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Premium Quickfinder® Handbook(2010 Tax Year)

Page Updates for the 2010 Tax Relief ActInstructions: This packet contains “marked up” changes to the pages in the Pre-mium Quickfinder® Handbook that were affected by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act), which was enacted after the handbook was published. To update your handbook, you can make the same changes in your handbook or print the revised page and paste over the original page.

Note: The pages included in this packet are “marked up” for the items described in the 2010 Tax Relief Act—Handbook Update Guide following this cover sheet.

Premium Quickfinder® Handbook2010 Tax Year

2010 Tax Relief Act—Handbook Update GuideHow to use this guide: This guide lists the topics discussed in the 2010 Handbook that were affected by the 2010 Tax Relief Act, which was enacted after the Handbook’s publication date. The changes listed here have been made for you by the Quickfinder editorial team in the Page Updates for the 2010 Tax Relief Act packet. To update your Handbook, you can make the same changes in your Handbook or print the revised page from the Page Updates for the 2010 Tax Relief Act packet and paste over the original page. For a complete summary of the 2010 Tax Relief Act (including provisions affecting 2011 and later years) go to the Tax Act—2010 Tax Relief Act section of the Updates section of Quickfinder.com.

Page Section or Table Title Change/CommentFront Cover Form 709 At the date the Handbook was published, there was no federal estate tax in

effect for 2010. Thus, the table presented only a gift tax rate schedule for 2010. Under the 2010 Tax Relief Act, the estate tax is reinstated for 2010 and the table has been updated to reflect the rates that now apply for both estate (un-less the executor elects for the estate tax to not apply) and gift taxes in 2010.

Front (inside) Cover

2010 AGI Phase-Out Amounts/Ranges Deduction for tuition and fees is extended to 2010 and 2011.

Back (inside) Cover

Filing Information At the date the Handbook was published, there was no federal estate tax in effect for 2010. Thus, the table did not present filing information for Form 706. Under the 2010 Tax Relief Act, the estate tax is reinstated for 2010 and the table has been updated to reflect the Form 706 filing options that now apply for the estate of a decedent who died in 2010.

Back (inside) Cover

Social Security Highlights For 2011, the Social Security tax rate is 4.2% for employees and 10.4% for self-employed individuals.

3-1 Quick Facts Data Sheet Additional 2010 and 2011 amounts are now available. 3-13 State and Local General Sales Tax

Deduction WorksheetElection to deduct state and local general sales taxes (in lieu of state and local income taxes) is extended to 2010 and 2011. See the State and Local Sales Tax Deduction Worksheet (2010) under 1040 Quickfinder® Handbook (2010 Tax Year) in the Updates section of Quickfinder.com.

4-14 Qualified Charitable Distribution (QCD) Qualified charitable distributions (QCDs) are allowed for 2010 and 2011. Note: Taxpayers can elect to treat QCDs made in January 2011 as occurring on December 31, 2010.

4-18 Tuition and Fees Deduction Deduction for tuition and fees is extended to 2010 and 2011.4-19 Additional Standard Deduction—Losses

From Federally Declared DisastersThe increase to the standard deduction for losses from federally declared disasters was not extended to disasters occurring in 2010.

4-19 Additional Standard Deduction—Real Property Taxes

The increase to the standard deduction for real property taxes paid (up to $500; $1,000 if MFJ) was not extended to 2010.

4-20 Exemptions The AGI-based phase-out of the deduction for personal exemptions does not apply for 2010–2012.

5-1 Limit on Itemized Deductions The AGI-based phase-out of itemized deductions does not apply for 2010–2012. 5-5 State and Local General Sales Taxes Election to deduct state and local general sales taxes (in lieu of state and local

income taxes) is extended to 2010 and 2011.5-12 Qualified Conservation Contributions The higher AGI limit (50%; 100% for qualified farmers and ranchers) is extended

to 2010 and 2011.5-15 Deductible Casualty Losses—Limits The $500 per-casualty reduction amount was not extended to 2010.5-15 Federally Declared Disasters—Quick

Summary of Special Tax Relief Provisions

The expired special relief provisions were not extended to federally declared disasters occurring in 2010.

6-14 Qualified Disaster Loss The longer five-year carryback period for an NOL attributable to a federally declared disaster was not extended to losses occurring in 2010.

6-21 Farm Equipment The five-year recovery period for new farm machinery and equipment was not extended for assets placed in service in 2010.

Copyright 2011 Thomson Reuters Premium Quickfinder® Handbook—2010 Tax Relief Act Handbook Update Guide Page-1

Continued on the next page

2010 Tax Relief Act—Handbook Update Guide (Continued)Page Section or Table Title Change/Comment6-22 Qualified Production Activities Income The provision that includes qualified production activities performed in Puerto

Rico in the domestic production gross receipts calculation is extended to 2010 and 2011.

7-1 Basis for Computing Gain or Loss Property inherited from a decedent who died in 2010 will have a basis equal to FMV at date of death and automatically have a long-term holding period unless the estate’s executor elects to be exempt from the estate tax. If so, the modified carryover basis rules apply.

7-15 Inherited Houses See comment above regarding property inherited from a decedent who died in 2010.

9-7 Educators The up-to-$250 educator’s expense deduction is extended to 2010 and 2011.10-2 Partial Table of Class Lives and Recov-

ery Periods—IRS Publication 946The five-year recovery period for new farm machinery and equipment was not extended to 2010.

10-9 Special Depreciation Allowance For qualifying property placed in service in 2010, the special depreciation al-lowance rate is as follows:•Property acquired and placed in service 1/1/10–9/8/10: 50%.•Property acquired and placed in service 9/9/10–12/31/10: 100%.

10-19 Leasehold Improvements, Retail and Restaurant Property—Special Rules (2010)

The 15-year MACRS recovery period for qualified leasehold improvements, restaurant property and retail improvements is extended to 2010 and 2011.

11-1 Business Vehicles—Quick Facts For 2010, the increased depreciation limits (annual Section 280F limits) that apply when 50% special depreciation is claimed also apply when 100% spe-cial depreciation is claimed (for property placed in service 9/9/10–12/31/10). However, the basis amount at which the Section 280F limits apply when 100% special depreciation is claimed is $11,060 for passenger autos and $11,160 for trucks and vans.

11-3 2010 Deduction Limits for Vehicles See above.11-3 Calculating Vehicle Depreciation Step 4: For new vehicles acquired 9/9/10–12/31/10, the special bonus allow-

ance is 100%.11-6 Depreciating Vehicles Acquired in a

TradeReferences to special depreciation should include both 50% and 100% special depreciation (100% if purchased 9/9/10–12/31/10).

11-6 Example Change the 2010 acquisition month from November to August so the 50% spe-cial depreciation rate used in the calculation is correct. (If November acquisition, 100% special depreciation would apply rather than 50%.)

11-14 Vehicles Subject to Section 280F Limit Depreciation Worksheet

Line 16—the rate used for special depreciation should be 100% for qualified vehicles purchased 9/9/10–12/31/10.

12-1, 12-2 Tax Credits Summary—Allowed Against AMT?

The provision allowing all personal credits to offset AMT as well as regular tax is extended to 2010 and 2011. Therefore, the child and dependent care, lifetime learning, elderly or disabled and the personal energy property credits should be changed to “yes.”

12-3 Child and Dependent Care Credit The child and dependent care credit can offset both regular tax and AMT in 2010 and 2011.

12-8 Education Tax Credits—AMT The lifetime learning credit can offset both regular tax and AMT in 2010 and 2011.12-12 Personal Energy Property Credit The personal energy property credit can offset both regular tax and AMT in

2010 and 2011.12-15 AMT Exemption Amounts The 2010 AMT exemption amounts are: $72,450 for MFJ and QW; $47,450 for

Single and HOH and $36, 225 for MFS. Thus, the exemptions are eliminated at AMTI of: $439,800 for MFJ and QW; $302,300 for Single and HOH and $219,900 for MFS.

12-26 Percentage Depletion Quick Facts—Net Income Limit

The 100%-of-net-income limit that normally applies is suspended for 2010 and 2011 for marginal production properties.

13-4 Tuition and Fees Deduction Tuition and fees deduction is extended to 2010 and 2011.13-5 Education Tax Incentives Comparison

Chart (2010)Tuition and fees deduction is extended to 2010 and 2011.

Page-2 Premium Quickfinder® Handbook—2010 Tax Relief Act Handbook Update Guide Copyright 2011 Thomson Reuters


2010 Tax Relief Act—Handbook Update Guide (Continued)Page Section or Table Title Change/Comment14-13 Qualified Charitable Distributions

(QCDs)Qualified charitable distributions (QCDs) are allowed for 2010 and 2011. Note: Taxpayers can elect to treat QCDs made in January 2011 as occurring on December 31, 2010.

14-21 Social Security and Medicare Highlights For 2011, the Social Security tax rate is 4.2% for employees and 10.4% for self-employed individuals. The maximum Social Security tax paid is $4,485.60 for employees and $11,107.20 for self-employed individuals.

17-7 Small Business Stock For noncorporate taxpayers, the 100% gain exclusion for qualified small busi-ness stock (QSBS) is extended one year so that it applies to stock acquired 9/28/10–12/31/11. The percentage of QSBS excluded gain that is an addition in computing alternative minimum taxable income is (1) 0% for 100% exclusion QSBS and (2) 7% (in tax years beginning before 1/1/13) for other QSBS—see Page 17-7 for later tax years’ addition percentages.

17-12, 18-2 Accumulated Earnings Tax The 15% rate is extended for two years.17-14 Enhanced charitable deduction for

qualified book and qualified computer donations.

The above-basis deductions for charitable donations by C corporations of (1) book inventories to public schools and (2) computer technology and equipment for educational purposes are extended for two years.

18-1 C Corporation vs. S Corporation The 0% and 15% tax rates on long-term capital gains and qualified dividends are extended for two years.

18-1 S Corporation Considerations The (1) 0% and 15% tax rates on long-term capital gains and qualified divi-dends and (2) reduced individual tax rates on ordinary income are extended for two years.

20-10 PHC Tax (IRC §541) The 15% rate is extended for two years.21-1, 21-5,

21-6Related Information; Taxes (line 11); Expenses deductible on Form 706.

The estate and generation-skipping transfer (GST) taxes have been reinstated for 2010, with an exclusion of $5 million for each tax, a maximum estate tax rate of 35% and a 0% GST tax rate.

21-4 Capital Gains and Losses (Schedule D) The basis of property acquired from a decedent who died in 2010 is generally the property’s FMV at the date of death, unless the executor elects to be ex-empt from estate tax, in which case, the modified carryover basis rules apply.

22-1 Estate and Gift Tax Returns An estate tax exclusion of $5 million and a maximum estate tax rate of 35% apply to decedents who died in 2010. Alternatively, the executor can elect for the decedent’s estate to be exempt from estate tax, in which case the basis of property acquired from the decedent is determined under the modified car-ryover basis rules.

22-1–22-3 Income and Expense Chart for a Dece-dent Who Died in 2010

This chart shows where to report selected items for a decedent who died in 2010 if the executor elects exemption from the estate tax. For where to report these items for a 2010 decedent to whom the estate tax applies, see Income and Expense Chart for a Decedent on Page 22-1 of the 2009 Tax Year Premium Quickfinder® Handbook.

22-4 Estate Administration Step-by-Step The estate tax has been reinstated for 2010 with an exclusion of $5 million and a maximum tax rate of 35%. The basis of property acquired from a 2010 decedent is determined under the modified carryover basis rules only if the executor elects for the estate to be exempt from the estate tax.

22-5 Deduction for estate tax paid prior to 2010.

As the estate tax has been reinstated for 2010, this deduction also applies for estate tax paid for a 2010 decedent.

22-6 Itemized Deductions As the estate tax has been reinstated for 2010, funeral, etc. expenses are deductible on Form 706 if it is required to be filed.

22-7 Gift Tax Return (Form 709) The discussion has been updated to reflect the reinstatement of the estate tax for 2010.

22-7 Gifts Subject to Gift Tax The 2010 Tax Relief Act repealed Section 2511(c), under which a post-2009 transfer in trust would have been treated as a gift.

22-8 Transfer to irrevocable trust. The example has been removed and replaced with a reference to the 2009 Handbook due to the 2010 Tax Relief Act repeal of Section 2511(c).

22-9 Death transforms joint tenancy gift into inheritance.

The discussion has been updated to reflect the reinstatement of the estate tax for 2010.

Copyright 2011 Thomson Reuters Premium Quickfinder® Handbook—2010 Tax Relief Act Handbook Update Guide Page-3


2010 Tax Relief Act—Handbook Update Guide (Continued)Page Section or Table Title Change/Comment22-9 Life estates and remainder interests. The discussion has been updated to reflect the reinstatement of the estate

tax for 2010.22-10 Estate Tax The discussion has been updated to reflect the reinstatement of the estate

tax for 2010.22-12 Generation-Skipping Transfer (GST) Tax The discussion has been updated to reflect the reinstatement of the GST tax

for 2010.22-12–22-13 Basis in Property The discussion has been updated to reflect that the basis of property acquired

from a decedent who died in 2010 is the property’s FMV at the date of death, unless the executor elects to be exempt from estate tax, in which case, the modified carryover basis rules apply.

22-14 Valuing Property The discussion has been updated to reflect the reinstatement of the estate tax for 2010.

22-14–22-16 Estate—Comprehensive Example Cautioned that the example is based on electing for the estate tax to not apply and referenced an estate tax example using 2009 law.

23-1 Depository taxes include: For 2011, the Social Security tax rate is 4.2% for employees and 10.4% for self-employed individuals. The maximum Social Security tax paid is $4,485.60 for employees and $11,107.20 for self-employed individuals.

24-2 Environmental clean-up costs. The ability to deduct environmental remediation costs paid or incurred to clean up a state designated “qualified contaminated site” is extended for two years.

24-3 Qualified disaster expenses. The ability to deduct certain disaster expenses that are normally capitalized was not extended to federally declared disasters occurring in 2010.

24-4 “In the U.S.” Requirement The provision that includes qualified production activities performed in Puerto Rico in the domestic production gross receipts calculation is extended to 2010 and 2011.

24-7 General Business Tax Credit Summary Several component credits of the general business tax credit that had expired 12/31/09 are extended to 2010 and 2011.

24-7 Low-Income Housing; Orphan Drug The low-income housing and orphan drug component credits of the general business credit are not scheduled to expire—they are permanently in effect under current law.

24-7 Work Opportunity The work opportunity credit is extended for four months, for wages paid to workers beginning work through 12/31/11.

24-10 Vehicle Refueling Property Credit The credit is extended for one year to apply to property placed in service through 12/31/11 (other than hydrogen refueling property, which already goes through 2014). The pre-2010 credit rate and maximum credit amounts apply for property placed in service in 2011.

24-11 Energy Efficient Home Builders Credit The credit is extended for two years to apply to homes acquired in 2010 and 2011.24-11 Appliance Manufacturers Credit The credit is extended for one year to apply to appliances manufactured in

2011, with up to $25 million in credits available per manufacturer, a 4% gross receipts limitation applying and the credit eligibility standards and credit amounts modified for various types of appliances.

24-15 Computer Software The cost of off-the-shelf computer software continues to qualify for Section 179 expensing through tax years beginning in 2012.

24-16 Depreciation For qualifying property placed in service in 2010, the special depreciation al-lowance rate is as follows:• Property acquired and placed in service 1/1/10–9/8/10: 50%.• Property acquired and placed in service 9/9/10–12/31/10: 100%.

24-20 Leasehold Improvements The 15-year MACRS recovery period for qualified leasehold improvements, restaurant property and retail improvements is extended to 2010 and 2011.

24-22 Research and Development Costs The research credit is extended for two years, for amounts paid or incurred through 12/31/11.

25-2 Tax Extenders Legislation The table has been updated to show whether these provisions were extended to 2010.

25-16 Federally Declared Disasters—Quick Summary of Special Tax Relief Provisions for Businesses

The expired special relief provisions were not extended to federally declared disasters occurring in 2010.

Page-4 Premium Quickfinder® Handbook—2010 Tax Relief Act Handbook Update Guide Copyright 2011 Thomson Reuters

Form 1120Corporation Tax Rate Schedule

—Quick Tax Method—For tax years beginning after December 31, 1992

TAXABLE INCOME × % MINUS $ = TAX$ 0 – $ 50,000 × 15% minus $ 0 = Tax

50,001 – 75,000 × 25% minus 5,000 = Tax75,001 – 100,000 × 34% minus 11,750 = Tax

100,001 – 335,000 × 39% minus 16,750 = Tax335,001 – 10,000,000 × 34% minus 0 = Tax

10,000,001 – 15,000,000 × 35% minus 100,000 = Tax15,000,001 – 18,333,333 × 38% minus 550,000 = Tax18,333,334 and over × 35% minus 0 = Tax

Note: See Basics of Corporations on Page 17-1 for exceptions to above tax rates and an example of how to use the Quick Tax Method.

Form 10412010 Fiduciary Tax Rate Schedule

—Quick Tax Method— TAXABLE INCOME × % MINUS $ = TAX$ 0 – $ 2,300 × 15% minus $ 0.00 = Tax

2,301 – 5,350 × 25% minus 230.00 = Tax5,351 – 8,200 × 28% minus 390.50 = Tax8,201 – 11,200 × 33% minus 800.50 = Tax

11,201 and over × 35% minus 1,024.50 = Tax

Note: The 10% tax bracket that applies to individuals does not apply to estates and trusts.

Form 709Gift Tax Rate Schedule—Quick Tax Method—For gifts made in 2010**

TAXABLE AMOUNT × % MINUS $ = TAX*$ 0 – $ 10,000 × 18% minus $ 0 = Tax

10,001 – 20,000 × 20% minus 200 = Tax20,001 – 40,000 × 22% minus 600 = Tax40,001 – 60,000 × 24% minus 1,400 = Tax60,001 – 80,000 × 26% minus 2,600 = Tax80,001 – 100,000 × 28% minus 4,200 = Tax

100,001 – 150,000 × 30% minus 6,200 = Tax150,001 – 250,000 × 32% minus 9,200 = Tax250,001 – 500,000 × 34% minus 14,200 = Tax500,001 and over × 35% minus 19,200 = Tax

* Less applicable credit amount. See the charts at the beginning of Tab 22.

Form 10402010 Quick Tax Method*

MFJ or QW Taxable Income$ 0 – $ 16,750 × 10% minus $ 0.00 = Tax

16,751 – 68,000 × 15% minus 837.50 = Tax68,001 – 137,300 × 25% minus 7,637.50 = Tax

137,301 – 209,250 × 28% minus 11,756.50 = Tax209,251 – 373,650 × 33% minus 22,219.00 = Tax373,651 and over × 35% minus 29,692.00 = Tax

Single Taxable Income$ 0 – $ 8,375 × 10% minus $ 0.00 = Tax

8,376 – 34,000 × 15% minus 418.75 = Tax34,001 – 82,400 × 25% minus 3,818.75 = Tax82,401 – 171,850 × 28% minus 6,290.75 = Tax

171,851 – 373,650 × 33% minus 14,883.25 = Tax373,651 and over × 35% minus 22,356.25 = Tax

HOH Taxable Income$ 0 – $ 11,950 × 10% minus $ 0.00 = Tax

11,951 – 45,550 × 15% minus 597.50 = Tax45,551 – 117,650 × 25% minus 5,152.50 = Tax

117,651 – 190,550 × 28% minus 8,682.00 = Tax190,551 – 373,650 × 33% minus 18,209.50 = Tax373,651 and over × 35% minus 25,682.50 = Tax

MFS Taxable Income$ 0 – $ 8,375 × 10% minus $ 0.00 = Tax

8,376 – 34,000 × 15% minus 418.75 = Tax34,001 – 68,650 × 25% minus 3,818.75 = Tax68,651 – 104,625 × 28% minus 5,878.25 = Tax

104,626 – 186,825 × 33% minus 11,109.50 = Tax186,826 and over × 35% minus 14,846.00 = Tax

* Assumes taxable income is all ordinary income. Multiply taxable income by the applicable tax rate and subtract the amount shown. Although this method differs from the IRS Tax Rate Schedules, the results are the same.U Caution: IRS Tax Tables must be used for taxable income under $100,000. To calculate the exact tax using the Quick Tax Method for taxable income under $100,000, round taxable income to the nearest $25 or $75 increment before using the formula. Round $50 or $100 increments up.

2010 Key AmountsStandard Deduction: Earned Income Credit (Maximum):

MFJ or QW1 ......................... $11,400 No children .......................... $ 457Single2 ................................. 5,700 1 child .................................. 3,050HOH2 ................................... 8,400 2 children ............................. 5,036MFS1 .................................... 5,700 >2 children ........................... 5,666Dependent2 .......................... 9503 Investment income limit ....... 3,100

Personal Exemption ............ $3,650 Kiddie Tax Threshold .......... $ 1,900Standard Mileage Rates: Section 179 Deduction Limits:

Business .............................. 50¢ Overall ................................ $500,000Medical/moving .................... 16.5¢ SUV (per vehicle) ................ 25,000Charitable ............................ 14¢ Qualified real property ......... 250,0001 Add $1,100 for age 65 or older or blind, each.2 Add $1,400 for age 65 or older or blind, each.3 If greater, amount of earned income plus $300 (but not to exceed $5,700).

TAX PREPARATION1040

SMALL BUSINESSESTATE AND TRUST

EXEMPT ORGANIZATIONPAYROLL TAX

2010 TAX YEARHANDBOOK

Premium

Copyright 2010 Thomson Reuters. All Rights Reserved.

** Executor may elect for estate tax to not apply. See Tab H.

Estate and Forms 706 and 709

and estates of decedents dying

If you have any questionsWe welcome comments and questions from readers. However, our response is limited to verification of specific information presented in the Quickfinder® Handbooks. We cannot give advice on a client’s tax situation or provide information beyond the contents of this publication. Questions must be submitted in writing by mail, fax or online at Quickfinder.thomson.com (Content Questions on the Contact Us page). Research editors are not available to answer questions over the phone.

Join in on our Message BoardDo you have a client-specific question? Visit Quickfinder.thomson.com and post your question on the Quickfinder Message Board!

UpdatesFor supplemental information to the material in this handbook, please refer to the Updates section of our website: Quickfinder.thomson.com.

Form 1040—Tax Rules By Age for 2010Age Rule13 Cannot claim a child care credit for children age 13 or older.17 Cannot claim $1,000 child tax credit for children age 17 or older.18 • Children working for parents’ unincorporated business subject to FICA.

• Generally cannot contribute to an ESA for children age 18 or older.• Adoption credit or exclusion generally unavailable for children age 18 or older.• Taxpayer qualifies for saver’s credit (if neither a dependent nor student).• Kiddie tax no longer applies at age 18 (or 19–23 and full-time student) if child’s

earned income is greater than half of his support.19 Exemption for dependent children who are not full-time students expires.21 Children working for parents’ unincorporated business subject to FUTA.24 • Exemption for dependent children who are full-time-students expires.

• Can purchase savings bonds and exclude income used for education.• Kiddie tax no longer applies.

25 Taxpayers with no children qualify for EIC.27 Income exclusion for health insurance coverage and self-employed health

insurance deduction for coverage of children age 26 and younger expires.30 Generally must distribute ESA when beneficiary reaches age 30.50 • Eligible for catch-up contributions to IRAs, SIMPLE-IRAs, 401(k) and 403(b)

plans.• Qualified public safety employees eligible for penalty-free withdrawals from a

governmental defined benefit pension plan, if retired. 55 • Eligible for penalty-free withdrawal from employer retirement plan (but not an

IRA) if separated from service.• Eligible for catch-up contributions to HSAs.

59½ • Penalty for early withdrawal from retirement accounts expires.• Roth IRA distributions are tax-free (if any Roth held for at least five years).

65 • Non-itemizers become eligible for a higher standard deduction.• Taxpayers with no children no longer qualify for EIC.• HSA and MSA withdrawals not used for medical costs are taxed but no longer

subject to a 10% penalty.• Eligible for credit for the elderly.

70½ • Contributions no longer allowed to traditional IRAs.• Required minimum distributions from retirement plans must begin.

Premium Quickfinder® HandbookCopyright 2010 Thomson Reuters.All Rights Reserved. ISSN 2152-1409 ISBN 978-0-7646-5393-8 PO Box 966 Fort Worth TX 76101-0966 Phone 800-510-8997 Fax 817-877-3694 Quickfinder.thomson.comThe Premium Quickfinder® Handbook is published by Thomson Reuters. Reproduction is prohibited without written permission of the publisher. Not assignable without consent.The Premium Quickfinder® Handbook is to be used as a first-source, quick reference to basic tax principles used in preparing individual and business tax returns. The focus of this Handbook is to present often-needed reference information in a concise, easy-to-use format. The summaries, highlights, tax tips and other information included herein are intended to apply to the average taxpayer only. Information included is general in nature and we acknowledge the existence of many exceptions in the area of tax. The information this Handbook contains has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. The author/publisher is not engaged in rendering legal, accounting or other advice and will not be held liable for any actions or suit based on this Handbook. For further information regarding a specific situation, see applicable IRS publica-tions, rulings, regulations, court cases and Code sections. This Handbook is not intended to be used as your only reference source.

Form 1040—2010 AGI Phase-Out Amounts/Ranges

Filing Status

Tuition and Fees Deduction1

Student Loan Interest Deduction

Education Savings Bond Interest

ExclusionLifetime Learning

CreditAmerican Opportunity

CreditEducation Savings

Account (ESA)MFJ $130,000 / $160,000 $120,000 – $150,000 $105,100 – $135,100 $100,000 – $120,000 $160,000 – $180,000 $190,000 – $220,000QW 65,000 / 80,000 60,000 – 75,000 105,100 – 135,100 50,000 – 60,000 80,000 – 90,000 95,000 – 110,000

Single 65,000 / 80,000 60,000 – 75,000 70,100 – 85,100 50,000 – 60,000 80,000 – 90,000 95,000 – 110,000HOH 65,000 / 80,000 60,000 – 75,000 70,100 – 85,100 50,000 – 60,000 80,000 – 90,000 95,000 – 110,000MFS Do Not Qualify Do Not Qualify Do Not Qualify Do Not Qualify Do Not Qualify 95,000 – 110,000

Child Tax Credit2

Saver’s Credit3

Earned Income Credit3 Traditional IRA Deduction4

Roth IRA Contribution

Adoption Credit/AssistanceNo Child 1 Child 2 Children >2 Children

MFJ $110,000 $ 55,500 $18,470 $40,545 $45,373 $48,362 $ 89,000 – $109,000 $167,000 – $177,000 $182,520 – $222,520QW 75,000 27,750 13,460 35,535 40,363 43,352 89,000 – 109,000 167,000 – 177,000 182,520 – 222,520

Single 75,000 27,750 13,460 35,535 40,363 43,352 56,000 – 66,000 105,000 – 120,000 182,520 – 222,520HOH 75,000 41,625 13,460 35,535 40,363 43,352 56,000 – 66,000 105,000 – 120,000 182,520 – 222,520MFS 55,000 27,750 Do Not Qualify 05 – 10,000 05 – 10,000 Do Not Qualify

1 The phase-out amounts for the $4,000 and $2,000 deductions, respectively, are shown. U Caution: Deduction expired after 2009 but may be extended. See Tax Extenders Legislation on Page 25-1.

2 Amount at which phase-out begins.3 Amount at which phase-out is complete.4 Phase-out only applies if taxpayer is an active participant in a retirement plan. For MFJ, phase-out range for non-participating spouse is $167,000 – $177,000.5 Married individuals filing MFS who live apart at all times during the year are treated as single.

Copyright 2010 Thomson Reuters. All Rights Reserved. The Quickfinder logo and Quickfinder® Handbooks are trademarks of Thomson Reuters.

2010 Employer Retirement Plan Contribution LimitsProfit Sharing 401(k) SIMPLE IRA SEP

Employee Elective Deferral:< Age 50≥ Age 50

N/AN/A

$16,500 22,000

$11,500 14,000

N/AN/A

Employer Contribution:Per Participant

Lesser of: 100% of comp or $49,000

Lesser of: 100% of comp or $49,000

N/A Lesser of: 25%2 of comp or $49,000

Total Deductible Contribution

25% of total comp1 paid to all participants

25% of total comp1 paid to all participants (excluding employee deferrals)

Either: 1) 100% match

up to 3% of comp or

2) 2% of comp1

25% of total comp1 paid to all participants

1 Limited to $245,000 per participant.2 20% of net SE income for self-employed.

Comparison of Traditional and Roth IRAs (2010 and 2011)Traditional Roth

Contributions:Limit < age 50 $5,000 $5,000Limit ≥ age 50 6,000 6,000Deductible? Yes1 NoAllowed after age 701/2? No Yes

Distributions:Taxable? Yes, to the extent they

exceed basis.No2

Required minimum distributions?

After age 701/2. After owner’s death.

10% penalty if before age 591/2?

Yes, subject to exceptions.

Yes, subject to exceptions.

Basis allocation? Portion of total basis in all traditional IRAs

allocated to each distribution.

Total basis in all Roth IRAs distributed before

earnings.

1 Deduction may be phased out if individual or spouse is covered by an employer retirement plan.

2 If a qualified distribution. If nonqualified distribution, distributions taxable after basis is recovered.

2011 Key AmountsHealth Savings Accounts

Self-only coverage: Contribution limit ................................................... $ 3,050Plan minimum deductible ..................................... 1,200Plan out-of-pocket limit ......................................... 5,950

Family coverage: Contribution limit ................................................... 6,150Plan minimum deductible ..................................... 2,400Plan out-of-pocket limit ......................................... 11,900

Additional contribution limit—age 55 or older ....................................... 1,000Profit-Sharing Plan/SEP

Contribution limit ..................................................................................$ 49,000Compensation limit (for employer contributions) ...................................245,000

Traditional IRA Deduction Phase-Out Begins at AGI of

Retirement Plan AmountsSIMPLE IRA Elective Deferral Limit

MFJ,1 QW1 ...................... $ 90,000 < age 50 ............................$ 11,500MFJ2 ............................. 169,000 ≥ age 50 ............................ 14,000Single1 .......................... 56,000 401(k) Elective Deferral LimitHOH1 ............................ 56,000 < age 50 ............................$ 16,500MFS1 .............................. 0 ≥ age 50 ............................ 22,000

1 Participant in employer retirement plan 2 Nonparticipating spouse

Filing InformationTax Return Return Due Extensions

Form 1065: Partnership/LLC

15th day of fourth month following close of tax year.

Form 7004 extends deadline five months.

Forms 1120/1120S: Corporation

15th day of third month following close of tax year.

Form 7004 extends deadline six months.

Form 1041: Estates and Trusts

15th day of fourth month following close of tax year.

Form 7004 extends deadline five months.

Form 709: Gift Tax April 15th following close of tax year of gift.

Form 4868 or 8892 extends deadline six months.

Form 990: Exempt Organizations

15th day of fifth month following close of tax year.

Form 8868 extends deadline three months. A second Form 8868 extends three additional months.

Form 706: Estates Nine months after date of decedent’s death.*

Form 4768 extends deadline six months.

* For estates of decedents dying after 12/31/09 and before 12/17/10, no earlier than nine months after 12/17/10.

Payroll Deposit Deadlines (Form 941)Type of

Depositor Monthly Semiweekly

Deposit Due Dates

15th day of following month

Payday on: Wednesday, Thursday, Friday

Due on: Following Wednesday

Payday on: Saturday, Sunday, Monday, Tuesday

Due on: Following Friday

Reason Classified

1) Total federal payroll taxes were $50,000 or less in the lookback period or

2) New employer.

Total federal payroll taxes were more than $50,000 in the lookback period.

Exceptions:• Employer accumulates less than $2,500 in taxes during the current or preceding

quarter: Deposit as above or send payment with quarterly tax return.• Employer accumulates more than $100,000 in taxes during payroll period:

Deposit due on next day (that is not a Saturday, Sunday or legal holiday) after the payday in which the $100,000 threshold is reached.

• Employers notified by the IRS to file Form 944 that accumulate less than $2,500 in taxes during the fourth quarter: Pay fourth quarter tax liability with Form 944.

• See IRS Pub. 15 for exceptions to the deposit penalties under the Accuracy of Deposit rules.

Social Security and Medicare HighlightsMaximum Earnings Subject to: 2010 2011

Social Security tax .................................................... $106,800 $106,800Medicare tax ............................................................. No Limit No Limit

Tax RatesEmployee: Social Security tax .......................... 6.20% 6.20% Medicare tax ................................... 1.45 1.45Self Employed: Social Security tax .......................... 12.40 12.40 Medicare tax ................................... 2.90 2.90

Maximum Earnings and Still Receive Full Benefits:Under full retirement age (FRA) ............................... $ 14,160 $ 14,160Year FRA reached .................................................... 37,680 37,680FRA or older ............................................................. No Limit No Limit

Medicare: Part A monthly premium1 .......................................... $ 461.00 $ 450.00Part B monthly premium2 .......................................... 96.40 96.40Hospital deductible ................................................... 1,100.00 1,132.00Medical deductible .................................................... 155.00 162.00

1 Cost for those ineligible for Social Security benefits. Lower premium if 30–39 quarters of covered employment.

2 High-income beneficiaries and those who did not have premiums withheld by the SSA pay a higher premium.

4.20

10.40

2010 Tax Year | Premium Quickfinder® Handbook 3-1

Quick Facts, Worksheets, Where to FileAll worksheets included in Tab 3 may be copied and used in your tax practice.

Quick Facts Data Sheet2011 2010 2009 2008 2007

General Deductions and CreditsStandard deduction:

MFJ or QW $ 11,600 $ 11,400 $ 11,400 $ 10,900 $ 10,700Single 5,800 5,700 5,700 5,450 5,350HOH 8,500 8,400 8,350 8,000 7,850MFS 5,800 5,700 5,700 5,450 5,350Additional for age 65 or older or blind each (MFJ, QW, MFS) 1,150 1,100 1,100 1,050 1,050Additional for age 65 or older or blind each (Single, HOH) 1,450 1,400 1,400 1,350 1,300

Itemized deduction phase-out begins at AGI of:MFJ, QW, Single or HOH N/A N/A $ 166,800 $ 159,950 $ 156,400MFS N/A N/A 83,400 79,975 78,200

Personal/dependent exemption $ 3,700 $ 3,650 $ 3,650 $ 3,500 $ 3,400Personal exemption phase-out begins at AGI of: 2

MFJ or QW N/A N/A $ 250,200 $ 239,950 $ 234,600Single N/A N/A 166,800 159,950 156,400HOH N/A N/A 208,500 199,950 195,500MFS N/A N/A 125,100 119,975 117,300

Earned income credit:Earned income and AGI must be less than (MFJ): 3

No qualifying children $ 18,740 $ 18,470 $ 18,440 $ 15,880 $ 14,590One qualifying child 41,132 40,545 40,463 36,995 35,241Two qualifying children 46,044 45,373 45,295 41,646 39,783Three or more qualifying children 49,078 48,362 48,279 41,646 39,783

Maximum amount of credit (all filers except MFS):No qualifying children $ 464 $ 457 $ 457 $ 438 $ 428One qualifying child 3,094 3,050 3,043 2,917 2,853Two qualifying children 5,112 5,036 5,028 4,824 4,716Three or more qualifying children 5,751 5,666 5,657 4,824 4,716

Investment income limit 3,150 3,100 3,100 2,950 2,900Child tax credit:

Credit per child $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000Additional (refundable) credit—earned income floor 3,000 3,000 3,000 8,500 11,750

Adoption credit:Maximum credit (and amount allowed for adoption of special needs child)

$ 13,360 $ 13,170 $ 12,150 $ 11,650 $ 11,390

Credit phase-out begins at AGI of:All taxpayers except MFS $ 185,210 $ 182,520 $ 182,180 $ 174,730 $ 170,820MFS Not Allowed Not Allowed Not Allowed Not Allowed Not Allowed

Kiddie tax unearned income threshold $ 1,900 $ 1,900 $ 1,900 $ 1,800 $ 1,700Foreign earned income exclusion $ 92,900 $ 91,500 $ 91,400 $ 87,600 $ 85,700

Table continued on the next page

Tab 3 TopicsQuick Facts Data Sheet .......................................... Page 3-1Business Use of Home Worksheet ......................... Page 3-4Capital Loss Carryover Worksheet ......................... Page 3-5Child Tax Credit Worksheet (2010) ......................... Page 3-5Donations—Noncash .............................................. Page 3-6Donated Goods Valuation Guide ............................ Page 3-6Donations Substantiation Guide ............................. Page 3-7Earned Income Credit (EIC) Worksheet (2010) ...... Page 3-8Forms 1098 and 1099—What’s Reported .............. Page 3-9Net Operating Loss Worksheet #1 ........................ Page 3-10

Net Operating Loss Worksheet #2— Computation of NOL ........................................... Page 3-11

Net Operating Loss Worksheet #3— NOL Carryback ................................................... Page 3-11

Social Security Benefits Worksheet (2010) ........... Page 3-12State and Local General Sales Tax

Deduction Worksheet ......................................... Page 3-13Student Loan Interest Deduction Worksheet ........ Page 3-13Where to File 2010 Form 1040, 1040EZ............... Page 3-14Where to File Form 1040-ES for 2011 .................. Page 3-14Where to File Form 4868 for 2010 Return ............ Page 3-14

3-2 2010 Tax Year | Premium Quickfinder® Handbook

Quick Facts Data Sheet (Continued)2011 2010 2009 2008 2007

FICA/SE TaxesMaximum earnings subject to tax:

Social Security tax $ 106,800 $ 106,800 $ 106,800 $ 102,000 $ 97,500Medicare tax No Limit No Limit No Limit No Limit No Limit

Maximum tax paid by:Employee—Social Security $ 4,485.60 $ 6,621.60 $ 6,621.60 $ 6,324 $ 6,045Self-employed—Social Security 11,107.20 13,243.20 13,243.20 12,648 12,090Employee or self-employed—Medicare No Limit No Limit No Limit No Limit No Limit

Business DeductionsSection 179 deduction—limit $ 500,000 $ 500,000 $ 250,000 $ 250,000 $ 125,000Section 179 deduction—SUV limit (per vehicle) 25,000 25,000 25,000 25,000 25,000Section 179 deduction—qualified real property limit 250,000 250,000 N/A N/A N/ASection 179 deduction—qualifying property phase-out threshold 2,000,000 2,000,000 800,000 800,000 500,000Depreciation limit—autos (1st year) 1 3,0604 2,9604 2,9604 3,060Depreciation limit—trucks and vans (1st year) 1 3,1604 3,0604 3,1604 3,260Standard mileage allowances:

Business 51¢ 50¢ 55¢ 50.5¢ / 58.5¢ 48.5¢Charity work 14¢ 14¢ 14¢ 14¢ 14¢Medical/moving 19¢ 16.5¢ 24¢ 19¢ / 27¢ 20¢

Health Care DeductionsHealth savings accounts (HSAs):

Self-only coverage: Contribution limit $ 3,050 $ 3,050 $ 3,000 $ 2,900 $ 2,850Plan minimum deductible 1,200 1,200 1,150 1,100 1,100Plan out-of-pocket limit 5,950 5,950 5,800 5,600 5,500

Family coverage: Contribution limit 6,150 6,150 5,950 5,800 5,650Plan minimum deductible 2,400 2,400 2,300 2,200 2,200Plan out-of-pocket limit 11,900 11,900 11,600 11,200 11,000

Additional contribution limit—age 55 or older 1,000 1,000 1,000 900 800Long-term care insurance—deduction limits:

Age 40 and under $ 340 $ 330 $ 320 $ 310 $ 290Age 41 – 50 640 620 600 580 550Age 51 – 60 1,270 1,230 1,190 1,150 1,110Age 61 – 70 3,390 3,290 3,180 3,080 2,950Age 71 and older 4,240 4,110 3,980 3,850 3,680

Long-term care—excludible per diem $ 300 $ 290 $ 280 $ 270 $ 260Medical savings accounts (MSAs):

Self-only coverage: Plan minimum deductible $ 2,050 $ 2,000 $ 2,000 $ 1,950 $ 1,900Plan maximum deductible 3,050 3,000 3,000 2,900 2,850Plan out-of-pocket limit 4,100 4,050 4,000 3,850 3,750

Family coverage: Plan minimum deductible 4,100 4,050 4,000 3,850 3,750Plan maximum deductible 6,150 6,050 6,050 5,800 5,650Plan out-of-pocket limit 7,500 7,400 7,350 7,050 6,900

Education Tax IncentivesEducation savings accounts (ESAs) phase-out begins at AGI of:

MFJ $ 190,000 $ 190,000 $ 190,000 $ 190,000 $ 190,000Single, HOH, QW and MFS 95,000 95,000 95,000 95,000 95,000

Hope/American Opportunity Credit—maximum credit (per student) $ 2,500 $ 2,500 $ 2,500 $ 1,800 $ 1,650Lifetime learning credit (LLC)—maximum credit (per return) $ 2,000 $ 2,000 $ 2,000 $ 2,000 $ 2,000Education credit phase-out begins at AGI of:

MFJ Hope/American Opportunity: $ 160,000 $ 160,000 $ 160,000 $ 96,000 $ 94,000LLC: 102,000 100,000 100,000 96,000 94,000

Single, HOH and QW

Hope/American Opportunity: 80,000 80,000 80,000 48,000 47,000LLC: 51,000 50,000 50,000 48,000 47,000

MFS Not Allowed Not Allowed Not Allowed Not Allowed Not AllowedStudent loan interest deduction limit $ 2,500 $ 2,500 $ 2,500 $ 2,500 $ 2,500Student loan interest deduction phase-out begins at AGI of:

MFJ $ 120,000 $ 120,000 $ 120,000 $ 115,000 $ 110,000Single, HOH and QW 60,000 60,000 60,000 55,000 55,000MFS Not Allowed Not Allowed Not Allowed Not Allowed Not Allowed



Quick Facts Data Sheet (Continued)2011 2010 2009 2008 2007

Savings bonds income exclusion phase-out begins at AGI of:MFJ and QW $ 106,650 $ 105,100 $ 104,900 $ 100,650 $ 98,400Single and HOH 71,100 70,100 69,950 67,100 65,600MFS Not Allowed Not Allowed Not Allowed Not Allowed Not Allowed

Tuition deduction phase-out begins at AGI of:MFJ $ 130,000 $ 130,000 $ 130,000 $ 130,000 $ 130,000Single, HOH and QW 65,000 65,000 65,000 65,000 65,000MFS Not Allowed Not Allowed Not Allowed Not Allowed Not Allowed

Alternative Minimum Tax (AMT)AMT exemption:

MFJ or QW $ 74,450 $ 72,450 $ 70,950 $ 69,950 $ 66,250Single or HOH 48,450 47,450 46,700 46,200 44,350MFS 37,225 36,225 35,475 34,975 33,125Child subject to kiddie tax—earned income plus 6,800 6,700 6,700 6,400 6,300

Retirement PlansIRA contribution limits:

Under age 50 $ 5,000 $ 5,000 $ 5,000 $ 5,000 $ 4,000Age 50 or older 6,000 6,000 6,000 6,000 5,000

Traditional IRA deduction phase-out begins at AGI of (active employer retirement plan participants):MFJ and QW (participating spouse) $ 90,000 $ 89,000 $ 89,000 $ 85,000 $ 83,000MFJ (non-participating spouse) 169,000 167,000 166,000 159,000 156,000Single and HOH 56,000 56,000 55,000 53,000 52,000MFS 0 0 0 0 0

Roth IRA contribution phase-out begins at AGI of:MFJ and QW $ 169,000 $ 167,000 $ 166,000 $ 159,000 $ 156,000Single and HOH 107,000 105,000 105,000 101,000 99,000MFS 0 0 0 0 0

Roth IRA conversion—AGI limit:MFJ, Single, HOH N/A N/A $ 100,000 $ 100,000 $ 100,000MFS N/A N/A Not Allowed Not Allowed Not Allowed

SIMPLE IRA plan elective deferral limits:Under age 50 $ 11,500 $ 11,500 $ 11,500 $ 10,500 $ 10,500Age 50 or older 14,000 14,000 14,000 13,000 13,000

401(k), 403(b), 457 and SARSEP elective deferral limits:Under age 50 $ 16,500 $ 16,500 $ 16,500 $ 15,500 $ 15,500Age 50 or older 22,000 22,000 22,000 20,500 20,500

Profit-sharing plan/SEP contribution limits $ 49,000 $ 49,000 $ 49,000 $ 46,000 $ 45,000Compensation limit (for employer contributions to profit sharing plans) $ 245,000 $ 245,000 $ 245,000 $ 230,000 $ 225,000Defined benefit plans—annual benefit limit $ 195,000 $ 195,000 $ 195,000 $ 185,000 $ 180,000Retirement saver’s credit phased-out when AGI exceeds:

MFJ $ 56,500 $ 55,500 $ 55,500 $ 53,000 $ 52,000HOH 42,375 41,625 41,625 39,750 39,000Single, MFS, QW 28,250 27,750 27,750 26,500 26,000

“Key employee” compensation threshold $ 160,000 $ 160,000 $ 160,000 $ 150,000 $ 145,000“Highly compensated” threshold $ 110,000 $ 110,000 $ 110,000 $ 105,000 $ 100,000

Social SecurityMaximum earnings and still receive full Social Security benefits:

Under full retirement age (FRA) at year-end, benefits reduced by $1 for each $2 earned over:

$ 14,160 $ 14,160 $ 14,160 $ 13,560 $ 12,960

Year FRA reached, benefits reduced $1 for each $3 earned over (months up to FRA only):

37,680 37,680 37,680 36,120 34,440

Month FRA reached and later: No Limit No Limit No Limit No Limit No LimitEstate and Gift Taxes

Estate tax exclusion $ 5,000,0006 $ 5,000,0005 $ 3,500,000 $ 2,000,000 $ 2,000,000Gift tax exclusion $ 5,000,0006 $ 1,000,000 $ 1,000,000 $ 1,000,000 $ 1,000,000GST tax exemption $ 5,000,000 $ 5,000,000 $ 3,500,000 $ 2,000,000 $ 2,000,000Gift tax annual exclusion $ 13,000 $ 13,000 $ 13,000 $ 12,000 $ 12,0001 Amount not released by IRS at publication time. When these amounts are available, an updated table will be posted to the Updates section of Quickfinder.com.2 Regardless of AGI, the exemption cannot be reduced below $2,433 (2009); $2,333 (2008) and $1,133 (2007).3 To get earned income/AGI phaseout amount for all other filers (except MFS), reduce amount shown by: $5,080 in 2011; $5,010 in 2010; $5,000 in 2009; $3,000 in 2008;

$2,000 in 2007.4 Add $8,000 if special depreciation claimed.5 Executor can elect that the estate not be subject to estate tax. If so, basis of property acquired from the decedent is determined under the modified carryover basis rules.6 Plus the amount, if any, of deceased spousal unused exclusion amount.


State and Local General Sales Tax Deduction Worksheet

For 2009, taxpayers could elect to deduct state and local sales taxes instead of state and local income taxes (see State and Local General Sales Taxes on Page 5-5). At publication time, Congress was considering legislation to extend this provision to 2010. See Tax Extenders

Legislation on Page 17-1.

If extended to 2010, the worksheet and tables will be posted to the Updates section of Quickfinder.com.

Student Loan Interest Deduction Worksheet

U Caution: Do not use this worksheet if taxpayer filed Form 2555 or 2555-EZ (related to foreign earned income) or Form 4563 (income exclusion for residents of American Samoa) or if taxpayer is excluding income from sources within Puerto Rico. Use the worksheet in IRS Pub. 970 instead.

1) Enter the total interest paid in 2010 on qualified student loans. Do not enter more than $2,500 ...................... 1)

2) Enter the amount from Form 1040, line 22 ......................................................................................................... 2)

3) Enter the total of the amounts from Form 1040, lines 23 through 32, plus any write-in adjustments entered on the dotted line next to line 36 ........................................................................................................... 3)

4) Subtract line 3 from line 2 ................................................................................................................................... 4)

5) Enter the amount shown below for taxpayer’s filing status:• Single, HOH or QW—$60,000• MFJ—$120,000................................................................................................................................................ 5)

6) Is the amount on line 4 more than the amount on line 5? ..................................................................................

No Skip lines 6 and 7, enter -0- on line 8 and go to line 9.

Yes Subtract line 5 from line 4 ....................................................................................................................... 6)

7) Divide line 6 by $15,000 ($30,000 if MFJ). Enter the result as a decimal (rounded to at least three places). If the result is 1.000 or more, enter 1.000........................................................................................................... 7)

8) Multiply line 1 by line 7 ....................................................................................................................................... 8)

9) Student loan interest deduction. Subtract line 8 from line 1. Enter the result here and on Form 1040, line 33. Do not include this amount in figuring any other deduction on taxpayer’s return (such as on Schedules A, C, E, etc.)...................................................................................................................................... 9)

2010 worksheet available—see State and Local Tax Deduction Worksheet (2010) under Premium

Quickfinder Handbook (2010 Tax Year) in the Updates section of Quickfinder.com


• Fourth-quarter estimate paid in January. The taxpayer made the last payment of 2009 estimated state or local income tax in 2010. Pro-rate the refund. If estimated tax was paid in four equal installments, report 75% of the refund as taxable income on line 10. Reduce state tax deducted on Schedule A by 25% of the refund. Attach a calculation explaining why the entire amount from Form 1099-G is not reported on line 10.

• Other refunds. The taxpayer received other re-funds, such as general sales tax or real property taxes, in 2010 of amounts deducted in an earlier tax year.

• Allowable sales tax deduction. Refund is more than the 2009 state and local income tax deduction minus the amount the taxpayer could have deducted for 2009 state and local general sales taxes.

• Alternative minimum tax owed or credits exceeded tax. The tax-payer owed AMT in 2009 or nonrefundable credits exceeded tax in 2009. Recompute the earlier year’s tax including the refund amount as income. If inclusion of the refund does not change the total tax, the refund does not need to be reported as income in 2010.

• Itemized deductions were limited. The taxpayer’s 2009 AGI was over $166,800 ($83,400 MFS). See Tax Benefit Rule under Recoveries in Publication 525.

State and Local Tax Refund Worksheet(See Form 1040 instructions if MFS in 2009.)

1) Enter the income tax refund. Do not enter more than income tax deducted on line 5a of 2009 Schedule A, line 5 ................ 1)

2) Enter total allowable itemized deductions from line 29 of the 2009 Schedule A .................................... 2)

3) Enter the amount shown below for the filing status claimed on the 2009 Form 1040. ......................................... 3) • $5,700 Single• $8,350 HOH• $11,400 MFJ or QW• $5,700 MFS not required to itemize

4) Multiply the number in the box on line 39a of the 2009 Form 1040 by $1,100 ($1,400 if single or HOH in 2009) ..... 4)

5) Enter the smaller of real estate taxes on the 2009 Sch. A, line 6 (not including any foreign taxes) or $500 ($1,000 if MFJ) ...... 5)

6) Enter any net disaster loss from the 2009 Form 4684, line 18 .................................................................................. 6)

7) Enter any new motor vehicle taxes from 2009 Schedule A, line 7. ................................................................................... 7)

8) Add lines 3, 4, 5, 6 and 7 ..................................................... 8) 9) Subtract line 8 from line 2. If zero or less, enter -0- ............. 9)

10) Taxable part of refund. Enter the smaller of line 1 or line 9 here and on line 10 of Form 1040 .............................. 10)

Alimony ReceivedSee Alimony on Page 13-10 and IRS Publication 504.

Business Income/LossSee Tab 6.

Capital Gain/LossSee Tab 7.Schedule D is not required if the only amounts reportable on Sched-ule D are capital gain distributions from box 2a of Form 1099-DIV and there are no amounts in boxes 2b (unrecaptured Section 1250 gain), 2c (Section 1202 gain), or 2d [collectibles (28%) gain]. Enter capital gain distributions on line 13 and check the box on that line. Use the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 instructions to calculate tax.

Other Gains/LossesSee Sales of Business Property on Page 7-10.

