regulations are expected to restrict S corporations from taking advantage of a carried interest exemption provision under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97). The TCJA requires certain money managers to hold investments for at least three years before becoming eligible for the lower, 20 percent capital gains rate. However, it exempted corporations from this holding period, which Treasury and many lawmakers on Capitol Hill say resulted in an unintended "loophole."

The proposed regulations are expected to clarify the law’s intent that S corporations are subject to the three-year holding period for carried interest, according to Treasury’s last press release on the matter issued in March 2018 (see "Treasury, IRS Issue Guidance On Carried Interest," at https://home.treasury.gov/news/press-releases/sm0302).

Legal Questions May Arise

Most notably, however, the TCJA does not expressly contain this limitation on S-corporations, which has left some on Capitol Hill questioning Treasury and the IRS’s authority to implement such a restriction via regulations. The IRS on November 15 directed Wolters Kluwer to Treasury for confirmation on this anticipated rule and projected timeline. As of press time, Treasury had not responded to Wolters Kluwer’s request for comment.

Hopes for a year-end tax extenders package appear to be dwindling on Capitol Hill.

Hopes for a year-end tax extenders package appear to be dwindling on Capitol Hill.

Tax Extenders Need a Legislative Vehicle

Over 30 expired or soon-to-be expired tax breaks known as tax extenders were originally considered a top contender for hitching a ride on a larger, must-pass government funding bill. Considering the lack of time left on the legislative calendar this year, a stand-alone tax bill has been considered an unlikely initiative. Thus, a must-pass appropriations bill was seen by several lawmakers as the likely legislative vehicle for tax extenders and other tax items such as technical corrections to Republicans’ 2017 tax reform law.

However, a spokesperson for Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, confirmed to Wolters Kluwer on October 28 that Grassley believes there is "no hope" for action this year on a tax extenders package if lawmakers do not move quickly with respect to its legislative driver. Many within the practitioner community following these developments have said that the chances of providing taxpayers with certain tax breaks retroactively significantly decrease if Congress moves into next year leaving them expired.

Another Stopgap Spending Bill Appears Likely

Currently, the federal government is operating on a stopgap spending bill temporarily extending fiscal year (FY) 2019 funding levels through November 21. Previously, several lawmakers, in particular Grassley, had hoped that a tax extenders package would be attached to a larger, more comprehensive appropriations bill next month. However, Senate Appropriations Committee Chair Richard Shelby, R-Ala., told reporters that another short-term stopgap spending bill is the more likely option to keep the government open after November 21. "Unless a miracle happens around here with the House and Senate, we will have to put forth another [continuing resolution] CR," Shelby told reporters.

Notably, another short-term government funding bill is considered unlikely to have any policy riders. Generally, stop gap spending bills are usually considered "clean," for the most part. Also playing a role in tax extenders’ fate is whether President Trump would sign a more comprehensive appropriations bill. At this time, his support for a larger FY 2020 funding bill, apart from tax policy reasons, remains unclear.

Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, and other top Senate tax writers are calling for Senate action on the bipartisan Setting Every Community Up for Retirement Enhancement Secure bill (HR 1994) (SECURE Act). The House-approved, bipartisan retirement savings bill has remained stalled in the Senate since May.

Senate Finance Committee (SFC) Chair Chuck Grassley, R-Iowa, and other top Senate tax writers are calling for Senate action on the bipartisan Setting Every Community Up for Retirement Enhancement Secure bill (HR 1994) (SECURE Act). The House-approved, bipartisan retirement savings bill has remained stalled in the Senate since May.

SECURE Act’s Route to Senate Floor Remains Unclear

Grassley’s communications director Michael Zona told Wolters Kluwer on October 21 that it remains "unclear at this point" whether the SECURE Act will move through committee, reach the Senate floor by unanimous consent, or be attached to a larger, year-end tax package. "Grassley supports the House-passed SECURE Act. There are several holds on the bill, and he is working to get them lifted," Zona said.

The SECURE Act cleared the House on May 23 by a 417-to-3 vote. The bipartisan measure, which proposes sweeping changes to retirement savings tax policy, was originally expected to quickly clear the Senate after its approval in the House. However, Sen. Ted Cruz, R-Tex., blocked the bill from reaching the Senate floor. Cruz blocked the bill in protest of House Democrats’ 11th hour-removal of a provision from the original bill that would have expanded tax-advantaged Section 529 education savings plans to include homeschooling and certain elementary and secondary expenses. Cruz and Sen. Patty Murray, D-Wash., are reportedly still holding up the measure from reaching the Senate floor.

Catch-All Tax Package

However, the SECURE Act, among other bipartisan tax-related items including tax extenders, could be attached to a catch-all tax package that is expected on Capitol Hill to hitch a ride on a year-end government funding bill. A "must-pass" appropriations bill, like the one currently being negotiated to keep the government open after funding expires on November 21, could serve as the tax package’s legislative vehicle, thus fast tracking its approval.

"As the economy continues to change, the way we approach retirement savings must change as well. Otherwise, too many Americans will be left behind," Grassley said on October 21, noting that the SECURE Act is under "active consideration."