IRA DistributionsSee Tab 14.Distributions and rollovers from traditional, Roth, SEP and SIMPLE IRAs are reported on lines 15a and 15b. Conversions of traditional, SEP and SIMPLE IRAs to Roth IRAs are also reported on lines 15a and 15b. Penalties for early withdrawals from those accounts are reported on line 58.Rollovers. Enter the total distribution on line 15a and write “Roll-over” next to line 15b. If the entire distribution was rolled over, enter zero on line 15b; otherwise, enter the amount not rolled over on line 15b unless Form 8606 is required as described below. Trustee-to-trustee transfers between IRAs do not need to be reported and a Form 1099-R should not be received.If the IRA distribution was rolled over into a qualified plan other than an IRA, or the rollover occurred in 2011, attach a statement explaining the rollover.Distributions—Traditional/SEP/SIMPLE IRAs:• Fully taxable distributions. Leave line 15a blank and report the

entire amount on line 15b. • Nondeductible contributions. Enter the total distribution on line

15a. If the taxpayer made nondeductible contributions to an IRA in previous years, use Form 8606 to calculate the taxable amount to report on line 15b.

Roth IRA distributions. Enter the total distribution on line 15a. Use Form 8606 to calculate the taxable amount to enter on line 15b. However, if the distribution is a qualified distribution or nontaxable due to an exception (Code Q or T in box 7 of Form 1099-R), enter zero on line 15b and do not complete Form 8606.Roth conversions. Enter total distribution on line 15a. Use Form 8606 to calculate the taxable amount entered on line 15b.Returned and recharacterized contributions. See Form 8606 and its instructions for information on how to compute and report on lines 15a and 15b the return of an excess IRA contribution (and related earnings). This includes the return of a 2009 or 2010 IRA contribution (with earnings) before the due date (including extensions) of the return for that year, excess IRA contributions for earlier years returned in 2010 or the recharacterization of part or all of a 2010 Roth or traditional IRA contribution.Qualified charitable distribution (QCD). Enter the total distribu-tion on line 15a. If the total distribution was a QCD, enter -0- on line 15b; if only part was a QCD, enter the non-QCD amount on line 15b (unless it’s not taxable because of another exception) and write “QCD” next to line 15b. See Qualified Charitable Distribu-tions (QCDs) on Page 14-13. U Caution: The QCD provision expired after 2009. However, at publication date, Congress was considering legislation extending this provision to 2010. See Tax Extenders Legislation on Page 25-1.Health savings account (HSA) funding distribution (HFD). An HFD is a one-time nontaxable distribution made directly by the trustee of the taxpayer’s IRA (other than SEP or SIMPLE IRAs) to the taxpayer’s HSA. A taxpayer who elects this treatment reports the total IRA dis-tribution on line 15a and the taxable amount (amount of distribution that was not an HFD) on line 15b. Enter “HFD” next to line 15b.Multiple exceptions. Attach a statement showing the amount for each exception instead of making an entry on line 15b.

Pensions and AnnuitiesSee Tab 14 and Form 1099-R, Box 7 Distribution Codes on Page 14-13.Fully taxable distributions. Distributions from pensions and an-nuities are fully taxable if: (1) the taxpayer did not contribute to the


Nondeductible expenses include:• Expenses of buying and/or selling a home.• Meal expenses.• Pre-move househunting expenses.• Temporary living expenses.General rules for moving expenses:1) Distance test. To deduct moving expenses, the

distance between the taxpayer’s new job location and former house must be at least 50 miles more than the distance between the old job location and former house.

Note for first-time employees or persons returning to work: If there is no established old job location, the distance test is met if the new workplace is at least 50 miles from the former home.

Moving Expenses—Distance Test1) Enter # of miles from old home to new workplace ...................... mi2) Enter # of miles from old home to old workplace ....................... miSubtract line 2 from line 1. If 50 or more, distance test is met .......... mi

2) Time test:• Employee. Moving costs are deductible only if the taxpayer

works as a full-time employee at the new location for at least 39 weeks in the 12-month period following arrival. For married taxpayers, only one spouse need satisfy the full-time work test.

• Self-employed individuals must work full-time for at least 39 weeks during the first 12 months and a total of at least 78 weeks during the first 24 months after arriving at the new job location. For this test, the taxpayer can count any full-time work as an employee or as a self-employed person.

• Fail to meet test. If in a later year the time test is not met, the taxpayer must either (1) report the moving expense deduction as other income on Form 1040 or (2) amend the prior-year return.

• Exceptions: The time test will not apply if one expected the job to last 39/78 weeks but lost it because of involuntary separation—other than for willful misconduct. Other Excep-tions: Death, disability, re-transfer by employer or military.

• IRS ruling: If the employee initiates a transfer before putting in the required 39 weeks of work, moving expenses are not deductible. The transfer must be beyond the control of the employee. (Rev. Rul. 88-47)

• Combine two jobs. If the employee leaves the first job without meeting the time requirements and gets a second job in the same general location, time spent on the two jobs may be combined to meet the 39-week rule.

3) Other considerations. The IRS allows a deduction only for a move “closely related” in time to the start of work at the new job location. Generally, the requirement is satisfied only when moving expenses are incurred within one year from the date a person first reports to work. If more than one year between the start of the job and the move, expenses are not deductible unless circumstances prevented the move within that time. Each case is judged by its own facts, but generally extra time is justified to allow a spouse to fulfill job commitments in the old location or for children to finish a segment of schooling.

4) Armed Forces. A member of the Armed Forces on active duty who moves because of a permanent change of station does not have to meet the distance and time tests.

One-Half Self-Employment TaxEnter amount from line 6 (Short Schedule SE) or line 13 (Long Schedule SE) on line 27.

Self-Employed SEP, SIMPLE and Qualified PlansSee Tab 14.Enter deductible contributions to a self-employed qualified plan, SEP or SIMPLE plan made for the benefit of a self-employed taxpayer or partner on line 28. Contributions made for the benefit of the taxpayer’s employees are deducted on Schedule C or F.

Self-Employed Health Insurance DeductionSee Part II—Expenses on Page 6-6.

Penalty on Early Withdrawal of SavingsEnter penalty from Form 1099-INT or 1099-OID for early withdrawal of savings or certificates on line 30. (Do not deduct the penalty from interest reported on line 8a.)

Alimony PaidSee Alimony on Page 13-10.Enter alimony paid on line 31a. Include the recipient’s Social Se-curity number on line 31b. If the taxpayer made alimony payments to more than one person, enter one SSN on line 31b and attach a statement listing the numbers of the other alimony recipients.To be deductible, alimony or separate maintenance payments must be required by a divorce or separation instrument and must meet several other requirements. Child support, property settlements and voluntary payments are not deductible alimony.

IRA DeductionSee Traditional IRAs on Page 14-4.2010 IRA contributions must be made by April 18, 2011—no extensions. Report:• Deductible IRA contributions for the taxpayer and

spouse on line 32.• Nondeductible contributions to a traditional IRA on Form 8606.• 2010 conversion contributions to a Roth IRA (funds are moved

from a traditional IRA or qualified plan to a Roth IRA or a traditional IRA is redesignated as a Roth IRA) on Form 8606. See Roth IRA Conversions on Page 14-7.

Student Loan Interest DeductionSee Student Loan Interest Deduction on Page 13-4 and IRS Publication 970.The maximum deduction is $2,500 regardless of the number of students in taxpayer’s family. Report on line 33.No deduction is allowed if the taxpayer’s filing status is MFS or if the taxpayer is claimed as a dependent on another return. If the taxpayer can be claimed as a dependent on another return, but the other taxpayer chooses not to claim the exemption, the taxpayer can deduct student loan interest (but cannot deduct his own dependency exemption).

Tuition and Fees DeductionU Caution: The tuition and fees deduction expired at the end of 2009 but at the time of publication, Congress was considering legislation that would extend it to 2010. See Tax Extenders Leg-islation on Page 25-1.See Tuition and Fees Deduction on Page 13-4.The maximum deduction is $4,000 or $2,000, depending on modi-fied AGI. Joint filers with modified AGI over $160,000 cannot claim the deduction (modified AGI of $80,000 for Single and HOH).Form 8917, Tuition and Fees Deduction, is used to compute the allowable deduction, which is reported on line 34.


Domestic Production Activities DeductionSee Domestic Producer Deduction (DPD) on Page 6-22.

Total AdjustmentsAdd lines 23 through 35 and enter the total on line 36.Include the following adjustments in the total on line 36, and enter the amount and description to the left of line 36:

Adjustment Item(Include in Line 36 Total)

Describe on Return as

Archer MSA deductions (see Archer MSA deduction below). MSAAttorneys fees paid in connection with a taxable IRS whistle-blower’s award after 12/19/06.

WBF

Attorneys fees for settlements after 10/24/04, in connection with unlawful discrimination, but only to the extent of the amount included in income.

UDC

Contributions by certain chaplains to Section 403(b) plans. 403(b)Contributions to Section 501(c)(18)(D) pension plans. This amount should be identified with Code H in box 12 of Form W-2.

501(c)(18)(D)

Expenses from the rental of personal property if the income from the rental of personal property was reported on line 21.

PPR

Forestation or reforestation amortization if the taxpayer could claim a deduction for these costs and did not have to file Schedule C, C-EZ or F.

RFST

Jury pay given to employer because employer continued to pay salary while on jury duty. (Also reported as income on line 21.)

Jury Pay

Repayment of supplemental unemployment benefits under the Trade Act of 1974. Alternatively, the taxpayer may be able to claim a credit against tax. See IRS Pub. 525.

Sub-Pay TRA

Archer MSA deduction. A medical savings account (MSA) is a trust established to pay for qualified medical expenses of the ac-count holder. A participant must:1) Work for a small employer or be self-employed and2) Have a high-deductible health plan (HDHP). (IRC §220)

2010 MSA High-Deductible Health Plan

Individual Coverage

Family Coverage

Annual plan deductibles

Minimum $2,000 $4,050Maximum 3,000 6,050

Out-of-pocket expense limitation 4,050 7,400Maximum annual contribution 65% of

deductible75% of

deductible

• Contributions are limited to net self-employment (SE) earnings or employee compensation from the business establishing the HDHP, and may be made by an employer, an employee or a self-employed individual.

• 2010 contributions must be made on or before April 18, 2011.

• Taxpayers will receive Form 5498-SA, which shows the amount contributed during the year. Taxpayers report all contributions on Form 8853. Enter the deductible amount in the total on line 36 of Form 1040 and write “MSA” to the left.

• Excess contributions are subject to a 6% penalty (calculated on Form 5329) unless the excess plus allocable income is distributed by the filing due date, including extensions.

Adjusted Gross IncomeIf line 37 is less than zero, the taxpayer may have an NOL [see Net Operating Loss (NOL) on Page 6-14] that can be carried to another year. See the NOL worksheets in Tab 3 and IRS Publica-tion 536, Net Operating Losses.

Taxes and CrediTs

Age 65 or Older and BlindCheck all applicable boxes on line 39a for the taxpayer and spouse.Age. For 2010, a taxpayer born before January 2, 1946 is consid-ered age 65 or older.Blindness:• If the taxpayer or spouse is completely blind as of December 31,

2010, attach a statement describing the condition.• If only partially blind, attach a copy of a statement certified by an

eye doctor or optometrist that sight is not better than 20/200 in the better eye with glasses or contact lenses or the field of vision is 20 degrees or less. If a statement filed in a prior year certified that the condition was unlikely to improve, a new certified state-ment from the doctor or optometrist is not required. The taxpayer must keep the statement for his records.

MFS and Spouse Itemizes Deductions or Dual-Status AlienCheck the box on line 39b if the taxpayer is MFS and his spouse itemizes deductions on a separate return (either MFS or HOH), or if the taxpayer is a dual-status alien. Exception: If the dual-status alien and his spouse who is a U.S. citizen file a joint return and both agree to be taxed on their combined worldwide income, do not check the box. Note: Married taxpayers filing as HOH do not need to check this box, even if their spouse itemizes deductions. (CCA 200030023)If the box on line 39b is checked, the standard deduction is zero.

Itemized/Standard DeductionSee Tab 5.Enter the larger of itemized deductions or the standard deduction on line 40. If the box on line 39b is checked, the standard deduction is zero, even if the taxpayer is age 65 or older or blind. Standard deductions are listed on the front cover of this handbook.Additional standard deduction (Schedule L). Taxpayers with either of the following use Schedule L to figure their standard deduction.• Losses from federally declared disasters. Additional standard

deduction equals the excess of taxpayer’s 2010 personal ca-sualty losses attributable to a 2008 or 2009 federally declared disaster over personal casualty gains. See Federally Declared Disasters on Page 5-15. U Caution: The standard deduction is only increased for a net disaster loss if the disaster was declared after 2007 and occurred before 2010. But, at the time of publi-cation, Congress was considering legislation that would extend this provision to disasters occurring in 2010. See Tax Extenders Legislation on Page 25-1.

• Qualified motor vehicle taxes that would be deductible if taxpayer itemized. State or local sales or excise tax paid in 2010 on the pur-chase (up to $49,500) of certain new vehicles (autos, light trucks, motor cycles or motor homes) between February 17, 2009 and December 31, 2009 increases the standard deduction. The increase phases out when AGI exceeds $135,000 ($260,000 if MFJ).

• Real property taxes. Additional standard deduction equals taxes that would be deductible if the taxpayer itemized, up to $500 ($1,000 if MFJ). U Caution: This provision expired after 2009, but at the time of publication, Congress was considering legisla-tion that would extend it to 2010. See Tax Extenders Legislation on Page 25-1.


Phase-out of itemized deductions. For 2010, itemized deduc-tions are not subject to the phase-out rules. The AGI-based phase-out of itemized deductions is scheduled to return in 2011. [IRC §68(f)]A taxpayer who elects to itemize deductions even though they are less than the standard deduction should complete Schedule A and check the box on line 30 of that schedule.@ Strategy: It may be advantageous to itemize deductions even though less than the standard deduction when the taxpayer is subject to AMT because the standard deduction is added back for AMT purposes. Also, there may be instances when the tax benefit of being able to itemize deductions on the taxpayer’s state tax return is greater than the tax benefit lost on his federal return by not taking the standard deduction.

ExemptionsGeneral exemptions. Each exemption is worth $3,650 for 2010. Enter the allowable exemption deduction on line 42.Note: The exemption deduction is not phased out based on the taxpayer’s AGI in 2010. However, the phase-out of the exemption deduction for higher-income taxpayers is scheduled to return in 2011.

TaxMethods used to calculate tax. Enter the tax on line 44. Use the following to compute tax unless Form 8615, Schedule D, Qualified Dividends and Capital Gain Worksheet, Foreign Earned Income Tax Worksheet, or Schedule J applies.• Tax Table. Use if taxable income is less than

$100,000. See Tab 1.• Tax Computation Worksheet. Use if taxable income is $100,000

or more. See 2010 Tax Computation Worksheet on Page 1-13.Form 8615. Use to figure the tax for children under age 18 [or age 18 (or full-time students age 19–23) whose earned income is less than or equal to half of their support] and who had more than $1,900 of investment income. Do not use if neither parent was alive on December 31, 2010. See Kiddie Tax on Page 13-1.Schedule D tax worksheets. Use the worksheets in the Sched-ule D instructions to calculate tax if Schedule D is required and the taxpayer has 28% rate capital gains or unrecaptured Section 1250 gains (line 18 or line 19 of Schedule D).Qualified dividends and capital gain tax worksheet. Use the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 instructions to calculate tax if the Schedule D Tax Worksheets are not required and the taxpayer reports (a) qualified dividends on Form 1040, line 9b, (b) capital gain distributions on Form 1040, line 13 or (c) capital gains on Schedule D and lines 15 and 16 of Schedule D are both more than zero.Foreign earned income tax worksheet. Use the Foreign Earned Income Tax Worksheet in the Form 1040 instructions if the taxpayer is claiming the foreign earned income exclusion or the housing exclusion or deletion on Form 2555.Schedule J. Use Schedule J to calculate tax for farmers or fisher-men who elect to income average. See Schedule F—Profit/Loss From Farming on Page 6-16.Other tax reported on line 44. Include in total for line 44:• Form 8814, Parents’ Election to Report Child’s Interest and

Dividends. Check box (a) on line 44. See Tab 13.• Form 4972, Tax on Lump-Sum Distributions. Check box (b) on

line 44. See Tab 14.• Recapture of an education credit. If a refund or tax-free educa-

tional assistance was received in 2010 for education costs for which an education credit was claimed in a prior year, all or part

of the previously claimed education credit must be recaptured. If owed, enter the amount and “ECR” on the dotted line next to line 44 and include in the amount on line 44. See the Form 8863 instructions for details.

Alternative Minimum TaxSee Alternative Minimum Tax (AMT) on Page 12-15.

Foreign Tax CreditSee Foreign Tax Credit on Page 12-11.

Credit for Child and Dependent Care ExpensesSee Child and Dependent Care Credit on Page 12-3.

Education CreditsSee Education Tax Credits on Page 12-8.

Retirement Savings Contributions CreditSee Retirement Saver’s Credit on Page 12-13.

Child Tax CreditSee Child Tax Credit Worksheet (2010) on Page 3-5 and Child Tax Credits on Page 12-5.If a child tax credit is claimed on line 51, check the box in column 4 of line 6c for each dependent claimed.

Residential Energy CreditsSee Residential Energy Tax Credits on Page 12-12.

Other CreditsSee the Tax Credit Summary (2010) table on Page 12-1.Elderly or disabled credit (Schedule R). The taxpayer or spouse must be either:• Age 65 or older by the end of 2010 or• Under age 65 by the end of 2010, and retired on permanent and

total disability and had taxable disability income in 2010.Adjusted gross income may not exceed:• Single, HOH, QW: $17,500.• MFJ (one spouse eligible): $20,000.• MFJ (both spouses eligible): $25,000.• MFS (lived apart entire year): $12,500. Note: Complete and attach Credit for the Elderly or the Dis-abled (Schedule R) to claim the credit on line 53. See Publications 524 and 554 for more information.Other credits reported on line 53:• Form 3800, General Business Credit.• Form 8801, Credit for Prior Year Minimum Tax. See Minimum

Tax Credit on Page 12-15.• Form 8834, Qualified Plug-In Electric Electric Vehicle Credit. See

Credits for Plug-in Vehicles on Page 11-7.• Form 8910, Alternative Motor Vehicle Credit. See Alternative

Motor Vehicle Tax Credit on Page 11-7.• Form 8911, Alternative Fuel Vehicle Refueling Property Credit.• Form 8912, Credit to Holders of Tax Credit Bonds.• Form 8936, Qualified Plug-In Electric Drive Motor Vehicle Credit.

See Credits for Plug-in Vehicles on Page 11-7.


Related Information• Auto Expenses—Tab 11• Contributions: Noncash Donations—Tab 3• Home Mortgages—Tab 15 of the 1040 Quickfinder® Handbook• Sales Tax Deduction Worksheet—Tab 3• Total Itemized Deductions Worksheet—Tab 3• Travel Expenses—Tab 9

Average Itemized Deductions—2008 Tax Returns

Adjusted Gross Income

Type of Deduction

Medical Taxes Interest Charitable Contributions

$ 15,000 – 29,999 $ 7,074 $ 3,146 $ 9,245 $ 2,02430,000 – 49,999 6,153 3,830 9,055 2,18950,000 – 99,999 7,102 6,050 10,659 2,693

100,000 – 199,999 9,269 10,798 13,734 3,757200,000 and over 28,558 38,090 24,543 15,754

Source: IRS 2008 Preliminary Data. The above averages are based on a return claiming a deduction for a particular category. For example, if no medical expenses are claimed on Schedule A, the zero amount does not reduce the overall average.

LimiT on iTemized deduCTions Note: The AGI-based phase-out of itemized deductions does not apply for 2010. However, it is scheduled to return in 2011.

mediCaL deduCTionsSee also IRS Pub. 502

Amount DeductibleMedical expenses in excess of 7.5%-of-AGI are deductible as itemized deductions. For alternative minimum tax (AMT), medical expenses must exceed 10%-of-AGI to be deducted. [IRC §56(b)(1)]

When to DeductMedical expenses are deductible in the year paid, regardless of when the expenses were incurred and regardless of the taxpayer’s accounting method. [Reg. §1.213-1(a)]Exceptions:• Credit card charge. If paid with a credit card, the

medical expense is deductible when charged, not when the credit card company is paid. (Rev. Rul. 78-39)

• Decedents. An election can be made to deduct medical expenses paid by a decedent’s estate within one year after the date of death on the decedent’s Form 1040, as if the expenses were paid when the medical services were provided. Thus, in some cases, an amended Form 1040 is filed. A statement must be attached to the decedent’s Form 1040 or 1040X on which the expenses are deducted stating that the ex-penses will not be claimed as a deduction on the federal estate tax return. [Reg. §1.213-1(d)]

Medical Expenses Paid for OthersDeductible medical expenses include expenses paid for the tax-payer’s spouse and for any person who qualifies as the taxpayer’s dependent (for claiming an exemption), except that some of the tests required to claim an exemption do not have to be met to deduct an individual’s medical expenses.Dependents, for deducting medical expenses, must be U.S. citi-zens or nationals or residents of the U.S., Canada or Mexico and the taxpayer’s:• Child, foster child, stepchild, sibling, step-sibling and any of their

descendants, if that person:– Is under age 19 (or under age 24 and a full-time student) or

permanently and totally disabled, – Lived with the taxpayer for more than half the year and – Did not provide more than half of his own support for 2010.

• Child, stepchild, foster child, a descendant of any of them (for example, grandchild), sibling, niece, nephew, parent, grandpar-ent, aunt, uncle, step-sibling, stepfather, stepmother, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law or sister-in-law or any other person if that person lived as a member of the taxpayer’s household all year (provided the relationship does not violate local law).

– For whom the taxpayer provided more than one-half the sup-port for the year.

• Former spouse, if the marriage existed either when the bills were incurred or at the time of payment.

• Adopted child before adoption, if child qualified as dependent when medical expenses were incurred or paid. After adoption is final, adopted child treated as the taxpayer’s own child. Note that an adopted child does not have to be a U.S. citizen or national, or a resident of the U.S., Canada or Mexico if the parent claiming the medical expense deduction is a U.S. citizen or national with whom the adopted child lived as a member of the household during the year the medical expenses were paid.N Observation: Taxpayers can deduct medical expenses paid for some individuals who don’t qualify for the dependency exemp-tion, such as a parent for whom the taxpayer provides over half the support, even if the parent’s income exceeds $3,650 (for 2010) [IRC §213(a)]. Likewise, medical expenses for a married child who

Schedule B—Interest and Dividends starts on Page 5-22.

Schedule A—Itemized Deductions

Tab 5 Schedule A TopicsLimit on Itemized Deductions .................................. Page 5-1Medical Deductions................................................. Page 5-1Taxes....................................................................... Page 5-5Interest Expense ..................................................... Page 5-6Interest Tracing ....................................................... Page 5-6Investment Interest Expense .................................. Page 5-7Interest—Mortgages ............................................... Page 5-8Points—Mortgages ................................................. Page 5-9Other Mortgage Interest Deduction Rules ............ Page 5-10Charitable Contributions ....................................... Page 5-11Casualty and Theft Losses ................................... Page 5-14Miscellaneous Itemized Deductions...................... Page 5-16Miscellaneous Job Costs ...................................... Page 5-18Work-Related Education Costs ............................. Page 5-18Investment Expenses............................................ Page 5-20Legal Fees ............................................................ Page 5-20


• Imputed interest. Part of the entrance fee to a life-care facility may be considered a loan if a portion of the payment is a long-term refundable fee. Certain taxpayers are exempt from the imputed interest rules on refundable fees treated as loans [IRC §7872(h)]. Exemption qualifications: The taxpayer (or spouse) must be age 62 or older, the facility must provide an independent living unit, along with an assisted living or nursing facility, or both, and substantially all of the independent living unit residents must be covered by continuing care contracts.

Insurance ReimbursementsDeductible medical costs must be reduced by any insurance re-imbursements received. Excess reimbursements are taxable only to the extent they were provided for under an employer plan and were not included in income.

TaxesSee also IRS Pubs. 523, 530 and 535

Taxpayers have the option of claiming a Schedule A item-ized deduction for either (1) state and local income taxes or (2) state and local general sales taxes.

State and Local Income TaxesState and local income taxes are deductible on Schedule A in the year paid. The tax may be paid either through withholding, estimated payments or payments for prior year returns. The IRS may disallow deductions for large estimated state income tax payments made solely to increase itemized deductions (Rev. Rul. 82-208). The prepayment of estimated state income tax should be based on tax liability. Penalties and interest are not deductible.

Court Case: A taxpayer claimed the standard deduction rather than itemizing and deducted nonresident state income taxes from royalties on Schedule E. The court found that state income taxes are not expenses incurred in the production of royalty income. [Strange, 88 AFTR 2d 2001-6752 (9th Cir. 2001)]

State and Local General Sales TaxesU Caution: The special rule allowing taxpayers to deduct state and local sales taxes instead of state and local income taxes expired at the end of 2009 but, at the time of this publication, Con-gress was considering legislation that would extend this provision to 2010. See Tax Extenders Legislation on Page 25-1.Taxpayers who choose to deduct state and local sales taxes can deduct either:1) Actual sales tax amounts (based on their records) or2) Predetermined deduction figures from IRS tables.To deduct actual amounts. Add up the nonbusiness general state and local sales taxes (including any compensating use taxes) paid during the year plus any selective sales taxes if the rate is the same as the general sales tax rate. Include selective sales taxes on food, clothing, medical supplies and motor vehicles even if the rate is lower than the general sales tax rate. If the selective sales tax rate on a mo-tor vehicle is higher than the general rate, deduct only the amount that would have resulted from charging the lower general sales tax rate.To deduct amounts from IRS tables. The table amounts depend on the taxpayer’s AGI plus nontaxable income (for example, tax-exempt interest and nontaxable portion of Social Security benefits), the number of exemptions claimed on Form 1040 and the state of residence. If the taxpayer lives in more than one state during the year, pro-rate the amount from the table for each state (based on the number of days spent there divided by 365), add up the pro-rated amounts and deduct the total. Note: In addition to the table amounts, the taxpayer can de-duct additional actual sales tax amounts from purchases of motor

vehicles (including leased vehicles). If the sales tax rate on a motor vehicle is higher than the general rate, deduct only the amount that would have resulted from charging the lower general sales tax rate. Also add sales taxes paid on boats, airplanes, homes (including mobile and prefabricated) or home building materials if the rate was the same as the general sales tax rate. Note: If Congress extends the deduction for state and local sales taxes to 2010 (see Caution in the previous column), the IRS tables taxpayers can use to compute the deduction will be posted to the Updates section of Quickfinder.com.

Real Estate TaxesA real estate tax is deductible in the year it is paid to the taxing authority. Prepaid real estate taxes can gener-ally be deducted in the year of the prepayment if the taxpayer is on the cash basis and does not live in an area in which the prepayment would be considered a deposit by the taxing authority. How prepaid taxes are treated var-ies among local jurisdictions. Taxes placed in escrow are deductible when actually paid to the taxing authority, not when paid to the escrow agent. Penalties and interest on late payments are not deductible.Generally, real estate taxes can be deducted only by the owner of the property upon which the tax is imposed. Regulation Section 1.164-3(b) defines real property taxes as “taxes imposed on inter-ests in real property and levied for the general public welfare…” Because of the lack of a detailed definition, the issue has been the subject of several court cases and IRS rulings. For example, the tax imposed on renters by the New York Real Property Tax Law is not deductible for federal tax purposes. Taxes paid under this law are considered rent, not property taxes. (Rev. Rul. 79-180)In contrast, Revenue Ruling 71-49 stated that certain payments made to an educational construction fund by a cooperative housing corporation did qualify as real property taxes, and were deductible by the tenant-shareholders.More than one property. Real estate taxes are deductible for all property owned by a taxpayer.Sale of real estate. The buyer and the seller must divide real estate taxes according to the number of days that each owned the property during the year. Both are considered to have paid their share of taxes, even if one or the other paid the entire amount.• Buyer-paid taxes. Deductible by the buyer only for the period

he owned the property. The buyer cannot deduct the real estate taxes of the seller. The buyer must add these taxes to the basis of the property. The seller treats this as additional sales proceeds.

• Seller-paid taxes. If the seller pays real estate tax owed by the buyer (beginning on the date of sale), the buyer is considered to have paid the tax. The tax is deductible by the buyer. The buyer must reduce the basis in the home by the tax paid. The seller treats this as a reduced selling price.

Beneficial owner. Taxpayers who do not have legal title to their residence may still claim a Schedule A deduction for real estate taxes paid if they are equitable and beneficial owners of the prop-erty. An equitable and beneficial owner of property is someone who has exclusive burden and benefit of the property: he pays the mortgage payments, maintains the property and occupies the property exclusively. (Njenge, TC Summary Opinion 2008-84)

Cooperative Housing Corporations (Co-Ops)Mortgage interest and property taxes allocated to a tenant-share-holder in a co-op are generally treated the same as those paid by other homeowners, provided the following conditions are met.1) The corporation has only one class of stock outstanding,2) Each shareholder has the right (but is not required) to occupy

a dwelling unit solely because of the ownership of the stock,Continued on the next page

See State and Local Sales Tax Deduction Worksheet (2010) under Premium Quickfinder® Handbook (2010 Tax Year) in the Updates section of Quickfinder.com.


Exchange students. Deduct up to $50 per school month for housing an exchange student (grade 12 or lower) sponsored by a qualified organization. The student does not have to be a foreign student as long as the student becomes a member of the taxpayer’s household under a written agreement between the taxpayer and the charitable organization.Foster parents. If there is no profit or profit motive, deduct expenses exceeding payments received from a charitable organization for providing support for quali-fied foster care individuals placed in the home.Canadian, Mexican and Israeli charities. Donations to certain Canadian, Mexican and Israeli charities may be deductible under an income tax treaty with that country. Special rules or limits may apply. U.S. income tax treaties with these countries can be found on the IRS website.æ Practice Tip: Certain donations for Haiti earthquake relief made after January 11, 2010 and before March 1, 2010 were deductible in 2009. If deducted in 2009, do not deduct in 2010.

Nondeductible ContributionsMoney or property given to:• Civic leagues, social and sports clubs, labor unions and chambers

of commerce.• Foreign organizations (other than certain

Canadian, Mexican and Israeli 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.Cost of raffle, bingo or lottery tickets.Dues, fees or bills paid to country clubs, lodges, fraternal orders or similar groups.Tuition (secular or religious).Value of blood given to a blood bank.Value of time or services rendered by the taxpayer.Rental value of a timeshare donated to charity, such as the right to stay at it for one week. The ownership interest in the timeshare must be donated to charity to make the contribution deductible.Charitable rollover from IRA. See Qualified Charitable Distribu-tions (QCDs) on Page 14-13.

Limits on Charitable ContributionThe deduction for charitable contributions cannot exceed 50% of the taxpayer’s AGI. A reduced limit of 30% or 20% applies for certain contributions.æ Practice Tip: Most organizations know whether they qualify for the 50% limit. Also, IRS Pub. 78, Cumulative List of Organizations, which can be found at www.irs.gov, lists the limitation percentage for many charities. Up to 50% of AGI limit. Donation of cash or property (other than capital gain property) to a publicly supported charity or foundation qualifying as a 50% limit organization. Examples of 50% limit organizations: Churches, educational orga-nizations, hospitals, medical research organizations, publicly sup-ported organizations that receive a substantial amount of support from the general public or governmental units, private operating foundations, private nonoperating foundations that distribute 100% of the contributions to qualified charities within 21/2 months after the end of the tax year, private foundations that pool contributions into a common fund and allow contributors to name the charities to receive their gifts if the income is distributed within 21/2 months after the end of the tax year.

Up to 30% of AGI limit:• Donation of capital gain property to a 50% limit organization.

Property is capital gain property if its sale at FMV on the date of the contribution would have resulted in long-term capital gain. Exception: 30% limit does not apply if donor elects to deduct only the property’s cost or other basis rather than its FMV.

• Donation of cash or property (other than capital gain property) to any qualified organizations other than 50% limit organizations (includes veterans’ organizations, fraternal societies, nonprofit cemeteries, certain private nonoperating foundations).

Up to 20% of AGI limit. Donation of capital gain property to any qualified organizations other than 50% limit organizations. For multiple contributions subject to different limits, use the worksheet in IRS Pub. 526 to compute the deduction.Qualified conservation contributions. The deduction for quali-fied conservation contributions is limited to 30% of AGI minus the deduction for all other charitable contributions. Any excess amount is carried forward 15 years. Note: For 2009, qualified conservation contributions were limited to 50% of AGI (100% of AGI for qualified farmers and ranchers). At the time of publication, Congress was considering legislation that would extend this provision to 2010. See Tax Ex-tenders Legislation on Page 25-1.

Five-Year Contribution CarryforwardContributions that exceed the AGI limit in the current year can be carried forward to each of the five succeeding years. Carryover contributions are subject to the original percentage limits in the carryover years, and are deducted after deducting allowable con-tributions for the current year. If there are carryovers from two or more years, use the earlier year carryover first. Note: Contribution deductions disallowed due to NOL car-ryovers are added to the unused NOL as additional NOL and no longer treated as contributions [Reg. §1.170A-10(d)]Standard deduction claimed. If the taxpayer claims the standard deduction in any of the carryover years (including the contribution year), the carryover amount is reduced by the amount that would have been deductible if itemizing. (Reg. §1.170A-10)Deceased spouse. Carryovers allocable to the excess contribu-tions of a deceased spouse may only be claimed on the final return of the deceased spouse, not by the surviving spouse. [Reg. §1.170A-10(d)(4)(iii)]

Contributions That Benefit the Taxpayer Contributions that are made partly for goods or services provided by the organization are deductible if:1) The amount of the payment exceeds the FMV of

goods and services received, and2) The donor intends to make a payment in excess of

the FMV of goods and services.

Example: Anita makes a large contribution to a charity that has a history of sponsoring a dinner-dance for donors making substantial contributions. The charitable deduction is limited to amount of the donation less the FMV of the anticipated dinner-dance even if the dance takes place in the following year.

Refused benefits. A donor can claim a full deduction if all benefits are actively refused (such as checking off a refusal box on a form sent by the charity). (Rev. Rul. 67-246)Gifts of more than $75. If the donor receives some benefit, the charity must provide a statement as to the deductible amount of the contribution. The charity must make a “good faith estimate” of the FMV of goods/services provided to the donor.Token benefits. A donor can disregard benefits if either:• The benefits received do not exceed the lesser of 2% of the

contribution or $96 (for 2010) or

2010 are


• Progressive deterioration.• Termite or moth damage.

Deductible Casualty LossesA casualty loss equals:1) The lesser of:

• Adjusted basis in the property before the casualty or theft, or• Decrease in FMV of the property as a result of the casualty

or theft,2) Minus any insurance or other reimbursement received or that

is expected to be received.Limits:• Personal-Use Property Deduction Limits (Form 4684, Section A).

– $100 per casualty: Reduction applies to each event that causes the casualty or theft. For example: a hailstorm dam-ages the house, garage and car. There is only one $100 reduction, not three.

U Caution: For 2009, the reduction amount for each casu-alty was $500 (rather than $100). At the time of publication, Congress was considering legislation that would extend this provision to 2010. See Tax Extenders Legislation on Page 25-1.

– 10% of AGI: Reduce the total of all casualty or theft losses on personal-use property by 10% of AGI. Apply this reduction after the $100 per casualty reduction.

• Business and Income-Producing Property (Form 4684, Section B). Losses on business property (including employee business-use property) and income-producing property are not subject to the $100 per casualty and 10%-of-AGI limits. If property was completely destroyed, the loss is generally the cost of the property minus accumulated depreciation. If property was damaged but not destroyed, the loss is generally the decrease in the property’s FMV up to the adjusted basis.

• Employee Business-Use Property. Casualty losses on employee business-use property (property used in performing services as an employee) are miscellaneous itemized deductions subject to the 2%-of-AGI limitation.

Insurance reimbursement. Reduce the casualty loss amount by ac-tual insurance reimbursement and by any expected reimbursement. If the property is covered by insurance, an insurance claim must be filed—otherwise, the casualty loss is not allowed. If the reimbursement exceeds the casualty amount (recovery is more than tax basis), the profit is currently taxable. Exception: If the insurance reimbursement is reinvested in similar property, tax is postponed until the replace-ment property is sold. See Involuntary Conversions on Page 7-14.• Time Limit. Reinvestment must be made by the end of the second

year following the insurance reimbursement. Taxpayers have four years to replace a main home in a federally declared disaster area.

Insurance reimbursement in following year. If a casualty loss is deducted in one year based on an expected insurance reimburse-ment, and the actual reimbursement in a following year turns out to be more or less than expected, an adjustment may be required.• More than expected. If the reimbursement is more than expected, the

excess amount is treated as ordinary income in the year received. Exception: The amount is not included in income to the extent the prior year’s deduction did not reduce tax liability. (IRC §111)

• Less than expected. If the reimbursement is less than expected, the difference is treated as a casualty loss in the year the tax-payer can reasonably expect no more reimbursement. The prior year’s tax return is not amended. The loss is combined with other casualty losses for that year. [Reg. §1.165-1(d)(2)]

Rule for real estate. Measure the decrease in FMV of the property and improvements as a whole, not as separate items.

Example: Elroy paid $150,000 for his home ($10,000 for the land and $140,000 for the house) and spent an additional $2,000 for landscaping. This year a fire destroyed his home and damaged the shrubbery and trees in the yard. An appraiser valued the property as a whole at $175,000 before the fire, but only $50,000 after the fire. There-fore, the starting point for determining Elroy’s casualty loss deduction is $125,000.

Net operating loss. If the deductible casualty loss exceeds in-come, the casualty loss may create an NOL. See Net Operating Loss (NOL) on Page 6-14 for NOL rules.

Business Casualty Loss—Cost of RepairsThe IRS has issued legal advice to its agents that the cost of repairing damaged property or cleaning up after a casualty must be capitalized if the taxpayer takes a casualty loss deduction for that property (AM 2006-006). Often, the cost of repairing property is used as an estimate of the decline in the property’s value due to the casualty (the amount of the casualty loss). However, the IRS says repair costs must be capitalized regardless of how the casualty loss deduction was computed.

Federally Declared DisastersTaxpayers affected by a federally declared disaster are eligible for special tax relief provisions. See the table Federally Declared Disasters—Quick Summary of Special Tax Relief Provisions below for an overview.

Federally Declared Disasters—Quick Summary of Special Tax Relief Provisions

Item Special Relief IRC §Casualty loss deduction

• 10%-of AGI limit waived.1

•Can elect to claim losses in year before year of the disaster.

165(h)(3)165(i)

Depreciation—50% bonus1

50% special (bonus) depreciation is allowed on qualified disaster assistance property 2 for the year it’s placed in service. Such property is not subject to the AMT adjustment for its entire recovery period.

168(n)

Disaster expenses1 Certain disaster-related expenses paid in connection with a trade or business or business-related property are deductible, even though they are normally capitalized.

198A(a)

Disaster relief payments

Payments are nontaxable. See Disaster relief payments on Page 5-16.

139

Involuntary conversion—business or income-producing property

Any tangible replacement property acquired for use in any business is treated as similar or related in service or use to the destroyed property.

1033(h)(2)

Involuntary conversions—principal residence

•Replacement period is four years rather than two years.

• Special rules for avoiding gain on receipt of insurance proceeds.

1033(h)(1)

Net operating loss (NOL) carryback1

NOL attributable to disaster loss may be carried back five years and fully deductible against AMT income.

172(b)(1)

Section 179 expense1

Deduction limit is increased by lesser of (a) $100,000 or (b) cost of qualified Section 179 disaster assistance property. Threshold for phaseout is increased by lesser of (a) $600,000 or (b) cost of qualified Section 179 disaster assistance property.

179(e)

Standard deduction1 Nonitemizers can increase their standard deduction by the amount of their disaster loss deduction.

63(c)(1)

Tax deadlines Deadlines for filing and paying taxes and making IRS contributions are often postponed.

7508A

1 U Caution: For federally declared disasters declared after 2007 and occurring before 2010. At the time of publication, Congress was considering legislation that would extend this provision to federally declared disasters occurring in 2010. See Tax Extenders Legislation on Page 25-1.

2 Qualified disaster assistance property is replacement or rehabilitation property used in the same county and similar to the destroyed property, and includes tangible property with a MACRS recovery period of 20 years or less, computer software, qualified leasehold improvements, nonresidential real property and residential rental property. See Pub. 946 for additional requirements.


sTarTing a BusinessSee also Tab 7 for Sales of Business Property

Asset AcquisitionsForm 8594, Asset Acquisition Statement Under Section 1060, is filed by both the seller and the buyer of a group of assets that consti-tutes a trade or business. The purpose of the form is to identify and separate the value of goodwill and any other intangible assets from the value of tangible assets. Different depreciation and amortization rules apply to each group of assets. See Asset Acquisitions in Tab N of the Small Business Quickfinder® Handbook for more details.

Start-Up Costs of a New Business Start-up costs are expenses connected with creating or inves-tigating the creation or purchase of a trade or business. These expenses occur before the trade or business begins operations. Start-up costs must be capitalized because they are not incurred in carrying on a trade or business. (IRC §195)Start-up costs include:• Survey of potential markets.• Advertising the opening of the business.• Consulting or other professional fees paid

in connection with starting the business.• Wages to employees being trained for the

new business.• Analysis of possible facilities, labor force,

supplies, etc.• Travel and related expenses to secure distributors, suppliers and

customers.Deducting/amortizing start-up costs. Taxpayers can elect to deduct up to $10,000 (for 2010) of start-up costs and amortize the remainder over 180 months. A taxpayer is deemed to have made the election so an election statement attached to the return is not required (Temp. Reg. §1.195-1T). Instead, a statement is required only when the taxpayer wants to forgo the deemed election and capitalize start-up costs.The $10,000 immediate deduction allowance is reduced dollar for dollar (but not below zero) by the taxpayer’s cumulative start-up expenditures in excess of $60,000. Amounts that cannot be de-ducted currently (either because they exceed $10,000 or because of the $60,000 rule) are amortized over 180 months.Amortization of start-up costs is reported on Part VI of Form 4562 and the deduction is carried to the “other expenses” line on Schedule C (or F).

neT operaTing Loss (noL)See also IRC §172, IRS Pub. 536,

and Tab 3 for NOL WorksheetsWhen business deductions exceed business income, an NOL may occur. An NOL may be caused by deductions from a trade or business, from working as an employee, or from casualty and theft losses, moving expenses or rental property.

Calculating an NOL1) Complete the tax return. Adjusted gross income

minus the standard or itemized deductions (line 41 of 2010 Form 1040) must be less than zero to have a potential NOL.

2) Separate business and nonbusiness income and deductions. An NOL must be caused by losses or deductions from business sources (as defined for NOLs). Use Net Operating Loss Worksheet #1 on Page 3-10 to determine business/nonbusiness income and deductions.

Determine business/nonbusiness source:• Pro-rate state and local income taxes

between business-source and nonbusi-ness-source income.

• Rental real estate activities (portion recognized after passive loss limitations) are considered business-source income o r loss.

• Separate partnership income or loss (after at-risk and passive loss limitations) between business-source and nonbusiness-source income.

• Royalties shown on Schedule C are business-source income; royalties shown on Schedule E are nonbusiness income.

• Casualty and theft losses are business deductions even if they involve nonbusiness property.

3) Separate business/nonbusiness capital gains and losses. In general, a net capital loss is not included in an NOL. However, business and nonbusiness capital transactions still must be separated and used in the NOL calculation. The holding period is not considered for NOL purposes.• Business Capital Transactions. Sale of goodwill or patent

rights and the sale of business assets that receive capital gain or loss treatment under Section 1231.

• Nonbusiness Capital Transactions. Sale of stock and other investment property.

4) Compute current year NOL. In general, NOL rules do not allow personal exemptions, net capital losses, nonbusiness losses, nonbusiness deductions or NOLs from other years. Use Net Operating Loss Worksheet #2—Computation of NOL on Page 3-11 (or Form 1045, Schedule A) to make the necessary adjust-ments.• Nonbusiness deductions are deductible to the

extent of nonbusiness income plus nonbusi-ness net capital gain.

• Nonbusiness capital losses are deductible to the extent of nonbusiness capital gains.

• The Section 199 domestic producer deduction is not allowed when computing an NOL.

If the adjustments on Worksheet #2 result in a negative amount, an NOL exists.

Using a Current-Year NOLAn NOL generally is carried back two years and then forward 20 years. Special rules apply to certain types of losses.

Carryback Rules for 2010 NOLsCarryback 5 Years 3 Years 2 Years Elect Out

NOL N/A N/A Automatic May electEligible loss N/A Automatic N/A May electFarming loss Automatic N/A May elect May elect

Qualified disaster loss Automatic N/A May elect May elect

Eligible loss. The portion of an NOL that is (1) a personal casualty loss or (2) for small businesses or farmers, attributable to a federally declared disaster. An eligible loss does not include a farm loss or qualified disaster loss (as defined below).Farming loss. The NOL computed by considering only farming income and deductions (or the NOL for the year, if smaller). Do not include any qualified disaster loss (as defined below).Qualified disaster loss. The lesser of the NOL or the casualty loss attributable to a federally declared disaster declared after 2007 and occurring before 2010, plus the deduction for qualified disaster expenses. U Caution: At the time of publication, Congress was


considering legislation that would extend this provision to di-sasters occuring in 2010. See Tax Extenders Legislation on Page 25-1. Also see Federally Declared Disasters on Page 5-15.Available elections. The following elections are irrevo-cable and must be made on a timely filed return (including extensions) for the NOL year.• Election to Waive the Carryback Period. Taxpayers may elect to

waive the carryback years and only use the NOL in the 20-year carryforward period. Attach the following statement to the return: “The taxpayer elects to waive the entire NOL carryback period under Section 172(b)(3) of the Internal Revenue Code.”

• Election to Disregard Five-Year Carryback Treatment. Taxpayers with a loss eligible for a five-year carryback may elect to treat the loss as if it was regular NOL and use a two-year carryback period. Attach the following statement to the return: “The taxpayer elects to treat any 2010 (specify type of loss, such as farming loss, qualified disaster loss, etc.) without regard to the special five-year carryback rule.”N Observation: Taxpayers could elect a two-, three-, four- or five-year carryback period for either the 2008 or 2009 NOL (or in some cases, both the 2008 and 2009 NOL) [IRC §172(b)(1)(H)]. See the 2009 Pub. 536 for details.

Deducting a CarrybackTo claim a refund from an NOL deduction, file either:• Form 1045. May be used to apply an NOL to all available car-

ryback years. It must be filed not later than one year after the close of NOL year.

• Form 1040X. Must use a separate 1040X for each carryback year to which the NOL is applied. Must file within three years after the due date (including extensions) for filing the return for the NOL year. Check the box next to line 1 and write “Carryback Claim” at the top of page 1 of the Form 1040X.

Decrease in tax computation. To calculate the decrease in tax for a carryback year, refigure the following, taking into account a refigured AGI that includes the NOL:• Special allowance for passive losses from rental real estate activity.• Taxable Social Security or tier 1 railroad retirement benefits.• IRA deduction.• Student loan interest deduction.• Tuition and fees deduction.• Excludable savings bond interest.• Excludable employer-provided adoption ben-

efits.• Medical, casualty and theft losses, as well as

miscellaneous deductions subject to the 2%-of-AGI limit.

• Phaseouts for itemized deductions and personal exemptions.• Tax credits that are based on or limited by the amount of tax.• Other taxes (such as alternative minimum tax).Do not refigure charitable contributions in an NOL carryback year.Self-employment tax. An NOL does not change the SE tax of any years to which it is carried forward or back.Interest and penalties. An NOL carryback to a year with a tax deficiency will only reduce tax. An NOL carryback will not reduce interest or penalties in the carryback year.Calculating how much NOL is used. If the NOL is not fully ab-sorbed in a year to which it is carried, modifications are made to income for that year to determine how much of the unused NOL is available for the following year. Use Net Operating Loss Worksheet #3—NOL Carryback on Page 3-11 (or Form 1045, Schedule B) to make this computation. Modifications are made for:

• Nondeductible items. The NOL carried to such year plus all future NOLs carried to such year, net capital losses, any Section 1202 exclusion, domestic production activities deduction and personal exemptions (prior-year NOLs carried forward are deductible).

• Refigure deductions due to change in AGI. After adding back the nondeductible items above, refigure items based on AGI, such as the items listed at Decrease in tax computation in the previous column. Also recompute the charitable contribution deduction, but do not include NOL carryback deductions. Note: Recomputed AGI and refigured deductions are only used for determining how much of the NOL is left to carry forward. This step does not recalculate the actual tax liability for the car-ryback or carryforward year.Net operating loss carryforward. For NOLs carried forward to a tax year after the NOL year, the NOL is shown as a negative amount on the other income line of Form 1040 (line 21 for 2010).

sCheduLe se—seLf-empLoymenT Tax

See also IRS Pub. 334Also refer to:• Farming Income and SE Tax—Page 6-17• Section 179 Recapture—Page 10-13• Ministers/Clergy—Page 12-18Self-employment tax computed on Schedule SE applies to sole proprietors (Schedules C and F) and general partners of a partnership (Schedule K-1, Form 1065).Tax rate for 2010. SE tax = net SE earnings × 15.3%, on net SE earnings up to $106,800 plus 2.9% × net SE earnings over $106,800. For this purpose, net SE earnings are the net profit from all trades and businesses multiplied by 92.35%. Net SE earnings are combined with any FICA wages earned as an employee for determining when the $106,800 limit is met.Health insurance premiums. For 2010, premiums a self-employed person deducts for income tax reduce the net profit from the busi-ness when computing SE tax. See Self-employed health insurance deduction on Page 6-6.Who must file schedule SE. In general, any individual who carries on a trade or business must file Schedule SE if net earnings from all trades or businesses are $433.13 or more ($433.13 × 0.9235 = $400).Trade or business. An activity carried on for a livelihood or in good faith to make a profit. A taxpayer does not actually have to make a profit to be a trade or business as long as there is a motive for making a profit. The activity does not have to be a regular full-time job to be subject to SE tax.Statutory employees. See Statutory Employees on Page 6-13.Automobile salespersons. An incentive payment made by an automotive manufacturer to a retail automobile salesperson is re-ported as “Other Income” on line 21 of the 2010 Form 1040. Such a payment is not subject to employment taxes or SE tax, whether paid directly to the individual or through the dealer. Expenses associated with the payment are reported as miscellaneous itemized deductions subject to the 2%-of-AGI limit. (Rev. Rul. 70-337; IRS Pub. 3204)Business interruption insurance. Proceeds are subject to SE tax, unless paid because the business is liquidated. (Rev. Rul. 91-19)Termination payments to former insurance agents working as independent contractors are excluded from SE tax if: [IRC §1402(k)]1) The amount is received after termination of the agent’s agree-

ment to perform services for the company,2) The agent does not perform any services for the company after

termination and before the close of the tax year,Continued on the next page


Business Use of Vehicles—75% RuleFarmers can claim 75% business use for ve-hicles used primarily for farming business instead of keeping records of business mileage. [Reg. §1.274-6T(b)]Once this method is elected, it must be used in future years. Likewise, if the standard mileage rate or actual expenses method is elected, the farmer cannot revert to the 75% rule.

Conservation ExpensesA farmer may elect to deduct or capitalize expenses for soil and water conservation or to prevent farmland erosion (IRC §175). The election must be made in the first year that the farmer pays or incurs such expenditures, and is binding for all subsequent years. Conservation expenses must be allocated if they benefit both land used for farming and land that does not qualify.Deductible conservation expenses. Water and soil conserva-tion expenses are deductible for land used currently or in the past for farming by the farmer or the farmer’s tenant. Water and soil conservation expenses may be deductible if they are consistent with a plan approved by the USDA’s Soil Conservation Service or a comparable state agency. The deduction cannot exceed 25% of gross income from farming. Deductions not allowed in the current year may be carried forward to following years, subject to the 25% limitation. Deductible conservation expenses include:• Treatment or movement of earth (grading, leveling, terracing,

conditioning, contour furrowing, restoration of fertility).

• Eradication of brush.

• Planting windbreaks.

• Construction, control and protection of irrigation and drainage ditches, diversion channels, earthen dams, outlets, ponds.

Notes:– Expenses to drain or fill wetlands are not deductible.