Similar to Grassley’s push, Sen. Tim Scott, R-S.C., led a letter sent to Senate Majority Leader Mitch McConnell, R-Ky., urging immediate Senate consideration of the SECURE Act. "This bipartisan legislation would expand access to retirement plans for millions of Americans, allow older workers and retirees to contribute more to their retirement accounts, increase 401(k) coverage to part-time employees, prevent as many as 4 million people in private-sector pension plans from losing future benefits, protect 1,400 religiously affiliated organizations whose access to their defined contribution retirement plans is in jeopardy, and do the right thing for Gold Star families," according to Scott.

The Senate blocked a Democratic resolution on October 23 to overturn Treasury rules preventing certain workarounds to the $10,000 state and local tax (SALT) federal deduction cap.

The Senate blocked a Democratic resolution on October 23 to overturn Treasury rules preventing certain workarounds to the $10,000 state and local tax (SALT) federal deduction cap.

SALT Cap Workaround

Senate Democrats’ resolution, S.J. Res. 50, forced a vote on Wednesday to nullify Treasury regulations that block taxpayers from circumventing the SALT cap through certain states’ programs that convert state and local taxes into fully deductible charitable contributions. The resolution failed by a largely party-line vote of 43-to-52.

Sen. Michael Bennet, D-Colo., voted against the Democratic measure while Sen. Rand Paul, R-Ky., supported it. While the resolution would not repeal the SALT cap itself, House Democrats are reportedly crafting legislation to do so. Democrats and some Republicans, particularly from high-tax states, have criticized the SALT cap since its enactment in 2017 under the Tax Cuts and Jobs Act (TCJA) ( P.L. 115-97).

Debate on SALT Cap, Treasury Rules

"Without any clear authority to do so, the Treasury Department reversed a long-standing IRS position that had allowed taxpayers a full deduction for charitable contributions to state tax credit programs," Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., said on the Senate floor before the vote. "My view is the Treasury Department should not be putting its thumb on the scale on behalf of Republican interests, and it shouldn’t be using phony regulatory justifications to fix Republicans’ extraordinarily poorly drafted law."

However, several Republicans cited to a recent report from the nonpartisan Joint Committee on Taxation (JCT), which estimated that repealing the SALT cap beginning in 2019 would result in over $40 billion of the associated tax cut going to taxpayers with incomes of at least $1 million ( JCX-35-19).

"It’s bad enough that my Democratic colleagues want to unwind tax reform, but it’s downright comical that their top priority is helping wealthy people in blue states find loopholes to pay even less," Senate Majority Leader Mitch McConnell, R-Ky., said from the Senate floor on October 23. "Repealing the SALT cap would give millionaires an average tax cut of $60,000. Meanwhile, the average tax cut for taxpayers earning between $50,000 and $100,000 would be less than ten dollars."

Vaping Tax

In other news, the House Ways and Means Committee approved a bipartisan vaping tax bill, ( HR 4742), on October 23 by a 24-to-15 vote. The bill would establish a $27.81 tax per gram of nicotine used in vaping devices.

Treasury and the IRS on October 31 announced the release of a new, draft form implementing certain reporting requirements under the Tax Cuts and Jobs Act Opportunity Zone program.

Treasury and the IRS on October 31 announced the release of a new, draft form implementing certain reporting requirements under the Tax Cuts and Jobs Act Opportunity Zone program.

The proposed Form 8996 for Qualified Opportunity Funds (QOFs) comes after numerous calls on Capitol Hill for more transparency within the Opportunity Zone program. "The form is designed to collect information on the amount of investment by opportunity funds in business property by census tract," according to a Treasury press release.

Opportunity Zones’ Architect Applauds Treasury’s Steps Toward Reporting Requirements

Ken Farnaso, press secretary for Sen. Tim Scott, R-S.C., chief architect of the TCJA’s bipartisan Opportunity Zone program, told Wolters Kluwer on October 31 that reporting requirements, "an important piece of the puzzle," were, in fact, originally in the bill. "Unfortunately, during the tax reform process, Senate Democrats blocked these requirements from being included in the Tax Cuts and Jobs Act. Since then, Senator Scott has continued working to restore those reporting requirements," Farnaso said.

Additionally, Farnaso told Wolters Kluwer that Scott applauds Treasury’s steps to ensure a clearer picture of the impact the Opportunity Zones initiative can have on the country. "Senator Scott will also continue to push for his current bill restoring robust reporting requirements to create a holistic picture of how the initiative is functioning," Farnaso said. "Overall, today is a good day for Opportunity Zones. We look forward to the more than $44 billion in currently anticipated investment being deployed in distressed communities across the nation, and that number growing even larger in the future."

Opportunity Zones Tax Incentive

The Opportunity Zone Program enacted under TCJA ( P.L. 115-97) is considered on Capitol Hill as one of the most generous and ambitious tax incentives for investors in distressed communities. Under Code Sec. 1400Z-2, investors may defer taxation of capital gains that are invested in a QOF.

Generally, the following investor tax benefits were created under the Opportunity Zone program:

• a temporary tax deferral for capital gains realized on the sale of appreciated assets and reinvested within 180 days in a QOF;
• the elimination of up to 10 or 15 percent of the tax on the capital gain that is invested in the QOF and held between five and seven years; and
• the permanent exclusion of tax when exiting a qualified opportunity fund investment held for at least 10 years.

Draft IRS Form 8996

Specifically, the new, draft Form 8996 for the 2019 tax year requires QOFs to report the following information:

• the Employer Identification Number (EIN) of each business in which the QOF has an ownership interest;
• the census tract location of the tangible property of the business;
  the value of the QOF’s investment; and
• the value and census tract location of qualified business property directly owned or leased.

"This is an important step towards a thorough evaluation of the Opportunity Zone tax incentive," Treasury Secretary Steven Mnuchin said. "We want to understand where Opportunity Zone investments are going and strengthening the economy so that investors and communities can learn from the successes of this bipartisan, pro-growth policy."

Generally, the collection of this information will play a role in allowing lawmakers and the public to evaluate the effects of the tax incentive and to understand why some locations may be more successful than others at attracting investment, according to Treasury.

Opportunity Zones Criticism

The Opportunity Zone program has not come to fruition without its share of criticism, however. Although lawmakers have called for reporting requirements related to QOFs since the TCJA’s enactment, the program has recently come under increased scrutiny and criticism. Senate Finance Committee (SFC) ranking member Ron Wyden, D-Ore., has said that the lack of reporting requirements are "inexcusable."

"Requiring taxpayers to prove they’re actually following the rules of the Opportunity Zone program is a positive first step, but it’s one that should have been taken two years ago…," Wyden said in an October 31 statement. "The Opportunity Zone program has been operating without any effort to ensure compliance and that’s inexcusable."

A California-based medical marijuana dispensary corporation’s motion for summary judgment challenging the constitutionality of Code Sec. 280E was denied. The Tax Court also addressed whether Code Sec. 280E applies to marijuana businesses legally operating under state (California) law, and whether the prohibition on deductions is limited to ordinary and necessary business expenses.

A California-based medical marijuana dispensary corporation’s motion for summary judgment challenging the constitutionality of Code Sec. 280E was denied. The Tax Court also addressed whether Code Sec. 280E applies to marijuana businesses legally operating under state (California) law, and whether the prohibition on deductions is limited to ordinary and necessary business expenses.

Section 280E

Congress enacted Code Sec. 280E after the court had allowed certain deductions for expenses incurred in connection with an illegal drug trade. Generally, Code Sec. 280E disallows any deductions attributable to a taxpayer’s illegal drug related trade or business. Taxpayers may reduce their income by the cost of goods sold (COGS), and Code Sec. 280E does not generally disallow deductions attributable to a taxpayer’s non-drug-related business.

Constitutionality

The Eighth Amendment of the Constitution prohibits excessive fines or penalties. The dispensary in this case claimed that Code Sec. 280E is a punitive provision that violates the Eighth Amendment. However, because Congress generally has the power to levy taxes under the Sixteenth Amendment, the Tax Court found that the law’s denial of certain deductions cannot be construed as a penalty.

Legality Under State Law

The dispensary also argued that its actions could not be considered "trafficking" for purposes of Code Sec. 280E because its activities were not illegal under California law. The court noted that because marijuana is still considered a Schedule I controlled substance and is banned under federal law, the application of Code Sec. 280E does not depend on the legality of marijuana sales under California law.

Additional Deductions

Finally, the dispensary argued that Code Sec. 280E only applies to deductions under Code Sec. 162, and that other deductions such as those under Code Secs. 164 and 167 should be permitted. However, the text of Code Sec. 280E broadly states that "no deduction or credit shall be allowed." It does not limit the deductions to those claimed under Code Sec. 162.

Dissenting Opinions

The Tax Court decision included several concurring and dissenting opinions, which primarily addressed the issue as to whether Code Sec. 280E is in fact a penalty provision that would violate the Eighth Amendment.

The dissenting opinions found that Code Sec. 280E is punitive in nature. One dissenter noted that rather than specify a narrow range of disallowed expenses, Code Sec. 280E attacks the entire marijuana industry with a broad denial of otherwise allowable deductions. The opinion stated that Congress passed Code Sec. 280E order to deter the sale of controlled substances and to penalize the drug trade. That intent was found to be "clearly in the nature of a penalty." Both dissents concluded with two additional questions, which the dissenters felt need to be addressed:

• Is the punitive nature of Code Sec. 280E excessive to the point where it violates the Eighth Amendment?, and
• Does the Eighth Amendment apply to corporation taxpayers?

The IRS has proposed regulations that define an eligible terminated S corporation (ETSC), and provide rules relating to distributions of money by an ETSC after the post-termination transition period (PTTP). The proposed regulations also extend the treatment of distributions of money during the PTTP to all shareholders of the corporation, and update and clarify the allocation of current earnings and profits to distributions of money and other property.

The IRS has proposed regulations that define an eligible terminated S corporation (ETSC), and provide rules relating to distributions of money by an ETSC after the post-termination transition period (PTTP). The proposed regulations also extend the treatment of distributions of money during the PTTP to all shareholders of the corporation, and update and clarify the allocation of current earnings and profits to distributions of money and other property.