– Expenses to maintain completed soil and water conservation structures (for example, the removal of drainage ditch sediment) are deduct-ible farm business expenses.

Depreciable conservation expenses. Expenses for nonearthen items of masonry or concrete must be capitalized. Exception: Part of an assessment for depreciable property levied against a farm by a soil and water conservation or drainage district may be deductible. Depreciable conservation expenses include: Materials, supplies, wages, fuel, hauling and moving dirt for structures or facilities such as tanks, reservoirs, pipes, conduits, canals, dams, wells or pumps made of masonry, concrete, tile, metal or wood.Land clearing versus soil and water conservation. Land clear-ing prepares the land for farming, while soil and water conservation preserves the quality of land being farmed. Expenses for land clearing are added to the basis of the land and are not deductible. Land clearing expenses include:• Cutting trees, blasting stumps, burning residual undergrowth.• Leveling land for planting or irrigation.• Removing minerals such as salt from the soil.• Diverting a stream to another watercourse.• Draining and filling a swamp or marsh.

Section 179 Deduction—Farm PropertySee Section 179 Deduction on Page 10-10 for general rules. Also see Section 179 Limit for SUVs on Page 11-3.

Farm property that qualifies for a Section 179 deduction includes:• Tangible personal property such as machinery and equipment,

milk tanks, automatic feeders, barn cleaners and office equip-ment.

• Livestock (horses, cattle, hogs, sheep, goats and mink and other fur bearing animals).

• Single-purpose agricultural and horticultural structures.Single-purpose agricultural structure. Building or enclosure specifically designed, constructed and used for: housing, raising and feeding a particular type of livestock (including poultry but not horses), their produce and the equipment necessary for feeding and caring [IRC §168(i)(13)]. This includes structures used to:• Breed chickens or hogs.• Produce milk from dairy cattle.• Produce feeder cattle or pigs, broiler chickens or eggs.Single-purpose horticultural structure:1) A greenhouse specifically designed, constructed and used for

the commercial production of plants or2) A structure specifically designed, constructed and used for

commercial mushroom production.

Depreciating Farm AssetsThree-, five-, seven- and 10-year MACRS property used in a farming business must be depreciated using the 150% declining-balance or straight-line method. See Partial Table of Class Lives and Recovery Periods on Page 10-1.Farm equipment. New machinery or equipment used in a farming business and placed in service during 2009 is depreciated over five years [IRC §168(e)(3)]. If the alternative depreciation system (ADS) is required or elected, the property is assigned a 10-year recovery period. Exception: The five-year recovery period does not apply to fences, land improvements, grain bins or cotton gin-ning assets. Note: At the time of publication, Congress was considering legislation that would extend this provision to 2010. See Tax Ex-tenders Legislation on Page 25-1.

Estimated TaxNo penalty for failing to make estimated tax payments for 2010 if at least two-thirds of total gross income was from farming or fishing during 2010 or 2009 and Form 1040 is filed and all the tax due is paid by March 1, 2011. See also Underpayment/Estimated Tax Penalty in Tab 16 of the 1040 Quickfinder® Handbook.If a farmer or fisherman must pay 2010 estimated tax, only one annual payment is required by January 18, 2011, using special rules to figure the amount of the payment. See Pub. 225 for details.Farming gross income. Determine if at least two-thirds of total gross income is from farming or fishing as follows.Gross income from farming includes:• Gross farm income from Schedule F.• Gross farm rental income from Form 4835.• Gross farm income from Schedule E, Parts II and III.• Gains from the sale of livestock used for draft, breeding, sport

or dairy purposes reported on Form 4797.Gross income from farming does not include:• Wages received as a farm employee.• Gains from sales of farmland and depreciable farm equipment.• Income received from contract grain harvesting and hauling with

workers and machines furnished by the taxpayer.


Form T (Timber)—Forest Activities ScheduleGenerally, Form T should be filed when standing timber is sold or cut, or when there are other timber transactions.Form T must be completed to claim a deduction for timber depletion, to elect to treat the cutting of timber as a sale or exchange under Sec-tion 631(a), or to report outright sales of timber under Section 631(b). Note: For more information about the taxation of timber, see Forest Landowners’ Guide to the Federal Income Tax, available at www.fs.fed.us/publications.Sale or exchange of timber:• Timber sold primarily for sale to customer. Gain or loss is treated

as ordinary income subject to SE tax. Farmers who cut and sell timber on their land in the form of logs, firewood or pulpwood report income and expenses as ordinary income and expenses on Schedule F.

• Standing timber sold from investment property. Treated as a capital gain or loss, reported on Schedule D.

• Outright sales of timber. Outright sales of timber by landowners qualify for capital gains treatment if the timber was held for more than one year before the date of disposal.

Generally, cutting of timber results in no gain or loss until sold or exchanged. Exception: Under Section 631(a) taxpayers can elect to treat the cutting of timber as a sale under Section 1231 in the year it is cut. To qualify for the Section 631(a) election, the timber must be cut for sale or for use in the taxpayer’s trade or business, and the taxpayer must own or hold a right to cut timber for more than one year before the timber is cut.Timber depletion. The depletion deduction for timber must be calculated using cost depletion. The depletion is taken in the year of sale or other disposition of the products cut from the timber, un-less the taxpayer elects to treat the cutting of timber as a sale or exchange. The depletion deduction is limited by the adjusted basis of the timber. The adjusted basis for depletion cannot include the residual value of land and improvements at the end of operations. [Reg. §1.612-1(b)(1)]

Example: Samuel purchases a timber tract for $160,000. The residual value of the land at the time of purchase, assuming all timber has been cut, equals $100,000. The depletable basis of the timber for cost depletion is $60,000 ($160,000 – $100,000). Samuel determines that the standing timber will pro-duce 1,000 units when cut. Samuel’s depletion per unit equals $60 ($60,000 ÷ 1,000). If Samuel sold 300 units during the year, his depletion allowance would be $18,000 (300 × $60).

domesTiC produCer deduCTion (dpd)

Form 8903

For 2010, the DPD is 9% of the lesser of the business’s:1) Qualified production activities income or 2) Taxable income (AGI for individual taxpayers) determined

without regard to the DPD.The DPD cannot exceed 50% of the wages paid and reported on Form W-2 by the business for the year (and allocable to domestic production gross receipts).Oil and gas activities. Starting in 2010, individuals with oil-related qualified production activities income must reduce their DPD by 3% of the least of their (1) oil-related qualified production activi-ties income, (2) qualified production activities income or (3) AGI (determined without regard to the DPD). [IRC §199(d)(9)]

Oil-related qualified production activities income is qualified pro-duction activities income attributable to the production, refining, processing, transportation or distribution of oil, gas or any primary product thereof.

Qualified Production Activities IncomeTo determine the net income that qualifies for the 9% deduction, the taxpayer’s receipts must be divided into those from eligible activities (domestic production gross receipts, or DPGR) and non-DPGR. Then, the taxpayer’s expenses are allocated between the two categories of income. The DPGR less allocable expenses equals qualified production activities income.Eligible activities. The following activities generate DPGR if performed in the U.S.: [IRC §199(c)(4)]• Manufacture, production, growth or extraction of:

– Tangible personal property (for example, clothing, goods, food, agricultural products).

– Computer software.– Sound recordings.

• Certain film production.• Production of electricity, natural gas or potable

water.• Construction or substantial renovation of residential and com-

mercial buildings and infrastructure by taxpayers engaged in the construction business.

• Engineering and architectural services performed by a taxpayer engaged in the business of performing engineering or architec-ture.N Observation: While most U.S. farming activities will generate DPGR, income from custom farming if the farmer does not have the benefits and burden of ownership of the property is not DPGR.U Caution: For 2006–2009, qualified production activities per-formed in Puerto Rico were included in the domestic production gross receipts calculation as long as the activity in Puerto Rico was subject to U.S. tax. At the time of publication, Congress was considering legislation that would extend this provision to 2010. See Tax Extenders Legislation on Page 25-1.Allocating costs. There are three methods for allocating costs to DPGR (that is, income that qualifies for the DPD) and non-DPGR. [Reg. §1.199-4]Small business simplified overall method. Allocate all deductions (including cost of goods sold) and losses between DPGR and non-DPGR based on relative gross receipts. Available to:• Taxpayers with average gross receipts under $5 million.• Taxpayers with average gross receipts of $10 million or less, if

they qualify to use the cash method under Revenue Procedure 2002-28.

• Farmers not required to use the accrual method.Simplified deduction method. Use gross receipts to allocate all costs and expenses except cost of goods sold. Cost of goods sold must be specifically traced to DPGR and non-DPGR. Available to taxpayers with average annual gross receipts of $100 million or less or total assets of $10 million or less at the end of the year.Section 861 Method. Deductions are allocated to DPGR using the rules under Section 861 for allocating deductions to foreign income. This is the most complex method because it requires tracing each cost to income.S corporations and partnerships. The DPD is determined at the shareholder or partner level so taxpayers should get the informa-tion from the partnership or S corporation Schedule K-1. Enter that information on Lines 7 and 17 of Form 8903.

—End of Tab 6—

2011

are

is


Where to Report Gains and LossesProperty Sold Sold at a Gain Sold at a Loss

Depreciable trade or business property1—Held one year or less2

Form 4797, Part II Form 4797, Part II

Depreciable trade or business property1—Held more than one year2

Form 4797, Part III Form 4797, Part I

Capital asset—Held one year or less Schedule D, Part I Schedule D, Part ICapital asset—Held more than one year Schedule D, Part II Schedule D, Part IIOrdinary-income property (for

example, inventory)Schedule C Schedule C

Personal-use property—Held one year or less

Schedule D, Part I Nondeductible; do not report3

Personal-use property—Held more than one year

Schedule D, Part II Nondeductible; do not report3

1 Also depreciable residential rental property.2 For cattle and horses, substitute “24 months” for “one year.”3 Report on Schedule D only if personal-use real property for which Form 1099-S

is received (but show -0- in column f).

Capital Gain and Dividend Tax Rates—2010Holding Period

Ordinary Tax Rate Bracket10% 15% 25% 28% 33% 35%

Capital GainsShort-term ≤ 1 year 10% 15% 25% 28% 33% 35%Long-term > 1 year 0% 0% 15% 15% 15% 15%

UnrecapturedSection 1250 > 1 year 10% 15% 25% 25% 25% 25%Collectibles > 1 year 10% 15% 25% 28% 28% 28%

Qualified Section 12021 > 5 years 10% 15% 25% 28% 28% 28%

DividendsQualified > 60 days2 0% 0% 15% 15% 15% 15%

Other ≤ 60 days2 10% 15% 25% 28% 33% 35%1 50% (60% for certain empowerment zone business stock) of the gain is

excluded so the maximum effective rate is 14%.2 90 days in the case of preferred stock.

Basis for Computing Gain or LossSee also IRS Pub. 551

Type of Acquisition

Basis for Gains or Losses

Holding Period Begins

Purchase Purchase price plus acquisition and installation charges.

On day after the date of acquisition.

Gift property: Sold at a

GAIN1

Donor’s basis. On date donor’s holding period began.

Gift property: Sold at a

LOSS1

Lesser of: Donor’s basis or

On date donor’s holding period began.

Property FMV at time of gift. On day after date of gift.Inherited property

FMV on date of decedent’s death.2

Automatically long-term3

Taxable exchange

FMV at time of exchange. On day after the date of acquisition.

Like-kind exchange

Basis of old property traded in plus any boot paid.

On day after the date the old property was acquired.

Property converted from

personal to business use

Basis for gain is cost. Basis for loss and depreciation is lesser of cost or FMV at time of conversion.

On day after the date of acquisition.

Property repossessed by

seller

Adjusted basis of the debt due, plus gain from the repossession, plus any repossession expenses.

On day after date property originally acquired, but doesn’t include time between sale and repossession.

Note: Basis is increased by improvements, additions, capital contributions, litigation expenses, etc., but not by appreciation. Basis is decreased by tax benefits such as a return of capital, depreciation (or depletion), tax credits, etc.

1 Gifted property:• Basis for depreciation is always the donor’s adjusted basis.• Basis is adjusted if gift tax has been paid.• Basis of gifts between spouses is always the donor’s adjusted basis.

2 See Basis of Inherited Property in Tab 15 of the 1040 Quickfinder® Handbook for special rules for jointly-owed property and property inherited from decedents who died in 2010.

3 Inherited property is always long term [IRC §1223(9)]. On Schedule D, list “Inherited” instead of the date of acquisition. Note: Automatic long-term holding period does not apply to property inherited from decedents who died in 2010 if the executor elected carryover basis rule.

Borrower’s Foreclosure Worksheet1

Part 1. Income from cancellation of debt. Note: If the taxpayer is not personally liable for the debt, there is no income from debt cancellation. Skip Part 1 and go to Part 2.1) Enter the amount of debt canceled by the transfer

of property .............................................................................. 1) $ 2) Enter the FMV of the transferred property .............................. 2) < >3) Income from cancellation of debt.2 Subtract line 2 from

line 1. If less than zero, enter -0- ............................................ 3) $ Part 2. Gain or loss from foreclosure or repossession.4) Enter the smaller of line 1 or line 2. Also include any

proceeds received from the foreclosure sale. (If the taxpayer is not personally liable for the debt, enter the amount of debt canceled by the transfer of property.) ............. 4) $

5) Enter the adjusted basis of the transferred property ............... 5) < >6) Gain or loss from foreclosure or repossession.

Subtract line 5 from line 4 ........................................................ 6) $ 1 See Foreclosures on Page 7-20.2 This income may not be taxable. See Report COD income on Page 7-21.

Schedule D; Form 4797; Sales and Exchanges

Tab 7 TopicsReal Estate Comparison Chart ............................... Page 7-2Settlement Costs on Sale or Purchase of

Real Estate ........................................................... Page 7-3Schedule D—General Rules ................................... Page 7-3Stocks and Other Securities ................................... Page 7-5Mutual Funds .......................................................... Page 7-8Employee Stock Options......................................... Page 7-9Bad Debts ............................................................. Page 7-10Sales of Business Property ................................... Page 7-10Installment Sales................................................... Page 7-11Involuntary Conversions ....................................... Page 7-14Home Ownership .................................................. Page 7-14Sale of Residence ................................................. Page 7-15Residence Gain Exclusion .................................... Page 7-16Reduced Exclusion Rules ..................................... Page 7-18Business or Rental Use of Home .......................... Page 7-19Foreclosures ......................................................... Page 7-20Like-Kind Exchanges ............................................ Page 7-22


Basis/Adjusted BasisThe method of acquisition determines the original basis of the home. If purchased or built, the basis is its cost. If acquired by some other method, such as inheritance, gift or a divorce property settlement, basis is either the FMV when received or the adjusted basis of the person from whom it was received. See the Basis for Computing Gain or Loss chart on Page 7-1.Once the original basis is determined, certain adjustments must be made throughout the period of ownership.Increases to basis generally include:• Cost of additions and other improvements that have a useful life

of more than one year.• Special assessments for local improvements.• Amounts spent after a casualty to restore damaged property.Decreases to basis generally include:• Discharge of qualified principal residence indebtedness that was

excluded from income (but not below zero).• Residential energy credits if the cost of the energy item was

added to basis.• If the taxpayer filed Form 2119 in the year the current home was

originally acquired to postpone gain on the sale of a previous home that was sold before May 7, 1997, the amount postponed decreases basis in the current home.

• Deductible casualty losses.• Insurance payments received or expected to be received for

casualty losses.• Payments received for granting an easement or right-of-way.• Depreciation allowed or allowable if the home was used for busi-

ness or rental purposes.• Adoption credit claimed for improvements added to

the basis of the home.• Nontaxable payments from an adoption assistance

program of an employer that were used for improve-ments added to the basis of the home.

• District of Columbia first-time homebuyers credit.• Energy conservation subsidy excluded from gross income be-

cause the subsidy was received (directly or indirectly) from a public utility after 1992 to buy or install any energy conservation measure. An energy conservation measure is an installation or modification that is primarily designed either to reduce consump-tion of electricity or natural gas or to improve the management of energy demand for a home.

Recordkeeping. Although the Section 121 exclusion rules may seem to eliminate the need to keep records, there are still many reasons to keep track of the basis in a home. For example, taxpay-ers may have gains in excess of the exclusion amount because of a change in filing status due to death or divorce that reduced the amount of the available exclusion. Also, taxpayers who have business or rental use of their home will need adequate records to compute the exclusion amount and taxable gain upon sale of the home as well as depreciable basis.

Fixing-Up ExpensesThe treatment of fixing-up expenses depends on whether they are considered improvements or repairs.Improvements. These add to the value of the home, prolong its useful life or adapt it to new uses. Add the cost of additions and other improvements to the basis of the home. For example, new recreation room, bathroom, fence, plumbing or wiring, new roof, paved driveway, deck, sunroom or garage.

Repairs. These costs maintain the home in good condition but do not add to its value or prolong its life. These costs are non-deduct-ible and are not added to the basis of the property. For example, repainting the house inside or outside, fixing the gutters or floors, repairing leaks or plastering and replacing broken window panes.

Inherited Houses• The basis of an inherited house equals FMV at the time of dece-

dent’s death, or the alternate valuation date, if used. Exception: In certain situations, property inherited from a person who died in 2010 will have carryover basis rather than basis equal to FMV at the time of death. See Basis of Inherited Property in Tab 15 of the 1040 Quickfinder® Handbook.

U Caution: When jointly owned property is inherited, only the basis in the portion of the property included in the decedent’s gross estate is adjusted to FMV. Exception: For community prop-erty, surviving spouses also adjust the basis of their half interest in the property. See Community property in Tab 15 of the 1040 Quickfinder® Handbook. The nine community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

• Inherited property is always considered to have been held long term. Exception: Property inherited from a decedent who died in 2010 generally has a tacked holding period beginning when the decedent acquired the property.

• Loss from the sale of an inherited house is generally a capital loss. However, if the inherited house was changed to business use before the sale, the loss would be deductible as an ordinary loss. For example, if an inherited house was rented and subse-quently sold, the entire loss may qualify as a deductible ordinary loss on the sale of business-use property.

U Caution: Offering the house for rent before sale does not automatically satisfy the change to business-use requirement. The IRS determination as to whether property is used for busi-ness is made on a case-by-case basis, with the taxpayer’s intent being an important factor.

• If the beneficiary uses the inherited house for personal purposes, any loss from the sale would not be allowed.

saLe of residenCeSee also IRS Pubs. 523 and 530

Sale of Residence Reporting RulesThe sale of a principal residence is generally not reported on a taxpayer’s return unless the taxpayer:• Has a gain and does not qualify to exclude it all.• Has a gain and elects not to exclude it.• Has a loss and receives a Form 1099-S.See Residence Gain Exclusion on Page 7-16 for details on gain exclusion. See Reporting the Sale on Page 7-16 for how to report any gain that is not excluded.U Caution: Taxpayers who claimed the first-time homebuyer credit and who sell the residence in 2010 may have to repay all or part of the credit in 2010. See First-Time Homebuyer’s Credit on Page 12-10 for more information.Form 1099-S. Generally, real estate agents, title companies, law-yers, etc., responsible for closing the transaction are required to issue Form 1099-S to the seller of real estate. An exception applies for the sale of a principal residence for $250,000 or less ($500,000 or less MFJ or certain surviving spouses) if the real estate reporting person obtains written certification from the seller. The certification must include information to support the conclusion that the full gain on the sale is excludable from the seller’s income. If there are joint sellers, each seller (whether married or not) must make written certification for the exception to apply. (Rev. Proc. 2007-12)

if executor elected carryover basis


ReimbursementsWhen an employer reimburses an employee for travel, meals or entertainment expenses, the reimbursement is excluded from the employee’s income if the reimbursement arrangement is an accountable plan. Similar rules apply to independent contractors [Reg. §1.274-5T(h)(2)]. Employees cannot deduct meals and entertainment expenses if the employer reimburses the expenses under an accountable plan and does not treat the reimbursement as wages. See Accountable Plan/Nonaccountable Plan below. Independent contractors cannot deduct meals and entertainment expenses if the customer or client makes direct reimbursement for the expenses and adequate records are submitted to the customer or client. See Elements to Prove Certain Business Expenses on Page 9-6. Note: If reimbursements for meals are excluded from the income of the employee or independent contractor, the employer (or customer/client) is generally subject to the 50% deduction limit. See 50% Limit on Page 9-2.Failure to claim reimbursement. Employees may not deduct busi-ness expenses that are eligible for reimbursement from the employer.

Accountable Plan/Nonaccountable PlanAccountable plan. Reimbursements made to an employee under an accountable plan are not included in the employee’s income, and the employee does not deduct the expenses.Nonaccountable plan. Reimbursements made to an employee under a nonaccountable plan are treated as taxable wages and re-ported in box 1 of Form W-2. The employee deducts the expenses on Form 2106, subject to the 2%-of-AGI limitation on Schedule A.An employee who receives payments under a nonaccountable plan cannot convert the payments to an accountable plan by voluntarily accounting to the employer or returning excess payment.Accountable plan requirements: [IRC §62(c)]1) Business Connection. The reimbursement must be for job-

related expenses the employee would reasonably be expected to incur. A plan that reimburses personal expenses does not qualify as an accountable plan.

2) Substantiation. The employee must substantiate the expense by providing receipts or other documenta-tion to the employer within a reasonable period of time.

3) Return of Excess Reimbursement. The employee must be required to return any excess reimbursement to the employer within a reasonable period of time.

Reasonable period of time. The following situations will be considered within a reasonable period of time for purposes of accountable plans.1) The employee receives an advance within 30 days of the time

the expense is incurred.2) The employee adequately accounts for the expense within 60

days of the time the expense was paid or incurred.3) Any excess reimbursement is returned to the employer within

120 days after the expense was paid or incurred.4) The employer provides a statement to the employee (at least

quarterly) asking the employee to either return or adequately account for outstanding advances, and the employee complies within 120 days of the statement.

If the above requirements are not met, the plan is considered a nonaccountable plan.Part accountable plan or part nonaccountable plan. If an employer makes reimbursements to an employee under an ac-countable plan, but some reimbursements do not qualify under accountable plan rules, only the reimbursements falling under the nonaccountable plan are considered taxable wages. Each plan is viewed separately, and the employer treats the employee as having received reimbursements under two different plans.

aBove-The-Line deduCTion for CerTain empLoyees

Government officials paid on a fee basis, qualified performing art-ists, Armed Forces reservists and educators can claim business expenses as an adjustment to income. [IRC §62(a)(2) and 162]Government fee basis officials (FBOs). Individuals who are employed by a state or local government and paid in whole or in part on a fee basis.Qualified performing artists (QPAs):1) Perform services as an employee in performing arts for at least

two employers during the tax year and receive at least $200 from any two of the employers,

2) Incur performing arts-related business expenses of more than 10% of the gross income from performing arts and

3) Have AGI of $16,000 or less before deducting performing arts expenses. To qualify, married individuals must file a joint return unless they lived apart for all of the tax year.

Armed Forces reservists. National Guard members and Armed Forces reservists who must travel more than 100 miles away from home and stay overnight to fulfill their training and service com-mitments can claim an above-the-line deduction for the cost of transportation, meals (subject to the 50% disallowance rule) and lodging. The deductible amounts are limited to general federal government per diem amounts for the applicable locale.Method of reporting. Form 2106 is completed to report eligible expenses for FBOs, QPAs and reservists. The expenses are then entered on line 24 of Form 1040.Educators. Grades K–12 teachers, instructors, counselors, prin-cipals and aides can deduct up to $250 of out-of-pocket expenses on line 23 of Form 1040 (up to $500 if MFJ and both spouses are educators). To qualify, the taxpayer must have spent at least 900 hours during a school year as an educator. Qualified expenses include amounts paid for books, supplies (other than nonathletic supplies for courses of instruction in health and PE), computer software and equipment, and other equipment and materials used in the classroom. Amounts that cannot be deducted above the line can be deducted as unreimbursed employee business expenses, subject to the 2%-of-AGI limit.U Caution: The special rule allowing teachers to deduct out-of-pocket expenses expired at the end of 2009 but, at the time of this publication, Congress was considering an extension to 2010. See Tax Extenders Legislation on Page 25-1.

per diem raTesSee also IRS Pub. 1542

Per Diem Substantiation MethodsThe per diem rates set by the IRS for meals, lodging and other incidental expenses vary depending on the travel location. The per diem rates for travel are revised each year on October 1. For the last three months of the year, taxpayers use either the per diem rates effective October 1 of the preceding year or the revised rates effective October 1 of the current year. They must use either the current rates or the revised rates consistently for all travel during that period.Meals and incidental expenses (M&IE) rate. Instead of deduct-ing actual expenses incurred for M&IE while traveling for business, employees and self-employed individuals may deduct IRS-approved per diem amounts, provided they can document the time, place and business purpose for the travel. Also, employees and self- employed individuals who are reimbursed for their meals and inci-dental expenses are treated as substantiating the amount of those


Partial Table of Class Lives and Recovery Periods—IRS Publication 946 (Continued)Asset Class Description of assets included: Class Life

(in years)GDS Life (MACRS) ADS

01.221 Any breeding or work horse 12 years old or less at the time it is placed in service .........................10 7 1001.222 Any breeding or work horse more than 12 years old at the time it is placed in service....................10 3 1001.223 Any race horse more than two years old at the time it is placed in service ..........................................2 33 1201.224 Any horse more than 12 years old at the time it is placed in service that is neither a

race horse nor a horse described in Class 01.222 ....................................................................................2 3 1201.225 Any horse not described in Classes 01.221, 01.222, 01.223 or 01.224 ...............................................2 7 1201.23 Hogs, breeding ......................................................................................................................................3 3 301.24 Sheep and goats, breeding ....................................................................................................................5 5 501.3 Farm buildings except structures included in Class 01.4 .....................................................................25 20 2501.4 Single-purpose agricultural or horticultural structures [within meaning of Section

168(i)(13)] ...............................................................................................................................................15 10 1510.0 Mining. Includes assets used in the mining and quarrying of metallic and nonmetallic

minerals (including sand, gravel, stone and clay) and the milling, beneficiation and other primary preparation of such materials ....................................................................................................10 7 10

13.1 Drilling of oil and gas wells. Includes assets used in the drilling of onshore oil and gas wells and the provision of geophysical and other exploration services; and the provision of such oil and gas field services as chemical treatment, plugging and abandoning of wells and cementing or perforating well casings. .....................................................................................................6 5 6

13.2 Exploration for and production of petroleum and natural gas deposits. Includes assets used by petroleum and natural gas producers for drilling of wells and production of petroleum and natural gas, including gathering pipelines and related storage facilities. ........................................14 7 14

15.0 Construction. Includes assets used in construction by general building, special trade, heavy and marine construction contractors, operative and investment builders, real estate subdividers and developers and others, except railroads ........................................................................6 5 6

23.0 Manufacturing of apparel and other finished products. Includes assets used in the production of clothing and fabricated textile products; does not include apparel from rubber and leather ................9 5 9

24.1 Timber cutting equipment .....................................................................................................................6 5 624.4 Assets used in the manufacturing of wood products and furniture ..............................................10 7 1027.0 Printing, publishing and allied industries. Includes assets used in printing by one or more

processes, such as letter-press, lithography, gravure or screen; the performance of services for the printing trade, such as bookbinding, typesetting, engraving, photo-engraving and electrotyping; and the publication of newspapers, books and periodicals .............................................. 11 7 11

39.0 Manufacture of athletic, jewelry and other goods. Includes assets in the production of jewelry, musical instruments, toys and sporting goods, motion picture and television films and tapes, and pens, pencils, office and art supplies, brooms, brushes, caskets, etc. .................................12 7 12

57.0 Distributive trades and services. Includes assets used in wholesale and retail trade, and personal and professional services. Includes Section 1245 assets used in marketing petroleum and petroleum products .......................................................................................................... 9 5 94

79.0 Recreation. Assets used in the provision of entertainment services for a fee or admission charge, such as bowling alleys, pool halls, theaters, concert halls and miniature golf courses. Does not include amusement and theme parks and specialized land improvements such as golf courses, sports stadiums, race tracks, ski slopes and buildings ...........................................................................10 7 10Personal property with no class life ................................................................................................................. 7 12Section 1245 real property with no class life ................................................................................................... 7 40Residential rental real property....................................................................................................................... 27.5 40Nonresidential real property. Includes office buildings, warehouses and qualified “office-in-home” ......... 31.5 or 39 40

1 Certain new farming machinery and equipment placed in service during 2009 had a five-year GDS recovery period. [IRC §168(e)(3)(B)] U Caution: At the time of publication, Congress was considering legislation that would extend this provision to 2010. See Tax

Extenders Legislation on Page 25-1.2 Properties described in asset classes 01.223, 01.224 and 01.225 are assigned recovery periods but have no class lives.3 Any race horse will have a three-year GDS recovery period (regardless of its age when placed in service) if it is placed in service

after 2008 and before 2014. [IRC §168(e)(3)(A)]4 High technology medical equipment is assigned a five-year recovery period for alternate MACRS method.GDS General Depreciation System. 200% declining-balance (DB) depreciation method for three-year, five-year, seven-year and 10-year

property; 150% DB for farm, 15-year and 20-year property; straight-line (SL) depreciation method for 27.5- and 31.5-year/39-year property; and recovery years for alternative minimum tax (AMT) depreciation for assets placed in service after 1998.

ADS Alternative Depreciation System. Recovery years for AMT depreciation for assets placed in service prior to 1999, C corporation “book” depreciation and exempt organizations. Can be elected for “tax” depreciation.

Note: Use this table for assets placed in service after 1986. See IRS Publication 946 for a list of all asset recovery periods.


speCiaL depreCiaTion aLLowanCeIRC §168(k)

A special (bonus) depreciation allowance equal to 50% of the de-preciable basis of qualified property is claimed in Part II of Form 4562 for assets purchased and placed in service during 2010.@ Strategy: If the special depreciation allowance is taken, there are no AMT adjustments for depreciation for that asset for the year placed in service or any later year.The special depreciation allowance equals 50% of the asset’s de-preciable basis (cost or other basis less Section 179 deduction and credits, such as the hybrid vehicle and disabled access credits). The amount of the special depreciation allowance is not affected by a short taxable year, or by the applicable convention. (See Conven-tions on Page 10-3.) But, assets for which the special depreciation allowance is claimed are still counted for determining whether the mid-quarter convention applies for the “normal” MACRS deduction. Note: For 2010, the 100% allowance applies to property acquired and placed in service 9/9/10–12/31/10.

Qualified PropertyTo qualify for the special depreciation allowance, the property must be a new asset (see Original use below) that is either:• MACRS property with an applicable recovery period of 20 years

or less,• Computer software (other than computer software covered by

Section 197),• Water utility property or• Qualified leasehold improvement property. See Qualified Lease-

hold Improvements Page 10-19.Business vehicles. The Section 280F limit on depreciation that applies to many vehicles is increased in 2010 by $8,000 for ve-hicles for which special depreciation is claimed. See the Business Vehicles—Quick Facts table on Page 11-1.Original use. To qualify for special depreciation, the asset must generally be new, rather than used. However, new property that a taxpayer acquired for personal and later converted to business use meets the original-use requirement. [Reg. §1.168(k)-1(b)(3)]

Electing OutTaxpayers can elect not to claim special depreciation for any class of property by attaching a statement to the tax return. The election out applies to all additions to an asset class (for example, five-year property) for the year. [IRC §168(k)(2)(D)]

Election Out of Special Depreciation AllowanceTaxpayer elects under IRC Sec. 168(k)(2)(D)(iii) not to claim the 50% special depreciation allowance for the following classes of property placed in service during the tax year ended [insert year-end]: [List property classes for which election is made.]

aLTernaTive minimum Tax adjusTmenTs

To compute alternative minimum tax (AMT), certain adjustments are made to MACRS depreciation deductions.

AMT Depreciation Methods and AdjustmentsPlaced in Service after 19981

MACRS Property

MACRS Meth-od/Recovery

Period2

AMT Method/Recovery Period2

AMT Adjustment

3-, 5-, 7- and 10-yr property

200% DB GDS

150% DB GDS

Difference between 200% and 150% DB methods.

15 and 20-yr property and farm property

150% DB GDS

150% DB GDS

None.

Property for which MACRS SL elected

SL GDS

SL GDS

None.

Property for which AMT 150% DB elected

150% DB GDS

150% DB GDS

None.

15-year §1250 property

150% DB 15 yrs

SL 15 yrs

Difference between 150% DB and SL.

27.5-yr residential real property

SL 27.5 yrs

SL 27.5 yrs

None.

39-yr nonresidential real property

SL 39 yrs

SL 39 yrs

None.

1 For property placed in service after 1986 and before 1999, the ADS recovery period generally applied for AMT purposes so, the AMT adjustment is sometimes the result of differences in both the depreciation method and recovery period.

2 See Partial Table of Class Lives and Recovery Periods on Page 10-1 for GDS and ADS recovery periods.

No AMT adjustment is required for the following:• Residential rental property placed in service after 1998.• Nonresidential real property with a class life of 27.5

years or more placed in service after 1998.• Other Section 1250 property placed in service after

1998 that is depreciated for regular tax using the SL method.

• Property (other than Section 1250 property) placed in service after 1998 that is depreciated for regular tax purposes using the 150% DB method or the SL method.

• Property depreciated using ADS for regular tax purposes.• Property for which the special depreciation allowance under Sec-

tions 168(k) is claimed. See Special Depreciation Allowance in the previous column.

• Qualified disaster assistance property for which a special depre-ciation allowance under IRC §168(n) is claimed. See Federally Declared Disasters on Page 5-15.

• Property for which a special depreciation allowance was claimed because it replaced property damaged in the New York terrorist acts on September 11, 2001, by Hurricane Katrina or by the Kan-sas storms that occurred in 2007. See Pubs. 4492 and 4492-A for details.

Continued on the next page“Isthereanythingaboutourfinancesyouhaven’ttoldme?

Thebankjustforeclosedonourbirdhouse!”

(or 100%)

(or 100%)


15 15 15

LeasehoLd improvemenTs

General RulesGenerally, any improvement to depreciable property has the same recovery period and method as the improved property (but is treated as placed in service when the improvement is made). So an improvement to a commercial building [whether made by the lessor (landlord) or the lessee (tenant)] generally would be depre-ciated straight-line over 39 years. But, see Qualified Leasehold Improvements below for special rules.Lessee (tenant). Any remaining undepreciated basis is deductible by the lessee when the lease terminates.Lessor (landlord). The lessor can deduct the undepreciated basis of the improvement at the end of the lease term only if the actual improvement is irrevocably disposed of or abandoned by the lessor at the termination of the lease. [IRC §168(i)(8)]

speCiaL ruLes for CerTain BuiLdings and improvemenTs

Leasehold Improvements, Retail and Restaurant Property—Special Rules (2010)

Qualified Leasehold

Improvement Property

Qualified Restaurant

Property

Qualified Retail

Improvement Property

MACRS recovery period 39 yr1 39 yr1 39 yr1

Eligible for 50% special (bonus) depreciation Yes No No

Eligible for Section 179 deduction Yes2 Yes2 Yes2

Includes: • Building interiors Yes Yes Yes• Buildings No Yes No• Elevators and

certain structural improvements?3

No Yes No

Must be placed in service more than three years after building placed in service?

Yes No Yes

Must be made pursuant to a lease? Yes No No

1 For 2009, a 15-year recovery period applied. At publication time, Congress was considering legislation extending the 15-year recovery period to 2010. See Tax Extenders Legislation on Page 25-1.

2 Heating and air conditioning units as well as property used to furnish lodging are not eligible.

3 This includes elevators, escalators, enlargement of the building, structural component benefitting a common area or internal structural framework.

Qualified Leasehold ImprovementsQualified leasehold improvement property is generally any improvement to a building that meets all of the following requirements:1) The building is nonresidential real property.2) The improvement is to an interior portion of a building.3) The improvement was made pursuant to a lease by

the tenant, sub-tenant or the landlord to property to be occupied exclusively by the tenant (or sub-tenant).

4) The improvement is placed in service more than three years after the date the building was first placed in service (by any taxpayer).

U Caution: Leases between related parties are not treated as leases for purposes of qualified leasehold improvement prop-erty [IRC §168(k)(3)]. Related parties include taxpayers and their spouses, parents, grandparents, children, grandchildren and siblings. Taxpayers are also considered related to certain entities that they own (directly or indirectly) 80% or more.Transfers of improvements made by lessor (landlord). If a landlord transfers ownership of qualified leasehold improvement property, the improvement will not be qualified property to any subsequent owner. (Exceptions exist for transfers because of death, corporate merger, formations of business entities where the taxpayer retains significant control, like-kind exchanges and involuntary conversions). [IRC §168(e)(6)]

Qualified Restaurant PropertyThis is any Section 1250 property that is a building or an im-provement to a building if more than 50% of the building’s square footage is devoted to preparation of, and seating for on-premises consumption of, prepared meals. [IRC §168(e)(7)]

Qualified Retail Improvement PropertyThis is generally any improvement to an interior portion of a build-ing that is nonresidential real property if: [IRC §168(e)(8)]1) Such portion is open to the general public and is used

in the retail business of selling tangible personal property to the general public and

2) Such improvement is placed in service more than three years after the date the building was first placed in service.

Improvements made by owners. If a taxpayer transfers ownership of qualified retail improvement property, the improve-ment is not qualified retail improvement property in the new owner’s hands. However, there are exceptions for transfers due to the owner’s death, corporate mergers, formation of business entities where the taxpayer retains significant control, like-kind exchanges and involuntary conversions.

CorreCTing depreCiaTion errorsFile Form 3115, Application for Change in Accounting Method, to report depreciation changes that qualify as accounting method changes. Changes that are not accounting method changes are reported on amended returns.Depreciation corrections made on From 3115.• The treatment of an asset from nondepreciable to depreciable

or vice versa.• Change to the depreciation method, recovery period or conven-

tion of a MACRS asset.• Changing from an incorrect to the correct amount of special

(bonus) depreciation.• Change from improperly expensing to capitalizing an asset.Depreciation corrections made on an amended return.• Correcting mathematical or posting errors.• A change in useful life (non-MACRS assets).• A change in salvage value (other than to zero).• A change in the placed-in-service date. Note: Generally, an accounting method is not established until the taxpayer uses it for two consecutive tax years. Thus, an account-ing method used on only one return would generally be corrected on an amended return. However, taxpayers can change a depre-ciation accounting method used on a single return either by filing an amended return or by filing a Form 3115. (Rev. Proc. 2008-52)


Business Vehicles—Quick FactsFor business vehicles placed in service 2010 2009 2008 2007 2006

Passenger Autos—Unloaded GVW 6,000 lbs or Less 1

Section 280F depreciation limits apply when basis exceeds2

If 50% special depreciation claimed $ 18,433 $ 18,266 $ 18,266 N/A N/AIf no special depreciation claimed 15,300 14,800 14,800 $ 15,300 $ 14,800

Leased auto income inclusion applies when FMV exceeds: 16,700 18,500 18,500 15,500 15,200Depreciation limits (annual Section 280F limits)3, 4

Acquisition year if 50% special depreciation claimed $ 11,060 $ 10,960 $ 10,960 N/A N/AAcquisition year if no special depreciation claimed 3,060 2,960 2,960 $ 3,060 $ 2,960Second-year limit 4,900 4,800 4,800 4,900 4,800Third-year limit 2,950 2,850 2,850 2,850 2,850All years thereafter 1,775 1,775 1,775 1,775 1,775

Trucks and Vans—Vehicle Built on a Truck Chassis With Loaded GVW 6,000 lbs or Less1

Section 280F depreciation limits apply when basis exceeds2

If 50% special depreciation claimed $ 18,600 $ 18,433 $ 18,600 N/A N/AIf no special depreciation claimed 15,800 15,300 15,800 $ 16,300 $ 16,300

Leased auto income inclusion applies when FMV exceeds: 17,000 18,500 19,000 16,400 16,700

Depreciation limits (annual Section 280F limits)3, 4

Acquisition year if 50% special depreciation claimed $ 11,160 $ 11,060 $ 11,160 N/A N/AAcquisition year if no special depreciation claimed 3,160 3,060 3,160 $ 3,260 $ 3,260Second-year limit 5,100 4,900 5,100 5,200 5,200Third-year limit 3,050 2,950 3,050 3,050 3,150All years thereafter 1,875 1,775 1,875 1,875 1,875

Heavy Vehicles—Loaded GVW over 6,000 lbs but not more than 14,000 lbsSection 179 expensing limit $ 25,000 $ 25,000 $ 25,000 $ 25,000 $ 25,000

Depreciation limit (annual Section 280F limit) N/A N/A N/A N/A N/A

Vehicles Not Subject to Depreciation Limitation RulesAutos rated at more than 6,000 lbs. unloaded gross vehicle weight (GVW), trucks and vans rated at more than 6,000 lbs. loaded GVW, and qualified nonpersonal-use vehicles are not subject to the Section 280F depreciation limits.

Standard Mileage Rates

Business miles 50¢ 55¢ 50.5¢: 1/1 – 6/30;58.5¢: 7/1 – 12/31 48.5¢ 44.5¢

Depreciation component of business standard mileage rate 23¢ 21¢ 21¢ 19¢ 17¢

Charitable miles 14¢ 14¢ 14¢ 14¢ 14¢

Medical or moving miles 16.5¢ 24¢ 19¢: 1/1 – 6/30;27¢: 7/1 – 12/31 20¢ 18¢

1 If less than 100% business use, the limits must be reduced to reflect actual business-use percentage.2 Assumes half-year convention applies.3 This limit applies to the sum of the MACRS depreciation and any Section 179 expense claimed.4 For limits in effect before 2006, see the Section 280F Depreciation Limits for Cars and Section 280F Depreciation Limits for Trucks and Vans tables on Page 11-14.

Autos and Listed Property

Tab 11 TopicsDeducting Vehicle Expenses ................................ Page 11-2Depreciating Vehicles ........................................... Page 11-2Maximizing Vehicle Section 179 Expense ............ Page 11-4Depreciation After Recovery Period Ends............. Page 11-4Depreciation Recapture ........................................ Page 11-5Basis—Autos ........................................................ Page 11-5Auto Trade-In Rules .............................................. Page 11-6Selling a Business Auto ........................................ Page 11-7Alternative Motor Vehicle Tax Credit ..................... Page 11-7Credits for Plug-In Vehicles................................... Page 11-7Commuting Expenses ........................................... Page 11-9

Autos—Documenting Business Use ..................... Page 11-9Employer-Provided Vehicles ............................... Page 11-10Listed Property .................................................... Page 11-10Leased Vehicles ...................................................Page 11-11Basis Worksheet—Vehicle Acquired in a

Trade-In ............................................................ Page 11-14Section 280F Depreciation Limits for Cars—

Placed in Service before 2006.......................... Page 11-14Section 280F Depreciation Limits for Trucks and

Vans—Placed in Service in 2003–2005 ........... Page 11-14Vehicles Subject to Section 280F Limit

Depreciation Worksheet ................................. Page 11-14

—50% / 100%/ 11,060

/ 11,160—50% / 100%


See the Business Vehicles—Quick Facts table on Page 11-1 for the limits that apply to vehicles placed in service during 2006–2010.Special use vehicles. These vehicles are not subject to the Sec-tion 280F depreciation limits. This category includes the following:1) An ambulance, hearse or combination ambulance-hearse used

in a trade or business.2) A vehicle used in the trade or business of trans-

porting persons or property for compensation or hire (for example, a taxicab).

3) Qualified non-personal use vehicles. See Quali-fied non-personal-use vehicles on Page 11-10.

2010 Deduction Limits for Vehicles

Description§280F

Depreciation Limit 1

Maximum §179

DeductionCar—GVW (unloaded) up to 6,000 lbs.• 50% special depreciation claimed.• No special depreciation claimed.

$11,0603,060

$11,0603,060

Truck or van (including SUVs and minivans on a truck chassis)—GVW (loaded) up to 6,000 lbs.• 50% special depreciation claimed.• No special depreciation claimed.

$11,160 3,160

$11,160 3,160

Car, truck or van (including SUVs and minivans), GVW over 6,000 but not over 14,000 lbs.

N/A $25,0002

Vehicles—GVW over 6,000 but not over 14,000 lbs that:• Are designed to seat more than nine passengers

behind the driver seat (for example, a hotel shuttle van);

• Have an open cargo area or covered box that is at least six feet long and not readily accessible from the passenger compartment (for example, a pick-up with full-size cargo bed) or

• Have an enclosure fully enclosing the driver compartment and load carrying device, do not have seating behind the driver’s seat and have no body section protruding more than 30 inches ahead of the windshield (for example a delivery van).

N/A $500,0003

Truck or van, GVW (loaded) over 14,000 lbs. N/A $500,0003

1 First year limit; reduce by any §179 expense claimed.2 Per vehicle limit. Also subject to overall Section 179 limit ($500,000 for 2010).3 Annual limit for all assets expensed.

Section 179 Limit for SUVsTrucks, vans and SUVs with a loaded GVW greater than 6,000 pounds are not subject to the depreciation limit. However, these vehicles are still considered listed property and are not eligible for accelerated depreciation or a Section 179 expense when business use is 50% or less. See Listed Property on Page 11-10.The GVW can normally be found on a label attached to the inside edge of the driver’s side door. Some manufacturers also list GVWs for their various models on their websites. Many of the larger trucks and SUVs have a loaded GVW over 6,000 pounds.Website: GVWs for many vehicles can be found at www.intellichoice.com and www.carsdirect.com/research. The Section 179 deduction for heavy passenger vehicles (cars, trucks, vans and SUVs with loaded GVW over 6,000 pounds) with a gross vehicle weight of 14,000 pounds or less is limited to $25,000 per vehicle. For exceptions to the $25,000 Section 179 limit, see the 2010 Deduction Limits for Vehicles table above.

Calculating Vehicle DepreciationStep 1: Determine the business/investment use percentage by dividing business/investment miles driven during the year by total miles driven.

Step 2: Multiply the Section 280F limit for the year by the business/investment use percentage. This is the maximum amount that can be claimed as depreciation (includ-ing any Section 179 deduction) for the year.

Step 3: Determine the Section 179 deduction. The Section 179 deduction can only be claimed in the year the auto is placed in service and only if business use is more than 50%.

Step 4: Determine the special depreciation allowance. New vehicles acquired and placed in service during 2010 and used more than 50% for business qualify for a 50% special deprecia-tion allowance.

N Observation: The special depreciation allowance applies unless the taxpayer elects out. See Tab 10 for details.

Step 5: Determine MACRS depreciation. If qualified business use is 50% or less, depreciation must be calculated SL with a five-year recovery period.

See the Vehicles Subject to Section 280F Limit Depreciation Worksheet on Page 11-14.

Example: A passenger auto is purchased new on July 10, 2010, for $24,000 and is used 75% for business during 2010. No Section 179 deduction is claimed. The taxpayer does not elect out of the 50% special depreciation allowance.

• $24,000 cost × 75% business use = $18,000• Section 280F limit = $11,060 × 75% business use = $8,295• $18,000 × 50% special depreciation allowance = $9,000• 2010 depreciation is limited to $8,295 (lesser of $9,000 or $8,295)

Electing Straight-Line DepreciationEven if business use exceeds 50%, a taxpayer may elect to depreciate an auto under the five-year SL method instead of using MACRS. By electing SL depreciation, a taxpayer can avoid the recapture of excess MACRS deductions if business use drops to 50% or less in a later year. The election is made by entering “SL” in column (g) of Part V, Form 4562. The elec-tion applies to the entire class of property for the year in which the election is made.

Business Use 50% or LessPassenger automobiles (see Passenger auto on Page 11-2) used 50% or less for business purposes are not eligible for Section 179 expense or special depreciation allowance and must be depreciated over five years using the SL method. The half-year or mid-quarter conventions still apply. See the Vehicle Depreciation—MACRS Percentages table on Page 11-4.Investment use. Investment use is not counted for determining whether a vehicle meets the more than 50% business-use test (to qualify for accelerated depreciation and Section 179 expensing). But, the combined business/investment percentage is used to compute the depreciable portion of the vehicle’s basis.

Example #1: An auto is used 40% in a trade or business and 25% for in-vestment. Method: SL depreciation must be used based on 65% business/investment use.Example #2: An auto is used 80% in a trade or business and 10% for in-vestment. Method: Accelerated depreciation (200% DB) may be used and calculated based on 90% business/investment use.


earlier accelerated MACRS and Section 179 deductions must be recaptured and reported as ordinary income on Form 4797. Con-verting a business auto to personal use reduces the business-use percentage to zero, so recapture income will be recognized at the conversion date if the auto was listed property and used more than 50% for business. See Depreciation Recapture on Page 11-5.

Auto ImprovementsTreat a capital improvement to an automobile as a new asset placed in service in the year of the improvement. Combine the depreciation deductions for both the automobile improvement and for the improved automobile.Total combined depreciation may not exceed the Section 280F depreciation limit for that year, based on the date the automobile was originally placed in service [Reg. §1.280F-2T(f)]. Note: A credit may be available when an auto is converted to a plug-in vehicle. See Alternative Motor Vehicle Tax Credit on Page 11-7.

Donating a Car to CharityIf the claimed value of a donated vehicle exceeds $500, the de-duction may be limited to the gross sales proceeds the charitable organization receives upon disposition of the vehicle. See Cars, Boats and Airplanes on Page 5-13 for more information.Blue Book value. One common method to assist in determining the FMV of an auto is with Kelley Blue Book values. Blue book values are not official, but provide a standard for comparison pur-poses. Blue book values are available at www.kbb.com.

auTo Trade-in ruLesReg. §1.168(i)-6(d)(3)

When an auto is traded in for a new vehicle, the like-kind exchange rules apply. The taxpayer’s basis for depreciating in the new vehicle consists of two separate components:1) The exchanged basis and2) The excess basis, if any.See Like-Kind Exchanges—Depreciation Rules on Page 10-18 for a discussion of the exchanged basis and the excess basis in a like-kind exchange.

Depreciating Vehicles Acquired in a Trade[Reg. §1.168(i)-6(d)(3)]

Step Compute: Deduction limited to:1 Depreciation on old car. Use applicable

convention for the year of disposition.Lesser of: 280F limit for the old car or the limit for the new car.1

2 50% special depreciation2 on new car’s exchanged basis (basis in the old car after step 1).

280F limit for the new car, less amount deducted in step 1.

3 MACRS depreciation on new car’s exchanged basis (after 50% special depreciation). Use same convention as for old car and the remaining recovery period.

Lesser of: 280F limit for the old car or the limit for the new car, less amounts deducted in steps 1 and 2.

4 Section 179 expense on the new car’s excess basis.

280F limit for new car, less amounts deducted in steps 1–3.

5 50% special depreciation2 on new car’s excess basis (after Section 179).


6 MACRS depreciation on new car’s excess basis (after Section 179 and special depreciation). Use applicable convention for the acquisition year and five-year recovery period.


1 If the replacement vehicle is acquired in a year after the year of disposition, depreciation in limited to the 280F limit for the old car.

2 If vehicle is eligible and taxpayer does not elect out.

Note: Cars, light general purpose trucks (for use over the road and weigh less than 13,000 pounds), crossovers, SUVs, minivans and cargo vans are like-kind property. (Ltr. Rul. 200912004)The Section 280F depreciation limit applies for computing the year-of-disposition depreciation for the old vehicle and for depre-ciating the new vehicle. In the exchange year, total depreciation claimed on both vehicles cannot exceed the Section 280F limit for the new vehicle.

æ Practice Tip: Taxpayers can elect not to apply like-kind exchange treat-ment by attaching a statement to a timely filed return (including extensions) stating “Election made under Reg. 1.168(i)–6(i)” for each property involved in the exchange. If this election is made, the entire basis of the replacement property is depreciated as a new asset on Form 4562. See the Basis Worksheet—Vehicle Acquired in a Trade-In on Page 11-14 for how to compute basis when the election out is made.U Caution: An employee who trades in an auto used for busi-ness as an employee elects out of the depreciation rules for like-kind exchanges by completing Form 2106, Part II, Section D to report the auto’s depreciation. If the employee does not elect out of the general rules, depreciation for the auto acquired in the exchange is reported on Form 4562.