Code Sec. 1371(f), as added by the Tax Cuts and Jobs Act ( P.L. 115-97) extends the period during which C corporation shareholders can benefit from the corporation’s accumulated adjustment account (AAA) generated during its former status as an S corporation. Specifically, the provision allows the C corporation to source qualified distributions of money to which Code Sec. 301 would otherwise apply to in whole or part to AAA. The provision only applies if the corporation is an ETSC as defined in Code Sec. 481(d).

Under the proposed regulations, the revocation of S corporation status may be made during the two-year period beginning on December 22, 2017, even if the effective date for the revocation occurs after the conclusion of the two-year period.

Shareholder Identity Requirement

A former S corporation is not an ETSC unless the owners of its stock are the same owners (and in identical proportions) on December 22, 2017, and on the date of the S corporation revocation. The proposed regulations identify various categories of stock transfers that are not considered an ownership change for purposes of this rule.

ETSC Proration

A distributing ETSC’s AAA is allocated to qualified distributions and the distributions are chargeable to the ETSC’s accumulated earnings and profits (AE&P) based on the ETSC proration. The ETSC proration is implemented in a manner that facilitates the prompt distribution of AAA and full transition to C corporation status. Specifically, the proposed regulations:

• specify the time at which amounts of AAA and AE&P are determined for purposes of the ETSC proration;

• provide AAA and AE&P ratios used to the implement the proration; and

• describe in detail the method of characterizing qualified distributions.

The proposed regulations adopt a "snapshot" approach under which amounts of AAA and AE&P are determined on a specified date. As a result, the same ETSC proration is applied to all qualified distributions. Under the proposed regulations, the determination date is the date when the S corporation revocation election is effective. A "dynamic" approach that recalculated the amounts before each qualified distribution was rejected as administratively cumbersome.

The proposed regulations provide two ratios for determining the part of a qualified distribution that is sourced from AAA and from AE&P. The AAA ratio is the ratio of historical AAA to the sum of historical AAA and historical AE&P. The AE&P ratio is the ratio of historical AE&P and the sum of historical AAA and historical AE&P. The qualified distribution is multiplied by these ratios to determine the amount sourced from AAA and AE&P.

The proposed regulations provide a priority rule under which ETSC proration first applies to qualified distributions during the tax year. The rules of Code Sec. 301 and allocation rules of Code Sec. 316 then apply to any nonqualified distributions that are not fully accounted for by the ETSC proration because the corporation’s AAA or AE&P are exhausted.

Effective Date

The proposed regulations will be effective in tax years beginning after the date they are published as final regulations. A taxpayer may apply the regulations in their entirely to tax years that begin on or before the date of publication as final regulations.

You have carefully considered the multitude of complex tax and financial factors, run the numbers, meet the eligibility requirements, and are ready to convert your traditional IRA to a Roth IRA. The question now remains, however, how do you convert your IRA?

Conversion basics

A conversion is a penalty-free taxable transfer of amounts from a traditional IRA to a Roth IRA. You can convert part or all of the money in your regular IRA to a Roth. When you convert your traditional IRA to a Roth, you will have to pay income tax on the amount converted. However, a traditional IRA may be converted (or rolled over) penalty-free to a Roth IRA as long as you meet the requirements for conversion, including adjusted gross income (AGI) limits in effect until 2010. You should have funds outside the IRA to pay the income tax due on the conversion, rather than taking a withdrawal from your traditional IRA to pay for it - those withdrawals are subject to an early withdrawal penalty and they cannot be put back at a later time to continue to accumulate in the tax-free environment of an IRA.

Big news for 2010 and beyond

Beginning in 2010, you can convert from a traditional to a Roth IRA with no income level or filing status restrictions. For 2008, Roth IRAs are available for individuals with a maximum adjusted gross income of $116,000 ($169,000 for joint filers and heads of household). These income limits have prevented many individuals from establishing or converting to a Roth IRA. Not only is the income limitation eliminated after 2009, taxpayers who convert to a Roth IRA in 2010 can recognize the conversion amount in adjusted gross income (AGI) ratably over two years, in 2011 and 2012.

Example. You have $14,000 in a traditional IRA, which consists of deductible contributions and earnings. In 2010, you convert the entire amount to a Roth IRA. You do not take any distributions in 2010. As a result of the conversion, you have $14,000 in gross income. Unless you elect otherwise, $7,000 of the income is included in income in 2011 and $7,000 is included in income in 2012.

Conversion methods

There are three ways to convert your traditional IRA to a Roth. Generally, the conversion is treated as a rollover, regardless of the conversion method used. Any converted amount is treated as a distribution from the traditional IRA and a qualified rollover contribution to the Roth IRA, even if the conversion is accomplished by means of a trustee-to-trustee transfer or a transfer between IRAs of the same trustee.

1. Rollover conversion. Amounts distributed from a traditional IRA may be contributed (i.e. rolled over) to a Roth IRA within 60 days after the distribution.

2. Trustee-to-trustee transfer. Amounts in a traditional IRA may be transferred in a trustee-to-trustee transfer from the trustee of the traditional IRA to the trustee of the Roth IRA. The financial institution holding your traditional IRA assets will provide directions on how to transfer those assets to a Roth IRA that is maintained with another financial institution.