Example: Jim purchased a Honda in February 2007 for $20,000. He used it 100% in his business. In November 2010, Jim exchanges, in a like-kind exchange, his Honda plus $14,000 cash for a new Mazda that will also be used solely in his business. The Mazda qualifies for 50% special depreciation. Jim also claims a $2,000 Section 179 deduction on the Mazda’s excess basis. The 2010 Section 280F limit for the Honda (if the trade hadn’t occurred) is $1,775. The 2010 280F limit for the Mazda is $11,060. The depreciation and basis calcula-tions for 2010 are as follows:

Depreciation/ Section 179 Basis

Honda basis at December 31, 2009 ($20,000 cost – $3,060 – $4,900 – $2,850) ........................................................... $ 9,190

Step 1: 2010 depreciation on Honda ($20,000 × 11.52%, limited to $1,775) ........................................ $ 1,775 < 1,775>Exchanged basis in Mazda .............................................................. 7,415

Step 2: 50% special depreciation on Mazda exchanged basis ($7,415 × 50%, limited to $11,060 – $1,775 = $9,285) ................................................... 3,708 < 3,708>

Step 3: Regular deprecation on Mazda exchanged basis (limited to $1,775 – $1,775 – $3,708= $0) ..... 0 < 0>Mazda exchanged basis at December 31, 2010 ............................. $ 3,707Mazda excess basis ....................................................................... $14,000

Step 4: Sec. 179 deduction (limited to $11,060 – $1,775 – $3,708 = $5,577) ...................................... 2,000 < 2,000>

Step 5: 50% special depreciation on excess basis [50% × ($14,000 – $2,000), limited to $11,060 – $1,775 – $3,708 – $2,000 = $3,577] ........................ 3,577 < 3,577>

Step 6: Regular depreciation on Mazda excess basis [($14,000 – $2,000 – $3,577) × 20%, limited to $11,060 – $1,775 – $3,708 – $2,000 – $3,577 = $0] ................. 0 < 0>Mazda excess basis at December 31, 2010 .................................... $ 8,423Total 2010 depreciation ........................................... $ 11,060Basis of Mazda at end of 2010 ($3,707 + $8,423) ........................... $12,130

August


— End of Tab 11 —

Basis Worksheet—Vehicle Acquired in a Trade-In Note: This method is used if the taxpayer elects to treat the trade-in as a tax-free disposition [that is, elects out of the general rules of Reg. § 1.168(i)-6(i)]. See Auto Trade-In Rules on Page 11-6 for details.1) Original basis of old vehicle, reduced by any

tax credits ................................................................ 1) $ 2) Total depreciation allowed on the old vehicle

(including amount for year of trade) ......................... 2) 3) Adjusted basis of old vehicle before trade-in

adjustment—Line 1 minus line 2 ............................. 3) 4) Cash and FMV of other property paid to the

to the other party ..................................................... 4) 5) Liabilities assumed or taken out by taxpayer ........... 5) 6) Liabilities assumed by the other party .................... 6) < >7) Additional basis in the new vehicle—

Sum of lines 4 through 6 .......................................... 7) 8) Basis in the new vehicle. Line 3 plus line 7.

This is the original basis in the vehicle for sale or exchange purposes ..................................................... 8)

9) Depreciation that would have been allowed (through year of trade) on the old vehicle at 100% business use ................................................. 9)

10) Actual depreciation allowed (line 2) ........................ 10) 11) Excess depreciation—Line 9 minus line 10 ............. 11) 12) Trade-in adjustment: Lesser of excess amount

(line 11) or adjusted basis of old vehicle (line 3) ...... 12) 13) Basis for depreciation. Line 8 minus line 12 ......... 13)

Section 280F Depreciation Limits for Cars—Placed in Service before 2006

Date Placed In Service 1st Year 2nd Year 3rd Year 4th & Later2005 $ 2,960 $ 4,700 $ 2,850 $ 1,6752004 10,6101 4,800 2,850 1,675

5/06 – 12/31/2003 10,7102 4,900 2,950 1,7751/01 – 5/05/2003 7,6602 4,900 2,950 1,775

2001 – 2002 7,6603 4,900 2,950 1,7752000 3,060 4,900 2,950 1,7751999 3,060 5,000 2,950 1,7751998 3,160 5,000 2,950 1,775

See the Business Vehicles—Quick Facts table on Page 11-1 for limits for vehicles placed in service after 2005.1 $2,960 if special depreciation allowance not claimed.2 $3,060 if special depreciation allowance not claimed.3 $3,060 if acquired before 9/11/2001 or special depreciation not claimed.

Section 280F Depreciation Limits for Trucks and Vans—Placed in Service in 2003–2005

Date Placed In Service 1st Year 2nd Year 3rd Year 4th & Later2005 $ 3,260 $ 5,200 $ 3,150 $ 1,8752004 10,9101 5,300 3,150 1,875

5/06 – 12/31/2003 11,0102 5,400 3,250 1,9751/01 – 5/05/2003 7,9602 5,400 3,250 1,975

See the Business Vehicles—Quick Facts table on Page 11-1 for limits for vehicles placed in service after 2005. For trucks and vans placed in service before 2003, use the Section 280F Limits for Cars table above.1 $3,260 if special depreciation not claimed.2 $3,360 if special depreciation not claimed.

Vehicles Subject to Section 280F Limit Depreciation Worksheet

Part I1) MACRS system (GDS or ADS) ................................. 1) 2) Property class ........................................................... 2) 3) Date placed in service .............................................. 3) 4) Recovery period ....................................................... 4) 5) Method and convention ............................................ 5) 6) Depreciation rate (see the Vehicle Depreciation—

MACRS Percentages table on Page 11-4 for 200% and SL methods and the 5-Year MACRS table on Page 10-5 for 150% DB method) ............................. 6)

7) Section 280F limit for this year (based on year placed in service). See the Business Vehicles—Quick Facts table on Page 11-1 ............................... 7)

8) Business/investment-use percentage ....................... 8) %9) Multiply line 7 by line 8. This is the adjusted Section

280F limit .................................................................. 9) 10) Section 179 deduction (not more than line 9).

Enter -0- if this is not the year the vehicle is placed in service .................................................................. 10)

Note: • If line 10 is equal to line 9, stop here. The combined

Section 179 and depreciation deduction is limited to the amount on line 9.

• If line 10 is less than line 9, complete Part II.

Part II11) Subtract line 10 from line 9. This is the limit on the

deduction for depreciation (including any special depreciation allowance) ............................................ 11)

12) Cost or other basis (reduced by credits, such as the alternative motor vehicle credit claimed on the vehicle) ............................................................. 12)

13) Multiply line 12 by line 8. This is the business/investment cost ......................................................... 13)

14) Section 179 claimed in the year the vehicle was placed car in service ................................................. 14)

15) Line 13 minus line 14. This is the tentative basis for depreciation ......................................................... 15)

16) Special depreciation allowance. If vehicle was placed in service in 2010 and eligible for special depreciation, multiply line 15 by 50%. Otherwise, enter zero ................................................................. 16)

Note:• If line 16 is equal to or greater than line 11, stop here.

The special depreciation deduction is limited to the amount on line 11.

• If line 16 is less than line 11, complete Part III.

Part III17) Line 11 minus line 16. This is the limit on the

MACRS depreciation deduction ............................... 17) 18) Subtract line 16 from line 15. This is the basis for

depreciation .............................................................. 18) 19) Multiply line 18 by line 6. This is the tentative

MACRS depreciation deduction ............................... 19) 20) MACRS depreciation. Enter the lesser of

line 17 or line 19 ..................................................... 20)

(or 100%)


Tab 12 Topics

Tax Credits, AMT and Special Taxpayers

Tax Credits Summary (2010)For information on additional credits available to individuals, see Line-By-Line Quick Reference to 2010 Form 1040 on Page 4-1.

Tax Credit IRC § For Rate IRS

PubTax

FormRefundability,

CarryoverAllowed Against AMT?

QF Page

Additional Child

24 Taxpayers who don’t claim full $1,000 tax credit for each child and have (1) one or more qualifying children and over $3,000 of earned income or (2) three or more qualifying children.

Up to $1,000 per child. 972 8812 Partially refundable

Yes 12-6

Adoption Expense

23 Expenses incurred in the legal adoption of a child under age 18 or for the adoption of an incapacitated or special needs person (regardless of age). Credit is phased out for modified AGI between $182,520–$222,520.

$13,170 for a special needs child; up to $13,170 per child for all other adoptions.

17 8839 Refundable Yes 12-2

Alternative Motor Vehicle

30B New hybrid and advanced lean-burn technology vehicles placed in service during the year.

Various limits based on models.

17 8910 Nonrefundable Yes 11-7

Child and Dependent Care

21 Care expenses for dependent(s) under age 13 or incapacitated that allow taxpayer to work or look for work.

20% to 35% of qualifying (limited) expenses depending on AGI level.

503 2441 Nonrefundable No1 12-3

Child 24 Taxpayers with qualifying children under age 17. Phase-out begins at modified AGI over $110,000 MFJ; $75,000 Single, HOH and QW; $55,000 MFS.

$1,000 per child. 972 1040 Generally nonrefundable

Yes 12-5

Earned Income

32 Working taxpayers with the following number of children: Maximum credit: 596 Sch. EIC

Refundable Yes 12-6• None; AGI < $13,460 ($18,470 if MFJ). • $457 for no children.• One; AGI < $35,535 ($40,545 if MFJ). • $3,050 for one child.• Two; AGI < $40,363 ($45,373 if MFJ). • $5,036 for two children.• Three or more; AGI < $43,352 ($48,362 if MFJ). • $5,666 for three or more

children.

Education—American Opportunity

25A Up to four years of qualified higher education expenses. Credit is per student. Modified AGI phase-out: $80,000–$90,000 ($160,000–$180,000 for MFJ).

Up to $2,500 (100% of first $2,000; 25% of next $2,000).

970 8863 Partially refundable (40%)

Yes 12-9

Education—Lifetime Learning

25A Postsecondary education and courses to acquire or improve job skills. Credit per return. Modified AGI phase-out: $50,000–$60,000 ($100,000–$120,000 for MFJ).

Up to $2,000 (20% of first $10,000).


Elderly or Disabled

22 Low-income taxpayers age 65 or older or permanently and totally disabled. Nontaxable Social Security (or equivalent) must be less than $7,500 MFJ if both spouses qualify.

Based on filing status, age and income. For MFJ also based on spouse’s age and income.

524 Sch. R

Nonrefundable No1 4-20

Federal Tax Paid on Fuels

34 Fuels used on a farm for farming purposes, for off-highway business use and other qualified uses.

Varies by type of fuel and use. 510 4136 Refundable Yes —

First-Time Homebuyer

36 First-time homebuyers and certain existing homeowners who purchase a home. Credit phases out for higher income taxpayers.

Lesser of (1) $8,000 ($4,000 MFS) or (2) 10% of purchase price. Limit is $6,500 ($3,250 MFS) for existing homeowners.


Foreign Tax 27 and 901(a)

Income taxes paid to a foreign country or U.S. possession on income that is also subject to U.S. federal income tax.

Amount of foreign tax up to U.S. tax multiplied by ratio of foreign/total taxable income.

514 1116 Nonrefundable; back 1 yr; fwd 10 years

Yes 12-11


Tax Credits Summary (2010) ................................ Page 12-1Adoption Credit or Benefit Exclusion .................... Page 12-2Child and Dependent Care Credit ......................... Page 12-3Child Tax Credit ..................................................... Page 12-5Earned Income Credit ........................................... Page 12-6Education Tax Credits ........................................... Page 12-8First-Time Homebuyer’s Credit ........................... Page 12-10Foreign Tax Credit ............................................... Page 12-11General Business Tax Credits ............................. Page 12-11Health Coverage Tax Credit ................................ Page 12-11Making Work Pay Credit ..................................... Page 12-11Residential Energy Tax Credits ........................... Page 12-12

Retirement Saver’s Credit ................................... Page 12-13Small Employer Health Insurance Credit ............ Page 12-13Alternative Minimum Tax (AMT) .......................... Page 12-15 Minimum Tax Credit ........................................... Page 12-15Household Employers ......................................... Page 12-17Ministers/Clergy .................................................. Page 12-18Military Personnel ............................................... Page 12-19Community Property ........................................... Page 12-21U.S. Taxpayers Working Abroad ......................... Page 12-21Non-U.S. Citizens ............................................... Page 12-23Oil and Gas Investors ......................................... Page 12-25

Yes

Yes

Yes


adopTion CrediT or BenefiT exCLusion

Form 8839; See also IRC §23 and §137

Taxpayers adopting an eligible or special needs child may be able to take an adoption expense tax credit (IRC §23) and/or exclude employer-provided adoption benefits from income (IRC §137). Both a credit and exclusion may be claimed for the same adoption; however, both cannot be claimed for the same expense. File Form 8839, Qualified Adoption Expenses, to claim the credit or exclusion.AMT. The credit can offset both regular tax and AMT.Refundable. For 2010 and 2011, the credit is refundable. It is claimed on line 71 of Form 1040. Check the “8839” box on that line.Any carryforward of an unused credit to 2010 is treated as a 2010 credit and, therefore, is refundable.Married couples must file a joint return to take the adoption credit or exclusion. An individual is not considered married if legally separated under a decree of divorce or separate maintenance.Married and living apart. A married individual can take the credit or the exclusion on a separate return if the individual:• Lives apart from his spouse for the last six months of the tax year,• Provides the home that is the eligible child’s home for more than

half the year and• Pays more than half the cost of keeping up that home for the year.

Qualifying ChildA credit or exclusion can be claimed with respect to the expenses of adopting either an eligible child or a child with special needs.Eligible child. A child who is either:• Under age 18 or• Physically or mentally incapable of caring for himself/herself.

Special needs child. A child who meets the following two requirements:1) Child is a citizen or resident of the United States

(including U.S. possessions) and2) A state determines that the child cannot or

should not be returned to the parents’ home, and unless adoption assistance is provided to the adoptive parents, the child will probably not be adopted due to a specific factor or condition. Example of factors/conditions: Child’s ethnic background, age, membership in a minority or sibling group, medical condition, or physical, mental or emo-tional handicap.

Child’s Identifying Number (SSN, ITIN, ATIN)Form 8839 requires an identifying number for each eligible child. Use whichever of the following numbers is appropriate.1) Social Security number (SSN) if the child has one or if the

parents can obtain one in time to file a tax return. Apply for an SSN on Form SS-5.

2) Individual Taxpayer Identification Number (ITIN) if the child is a resident or nonresident alien and not eligible for a SSN. Apply for an ITIN on Form W-7.

3) Adoption Taxpayer Identification Number (ATIN) if the child is a U.S. citizen or resident and the parents are unable to obtain the child’s existing SSN or apply for a new SSN until the adoption is final. An ATIN may be obtained by filing Form W-7A with the IRS along with a copy of legal placement papers. The ATIN will remain in effect for two years. An extension is available.

Note: An ATIN may be used to claim the child’s dependency exemption, the child care credit or the child tax credit; an ATIN may not be used to claim the EIC.

Tax Credits Summary (2010) (Continued)

Tax Credit IRC § For Rate IRS

PubTax

FormRefundability,

CarryoverAllowed Against AMT?

QF Page

Health Coverage 35 Individuals eligible to receive trade adjustment allowance or who receive pension benefits from the PBGC.

80% of qualified health insurance cost.


Making Work Pay

36A Individuals with earned income; must have SSN; reduced by the $250 economic recovery payment made to certain retirees in 2010, if any. Modified AGI phase-out: $75,000–$95,000 ($150,000– $190,000 for MFJ);

Lesser of (1) 6.2% of earned income or (2) $400 ($800 MFJ).

17 Sch. M Refundable Yes 12-11

Minimum Tax 53 Credit allowed against regular tax for part of the alternative minimum tax (AMT) paid and attributable to deferral items (timing preferences and adjustments).

AMT attributable to deferral items.

17 88016251

Partially refundable; fwd indefinitely

Yes (refund-

able part)

12-15

Mortgage Interest

25 Part of interest expense paid by homebuyers issued a government mortgage credit certificate.

Based on interest paid and credit rate under certificate.

530 8396 Nonrefundable; fwd 3 years

Yes —

Personal Energy Property

25C Homeowners who install certain energy saving improvements such as insulation, doors, windows, heat pumps, etc.

30% of cost; $1,500 (aggregate limit) for both 2009 and 2010.


Residential Energy Efficient Property

25D Following property installed on taxpayer’s personal residences (principal residence only for fuel cell): solar water heating, solar electric, fuel cells, small wind energy, geothermal heat pump.

30% of cost; $1,000/kW limit for fuel cells.

17 5695 Nonrefundable; fwd indefinitely

Yes 12-13

Retirement Saver’s

25B For individuals who make retirement plan contributions. Credit in addition to tax deduction. AGI ≤ $55,500 MFJ; $41,625 HOH; $27,750 Single, MFS, QW.

10% to 50% of contributions. Maximum: $2,000 MFJ, $1,000 other.

590 8880 Nonrefundable Yes 12-13

Small Employer Health Insurance

45R Certain employers who pay health insurance premiums for their employees.

Up to 35% of premiums paid (state average premium for small market, it less).

— 8941 Nonrefundable; back 5, fwd 20.2

Yes 12-13

1 For 2009, credit could offset both regular tax and AMT. At the time of publication, Congress was considering legislation that would extend this provision to 2010. See Tax Extenders Legislation on Page 25-1.

2 For 2010, a general business credit (which includes the small employer health insurance credit) for a small business (average gross receipts of $50 million or less) can be carried back for five years (instead of the normal one-year period).

Yes


Dollar and AGI LimitationsCredit and exclusion limits:• The credit or exclusion is based on the amount of qualifying adop-

tion expenses the taxpayer pays in connection with the adoption (except for the adoption of a special needs child, see below).

• For 2010, the limit is $13,170 for the adoption of each eligible child.

• The limit is a cumulative, per child limit over all tax years (not an annual limit).

• Limit applies separately to the credit and exclusion (each can be up to $13,170 per child in 2010) if both are taken.

• Expenses of an unsuccessful adoption are combined with ex-penses of a later successful adoption for dollar limits.

Special needs child. The $13,170 credit or exclusion is allowed for the adoption of a special needs child even if the taxpayer does not have qualified adoption expenses.

Example: Mark and Peggy adopt a special needs child and the adoption is finalized in 2010. Their actual adoption expenses are only $6,000. They are still allowed to claim the full $13,170 credit in 2010.

AGI limit. The credit and exclusion are phased out for taxpayers with a modified AGI between $182,520 and $222,520 (for 2010). The AGI phase-out is applied only in the year the adoption credit is generated, and is not applied in future years to reduce any credit carryovers.

Qualified Adoption ExpensesIncludes: Does not include:• Adoption fees.• Attorneys fees.•Court costs.• Travel expenses (including

meals and lodging) while away from home.

•Re-adoption expenses related to the adoption of a foreign child.

• Expenses paid under any state, local or federal program.

• Expenses that violate state law.•Cost of carrying out a surrogate parenting

arrangement.•Cost of adopting spouse’s child.• Expenses paid or reimbursed by employer,

another person or an organization.• Cost otherwise allowed as a deduction or credit.

When to Claim Adoption Credit or ExclusionDomestic Adoption Foreign Adoption1

Adoption CreditExpenses paid in a year… Claim credit in…

Before adoption is final Following year Year adoption is finalAdoption is final Year paid Year paidAfter adoption is final Year paid Year paid

Exclusion for Employer-Provided Adoption BenefitsBenefits received in a year… Claim exclusion in…

Before adoption is final Year received Year adoption is final2Adoption is final Year received Year receivedAfter adoption is final Year received Year received1 For a foreign adoption, credit and/or exclusion is allowed only if adoption

becomes final.2 See Form 8839 instructions on how to report employer provided benefits in

years before the adoption is final.

When Is a Foreign Adoption Final?A foreign adoption that is a convention adoption is considered final in the year that either (1) the foreign country enters a final decree of adoption or (2) the Secretary of State issues a Hague Adoption Certificate. (Rev. Proc. 2010-31)A convention adoption is the adoption of a non-U.S. citizen or resident child who, in connection with the adoption has moved, or

will move, from a country that is a party to the Hague Convention on Protection of Children and Cooperation in Respect of Intercountry Adoption, if the adoptive parent has filed an Application for Determination of Suitability to Adopt a Child from a Convention Country (Form 1-800A or successor) with the Department of State on or after April 1, 2008. A list of countries that are parties to the Hague convention can be found at www.adoption.state.gov/hague/overview/countries.html.See Rev. Proc. 2005-31 for when a foreign adoption that is not a convention adoption is final.

Substantiation RequirementsStarting in 2010, taxpayers must attach a copy of the adoption order or decree to their tax return if they claim the adoption credit for a domestic or foreign adoption finalized in the U.S. Taxpayers claiming the credit for a domestic adoption that is not final must include the child’s adoption TIN on their return or attach one of the following to the return:1) Home study completed by an authorized placement agency. 2) Placement agreement with an authorized placement agency. 3) Document signed by a hospital official authorizing the release

of a newborn child from the hospital to the taxpayer for legal adoption.

4) Court document ordering or approving the placement of a child with the taxpayer for legal adoption.

5) Original affidavit or notarized statement signed under penal-ties of perjury from an adoption attorney, government official or other person, stating that the signor placed or is placing a child with the taxpayer for legal adoption, or is facilitating the adoption process for the taxpayer in an official capacity.

See Notice 2010-66 for substantiation requirements for the adop-tion of a special needs child or for foreign adoptions finalized outside the U.S.

ChiLd and dependenT Care CrediTForm 2441; see also IRC §21 and IRS Pub. 503

Taxpayers can claim a nonrefundable credit for a percentage of their dependent care expenses that enable them to work. In 2010, the credit can offset regular tax but not AMT. U Caution: For 2009, the credit could offset both regular tax and AMT. At the time of publication, Congress was considering legisla-tion that would extend this provision to 2010. See Tax Extenders Legislation on Page 25-1.

“Therearehomesinyourpricerange,butlocationisaproblem.Youhavetogobackto1945.”

and


3) The preparer must make “reasonable inquiries if the information furnished to, or known by, the preparer appears to be incorrect, inconsistent, or incomplete…”

4) The preparer must retain the above information, including a record of how and when the information was obtained and the identity of any person furnishing the information, for three years after the June 30th following the date the return was presented to the taxpayer for signature.

Advance EICTaxpayers who are eligible to claim the EIC and have at least one qualifying child can receive part of the credit in their paychecks throughout the year. (IRC §3507)U Caution: The advance EIC is repealed after 2010.Form W-5, Earned Income Credit Advance Pay-ment Certificate, must be completed and given to the employer for each year the taxpayer is eligible.Advance payments are limited to 60% of the maximum credit for a taxpayer with one qualify-ing child. Form 1040 or 1040A must be filed to report advance payments received during the year and to receive any additional EIC for which the taxpayer may qualify.

eduCaTion Tax CrediTsForm 8863; see also IRC §25A and IRS Pub. 970

For 2010, the following education credits are available:• American opportunity credit. An enhanced version of the former

Hope credit and only available for 2009 and 2010. Note: After 2010, the former Hope credit will be available.

• Lifetime learning credit (LLC). Same as in past years.AMT. The American opportunity credit can offset regular tax and AMT. For 2010, the LLC can offset regular tax, but not AMT. U Caution: For 2009, the LLC could offset both regular and AMT. At the time of publication, Congress was considering legisla-tion that would extend this provision to 2010. See Tax Extenders Legislation on Page 25-1. Note: See the Education Tax Incentives Comparison Chart (2010) on Page 13-5 for more education-related tax breaks.

Who Claims the Credit?The education credits are available for qualified tuition and/or related expenses of the taxpayer, the taxpayer’s spouse or a de-pendent of the taxpayer claimed on the taxpayer’s return. They are not available to married taxpayers filing separate returns. Excep-tion: The individual can qualify as unmarried for filing purposes. See Considered unmarried on Page 4-8.Dependent claimed on another person’s re-turn. If a parent claims a child as a dependent, only that parent may claim the education credit for the child. If the parent is eligible to, but does not claim the student as a dependent, only the student can claim the education credit. [Reg. §1.25A-1(f)] Note: This does not change the basic rule that a child cannot claim a personal exemption for himself if the parent is eligible to, but chooses not to, claim the child as a dependent. [IRC §151(d)(2)]Qualifying expenses paid by a student are considered to have been paid by the parent if the student is claimed as a dependent on the parent’s tax return [Reg. §1.25A-5]. Likewise, if the student is not claimed as a dependent, qualifying expenses paid by parent can be claimed by the child. See Third-party payments in the next column.

Example #1: In 2010, Ferdinand pays qualified tuition for his son to attend college during 2010. Ferdinand claims his son as a dependent on his tax return. Assuming he meets other requirements, Ferdinand is allowed an education credit on his tax return regardless of who paid the qualifying expenses. His son cannot claim the credit.

@ Strategy: It may be advantageous for parents who do not qualify for the education credit for their child’s expenses due to the AGI limitation to not claim the child as a dependent, so the child (student) can claim the education credit on his return. In that situation, no one claims the dependency exemption.Third-party payments. If a third party (anyone other than the taxpayer, his spouse or a claimed dependent) pays a student’s qualified expenses directly to an eligible institution, the student is treated as receiving the payment from the third party and, in turn, paying the qualified expenses. If the student is not claimed as a dependent on another person’s return, the student claims the education credit (if otherwise eligible). If the student is claimed as a dependent on another person’s return, the expenses treated as paid by the student are treated as paid by the person claiming the dependency exemption, and that person claims the education credit. [Reg. §1.25A-5(b)]

Example #2: Assume the same facts as Example #1, but Ferdinand chooses not to claim his son as a dependent on his tax return (even though eligible to do so). If Ferdinand’s son meets other requirements, he may claim the education credit on his return. The result would be the same regardless of whether Ferdinand or his son paid the qualified expenses. (FSA 200236001)

Qualified ExpensesThe following table shows which education expenses qualify for which credits.

Qualified Education Expenses (2010)American

OpportunityLifetime Learning

Tuition and fees Yes Yes1

Course-related books, supplies and equipment Yes2 Yes3

Room and board No No1 Includes courses taken to acquire or improve job skills.2 Books, supplies and equipment needed for a course of study whether or not

the materials are purchased from the educational institution as a condition of enrollment or attendance.

3 Must be paid to the institution as a condition of enrollment or attendance.

• Expenses qualify in the tax year paid. Payments must be for an academic period (such as quarter, semester or trimester) that begins either in the same tax year or in the first three months of the following tax year. For institutions that use credit hours or clock hours and not academic periods, each payment period may be treated as an academic period.

• An eligible institution is any accredited college, university, vocational school or other accredited post-secondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education (DOE). This includes certain institu-tions located outside the U.S. that participate in the DOE programs. An institution should be able to state whether it is eligible. There’s also a list at www.fafsa.ed.gov. Click on “Search for School Codes.”

Qualified expenses do not include:• Expenses for hobby courses that involve sports, games or hob-

bies, or any noncredit course unless it is part of the student’s degree program. Exception: These expenses will qualify for the lifetime learning credit if taken to acquire or improve job skills.

and


Making Work Pay Credit Phase-OutFiling Status Modified AGI

Single, HOH, MFS $ 75,000 – 95,000MFJ 150,000 – 190,000

Modified AGI = AGI + excluded foreign earned income and housing costs + excluded income from certain U.S. possessions and Puerto Rico.

Rules and DefinitionsEligible individuals. An eligible individual is any individual other than: (1) a nonresident alien; (2) an individual who can be claimed as a dependent. An individual is not eligible if he does not include his Social Security number on the return. For joint filers, this requirement is met if the Social Security number of one of the spouses is included on the return.Earned income. Earned income is the same as for the earned income credit (see Earned Income Credit on Page 12-6) with two modi-fications: (a) it does not include self-employment earnings which are not taken into account in comput-ing taxable income and (b) it includes nontaxable combat pay. Coordination with economic recovery payment. The credit is reduced by any economic recovery payment received in 2010 by recipients of Social Security, SSI, railroad retirement and Veteran’s disability compensation or pension benefits.

Tax ReportingThe Making Work Pay credit is claimed on Form 1040, Schedule M and carried to line 63 of Form 1040.

residenTiaL energy Tax CrediTsForm 5695; see also IRC §25C and §25D and IRS Pub. 17

See Selected Energy Tax Incentives for Businesses on Page 24-8 for energy tax incentives for businesses.

Personal Energy Property CreditTaxpayers can claim a credit for certain home improvements placed in service in 2009 and 2010 (IRC §25C). This credit for personal energy property was also available for qualifying improvements placed in service in 2006 and 2007, but not in 2008.Allowable credit:• The credit is equal to 30% of the cost

of qualified energy-efficient property or improvements.

• The total amount of credit that can be claimed in 2009 and 2010 combined is $1,500.

• There are no AGI or income limits so all individuals can claim the credit.

• For 2010, the credit can offset regular tax but not AMT. U Caution: For 2009, the credit could offset both regular tax and AMT. At the time of publication, Congress was considering legislation that would extend this provision to 2010. See Tax Extenders Legislation on Page 25-1.

• The credit is reported on Part I of Form 5695, Residential Energy Credits.N Observation: Other than the overall $1,500 (aggregate) credit limit, there are no limits on the amount allowed for specific types of property, as there were in 2006 and 2007. In addition, claiming a credit in 2006 or 2007 does not impact the ability to claim the full $1,500 credit in 2009 and 2010.

Qualifying property. See the Personal Energy Property Credit—Qualifying Property (2010) table below for descriptions of property that qualifies for the credit. The property must be installed on or in the taxpayer’s principal residence that is located in the U.S. (new construction, vacation and rental homes don’t qualify). The improvement must be new (not used) propertyQualifying property must meet technical requirements related to energy savings. Taxpayers are not required to determine whether these requirements are met. Instead, a manufacturer’s certification statement (that the property meets the technical requirements) generally is required to claim the credit.N Observation: For 2009 and 2010, qualifying property is slightly different that what qualified in 2006 and 2007. The changes include the addition of biomass fuel stoves and asphalt roofs (with appropriate cooling granules) and the removal of geothermal heat pumps (which now qualify for the residential energy efficient property credit discussed on Page 12-13). Also, the technical re-quirements regarding energy efficiency for many types of property have been updated. Property used partly for business. If the home is used partly for business (for example, a home office), any qualified expenditure must be allocated between nonbusiness and business use if the improvement is used more than 20% for business. If allocation is required, only the portion of the expenditure allocated to nonbusi-ness use qualifies for the credit.

Personal Energy Property Credit— Qualifying Property (2010)

Summary: (1) equals 30% of cost of qualified property, (2) $1,500 limit (2009 and 2010 combined) and (3) taxpayer’s main home only.

Product Energy RequirementsAdvanced Main Air

Circulating Fan1Must use no more than 2% of the furnace’s total energy.

Air Source Heat Pump1

• Split systems: HSPF ≥ 8.5; EER ≥12.5; SEER ≥ 15.• Package systems: HSPF ≥ 8; EER ≥ 12; SEER ≥ 14.

Biomass Stove1 Thermal efficiency rating of at least 75% as measured using a lower heating value.

Central Air Conditioning1

• Split systems: EER ≥13; SEER ≥ 16.• Package systems: EER ≥ 12; SEER ≥ 14. Not all ENERGY STAR products qualify.

Electric Heat Pump Water Heater1

Energy factor ≥ 2.0. All ENERGY STAR qualified electric heat pump water heaters qualify.

Gas, Oil or Propane Hot Water Boiler1

AFUE ≥ 90.

Gas, Oil or Propane Water Heater1

Energy factor ≥ 0.82 or a thermal efficiency of at least 90%.

Insulation2 Must meet 2009 IECC (including supplements) prescriptive criteria. To qualify, its primary purpose must be to insulate. Therefore, insulated siding does not qualify.

Natural Gas or Propane Furnace1

AFUE ≥ 95.

Oil Furnace1 AFUE ≥ 90.

Roof (Metal and Asphalt)2

Metal roofs with appropriate pigmented coatings and asphalt roofs with appropriate cooling granules that also meet ENERGY STAR requirements.

Storm Windows & Doors2

In combination with the exterior window/door over which it is installed: has a U-factor and SHGC of 0.30 or below and meets the IECC prescriptive criteria.

Windows and Skylights2

U factor ≤ 0.30; SHGC ≤ 0.30.

1 Installation costs also qualify. 2 Installation costs not included.SOURCE: www.energystar.gov.

and


aLTernaTive minimum Tax (amT)Form 6251; see also IRC §55–59

The AMT is calculated using a different set of tax rules than those used for regular tax. Under the AMT rules, some deductions taken for regular tax are not allowed (or are limited). Also, certain income and expenses are recognized under different rules for AMT.If the AMT calculation results in a higher tax than regular income tax, the difference is added to regular income tax on Form 1040. In effect, the taxpayer is liable for either the AMT or regular income tax, whichever is higher.IRS resource. The AMT Assistant—a tool based on the AMT work-sheet in the Form 1040 instructions—is designed to help taxpayers determine if they are subject to the AMT. It can be accessed by typing “AMT Assistant” in the search box at www.irs.gov.

Alternative Minimum Taxable Income (AMTI)The starting point for the AMTI calculation is AGI for taxpayers who do not claim itemized deductions, or AGI minus itemized deduc-tions for taxpayers claiming itemized deductions. To that amount, taxpayers must add or subtract certain adjust-ments and preferences. See AMT for Individuals—Adjustments and Preferences on Page 12-16.• Adjustments are income or expense items computed differently

for AMT and regular tax. They can increase or decrease AMTI.• Preferences are items that can only increase AMTI.Both the standard deduction and the deduction for personal exemp-tions are preferences that are not deductible for AMT. However, they are not reported on Form 6251, because the starting point for computing AMTI on that form is income before the standard deduction and deduction for personal exemptions.@ Strategy: Taxpayers who claim the stan-dard deduction for regular tax cannot itemize for AMT. Since the standard deduction is not deducted for AMT, taxpayers who are subject to AMT might save tax by itemizing deductions for regular tax (assuming those deductions are deductible for AMT), even if less than the standard deduction. However, consider any state income tax effect, since many states require taxpayers to use the same method (standard or itemized deductions) for state as they use for federal tax. Elect itemized deductions rather than the standard deduction by filing Schedule A and checking the box on line 30.AMT NOL. Any NOL deducted to arrive at AGI is added back to AMTI, which is then reduced by the alternative tax NOL deduction (ATNOLD). The ATNOLD is generally limited to 90% of AMTI (fig-ured without regard to the ATNOLD and any Section 199 domestic producer deduction). The instructions for Form 6251 line 12 explain these computations.Married-filing-separate filers. MFS filers with AMTI above the upper limit of the exemption phase-out range must add to AMTI the lesser of: (1) 25% of the excess of AMTI over that amount or (2) their AMT exemption amount. This amount is added to the total reported on Form 6251, line 29.

AMT ExemptionAn exemption is subtracted from AMTI to determine the amount subject to tax.

AMT Exemption Amounts2010

See Caution below 2009

AMT exemption:MFJ or QW $45,000 $ 70,950 Single or HOH 33,750 46,700MFS 22,500 35,475 Exemption reduced by 25% of AMTI over:MFJ or QW $ 150,000 $ 150,000Single or HOH 112,500 112,500MFS 75,000 75,000Exemption eliminated at AMTI of:MFJ or QW $ 330,000 $ 433,800Single or HOH 247,500 299,300MFS 165,000 216,900

U Caution: 2010 amounts shown will be effective absent action by Congress. However, Congress has temporarily increased the exemption every year since 2001 and is expected to do so again for 2010. See Tax Extenders Legislation on Page 25-1. The 2009 amounts shown reflect the temporary increase in effect for that year.

Child subject to kiddie tax. A child’s exemption amount is the lesser of the exemption for a single taxpayer or the child’s earned income plus $6,700 (for 2010).

AMT Tax Rates/ComputationTaxpayers who reported capital gain distributions directly on line 13 of Form 1040, who reported qualified dividends on line 9b of Form 1040, or who had a gain on both lines 15 and 16 of Schedule D (refigured for the AMT) calculate tax in Part III, Tax Computation Using Maximum Capital Gains Rates, of Form 6251. Tax rates for capital gains are the same as for regular tax and are applied in the same order (0%, 15%, 25% and 28%). Qualified dividends are also taxed at the same rates for both AMT and regular tax.All others use AMT tax rates of:• 26% on amounts up to and including $175,000 ($87,500 MFS).• 28% on amounts above $175,000 ($87,500 MFS).Tentative minimum tax (TMT). Once the appropriate tax rate has been applied to AMTI, the amount is reduced by the AMT foreign tax credit to arrive at TMT. See Simplified AMT foreign tax credit on Page 12-11.Alternative minimum tax is the excess of TMT over an adjusted regular income tax.

Tentative minimum tax (TMT)– Regular income tax + Tax on lump-sum distributions+ Foreign tax credit for regular tax= AMT. Report on line 45 of Form 1040.

minimum Tax CrediTForm 8801; see also IRC §53

The minimum tax credit (MTC) is available if the taxpayer paid AMT generated by deferral items in a prior year.AMT adjustments and preferences fall into two categories:1) Deferral items. Items that do not cause a permanent difference

in taxable income over time (depreciation, etc.).2) Exclusion items. Items that cause a permanent difference in

taxable income (are never deductible or taxable for AMT).See AMT for Individuals—Adjustments and Preferences on Page 12-16.

Continued on Page 12-17

72,45047,45036,225

439,800302,300219,900



Notes

generally must deduct IDC in all subsequent years as it is paid or incurred for all properties. However, he can still make an annual election under Section 59(e) to capitalize and amortize some or all of the IDC incurred that year over 60 months.

• If the Section 263(c) expensing election is not made, IDC is capitalized and recovered through depletion (or depreciation if the cost was associated with transporting or installing physical property).

Dry holes. A taxpayer who does not elect to expense IDC may still elect to expense IDC on nonproductive wells (dry holes). The deduction is allowable only in the year the wells are completed as dry holes [Reg. §1.612-4(b)(4)]. Even when some costs are incurred in one year and the outcome of the well is known by the time that year’s tax return is filed, the costs may not be deducted until the year the well is completed.æ Practice Tip: For a taxpayer to deduct LHC on dry holes, there must be an identifiable event or point (plugging and abandoning) when the property becomes worthless. Taxpayers do not auto-matically abandon a lease if a well is dry; therefore, tax preparers should verify with clients that they intend to abandon or not renew the lease before writing off the LHC.Depreciation. A working interest owner’s share of L&WE costs is normally capitalized and depreciated. Often, the majority of an owner’s depreciable costs are incurred when a well is determined to be a producing property and pumping and storage equipment is placed in service at the well site. The operator of the well (usually not the working interest owner) determines the character of expenditures as either IDC or capitalizable L&WE. See Partial Table of Class Lives and Recover Periods on Page 10-1 for oil and gas asset recovery periods. Section 179 Deduction on Page 10-10 also applies.Domestic producer deduction. A working interest owner qualifies to claim the Sec-tion 199 domestic producer deduction (if property is in the U.S.). See Tab 6.Depletion. A working interest owner is en-titled to a deduction for the greater of cost depletion (IRC §612) or allowable percentage depletion (some-times called statutory depletion—IRC §613A). Cost depletion is based on the property’s LHC and is calculated using the mineral reserves (obtained from engineering reports) and the number of units sold for the year [Reg. §1.611-2(a)]. For cash-basis taxpay-

ers, the “number of units sold” means units for which payment was actually received within the tax year.

Cost Depletion Calculation

Unrecovered depletable costs × Units sold = Cost

depletionEstimated recoverable reserves (in units) at the

beginning of year** Usually obtained from engineering reports.

æ Practice Tip: For cost depletion, natural gas production is converted into equivalent barrels of oil using a ratio of 6,000 cubic feet to one barrel (or six MCF equals one barrel). [IRC §613A(c)(4)]

Percentage Depletion Quick FactsAmount A percentage of gross receipts from the property.

Rate Generally 15% for oil and gas properties.

Who Qualifies?

Independent producers (generally working interest owners who are not retailers or refiners) with <1,000 barrels of daily production. Royalty owners are also eligible.

Net Income Limit

Percentage depletion is limited to the net income from each property before any depletion or Section 199 domestic producer deductions. Report income and expenses by property in a supporting schedule to Schedule C.U Caution: For 2009, the net income limit did not apply to “marginal production,” which is domestic production from a stripper well property or from a property primarily producing heavy oil [IRC §613A(c)(6)]. At publication time, Congress was considering extending this suspension of the net income limit on marginal production to 2010. See Tax Extenders Legislation on Page 25-1.

65% Limit

A taxpayer’s total percentage depletion from all oil and gas properties cannot exceed 65% of taxable income, computed before percentage depletion, NOL and capital loss carryback and Section 199 deductions [IRC §613A(d)]. Deductions denied by this limitation are carried to succeeding tax years.

Not Limited to Basis

Cost depletion stops when LHC is fully depleted. Percentage depletion continues (even after LHC is depleted) because it is based on a percentage of gross income from the property.

does2010


• Interest is tax-free if the amount of bonds redeemed (principal plus interest) is less than qualified educational expenses in year of redemption. If redemption amount is more than expenses, the excludable amount is based on the ratio of expenses to redemp-tion amount.

• Married taxpayers filing separate returns are not eligible for the bond interest exclusion, unless an individual is not considered married. See Considered unmarried at Page 4-8.

• Exclusion phases out for 2010 when modified AGI is between $70,100 – $85,100 ($105,100 – $135,100 MFJ or QW). Modified AGI is AGI (before the savings bond interest exclusion) increased by: (1) foreign earned income and housing exclusion, (2) foreign housing deduction, (3) exclusion for income from certain U.S. possessions and Puerto Rico, (4) exclusion for employer adop-tion benefits, (5) student loan interest deduction, (6) domestic production activities deduction and (7) tuition and fees deduction.

The AGI phase-out applies to the year the bonds are redeemed and interest is excluded from income. It does not matter what the bond owner’s AGI is in any other tax year.

sTudenT Loan inTeresT deduCTionSee also IRC §221 and IRS Pub. 970

Taxpayers can deduct up to $2,500 of interest paid on qualified education loans for college or vocational school expenses as an adjustment to income (above-the-line) (IRC §221). The deduction is available on qualifying loans for the benefit of the taxpayer or the taxpayer’s spouse or dependent at the time that the debt was incurred.For 2010, the deduction is phased out when modified AGI is between $60,000 and $75,000 ($120,000 and $150,000 MFJ). Modified AGI is AGI (before the student loan inter-est deduction) increased by: (1) foreign earned income or housing, (2) foreign housing deduction, (3) income from certain U.S. possessions or Puerto Rico, (4) domestic production activities deduction and (5) tuition and fees deduction.

Qualified LoansQualified education loans are loans taken out solely to pay quali-fied education expenses, including tuition, fees, room and board, books, equipment and transportation to attend an eligible educa-tional institution.Coordination with other education benefits. Qualified education expenses must be reduced by amounts paid with nontaxable edu-cation benefits received, such as employer-provided educational assistance, nontaxable distributions from an ESA or QTP, Series EE bond interest education exclusion or veteran’s educational benefits.Eligible educational institutions include colleges, vocational schools and other post-secondary institutions that are eligible to participate in Department of Education student aid programs.Eligible student. Students must take at least one half the normal full-time load in a degree, certificate or other qualified program at an eligible institution.

Restrictions1) Not available to taxpayers who are

claimed as dependents (listed on line 6c of Form 1040) on another taxpayer’s return.

2) Not available to married taxpayers filing separately.3) The taxpayer must have primary obligation to repay the loan

and actually pay the interest during the tax year to deduct the interest.

4) Interest on a loan from a related person does not qualify. Re-lated persons include: siblings, spouses, ancestors (parents, grandparents, etc.) and lineal descendants, as well as certain corporations, partnerships, trusts and exempt organizations.

5) Loans from a qualified employer plan [for example, 401(k) plan] do not qualify.N Observation: Because of restrictions 1 and 3, a student loan interest deduction often will not be allowed when the student takes out the loan and his parents claim a dependency deduction for the student/child. Reason: If the student has the primary obligation to repay, his parents cannot deduct any interest they pay. Alternatively, if the student pays interest on the loan, he cannot deduct the inter-est if his parents claim a dependency exemption deduction for him. But, even if a dependency exemption deduction is claimed by the parents for the student/child, it may make sense for the student/child to take out the loan when payments will not be due until after graduation, at which point the child will likely no longer be claimed as a dependent and can therefore, deduct the interest on his return.

TuiTion and fees deduCTionForm 8917; See also IRC §222 and IRS Pub. 970

U Caution: The deduction for tuition and fees expired at the end of 2009 but at the time of this publication, Congress was considering an extension to 2010. See Tax Extender’s Legislation on Page 25-1.Taxpayers are allowed to claim an above-the-line tuition and fees deduction for qualified higher education expenses paid (IRC §222). The deduction is limited based on the taxpayer’s modified AGI.The deduction is not allowed for MFS filers or for any taxpayer who qualifies as a dependent (whether or not claimed) on another taxpayer’s return.

Tuition and Fees Deduction Limit

Deduction Limit*If Modified AGI is:

Single, HOH, QW MFJ$ 4,000 $ 0 – $ 65,000 $ 0 – $130,000

2,000 65,001 – 80,000 130,001 – 160,0000 Over $ 80,000 Over $160,000

* Deduction equals qualified expenses, if less. Note: There is no AGI phase-out range. Thus married taxpayers with $4,000 of qualifying educational expenses and modified AGI of $130,000 or less would be entitled to deduct the full $4,000.

Modified AGI is AGI before the tuition and fees deduction, in-creased by: (1) foreign earned income and housing exclusion, (2) foreign housing deduction, (3) exclusion for income from certain U.S. possessions and Puerto Rico and (4) domestic production activities deduction.

Qualified Higher Education Expenses• Tuition and fees required for the enrollment or attendance at an

eligible educational institution for the taxpayer, spouse or a de-pendent. Charges and fees associated with books, supplies and equipment are qualified tuition and related expenses if the fee must be paid to the eligible educational institution as a condition of the enrollment or attendance of the student. [Reg. §1.25A-2(d)(2)]

• Expenses qualify in the tax year paid. Payment must be for education that begins either in the same tax year or in the first three months of the following tax year.

• An eligible institution is any accredited college, university, vo-cational school or other accredited post-secondary education institution.

Continued on Page 13-6


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ithdr

awal

pena

lty is

waiv

ed.

Inter

est is

exclu

dable

fro

m inc

ome.

Abov

e-the

-line

dedu

ction

.Ab

ove-

the-lin

e de

ducti

on.

Earn

ings n

ot tax

ed

(savin

gs pl

an) o

r tax

-fre

e edu

catio

n cre

dits

(pre

paid

plan)

.

Earn

ings n

ot tax

ed.

2010

Ann

ual

Lim

itsCr

edit u

p to $

2,500

per

stude

nt (1

00%

of fir

st $2

,000 o

f exp

ense

s and

25

% of

next

$2,00

0).

Cred

it up t

o $2,0

00 pe

r re

turn (

20%

of up

to

$10,0

00 of

expe

nses

).

Amou

nt of

quali

fying

ex

pens

es.

Amou

nt of

quali

fying

ex

pens

es.

Dedu

ction

of up

to

$2,50

0 of in

teres

t paid

on

educ

ation

loan

.

Dedu

ction

of up

to

$4,00

0 of q

ualify

ing

expe

nses

paid.

Nond

educ

tible

contr

ibutio

ns lim

ited

to am

ount

nece

ssar

y to

cove

r qua

lified

ex

pens

es.

$2,00

0 non

dedu

ctible

co

ntribu

tion p

er ch

ild

unde

r age

18 an

d any

ag

e spe

cial-n

eeds

child

.

Quali

fied

Ed

ucat

ion

Ex

pens

es (Q

EE)3

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment.

2

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment.

5

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment;

6 room

an

d boa

rd if

at lea

st ha

lf-tim

e atte

ndan

ce;

comp

uter a

nd in

terne

t se

rvice

.

Tuitio

n and

fees

; bo

ok, s

uppli

es

and e

quipm

ent;5

contr

ibutio

ns to

QTP

s an

d ESA

s.

Tuitio

n and

fees

; boo

ks,

supp

lies a

nd eq

uipme

nt;

room

and b

oard

, tra

nspo

rtatio

n, oth

er

nece

ssar

y exp

ense

s.

Tuitio

n and

fees

; bo

ok, s

uppli

es an

d eq

uipme

nt.5

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment;

6 room

an

d boa

rd if

at lea

st ha

lf-tim

e atte

ndan

ce;

comp

uter a

nd In

terne

t se

rvice

.

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment;

6 room

and

boar

d if a

t leas

t half

-time

atten

danc

e; pa

ymen

ts to

QTP;

comp

uter a

nd

Inter

net s

ervic

e.QE

E Mu

stBe

For

Taxp

ayer,

spou

se or

de

pend

ent.

Taxp

ayer,

spou

se or

de

pend

ent.

Taxp

ayer,

spou

se, c

hild

or gr

andc

hild.

Taxp

ayer,

spou

se or

de

pend

ent.

Taxp

ayer,

spou

se or

de

pend

ent.

Taxp

ayer,

spou

se or

de

pend

ent.

Acco

unt b

enefi

ciary.

Acco

unt b

enefi

ciary.

Quali

fyin

g Ed

ucat

ion

First

four y

ears

of un

derg

radu

ate.

Unde

rgra

duate

and

grad

uate.

Unde

rgra

duate

and

grad

uate.

Unde

rgra

duate

and

grad

uate.

Unde

rgra

duate

and

grad

uate.

Unde

rgra

duate

and

grad

uate.

Unde

rgra

duate

and

grad

uate.

K–12

, und

ergr

adua

te an

d gra

duate

.

Othe

r Rul

es an

d Re

quire

men

tsMu

st be

enro

lled a

t leas

t ha

lf-tim

e in a

degr

ee

prog

ram;

pare

nts ca

n sh

ift cre

dit to

stud

ent b

y no

t clai

ming

stud

ent a

s a d

epen

dent.

Avail

able

for un

limite

d nu

mber

of ye

ars f

or bo

th de

gree

and n

on-d

egre

e pr

ogra

ms; p

aren

ts ca

n sh

ift cre

dit to

stud

ent b

y no

t clai

ming

stud

ent a

s a d

epen

dent.

Pena

lty w

aived

on

distrib

ution

s up t

o the

am

ount

of qu

alifie

d ex

pens

es fo

r the

year.

Appli

es on

ly to

quali

fied

Serie

s EE

bond

s iss

ued

after

1989

or S

eries

I b

onds

; bon

d own

er

must

be at

leas

t 24

year

s old

when

bond

iss

ued.

Must

be en

rolle

d at le

ast

half-t

ime i

n a de

gree

pr

ogra

m; lo

an m

ust b

e inc

urre

d sole

ly to

pay

quali

fied e

duca

tion

expe

nses

.

Not a

llowe

d if e

duca

tion

expe

nses

are d

educ

ted

unde

r ano

ther p

rovis

ion

or ed

ucati

on cr

edit i

s cla

imed

.

Acco

unt o

wner

can

chan

ge be

nefic

iary

or re

claim

fund

s; ca

n ele

ct to

spre

ad gi

ft ov

er fiv

e yea

rs; so

me

states

allow

dedu

ction

to

resid

ents;

bene

ficiar

y ca

n be a

nyon

e.

Contr

ibutio

ns m

ust b

e ma

de by

the o

rigina

l re

turn d

ue da

te; m

ay

also c

ontrib

ute to

QTP

; ma

ndato

ry dis

tributi

ons

at ag

e 30;

bene

ficiar

y ca

n be a

nyon

e.

2010

Mod

ified

AGI

Ph

ase-

Out

Not a

llowe

d if M

AGI

exce

eds:4

MFJ ..

........

........

.......

$ 16

0,000

– 18

0,000

$ 10

0,000

– 12

0,000

N/A

$ 10

5,100

– 13

5,100

$ 12

0,000

– 15

0,000

$ 16

0,000

N/A

$ 19

0,000

– 22

0,000

Sing

le, H

OH, Q

W7 ...

8

0,000

– 9

0,000

5

0,000

– 6

0,000

7

0,100

– 8

5,100

6

0,000

– 7

5,000

8

0,000

9

5,000

– 11

0,000

MFS .

........

........

.......

Do N

ot Qu

alify

Do N

ot Qu

alify

Do N

ot Qu

alify

Do N

ot Qu

alify

Do N

ot Qu

alify

9

5,000

– 11

0,000

1 Not

refun

dable

for c

ertai

n chil

dren

unde

r age

24. S

ee A

mer

ican

Oppo

rtunit

y Cre

dit on

Pag

e 12-

9.2 In

clude

s boo

ks, s

uppli

es, a

nd eq

uipme

nt ne

eded

for a

cour

se of

stud

y whe

ther o

r not

the m

ateria

ls ar

e pur

chas

ed fr

om th

e edu

catio

nal in

stitut

ion as

a co

nditio

n of e

nroll

ment.

3 Qua

lifying

educ

ation

al ex

pens

es m

ust b

e red

uced

by an

y tax

-free

scho

larsh

ips an

d gra

nts. T

he sa

me ed

ucati

onal

expe

nses

cann

ot be

used

for f

igurin

g mor

e tha

n one

bene

fit.4 N

o AGI

phas

e-ou

t ran

ge. U

p to $

4,000

is de

ducti

ble if

MAGI

does

not e

xcee

d $65

,000 (

$130

,000 f

or M

FJ).

Up to

$2,00

0 is d

educ

tible

if MAG

I doe

s not

exce

ed $8

0,000

($16

0,000

for M

FJ).

5 Mus

t be p

aid to

the e

ligibl

e edu

catio

nal in

stitut

ion as

a co

nditio

n of th

e stud

ents

enro

llmen

t or a

ttend

ance

at th

e ins

titutio

n.6 M

ust b

e req

uired

for e

nroll

ment

or at

tenda

nce a

t an e

ligibl

e edu

catio

nal in

stitut

ion.

7 For

savin

gs bo

nd in

teres

t exc

lusion

, QW

is su

bject

to the

same

phas

e-ou

t ran

ge as

MFJ

.8 E

xpire

d afte

r 200

9; ho

weve

r, at p

ublic

ation

time,

Cong

ress

was

cons

iderin

g leg

islati

on th

at wo

uld ex

tend t

he de

ducti

on to

2010

. See

Tax E

xtend

er’s

Legis

lation

on P

age 2

5-1.


Form 1099-R, Box 7 Distribution Codes1 Early distribution, no known exception (in most cases, under age 591/2).

2 Early distribution, exception applies (under age 591/2).

3 Disability.

4 Death.

5 Prohibited transaction.

6 Section 1035 exchange (a tax-free exchange of life insurance, annuity, qualified long-term care insurance or endowment contracts).

7 Normal distribution.

8 Excess contributions plus earnings/excess deferrals (and/or earnings) taxable in 2010.

9 Cost of current life insurance protection.

A May be eligible for 10-year tax option (see Form 4972).

B Designated Roth account distribution.

D Excess contributions plus earnings/excess deferrals taxable in 2008.

E Distributions under Employee Plans Compliance Resolution System (EPCRS).

F Charitable gift annuity.

G Direct rollover of a distribution (other than a designated Roth account distribution) to a qualified plan, a Section 403(b) plan, a governmental 457(b) plan or an IRA.

H Direct rollover of a designated Roth account distribution to a Roth IRA.

J Early distribution from a Roth IRA, no known exception (in most cases, under age 591/2).

L Loans treated as distributions.

N Recharacterized IRA contribution made for 2010 and recharacterized in 2010.

P Excess contributions plus earnings/excess deferrals taxable in 2009.

Q Qualified distribution from a Roth IRA.

R Recharacterized IRA contribution made for 2009 and recharacterized in 2010.

S Early distribution from a SIMPLE IRA in first two years, no known exception (under age 591/2).

T Roth IRA distribution, exception applies.

U Dividend distribution from ESOP under Section 404(k) (not eligible for rollover).

W Changes or payments for purchasing long-term care insurance contracts under combined arrangements.

Box 8. The current actuarial value of an annuity contract (that is part of a lump-sum distribution). This amount will not be included in boxes 1 and 2a.Box 9a. The percentage received by the person whose name appears on the Form 1099-R (for a total distribution made to more than one person).Box 9b. For a life annuity from a qualified plan or from a Section 403(b) plan (with after-tax contributions), the employee’s total investment in the contract. It is used to compute the taxable part of the distribution.Boxes 10-15. State and local tax information provided for the recipient’s convenience.

Qualified Charitable Distributions (QCDs)U Caution: The special rule allowing QCDs expired at the end of 2009, but at the time of publication, Congress was considering an extension to 2010. See Tax Extenders Legislation on Page 25-1.

Taxpayers who have reached age 701/2 can make a distribution of up $100,000 directly (by the trustee) from their IRA to a charitable organization. [IRC §408(d)(8)]• For joint filers, each spouse can make a QCD of up to $100,000.• A QCD is nontaxable.• QCDs are limited to the amount of distribution that otherwise

would have been taxable.• No charitable deduction is allowed for any QCD.• QCD counts toward a taxpayer’s a required minimum distribution. Note: QCDs made in January 2011 can be treated as occur-ring on December 31, 2010.

401(k) Hardship RulesEmployees generally cannot withdraw funds from a 401(k) plan until they leave the company. However, employees may qualify to withdraw 401(k) elective contributions before then if there is an immediate and heavy financial need. [Reg. §1.401(k)-1(d)(2)]Expenses that satisfy the financial need requirement:• Medical expenses, including expenses not

yet incurred.• Purchase of principal residence.• Tuition for post-secondary education (one full year’s payment for

the employee, spouse, children or dependents).• To prevent eviction or to halt a mortgage foreclosure on the

taxpayer’s principal residence.• Amounts to cover anticipated federal and state income taxes,

plus early withdrawal penalties due to the hardship distribution.• Cost of burial or funeral expenses for the employee, parent, child

or other dependent.• Certain expenses relating to the repair of damage to the em-

ployee’s principal residence that qualify for the casualty loss deduction without regard to whether loss exceeds 10% of AGI. Note: A plan that permits hardship distributions may include distributions for medical, tuition and funeral expenses for a primary beneficiary under the plan (even if not a spouse, child or depen-dent of the employee) (Notice 2007-7). In addition, a hardship of the employee’s spouse or dependent is deemed to constitute a hardship of the employee.Tax treatment. There are no income tax or penalty exceptions specifically for hardship withdrawals. Thus, they are taxable and subject to a 10% penalty, unless a penalty exception applies. See the Exceptions to 10% Early Withdrawal Penalty Before Age 591/2 on Page 14-3 for exceptions to the 10% penalty.

required minimum disTriBuTions (rmds)

See also Reg. §1.401(a)(9)-0 through -9, Reg. §1.408-8 and IRS Pub. 590

Annual minimum distributions from traditional IRAs, SIMPLE IRAs and SEP IRAs must begin starting for the year the taxpayer reaches age 701/2. Taxpayers can choose to delay receipt of the first dis-tribution until April 1 of the year following the year they turn 701/2. Thereafter, the RMD for each year must be made by December 31. If the first distribution is delayed until April 1 of the following year, the second distribution must be made by December 31 of that year.Like RMDs from IRAs, RMDs from qualified employer plans gen-erally must begin for the year the individual reaches age 701/2. However, RMDs can be delayed until the year the individual retires from the employer if he continues to work past age 701/2. However, this RMD exception doesn’t apply to participants who are more-than-5% owners of the business sponsoring the qualified plan. [IRC §401(a)(9)(C) and Reg. §1.408-8, Q&A-2]


Social Security and Medicare Highlights2011 2010 2009

Cost-of-living (COLA)adjustment 0.0% 0.0% 5.8%Maximum earnings and still receive full benefits:Under full retirement age (FRA) at year-end ..................................... $ 14,160 $ 14,160 $ 14,160Year FRA reached5 ......................... 37,680 37,680 37,680Month FRA reached and later ......... No Limit No Limit No Limit

Maximum earnings subject to:Social Security tax .......................... $ 106,800 $ 106,800 $ 106,800Medicare tax .................................. No Limit No Limit No Limit

Rate of tax: 1, 2

Social Security ................................ 12.4% 12.4% 12.4%Medicare ......................................... 2.9 2.9 2.9

Maximum tax paid by:EmployeeSocial Security ................................ $ 6,621.60 $ 6,621.60 $ 6,621.60Medicare ......................................... No Limit No Limit No Limit

Self-Employed 3

Social Security ................................ $13,243.20 $13,243.20 $13,243.20Medicare ......................................... No Limit No Limit No Limit

Earnings needed to earn one quarter of coverage $ 1,120 $ 1,120 $ 1,090Medicare:Part A monthly premium4 ................ $ 450.00 $ 461.00 $ 443.00Part B monthly premium6 ................ 96.40 96.40 96.40Hospital deductible ......................... 1,132.00 1,100.00 1,068.00Medical deductible .......................... 162.00 155.00 135.00

1 Employees pay 50% of the rate shown.2 Self-employed individuals pay 100% of the rate shown.3 Does not reflect special deductions for self-employed individuals. 4 Cost for those ineligible for Social Security benefits. Lower premium if 30–39

quarters of covered employment.5 Limit applies only to months before attaining FRA. See Earnings May Reduce

Benefits on Page 14-25.6 Beneficiaries with higher incomes or who did not have premiums withheld by

the SSA pay a higher premium. See Medicare on Page 14-27.

ConTaCTing The soCiaL seCuriTy adminisTraTion (ssa)

Online. The following services are available at www.ssa.gov: • Apply for Retirement, Disability or Spouse’s Benefits,• Apply for help with Medicare prescription drug costs,• Request a Social Security Statement (or replacement),• Request a replacement Medicare Card,• Request a Benefit Verification Letter,• Figure retirement, disability or survivors benefits,• Subscribe to eNews, an email newsletter,• Find Social Security forms,• Find the nearest Social Security office,• Find Social Security publications and• Change address or telephone number.Phone. In addition to the above, the following services are available by calling 1-800-772-1213 (TTY 1-800-325-0778):• Request an application for a replacement Social Security card

(Form SS-5, Application for a Social Security Card),• Correct the name on a Social Security record (proof of identity

or other documentation may be required at the local office),• Have Social Security benefits sent directly to a bank account,• Discuss the rules for getting Social Security benefits,• Ask questions about a check or report a missing check,• Report a death,• Discuss the amount of an overpayment,• Set up a plan for repaying an overpayment, • Ask to repay an overpayment in installments,• Ask SSA to waive an overpayment,• Discuss Representative Payee situations,• Request an appointment at a Social Security office or• Get phone numbers for other government agencies. If additional services are needed, check the Field Office Locator at www.ssa.gov for the nearest office.

Social Security StatementSocial Security Statement is a concise, easy-to-read personal record of the earnings on which an individual has paid Social Security taxes during his working years and a summary of the estimated benefits he and his family may receive as a result of those earnings. Statements are automatically sent annually to workers ages 25 and older, and provide an estimate of benefits along with a complete earnings history. Individuals may also file Form SSA-7004, Request for Social Security Statement, by mail or request the statement online from the SSA’s website.The form asks for name, Social Security number, date of birth, pre-vious year’s earnings, estimate of current year’s earnings, planned age of retirement and projected annual earnings until retirement. Estimating Social Security benefits. An estimate of Social Secu-rity benefits can be found on the Social Security Statement or online at www.ssa.gov/planners/calculators.htm. There are calculators that estimate potential benefit amounts using assumptions about retirement dates and different levels of potential future earnings. The calculators show retirement benefits as well as disability and survivor benefit amounts.

Social Security

Social Security TopicsSocial Security and Medicare Highlights............. Page 14-21Contacting the Social Security

Administration (SSA) ........................................ Page 14-21Social Security Quick Chart—Retirement

Benefits (2011) ................................................. Page 14-22Social Security Quick Chart—Family, Survivor

and Disability Benefits (2011) ........................... Page 14-23Social Security Benefits ...................................... Page 14-24Retirement Benefits ............................................ Page 14-25Family and Survivor Benefits .............................. Page 14-26Disability Benefits................................................ Page 14-26Medicare ............................................................. Page 14-27Medigap Insurance ............................................. Page 14-29Medicaid.............................................................. Page 14-30Supplemental Security Income ........................... Page 14-30

11,107.20

4,485.60

10.4%

Exception: For 2011, employee’s Social Security tax rate is 4.2%.


@ Strategy: Careful planning of stock purchases can preserve the benefits of Section 1244 for shareholders. Especially if there is a significant risk of loss on investment in Section 1244 stock, the purchaser should make sure additional shares are issued for each contribution made to capital. If shares are purchased over time, as in the case of agreement to pay corporate expenses in exchange for stock, a written plan should be drafted and carefully followed.Partners and S corporation shareholders. If a partnership acquires Section 1244 stock and later sells at a loss, an ordinary loss deduction may be claimed only by individuals who were partners when the stock was issued. However, loss incurred by an S corporation on the sale of Section 1244 stock cannot be passed on to the shareholders as an ordinary loss [Reg. §1.1244(a)-1(b)]. They must treat the loss as a capital loss.

smaLL Business sToCkIRC §1202 and §1045

Options by Holding Period for Small Business Stock1 Yr or less Over 6 Months Over 1 Yr Over 5 YrsShort-term capital gain

Rollover gain Section 1045

Long-term capital gain

50%, 60%, 75% or 100% exclusion of gain

Section 1202Individuals may be able to (1) exclude up to 50% (75% for stock acquired 2/18/09–9/27/10; 100% for stock acquired 9/28/10–12/31/10) of gain or (2) defer gain from the sale of qualified small business stock.Exclusion of gain from the sale of small business stock (IRC §1202). An individual may exclude 50% (75% for stock acquired 2/18/09–9/27/10; 100% for stock acquired 9/28/10–12/31/10) of the gain from sale of qualified small business stock. The stock must have been issued by a C corporation after August 10, 1993, and held more than five years. The exclusion may not exceed 10 times the taxpayer’s basis or $10 million, whichever is greater. Gain remaining after the exclusion is taxed at a maximum rate of 28%, resulting in an effective tax rate of 14%, for example, for 50% exclusion gain.N Observation: Because of the five-year holding period require-ment, 2014 will be the earliest a taxpayer can take advantage of the 75% gain exclusion (2015 for the 100% exclusion). Note: The 2003 Tax Act reduced the maximum tax rate for most capital gains to 15% through 2010. With an effective tax rate of 14% for 50% exclusion qualified small business stock, the benefit of the exclusion is greatly reduced, and only favors taxpayers with taxable income above the 15% bracket.For taxpayers qualifying for the 0% capital gains rate in 2010, the Section 1202 exclusion may create higher tax liability than if the exclusion had not been in place. However, should capital gains rates return to their pre-2003 Tax Act levels as they are scheduled to do on 1/1/11, the Section 1202 provisions may once again be beneficial, especially when the 75% exclusion (7% effective tax rate) or 100% exclusion (no tax) applies. In addition, Section 1045 rollover remains a benefit of meeting the qualified small business stock requirements.Alternative minimum tax. The addition in computing alternative minimum taxable income (AMTI) is 7% of the amount excluded under Section 1202 [IRC §57(a)(7)]. However, for 100% gain ex-clusion qualified small business stock acquired 9/28/10–12/31/10, none of the excluded gain is added back in computing AMTI.U Caution: Unless Congress extends beyond 12/31/10 the deadline for acquiring qualified small business stock eligible for the 100% gain exclusion, then (1) the 50% and 60% gain exclusion rules will again be in effect. and (2) the percentage of otherwise-excluded gain that is added back in computing AMTI will be 28%

(for stock acquired after 2000) or 42% (for stock acquired before 2001)—because the 7% AMTI add back rate is also scheduled to increase after 2010.Empowerment zone businesses. The exclusion is 60% for stock acquired after 12/21/00 (75% for stock acquired from 2/18/09–9/27/10; 100% for stock acquired 9/28/10–12/31/10) in corporations that conduct business within an empowerment zone, as designated by the Secretaries of Agriculture and HUD [IRC §1202(a)(2)]. The District of Columbia Empowerment Zone is not treated as an em-powerment zone for purposes of the exclusion.Capital gain from the sale of qualified empowerment zone assets held for more than one year may be rolled over if new property in the same zone is purchased within 60 days of the sale. (IRC §1397B)Rollover of gain from sale of small business stock (IRC §1045). An election is available for tax-deferred rollover of gain from the sale of qualified small business stock held more than six months. The taxpayer must purchase new qualified small business stock within 60 days to qualify for the election. The entire gain is deferred if the new stock costs at least as much as the amount realized from the sale of the old stock. If the new stock costs less than the amount realized, the difference is taxable up to the amount of gain. Basis of new stock is reduced by the amount of gain deferred. Holding period: The new stock must continue to meet the active business requirement for at least six months after purchase to qualify for rollover under Section 1045. (See Active business requirement below.) For determining capital gain rates on a subse-quent sale, the holding period of the new stock generally includes the holding period of the old stock. However, the holding period of the old stock does not count for meeting the six-month test.Regulations: For guidance on sales by partnerships (and partner distributees) of qualified small business stock, see Regulation Section 1.1045-1.

Qualified Small Business StockC corporation. The stock must be issued by a C corporation with total gross assets of $50 million or less at all times after August 9, 1993, and before it issued the stock, and immediately after it issued the stock.The corporation cannot be a:1) Domestic international sales corporation or

former DISC,2) Regulated investment company (RIC),3) Real estate investment trust (REIT),4) Real estate mortgage investment conduit

(REMIC),5) Cooperative or6) Corporation electing the Puerto Rico and possessions tax credit

or having a direct or indirect subsidiary so electing.Original issue stock. The stock must be acquired by the taxpayer at its original issue in exchange for money, property other than stock or as compensation for services. Note: The stock will not qualify if the corporation redeemed stock from the taxpayer or a related person during a four-year period beginning two years before the issuing date. Further, the stock will not qualify if the corporation redeemed more than 5% by value of its stock during a two-year period beginning one year before the issuing date.Active business requirement. During the taxpayer’s holding period, the corporation must use at least 80% of its assets by value in the active conduct of one or more qualified trades or businesses.A qualified trade or business is any business other than those listed in Section 1202(e)(3). Businesses that do not qualify include professional service firms, financial businesses, farms, natural resource producers, hotels and restaurants.If the corporation owns more than 50% of another corporation, a pro rata share of that corporation’s assets are included in the 80%

Similarly, as the 7% AMT preference rule applies to taxpayers beginning before 1/1/13,

12/31/11

1/1/13

–2012

12/31/11

12/31/11

12/31/11

, except for 100% gain exclusion stock for which the AMTI addback is zero


E&P Example (Continued)Book income for purposes of E&P:Gross sales ................................................................................... $ 90,000Beginning inventory .................................... $ 8,000

>Merchandise purchases ............................. 30,000Minus ending inventory ............................... < 8,600Cost of goods sold ........................................................................ $ 29,400Gross profit ................................................................................... $ 60,600Interest income ............................................................................. 750Total income ................................................................................. $ 61,350Advertising .................................................. $ 5,000Wages ........................................................ 20,000Office expenses .......................................... 13,500Depreciation ($25,000 × 5.00%) ................. 1,250Total operating expenses .............................................................. $ 39,750Net income before tax .................................................................. $ 21,600Minus federal income tax per tax return ....................................... < 2,854> Net income after tax (E&P) ........................................................... $ 18,746

Ending balance sheet:Assets:Cash ........................................................... $ 550

>

Inventory ..................................................... 8,600Equipment .................................................. 25,000Minus accumulated depreciation ................ < 1,250Total assets $ 32,900

Liabilities and Equity:Federal tax payable (total liabilities) ............................................ $ 154EquityCommon stock ............................................ $ 1,000Retained earnings (E&P) (13,000 + 18,746) 31,746Total equity .................................................................................. $ 32,746Total liabilities + equity .................................................................. $ 32,900

Ending E&P calculation:Beginning E&P balance .............................. $13,000Plus taxable income ................................... 19,027Plus tax-exempt interest ............................. 250Plus accelerated depreciation in excess of SL ($3,573 - $1,250)............. 2,323Minus federal income taxes ........................ < 2,854 >Minus dividend distributions ....................... < 0 >Equals ending E&P ....................................................................... $ 31,746

Tax Effect of Tax-Exempt IncomeAlthough a C corporation does not pay tax on earnings from tax-exempt income such as municipal bond interest, the income will increase E&P. Thus, the amount of taxable dividends available to shareholders is increased by tax-exempt income.Nondeductible expenses such as penalties, fines, capital losses in excess of capital gains, etc. reduce E&P and the amount of taxable dividends available for distribution to shareholders.

aCCumuLaTed earnings TaxA C corporation that accumulates earnings beyond reasonable business needs is assumed to be accumulating earnings for the purpose of tax avoidance, unless the taxpayer can prove otherwise [IRC §533(a)]. The accumulated earnings tax (AET) is not reported on the tax return; it is a penalty imposed after an IRS audit. The tax applies regardless of the number of shareholders.The AET is currently 15% of accumulated taxable income (IRC §531). The 15% rate is scheduled for repeal after 2010, at which time the AET will be imposed at the highest individual tax rate—be alert for legislation that could change the post-2010 AET rate structure.Accumulated taxable income is the corporation’s taxable income for the year reduced by items such as federal tax, excess charitable contributions, dividends paid deduction and the accumulated earnings credit. [IRC §535(a)]

The accumulated earnings credit represents the amount accumulated for reasonable business needs. If audited, the burden of proof is on the corporation to demonstrate that an accumulation is reasonable [IRC §533(a)]. Note: Businesses that function as mere holding or investment companies are assumed to operate with a tax avoidance motive [IRC §533(b)]. Such businesses are allowed a minimum credit, but are not allowed additional accumulation for reasonable business needs.Minimum credit. Retained earnings of $250,000 or less [$150,000 for personal service corporations (PSCs)] are considered to be within reasonable business needs. [IRC §535(c)(2)]Reasonable business needs are analyzed in Regulation Sections 1.537-1 and 1.537-2. Items identified include:• Expansion. Includes purchase of assets, acquisition of another

business enterprise or plant replacement.• Pay off business debts.• Section 303 redemptions. A corporation can accumulate earn-

ings in anticipation of a need to redeem stock from a deceased shareholder’s estate.

• Supplier or customer needs. A corporation can accumulate earn-ings to provide for investments or loans to suppliers or customers if necessary to maintain the business of the corporation.

• Working capital. A corporation may need an amount of working capital to conduct business. For example, a supermarket needs $4 million of inventory on hand to operate. The corporation can accumulate earnings to obtain inventory.

• Provide for contingencies such as the payment of reasonably anticipated product liability losses, actual or potential lawsuit, loss of a major customer, or self insurance.

Appropriated retained earnings account. If a corporation needs to accumulate earnings, the board of directors should discuss the need and the discussion should be reflected in the corporation’s minutes. This will help the taxpayer demonstrate that the accumulation is for reasonable business needs in the event of IRS audit. The financial statements should also reflect the need to accumulate earnings so shareholders will know the appropriate amount of earnings available for dividends. Corporations commonly reflect such business needs by establishing an appropriated retained earnings account.Not reasonable business needs. The following purposes are not considered reasonable business needs:• Accumulating income to avoid dividend distributions.• Providing loans to shareholders.• Paying expenses for the personal benefit of

shareholders.• Providing loans that have no reasonable relation to the

conduct of the business.• Providing loans to related corporations or shareholders.• Investments unrelated to business activities.• Providing for unrealistic hazards.

Court Case: A corporation subject to the accumulated earnings tax argued that it should be able to reduce accumulated taxable income by the amount of tax accrued on an installment sale of real estate. The taxpayer also argued that it should be able to deduct a contested tax liability it had paid.The Tax Court ruled against the taxpayer on both counts. The court did not allow a reduction for tax accrued against installment sale income that had not yet been reported. With regard to the adjustment for the contested tax liability, the taxpayer relied on Regulation Section 1.535-2(a)(1), which states, “In com-puting the amount of taxes accrued, an unpaid tax which is being contested is not considered accrued until the contest is resolved.” The court found that in this case, the fact that the taxpayer had paid the contested liability did not mean the contested liability could be accrued. [Metro Leasing and Development Corporation, 119 TC 8 (2002). On appeal, the 9th Circuit agreed with the Tax Court. (94 AFTR 2d 2004-5251)]

to expire for tax years beginning after 12/13/12


Taxable income for limitation purposes is calculated without taking into account the deductions for:• Charitable contributions.• Dividends received.• Premium on repurchase of convertible debt. • Domestic production activities deduction.• Dividends paid on certain public utility preferred stock.• Net operating loss carrybacks.• Capital loss carrybacks.Unused contributions from this limitation can be carried forward for five years. No carryback is allowed. [IRC §170(d)(2)]Enhanced charitable deduction for qualified book and qualified computer donations.These enhanced deductions expired December 31, 2009 [IRC §170(e)(3)(D)(iv) and (e)(6)(G). However, at the time of publica-tion Congress was considering legislation that would extend the enhanced deductions to 2010. See Tax Extenders Legislation on Page 25-1.Research property. An exception to the contribution limits applies to contributions of scientific equipment for use in experimentation or for certain research training. This exception is only available for C corporations other than PHCs or service organizations as described in Section 414(m)(3) [IRC §170(e)(4)]. These contribu-tions are subject to the special computation rules discussed at Charitable Contributions of Inventory below.

Intellectual property. In addition to the initial deduction, a tax-payer who has donated qualified intellectual property may claim a subsequent charitable contribution based on a percentage of the net income received by the charity (other than certain private foundations) from the property. [IRC §170(m)]

Substantiation requirements. Strict rules exist for substantiating charitable contributions. For all monetary contributions, the cor-poration must maintain a bank record or a receipt, letter or other written communication from the donee organization indicating the organization’s name, the date of the contribution and the amount [IRC §170(f)(17)]. There is no de minimis exception. For contri-butions of $250 or more of either cash or property, the taxpayer must have a contemporaneous written acknowledgement from the donee (a cancelled check will not suffice). [Reg. §1.170A-13(f)]Charitable contributions of property over $5,000. C corpo-rations are required to obtain a qualified appraisal for donated property if the claimed deduction exceeds $5,000. For individuals, partnerships and corporations, if the claimed deduction of property other than cash, inventory or publicly traded securities exceeds $500,000, a qualified appraisal must be attached to the donor’s tax return.Conservation easements. A deduction is available for qualified donations. See Conservation easements in Tab N of the Small Business Quickfinder® Handbook.

Charitable Contributions of InventoryThe deduction for a charitable contribution of inventory or other ordinary income producing property is gener-ally limited to the adjusted basis of the property.A provision in the Code allows a C corpora-tion (not an S corporation) to donate inven-tory to charity and deduct up to one-half of FMV above cost as a charitable contribution [IRC §170(e)(3) and Reg. §1.170A-4A]. For purposes of this provision, depreciable property under Section 1221(a)(2) also qualifies for the deduction.

The following rules must be met: [IRC §170(e)(3)]1) The charity must be a Section 501(c)(3) organization,2) The charity must use the donated property solely for the care

of the ill, the needy or infants,3) The charity cannot exchange the donated property for money,

other property or services,4) The corporation must be given a written statement from the

charity that says it will follow rules (2) and (3) above,5) If the property is subject to the Federal Food, Drug and Cos-

metic Act regulations, all such regulations must be satisfied and6) Use of the donated property must be related to the purpose or

function that gives the charity its exempt status.The charitable deduction is computed by taking the FMV of the donated property at the time of contribution and subtracting one-half the gain that would not have been long-term capital gain if the property had been sold at its FMV. The deduction is further limited to twice the basis of the donated property.If the donated property has any potential recapture of ordinary income under Section 617, 1245, 1250 or 1252 (depreciation re-capture), then the FMV for the above computation purposes must first be reduced by the recapture amount before making the above charitable deduction computation. [IRC §170(e)(3)(E)] Note: If the inventory’s cost is incurred in the same year as the contribution, the amount is included in cost of goods sold (COGS). The contribution is not subject to the 10% of taxable income limita-tion. If the contribution is made from beginning inventory, the item is removed from inventory and shown as a charitable contribution subject to the 10% limitation. [Reg. §1.170A-1(c)(4)]

Example: GIJ Corporation donates inventory to Toys for Tots. The FMV of the inventory equals $1,000, and GIJ’s basis in the inventory equals $200. If GIJ had sold the inventory for its FMV, the amount of gain that would not be long-term capital gain is $800 ($1,000 – $200). One-half of $800 is $400. The charitable deduction would be $600 ($1,000 – $400) except for the fact that the deduction is limited to twice its basis ($200 × 2 = $400). GIJ can take a charitable contribution deduction of $400 and must reduce its COGS by $200.

N Observation: Some corporations making donations that qualify for the enhanced deduc-tion for inventory may, because of the 10% of taxable income limitation, prefer to limit their deduction and the required cost of goods sold adjust-ment to the inventory’s basis. While it studies this issue, the IRS will not challenge either method. (Notice 2008-90)

Capital Gains and LossesC corporations pay tax on capital gains at the same tax rate as ordinary income. The maximum corporate tax rate on net capital gains is 35%. (IRC §1201)Capital losses are allowed only to the extent of capital gains. A current-year deduction for a net capital loss is not allowed. A net capital loss may be carried back three years and forward five years as a short-term capital loss. Carry back a capital loss to the extent it does not increase or produce an NOL in the carryback year.Foreign expropriation capital losses may not be carried back, but may be carried forward 10 years. A net capital loss for a RIC may be carried forward eight years. (IRC §1212)

Like-Kind ExchangesIf a corporation engages in a Section 1031 like-kind exchange with a related party and either party disposes of the property within two years, nonrecognition treatment may be nullified. See Like-Kind Exchanges on Page 7-22.

2011


S Corporations

Related Information:Shareholder’s Adjusted Basis Worksheet—Tab 15Depreciation and Amortization—Tab 10Employee Benefit Plans—Tab K*Accounting Methods—Tab L*Corporate Liquidations—Tab N*Disposition of Assets—Tab N*Business Tax Deductions—Tab 24Tax Credits—Tab 24Net Income per Books vs. Taxable Income—Tab 24S Corporation Year-End Planning Checklist—Tab P*New Law—Tab 25* In the Small Business Quickfinder® Handbook

BasiCs of s CorporaTionsForm 1120S

For guidance on tax planning for S corporations, see the S Corpo-ration Year-End Planning Checklist in Tab P of the Small Business Quickfinder® Handbook. See also Tab 13 of the Tax Planning for Businesses Quickfinder® Handbook.Filing requirements. Every S corporation must file, regardless of the amount of income or loss. It must file even if it stops conducting business. Filing ends when totally dissolved.Filing deadline. By the 15th day of the third month following the close of its tax year.Electronic filing of Form 1120S is mandatory for S corporations that have $10 million or more in assets and annually file 250 or more returns of any type (including information returns such as Forms W-2 and 1099). (Reg. §301.6037-2)Extension deadline and form number. A six-month extension may be obtained by filing Form 7004, Application for Automatic 6-Month Extension of Time To File Certain Business Income Tax, Information, and Other Returns.Penalties. The penalty for failure to file a return is $195 per month per shareholder up to 12 months (IRC §6699). The penalty is as-sessed against the corporation.If S corporation taxes are due, a late filing penalty may be imposed equal to 5% of tax owed per month, up to 25%. If the return is more than 60 days late (including extensions) a minimum penalty of the lesser of $135 or the amount of unpaid tax applies. A late payment of tax penalty may also be imposed equal to one-half of one percent per month, up to 25%. (IRC §6651)Schedule K-1 deadline. S corporations are required to furnish a Schedule K-1 to each shareholder by the due date, including exten-sions, of the corporation tax return (Form 1120S). A $100 ($50 for K-1s required to be filed before 2011) penalty, imposed with respect to each Schedule K-1 for which a failure occurs, applies for failure to furnish Schedule K-1 when due, failure to include all required information or for including incorrect information. The post-2010 $100 penalty is reduced to $30 or $60 per failure, depending on when and whether the failure is corrected. (IRC §6722)

The pre-2011 maximum penalty was $100,000 for all such failures during a calendar year. The post-2010 maximum penalty ranges from $250,000 –$1,500,000 ($75,000–$500,000 for small busi-nesses). Higher penalties apply if the failure is due to intentional disregard of the law, and the penalties will be adjusted for inflation. See Section 6722 for details.Reasonable cause exception. The penalties discussed in the previous column at Penalties and Schedule K-1 deadline will not be imposed if the failure was due to reasonable cause. (IRC §6651, 6699 and 6724)Estimated tax requirements. Shareholders pay estimated tax for their individual returns. The S corporation pays estimated tax if corporate-level taxes apply. [IRC §6655(g)(4)]

C Corporation vs. S CorporationAn eligible domestic corporation can elect to be taxed as an S cor-poration. An S corporation generally does not pay federal income tax—its profits and losses pass through directly to shareholders. This avoids the C corporation double tax, and allows shareholders to deduct corporate losses on their individual returns.

C Corporation S CorporationTaxation Double taxation of profits. Income

is taxed at the corporate level; profits distributed as dividends are taxed at the individual level.

Profits are passed through directly to shareholders, escaping corporate-level tax.

Dividends Dividends paid by a C corporation are general ly taxed to the individual at the same rate as long-term capital gains (0% or 15%) in 2010.

S corporation earnings passed through to a shareholder are taxed as ordinary income.

Ordinary Losses

C corporation losses are not passed through to shareholders. Losses can be deducted only at the corporate level as NOL carrybacks and carryforwards.

Losses are passed through directly to shareholders. Current-year losses are deductible up to the shareholder’s basis in S corporation stock and loans to the S corporation.

Capital Gains

Taxed at the same rate as ordinary income.

Pass through to shareholders and are eligible for favorable capital gain tax rates for individuals.

Capital Losses

Allowed only to the extent of capital gains. Net capital losses are carried back three years and forward five years.

Pass through to shareholders. Capital losses are deductible subject to limitations on the shareholder’s return.

For tax purposes, S corporations are treated similar to partnerships. Many rules governing S corporations are intended to subject S corporation shareholders to the same tax treatment as partners.An S election can be useful in a corporation’s early years, since losses pass through to shareholders.

S Corporation ConsiderationsUnder the 2003 Tax Act, the tax rate for individuals on most divi-dends was lowered to the same rate as long-term capital gains. This significantly reduced the negative effects of double taxation at the C corporation level. Considering that S corporation profit passed through to shareholders is taxed as ordinary income, in certain situations it was advantageous for an S corporation to terminate its S status and convert to a C corporation. U Caution: The taxation of dividends paid to individuals at long-term capital gain rates is scheduled to expire after 2010. In addition, individual long-term capital gain and ordinary income tax rates are scheduled to increase after 2010. See Future Tax Rates on Page 25-1 for more information on these and other favor-able tax rate provisions that are scheduled to expire after 2010.


Tab 18 TopicsBasics of S Corporations ...................................... Page 18-1S Corporation Taxes ............................................. Page 18-6Reasonable Wages ............................................... Page 18-8Shareholder’s Basis .............................................. Page 18-8Distributions ........................................................ Page 18-10S Corporation Example ....................................... Page 18-11S Corporation Shareholder Codes for

Schedule K-1, Form 1120S .............................. Page 18-21

2012

2012

2012


Regardless of whether these provisions are extended, the marginal tax rates (current and projected) of specific shareholders and cor-porations should be used in determining the most tax-favorable form of business organization (such as a C corporation versus an S corporation).Factors to consider:• The accumulated earnings tax for C corporations has been lowered

from the top individual rate to 15% (through 2010). (IRC §531)• An S corporation that elects to revoke its S status must generally

wait five years before it can again elect S corporation status.• Previously taxed S corporation profits not distributed within one

year from the date of S corporation termination are converted to taxable earnings and profits (E&P). See Post-Termination Transition Period on Page 18-10.

• C corporations may be subject to personal holding company (PHC) or personal service corporation (PSC) taxes. See Tab 20.

• C corporations with accumulated E&P may be subject to addi-tional taxes upon conversion to an S corporation. See S Corpora-tion Taxes on Page 18-6.

• S corporation losses flow through to shareholders. C corporations do not pass losses through.

S Corporation Requirements• All shareholders must consent to S corporation status.• Limited to 100 shareholders.• The corporation can have only one class of stock. See One Class

of Stock on Page 18-3.• Must be a domestic corporation. Individual

shareholders must be U.S. citizens or resi-dents. A resident alien [one who (1) has been lawfully admitted for permanent residence in the U.S., (2) meets a substan-tial presence test as outlined in Section 7701(b)(3) or (3) elects to be treated as a U.S. resident, but is not a citizen] can be a shareholder, but a nonresident alien (someone who is neither a citizen of the U.S. nor meets any of the tests for resident alien status) cannot. [Reg. §1.1361-1(g)(1)]

• The corporation must use a permitted tax year, or elect to use a tax year other than a permitted tax year. See Required Tax Year in Tab L of the Small Business Quickfinder® Handbook.

• Only individuals, estates, certain trusts and certain charities may be shareholders. (IRC §1361)

Ineligible shareholders. Corporations, partnerships (unless the stock is held as a nominee for an individual treated as the share-holder), LLCs, LLPs, nonresident aliens and IRAs are ineligible. Exception: Certain single-member LLCs can be S corporation shareholders. (Letter Rul. 9745017)U Caution: Actions by one shareholder can terminate S status.

IRS Ruling: A minority shareholder in an S corporation sold one share of stock to an ineligible shareholder in a dispute over dividends. The corporation’s S status was terminated. The IRS did allow the corporation to reelect S status without the normal five-year waiting period, but the corporation needed to obtain a private letter ruling to do so. (Letter Rul. 9616022)

@Strategy: An S corporation should keep control of stock trans-fers with a shareholder transfer agreement, right of first refusal, call option or other buy/sell agreement terms.

Stock Ownership RequirementsA C corporation is not eligible to hold stock in an S corporation; however, an S corporation can own up to 100% of the stock of a C corporation. An S corporation cannot file a consolidated return with an affiliated C corporation. The C corporation may, however, still file a consolidated return with its affiliated C corporations.

Qualified Subchapter S subsidiary (QSub). An S corporation can elect to treat a wholly owned subsidiary as part of the S corporation for tax purposes—the subsidiary is disregarded. The subsidiary does not need to be an S corporation, but it must be a corporation that would qualify for S status if its stock was held by the shareholders of the parent S corporation. [IRC §1361(b)(3)]U Caution: A QSub is treated as a separate corporation for purposes of employment taxes (including FICA and FUTA, Railroad Retirement and FIT withholding) and certain excise taxes (such as the retail excise taxes of Chapter 31 of the Code and the facilities and services taxes of Chapter 33). [Reg. §1.1361-4(a)(7) and (8)]A QSub-eligible subsidiary is a domestic corporation that is owned 100% by an S corporation and is not one of the following:• A bank or thrift institution that uses the reserve method of ac-

counting for bad debts under Section 585,• An insurance company subject to tax under the rules of Sub-

chapter L of the Code,• A corporation that has elected to be treated as a possessions

corporation under Section 936 or• A domestic international sales corporation (DISC) or former DISC.Form 8869, Qualified Subchapter S Subsidiary Election, may be filed at any time during the tax year, but the effective date of elec-tion cannot be more than:• Two months and 15 days prior to date of filing the election, or• Twelve months after the date of filing the election.Late filed election. The IRS has the authority to waive inadver-tently invalid QSub elections or terminations of these elections. To obtain relief, the QSub and the S corporation parent must: (1) take steps to qualify the corporation as a QSub within a reason-able period of time after discovering the circumstances causing the invalid election or termination, and (2) agree to any adjustments proposed by the IRS to treat the corporation as a QSub during the relevant period. [IRC §1362(f)]Tax effects of election:• Existing Corporation. If an election is made to treat an existing

corporation as a QSub, the transaction is treated as a deemed liquidation of the subsidiary under Sections 332 and 337. See Parent-Subsidiary Liquidations in Tab N of the Small Business Quickfinder® Handbook.

• New Corporation. If a QSub election is in effect when the sub-sidiary is formed, liquidation is not considered to have occurred. The QSub is disregarded for tax purposes.

Eligible Trusts [IRC §1361(c)(2), (d) and (e)]1) Grantor trusts owned by a U.S. citizen or resident. The trust can

continue as an eligible shareholder for two years beginning on the grantor’s date of death.

2) Testamentary trusts to which stock is transferred under the terms of a will. The trust is an eligible shareholder for two years after the stock is transferred to it. The decedent’s estate is considered the shareholder for the 100-shareholder limit.

3) Trusts created to exercise voting power of stock transferred to them. Each beneficiary of the trust is treated as a shareholder for the 100-shareholder limit.

4) Qualified Subchapter S trusts (QSSTs). May have only one in-come beneficiary and must distribute or be required to distribute all accounting income each year. Principal distributed during the beneficiary’s life must be distributed to the beneficiary.

5) Electing small business trusts (ESBTs). An ESBT must meet the following requirements:a) The trust may not have a beneficiary other than an indi-

vidual or an estate that is eligible to be an S corporation shareholder. Exception: Some charitable organizations are eligible beneficiaries; others are only if they hold a contingent remainder interest.

2012


PHC Tax (IRC §541)A PHC is subject to a flat 15% rate (for 2010) on undistributed income (the 15% rate is scheduled for repeal after 2010, at which time the PHC tax will be imposed at the highest individual tax rate—be alert for legislation that could change the post−2010 PHC rate structure). The tax is computed on Schedule PH of Form 1120 and is carried to line 8 of Schedule J (Form 1120). The tax is in addition to the regular corporate income tax.UCaution: In many cases, PHC classification is unintentional, and may produce unexpected tax consequences.The PHC rules are intended to prevent what is considered an abuse of corporations to shield investment income. If a corporation meets the 60% PHC income test and the 50% ownership test, it will be subject to PHC tax regardless of reason or intent. For example, if a corpora-tion sells its assets and invests the proceeds prior to liquidating, it will be subject to PHC tax if it meets the criteria. However, a corporation can avoid PHC tax if it pays out its PHC income in dividends to shareholders.Exceptions. PHC classification does not apply to the following even if the two preceding requirements are met: [IRC §542(c)]• Tax-exempt corporations.• Life insurance companies.• Banks and domestic building and loan associations.• Certain lending or finance companies.• Surety companies.• Foreign corporations.• Certain small business investment companies.• Corporations under the jurisdiction of the court in a Title 11 or

similar case.• S corporations. [IRC §1363(a)]• Certain Real Estate Investment Trusts (REITs). [IRC §856(h)(3)(B)]

PHC Income Defined (IRC §543)Personal holding company income generally consists of:1) Dividends,2) Interest minus certain amounts excluded

under Sections 543(a)(1) and 543(b)(2)(C),3) Royalties minus certain expenses allowed

under Section 543(b)(2)(B),4) Annuities,5) Rents minus certain expenses allowed under

Section 543(b)(2)(A),6) Compensation received for the use of corpora-

tion property from shareholders who own at least 25% of the corporation,

7) Amounts received under a personal service contract if someone other than the corporation designates the individual who is to perform the services and that individual performing the services owns at least 25% of the corporation, and

8) Income from estates and trusts. Note: See Section 543(a) for exceptions.

PHC Adjusted Ordinary Gross IncomeIn general, a corporation’s adjusted ordinary gross income is the corporation’s gross income minus: [IRC §543(b)]

• Gains from the sale or disposition of capital assets,• Gains under Section 1231(b),• Certain expenses allowed against rental income,• Certain expenses allowed against (1) min-

eral or oil and gas royalties and (2) working interest income from oil and gas wells,

• Certain interest income and• Certain deductions allowed against income from the use of

manufactured property.

Notes


to expire for tax years beginning after 12/31/12


Fiduciary Tax Returns (Form 1041)

Fiduciary Tax Rate Schedules2010 rates—See front cover2009 rates—See inside front cover of the Small Business Quickfinder® Handbook

Related Information• Decedent’s final Form 1040 and 2010 estate and GST tax re-

peal—Tab 22• Estate planning—Tab 15, 1040 Quickfinder® Handbook; Tab 15,

Tax Planning for Individuals Quickfinder® Handbook• Worksheet to reconcile income reported on final Form 1040 and

Form 1041—Tab 15• IRS Publication 559, Survivors, Executors, and Administrators

fiduCiary reTurn faCTsFiling requirements:• Estates. Gross income of $600 or more, or a nonresident alien

beneficiary.• Trusts. Any taxable income, gross income of $600 or more, or a

nonresident alien beneficiary.• Grantor Trusts. See the Grantor Trusts—Tax Returns and Report-

ing Requirements chart on Page 21-8.Tax year:• Estates. Day after death is the beginning of the first tax year. The

first year can cover any period of 12 months or less that ends on the last day of a month. The executor chooses a tax year when the first fiduciary return is filed.

• Trusts. Calendar year. Exception: A grantor trust that files Form 1041 uses the same tax year as the grantor.

Filing deadlines:• Calendar year 2010: April 18, 2011.• Fiscal year: The 15th day of the fourth month following the close

of the tax year.File a 2010 Form 1041 for:• Calendar year 2010.• Fiscal year beginning in 2010 and ending in 2010 or 2011.• Fiscal year beginning in 2011 if the 2011 form is not available by

the due date for the return. Use year 2011 tax rates and incor-porate any law changes.

Beneficiary’s year. Beneficiaries report income in the tax year in which the trust or estate year ends. For example, the estate of a decedent who died on February 17, 2010, closes its first year on January 31, 2011. The estate files a 2010 Form 1041 for the first year. A calendar-year beneficiary reports any items from the Schedule K-1 on his or her year 2011 Form 1040 even though the items are reported on a 2010 Schedule K-1.Estimated tax requirements (Form 1041-ES):• Estates. Estimated payments are only required for tax years end-

ing two or more years after the decedent’s death [IRC §6654(l)].

(This rule also applies to a decedent’s grantor trust that will receive the residue of the estate under the decedent’s will or, if no will is probated, to the trust primarily responsible for paying the decedent’s debts, taxes and administrative expenses.)

• Trusts (and estate tax years ending two or more years after the decedent’s death). Estimated payments are required if tax after subtracting withholding and credits is $1,000 or more, and with-holding and credits is less than the smaller of: [IRC §6654(d)]

1) 90% of the tax for the current year or2) 100% of the tax from the previous year.

However, if a return was not filed in the previous year, or the previous year’s return did not cover a full 12 months, then number 2 does not apply. If adjusted gross income (AGI) in the previous year was more than $150,000, and less than two-thirds of gross income is from farming or fishing, the safe harbor is 110% (not 100%) of the previous year’s tax.

A domestic estate or trust that had a full 12-month prior tax year with no tax liability for that year is not required to make ES payments the next year. A trust (or an estate in its final year) may allocate estimated tax payments to beneficiaries under Section 643(g). File Form 1041-T by the 65th day after the close of the tax year.Estimated tax—special rules:• Individuals calculate estimated tax payments using income for

months ending before the due date of the installment. For example, the June 15 payment is based on income through May 31. For trusts and estates, the period ends one month earlier [IRC §6654(l)(4)]. Estimated payments are based on income through February 28 (April 15 payment), April 30 (June 15 payment), July 31 (September 15 payment) and November 30 (January 15 payment).

• A beneficiary is not required to include income distributed during the first 65 days of the following year in annualized income for the January 15 payment when a trust or estate elects to treat such income as if it were paid during the current year. (Rev. Rul. 78-158)

Employer identification number (EIN). Any estate or trust re-quired to file Form 1041 must obtain an EIN. See inside front cover.

ExemptionsEstates ...................................................................... $ 600Trusts required to distribute all income currently ..................... 300Trusts permitted to accumulate income ................................ 100

Extensions. Use Form 7004 for an automatic extension of five months for 1041s.Penalties. Late filing penalty of 5% of tax per month up to 25%, plus late payment penalties and interest. If a return is more than 60 days late, the minimum late filing penalty is the smaller of $135 or the tax due. The penalty may be waived if an explanation showing reasonable cause for the delay is attached to the return.Grantor trusts in the year of death. Grantor trust rules apply to the grantor only through the date of the grantor’s death. The trust must file Form 1041 for the short tax year from the date of death and ending December 31. Exception: A qualified revocable trust (QRT) can elect to be treated as part of the decedent’s estate under Section 645.Section 645 election (Reg. §1.645-1). A QRT is any trust (or por-tion thereof) treated as owned by the decedent (thus, a grantor trust) due to a power to revoke that was held by the decedent on the date of death. A trust can be a QRT even if the decedent’s spouse or a nonadverse party (a person or entity not having an economic interest in the trust) must consent to the revocation.

Tab 21 TopicsFiduciary Return Facts .......................................... Page 21-1Trust and Estate Terminology ............................... Page 21-2Overview of Income Taxation of Trusts and

Estates................................................................ Page 21-3Grantor Trusts—Tax Returns and Reporting

Requirements ..................................................... Page 21-8Grantor Trusts ....................................................... Page 21-8Simple Trust—Detailed Example ........................ Page 21-10Complex Trust—Detailed Example ..................... Page 21-13Form 1041, Schedule K-1 Codes........................ Page 21-16

and reinstatement


Capital Gains and Losses (Schedule D)Basis and holding periods:• Property acquired from a decedent. Property inherited from a

decedent who dies in 2010 is subject to a modified carryover basis, which is the lesser of: [IRC §1022(a)]

1) The decedent’s adjusted basis (with certain modifications) or

2) The FMV of the property at the date of the decedent’s death.

Estates can increase the basis (but not above FMV at the date of death) up to $1.3 million on certain appreciated assets. An additional $3 million basis increase is avail-able for property transferred to a surviving spouse.

The holding period for assets inherited from a de-cedent who dies in 2010 is no longer automatically deemed to be more than one year. If the decedent’s basis is lower than the property’s FMV on date of death, the decedent’s holding period will tack on to the recipient’s holding period. However, if the property’s FMV is lower on date of death than the decedent’s basis, the holding period generally begins on the decedent’s date of death. See Tab 22 for further information on the modified carryover basis rules.

• Assets transferred by a living grantor into an irrevocable trust are generally completed gifts. The basis of property acquired as a gift is generally the grantor’s adjusted basis (IRC §1015). The trust’s holding period includes the grantor’s holding period [IRC §1223(2)]. Show the date acquired by the grantor on Schedule D.

Allocation between trust and beneficiaries. Gains are allocated between the fiduciary and beneficiaries in Part III of Schedule D. The allocation made in Part III determines whether the trust or the beneficiaries will pay tax on the gains. Any gain allocated to beneficiaries in Part III is transferred to line 3 of Schedule B and becomes part of the calculation of DNI. Capital gains are generally allocated to the fiduciary unless ac-tually distributed to a beneficiary or used to make a charitable contribution [Reg. §1.643(a)-3]. However, capital gains are tax-able to beneficiaries (included in DNI) if, (1) under the terms of the governing instrument and local law or (2) according to the fiduciary’s reasonable and consistent exercise of discretionary power (if granted by local law or the governing instrument and not inconsistent with local law), they are allocated to:• Income,• Principal, but treated by the fiduciary on the trust’s books, records

and tax returns as part of a distribution to a beneficiary or• Principal, but used by the fiduciary in determining the amount

distributed or required to be distributed to a beneficiary.

Example: The Jones Trust instrument provides that all trust income is to be paid to Conrad for life. The instrument also gives Sam, the trustee, the discretion-ary power to invade principal for Conrad’s benefit and to deem discretionary distributions to be made from capital gains realized during the year. In 2010, the trust’s first tax year, the trust has $5,000 of dividend income and $10,000 of capital gain. During the year, Sam distributes the $5,000 of income to Conrad plus another $12,000 from principal.Sam plans to follow a regular practice of treating discretionary distributions of principal as being paid first from any net capital gains realized by the trust during the year. Therefore, the $10,000 capital gain is included in the trust’s DNI for 2010, which is passed through and taxed to Conrad. This treatment of the capital gain is a reasonable exercise of Sam’s discretion. In future years, Sam must treat all discretionary distributions as being made first from any realized capital gains.

Losses are netted against gains except for gains used in deter-mining the amount distributed or required to be distributed to a particular beneficiary. See Reg. §1.643(a)-3 for examples.