3. Internal conversions. Amounts in a traditional IRA may be transferred to a Roth IRA maintained by the same trustee. Conversions made with the same trustee can be made by redesignating the traditional IRA as a Roth IRA, in lieu of opening a new account or issuing a new contract. As with the trustee-to-trustee transfer, the financial institution holding the traditional IRA assets will provide instructions on how to transfer those assets to a Roth IRA. The transaction may be simpler in this instance because the transfer occurs within the same financial institution.

Failed conversions

A failed conversion has significant negative tax consequences, and generally occurs when you do not meet the Roth IRA eligibility or statutory requirements; for example, your AGI exceeds the limit in the year of conversion or you are married filing separately (note: as mentioned, the AGI limit for Roth IRAs will no longer be applicable beginning in 2010).

A failed conversion is treated as a distribution from your traditional IRA and an improper contribution to a Roth IRA. Not only will the amount of the distribution be subject to ordinary income tax in the year of the failed conversion, it will also be subject to the 10 percent early withdrawal penalty for individuals under age 59 1/2, (unless an exception applies). Moreover, the Tax Code imposes an additional 6 percent excise tax each year on the excess contribution amount made to a Roth IRA until the excess is withdrawn.

Caution - financial institutions make mistakes

The brokerage firm, bank, or other financial institution that will process your IRA to Roth IRA conversion can make mistakes, and their administrative errors will generally cost you. It is imperative that you understand the process, the paperwork, and what is required of you and your financial institution to ensure the conversion of your IRA properly and timely. Our office can apprise you of what to look out for and what to require of the financial institutions you will deal with during the process.

Determining whether to convert your traditional IRA to a Roth IRA can be a complicated decision to make, as it raises a host of tax and financial questions. Our office can help you determine not only whether conversion is right for you, but what method is best for you, too.

In a period of declining stock prices, tax benefits may not be foremost in your mind. Nevertheless, you may be able to salvage some benefits from the drop in values. Not only can you reduce your taxable income, but you may be able to move out of unfavorable investments and shift your portfolio to investments that you are more comfortable with.

First, you should keep in mind that gain and loss on a sale of stock or mutual fund shares depends on the fair market value of the shares when sold or disposed of, compared to the cost basis of the stock. Your investments may have lost substantial value over recent periods. Nevertheless, if the stock's value when sold is higher than the basis, you still have a gain.

Example. You purchased X Corp stock in 2004, when it cost $5. At the end of 2007, the stock is worth $12. In November, 2008, you sell the stock when its value is $8 a share. Even though your investment has declined in value by 33 percent, you have a gain of $3 a share on the sale ($8 sales price less $5 cost).

The same tax-basis situation that may cause capital gain on the sale of shares that have dropped significantly in value over the past year also is causing many owners of mutual funds that have declined in value to be surprised with a capital gains distribution notice from their fund managers. If you own the mutual fund shares at the time of the capital gain distribution date, you must recognize the gain. Of course, that gain may be netted against your losses from stock or other capital asset sales.

If you realize a profit on a stock sale, the long-term capital gains tax is a maximum of 15 percent, while taxes on wages and other ordinary income can be taxed as high as 35 percent. For taxpayers in the 10 or 15 percent rate brackets, there is no capital gains tax. These reduced capital gains rates are scheduled to expire after 2010. Short-term capital gains (investments held for one year or less) are taxed at ordinary income rates up to 35 percent.

Capital losses can offset capital gains and ordinary income dollar for dollar. Capital gains can be offset in full, whether short-term or long-term. Ordinary income can be offset up to $3,000. If net capital losses (capital losses minus capital gains) exceed $3,000, the excess can be carried forward without limit and can offset capital gains and $3,000 of ordinary income in each subsequent year.

Because a capital loss can offset income taxed at the 35 percent rate, it can be advantageous to sell stock that yields capital gains in one year, while delaying the realization of capital losses until the following year.

Example. Mary has two assets. One asset would yield a $6,000 long-term capital loss when sold. The other would yield a $6,000 long-term capital gain. If Mary sells both assets in the same year, she has a net capital gain of zero. If she realizes the gain in 2008 and the loss in 2009 (by selling the assets in different years), she will increase her 2008 taxes by a maximum of $900 ($6,000 X 15 percent), but will reduce her taxes in 2009 and 2010 by a maximum of $2,100 ($3,000 X 35 percent X 2 years). She will reduce her taxes by $1,200 merely by shifting the timing of the sales.

Worthless securities. You can write off the cost of totally worthless securities as a capital loss, but cannot take a deduction for securities that have lost most of their value from stock market fluctuations or other causes if you still own them and they still have a recognizable value. You do not have to sell, abandon or dispose of the security to take a worthless stock deduction, but worthlessness must be evidenced by an identifiable event. An event includes cessation of the corporation's business, commencement of liquidation, actual foreclosure and bankruptcy. Securities become worthless if the corporation becomes worthless, even if the corporation has not dissolved, liquidated or ceased doing business.

If you would like to discuss these issues, please contact our office. We can help you consider your options.

The high cost of energy has nearly everyone looking for ways to conserve and save money, especially with colder weather coming to many parts of the country. One surprising place to find help is in the financial markets rescue package (the Emergency Economic Stabilization Act of 2008) recently passed by Congress. Overshadowed by the financial provisions are some very important energy tax incentives that could save you money at home and in your business.