If losses exceed gains, all losses are allocated to the estate or trust. Capital losses can be deducted against ordinary income (lesser of net loss or $3,000). A capital loss may be carried forward indefinitely. Unused capital loss carryovers can be passed through to the beneficiaries in the year of termination. [IRC §642(h)]Limitations on sales between related parties. A loss from the sale or exchange of property between related taxpayers is not deductible. Gain from the sale or exchange of depreciable property between re-lated taxpayers is treated as ordinary income (IRC §267 and §1239). Related taxpayers include:1) Trustee and grantor.2) Trustee and beneficiary.3) Trustees of trusts created by the same grantor.4) Trustee and beneficiary of different trusts created by

same grantor.5) Estate and beneficiary unless transaction satisfies a

pecuniary bequest.6) Trustee and corporation owned over 50% by trust or grantor.Beneficiaries are related unless they have only a remote contingent interest. (IRC §1239)Election to recognize gain on property distributions. When noncash property is distributed by an estate or trust, gain or loss generally is not recognized. Instead, the fiduciary’s basis and holding period carry over to the recipient. However, estates and trusts may elect to recognize gain (but not loss) on the distribution, which causes a step-up in basis to the beneficiary as if the property had been sold to him or her at FMV [IRC §643(e)(3)]. Losses are disallowed due to the related party rules described above. When the election is made, the distribution deduction and income inclu-sion amounts are the FMV of the property distributed. The elec-tion applies to all property distributions made during the tax year (except specific bequests and pecuniary bequests). To make the Section 643(e)(3) election, check the box on Form 1041, page 2, line 7 under Other Information, and report the “sale” on Schedule D as if it actually occurred.

Tax-Exempt Income• Life insurance benefits. (IRC §101)• Interest on state or local bonds, including exempt-interest divi-

dends received from a mutual fund. (IRC §103)• Compensation for certain injuries or sickness. (IRC §104)• Income from discharge of indebtedness. (IRC §108)If a trust or estate has tax-exempt income, some of its deduc-tions may be disallowed or reduced: (IRC §265)• Expenses directly attributable to tax-exempt income are not

deductible. For example, interest expense on debt incurred to buy tax-exempt bonds.

• Expenses directly attributable to taxable income are deductible. For example, rental expenses, tax return preparation.

• Expenses not exclusively related to either tax-exempt or taxable income (indirect expenses) must be reduced by the portion attributable to tax-exempt income. The apportionment can be made based on gross income (calculation below) or by using any reasonable method. Attach calculation to Form 1041.

Gross Tax-Exempt Income × Indirect ExpensesGross Accounting Income

Exception: For tax-exempt interest, only allocable Section 212 expenses and interest expense are subject to disallowance [IRC §265(a)]. Other expenses, such as state and local income taxes and business expenses, are deductible even if directly allocable to the exempt interest income. For more on Section 212 expenses, see Administration expenses under Deductions on Page 21-5.

Reporting tax-exempt income. If the estate or trust received tax-exempt income, allocate expenses between tax-exempt and taxable income on a separate sheet and attach it to the return. Enter only the deductible amounts on the return. Answer “Yes” to Question 1 under Other Information on page 2 of Form 1041.

(if the executor elects exemption from the estate tax)

• Property acquired from a decedent (general rule). Basis is estate tax value from Form 706, or if not filed, FMV on date of death. Holding period is long-term.

(2010 only)

(if the executor elects exemption from the estate tax)


If tax-exempt income includes tax-exempt interest, report the amount of tax-exempt interest (including exempt-interest dividends from mutual funds) in the space provided at the end of Question 1. Do not include other types of tax-exempt income in the total. See Tax-Exempt Interest on Page 21-10 for an example.

DeductionsMost deductions allowed to individuals are also allowed on fiduciary returns. (IRC §641)See Complex Trust—Detailed Example on Page 21-13 for calculation of AGI.Interest (line 10):• Investment interest (limited to net investment

income). Calculate on Form 4952. Interest on debt used to purchase or carry tax-exempt obligations is not deductible.

• Interest on a mortgage secured by a home that is owned by an estate or trust is deductible if (1) a beneficiary uses the home as a principal or second residence, and (2) that beneficiary has a present or residual interest in the estate or trust.

• Interest paid on the unpaid portion of estate tax attributable to the value of a reversionary or remainder interest in property. [IRC §163(h)(2)(E)]

Example: Rob was living with his mother Mimi when she died. Her house became part of the probate estate. The estate continued to make Mimi’s mortgage payments during probate and Rob continued to live in the house. Her estate will pass to her four children equally under state law because she had no will. The interest is deductible because Rob used the house as his principal residence and he is a beneficiary with a residual interest.

Taxes (line 11):• State and local income, personal property and real property taxes

that are not deducted on Schedules C, E or F.• Generation-skipping transfer (GST) tax on trust income distri-

butions (although none will be paid in 2010 due to repeal—see Tab 22.

• Foreign or U.S. possession income and excess profits taxes.Administration expenses. Section 212 authorizes deduction of expenses for:• Production or collection of income,• Management, conservation or maintenance of property held for

the production of income and• Determination, collection or refund of any tax (including prepara-

tion and advice for income, estate, gift, property or other tax).Fiduciary fees and other ordinary and necessary administrative expenses are deductible as miscellaneous itemized deductions under Section 212 [Reg. §1.212-1(i)]. Expenses deductible under Section 212 are generally allowed only to the extent that they exceed 2% of AGI. Deductions not subject to the 2% limitation: Administration ex-penses that would not have been incurred if the property were not held by the estate or trust [IRC §67(e)(1)]. Fully deductible expenses generally include:• Trustee and personal representative fees (line 12).• Attorney and accountant fees for administration (line 14).• Form 1041 tax return preparation (line 14).• Fiduciary bonds, court fees, court-required appraisal

fees and other required expenses (line 15a).Deductions subject to the 2% limitation: Expenses that are commonly incurred in the absence of an estate or trust. The IRS has provided examples of expenses that are not considered “unique” to a trust or estate (and thus, are subject to the 2% floor), including: [Prop. Reg. §1.67-4(b)]• Custody or management of property.• Investment advice.

• Preparation of gift tax returns.• Defense of claims by creditors of the decedent or grantor.• The purchase, sale, maintenance, repair, insurance or

management of non-trade or business property.Corporate trustees commonly charge a unitary fee for a bundle of trust services, including investment advisory fees, for their services. Proposed regulations require fiduciaries to unbundle their single fees to include both “unique” and “non-unique” costs for purposes of subjecting the “non-unique” costs to the 2% floor rules. [Prop. Reg. §1.67-4(c)]IRS Notice 2010-32 provided guidance for Forms 1041 with tax years beginning before 2010, indicating that fiduciary fees will not have to be “unbundled” unless paid to a third party for a cost that is clearly identifiable as the type that would be subject to the 2% floor rules. Instead, for those years, taxpayers may deduct the full amount of any bundled fiduciary fees. However, no additional guidance has been provided for tax years beginning in 2010.U Caution: The proposed regulations are not binding until issued in final form and are likely to change. Furthermore, the final regula-tions may contain safe harbors for allocating costs between those that are subject to the 2% floor rules and those that are not. Prac-titioners should closely monitor current developments in this area.Third-party investment management fees. Although there has been a conflict among circuit courts on this issue, the Supreme Court settled this debate, holding that the trust’s investment advi-sory fees are subject to the 2% floor if they are “commonly incurred” outside of a trust [Knight, 101 AFTR 2d 2008-544 (2008)]. (Note that this case was previously referred to as the Rudkin Testamentary Trust case, but is now known as the Knight case. Michael J. Knight was the trustee in Rudkin.)

Court Case: In Knight, the Supreme Court affirmed the Second Circuit’s holding in Rudkin [98 AFTR 2d 2006-7368 (2nd Cir. 2006)] that the trust’s investment advisory fees were subject to the 2% floor because the fees were of a type commonly incurred outside of a trust. However, the Supreme Court disagreed with the requirement in the proposed regulations that the exception to the 2% floor rules only applies to unique costs—those that could not be incurred (that is, not capable of being incurred) by individuals holding the same type of property. Instead, the Supreme Court said that the exception applies to costs that would not be common for an individual with the same type of property to incur. The IRS is expected to modify the proposed regulations as a result of the Supreme Court decision; practitioners should monitor this issue closely.

The Supreme Court left the “door” slightly open for the full deduct-ibility of investment advisory fees. Costs that aren’t “commonly incurred” outside of a trust or estate are not subject to the 2% floor rules, according to the Court. For example, investment advisory fees could be deductible if the trust has an unusual investment objective or requires a specialized balancing of interests among parties, so that a reasonable comparison with individual investors would be impossible. Extra, special, incremental or distinctive costs (for example, fees charged just to fiduciaries, so they’re not “com-monly incurred” by individuals) may also be excepted from the 2% floor rules. However, the trustee would have to prove that these fees were higher for a trust or estate than they would have been for an individual in a similar situation, and only the incremental costs would be fully deductible. The cost of routine investment advice would still be subject to the 2% floor rules.Expenses deductible on Form 706 (other than in 2010). Other than for deaths in 2010 when the estate tax is repealed, most ad-ministration expenses can be deducted either on Form 706 or 1041, but not on both. If expenses are deducted on Form 1041, attach two copies of a statement signed by the personal representative listing the expenses and stating, “These expenses have not been claimed as deductions for federal estate tax purposes. All rights to claim such deductions are waived.” The waiver is irrevocable. It is required even if the estate is not required to file Form 706.

executor elects exemption from the

0% GST tax rate


If expenses for selling property are deducted on Form 706, the same expenses cannot be included in the basis of the asset when the sale is reported on Form 1041.The rule against double deduction does not apply to deductions in respect of a decedent (DRD). Other than for deaths in 2010, an estate can deduct expenses incurred by the decedent prior to death, but paid by the estate, on both Form 1041 and Form 706. DRD includes business expenses (Section 162), interest (Section 163), income and property taxes (Section 164), and expenses for the production of income (Section 212).

Example: A decedent died in 2009 before paying his tax preparer for work already performed. The estate pays the preparer. The expense is claimed on Form 706 as a debt of the decedent and is also deductible on line 14 of Form 1041.

Estate tax paid on IRD (line 19). If income in respect of a dece-dent (IRD) is taxable to an estate or trust, the deduction for estate tax paid on that IRD is also taken on Form 1041 in the year the IRD is reported.

Excess Deductions on TerminationIf an estate or trust has deductions in excess of gross income in its final year, the excess deductions are reported on the benefi-ciary’s tax return [Reg. §1.642(h)-2]. Charitable deductions and the personal exemption are not allowed as excess deductions.Excess deductions are taken on Schedule A of Form 1040 as miscellaneous itemized deductions subject to the 2% AGI limita-tion. The deduction is allowed only in the taxable year the estate or trust terminates. The beneficiary cannot carry the deduction over to the following year.A capital loss may also be distributed to the beneficiaries in the final year and deducted on Schedule D of Form 1040. A loss received from an estate or trust can be carried over by the taxpayer if not fully used in the termination year.Excess deductions in years prior to the final year are lost and can-not be carried forward—except for net operating losses (NOLs), capital losses and investment interest expenses.Termination of estates and trusts [Reg. §1.641(b)-3]. Trusts and estates terminate at the end of the period actually required by the administrator to perform the ordinary duties of administration (collection of assets, payment of debts, taxes, legacies and bequests). The administration period cannot be unduly prolonged. An estate or trust will be considered terminated for income tax purposes when all assets have been distributed except for a reasonable amount set aside in good faith for the payment of unascertained or contingent liabilities. After termination for tax purposes, the beneficiaries report income, deductions and credits of the estate or trust. If a Section 645 election was made to treat a revocable trust as part of the estate, the estate does not terminate until the trust terminates or the election period otherwise expires. See Section 645 election on Page 21-1.

Depreciation and DepletionEstates and trusts are not allowed to elect the Section 179 ex-pense deduction. Depreciation and depletion must be apportioned between the fiduciary and income beneficiaries on the basis of fiduciary accounting income allocated to each.Exception for trusts: If a trustee is required or permitted to maintain a depreciation reserve (and actually does so), the deduction is first allocated to the trust, up to the amount of the reserve. [Reg. §1.167(h)-1(b)]

Example #1: A complex trust with rental property has two income beneficiaries. The trust is allowed to accumulate 30% of net accounting income. Beneficiary #1 receives an income distribution of 45% and Beneficiary #2 receives an income distribution of 25%. Assume total depreciation equals $3,000. The trust deducts $900 on Schedule E (line 5 of Form 1041). Beneficiary #1 is allocated $1,350 and Beneficiary #2 is allocated $750 (line 9 of Schedule K-1 with tax code A).Example #2: A simple trust with farm income does not provide for a deprecia-tion reserve. None is required by local law. The trust does not deduct anything for depreciation on Schedule F (line 6 of Form 1041). All depreciation is allocated to the beneficiaries on line 9 of Schedule K-1 with tax code A, in proportion to each beneficiary’s share of trust accounting income.Example #3: A trust instrument permits the trustee to maintain a depreciation reserve equal to 50% of the depreciation allowed for income tax purposes. The trustee maintains a 50% reserve. The remaining 50% of depreciation is allocated to three beneficiaries based on the portion of trust accounting income allocated to each. The trust is allowed to deduct 50% of total depreciation even though it does not accumulate 50% of the accounting income.

Charitable Deduction (Schedule A)An estate or trust can deduct charitable contri-butions only if:1) The contribution is allowed by the terms of a will

or trust instrument, and 2) The will, trust instrument or local law requires

that payment be made from gross income. [IRC §642(c)]

Amounts paid from tax-exempt income are not deductible, nor are contributions of principal unless they are included in taxable gross income.Exception: An estate or trust that owns an interest in a pass-through entity such as a partnership can deduct its distributive share of a charitable contribution made from the pass-through entity’s gross income even though the will or trust instrument does not authorize charitable contributions. (Rev. Rul. 2004-5)The deduction is not limited to a percentage of AGI. The deduction is calculated on Schedule A, page 2, of Form 1041.

Example #1: Rita’s will includes a specific gift of her BTA Stock to the School of Music. State law requires that the estate pay all after-death earnings on specifically gifted property to the beneficiary of the property. The estate distributes the stock plus $2,000 of dividends earned in the tax year to the school. The gift of the stock was not deductible because it was not required to be paid from gross income. The gift of the dividends is deductible since it was made from income.Example #2: Assume the same facts as Example #1, except that BTA is a mutual fund that earned capital gains of $2,000 in the tax year. Capital gains paid to the school are deductible even if allocated to principal because they were paid from gross income reported on Form 1041. Example #3: Martin’s will provides that his residual estate is to be distributed equally to his daughter and the First Church. In the estate’s final year, there is $10,000 of interest income, which the personal representative distributes equally, along with the balance of the estate, to the beneficiaries. The estate’s charitable contribution deduction is $5,000, which is its share of the income distributed to the First Church.Example #4: Hilda died without a will. During probate, Hilda’s personal rep-resentative donated household items valued at $2,000 to a charity thrift shop. No deduction is allowed on the estate’s Form 1041 because the donation was not required by the terms of a will. An alternative is to distribute the household goods to an heir, who can then donate the items to charity and deduct their FMV on his or her Schedule A (Form 1040).

Contributions must be reduced by the proportion of tax-exempt income included in gross accounting income unless the will, trust agreement or state law specifically requires payment from taxable income. [Reg. §1.642(c)-3(b)(2)]

when the executor elects exemption from the estate tax


die in 2010. In place of these rules, a modified carryover basis system applies (IRC §1022). See Modified Carryover Basis for Inherited Property for Deaths in 2010 (IRC §1022) on Page 22-12.

Estate Tax Exclusion and CreditYear Exclusion Credit

2000 – 2001 $ 675,000 $ 220,5502002 – 2003 $ 1,000,000 $ 345,8002004 – 2005 $ 1,500,000 $ 555,8002006 – 2008 $ 2,000,000 $ 780,800

2009 $ 3,500,000 $ 1,455,8002010 No tax No tax2011 $ 1,000,000 $ 345,800

Gift Tax Exclusion and CreditYear Exclusion Credit

2000 – 2001 $ 675,000 $ 220,5502002 – 2009 $ 1,000,000 $ 345,800

2010 $ 1,000,000 $ 330,8002011 $ 1,000,000 $ 345,800

* The 2010 credit amount is based on the reduced gift tax rate of 35% in 2010 ($1,000,000 x 35% minus $19,200).

Estate and Gift Tax ExclusionPrior to 2001 Tax Act

Year Exclusion Credit2002 – 2003 $ 700,000 $ 229,800

2004 $ 850,000 $ 287,3002005 $ 950,000 $ 326,300

2006 and later $ 1,000,000 $ 345,800 Note: Amounts over these exclusion levels are being taxed by some states.

Estate and Gift Tax Returns

Estate and Gift Tax Rate ScheduleSee Form s 706 and 709 chart on this Handbook’s front cover.

Estate and Gift Tax Maximum RatesYear Top Bracket Top Rate

2007 – 2009 $ 1,500,001 and over × 45% minus $119,200 = Tax2010 – 2011 Estate Tax Repealed × 35% minus $ 19,200 = Tax

2011* $ 3,000,000–10,000,000 × 55% minus $359,200 = Tax—Gift Tax Only—

2010 $ 500,001 and over × 35% minus $ 19,200 = Tax* The benefit of graduated rates is phased out for transfers > $10 million.

Law Change Alert: The federal estate and GST taxes are repealed in 2010. In addition, the basis step-up (or step-down) to FMV rules are repealed for property acquired from decedents who

Income and Expense Chart for a Decedent Who Died in 2010*—Cash Method of Accounting—

Category Where to Report ExplanationAdministration

ExpensesForm 1041 Court costs; fees paid to attorneys, accountants, personal representatives, appraisers and tax preparers. Executor

can elect to claim some administration expenses on Form 1041 when paid. On Form 1041, expense is subject to 2% adjusted gross income (AGI) limit unless it would not have been incurred if the property had not been held in the estate. If deducted on Form 1041, a waiver should be attached. See discussion under Itemized Deductions on Page 22-6.

Business Income and Expenses

Final Form 1040, Schedule C and Schedule F

Income and expenses received or paid up until date of death.• Business income is subject to self-employment (SE) tax on the final Form 1040.• A net operating loss (NOL) cannot be carried from the decedent’s final Form 1040 to Form 1041.

Form 1041 (or beneficiary’s return)

Income and deductions accrued at date of death but not actually received or paid until after death are reported on Form 1041 [as income and deductions in respect of a decedent (IRD and DRD)].

Form 1041 (Use Schedule C or Schedule F of Form 1040)

If estate continues to operate the business, income and expenses incurred after death. Net income is not subject to SE tax. NOLs incurred by estate are computed same way as for individuals. Any unused NOL on final estate income tax return can be passed through to beneficiaries on Schedule K-1 (Form 1041). NOLs are not allowed by estates engaged only in investment activities.

Business Tax Credits Final Form 1040, Form 3800 Credits and carryforward credits must be used on final Form 1040. Unused amounts cannot be carried to Form 1041. [IRC §196(b)]

Capital Gains and Losses

Final Form 1040, Schedule D When payment is received through date of death. Capital loss carryovers are deductible up to the annual limitation on final Form 1040. The 2010 $1.3 million aggregate basis increase for modified carryover basis can be increased by the sum of any capital loss carryovers. Unused capital loss carryover from separately owned property is not available to a surviving spouse. (Letter Rul. 8510053)

Form 1041 (or beneficiary’s return) Capital asset transactions before death when payment is received after death (IRD) (for example, installment sales).Form 1041, Schedule D (or beneficiary’s return)

Sales/exchanges occurring after death; basis of property received from an estate of a decedent who died in 2010 is the lesser of: (1) the decedent’s adjusted basis (with certain modifications, see Basis increase on Page 22-12) or (2) the FMV of the property at the date of death. See Holding period rules on Page 22-12 for special rules applicable in 2010. Net capital loss allowed each year is limited to $3,000. Unused capital loss can be passed through to beneficiaries on Schedule K-1 (Form 1041) when estate terminates.

Casualty andTheft Losses

Final Form 1040 Casualties and thefts incurred before death.Form 1041 Casualties and thefts during administration of estate may be reported on Form 1041 if elected. Attach a state-

ment that loss was not claimed for estate tax purposes.

Tab 22 TopicsDeath of a Taxpayer .............................................. Page 22-4Taxable Income in the Year of Death .................... Page 22-4Final Form 1040―For Deaths in 2010.................. Page 22-6Gift Tax Return (Form 709) ................................... Page 22-7Gift Tax Example ................................................. Page 22-10Estate Tax ........................................................... Page 22-10Generation-Skipping Transfer (GST) Tax ............ Page 22-12Basis in Property ................................................. Page 22-12Valuing Property .................................................. Page 22-14Estate—Comprehensive Example ...................... Page 22-14


if the executor elects exemption from the estate tax.

$ 5,000,000

$ 5,000,000*

$ 1,730,800

$ 1,730,800*

$ 1,500,001 and over

$ 5,000,000* $ 1,730,800*

Plus the amount of any deceased spousal unused exclusion (credit).

were reinstated for 2010. However,

* If executor elects exemption from estate tax. For where to report for a 2010 decedent to whom estate tax applies, see Page 22-1 of the 2009 Tax Year Handbook.


deaTh of a Taxpayer

Personal Representative DutiesThe primary duties of a personal representative are to collect the decedent’s assets, pay the decedent’s creditors and distribute the remaining assets to the heirs and beneficiaries. The personal representative is either the executor, a court-appointed estate rep-resentative or, if no probate proceeding is required, any person in actual or constructive possession of the decedent’s property. The personal representative is also responsible for filing tax returns and paying tax on behalf of the decedent and estate. The IRS has a lien on all property included in the gross estate (including property not subject to probate) and can collect tax up to 10 years after death (IRC §6324). Thus, beneficiaries of estate assets are ultimately responsible for the tax liabilities of the decedent and estate to the extent of assets received. A personal representative can be held personally liable for tax if estate assets are distributed to beneficiaries or to creditors while taxes remain unpaid. See also Who Files Return on Page 22-6.

Estate Administration Step-by-Step 1) Locate will and codicils. 2) Make a preliminary inventory of the decedent’s assets

and liabilities. Determine which assets are probate assets (see Probate Assets table on Page 22-5). If the probate assets’ value is high enough to require probate under state law, apply for probate.

3) Verify deadlines for probate and tax filings: (a) estate tax return (if required), (b) gift tax return for decedent’s final year, (c) fiduciary income tax return, (d) decedent’s final Form 1040, (e) Forms 1040 for preceding years unfiled by decedent, (f) GST tax return if taxable termination occurred at death and, (g) (in 2010 only) modified carryover basis allocation form (see Reporting Modified Carryover Basis on Page 22-16).

4) Obtain an employer identification number (EIN) and a state identification number for the decedent’s estate if required. See Employer Identification Numbers (EINs) on the inside front cover of the Small Business Quickfinder® Handbook for how to obtain an EIN.

5) Notify the IRS of fiduciary relationship (Form 56 can be used). The IRS will send notices concerning the decedent’s tax liabil-ity to the decedent’s last known address until the notification is filed. (Reg. §301.6903-1)

6) Locate and arrange to collect probate property. Open an estate checking account and transfer assets to cover expenses.

7) Notify all payers who issued Form 1099 to the decedent in the previous year of the decedent’s death. For probate assets, provide the estate EIN and request that after-death income be reported to the estate. For nonprobate assets, provide the recipient’s Social Security number and request that after-death income be reported to the recipient.

8) Notify all partnerships and S corporations in which the dece-dent held an interest.

9) Prepare a detailed inventory and valuation (see the Estate Inven-tory Worksheet in Tab 15). Arrange for appraisals of property if required for allocating basis increase under the modified carry-over basis rules. Nonprobate assets may also require valuation.

10) Request Form 712 for any life insurance policy on decedent’s life. Notify life insurance company of death.

11) Obtain names, addresses and SSNs of all beneficiaries.12) If the decedent was receiving Social Security benefits before

death, return any benefits received after death to the Social Security Administration.

13) Hold and manage property during probate and collect income.14) If the estate is solvent and distributions are authorized by state

law, pay administration expenses as incurred, pay claims as they are settled and make partial distributions to beneficiaries if appropriate.

15) Sell property if assets are needed to pay expenses or claims or if distribution in kind is not practical (check state law to determine authority to sell).

16) File tax returns as they become due [Final Form 1040, Form 1041, Form 706 (if required), modified carryover basis alloca-tion form (for deaths in 2010) and Form 709 (if gifts made in year of death)]. Make estimated tax payments if required for any tax year ending two or more years after death.

17) Optional—Request prompt assessment under Section 6501(d) to shorten the statute of limitations on income tax returns from three years to 18 months. File Form 4810 separately after the returns are filed. Prompt assessment is available for Forms 1041, 1040 and 709 including returns filed by the decedent before death.

18) Optional—Request discharge from personal liability for the decedent’s income and gift taxes (under Section 6905) by filing Form 5495. (Reg. §20.2204-1 and 301.6905-1)

19) After the expiration of the probate creditor claims period, prepare to close the estate. Plan for payment of final expenses and taxes.

20) Pay any remaining claims against the estate.21) Pay any specific gifts made by will.22) Account to the heirs entitled to share the residual estate, and

distribute the estate assets according to the terms of the will or state intestacy law.

23) Close probate. Estate administration generally ends either by court order or after the personal representative submits a closing document to the court. An estate can terminate for federal income tax purposes before the administration ends under state law [Reg. §1.641(b)-3]. An estate terminates for income tax purposes when all assets have been distributed except for a reasonable amount set aside in good faith for payment of unascertained or contingent expenses. A personal representative can file a final Form 1041 return even though a set-aside amount is held in an estate account. After the estate terminates for tax purposes, the beneficiaries report any gross income, deductions and credits of the estate.

TaxaBLe inCome in The year of deaTh

If the decedent was a cash method taxpayer, income received (actually or constructively) by the decedent through the date of death is reported on the decedent’s final Form 1040. If the decedent was an accrual method taxpayer, income accrued prior to death is reported on the final Form 1040. After-death income is reported on the return of the recipient of the income.Estate. Income earned on decedent’s assets during the time they are held by the probate estate is reported on the estate income tax return (Form 1041). This period begins the day after death and ends when the assets are distributed to the beneficiaries. Income in respect of the decedent paid to the decedent’s estate and capital gains and losses on assets sold by the estate are also reported on Form 1041.Beneficiary. Even if probate is required for some assets in an estate, other assets may bypass probate and be paid directly to a surviving joint tenant, pay-on-death designee or beneficiary.

if executor

elects exemption from the estate

tax

if required

estate tax (under Section 2204) and for

final determination of estate tax liability

and

Form 706, probate proceeding, or


Taxable income from these nonprobate assets is reported on the recipient’s Form 1040, not on the estate’s Form 1041.

Probate Assets Nonprobate Assets

• Assets owned individually by the decedent.

• The decedent’s share of assets owned as a tenant in common or owned as community property.

• Life insurance, annuities and retirement assets without beneficiary designations or with estate as beneficiary.

• Life insurance, annuities and retirement assets if the estate is the named beneficiary, or if the estate receives the asset because the named beneficiaries are deceased or disclaim the asset.

• Assets owned jointly with right of survivorship.

• Life insurance, annuities and retirement assets with valid beneficiary designations other than the estate.

• Bank accounts and other assets with pay-on-death designations.

• Securities or security accounts to be transferred on death.

• Assets in trust if the instrument includes a plan for distribution after death.

Incorrect Form 1099 and nominee recipients. Although income paid through the date of death should be reported to the decedent and after-death income should be reported to the recipient, many payers of income issue only one Form 1099 for the calendar year to the owner of record at year-end.If Form 1099 includes both before-death and after-death income, the Form 1099 recipient should do the following:1) Determine income paid through the date of death. Generally,

this income must be calculated from the periodic statements issued by the payer.

2) List the entire income reported on Form 1099 on the appropriate schedule of the recipient’s Form 1040 or Form 1041.

3) On a separate line, subtract the income that does not belong to the recipient. Label the subtraction “Nominee Distribution.”

4) Issue Form 1099 for the amount subtracted to the decedent or to the income recipient using the same type of Form 1099 as received.

5) File Forms 1099 and 1096 with the IRS. Note: If the Form 1099 dividend and interest income (reported using the decedent’s SSN) is included on Form 1041 (disclosing the name, address and TIN of the actual recipient), the nominee reporting method is not required. However, to avoid matching notices, the in-come should be reported on the decedent’s final Form 1040 and backed out (with an attached explanation).Incorrect Forms 1099 may also be issued to estate beneficiaries in the year assets are transferred out of a probate estate. If Form 1099 includes income for the entire year, the beneficiary can follow the same steps to report the estate’s share of income.

Income in Respect of a Decedent (IRD)Income in respect of a decedent is gross income the decedent had a right to receive that is not includable in his or her final return. For a cash basis decedent, IRD is income earned but not received prior to death. Income in respect of a decedent is taxable income to the recipient the year received. If IRD is paid to the estate, it is reported on Form 1041. If IRD is paid directly to a beneficiary, it is reported on the beneficiary’s tax return.IRD (for a cash basis decedent) includes:• Uncollected salaries, wages, bonuses, commissions, vacation

pay and sick pay of a cash basis employee.• Certain deferred-compensation and stock-option plans.• Qualified pension plans, profit-sharing plans, SEPs, SIMPLEs,

Keogh plans and IRAs except nondeductible contributions.• Accounts receivable of a sole proprietor.• Interest and dividends accrued but unpaid at death.

• Rents and royalties accrued before death.• Gain from the sale of property if the sale is deemed to occur

before death, but proceeds are not collected until after death.• Difference between the face amount and the decedent’s basis

in an installment sales obligation.• Interest accrued through the date of death on Series EE bonds,

unless (1) the decedent elected to report interest annually, or (2) the interest was reported on the decedent’s final Form 1040.

• Annuity payments in excess of the decedent’s investment in the contract.

Deductions in respect of a decedent (DRD). Business expenses, income-production expenses, interest and taxes owed by the dece-dent but not allowed on the final Form 1040 can be deducted by the estate in the tax year paid. Similarly, if a beneficiary receives income or property from a decedent and is obligated to pay such expenses, they are deductible on the beneficiary’s tax return in the year paid.Deduction for estate tax paid prior to 2010. If income in respect of a decedent was included in the decedent’s gross estate on a prior year Form 706 and federal estate tax was paid on IRD, a deduc-tion can be claimed on the income tax return that reports the IRD.

Example: Denton’s IRA was valued at $100,000 at his death in 2009. The $100,000 was included in his gross estate and subject to estate tax. The IRA is IRD. Denton’s son Mac is the beneficiary of Denton’s IRA and must pay income tax on the distributions. Mac is allowed a deduction on his Form 1040 for the estate tax paid on the IRD.

Partner in a PartnershipA partner’s tax year automatically terminates at death. The part-ner’s share of income through the date of death is reported on the deceased partner’s final return (based on a pro rata amount for the year or an interim closing of the books). A deceased partner’s SE income is his or her distributive share of income earned through the end of the month of death. For this purpose, partnership income is considered to be earned equally in each month.

Example: Tod and Tim are equal partners in TT, which uses a calendar year. Tim dies on March 18, 2010. TT’s 2010 income is $40,000. Tim’s SE income is $5,000 ($40,000 × 1/2 × 3⁄12) and should be reflected on the Schedule K-1 received from the TT partnership.

S Corporation ShareholderThe final Form 1040 must include the decedent’s pro rata share or, if elected, specific accounting share of S corporation income, deductions, losses, etc., up to the date of death.

Self-Employment TaxBusiness income reported on Schedules C and F is subject to SE tax on the final Form 1040 even though the taxpayer is deceased. Business income reported on Form 1041 is not subject to SE tax.

FICA WithholdingA deceased employee will usually have wages accrued but not paid at the time of death. These wages are IRD and are not reported on the final Form 1040. Accrued wages paid to the estate in the calendar year of death are subject to the Federal Insurance Con-tributions Act (FICA) and Federal Unemployment Tax Act (FUTA) taxes. FICA taxes should not be withheld from wages paid to the estate after the calendar year of death. (Rev. Rul 86-109)The employer should include the accrued wages in the Social Security and Medicare wages reported on the decedent’s Form W-2. However, the accrued wages should not be included in the total taxable wages reported on the Form W-2. The employer should issue Form 1099-MISC to the estate for the accrued wages.


Where to Report Taxable IncomeTax Return Income to Report

Decedent’s Final Form 1040

Income received prior to death (cash basis taxpayer) or income accrued prior to death (accrual taxpayer).

Estate Income Tax Return Form 1041

• Income earned on assets held by the estate.• Capital gains or losses on assets sold by the estate.• IRD received by the estate.

Beneficiary’s Form 1040

• Income earned on assets received directly from the decedent (beginning at death).

• Income earned on assets after distribution from the estate.• Capital gains or losses on assets sold by the beneficiary

whether received directly from the decedent or distributed from the estate.

• IRD received by the beneficiary.• Estate income taxable to the beneficiary reported by the

estate on Schedule K-1 (Form 1041).

finaL form 1040―for deaThs in 2010

Who Files ReturnIf a court appoints a personal representative or other estate ad-ministrator, that person must file returns for the decedent. If the decedent was married at the time of death, the personal repre-sentative and surviving spouse may file a joint return if both elect to do so. If the surviving spouse remarried before the end of the tax year, the decedent’s filing status is MFS.An executor or representative named in a will has no authority over the estate until appointed by a court. If probate is not required, the named representative never receives court authority and is considered a person in charge of decedent’s property.Surviving spouse. If there is no court-appointed repre-sentative by the deadline for the return, the spouse can file a joint return with the decedent as long as he or she did not remarry before the end of the tax year. A spouse can file a joint return even if he or she expects an estate representative to be appointed. The representative, once appointed, may revoke the election to file jointly. If the surviving spouse is the appointed personal represen-tative, he or she files for decedent as personal representative and not as surviving spouse.Person in charge of decedent’s property. If there is no court-appointed representative and no surviving spouse, a “person in charge of the decedent’s property” must file the returns. This person is usually one of the heirs chosen informally by the others to act in this capacity. Filing by a person in charge of decedent’s property should only be done for estates which will not require probate. If the return shows a refund, the person is required to verify on Form 1310 that a court has not and will not appoint a personal representative.The IRS uses the term “personal representative” in its publica-tions and instructions to refer to both appointed representatives and persons in charge of decedent’s property. Under state law, “personal representative” generally refers only to someone who is actually appointed by the court.

Itemized DeductionsMost rules for deductions for a decedent are the same as for individuals. Deductions are allowed if they were paid prior to decedent’s death and would have been deductible by the decedent as of the date of death (accrued before death for accrual method taxpayers).

Exceptions:• Medical costs of the decedent paid from his or her estate within

one year of the day following death can be deducted on Schedule A of the decedent’s Form 1040 [IRC §213(c)]. If such costs are deducted on the decedent’s Form 1040, they are deducted in the year incurred, either on the decedent’s final 1040 or by amend-ing Form 1040 from a prior year. If the expenses are claimed on Form 1040 or 1040X, attach a statement in duplicate listing the expenses, stating, “These amounts have not been claimed as deductions on Form 706. The estate waives the right to claim these amounts at any time as estate tax deductions.” [See Reg. §1.213-1(d).] The waiver is irrevocable. The statement is required even if the estate is not required to file Form 706. A taxpayer who paid medical expenses for a deceased spouse or dependent can deduct the expenses in the year paid without attaching a waiver statement. Expenses are deductible if the decedent was the taxpayer’s spouse or dependent either when the medical service was provided or when the expense was paid.

• If the decedent was receiving a pension or annuity, any invest-ment lost because there is no surviving annuitant can be deducted as a miscellaneous itemized deduction not subject to the 2% AGI limitation. [IRC §72(b)(3) and §67(b)(10)]

Funeral expenses are not deductible. Probate and other estate expenses may be deductible on Form 1041, but are not deductible on Form 1040. If liability for deductible expenses passes to the estate or other beneficiary as a result of the transfer of property or income rights belonging to the decedent, these expenses are deductible by the estate or beneficiary.

Standard Deduction, Personal ExemptionThe standard deduction and personal exemption can be claimed in full as if death had not occurred. However, the higher standard deduction for age is not allowed unless the decedent was 65 or older at the time of death. The decedent cannot use the standard deduction if the surviving spouse files a separate return and item-izes deductions. The decedent cannot claim the personal exemp-tion if someone else can claim the decedent as a dependent.

CreditsAny credits that applied to the decedent before death can be claimed on the decedent’s return. An earned income credit (EIC) may be claimed even if the decedent’s return covers only a part year and the decedent would not have qualified with a full year’s income [IRC §32(e)]. A decedent’s EIC is refundable.

HeadingsWrite “DECEASED,” the decedent’s name and the date of death across the top of the tax return. On a joint return, write the names, address and Social Security numbers of the decedent and surviving spouse as usual. If the return is not joint, write the decedent’s name in care of the person filing the form and that person’s address.

Signing FormsEstate representative. If there is a court-appointed estate rep-resentative, he or she must sign the return and include his or her title. If a joint return is filed, the personal representative signs for the decedent, and the surviving spouse signs as usual in the space for his or her signature. If the spouse is also the personal repre-sentative, he or she should sign the return twice. The words “Filing as Surviving Spouse” should not be written on the signature line.Surviving spouse. If there is no court-appointed representative, write “Filing as Surviving Spouse” in the space for the decedent’s signature. The surviving spouse signs in the space for his or her signature.

only on Form 706

either Form 706 or


Person in charge of decedent’s property. Sign name, followed by the words, “Personal Representative.”

Documents Needed to Claim a RefundIf the tax return shows a refund, Form 1310 or other documenta-tion may be required depending on who files and signs the return.Estate representative. If there is a court-appointed representa-tive, a court certificate showing the representative’s appointment must be attached to the return (usually a certified copy of Letters of Testamentary or Letters of Administration). Form 1310 is not required if the representative is filing an original return. Form 1310 is required if a refund is claimed on an amended return. A copy of a will cannot be attached in place of the court certificate. The executor or representative named in a will has no authority over the estate until appointed by a court. If probate is not required, the named representative never receives court authority and is considered a person in charge of the decedent’s property.Surviving spouse. If there is no personal representative and a joint return is filed by the surviving spouse, no additional docu-mentation is required.Person in charge of decedent’s property. If there is no court-appointed representative and no surviving spouse, Form 1310 must be attached to the return. Proof of death (death certificate or other official governmental notification of death) must be maintained and provided if requested. Note: Also, use Form 1310 to request that a check issued jointly be reissued to the surviving spouse.

Tax FormsThe decedent’s Form 1040 must be filed on forms for the appropri-ate tax year. Therefore, 2010 tax forms must be used for the final Form 1040 for a taxpayer who dies anytime during 2010.

Employer Identification Number RequiredAn EIN is generally required if decedent’s estate is probated. An EIN must be used on the estate’s income tax return (Form 1041) but is not required for a decedent’s estate tax return (Form 706). See Employer Identification Numbers (EINs) on the inside front cover of the Small Business Quickfinder® Handbook for how to obtain an EIN.

gifT Tax reTurn (form 709)Gift tax in 2010. The gift tax, unlike the estate tax, is not repealed for 2010. The 2010 gift tax credit is $330,800 and equates to a lifetime applicable exclusion amount of $1 million for 2010. Tax rates. For 2010, the maximum gift tax rate is 35%. See the front cover of this Handbook for the tax rate table.Tax info sheet. For a resource to aid in collecting information needed to prepare Forms 709, see Tax Info Sheet for Gift Tax Returns on Page 15-10.Filing deadline. April 18, 2011, for gifts made in 2010.Extensions. An income tax extension may also extend the dead-line for filing gift tax returns [IRC §6075(b)(2)]. Taxpayers who ex-tend their Form 1040 using Form 4868 (for a six-month extension) are also deemed to have extended their gift tax return, provided no gift tax is due with the extension. If gift or GST tax is due with the extension and Form 4868 is used to extend the individual income tax return, Form 4868 also extends the gift tax return, but, the donor must also complete Form 8892-V as a payment voucher for the gift and/or GST tax. If the taxpayer does not extend Form 1040, the taxpayer must file IRS Form 8892 to extend the gift tax return.Penalties. Late filing penalty of 5% of tax per month up to 25% in addition to late payment penalties and interest. [IRC §6651(a)(1)]

Estimated tax requirements. None—tax is due with return.Filing requirements. A return is required if the taxpayer gave any of the following in calendar year 2010:• More than $13,000 to anyone other than a spouse or charity.• A future interest to anyone other than a U.S. citizen spouse.• A terminable interest to a spouse that does not qualify for the

marital deduction or qualifies under Section 2523(f) as QTIP.• More than $134,000 to a noncitizen spouse.• A partial interest to a charity (other than a conservation ease-

ment), including a remainder interest in property previously given in part to a noncharity.

• Split gifts. Each spouse must file if (1) he or she personally gave any donee more than $13,000, (2) any one donee received more than $26,000 from the spouses or (3) either spouse gave a gift of a future interest of any value. See Returns for Married Couples and Gift-Splitting on Page 22-9 for more information.

Only individuals file gift tax returns. If a trust, estate, partnership or corporation makes a gift, the beneficiaries, partners or sharehold-ers are considered the donors.If a taxpayer meets any of the filing requirements, Form 709 is required even if the taxpayer’s estate is too small to ever be liable for estate and gift tax.Definitions. A terminable interest gives the recipient rights in the property for a limited time ending at death, on the occurrence of some other specified event, or at a specific time (life estates, income interests in trust, etc.). A future interest postpones the recipi-ent’s right to use, possess and enjoy the property (remainder interests, interests in trust, etc.). See Annual Exclusion on Page 22-9 for a more detailed discussion of present and future interests.Gifts reported. When a return is required, not all gifts need to be reported. Each donee is considered separately. If all gifts to one donee are excluded by the annual exclusion, no gifts to that donee are reported. If gifts to a second donee are not fully excluded, all gifts to that donee must be reported. The annual exclusion for the second donee is claimed on Schedule A, Part 4, of Form 709. See the Gifts Reported on Form 709 in 2010 chart on Page 22-8. Note: Fair market value of gifts where the value is not read-ily available (gifts other than cash or publicly traded securities) as well as discounted gifts must be substantiated in attachments to Form 709.

Gifts Subject to Gift TaxGenerally, all transfers of property or property interests without adequate consideration are gifts subject to gift tax. Gifts can include transfers of cash or property, payments made to third parties on behalf of another, interest-free loans, below-market sales, irrevocable transfers to trust and the creation of certain joint tenancies.A transfer is only subject to gift tax when the gift is complete—when the donor no longer has the power to change its disposition (Reg. §25.2511-1 and -2). Gifts are taxable in the calendar year made and valued on the date they are completed. Note: For 2010 (when the estate tax is repealed), any transfer to a trust (except to one treated as a wholly-owned grantor trust by the donor or the donor’s spouse), is considered a gift of the entire interest in the property [IRC §2511(c)]. This causes some transfers in trust (that were previously considered to be incomplete) to be completed gifts in 2010.


Examples of gifts subject to gift tax:Gift of stock. Elsa transfers stock to Alice. Elsa has made a gift when she delivers the endorsed certificate to Alice—or, if transfer is made through a broker, on the date the stock is transferred on the corporate books. [Reg. §25.2511-2(h)]Below-market loan. Joan loans her daughter $300,000 to be repaid in six years with no interest. Each year Joan makes a gift of the interest that would be charged using the applicable federal rate. In addition to the gift tax conse-quences, Joan must pay income tax on the amount of imputed interest. See Imputed Interest on Below Market Loans on Page 5-24 for interest rates and exceptions for smaller loans.Debt forgiveness. Assume the same facts as in the below-market loan example above. After three years Joan forgives the unpaid principal balance. Joan has made a gift of the unpaid principal balance. Since it is a gift, her daughter does not realize any debt forgiveness income.Below-market sale. Kim sells her cabin to Laura for $20,000. The cabin has an FMV of $35,000. Kim’s basis is $12,000. Kim intends the discount to be a gift to Laura. Kim reports a $15,000 gift on Form 709. She reports a capital gain of $8,000 on her Form 1040 ($20,000 amount realized – $12,000 basis). See Basis of Gift Property (IRC §1015) on Page 22-13 for information on determining Laura’s basis.Forced sale. Assume the same facts as the below-market sale example above, except that Kim did not intend the reduced price to be a gift. She was in a hurry to sell the cabin and reducing the sale price increased the chances of finding a buyer fast. Kim has not made a gift to Laura.Transfer to revocable trust. Maude creates a trust to pay income to Ruth for life, remainder to Gary. The trust instrument signed by Maude states, “I reserve the right to revoke this agreement.” Maude has not made a completed gift because she can change the disposition of the trust assets at any time. Maude makes a gift to Ruth each year when income is paid from the trust. [Reg. §25.2511-2(b) and (c)]

Examples continued in the next column

Transfer to irrevocable trust. In 2010, Maude irrevocably transfers property to a trust to pay the income to Ruth for life. The remainder will be transferred to other persons that Maude will later decide. In 2010, the entire value of the property is treated as transferred by gift.Annuity. Basil purchases a joint and survivor annuity, which will be paid to him for life and then to his sister Carla for her life. Basil has made a gift to Carla. The value of the gift is the premium paid by Basil less the premium for a similar annuity for Basil’s life alone. [Reg. §25.2512-6(a)]Year-end check. Riley gives Kitty a check, which she deposits in her bank on December 28, 2010. It clears Riley’s bank on January 4, 2011. The gift is complete on December 28, 2010, if (1) the donor intended to make a gift, (2) the delivery was unconditional, (3) the deposit was made in the year for which completed gift treatment is sought and within a reasonable time of issuance, (4) the donor’s bank did not reject the check and (5) the donor was alive when the donor’s bank paid it. (Rev. Rul. 96-56)

Joint Tenancy GiftsTransfers of certain types of assets into joint tenancy are considered completed gifts. For other assets, the gift is only complete when the assets are withdrawn by the noncontrib-uting owner for his or her use. Generally, a joint gift is incomplete if the donor can regain the property without the donee’s consent.

The rights of joint tenants and other co-owners are generally deter-mined under state law. Unless federal law regulates the asset, the question of whether the creation of a joint tenancy in a particular asset is a completed gift is a question of state law.

Transfer Withdrawals…of the assets listed are generally “Completed Gifts”

• Real property• Mutual funds• Stocks and bonds

• Bank, S&L, credit union accounts• Brokerage accounts• U.S. savings bonds

Gifts Reported on Form 709 in 2010Reported Not Reported Page

Qualified Transfers—Tuition and Medical

Not considered a gift for tax purposes. Direct payment of another person’s medical expenses or tuition.

22-9

Transfers to Political Organizations

Not considered a gift for tax purposes. Transfers to political organizations defined in Section 527(e)(1) for the use of the organization.

—

Gifts to U.S. Citizen Spouse

• Terminable interests unless all terminable interests were life estates with power of appointment.

• Future interests only if the present interest was given to another donee and must therefore be reported.

• Property for which donor spouse wishes to make QTIP election.

Other gifts to a spouse regardless of the amount. 22-9

Gifts toNoncitizen Spouse

All gifts if spouse received:• A future interest of any value,• More than $134,000 or• A terminable interest that would not qualify for the marital deduction if

given to a U.S. citizen spouse.

Generally, non-terminable present interest gifts to a noncitizen spouse of $134,000 or less.

—

Gifts to Nonspouses

All gifts to a donee who received:• A future interest of any value, or• More than $13,000.See Generation-Skipping Transfer (GST) Tax on Page 22-12.

Gifts to a donee who received present interests of $13,000 or less.

22-7

Gifts to Charities

• A partial interest in property other than a conservation easement.• Property in which donor previously gave an interest to a noncharitable

beneficiary other than a conservation easement.• If Form 709 is otherwise required, include gifts to charities.

• If the only gifts were those given to charity:– Gifts of cash regardless of amount.– Gifts of other property if entire interest was donated,

regardless of amount.• Conservation easements under Section 2522(d).

—

Present interest. Allows the recipient to use, possess and enjoy the property immediately.Future interest. Postpones the recipient’s right to use, possess and enjoy the property.Terminable interest. Gives the recipient rights in the property for a limited time ending at death, on the occurrence of some other specified event or at a specific time.

2010 Tax Relief Act repealed IRC §2511(c) so the example is no longer valid. See Page 22-8 in the 2009 Tax Year Handbook.


Examples of joint tenancy gifts:Joint bank account. On July 1, Olga deposits $25,000 in a bank account. The account is a joint account under state law payable on request to either Olga or her nephew Billy. On August 1, Olga’s money is still in the account. No gift has been made because Olga can unilaterally withdraw all funds. On September 1, Billy withdraws $100. Olga has made a completed gift to Billy of $100. On October 1, Billy cleans out the account and takes an Alaskan cruise. Olga has made a gift of the balance in the account on October 1. [Reg. §25.2511-1(h)(4)]Joint ownership of real property. Frank conveys title to his home to himself and his daughter Nancy as joint tenants. Under state law, Frank cannot regain title to Nancy’s half interest without her consent. Frank has made a completed gift of one-half the value of his home. [Reg. §25.2511-1(h)(5)]Co-ownership of U.S. bonds. Rocky buys Series EE bonds naming Burt as co-owner and physically gives the bonds to Burt. Rocky has not made a com-pleted gift. A gift occurs when Burt redeems the bonds and retains proceeds or when the bonds are reissued solely in Burt’s name (Rev. Rul. 55-278). U.S. bonds are regulated by federal law, so this rule applies to owners in all states.Joint brokerage accounts and securities. Katherine changes her brokerage account to a joint account when she marries Spence. The account is a street name account—securities held in the account are registered in the name of a person designated by the broker and not in Katherine’s name. Katherine has not made a completed gift to Spence (Rev. Rul. 69-148). Spence owns 100 shares of Better Than Average Inc., a listed security valued at $80,000. He changes ownership of the shares, and the company issues a new certificate to Spence and Katherine as joint tenants with right of survivorship. Spence has made a completed gift of $40,000, although this gift qualifies for the marital deduction.

Death transforms joint tenancy gift into inheritance. If prop-erty remains in joint tenancy until the donating tenant’s death, the tenancy is treated as an inherited interest. However, in 2010, the basis of inherited property will be subject to the modified carryover basis rules. See Modified Carryover Basis for Inherited Property for Deaths in 2010 (IRC §1022) on Page 22-12.Life estates and remainder interests. This type of joint ownership is commonly used for real estate. The owner deeds the property to one or more donees and in the deed specifically reserves a life estate (the right to use and possess the property until death). Rules similar to those for joint tenancies apply to the remainder interest. If the deed is recorded or delivered so that the transfer is considered completed under state law, the gift must be reported on Form 709. The valuation tables for valuing annuities, life estates and remain-der or reversionary interests are available on the IRS’s website at www.irs.gov/retirement/article/0,,id=206601,00.html.

Annual ExclusionFor 2010, a taxpayer can exclude the first $13,000 given to each donee in the calendar year on Form 709. The annual exclusion is indexed for inflation and is also $13,000 in 2011.Present interest required. To qualify for the annual exclusion, a gift must be a present interest. A present interest is the immediate right to the use, possession, enjoyment and income of the property. The annual exclusion does not apply if these rights begin at some future time. (Reg. §25.2503-3)Indirect gifts (such as gifts in trust and gifts of business interests) qualify as present interests only if the recipient receives a substan-tial present economic benefit by reason of the use, possession or enjoyment of either the property itself or income from the property [Hackl, 92 AFTR 2d 2003-5254 (7th Cir. 2003)]. If a donee has no right to income and cannot unilaterally demand a payment or sell the interest, the gift is a future interest. An income interest is a present interest only if the entity will actually receive income and an ascertainable portion will flow steadily to the beneficiary. If income can be withheld from the beneficiary, the gift is not a

present interest. See Regulation Section 25.2503-3 for other examples of future interests.Exceptions:• Gifts to a minor’s trust or custodian qualify as

present interests if (1) the funds can be used im-mediately for the minor’s benefit, (2) the minor will receive the property by age 21 and (3) the property will pass to the minor’s estate if the minor dies before age 21. [IRC §2503(c)]

• Annual gifts in trust qualify as present interests if the trust in-strument includes a valid Crummey Power. See Tab 21 for an explanation of Crummey Power.