While the energy tax incentives in the new law are generous, they are also complex. The names of the tax credits and deductions themselves can be daunting. Don't be put off by all the complex rules. Our office can help you navigate them and take advantage of their benefits.

Individuals

Improvements. If you are thinking of installing insulation or new energy-efficient windows and doors, you may be eligible for the residential energy property credit. This credit (also known as the Code Sec. 25C credit) gives eligible taxpayers a lifetime credit of up to $500 for making energy-efficient improvements to their residences. Up to $200 of the credit can be taken for the cost of windows. Besides insulation and energy-efficient windows and doors, some electric heat pump water heaters, natural gas, propane and oil furnaces, and other items qualify. The credit limits and energy-efficiency ratings are very complex so please contact our office before you make a purchase. We don't want you to miss out on a potentially valuable tax break. However, because of a quirk in the new law, the residential energy property credit is not available for 2008. However, you can take advantage of it in 2009.

Alternative energy. This credit (also known as the Code Sec. 25D credit) sounds a lot like the credit for energy efficient property but it is different. The key word in the title of the credit is "alternative." This credit rewards individuals who install certain types of alternative energy systems in their homes, particularly systems that utilize solar power and wind energy. These include solar electric, solar water heating, small wind energy, and geothermal heat pump property. Generally you must install the property before the end of 2016.

Businesses

Solar and wind power. Businesses are also eligible for some valuable energy tax breaks. Businesses that install solar energy and small wind energy property can take advantage of special tax credits that can reach as high as 30 percent. Generally, the solar or wind energy property must be used to generate electricity that heats, cools or lights a building.

Improvements. There is also a special tax deduction for energy efficient improvements made to commercial buildings. Generally, the improvements to heating, cooling, ventilation, lighting, and other qualifying systems must significantly reduce annual energy costs. Many of the new heating, cooling and lighting systems currently on the market meet these standards. If you recently installed new heating, cooling or lighting systems, you may have qualified for a tax break without even knowing it.

Manufacturers and builders. Manufacturers of energy efficient appliances, such as washing machines and refrigerators, are eligible for special tax credits. Additionally, contractors that build energy efficient homes can take advantage of tax breaks.

Transportation

In the not too distant future, you may be able to purchase a plug-in electric vehicle. In anticipation of that day, Congress created a new plug-in electric vehicle tax credit. The credit is available to everyone: individuals and businesses. Electric plug-in vehicles could be on the market as soon as 2010 so keep this tax break in mind if you shop for one.

These are just the highlights of some of the many energy tax incentives in the new law. Please contact our office for more details.

Nonbusiness creditors may deduct bad debts when they become totally worthless (i.e. there is no chance of its repayment). The proper year for the deduction can generally be established by showing that an insolvent debtor has not timely serviced a debt and has either refused to pay any part of the debt in the future, gone through bankruptcy, or disappeared. Thus, if you have loaned money to a friend or family member that you are unable to collect, you may have a bad debt that is deductible on your personal income tax return.

The fact that the debtor is a family member or other related interest does not preclude you from taking a bad debt deduction, provided that the debt was bona fide and that worthlessness has been established. A direct or indirect transfer of money between family members may create a bona fide debt eligible for the bad debt deduction. However, these transactions are closely scrutinized to determine whether the transfer is a bona fide debt or a gift.

Bona-fide debt and other requirements for deductibility

You may only take a bad debt deduction for bona-fide debts. A bona-fide debt is a debt arising from a debtor-creditor relationship based on a valid and enforceable obligation to repay a fixed or determinable sum of money. You must also have the present intention to seek repayment of the debt. Additionally, for a bad debt you must also show that you had the intent to make a loan, and not a gift, at the time the money was transferred. Thus, there must be a true creditor-debtor relationship.

Moreover, nonbusiness bad debts are only deductible in the year they become totally worthless (partially worthless nonbusiness bad debts are not deductible).

To deduct a bad debt, you must also have a basis in it, which means that you must have already included the amount in your income or loaned out your cash (for example, if your spouse has not paid court-ordered child support, you can not claim a bad debt deduction for the amount owed as this amount was not previously included in your gross income).

Reporting bad debts

You can deduct nonbusiness bad debts as short-term capital losses on Schedule D of your Form 1040. On Schedule D, Part I, Line 1, enter the debtor's name and "statement attached" in column (a). Enter the amount of the bad debt in parentheses in column (f). If you are reporting multiple bad debts, use a separate line for each bad debt. For each bad debt, attach a statement to your return containing the following:

•  A description of the debt, including the amount and date it became due;
• The name of the debtor, and any business or family relationship between you and the debtor:
• The efforts you made to collect the debt; and
• An explanation of why you decided the debt was worthless (for example, you can show the debtor has declared bankruptcy or is insolvent, or that collection efforts such as through legal action will not likely result in the debt being paid).

If you did not deduct a bad debt on your original income tax return for the year it became worthless, you can file a refund claim or a claim for a credit due to the bad debt. You must use Form 1040X to amend your return for the year the debt became worthless. It must be filed with 7 years from the date your original return for that year had to be filed, or 2 years from the date you paid the tax, whichever is later.