Qualified tuition programs (QTPs). Contributions to QTPs for the benefit of another individual are treated as present interests and qualify for the annual exclusion. In addition, a taxpayer who gave more than $13,000 to a QTP on behalf of a single beneficiary in 2010 can elect to treat up to $65,000 as having been given over a five-year period. Make the election by checking the box on line B, Schedule A of Form 709. Attach a statement listing the amounts contributed for each beneficiary, the amount for which the election is made, and the name of the individual for whom the contribution was made. Report 20% of the gift each year for five years. If no other gifts are made to the same beneficiary, annual exclusions will exclude the entire gift from tax. If, in any of the four years fol-lowing the election, the taxpayer is not required to file Form 709 other than to report that year’s portion of the election, the taxpayer does not need to file or otherwise report that year’s portion. Any amount in excess of $65,000 must be reported in the year the gift is made [IRC §529(c)(2)]. If the donor dies before the end of the five-year period, contributions allocable to periods after the date of death are included in the donor’s gross estate. [IRC §529(c)(4)]Distributions from QTPs are generally not taxable gifts. Exception: Gift and possibly generation-skipping transfer (GST) tax apply to a transfer or rollover if there is a change of beneficiary and the new beneficiary is a generation below the old beneficiary. [IRC §529(c)(5)]

Qualified Transfers—Tuition and Medical CareDirect payment of medical expenses or tuition for another person is not a gift for gift tax purposes [IRC §2503(e)]. Payment must be made to the school or medical provider and not to the beneficiary. Qualified transfers are not reported on Form 709. Payments for books, supplies, dormi-tory fees and board do not qualify. Contributions to qualified tuition programs do not qualify. Tuition for part-time students qualifies. Medical payments can cover any type of expense deductible for income tax purposes, including payment of insurance premiums. The beneficiary of a qualified transfer does not need to be related to the taxpayer. An annual exclusion gift can also be made to the beneficiary of a qualified transfer.

Returns for Married Couples and Gift-SplittingGift tax returns cannot be filed jointly. Each spouse has a separate annual exclusion and must file a return if he or she made report-able gifts in the calendar year. Unless gift-splitting is elected, gifts made by one spouse have no effect on the gift tax return of the other. Gifts of community property or joint assets are considered made one-half by each spouse. Returns are not required if joint gifts are present interests of $26,000 or less.Gift-splitting. Allows a married couple to treat all gifts made to third parties by either spouse during the year as made one-half by each spouse. It allows spouses to maximize the utilization of their annual exclusions and applicable credit amounts. Gift-splitting is only necessary when a gift is made from assets belonging to only one spouse and the gift is not fully excluded by that spouse’s annual exclusion.

See Page 22-9 in the 2009 Tax Year Handbook.

See Page 22-9 in the 2009 Tax Year Handbook.


To qualify, spouses must be U.S. citizens or residents. They must be married at the time of the gift and can-not remarry others before the end of the year. One spouse cannot give the other a general power of appointment over the gift. The election is made on lines 12 through 17 of Form 709. Each spouse must consent by signing line 18 of the other spouse’s Form 709. The returns should be mailed to the IRS in the same envelope.

Example: In 2010, Bud was the sole owner of land valued at $40,000 that he gave to his son. Maxine (Bud’s wife) gave $26,000 from her separate assets to her daughter in 2010. Bud and Maxine must each file Form 709 for 2010. They agree to split gifts.Bud lists both gifts in Part 1 of Schedule A (page 2). His gift of the land is listed in the top half. Maxine’s gift is listed in the bottom half under “Gifts made by spouse.” The full value of each gift is entered in column F. One-half of the value is entered in column G and column H. The column H total is transferred to Part 4 of Schedule A (page 3). Bud claims two annual exclusions and reports taxable gifts of $7,000.Maxine’s Form 709 is the same as Bud’s except she reports her gift in the top half of Part 1 and Bud’s gift in the bottom half.Bud’s 709 F G HGifts of donor .................................... $ 40,000 $ 20,000 $ 20,000Gifts made by spouse ....................... 26,000 13,000 13,000Total gifts of donor ................................................................... $ 33,000Annual exclusions .................................................................... < 26,000>Taxable gifts ............................................................................. $ 7,000

Maxine’s 709 F G HGifts of donor ..................................... $ 26,000 $ 13,000 $ 13,000Gifts made by spouse ........................ 40,000 20,000 20,000Total gifts of donor ................................................................... $ 33,000Annual exclusions .................................................................... < 26,000>Taxable gifts ............................................................................. $ 7,000

Gifts under $13,000 required to be reported. A taxpayer who makes a gift of a present interest of $13,000 or less does not ordi-narily need to report the gift. If gift-splitting is elected, the Form 709 instructions ex-plicitly require that the entire value of every gift made during the calendar year while married be entered on the donor spouse’s Schedule A.Simplified reporting. Each spouse must file a separate gift tax return unless:1) All gifts made by the couple were present interests,2) Only one spouse (the donor spouse) made gifts over $13,000

per donee and3) No donee received more than $26,000.If these conditions are met, the donor spouse files Form 709, and the other spouse signs the return as consenting spouse. (Reg. §25.6019-2)

Example: Hal gave Bobby $15,000 cash. Hal and Wanda agree to split gifts. The returns required depend on the gifts Wanda gave.Gift From Gift From Gift From

Hal to Bobby

Wanda to Bobby

Wanda to Sister

Total Filing Requirement

$15,000 $ 0 $ 0 $15,000 Hal files Form 709.15,000 0 2,000 17,000 Hal files Form 709.15,000 13,000 0 28,000 Hal and Wanda each file a

Form 709.

gifT Tax exampLeSee completed Form 709 on Page 22-11

Mrs. Miller made the following cash gifts in 2010: • $200,000 to her son Chad.• $100,000 to her church.• $13,000 each to her five grandchildren.Mrs. Miller is required to file a gift tax return for 2010. She reports the cash gift to her son of $200,000 and the $100,000 gift to her church, on Part 1 of Schedule A (page 2, Form 709). She carries the total of column H to line 1 of Part 4 (page 3). She claims an annual exclusion for each gift on Part 4, line 2, reports the chari-table deduction (net of its exclusion) on Part 4, line 7, and reports taxable gifts of $187,000. The gift tax is calculated on page 1 of Form 709. The gift tax rate schedule is on the front cover of this Handbook. Mrs. Miller’s tax of $50,640 is completely offset by her applicable credit amount, and she pays no tax.According to Form 709 instructions, if Mrs. Miller is required to file a return to report non-charitable gifts, she must include her gifts to charities on the return. Mrs. Miller does not report the gifts to her grand-children because each gift qualifies in full for the annual exclusion.

esTaTe Tax

Estate Tax—2009For 2009, the estate tax exclusion was $3.5 million per taxpayer. The maximum estate tax rate was 45% in 2009.

Estate and GST Tax Repeal in 2010 Law Change Alert: At the time of publication, the federal estate and GST taxes are repealed for 2010. No Form 706 is required for a decedent who dies in 2010.In addition, for 2010 only, the basis rules for inherited property have changed. A new modified carryover basis system applies to inherited property. The rules that permitted inherited property to receive a basis step-up based on date of death FMV will not apply. See Modified Carryover Basis for Inherited Property for Deaths in 2010 (IRC §1022) on Page 22-12.However, the estate and GST taxes are scheduled to return in 2011 with the 2001 rules: • $1 million estate tax applicable exclusion amount, • $1 million (indexed for inflation) GST tax exemption,• 55% maximum tax rate and• Step-up in basis rules for inherited property.Some practitioners expect Congress to instead establish exclu-sions and rates for 2011 similar to the 2009 amounts ($3.5 million applicable exclusion amount and 45% maximum rates). Note: When Congress addresses estate tax repeal, they could permit taxpayers in 2010 a choice of either using the modified carryover basis system (which will impact the income tax owed by heirs) or elect to pay estate tax under the old rules (perhaps using the 2009 exclusions and rates). If a 2010 estate is less than $3.5 million, electing to use the old rules will likely be the best answer—no estate tax and possibly less income tax for heirs.N Observation: Because there is no estate tax in 2010, taxpay-ers cannot make a QTIP election to qualify property for the estate tax marital deduction. If a will directs property to a trust that would have qualified for the marital deduction in prior years (a QTIP-type trust), the property in that trust escapes estate tax in 2010, and because no QTIP election can be made in 2010, it should also avoid being taxed in the survivor’s estate. Practitioners should watch for legislation to address this.

See Estate and Gift Tax—2010–2012 in the Updates

section of Quickfinder.com under Premium Quickfinder® Handbook

(2010 Tax Year).

Tax—2010 and Later Years


generaTion-skipping Transfer (gsT) Tax

The GST tax has historically been imposed on direct transfers to beneficiaries more than one generation below that of the transferor (a “skip person”) and on transfers involving trusts having beneficia-ries in more than one generation below that of the transferor. The GST tax has applied to three types of transfers: direct skips, taxable distributions, and taxable terminations. Law Change Alert: The GST tax is re-pealed in 2010. This means that direct skip transfers, taxable terminations, and taxable distributions that occur in 2010 are not subject to the GST tax.U Caution: It is not clear whether taxable terminations and distributions that occur after 2010 for transfers in trust made in 2010 will be subject to the GST tax. Practitioners should monitor further guidance.There is no provision in 2010 to allocate any GST tax exemption to 2010 transfers that could lead to future GST tax when the dis-tributions are made.The following GST terms are important to understand:Direct skips. A transfer of property, subject to gift or estate tax, made to a skip person.Taxable terminations. A termination of a trust interest that passes property or a property interest to a skip person.Taxable distributions. Any other trust distribution to a skip person.Skip person. A skip person is a relative two or more generations below the transferor (grandchildren, grandnieces, grandnephews and their descendants) or an unrelated person more than 371/2 years younger than the transferor. Relatives not descended from the transferor’s grandparents are considered unrelated. Spouses, former spouses, tax-exempt orga-nizations and charitable trusts are nonskip persons. (IRC §2651)Deceased-parent exception. If the transferor’s child is deceased, the grandchildren by that child are considered the first generation and are not skip persons. If the transferor has no lineal descendants and a niece or nephew of the transferor is deceased, the children of the deceased niece or nephew are not skip persons. [IRC §2651(e)]GST tax exemption allocation. Each transferor has historically been allowed to allocate up to a certain amount (the GST tax ex-emption) to transfers that could later result in GST taxable distribu-tions or terminations. In addition, the allocation was automatically allocated to certain transfers (such as lifetime direct skips and lifetime indirect skips to GST trusts). There are no provisions for GST tax exemption allocation in 2010.N Observation: Unless Congress provides otherwise, the 2011 GST tax exemption is scheduled to be $1 million (indexed for inflation). This is a return to the 2001 rules, which would also mean that there would be no automatic allocation of the GST tax exemption to indirect skips or any ability to make retroactive allocations of the GST tax exemption.

Basis in properTyHistorically, inherited property received a basis step-up (or step-down) to FMV on the decedent’s date of death. (IRC §1014) Law Change Alert: The step-up in basis rules are replaced with modified carryover basis rules for property acquired from decedents who die in 2010.

Modified Carryover Basis for Inherited Property for Deaths in 2010 (IRC §1022) The basis of property inherited from a decedent who dies in 2010 will be the lesser of:1) The decedent’s adjusted basis (generally equal to cost) or2) The FMV of the property at the date of the decedent’s death.Basis increase. Estates can increase the basis (but not above FMV at the date of death) by up to $1.3 million on certain appreci-ated assets. This is known as the aggregate basis increase. An additional $3 million basis increase is available for outright transfers or qualified terminable interest property (QTIP) transferred to a sur-viving spouse, referred to as the spousal property basis increase. This means property passing outright to surviving spouses (or into QTIP-type trusts) can be allocated up to $4.3 million of additional basis. (Estates of nonresidents who are not U.S. citizens are al-lowed only an aggregate basis increase of $60,000.) Note: A QTIP-type trust is one that meets the requirements for a QTIP election, but for which no election is made. Because the estate tax is repealed in 2010, a QTIP election cannot be made in 2010.The executor can make the allocation on an asset-by-asset basis. For example, the basis increase can be allocated to a share of stock or a block of stock. However, the basis is never permitted to be adjusted above its FMV on the decedent’s date of death.The $1.3 million basis increase can be increased by the sum of:1) Any capital loss carryovers and net operating loss carryovers

that the decedent would have otherwise (if not for death) been able to carry over to a later year, and

2) The amount of any unrealized losses that would have been allowable under Section 165 (for example, losses from a trade or business and worthless securities that have not been com-pensated by insurance).

Assets Eligible for Basis Increase Assets Ineligible for Basis Increase

• Half of jointly held property with spouse.

• Jointly held property with others (to extent of consideration).

• Property decedent transferred to a qualified revocable trust.

• Surviving spouse’s half of community property.

• Property received by gift from spouse within three years of death (unless transferor spouse received by gift) in the three-year period.

• Any property passing from the decedent without consideration.

• IRD property.• Property received by gift during

the 3 years prior to death (unless received from spouse).

• Foreign personal holding company stock (or former foreign personal holding company stock).

• Domestic international sales corporation (DISC) stock (or former DISC stock).

• Passive foreign investment company stock.

• Property over which decedent held a power of appointment.

• QTIP trust property created by a deceased spouse prior to 2010 for which decedent was income beneficiary.

Holding period rules. Because the basis for assets of a decedent who died in 2010 is not determined under the step-up rules (IRC §1014), the automatic long-term holding period rules for inherited property are also eliminated in 2010. In 2010, if the recipient’s basis is the same (in whole or in part) as the decedent’s basis, the de-cedent’s holding period can tack on the recipient’s holding period. Otherwise, the holding period begins on the decedent’s date of death. See Holding Periods on Page 22-13 for further information.@ Strategy: The aggregate basis increase and the spousal property basis increase should be first allocated to assets that, if sold, would generate ordinary income rather than long-term capital gains.

The GST tax was initially repealed, but then reinstated by the 2010 Tax Relief Act, for 2010. However, the GST tax rate is deemed to be 0%, so there is no actual GST liability for 2010. The GST tax exemption for 2010 is $5 million.

If executor elects for estate tax to not apply, the

—See Page 22-13 in the 2009 Tax Year Handbook for more GST tax information.

is

is

—$5 million

for 2010

were initially scheduled to be

, but the 2010 Tax Relief Act makes stepped-up basis the general rule in 2010.

and

If the executor chooses for the estate tax to not apply,


Liabilities in excess of basis. Liabilities in excess of basis will be disregarded in determining the adjusted basis of property acquired from a decedent in 2010 (unless the recipient is a tax-exempt en-tity). However, the debt cannot be added back to the decedent’s basis in the asset. The beneficiary is not protected from recognizing gain attributable from the liability when the property is later sold.

Example: Betty died on March 1, 2010, owning commercial property with an FMV of $400,000 (adjusted basis of $200,000). Betty’s executor does not allocate any of the aggregate basis increase to the property. The property is encumbered by a $300,000 mortgage. Raymond, Betty’s son, inherits the property. No gain is recognized when Betty dies or when the property is dis-tributed to Raymond for the $100,000 excess of debt over basis. Raymond’s basis will be $200,000. If Raymond sells the property for $500,000 (buyer’s assumption of $300,000 mortgage plus $200,000 cash), he must recognize a gain of $300,000 ($500,000 sales proceeds less $200,000 carryover basis).

N Observation: Taxpayers have relied on the tra-ditional step-up in basis rules for a number of years and may not have kept careful records for the basis of their assets. Obtaining basis information may be the most difficult task for practitioners providing services to estates of decedents who died in 2010.Reporting the basis allocation. For estates created in 2010, the executor is required to file a tax return providing informa-tion on all assets (other than cash) owned by and acquired from the decedent when those assets are worth more than $1.3 million ($60,000 for estates of nonresidents who are not U.S. citizens). The return is due when the decedent’s final income tax return is due, including extensions. Note: At the time of publication, no IRS form was available to report this information.The return must include the following information: [IRC §6018(c)]1) The name and tax ID number of the person who acquired the

property from the decedent.2) An accurate description of such property.3) The adjusted basis of such property in the hands of the dece-

dent and its FMV at the time of the decedent’s death.4) The decedent’s holding period for such property.5) Enough information to determine whether any gain on the sale

of the property would be treated as ordinary income.6) The amount of the basis increase allocated to each asset.7) Any other information required by the regulations.The return must also report any appreciated property acquired by the decedent by gift (other than from his spouse) that was subject to gift tax filing, regardless of whether the $1.3 million filing threshold is met.Beneficiaries should be given a copy of this information so that they are notified of the basis of any assets they receive. Once made, the allocation can only be changed as provided by the IRS.See Reporting Modified Carryover Basis on Page 22-16 for an example of reporting the basis allocation information.

Basis of Gift Property (IRC §1015)Gain. If a taxpayer sells property received as a gift, the basis for calculating gain is the donor’s adjusted basis plus any gift tax paid on the appreciation of the property’s value while held by the donor. Basis can only be increased for gift tax actually paid, not for tax offset by the donor’s applicable credit amount.Loss. The basis for calculating a loss is the lower of the donor’s adjusted basis or fair market value (FMV) of the property at the time of the gift.

Example #1: Hope sold property for $120,000 which she received as a gift from Ruby. At the time of the gift, the property had an FMV of $100,000, and Ruby’s adjusted basis was $80,000. Ruby paid $33,300 gift tax on the gift. Hope’s basis is Ruby’s adjusted basis ($80,000) plus the gift tax on the appreciation (20% of $33,300 = $6,660) for a total of $86,660. Appreciation was 20% of the gift: ($100,000 FMV – $80,000 basis) ÷ $100,000 FMV.Example #2: Joy sold property for $80,000 which she also received as a gift from Ruby. At the time of the gift, its FMV was $90,000, and Ruby’s adjusted basis was $100,000. Since Joy sold her property at a loss, her basis is $90,000—FMV at the time of the gift.Example #3: Assume the same facts as in Example #2, except Joy sells the property for $95,000. There is no gain or loss. Joy’s basis for gain is $100,000 so there is no gain. Joy’s basis for loss is $90,000 so there is no loss. (Reg. §1.1015-1)

Below-market sale (part sale/part gift). The buyer’s basis is the greater of the amount paid for the property or the donor’s adjusted basis. Basis can be increased by gift tax paid on the appreciation of the property’s value (see Gain in the previous column). Basis for loss cannot exceed FMV at the time of the gift. The seller’s capital gain is the difference between the amount realized from the sale and the seller’s adjusted basis. A loss is not deductible by the seller. [Reg. §1.1001-1(e)]

Example #4: Thelma sells property to Lilian for $20,000. Thelma’s basis is $12,000 and the FMV is $35,000. Thelma must report a capital gain of $8,000 on her Form 1040. (Thelma also has a reportable gift to Lilian of $15,000.) If Lilian later resells the property for $50,000, her basis is $20,000 (the greater of the amount she paid or Thelma’s basis).Example #5: Assume the same facts as in Example #4, except Thelma’s basis is $40,000. Thelma cannot deduct the capital loss from the sale on her Form 1040. If Lilian later sells the property for $15,000, her basis is limited to $35,000.

Holding PeriodsGifts. The donee’s holding period includes that of the donor. [IRC §1223(2)]Inherited property. Prior to 2010, inherited property was deemed to have been held for more than one year; when that property was sold, it received long-term capital gain treatment. Law Change Alert: Assets received from an estate of a de-cedent who died in 2010 are not automatically treated as if held long-term. A tacked holding period may be available if the recipi-ent’s basis in the property (for gain or loss) is the same (in whole or in part) as the decedent’s basis. The tacked holding period would include the period held by the decedent, as well as the period that the estate (or other recipient) holds the asset.If the FMV at date of death is less than basis, the tacked holding period is not available (that is, the holding period for the recipient begins on the decedent’s date of death). Note: If the executor allocates the decedent’s aggregate basis increase or spousal property increase to the property, the tacked holding period should still be available regardless of whether the full $1.3 million (and/or $3 million) basis increase is elected.

Example #1: Mitch bought XYZ stock for $10,000 on October 10, 2009. Mitch died on August 1, 2010 when the stock is worth $12,500. His executor does not allocate any of Mitch’s aggregate or spousal property basis increase to the stock. The executor sold the stock on November 1, 2010 for $12,675. Because the estate’s basis is the same as Mitch’s basis, the holding period tacks on and the sale of the stock is a long-term gain.Example #2: Assume the same facts as in Example #1, except that Mitch’s executor allocates $2,500 of Mitch’s aggregate basis increase to the stock and sells it on September 30, 2010 for $12,600. The basis of the stock is still determined (in part) by Mitch’s basis and the holding period tacks, but results in a short-term gain of $100 [$12,600-($10,000 + $2,500)] because even with Mitch’s tacked holding period, the stock is held for less than one year.

if the modified carryover basis rules apply



, but it will be Form 8939.

if the

modified carryover

basis rules apply

and in 2010 when estate tax applies


Example #3: Assume the same facts as in Example #1, except that the value of the stock on Mitch’s date of death is $9,000. No basis increase can be allocated (because the basis increase can only be allocated to appreciated assets). The estate’s basis is $9,000 (the lesser of Mitch’s basis or FMV on date of death). It is not determined (in whole or in part) with reference to Mitch’s basis, which means Mitch’s holding period does not tack. When the executor sells the stock on November 1, the result is a $3,675 short-term gain ($12,675 - $9,000).

vaLuing properTyFor deaths in 2010, the fair market value (FMV) of inherited property must be determined to apply the modified carryover basis rules. See Modified Carryover Basis for Inherited Property for Deaths in 2010 (IRC §1022) on Page 22-12.

Fair Market ValueFair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts (Reg. §20.2031-1). The sale price of an item does not set FMV if the item is sold in a market other than that in which such items are most commonly sold to the public. For property that is generally obtained by the public in a retail market, FMV of such property is the price at which the property or comparable property would be sold at retail. (Reg. §20.2031-1)

Valuation of Particular Types of PropertyVehicles, personal and household property. The retail rather than the trade-in value must be used for vehicles. NADA and Blue Book values can be used as a basis for FMV. The sale price of property sold through a classified ad or at public auction establishes the retail sales price if similar property is commonly sold in such a manner, the sale was made within a reasonable period follow-ing the valuation date, and no substantial change has occurred in the market for similar items (Rev. Proc. 65-19). For information on cataloguing and valuing household and personal effects, see Regulation Section 20.2031-6.Checking account. Account balances can be reduced by checks written by the decedent prior to death for bona fide obligations of the decedent which clear the decedent’s bank after death.Gift checks to charity that are delivered before death and clear after death can also be excluded from the gross estate [Belcher, 83 TC 227 (1984)]. The Tax Court and the Second Circuit have held that gift checks to individuals that do not clear the decedent’s bank before death are incomplete gifts and must be included in the gross estate. [Newman, 84 AFTR 2d 99-6451 (1999); Rosano, 87 AFTR 2d 2001-1619 (2nd Cir. 2001)]Stocks and bonds. Average the high and low selling prices on the date of death. If only closing prices are quoted, use the average closing price on the date of death and the previous trading day. If death occurred on a week-end, the value is the average of the Monday high and low average and the Friday high and low average. If the stock was not traded on a trading day, the value must be calculated using a weighted average for sales on the nearest sales dates. (Reg. §20.2031-2)Mutual funds. Most mutual funds are valued at the public redemp-tion price (net asset value, or NAV) on the date of death. If death occurred on a weekend or holiday, use the public redemption price for the day preceding the date of death. For example, Friday’s NAV for death on a weekend. [Reg. §20.2031-8(b)]Business interests. Factors considered in valuing stock in a closely held corporation include net worth, prospective earning

power, dividend-paying capacity, goodwill, economic outlook in the company’s industry, the company’s position in the industry and the value of securities of other corporations engaged in the same or similar lines of business (Reg. §20.2031). See Revenue Ruling 59-60 for a more detailed discussion.The FMV of a minority interest in a closely held business may be discounted because the holder lacks control over management. An additional discount may be taken if there is no ready market for the shares. There is no clear standard for determining discounts. The percentages allowed by the courts in contested cases vary widely (10% to 45%). Taxpayers should have appraisals supporting the valuation reported on the return.The FMV of a sole proprietorship or partnership is the net amount that a willing purchaser would pay for the interest of a willing seller, both having reasonable knowledge of the relevant factors. Relevant facts include the value of the assets of the business, the demon-strated earning capacity and other factors used to value corporate stock if relevant to the particular situation. (Reg. §20.2031-3)N Observation: The IRS has traditionally argued for smaller valuation discounts for estate and gift tax purposes, thus increasing the value subject to estate or gift tax. However, for decedents who die in 2010, the IRS could reverse this position for inherited assets due to the modified carryover basis rules because discounts may increase any income tax due when the inherited property is sold. See Modified Carryover Basis for Inherited Property for Deaths in 2010 (IRC §1022) on Page 22-12.

esTaTe—Comprehensive exampLeRonald Martin died on March 4, 2010. His will names his nephew Barnum as his personal representative. Under the terms of the will, Barnum receives the entire residue of Ronald’s estate after payment of expenses. Barnum submits the will for probate and is appointed personal representative by the court.A list of Ronald’s assets valued on the date of death is shown below. Ronald owned his home and cabin with his girlfriend Sally. Because they were owned as joint tenants with right of survivorship, Sally owns a 100% interest in the house and cabin at his death. Ronald also named Sally as the beneficiary of his IRA. The house, cabin and IRA pass to Sally without probate. Because they are nonprobate assets, they are not subject to the terms of Ronald’s will. Ronald owned all other assets in his name alone; they are subject to probate and will pass to Barnum under the terms of the will. Ronald died in a state where no state death tax was assessed in 2010.

Decedent’s Assets

Asset Ownership Basis FMVProbate Amount

House ........................................ JT $ 201,000 $ 480,000 $ 0Cabin ......................................... JT 70,000 185,000 0Stock .......................................... S 600,000 980,619 480,619Mutual fund ................................ S 299,000 377,000 377,000Municipal bond .......................... S 45,000 52,000 52,000Series EE savings bond ............ S 5,000 8,960 8,960Cash .......................................... S 820 820 820Bank accounts and CDs ............ S 1,195,381 1,195,381 1,695,381Vehicles and misc. property ....... S 265,000 157,380 157,380IRA ............................................ S/B −0− 345,000 0Accrued dividend ....................... S −0− 1,400 1,400Accrued interest:– Municipal bond ....................... S −0− 707 707– Savings accounts and CDs .... S −0− 749 749Total: .......................................... $ 3,785,016 $ 2,775,016JT = Joint tenancy with right of survivorship.S = Separate (100% owned by decedent).S/B = Separate with designated beneficiary.

See Page 22-18 in the 2009 Handbook if estate

tax applies.

U Caution: This example assumes that Barnum elects for estate tax to not apply to Ronald’s estate. See Page 22-19 in the 2009 Handbook for an example with estate tax.

if are elected

if the executor elects for the estate tax to not apply


Estate Expenses

ExpenseTotal

ExpensesForm 1041 Deduction

Funeral ....................................................................... $ 7,800 $ 0Attorneys fees ............................................................. 4,200* 4,200Tax preparation ........................................................... 2,000* 2,000Probate expenses ....................................................... 1,650* 1,650Form 1040 balance due .............................................. 5,040 0State income tax balance due .................................... 300 300Credit card balance .................................................... 2,040 0Dental bill .................................................................... 380 0Total: ........................................................................... $ 23,410 $8,150* In years other than 2010, administration expenses can be deducted on Form

1041 or 706 but not both. However, in 2010, when no 706 is required to be filed, these expenses are deducted on Form 1041. State income tax is deductible on both Form 706 and Form 1041 in years that the estate tax applies.

Tax Returns RequiredForm 1040. Barnum is responsible for filing Ronald’s final Form 1040, which is due on April 18, 2011.Form 709, Gift Tax Return. Barnum confirms that Ronald made no reportable gifts in 2010.Form 1041. The estate must file an income tax return if it has gross income of $600 or more in a tax year. The personal representa-tive selects the estate’s tax year when the first return is filed. The period included on the first return can end on the last day of any month following death. It can be as short as a few days, but no longer than one year. Ronald died on March 4, 2010. The shortest possible first year ends March 31, 2010. The longest possible first year ends February 28, 2011. Returns are due on the 15th day of the fourth month following the close of the year. Barnum can postpone the decision until he is ready to file a return. He must file a return by June 15, 2011.When the estate is first opened, the personal representative must obtain an employer identification number (EIN). See Employer Identification Numbers (EINs) on the inside front cover of the Small Business Quickfinder® Handbook for how to obtain an EIN. Although the closing month of the accounting year must be listed on Form SS-4, the personal representative elects the year by filing the first return, and is not bound by the month listed on Form SS-4.Form 706 (Except in 2010). In years other than 2010, Ronald’s estate would be required to file an estate tax return (Form 706) and include both probate and nonprobate assets if his total assets and lifetime gifts exceed the applicable exclusion amount for that year. In 2010, the estate and GST taxes are repealed.

Modified Carryover Basis Allocation Form. Although no Form 706 is required for deaths in 2010, the executor of the estate must file a return providing information on all assets (other than cash) owned by and acquired from the decedent if those assets are worth more than $1.3 million. The return is due when the decedent’s final income tax return is due, including extensions. (At the time of publication, the IRS has not issued the form for reporting this information.) See Modified Carryover Basis Schedule on Page 22-18 for an example of what the estate should report.

Income AllocationRonald was a cash basis taxpayer. Taxable income in the year of his death is therefore allocated between Forms 1040 and 1041 on a cash basis. Barnum calculates income paid through the date of death and income paid after death using the periodic statements from the bank, brokerage and mutual funds.

Income received by Ronald through the date of death is reported on his final Form 1040. After-death income earned on probate assets and other income paid to the probate estate is reported on Form 1041. After-death income from nonprobate assets is reported on the recipient’s return. Sally reports distributions from the IRA on her Form 1040 in the year received.

Exception for Series EE bonds. The estate redeemed the Series EE bond for $9,272 in November 2010. Ronald bought the bond in April 1995 for $5,000. The $4,272 difference is taxable interest (Ronald did not elect to report interest annually). Barnum has two options for reporting the interest: (Rev. Rul. 68-145)

1) Elect to report interest accrued through death ($3,960) on the final Form 1040 and after death income ($312) on Form 1041, or

2) Report all interest ($4,272) on Form 1041 and treat the interest accrued through death ($3,960) as IRD.

Barnum elects to report interest through the date of death on the final Form 1040.

Income in respect of a decedent. Gross income owed to Ronald that he did not receive before death is IRD, which is allocated among the tax returns in the same way as other income.

The allocation of income for calendar year 2010 is shown in the Income—Calendar Year 2010 table below.

Income—Calendar Year 2010

Income TotalReported on Final

Form 1040Reported on Estate’s

Form 1041Reported on Sally’s

Form 1040 IRD AmountDividends $ 2,600 $ 1,200 $ 1,400 $ 0 $ 1,400Capital gain distributions 800 0 800 0 0Municipal bond interest 4,000 2,000* 2,000** 0 0Series EE bond interest 4,272 3,960 312 0 0Savings account and CD interest 12,850 6,350 6,500 0 749IRA distributions 10,000 0 0 10,000 10,000Pension 37,000 37,000 0 0 0Estate account interest 200 0 200 0 0Totals: $ 71,722 $ 50,510 $ 11,212 $ 10,000 $12,149* Tax-exempt interest of $2,000 paid on May 1, 2010, is reported on Ronald’s Form 1040, line 8b.** Tax-exempt interest of $2,000 paid on November 1, 2010, is reported on line 1 “Other Information,” page 2 of Form 1041.

or had Barnum not elected for the estate tax to not apply,

if executor elects for estate tax to not apply



Form 1041 (Page 22-17)Income tax rules for estates are similar to those for complex trusts. Concepts illustrated in this example are discussed in more detail in Tab 21.

IncomeIncome earned on probate assets after death as well as IRD paid to the estate are reported on lines 1 through 9. Barnum reports interest from the savings account and CD ($6,500), Series EE bond ($312) and the estate account ($200). He reports dividends ($1,400) and capital gain distributions ($800).Capital gains and losses (line 4 and Schedule D). If the estate sells capital assets, the sales are reported on Schedule D (Form 1041). Capital gain distributions ($800) are reported on line 9 of Schedule D. Total gain or loss from Schedule D is carried to line 4, page 1.Tax-exempt income. The estate reports its tax-exempt interest of $2,000 on line 1 of “Other Information” (page 2 of Form 1041). When an estate earns tax-exempt interest, its deductions for administration expenses are reduced.

DeductionsAdministration expenses. Administration expenses paid by the estate and not deducted on Form 706 are fully de-ductible on Form 1041 if they would not have been incurred if property were not held by the estate (that is, they are unique to the estate).In this example, because there is no estate tax in 2010, all ad-ministration expenses are deducted on Form 1041. The indirect administration expenses must be reduced by the amount allocable to tax-exempt interest. Thus, total deductible attorney fees are $3,451 or $4,200 – [($2,000 ÷ $11,212) x $4,200]. (The $2,000 tax preparation fee can be directly attributed to taxable income.) Total deductible probate fees are $1,356, or $1,650 - [($2,000 ÷ $11,212) x $1,650]. A statement should be attached to Form 1041 that irrevocably waives the right to deduct estate administration expenses on Form 706. See Deductions on Page 21-5.

æ Practice Tip: Although the estate tax is repealed in 2010 and no Form 706 is required, the authors recommend attaching the statement. In years in which the estate tax applies, the statement is required even if no Form 706 is required to be filed.Line 20. Estate exemption is $600.

Income Distribution Deduction—Schedule BThe allocation of taxable income between the trust and the beneficiaries is calculated on Schedule B.No distributions were made from Ronald’s estate during the tax year. The estate therefore pays all of the tax on the income, and no Schedule K-1 is issued to Barnum. See Simple Trust—Detailed Example on Page 21-10 for a return with distributions to a single beneficiary. See Complex Trust—Detailed Example on Page 21-13 for a return with distributions to multiple ben-eficiaries. See also Income Distribution Deduction (Schedule B) on Page 21-7 and Distributable Net Income (Schedule B) on Page 21-7.

Reporting Modified Carryover BasisBarnum is required to file a tax return providing information on all assets other than cash owned by Ronald because Ronald’s total assets (other than cash) were worth more than $1.3 million. (Ronald had no capital or net operating loss carryforward or losses allow-able under IRC §165.) Thus, Ronald’s estate is eligible only for the $1.3 million aggregate basis increase. (See Basis increase on Page 22-12 for information about assets eligible for basis increase.) Note: The IRS has not released the form for reporting this information at the time of publication. However, the required in-formation is explained in IRC §6018(c). (See Reporting the basis allocation on Page 22-13.)After the preparer reviews the information and prepares an alloca-tion schedule (see Modified Carryover Basis Schedule on Page 22-18), he determines that of the possible $1.3 million aggregate basis increase, Ronald’s estate can only use $859,619. The execu-tor submits the information to the IRS at the time Ronald’s final Form 1040 is filed. In addition, each beneficiary is provided the basis information for the assets he or she inherited from Ronald.

Notes

Barnum elected for the estate tax to not apply

Barnum elected for the estate tax to not apply



Payroll Tax ReturnsSee IRS Publication 15 (Circular E), Employer’s Tax Guide;

Publication 15-A, Employer’s Supplemental Tax Guide; and Publication 15-B, Employer’s Tax Guide to Fringe Benefits

Court Case: The employer is responsible for payment of these taxes and cannot avoid its responsibility by transferring the taxes to another party, such as an employee or agent, and delegating payment to that party. The employer is liable until the government receives payment. [Pediatric Affiliates, 99 AFTR 2d 2007-2240 (3rd Cir. 2007)]

Depository taxes include:• Federal income tax withheld from employee wages.• Social Security tax withheld from employee wages (6.2%, up to a

maximum wage base of $106,800 each year for 2010 and 2011).• Medicare tax (1.45%, with no wage limit).• Employer matching amounts for Social Security and Medicare.• Federal unemployment (FUTA) taxes (6.2% on wage up to $7,000

through June 30, 2011, 6.0% for the remainder of 2011 and calendar years thereafter). See FUTA tax rate and wage base on Page 23-6 for state credit.

Penalties may apply if the required deposit is not on time, the de-posit is made at an unauthorized financial institution, the taxpayer deposits less than the required amount or the taxpayer does not use the EFTPS when required.Late deposit and other penalties. Penalties applying to late deposits: (IRC §6656)• 2% of required deposit if made one to five days late.• 5% of required deposit if made six to 15 days late.• 10% of required deposit if made 16 or more days late.• 10% of required deposit if made at an unauthorized financial

institution, paid directly to the IRS or paid with the tax return.• 10% of amount required to be electronically deposited using

EFTPS if deposited instead using Form 8109, paid directly to the IRS or paid with the tax return.

• 15% of required deposit if amount is still unpaid more than 10 days after the date of the first IRS notice asking for the tax due or the day demand for immediate payment is received, whichever is earlier. Note: Penalties may be waived if the failure to make a proper, timely deposit was due to a reasonable cause.

2011 Federal Withholding Computation—Quick Tax MethodPrint the 2011 worksheet and federal income tax withholding (FITW) tables from the Updates section of Quickfinder.com. It should be available in January 2011.

payroLL Tax deposiT requiremenTsBeginning January 1, 2011, an employer is required to deposit federal payroll taxes electronically using the Electronic Federal Tax Payment System (EFTPS). The system that processes the Form 8109, Federal Tax Deposit Coupon, is being eliminated News Re-lease IR–2010-92. See Electronic Federal Tax Payment System on Page 23-2.

Payroll Tax CalendarFederal withholding and FICA deposits: See Deposit Deadlines (Forms 941, 944 and 945) on Page 23-2. See also Regulation Section 31.6302-1.• Employers that report $50,000 or less in employment taxes in the look-back period must deposit taxes monthly.• Employers that report amounts greater than $50,000 in the look-back period must deposit taxes semi-weekly.• Any time payroll taxes accumulate to $100,000 or more, the deposit must be made immediately (that is, by the close of the next banking day).FUTA deposits: [Reg. §31.6302(c)-3]• Employer must generally deposit FUTA taxes if at any time the FUTA tax liability exceeds $500 in a calendar quarter. For more information, see FUTA deposit rules on Page 23-6.• Liability of $500 or less in a calendar quarter may be carried to the next quarter.Federal due dates: State due dates: Unemployment, withholding, etc.January 31: (Practitioner to fill in.)• Form W-2 must be given to each employee.• Form 941, Employer’s QUARTERLY Federal Tax Return, Fourth Quarter (or Form 944, Employer’s ANNUAL Federal Tax Return, if applicable) (10 additional days if all deposits timely). (See Pub. 15.)• Form 940, Employer’s ANNUAL Federal Unemployment (FUTA) Tax Return (10 additional days if all deposits timely). (See Pub. 15.)February 28:• Form W-3, Transmittal of Wage and Tax Statements.• Copy A of all Forms W-2 issued (March 31 if filed electronically).April 30. Form 941, Employer’s QUARTERLY Federal Tax Return, First Quarter. (See Page 23-5.)July 31. Form 941, Employer’s QUARTERLY Federal Tax Return, Second Quarter.October 31. Form 941, Employer’s QUARTERLY Federal Tax Return, Third Quarter.

Tab 23 TopicsPayroll Tax Deposit Requirements ........................ Page 23-1Payroll Tax Payments ........................................... Page 23-2Withholding Federal Income Tax ........................... Page 23-2Withholding Methods and Examples..................... Page 23-3FICA and FUTA Wage Base.................................. Page 23-4New Hire Reporting............................................... Page 23-4Recent Employment Incentives ............................ Page 23-4Payroll Tax Reporting ............................................ Page 23-5Student Employment at Educational Institution .... Page 23-8Special Compensation .......................................... Page 23-8Gross-Up Computation ......................................... Page 23-9Disregarded Entity Employment Taxes ................. Page 23-9Trust Fund Recovery Penalty ............................. Page 23-10Other Payroll Tax Issues ..................................... Page 23-10

for 2010 and 4.2% for 2011


Charitable contributions. See Charitable Contributions on Page 24-15. For C corporations, see Charitable Contributions on Page 17-13 and Charitable Contributions of Inventory on Page 17-14. See also Tab 5 and Tab 12 of the Tax Planning for Businesses Quickfinder® Handbook.Circulation expenses. The cost of increasing circulation of a newspaper, magazine or other periodical is deductible as a cur-rent operating expense, or may be capitalized and amortized as a deferred expense. (IRC §173)Club dues are generally nondeductible if the club has a principal purpose of providing access to or conducting entertainment activi-ties for members or their guests. Out-of-pocket business meals and entertainment expenses incurred at a club are deductible, subject to limits. See Tab 9. Computer software. See Computer Software on Page 24-15.Cost of goods sold. See Cost of Goods Sold (COGS) on Page 24-16.Demolition expenses. Costs incurred to demolish a structure are added to basis of the land where the demolished structure was located. (IRC §280B)Depletion. See Tab 10.Depreciation. See Tab 10.Development costs. Costs of developing a mine or other natural deposit (other than an oil or gas well) may be deducted. The costs must be paid after the discovery of ores or minerals in commercially marketable quantities [IRC §616(a)]. An election can be made to treat the costs as deferred expenses deducted ratably as the ores/minerals are sold [IRC §616(b) or to amortize the costs over ten years. [IRC §59(e)]Donations of patents, etc. A deduction for a contribution of a patent or certain other items of intellectual property to charity is limited to the lesser of (1) the taxpayer’s basis in the property or (2) the FMV. Tax-payers may deduct certain additional amounts in later years, based on a specified percentage of qualified income received by the charitable organization from the contributed property. No deduction is permitted for income received by the charity after the expiration of the legal life of the patent or other intellectual property. [IRC §170(e) and (m)]Education expenses. An employer can deduct the following employee education expenses:• Educational Assistance Program. Up to $5,250 of qualified edu-

cational assistance can be excluded from an employee’s income (IRC §127). See Tab K of the Small Business Quickfinder® Hand-book for more information about educational assistance programs.

• Working Condition Fringe Benefit [IRC §132(d)]. Employer-provided education is excludable from an employee’s income if the expense would have been deductible as a business expense if paid out of the employee’s pocket. An individual is generally not allowed to deduct education expenses if (1) the education is required to meet minimum requirements of the individual’s em-ployment or trade, or (2) the education will qualify the individual for a new trade or business. See Education Costs in Tab 5 for more information about deducting education expenses for individuals.

Employee awards. See Awards and bonuses on Page 24-1.Employee benefit programs. See Tab K of the Small Business Quickfinder® Handbook.Entertainment. See Meals and entertainment on Page 24-3.Entertainment expenses included in W-2 wages. When an employer adds the personal value of a benefit to a “specified indi-vidual’s” taxable W-2 wages, the employer’s deduction is limited to the lesser of the actual cost of the benefit or the amount included in the employee’s taxable wages. This rule applies to expenses for activities generally considered to be entertainment, amusement or recreation and facilities used in connection with such activities, such as a company airplane. “Specified individuals” generally

include officers, directors and 10% or greater owners of private and publicly held companies. [IRC §274(a) and (e)]Environmental clean-up costs. Revenue Ruling 94-38 held that costs incurred to construct groundwater treatment facilities were capital expenses. Other costs incurred to clean up land and to treat groundwater contaminated with hazardous waste resulting from business operations were deductible as business expenses. However, Revenue Ruling 2004-18 issued a clarification of the prior ruling, stating that otherwise deductible costs incurred by a manufacturing operation must be included in inventory under the uniform capitalization rules of Section 263A.If a taxpayer purchases land contaminated prior to acquisition, the clean-up cost must generally be capitalized. However, envi-ronmental remediation costs paid or incurred to clean up a state designated “qualified contaminated site” may qualify for deduction. The deduction applies for expenditures incurred through Decem-ber 31, 2009. (IRC §198)U Caution: Although the deduction for environmental remedia-tion costs expired for expenditures paid or incurred after December 31, 2009, at the time of publication Congress was considering legislation that would extend the deduction to 2010. See Tax Ex-tenders Legislation on Page 25-1.The IRS has privately applied rules similar to those for soil re-mediation costs to a taxpayer removing mold from a building. A deduction was allowed for the cost of removing mold from a nursing home where the facility was not contaminated at acquisition and the mold removal did not prolong the building’s life or increase its value. (Letter Rul. 200607003)Environmental remediation costs incurred to clean up land contami-nated with a taxpayer’s hazardous waste during operation of the taxpayer’s manufacturing activities are allocable to the inventory produced under Section 263A during the year costs are incurred. (Rev. Rul. 2005-42)Fines. See Penalties and Fines on Page 24-21.Franchise. See Intangible Assets on Page 24-18.Fringe benefits. See Tab K of the Small Business Quickfinder® Handbook.Gifts. See Awards and bonuses on Page 24-1.Goodwill. See Intangible Assets on Page 24-18.Impact fees on real estate development (Rev. Rul. 2002-9). Impact fees are one-time charges imposed by a state or local government for offsite capital improvements necessitated by a new or expanded development. The Revenue Ruling treats impact fees as capital expenses that are added to the basis of the buildings. This allows developers to depreciate impact fees over the life of constructed buildings, rather than adding the fees to the basis of nondepreciable land. Impact fees may also be considered for purposes of computing the low-income housing credit.Impairment losses. See Impairment Losses on Page 24-17.Improvements and repairs. Cost of incidental repairs that keep property in efficient operating condition and do not materially add to its value or appreciably prolong its life are deductible as current operating expenses (Reg. §1.162-4). Also see Capital expenses on Page 24-1 and Expensing Policy on Page 10-16.Insurance. See Insurance on Page 24-18.Intangible assets. See Intangible Assets on Page 24-18.Intangible drilling costs. See Intangible Drilling Costs on Page 24-19.Interest. See Interest Expenses on Page 24-19.Inventories. See Inventories in Tab L of the Small Business Quickfinder® Handbook.Investment expenses. See Investment Interest Expense on Page 5-7.

2011


Lawyers’ costs incurred on behalf of clients. Costs such as filing fees, travel expenses, expert witness fees, etc., paid by a law firm on behalf of a client may be deductible depending on the fee structure. Such expenses paid under a contingent “net fee ar-rangement” (an agreement stating expenses will be paid out of a settlement before the lawyers’ fees are determined) have generally been considered by the courts as nondeductible advances when incurred, and are not included in income when recouped. In con-trast, client expenses paid under a “gross fee arrangement” (where lawyers’ fees are based solely on a percentage of a settlement) are considered ordinary and necessary business expenses and are deductible when incurred. [Boccardo, 75 AFTR 2d 95-2244 (9th Cir. 1995)]Lease payments. See Lease and Rental Expenses on Page 24-20.Legal and professional fees. Legal, accounting and other profes-sional fees that are ordinary and necessary expenses of operating a business are deductible as a current operating expense. Fees paid to acquire a business asset must be added to its basis. Fees paid to organize a partnership or corporation are deducted as a current business expense up to $5,000. The $5,000 deduction is reduced for organizational costs exceeding $50,000. Any remaining costs are amortized over 180 months (IRC §248 and 709). See Organizational and Start-up Costs on Page 10-22. Licenses and fees. Annual license and regulatory fees paid to state or local governments generally are deductible. However, costs for licenses that are essential to the establishment of a taxpayer’s trade or business must be capitalized. For example, costs of acquiring (including issuing or renewing) a liquor license, taxicab medallion or license, or a television or radio broadcasting license must be amortized as Section 197 intangibles.Lodging. Expenses incurred in connection with business travel are deductible if reasonable and necessary. The travel must be directly related to the conduct of the taxpayer’s business. Personal activities during business travel will not automatically disqualify the deduction, but the trip must be primarily for business in order to qualify for deduction. [IRC §162(a)(2)]Losses. See Business Bad Debts on Page 24-13, Capital Gains and Losses on Page 24-14, Demolition Expenses or Losses on Page 24-16 and Impairment Losses on Page 24-17.Machinery parts. Unless the Uniform Capitalization Rules (Tab L of the Small Business Quickfinder® Handbook) apply, the cost of replacing short-lived parts of a machine to keep it in working condition are deductible.Meals and entertainment. In general, 50% of business-related meal and entertainment expenses are deductible [IRC §274(n)]. The limit applies to employers (including partnerships and corpora-tions) even if they reimburse employees for 100% of the expenses. See Tab K of the Small Business Quickfinder® Handbook for dis-cussion and exceptions to the 50% limit.Moving or installing machinery. The cost of moving machinery from one location to another is deductible. The cost of installing newly purchased machinery is added to the machinery’s basis.Nonaccountable plan. Employee expense reimbursements made under a plan that does not meet the requirements for an accountable plan (see Accountable plan on Page 24-1) are considered made under a nonaccountable plan. Reimbursements made under a nonaccountable plan are taxable wages to the employee.Not-for-profit activities. If an activity is not engaged in for profit, the deduction for expenses associated with the activity is limited to income. The deduction limit applies to individuals, partnerships, estates, trusts and S corpora-tions, but not to C corporations [Reg. §1.183-1(a), IRS Pub. 535]. See information about hobby loss limits in Tab 6.Office in home. See Home Office for the Small Business in Tab P of the Small Business Quickfinder® Handbook. See also Business Use of Home on Page 6-9.

Organizational costs. See Organizational and Start-Up Costs on Page 10-22.Outplacement services. The cost of providing out-placement services to employees to help them find new employment is deductible if the services are provided on the basis of need and a substantial business benefit exists for the employer (positive business image, maintaining employee morale, avoiding wrongful termination suits, etc.). If the employee can choose to receive cash or taxable benefits in place of the services, the value of the services is included in the employee’s income. (Rev. Rul. 92-69)Payroll. See Salaries and Wages on Page 24-22 and Taxes on Page 24-23. See Tab 23 and Tab K of the Small Business Quick-finder® Handbook for more information.Penalties and fines. See Penalties and Fines on Page 24-21.Personal expenses. In general, personal expenses are not deductible [IRC §262(a)]. If an expense relates to an item that is used for both personal and business purposes, only the business portion may be deducted.Political and lobbying expenses. Amounts paid to influence legislative matters or to participate in political campaigns gener-ally are not deductible [IRC §162(e)]. Dues paid to a tax-exempt organization are not deductible to the extent the amounts are used by the organization for nondeductible lobbying activities. Paying for advertising in convention programs or admission to dinners or inaugural events is considered an indirect political contribution and is not deductible if any of the proceeds are for the benefit of a party or candidate.An exception exists for expenses of lobbying a local governing body with regard to local legislation that is of legitimate business interest to the taxpayer. In addition, a de minimis exception states that in-house expenses connected with lobbying are deductible, but only if the total of such expenses do not exceed $2,000 for the tax year. A professional lobbyist is allowed to deduct business expenses in connection with lobbying.Qualified disaster expenses. Expenses that qualify as disaster expenses incurred in connection with a trade or business under Section 198A and are paid after 2007 for disasters occurring before 2010 may, at the election of the taxpayer, be deducted. See also Disaster Relief for Businesses on Page 25-1.U Caution: Although The deduction for qualified di-saster expenses expired for expenditures on account of disasters occurring after December 31, 2009, at the time of publication Congress was considering legislation that would extend the deduction to 2010. See Tax Extenders Legislation on Page 25-1.Reimbursed employee expenses. See Accountable plan on Page 24-1.Rent. See Lease and Rental Expenses on Page 24-20.Repairs. See Improvements and repairs on Page 24-2.Research and development costs. See Research and Develop-ment Costs on Page 24-22.Restaurant or tavern smallwares (Rev. Proc. 2002-12). Costs of replacing smallwares such as glassware, dinnerware, pots and pans, tabletop items, kitchen utensils and food storage supplies are deducted in the year they are available for use at a taxpayer’s restaurant. An automatic change in accounting method is available subject to limitations set forth in the Revenue Procedure. Note: The deduction is for replacement items only. Costs of opening a restaurant with an inclusive package of smallwares purchased as part of a business acquisition must be deducted and/or amortized or capitalized as start-up costs.Retirement plans. See Tab K of the Small Business Quickfinder® Handbook.Rotable spare parts. Companies that provide maintenance con-tracts with equipment sold or leased often use spare parts from pools to complete repairs, then recondition the old parts and return


them to the pool for later use. These “rotable spare parts” are treated as depreciable assets, not inventory. (Rev. Rul. 2003-37)Start-up costs. See Organizational and Start-Up Costs on Page 10-22.Supplies and materials. Costs of incidental supplies and materials are deductible as current operating expenses. This includes office supplies, books and equipment with a useful life of less than one year. If an unusually large purchase is made, the cost is considered a pre-paid expense, and a deduction is not allowed until the year in which the items are used. Supplies and materials used to manufacture a product are added to inventory and deducted as cost of goods sold.Taxes. See Taxes on Page 24-23.Tools. The cost of tools with a useful life of less than one year is generally deductible when purchased, unless the Uniform Capitalization Rules (Tab L of the Small Business Quickfinder® Handbook) apply. Tools with a useful life of more than one year are depreciated. Tab 10 covers depreciation.Trademark and trade names. See Intangible Assets on Page 24-18.Travel. Costs for transportation, lodging and meals are generally deductible if the expenses are reasonable and necessary, and if the trip is primarily for business. See Lodging and Meals and entertainment, both on Page 24-3.Truck and trailer tires. Revenue Procedure 2002-27 establishes the original tire capitalization method (OTCM). Under the method, the cost of original tires is depreciated as part of the vehicle and the cost of replacement tires is deducted as a current expense. A taxpayer must use OTCM consistently for all its vehicles.Wages. See Salaries and Wages on Page 24-22.

u.s. produCTion deduCTionIRC §199; see also Page 24-6 for a Filled-In Sample Form 8903

and Page 24-24 for a U.S. Producer Deduction WorksheetTaxpayers can deduct (for both regular tax and AMT) a percent-age of their qualified domestic production activities income (IRC §199). C corporations, S corporations, LLCs, partnerships, sole proprietorships, cooperatives, estates and trusts may all claim this domestic producers deduction (DPD).U Caution: The DPD does not reduce self-employment (SE) earnings for SE tax. [IRC §1402(a)(16)]

DPD Key Terms and AcronymsDPD Domestic Producers Deduction

DPGR Domestic Production Gross ReceiptsMPGE Manufactured, Produced, Grown or ExtractedQPAI Qualified Production Activities IncomeQPP Qualified Production Property

The deduction equals a percentage of the lesser of the business’s (1) qualified production activities income (QPAI) or (2) taxable in-come (AGI for individual taxpayers) determined without regard to the DPD. QPAI equals the taxpayer’s domestic production gross receipts (DPGR) for the year less cost of goods sold and other expenses properly allocable to DPGR.The DPD cannot exceed 50% of the taxpayer’s W-2 wages that are properly allocable to DPGR for the tax year.