Note. If you deduct a bad debt and in a later year collect all or part of the money owed, you may have to include this amount in your gross income. However, you can exclude from your gross income the amount recovered up to the amount of the deduction that did not reduce your tax in the year you deducted the debt.

With the U.S. and world financial markets in turmoil, many individual investors may be watching the value of their stock seesaw, or have seen it plummet in value. If the value of your shares are trading at very low prices, or have no value at all, you may be wondering if you can claim a worthless securities deduction for the stock on your 2008 tax return.

Capital or ordinary loss treatment

When stock you own in a corporation becomes totally worthless during the tax year, you may be able to report a loss in the stock equal to its tax basis. Generally, a worthless stock loss is characterized as a capital loss because securities like stock that become worthless are usually treated as capital assets. When a security that is not a capital asset becomes wholly worthless, the loss is deductible as an ordinary loss. For example, if worthless stock is Code Sec. 1244 stock, ordinary loss treatment applies. Worthless stock is treated as if it was sold on the last day of the tax year.

Note. You may only deduct a loss on worthless securities if the loss is incurred in a trade or business, in a transaction entered into for profit, or as the result of a fire, storm, shipwreck, another casualty, or theft. It is generally assumed that an individual acquires securities for profit (although this assumption may be refuted).

Your stock is trading at $1.08 a share: Is it "worthlessness?"

A worthless stock deduction may only be taken when your securities have become totally worthless. You can not take the deduction for stock that has become only partially worthless. The Internal Revenue Code, however, does not define "worthlessness." Nonetheless, in the IRS's eyes, a company's stock is not going to be automatically considered worthless simply because the stock or security has plummeted in value and is now trading at mere dollars and cents.

With the current market turmoil, many stocks have taken big hits and dropped significantly in value, perhaps even trading for a $1.08 per share, but are nonetheless still alive and trading on an exchange. Therefore, you can not take a worthless stock deduction for a mere decline in value of stock caused by a fluctuation in market price or other similar cause, no matter how steep the decline, if your stock has any recognizable value on the date you claim as the date of loss. Even if a company in which you have stock files for bankruptcy, or lawsuits are filed against it, does not automatically qualify the stock or securities as worthlessness.

More hurdles to overcome

Even if you can establish that the stock you own has become totally worthless, the loss must be (1) evidenced by a closed and completed transaction, (2) fixed by identifiable events and (3) actually sustained during the tax year. First, you may only claim the deduction on your return for the tax year in which the stock has become completely worthless, and you must be able to show that the year in which you are claiming the loss is the appropriate tax year.

Generally, a worthless stock loss deduction can be taken in the year in which you abandon the stock. To abandon a security, you must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for the security. But, whether the transaction qualifies as abandonment, and not an actual sale or exchange, is a facts and circumstances test.

If you would like to know whether the stock or other securities you own have become worthless, please contact our office. We can help you navigate these complex rules.

The Housing Assistance Tax Act of 2008 (2008 Housing Act) gave a boost to individuals purchasing a home for the first time with a $7,500 first-time homebuyer tax credit. The credit was enhanced from $7,500 to $8,000 and extended for certain purchases under the American Recovery and Reinvestment Act of 2009 (2009 Recovery Act). This article explains how to determine the credit for eligible first-time homebuyers.

The $7,500 credit

The first-time homebuyer tax credit is a refundable, but temporary, tax credit equal to 10 percent of the purchase price of the residence, up to $7,500 for single individuals and married couples filing jointly, and $3,750 for married individuals who file separately. The $7,500 credit is only available for first-time purchases of primary residences (i.e. no second homes) made on or after April 9, 2008 and before July 1, 2009. To be eligible to claim the credit, however, an individual (or his or her spouse) must not have had any type of ownership interest in a principal residence during the three-year period before the date that the principal residence, for which the credit is to be taken, is purchased. You can claim a credit of up to either $7,500, or 10 percent of the purchase price, whichever is less.

The $8,000 credit under the 2009 Recovery Act

The 2009 Recovery Act raised the $7,500 maximum credit to $8,000, and extended that level through 2009 for eligible home purchases. The new law also eliminates any required repayment to the IRS after 36 months in the home. However, the enhanced $8,000 credit only applies to purchase of a principal residence made by a "first-time" homebuyer after December 31, 2008. Purchases on or after April 9, 2008 and before January 1, 2009 continue to be governed by the original first-time homebuyer credit enacted in the 2008 Housing Act.

The credit must be repaid in equal installments over the course of 15 years; the credit is interest-free. Repayments start two years after the year in which the residence is purchased. If the taxpayer sells or no longer uses the home as his or her principal residence before repaying the credit, the unpaid amount accelerates and becomes due on the return for the year in which the residence is sold or no longer used as a principal residence. The credit does not need to be repaid if the taxpayer dies. Special rules also exist for an involuntary conversion and a residence transferred in a divorce.

Example. Jim and Marsha, a married couple, are new homebuyers. They have never owned any other real property as a primary residence. Their combined modified adjusted gross income (AGI) is $74,600. They purchase their home in June 2009. Their first-time home purchase qualifies for the full $7,500 credit. They may file an amended 2008 return to claim the credit. Repayments of the $7,500 credit would begin in 2011.

Example. Mary and Tim are married joint filers who close title on a new home in February 2009. Their combined modified AGI is $100,000. They are entitled to claim the $8,000 first-time homebuyer tax credit. If they remain in the home for 36 months, they are not required to repay the credit to the government.

Phase-outs

The $7,500 and $8,000 credits both begin to phase-out for married couples with modified AGI between $150,000 and $170,000, and for single taxpayers with modified AGI between $75,000 and $95,000. However, the new credit benefits more than just single individuals and married couples, and can be taken by all co-owners, such as same-sex couples and family members who buy the residence together. However, the total amount of the credit allowed to such individuals, jointly, cannot exceed $7,500 (or $8,000).

Figuring the credit

If your modified AGI exceeds income threshold at which the credit begins to phase-out - $75,000 for single filers and $150,000 for joint filers - use the following steps to help determine the amount of the credit you can take.

1. Subtract the "phase-out amount" ($75,000 for single filers, or $150,000 for joint filers) from your (or you and your spouse's) modified AGI.
2. Take this dollar amount and divide it by $20,000.
3. Multiply this number by $7,500 (for single and joint filers), $3,750 for a married individual filing separately, or 10 percent of the purchase price of your home, whichever amount is applicable in your circumstances. (For example, if the purchase price of your home is $50,000, you would be able to claim the credit up to $5,000, since 10 percent of $50,000 (the purchase price) is less than $7,500). The resulting amount is the total amount of the credit that you may claim.

Note. This same formula will work for determining the $8,000 credit under the 2009 Recovery Act. Simply substitute $8,000 for $7,500 where applicable.

 Example. Jane, a single filer, is a first-time homebuyer. Her modified AGI is $80,000. She buys a home in October 2008 for $200,000. Because 10 percent of the purchase price ($20,000) is more than $7,500, the maximum credit amount she can claim is $7,500. However, because her modified AGI exceeds $75,000, she will not be able to claim the entire credit amount. Instead, she will be able to claim a credit of $5,625 ($80,000 - $75,000 = $5,000. $5,000 divided by $20,000 = .25. $7,500 multiplied by .25 = $1,875. $7,500 - $1,875 = $5,625).

Example. Michael is a single filer and first-time homebuyer. His modified AGI is $87,600. He buys a home in September 2008 for $50,000. Because 10 percent of the home's purchase price ($5,000) is less than the maximum amount of the allowable credit ($7,500), the maximum credit he can claim is $5,000. However, because his modified AGI exceeds the amount at which the credit phases out, his credit will be further reduced. Michael can claim a credit of $1,850 ($87,600-$75,000= $12,600. $12,600 divided by $20,000 = .63. $5,000 multiplied by .63 = $3,150. $5,000 - $3150 = $1,850.

Example. Linda and Ed, married joint filers, are first-time homebuyers. Their modified AGI is $162,400. They buy their first home in August 2008 for $300,000. Since their modified AGI exceeds the phase-out amount ($150,000 for joint filers), they will not be able to claim the entire credit amount of $7,500. Instead, they will be able to claim a maximum credit of $2,850 ($162,400 - $150,000 = $12,400. $12,400 divided by $20,000 = .62. $7,500 multiplied by .62 = $4,650. $7,500 - $4,650 = $2,850).

The credit amounts in every case will need to be repaid beginning two years after the date the home is purchased, in equal installments over the course of 15 years.

If you or anyone close to you is considering purchasing a first home as defined under the new law, the new tax credit may be able to make an otherwise difficult down payment sail through. Please contact this office for further details.

As you open the doors of your new business, the last thing on your mind may be the potential for loss of profits through employee oversight or theft - especially if you are the only employee. However, setting up some basic internal controls to guard against future loss before you hire others can save you headaches in the future.

As you open the doors of your new business, the last thing on your mind may be the potential for loss of profits through employee oversight or theft - especially if you are the only employee. However, setting up some basic internal controls to guard against future loss before you hire others can save you headaches in the future.

Soon after you start making money and the world realizes that they cannot live without your goods or service, you will probably need to hire employees. Although necessary for your growing company, hiring employees increases your risk of loss through errors, oversights and theft.

Implementing internal controls to help you monitor your business can decrease the need for constant supervision of your employees. Internal controls are checks and balances to prevent fraud, limit financial losses and reduce errors or oversights by employees. For example, the most basic internal control concept requires that certain tasks be handled by different people. This process, called "separation of duties", can greatly decrease the probability of loss.

The following basic internal control checklist includes suggestions that, once implemented, can help you and your employees avoid concerns about fraud or theft in the workplace:

• Have one person open the mail and list all the checks on the deposit slip while another enters cash receipts in your financial records.

• Make sure someone who does not handle the checkbook or purchasing is in charge of payments to suppliers and vendors.

• Have your bank reconciliation done by someone who does not have access to daily checkbook transactions.

• Make sure that you approve all vendors and that you count all goods received. Check all orders to make sure they are correct and of the quality you intended. Sign each check and review the invoice, delivery receipt and purchase order.

As your company grows, you may want to become less and less involved with the day-to-day operations of the business. The internal controls you put into place now will help keep the profits up, the losses down, and help you sleep better at night. If you need any assistance with setting up internal controls for you business, please feel free to contact our office.