DPD PercentageTax Year Begins in Percentage1

2005 or 2006 ...................... .............................3%2007 through 2009 .................. .............................6%2010 and thereafter .................. .............................9%

1 For tax years beginning after 2009, oil-related QPAI is reduced by 3% of the least of the taxpayer’s: [IRC §199(d)(9)]• Oil-related QPAI (a broadly defined term) for the tax year; • QPAI for the tax year; or • Taxable income, determined without regard to the DPD [for individuals,

modified AGI as defined in Section 199(d)(2)]. This effectively freezes the DPD for oil-related income at 6%.

UCaution: Practitioners should continue to watch for IRS re-leases on Section 199 issues to ensure that all available guidance is considered in planning for and preparing clients’ DPD computations.

What Is QPP?Definition. Section 199(c)(5) provides that the term QPP includes tangible personal property, computer software and sound recordings. [Reg. §1.199-3(j)]• The fact that property is personal property or tangible

property under local law is not controlling.• Property may be tangible personal property for Section 199 even

if local law considers it a fixture (real property).• Tangible personal property does not include land, buildings,

inherently permanent structures or land improvements, oil and gas wells or infrastructure.

Examples. Machinery, printing presses, transportation equipment, office equipment, refrigerators, grocery counters, testing equip-ment, display racks and shelves and signs that are contained in or attached to a building are tangible property for the DPD. Fur-thermore, property that is in the nature of machinery, other than structural components of a building, is tangible personal property even though located outside a building. For example, a gasoline pump, hydraulic car lift or automatic vending machine, although attached to the ground outside, is tangible personal property.æ Practice Tip: It may be helpful to review the old investment credit rules in Regulation Section 1.48-1, since those rules dealt with these same concepts and can provide some valuable information on the distinctions between real property and tangible personal property.

“In Significant Part” Requirement Taxpayers must manufacture, produce, grow or extract QPP in whole or in significant part within the U.S. A taxpayer manufactures QPP in significant part if the taxpayer meets one of two tests. [Reg. §1.199-3(g)]Substantial in

Nature Test• Based on all of the taxpayer’s facts and circumstances,

the manufacturing, production, growth or extraction activity performed by the taxpayer in the U.S. is substantial in nature.

Safe Harbor Test

• The taxpayer’s direct labor and overhead for the manufacture, production, growth and extraction of the QPP within the U.S. account for 20% or more of the taxpayer’s cost of goods sold, or in a transaction without cost of goods sold (such as a lease, rental or license) account for 20% or more of the taxpayer’s unadjusted depreciable basis of the QPP.

• Taxpayers subject to the UNICAP rules: overhead includes all costs required to be capitalized under Section 263A except for direct materials and direct labor.

• Taxpayers not subject to UNICAP can compute overhead using any reasonable method, but overhead cannot include any costs that would not be required to be capitalized under Section 263A.

Note: A taxpayer engaging in only packaging, repackaging, labeling and minor assembly operations must disregard the substantial in nature and safe harbor tests because these activities are not MPGE activities. [Reg. §1.199-3(e)(2)]

“In the U.S.” RequirementU.S.

Defined• The 50 states, District of Columbia, U.S. territorial waters and the

seabeds and subsoils of any waters adjacent to U.S. territorial waters that the U.S. has exclusive exploration and exploitation rights over. [Reg. §1.199-3(h)]

• Taxpayers with foreign activities must allocate gross receipts. Imports • Some taxpayers import partially manufactured items and then finish

the process in the U.S.• To the extent that the taxpayer’s actions, given all of the facts and

circumstances, are substantial, the gross receipts from the activity will qualify as DPGR.

Exports • If the taxpayer manufactures a product in the U.S. and then exports it, all of the gross receipts will be DPGR, regardless of whether the taxpayer imports the property back into the U.S. for final disposition. [Reg. §1.199-3(g)(5), Ex. 5]

Note: The DPD for certain Puerto Rico activities was previously extended to tax years beginning in 2008 and 2009. At the time of publication, Congress was considering legislation that would extend it to 2010. See Tax Extenders Legislation on Page 25-1.

2010 and 2011

is


General Business Tax Credit Summary1

Tax Credit IRC § For Rate IRS Pubs

Tax Forms

Agricultural Chemicals Security

45O Retailers, distributors, formulators, aerial applicators and manufacturers of specified agricultural chemicals.

30% of qualified expenditures subject to facility and annual limitations.

334 8931

Alcohol and Cellulosic Biofuel Fuels

40 Sale of straight alcohol or mixture as fuel at retail or use in business. Rate varies depending on mixture. 334 64782

Biodiesel and Renewable Diesel Used as Fuel3

40A Use in the production of biodiesel mixture; use of biodiesel in a trade or business or sale at retail; production of qualified agri-biodiesel. For biodiesel mixture and biodiesel components, $1 rate applies if agri-biodiesel or renewable diesel (may include certain aviation fuel) is used.

Biodiesel mixture: $1 per gallon used. Biodiesel: $1 per gallon used or sold at retail. Agri-biodiesel: 10¢ for each gallon produced.

334 8864

Carbon Dioxide Sequestration

45Q The capture of carbon dioxide from an industrial source that would otherwise be released into the atmosphere as greenhouse gas.

For 2010, $20.24 per metric ton of qualified carbon dioxide captured at a qualified facility ($10.12 per metric ton if used as a tertiary injectant in oil/gas recovery).

334 8933

Differential Wage Payment3 45P Small business employers paying differential wage payments to qualified employees that are active duty uniformed service members.

20% of eligible differential wage payments; $20,000 maximum wage payments per year per employee.

334 8932

Disabled Access 44 Expenses to make business accessible to or usable by disabled. 50%; $5,000 maximum credit. 334 8826Distilled Spirits 5011 Wholesalers and warehousers of distilled spirits. For 2010, 13.756¢ per case of distilled spirits

purchased or stored.334 8906

Employer-Paid FICA on Tips 45B Amount paid on tips above minimum wage. 100% of eligible amounts. 334 88462

Employer-Provided Child Care

45F Employers who provide child care and related services to employees.

25% of qualified child care facility plus 10% of resource and referral costs.

551 8882

Empowerment Zone and Renewal Community Employment

1396 and

1400H

Wages paid to employees working in selected geographic areas. Empowerment zone: 20% of wages up to $15,000; Renewal community: 15% of wages up to $10,000.

954 88442

Energy Credits Var. See Energy Tax Incentives for Businesses on Page 24-8. Varies 334 Var.Indian Employment3 45A Wages and health insurance costs paid to members of an Indian

tribe or spouse for services performed on a reservation. 20% of increase over amount paid in 1993. 334

9548845

Investment Credit:• Rehabilitation Property• Energy Credit• Qualifying Advanced Coal

Project• Qualifying Gasification

Project• Qualified Advanced Energy

Project• Therapeutic Discovery

4748

48A

48B

48C(d)

48D

• Pre-1936 nonresidential buildings/certified historic structures.• Equipment that uses solar energy to generate electricity, to heat

or cool or provide hot water for use in a structure, or to provide solar process heat. Also, equipment used to produce or use energy derived from a geothermal deposit.

• Investment in qualifying advanced coal project.• Investment in qualifying gasification project.• Investment in qualifying advanced energy project. • Investment in qualifying therapeutic discovery project.

• 10% for pre-1936 buildings; 20% for historic structures.

• 10%; 30% for qualified fuel cell and certain solar energy property.

• 15% or 20% of qualified investment.• 20% of qualified investment.• Up to 30% of qualified investment. • Up to 50% of qualified investment.

334 3468

Low-Income Housing 42 Owners of residential rental buildings providing qualified low-income housing.

70% (or 30%) of qualified building basis over 10 years. 334 85868609-

ALow-Sulfur Diesel Fuel 45H Production of low-sulfur diesel fuel by a small business refiner. 5¢ for each gallon produced. 334 8896Mine Rescue Team Training3 45N Training program costs for qualified employees. 20% of up to $50,000/employee. 334 8923New Markets3 45D Investment in community development entities. 5% – 6% per year over seven years. 954 8874Nonconventional Source Fuel

45K Production of fuel from a nonconventional source. $3 per barrel-of-oil equivalent sold, subject to inflation adjustment and phase out.4

334 8907

Nuclear Power Facility 45J Production of electricity at an advanced nuclear power facility. 1.8¢ per kwh of electricity sold. 5 5

Orphan Drug 45C Expenses in testing certain drugs for rare diseases or conditions. 50% of qualified clinical testing costs. 334 8820Pension Plan Start-Up Costs 45E Credit for start-up costs of new employer retirement plans.

Employer cannot have more than 100 employees.50% of eligible costs up to a maximum credit of $500, for first 3 years of plan.

560 8881

Railroad Track Maintenance3 45G Costs to maintain certain railroad track, roadbed, bridges, etc. 50%; not over $3,500 × track miles. 5 89002

Renewable Electricity Refined Coal and Indian Coal Production

45 • Electricity sold that was produced using wind, closed-loop biomass, geothermal, and solar sources or marine and hydrokinetic renewables.

• Steel industry fuel produced at a qualified refined coal production facility.

• Refined coal or Indian coal produced at qualified facilities.

• 2.2¢ per kwh of electricity sold (wind, etc.) or 1.1¢ per kwh (marine, etc.).

• $6.27 (refined) or $2.20 (Indian) per ton of coal sold.• $2.87 per barrel-of-oil equivalent produced and sold.• Phaseout rules may apply to electricity and refined

coal.

334 8835

Research Credit3 41 Business research and experimental expenditures. 20% of expenses over base amount. 334 6765Retained Worker – Employers that retain workers that qualified for the payroll tax

holiday for new employees provided by the HIRE Act §102. 6.2% of the wages paid during a 52-consecutive-week period; $1,000 maximum credit per retained worker.

5 5884-B

Small Employer Health Insurance

45R Qualified small employers that pay at least 50% of a qualified health arrangement for their employees.

Up to 35% (25% for tax-exempt organizations) of the lesser of: (1) the amount contributed or (2) the small business benchmark premium.

5 89412

Work Opportunity 51 Effective for work begun before 9/1/11. Employment of specially targeted group of individuals.

Generally, 40% of $6,000 of first-year wages; 25%/0% if worked under 400/120 hrs. Rates vary for certain targeted groups.

954 58842

8850

1 At the time of publication, only a draft version of the 2010 Form 3800 was available. See the final version of Form 3800, the other referenced forms and their instructions for details of these credits and others that may be required 2010 Form 3800 entries.

2 Credit does not carry to page 1 of Form 3800.3 Although these credits expired December 31, 2009, at the time of publication Congress was considering legislation that would extend them to 2010. See Tax Extenders

Legislation on Page 25-1.4 Notice 2010-31 contains the 2009 amounts—$56.39 reference price; $3.40 credit amount for coke or coke gas only. The IRS will publish the 2010 amounts by April 2011 in a Notice.5 No IRS Publication and/or Form addressed these particular tax credits at the time this material went to print.See Tab 12 for information on personal tax credits.

they were extended by the 2010 Tax Relief Act to apply in 2010 and 2011

1/1/12

had


New qualified fuel cell vehicle credit. A qualified fuel cell vehicle is a motor vehicle that is propelled by power derived from one or more cells that convert chemical energy directly into electricity by combining oxygen with hydrogen fuel that is stored on board the vehicle and may or may not require reformation prior to use. [IRC §30B(b)]

The fuel cell credit has two parts: (1) a flat amount based on the vehicle’s weight and (2) an additional amount based on fuel ef-ficiency improvements compared to 2002 models. To be eligible for this credit, fuel cell vehicles must also meet certain federal emission standards.

Search www.irs.gov for “Qualified Fuel Cell Vehicles” to see the list of vehicles the IRS has certified as qualifying for the credit.

New Qualified Fuel Cell Vehicle Credit—Base Credit AmountsCredit Amount Gross Vehicle Weight Rating (GVWR) in Pounds

$ 8,000* Vehicle ≤ 8,50010,000 8,500 < vehicle ≤ 14,00020,000 14,000 < vehicle ≤ 26,00040,000 26,000 < vehicle

* $4,000 for vehicles placed in service after 2009.

New qualified alternative fuel motor vehicle credit. New qualified alternative fuel motor ve-hicles include those capable of running only on compressed or liquefied natural gas, liquefied petroleum gas, hydrogen or any liquid that is at least 85% methanol. Reduced credits are allowed for mixed-fuel vehicles (which include only vehicles weighing more than 14,000 pounds) that run on a mixture that consists of at least 75% of an alternative fuel and not more than 25% of a petroleum-based fuel. To qualify for this credit, mixed-fuel vehicles must also meet certain federal emission standards. [IRC §30B(e)]

Search www.irs.gov for “Qualified Alternative Fuel Motor Vehicles” to see the list of vehicles the IRS has certified as qualifying for the credit.U Caution: This credit does not apply to property placed in service after 2010.Plug-in conversion credit. A tax credit is allowed for plug-in electric drive conversion kits. The credit equals 10% of the cost of converting a vehicle to a Section 30D qualified plug-in electric drive motor vehicle that is placed in service after February 17, 2009 and be-fore 2012. The maximum amount of the credit is $4,000. Taxpayers may claim this credit even if they claimed a hybrid vehicle credit for the same vehicle in an earlier year.

Vehicle Refueling Property CreditForm 8911; see also IRC §30CTaxpayers may claim a 30% credit for the cost of installing clean-fuel vehicle refueling property to be used in a trade or business or installed at the taxpayer’s principal residence. The credit generally applies to property placed in service after 2005 and before 2011 (before 2015 for hydrogen-related property).The maximum allowable credit is:• $30,000 for business property.• $1,000 for property installed at a principal residence.

Special rules apply for property placed in service during 2010. For non-hydrogen property, the following increases apply: • 50% replaces the 30% credit.• $50,000 replaces the $30,000 maximum credit.• $2,000 replaces the $1,000 maximum credit for prop-

erty installed at a principal residence.For hydrogen property, the maximum credit is increased to $200,000.Qualified alternative fuel vehicle refueling (QAFVR) property is any property, not including a building and its structural components, whose original use begins with the taxpayer, that is depreciable (not required for the $1,000/$2,000 credit) and that:1) Stores or dispenses a clean-burning fuel into the fuel tank of a

vehicle propelled by that fuel, but only if the storage or dispens-ing of the fuel is at the point where the fuel is delivered into the fuel tank of the vehicle or

2) Recharges vehicles propelled by electricity, but only if the prop-erty is located at the point where the vehicles are recharged.

Clean-burning fuels include:• Any fuel at least 85% of which consists of one or a mixture of

ethanol, natural gas, compressed natural gas, liquefied natural gas, liquefied petroleum gas or hydrogen.

• Any fuel that is a mixture of diesel fuel and biodiesel determined without regard to any use of kerosene and containing at least 20% biodiesel.

• Electricity.The tax basis of QAFVR property is reduced by the portion of the property’s cost allowed as a credit. Notice 2007-43 provides interim guidance on the credit pending issuance of regulations.

Plug-In Electric Drive Motor Vehicle Credit Form 8936, IRC §30DTaxpayers can claim a credit for each qualifying vehicle purchased. The portion of the credit attributable to the business-use percentage of the vehicle is treated as part of the taxpayer’s general business credit. The remainder is treated as a nonrefundable personal credit that can offset both regular tax and AMT (IRC §30D). Phase-out rules similar to those for the manufacturers of hybrid vehicles (see Phase-out based on vehicle sales on Page 24-9) will apply when a manufacturer sells 200,000 qualifying vehicles. Vehicles acquired after 2009. A credit is available for 4-wheeled vehicles propelled to a significant extent by an electric motor that draws electricity from a battery that has a capacity of at least four kilowatt hours, and is capable of being recharged from an external electricity source. The credit equals $2,500, plus for vehicles that draw propulsion energy from a battery with at least five kilowatt hours of capacity, $417 for each kilowatt hour of capacity in excess of five kilowatt hours up to a total of $5,000. Therefore, the total amount of the credit allowed for a vehicle is limited to $7,500. However, vehicles manufactured primarily for off-road use, such as for use on a golf course, do not qualify. Purchasers can rely on a manufacturer’s certification (unless withdrawn by the IRS) that a vehicle is eligible for the credit and the credit amount. (Notice 2009-89, sections 5.02 and 5.09)N Observation: The IRS will acknowledge manufacturers’ cer-tifications within 30 days of receipt of the request for certification (Notice 2009-89, section 5.04). Search www.irs.gov for “Qualified Vehicles Acquired after 12-31-2009” to see lists of vehicles, by manufacturer, that the IRS has certified as qualifying for the credit.

2012


Low-Speed and 2- and 3-Wheeled VehiclesForm 8834; IRC §30For vehicles purchased after February 17, 2009 and before 2012, a nonrefundable credit is available to purchasers of the following plug-in electric vehicles, if they meet certain technical require-ments: (IRC §30)1) Low-speed vehicles (four-wheeled vehicles with maximum

speed between 20 and 25 miles per hour and a gross vehicle weight rating of 3,000 pounds or less),

2) Motorcycles and3) Three-wheeled vehicles.The credit is 10% of the cost (less any Section 179 deduction, if used in business), capped at $2,500. The vehicles must be new (not used). Taxpayers can rely on a manufacturer’s certification that the vehicle qualifies for the credit unless the IRS announces a withdrawal of the certificate. (Notice 2009-58, as amplified by Notice 2009-89)The IRS has certified several manufacturers’ vehicles as qualifying for the credit. Go to www.irs.gov and search for “Plug-In Electric Vehicles” for the most recent list.U Caution: After 2009, a vehicle that qualifies for a credit under Section 30 does not qualify for the credit under Section 30D.

Energy Efficient Home Builders CreditForm 8908; see also IRC §45LContractors that build new energy efficient homes in the U.S. may claim a tax credit of $2,000 per dwelling unit for homes sold after 2005 and before 2010. To qualify, the unit must be certified to have annual energy consumption for heating and cooling that is at least 50% less than comparable units and meet certain other requirements. The credit can also apply to a substantial reconstruction and rehabilitation of an existing dwelling unit because that counts as new construction for this purpose. A manufac-tured home that meets a 30% reduced energy consumption standard can generate a $1,000 credit. These credits only apply to homes sold by contractors for use as personal residences. The contractor’s tax basis in the home is reduced by the amount of the credit. The credit applies through 2009.U Caution: Although the energy efficient home builder’s credit expired for homes acquired after December 31, 2009, at the time of publication Congress was considering legislation that would extend it 2010. See Tax Extenders Legislation on Page Q-1. IRS has guidance on the certification process that builders must complete to qualify for the credit. See Notice 2008-35 for standard homes rules. Notice 2008-36 covers manufactured homes. A list of software programs that may be used in calculating energy consump-tion for purposes of obtaining a certification is available at www.irs.gov/businesses/small/industries/article/0,,id=155445,00.html.

Commercial Buildings DeductionSection 179D allows businesses to deduct, rather than capitalize and depreciate, all or part of the cost of energy efficient commer-cial building property. The deduction is allowed only for qualifying property placed in service in 2006 through 2013. IRS guidance in Notices 2006-52 and 2008-40 is summarized below.Qualifying property. Energy efficient commercial building property is depreciable property that is:• Installed on or in a building located in the U.S. that is not a single-

family house, a multi-family structure of three stories or fewer above grade, a mobile home or a manufactured house.

• Part of the (1) interior lighting system, (2) heating, cooling, ventilation and hot water systems or (3) the building envelope.

• Certified that it will reduce or is part of a plan to reduce the overall energy costs of these systems by 50% or more.

Deduction limits. There are several deduction limits to consider:

• Qualifying property. For any one building, the total deduction for property meeting the 50% or more energy reduction requirement is limited to $1.80 times building square footage.

• Partially qualifying property. Property that reduces energy costs between 162/3% and 50% is still eligible for a reduced deduction that is limited to 60¢ times the building square footage.

Note: Pending issuance of final regulations, special interim rules apply to certain lighting systems that reduce lighting power density by at least 25% (50% for warehouses).

Certification. Before claiming the deduction, the property must be certified as meeting the requirements by an unrelated qualified and licensed engineer or contractor. Taxpayers must retain these certifications in their tax records.

Software programs. The Department of Energy maintains a public list of software that may be used to calculate energy and power consumption and costs as part of the certification process. The list appears at www1.eere.energy.gov/buildings/qualified_software.html.

Appliance Manufacturers CreditForm 8909; see also IRC §45MA business tax credit is available for the manufacture of qualifying energy efficient dishwashers, clothes washers and refrigerators in the U.S.

The per-appliance credit amount depends on the type of ap-pliance. The taxpayer’s cumulative credit amount for all years generally cannot exceed $75 million. However, with some excep-tion, a “fresh start” is allowed in calculating the cumulative credit amount by considering only credits claimed in tax years beginning after 2007 (previously claimed credits are “not counted”). Also, the credit amount for a tax year cannot exceed 2% of average annual gross receipts for the preceding two calendar years. This credit will benefit consumers to the extent appliance manufactur-ers pass along their tax savings.

“Thiscalendarhas11daysaweek,9weeksamonth,and17monthsayear.IboughtitattheTimeManagementSeminar.”

2011

three tax

Law Change Alert: The 2010 Tax Relief Act has extended the credit to apply to appliances manufactured in 2011 and made some modifications.

2012


Accounting for Bookkeeping Accounting for Income TaxCharitable

Contributions Generally deductible as incurred and recorded at FMV. An

unconditional promise to give cash should be recorded at the time it is promised by increasing a liability and recording contribution expense.

Fully deductible. No adjusted gross income (AGI) or taxable income limitation.

Individuals (including partners and S corporation shareholders) can deduct charitable contributions on Schedule A of Form 1040. The deduction is limited to 50% of AGI (30% and 20% limits apply to certain contributions) [IRC §170(b)(1)]. Excess contributions are carried forward for five years.C corporations can deduct charitable contributions as a business expense. The deduction is limited to 10% of the corporation’s taxable income before considering the charitable contribution [IRC §170(b)(2)]. Contributions that exceed the 10% limit are carried forward for five years. [IRC §170(d)(2)(A)]

Circulation Expenses

Generally deductible as incurred. Capitalized and written off as part of basis if the asset has

a reasonably determinable useful life. [IRC §312(n)(3)]

The cost to establish, maintain or increase circulation of a newspaper, magazine or other periodical is currently deductible, or may be capitalized and amortized as a deferred expense. (IRC §173)

For personal holding companies and noncorporate taxpayers, expenses are amortized over three years. [IRC §56(b)(2)]

Computer Software

FASB ASC 350-40, Intangibles–Goodwill and Other–Internal Use Software (original pronouncement was AICPA Statement of Position 98-1), governs accounting for internal-use software, which is software acquired, internally-developed or modified solely to meet the entity’s internal needs, if during the software’s development or modification, no substantive plan exists or is being developed to market the software externally.Capitalized or Expensed SoftwarePreliminary Project Stage. Internal and external costs incurred are expensed as incurred.Application and Development Stage. Internal and external costs in-curred are capitalized. Costs to develop or obtain software allowing for access or conversion of old data by new systems are capitalized. Training costs, and data conversion costs not mentioned in the previous sentence, are expensed as incurred.Post-Implementation/Operation Stage. Internal and external training costs and maintenance costs are expensed as incurred.Capitalized SoftwareCapitalized costs of computer software developed or obtained for in-ternal use include: (1) external direct costs of materials and services used in developing or obtaining the software; (2) payroll, payroll taxes and employee benefit costs for employees directly associated with and devoting time to the internal-use software project, to the extent time is spent directly on the project and (3) interest costs incurred in developing internal-use software. Note: General and administrative costs and overhead costs incurred in developing or obtaining internal-use software are expensed as incurred. Software’s Purchase Price Includes Multiple ElementsThe purchase price of developing or obtaining internal-use software can include multiple elements, such as software training, main-tenance, data conversion, reengineering, future upgrades and enhancements. In such a case, the entity allocates the purchase price among the different elements. The elements of cost are then expensed or capitalized in accordance with the rules discussed above regarding expensing versus capitalization. N Observation: Different capitalization versus expensing rules may apply for software sold, leased, or otherwise marketed and for software used in research and development. See Research and Development Costs on Page 24-22.

Cost of acquired computer software:• Software included in the purchase price of a computer

(not separately stated) is added to the basis of the computer and depreciated over five years, or expensed under Section 179.

• Software readily available for purchase by the general public is depreciated over 36 months using the SL method, beginning with the month the software is placed in service [IRC §167(f)(1)]. Note: Include depreciation on line 16 of Form 4562 as “Other depreciation.”

• For tax years beginning after 2002 and before 2012, the cost of off-the-shelf computer software is eligible for a Section 179 deduction. [IRC §179(d)(1)]

• Software purchased with a useful life of less than one year is deductible as a current expense. [Reg. §1.263(a)-4(f)(1)]

Cost of developing software (Rev. Proc. 2000-50). The cost of developing software closely resembles research and experimental expenses under Section 174.• Treat costs as a current expense, or• Capitalize and amortize over 60 months from the date of completion of

the development, or 36 months from the date the software is placed in service.

Leased or licensed software. Deduct as a rental expense.Software included in the purchase price of a trade or business. Amortize over 15 years. [IRC §197(e)(3)]


2013


Accounting for Bookkeeping Accounting for Income TaxCost of

Goods Sold (COGS)

Revenue is recognized at the point of sale. The cost of a product is not deductible until it is sold. GAAP requires the accrual accounting method so that revenues and related expenses are reported in the same accounting period.In determining the cost of goods sold (COGS), an inventory account is maintained to keep track of the tangible personal property on hand that may be classified as raw materials, work in process and finished goods. Long-term assets subject to depreciation and selling expenses are not included in inventory. GAAP requires certain overhead expenses to be included in inventory.Under the periodic system, a physical count of inventory on hand is taken as of a specific date. The net change between the beginning and ending inventories determines the COGS amount. Various COGS expense accounts are used to record daily transactions such as purchases, purchase returns and allowances, purchase discounts and freight-in. At the end of the period, inventory is debited or credited to its actual balance, the expense accounts are debited or credited to eliminate existing balances, and a COGS account is debited to balance the entry.Under the perpetual system, inventory records are maintained and updated continuously as items are purchased and sold. The inventory account is debited when an item is purchased. The COGS account is debited and inventory is credited when the item is sold. At the end of the accounting period, inventory is adjusted to the actual physical count.

The cost of an item that is produced or purchased for sale to customers is deductible. An inventory account must be kept when the production, purchase or sale of merchandise is an income-producing factor. The accrual accounting method must generally be used for inventory transactions, even though the cash method may be used for service-related transactions. (Reg. §1.446-1)Example: An auto repair shop reports the purchase and sale of parts on the accrual basis while using the cash method to report labor charges and general operating expenses. See Inventory Methods in Tab L of the Small Business Quickfinder® Handbook.UNICAP. Under Section 263A, an allocable portion of most indirect costs must be included in inventory and expensed under the cost of goods sold rules. See Uniform Capitalization Rules in Tab L of the Small Business Quickfinder® Handbook for more information.Exception (Rev. Procs. 2001-10 and 2008-52): An exception to the accrual requirement for inventory applies for taxpayers with average annual gross receipts of $1 million or less. Under this exception, the taxpayer can use the cash method of accounting even though the production, purchase or sale of merchandise is an income-producing factor. However, the taxpayer must still account for the purchase of inventory in the same manner as materials and supplies. Materials and supplies cannot be deducted until they are used. (Reg. §1.162-3)Another exception to the accrual requirement applies when gross receipts are $10 million or less. However, this exception generally excludes manufacturers, wholesalers, retailers, miners, certain publishers, and certain information industries unless they are principally a service business or perform certain kinds of custom manufacturing. (Rev. Proc. 2002-28)See Accounting Methods in Tab L of the Small Business Quickfinder® Handbook, for more details.

Demolition Expenses or

Losses

Although there is no direct guidance in the current FASB Codification, a practical method of accounting for demolition is to add costs less salvage value to the basis of the land. Costs added would include the adjusted basis of any demolished structure and the cost of demolition. This treatment is supported by a former AICPA Statement of Position, Accounting for Certain Costs Related to Property, Plant, and Equipment, which was discontinued in 2004. GAAP for the types of assets that might be susceptible to demolition is now provided in FASB ASC 360, Property, Plant, and Equipment.

Costs incurred to demolish a structure must be added to the basis of the land where the demolished structure was located. [IRC §280B(2)]

Depletion Cost depletion is the basic method of computing a depletion deduction. An estimate is made of the amount of natural resources to be extracted in units, tons, barrels or any other measurement. The estimate of total recoverable units is divided into the total cost of the depletable asset to arrive at a depletion rate per unit. The annual depletion expense is the rate per unit times the number of units extracted during the year.If there is a revision of the estimated number of units that are expected to be extracted, a new unit rate is computed. The cost of the natural resource property is reduced each year by the amount of the depletion expense for the year.

A depletion deduction is allowed only if a taxpayer has an economic interest (generally an owner or operator) in mineral property, an oil, gas or geothermal well, or standing timber. See Depletion on Page 10-9 for more information.

With respect to each property, the excess of the depletion deduction for regular tax purposes over the adjusted basis in the property (determined without regard to the depletion deduction for the tax year) is added back into income for AMT purposes. Exception: Depletion taken by independent oil and gas producers and royalty owners. [IRC §57(a)(1)]

Depreciation The cost of an asset minus its salvage value (if any) is depreciated over the estimated useful life of the asset. The useful life is the period for which services are expected to be rendered by the asset, and it can vary from company to company. GAAP allows several depreciation methods including straight-line (SL), units-of-production, sum-of-the-years’-digits and DB.All normal expenditures to put an asset in service for use by the business are added to the basis of the asset. Expenditures that do not improve the asset or prolong the asset’s useful life should be deducted as a current expense.Example: A repair to a piece of equipment damaged during shipment should be expensed rather than added to basis.

Assets are depreciated using SL depreciation over the alternative depreciation system (ADS) life listed in Tab 10. If the Section 179 deduction was used for tax purposes, the life is five years for E&P purposes. [IRC §312(k)(3)]

Assets are depreciated under the modified accelerated cost recovery system (MACRS). Three-year, five-year, seven-year and 10-year properties are depreciated using the 200% DB method. Fifteen-year and 20-year properties are depreciated using the 150% DB method. Real property is depreciated using the SL method. Elections are available to use less accelerated methods of depreciation.Up to $500,000 (2010) of the cost of tangible property may be expensed under Section 179. For 2010, qualified real property of not more than $250,000 may be included in the $500,000 aggregate cost limitation. Certain limits apply.See Tab 10 for more information on tax depreciation, including the 50% special (bonus) depreciation allowance for qualified new property acquired in 2010.

If the 200% DB method was used for tax purposes, the 150% DB method must be used for AMT purposes. The MACRS recovery periods are used for both regular tax and AMT purposes [IRC §56(a)(1)]. No AMT adjustment is made on property expensed under Section 179. Also, no AMT adjustment results from bonus depreciation.

(or 100%)


Accounting for Bookkeeping Accounting for Income TaxLeaseand

Rental Expenses

Leases that are not identified as capital leases are called operating leases and are deductible as each lease payment is made.A capital lease is a lease which, at its inception, meets one or more of the following criteria:1) By end of lease, ownership is transferred to the

lessee,2) The lease contains a bargain purchase option,3) The lease term equals 75% or more of the

estimated useful life of the leased property and/or4) The present value of the lease payments (with

certain adjustments) is 90% or more of the FMV of the leased property.

Note: The 75% and 90% tests do not apply to lease terms beginning within the last 25% of the leased property’s economic life.If the lease is considered a capital lease, then it is accounted for by the lessee as if the asset was purchased by borrowing the necessary funds. If preceding item (1) or (2) applies, the leased asset must be amortized over its economic useful life. If (3) or (4) applies, the leased asset must be amortized over the term of the lease.The lessor treats the lease as a sale and financing of an asset. A lease involving land only is not classified by the lessor as a sales-type lease unless the title to the leased property is transferred to the lessee at or shortly after the end of the lease term. Classification of a real estate lease depends on whether the lease involves land only; land and buildings; land, buildings and equipment; or only part of a building.

Lease and rental expenses are deductible if paid for the use of property not owned by the business. Payments resulting in acquisition of equity are capital expenses and are not deductible as rent.Payment of advance rent is deductible only to the extent the rent applies to the current year.If the lessee pays property tax or other expenses for the lessor’s property, the amounts are considered rent paid. Also see Leasehold Improvements below.Lease with option to buy. Whether a lease payment is deductible as rent or capitalized as an acquisition expense depends on facts and circumstances. The answer depends on whether the burdens and benefits of ownership have passed to the purported purchaser (Gaudiano, TC Memo 1998-408). For example, if a lessee agrees to make lease payments that are higher than fair rental value in exchange for a lower option price, the transaction is treated as the purchase of an asset, not as a lease arrangement. Factors considered by the courts:• Intent of the parties.• Whether legal title is transferred or equity created.• Whether rights of possession are vested in the purchaser.• Which party bears the risk of loss or damage to the property.• Which party receives profits from the operation and sale of the property.• Option price in relation to the value of the property.• Which party pays property tax.Cost of acquiring a lease. Commissions, bonuses or fees paid to acquire a lease are amortized over the life of the lease. If an existing lease is acquired from another lessee, any additional costs incurred in securing the lease are also amortized over the life of the lease.Option to renew. The term of a lease for amortization purposes includes all renewal options if less than 75% of the cost of getting the lease is for the term remaining on the purchase date [IRC §178(a)]. Allocation of the cost between the original term and the option term is made based on facts and circumstances, using a present value computation. [Reg. §1.178-1(b)(5)]Termination payments. Treatment of lease termination payments depends on whether the termination is connected to acquisition of new property. If a termination payment takes the form of damages to release a lessee from an unprofitable contract, the amount is a deductible business expense. If the lease is terminated in order for the taxpayer to acquire new property, such as when a company moves its headquarters, the termination payment is considered an acquisition cost for the new property and must be capitalized. (Letter Rul. 9607016)Also see Uniform Capitalization Rules in Tab L of the Small Business Quickfinder® Handbook for rent payments that must be capitalized.

Leasehold Improvements

A leasehold improvement should be amortized or depreciated over the shorter of the life of the improvement or the length of the lease.The depreciation method and life should be the same as similar assets that are owned by the business.

The tenant must use MACRS depreciation for the class of property being leased [IRC §168(i)(8)]. Unrecovered basis is allowed as a loss when the lease is terminated. Note: If the tenant reimburses the landlord for improvements, the cost is considered advance rent, which is deductible over the remaining lease term. If the remaining lease term is shorter than the MACRS recovery period, it may be advantageous for the tenant to reimburse the landlord for the cost of the improvements, rather than making the improvements directly. [Reg. §1.61-8(c)]If placed in service before 2010, qualified leasehold improvements to nonresidential real property and qualified restaurant property (includes buildings in 2009) qualify for a 15-year recovery period (qualified retail improvement property placed in service in 2009 also qualifies). The straight-line method must be used. [IRC §168(b)(3) and (e)(3)(E)]U Caution: Although the 15-year straight line cost recovery for these specific items expires after December 31, 2009, at the time of publication Congress was considering legislation that would extend this recovery period to 2010. See Tax Extenders Legislation on Page 25-1.If the tenant makes improvements in lieu of rent, the cost is considered rent if the intent is plainly disclosed in the rental agreement. [McGrath, TC Memo 2002-231, aff’d 92 AFTR 2d 2003-6159 (5th Cir. 2003)]

Life Insurance

See Insurance on Page 24-18.

Proceeds received from insurance on the life of a corporate officer increase E&P (Rev. Rul. 54-230). Premiums paid on a policy in excess of the current increase in cash surrender value for coverage of corporate officers decrease E&P. (Letter Rul. 7839030)

Life insurance proceeds paid because of death of the insured are generally not taxable [IRC §101(a)]. Tax-free treatment is extended to benefits received before the death of a terminally or chronically ill individual. [IRC §101(g)(1)]For employer-owned life insurance contracts issued after 8/17/2006, businesses generally must include death benefit proceeds (in excess of premiums paid) in gross income unless: (1) the insured individual was an employee within 12 months before death, (2) the proceeds are paid to buy back an equity interest or (3) the insured person was a “highly compensated employee” (meaning a more-than-5% owner, a director or anyone else in the top 35% of employees based on pay) at the time the contract was issued. There are also notice, consent and reporting requirements. [IRC §101(j)]Premiums. No deduction is allowed for premiums or interest paid on a life insurance, annuity or endowment contract by a company that is a beneficiary. (IRC §264)

2012 before 2012


Accounting for Bookkeeping Accounting for Income TaxResearch

and Development

Costs

Research and development (R&D) costs should generally be expensed in the period incurred (FASB ASC 730-10-25, Research and Development—Recognition). Some costs related to R&D activities are capitalized if they have alternative future uses.Costs incurred in establishing the technological feasibility of a computer software product that is sold, leased or otherwise marketed are expensed in the period incurred (FASB ASC 985-20, Costs of Software to Be Sold, Leased, or Marketed). However, the cost of purchased software having an alternative future use should be capitalized and accounted for according to its use. Once the technological feasibility of a software program is established, costs for coding and testing are capitalized and (1) amortized over the product’s economic life and (2) reported at the lower of unamortized cost or net realizable value.The capitalization of costs ends when the product is available to be sold, leased or marketed.

Reasonable research and experimental costs may qualify for one of the following methods of recovery: (1) deduction as a current expense [IRC §174(a)(1)], (2) amortization over 60 months [IRC §174(b)(1)] or (3) amortization over a 10-year period. [IRC §174(f)(2) and §59(e)]Research and experimental costs include expenses incurred to provide information that would eliminate uncertainty about development or improvement of a product. The term product for this purpose includes a formula, invention, patent, pilot model, process, technique or similar property. For example, costs of obtaining and perfecting a patent application are research and experimental costs, but costs to obtain another’s patent are not. Research and experimental costs do not include costs for market research, management surveys or normal product testing. (Reg. §1.174-2)Credit for increasing research activities (Form 6765):Costs of qualified research undertaken for discovering information that is technological in nature qualify for a credit under Section 41. The application must be intended for use in developing a new or improved business component of the taxpayer. The expenses must qualify under Section 174, and substantially all of the activities of the research must be elements of a process of experimentation relating to a new or improved function, performance, reliability or quality. [IRC §41(d)]U Caution: Although the research credit expires after December 31, 2009, at the time of publication Congress was considering legislation that would extend the credit to 2010. See Tax Extenders Legislation on Page 25-1.

Salariesand

Wages

Wages are generally deductible as incurred, unless they are required to be capitalized or added to inventory based on the services performed. An adjusting entry is usually made at the end of the accounting period to accrue wages for services performed by employees who have not yet been paid.Example: The last pay day during a calendar year falls on Friday, December 31, and covers work performed through Wednesday, December 29. An adjusting entry is made to accrue wages that will be paid next year for work performed on December 30 and 31.

Wages, salaries, commissions, etc., are deductible if they meet the tests below. Wages are capitalized when they are incurred to produce capital assets. Wages are included in inventory and deducted as part of COGS when they are incurred to produce merchandise sold to customers.Deductibility tests:• The wages must be an ordinary and necessary expense directly connected

with carrying on a trade or business. Wages paid in connection with the start up or organizing of a business are deductible as a current business expense up to $5,000 ($10,000 for 2010 start-up costs). The $5,000 ($10,000 for 2010 start-up costs) deduction is reduced for expenditures exceeding $50,000 ($60,000 for 2010 start-up costs). Any remaining costs are amortized over 180 months.

• The wage must be paid for services actually performed by the employee, and it must actually be paid or incurred during the tax year. For example, token wages paid to family members who do not work for the business are not deductible. Likewise, a sole proprietor cannot treat joint personal expenses paid as wages to a spouse who performs services for the business.

• Reasonable compensation for shareholders. C corporations have incentive to pay high wages to shareholders because wages are deductible by the corporation, and therefore double taxation on the amount is avoided. However, S corporations have incentive to pay low wages to shareholders, and pass through remaining income to avoid FICA tax. The IRS frequently challenges whether wages paid to shareholders are reasonable, and the issue often results in litigation. See Wages for Shareholders on Page 17-8 and Reasonable Wages on Page 18-8.

Public companies. Wages paid to certain employees of publicly held corporations are not deductible if they exceed $1 million per employee [IRC §162(m)]. This rule applies to any employee of the taxpayer if, at the close of the tax year, (1) the employee is the principal executive officer or acts in such capacity or (2) total compensation of that employee for the tax year is required to be reported to shareholders under SEC rules because the employee is among the three highest compensated officers for that year other than the principal executive or financial officer. Compensation of the principal financial officer for whom SEC reporting is also required is not subject to the Section 162(m) limitation. (Notice 2007-49)For purposes of the $1 million limit, compensation does not include qualified retirement plan contributions, tax-free fringe benefits, performance-based compensation meeting certain requirements or compensation paid on a commission basis. Compensation paid to an executive is not considered qualified performance-based compensation if the agreement/contract provides for payment of that compensation to employees for meeting performance goals if they are terminated without cause or for good reason or voluntarily retire (Rev. Rul. 2008-13). Compensation paid to an executive under an incentive plan on the attainment of performance goals under any performance share/unit awards is not considered Section 162(m)(4)(C) performance based compensation. (Ltr. Rul. 200804004)Executives of companies participating in the troubled assets relief pro-gram. The deduction for compensation paid to certain top executives of publicly traded companies selling more than $300 million of troubled assets to the federal government in the bailout program is capped at $500,000 (instead of $1 million) for each such employee per year [IRC §162(m)(5)]. See IRS Notice 2008-94 for more information.

25-2 2010 Tax Year | Premium Quickfinder® Handbook Tax Extender’s Legislation

Tax Extenders Legislation—Updated for 2010 Tax Relief Act

Note: When the 2010 Premium Quickfinder® Handbook was published, Congress was considering legislation that would extend many expired tax provisions to 2010. The Tax Extenders Legislation table on Page 25-2 of the Handbook listed many expired provi-sions that, at the time of publication, might be extended. After the Handbook was published, the 2010 Tax Relief Act extended many of the provisions listed in the Tax Extenders Legislation table, which is reproduced below, along with a new column noting whether the provision was extended. For more details, see the 2010 Tax Relief Act summary table in the Updates section of Quickfinder.com.

Item Description of Expired Provision QF Page

Extended to 2010?

Individual DeductionsCasualty Losses Individuals’ per-casualty floor for losses on personal-use property raised from

$100 to $500. 5-15 No

Conservation Contributions

Increased percentage-of-AGI limits for contributions of real property for conserva-tion purposes.

5-12 Yes

Educator’s Expenses Up to $250 above-the-line deduction for educator’s expenses. 9-7 YesReal Property Taxes Standard deduction increased by up to $500 ($1,000 if MFJ) of real property

taxes paid. 4-19 No

Sales Tax Election to deduct state and local sales taxes instead of state and local income taxes.

5-5 Yes

Tuition and Fees Up to $4,000 above-the line deduction for qualified higher education tuition and fees.

13-4 Yes

Individual Retirement AccountsCharitable Rollover Qualified charitable distributions from IRAs for individuals age 70½ or older.

Note: The new law also allows individuals to treat a QCD made in January 2011 as made in 12/31/2010.

14-13 Yes

Businesses and Sole Proprietors Environmental Remediation

Expensing for cost of Brownfields environmental remediation. – Yes

Farm Equipment Five-year depreciation recovery period for new farming business machinery and equipment.

6-21, 10-2

No

Indian Reservation Property

Accelerated recovery periods for qualified Indian reservation property. – Yes

7-Year Life for Motorsports Entertainment Complexes

7-year depreciation recovery period for certain motorsports entertainment complex property.

– Yes

15-Year Life for Certain Real Property

15-year (39-year for ADS) straight-line depreciation for qualified leasehold improve-ments, qualified restaurant property and qualified retail improvements.

10-13, 10-14

Yes

Charitable Contributions Charitable deduction enhancement for businesses for contributions of food inven-tory, book inventories to public schools (C corporations only) or computer equip-ment for educational purposes (C corporations only).

17-14 Yes

Domestic Producer’s Deduction

Domestic producer’s (Section 199) deduction allowable for income attributable to production activities in Puerto Rico.

6-22 Yes

Percentage Depletion Suspension of the 100% of net income limit on percentage depletion for marginal oil and gas well production.

12-26 Yes

S Corporation Stock S shareholders reduce their stock basis by their allocable share of the property’s adjusted basis when S corporations make charitable contributions of property.

– Yes

Alternative Minimum TaxIncreased Exemption Increase to the AMT exemption amount, which for 2010 are $72,450 (MFJ or QW),

$47,450 (Single or HOH) and $36,225 (MFS).12-15 Yes

Use of Credits to Offset Allow the following credits to offset AMT: child and dependent care, elderly or disabled, mortgage interest, lifetime learning, personal energy property and DC first-time homebuyers.

12-3, 12-9, 12-12

Yes

Tax CreditsAlternative Motor Vehicles Tax credit for hybrid vehicles other than passenger automobiles and light trucks. 11-7 NoBiodiesel and Renewable Diesel Used as Fuel

Certain credits for production or use in a trade or business of various biodiesel mixtures.

24-7 Yes


2010 Tax Year | Premium Quickfinder® Handbook 25-3Tax Extender’s Legislation

Tax Extenders Legislation—Updated for 2010 Tax Relief Act (Continued)

Note: When the 2010 1040 Quickfinder® Handbook was published, Congress was considering legislation that would extend many expired tax provisions to 2010. The Tax Extenders Legislation table on Page 25-2 of the Handbook listed many expired provi-sions that, at the time of publication, might be extended. After the Handbook was published, the 2010 Tax Relief Act extended many of the provisions listed in the Tax Extenders Legislation table, which is reproduced belong, along with a new column noting whether the provision was extended. For more details, see the 2010 Tax Relief Act summary table in the Updates section of Quickfinder.com.

Expired Provision Description QF Page

Extended to 2010?

Tax Credits (Continued)Differential Wage Payment Employer wage credit for activated military reservists. 24-7 YesIndian Employment Employer credit for wages and health insurance costs paid to a member (or spouse)

of an Indian tribe for services performed on a reservation.24-7 Yes

Mine Rescue Team Training Employer credit for training program costs for qualified employees. 24-7 YesNew Energy Efficient Homes Credit

$2,000 tax credit per qualifying home for builders of energy efficient homes. 24-11 Yes

New Markets Credit Credit for investment in community development entities. 24-7 YesRailroad Track Maintenance Credit for costs to maintain certain railroad track, roadbed, bridges, etc. 24-7 YesResearch Credit Research and experimentation expenses credit. 24-7 YesFederally Declared Disasters Casualty Losses Waiver of 10%-of-AGI threshold for net disaster losses. 5-14 NoSpecial Depreciation Allowance

Property that replaces or rehabilitates property destroyed in a federally declared disaster qualifies for the 50% special depreciation allowance.

5-15 No

NOL Carryback An NOL attributable to a qualified disaster loss can be carried back five years. 6-14 NoQualified Disaster Expenses

Certain business expenses related to a federally declared disaster can be expensed instead of capitalized.

5-15 No

Tax Provisions That Expired After 2009

Note: The tax provisions listed in this table expired at the end of 2009. At the time of publication, no legislation to extend them to 2010 had been introduced. See the Tax Extenders Legislation table on Page 25-2 for additional tax provisions that expired after 2009, but for which Congress was considering an extension to 2010 at the time of publication.

Individuals• Estimated tax payments reduction for qualified individuals.• Government retiree credit.• IRA contributions—additional contribution allowed to individuals employed by certain bankrupt employers.• Required minimum distribution (RMD) waiver for IRAs and defined contribution plans.• State sales tax and excise tax deduction on the purchase of new qualified motor vehicles.• Unemployment compensation benefits exclusion from gross income.

Businesses (Including Sole Proprietorships)Corporate election to accelerate AMT and research credits in lieu of special depreciation allowance—(expires 12/31/10 for certain long-lived and transportation property). Note: Election is available for property placed in service in 2011 and 2012 (but not 2010).

Notes

25-16 2010 Tax Year | Premium Quickfinder® Handbook Federally Declared Disasters

Federally Declared Disasters—Quick Summary of Special Tax Relief Provisions for BusinessesItem Special Relief

Depreciation— 50% bonus1

50% special (bonus) depreciation is allowed on qualified disaster assistance property 2 for the year it’s placed in service. Such property is not subject to the AMT adjustment for its entire recovery period. [IRC §168(n)]

Disaster expenses1 Certain disaster-related expenses paid in connection with a trade or business or business-related property are deductible, even though they are normally capitalized. [IRC §198A(a)]

Involuntary conversion— business or in-come-producing property

Any tangible replacement property acquired for use in any business is treated as similar or related in service or use to the destroyed property. [IRC §1033(h)(2)]

Net operating loss (NOL) carryback1

NOL attributable to disaster loss may be carried back five years and fully deductible against AMT income. [IRC §172(b)(1)]

Section 179 expense1

Deduction limit is increased by lesser of (1) $100,000 or (2) cost of qualified Section 179 disaster assistance property. Threshold for phaseout is increased by lesser of (1) $600,000 or (2) cost of qualified Section 179 disaster assistance property. [IRC §179(e)]

Tax deadlines Deadlines for filing and paying taxes and making IRA contributions are often postponed. [IRC §7508A]

1 U Caution: For federally declared disasters declared after 2007 and occurring before 2010. At the time of publication, Congress was considering legislation that would extend this provision to federally declared disasters occurring in 2010. See the Tax Extenders Legislation table on Page 25-2.

2 Qualified disaster assistance property is replacement or rehabilitation property used in the same county and similar to the destroyed property, and includes tangible property with a MACRS recovery period of 20 years or less, computer software, qualified leasehold improvements, nonresidential real property and residential rental property. See IRS Pub. 946 for additional requirements.

Notes

—End of Tab 25—