TABLE OF CONTENTS

SECTION H

TAX PLANNING: PRACTICE POINTERS (Updated through 11-15-17)

Page Employee Annuities .............................................. 1

Long-term Care (LTC) Insurance – Funding with Annuity Contracts and/or Life Insurance Policies ..................... 2

Adequate Disclosure for Gifts ................................... 3-4

Casualty Losses ................................................. 5-6

IRC Section 1250 Recapture/Capital Gain/Dividends ............... 7-8

Home Office Expense ............................................. 9-18

Qualified Principal Residence Indebtedness ...................... 19-20

Sale of Principal Residence ..................................... 21-32

Vacation Property Issues ........................................ 33

Self-Rental and Passive Activity Issues ......................... 34-35

Ministers – Issues .............................................. 36-37

Military Issues ................................................. 38-41

Armed Forces Tax Guide .......................................... 42-43

Independent Contractor or Employee .............................. 44-48

Retirement Savings Contribution Credit (Saver's Credit) ......... 49-50

Materials & Supplies; Repairs and Improvements: Capitalize or Deduct Currently? ......................................... 51-56

Tax-Free IRA Transfers to Charity (Taxpayers Age 70½) ........... 57-58

Charitable Contribution of Used Motor Vehicles, Boats & Airplanes (Form 1098-C) .............................. 59

Charitable Donation Substantiation(Quick Reference Guide) ....... 60-63

Qualified Conservation Contribution ............................. 64

Contributions of Food Inventory ................................. 64-65

Selected Charitable Provisions .................................. 66-67 Substantiation of Cash Contributions ............... 66 Substantiation of Contributions of $250 or more .... 66 Contributions of Used Clothing & Household Items ... 66 Basis Adjustment to “S” Corporate Stock - Contributed Property ............................ 66 Qualified Appraiser ................................ 67 Accuracy Related Penalties – Charitable Contributions ................................... 67 Incorrect Appraisal Penalty – (Appraiser) .......... 67

Child Day Care Providers – Standard Meal/Snack Rates ............ 68

Tax Planning for the Social Security Recipient .................. 69

TABLE OF CONTENTS

SECTION H

TAX PLANNING: PRACTICE POINTERS (Updated through 11-15-17)

Page IRC §183 – Hobby Losses ......................................... 70-72

Household Employment Taxes – Nanny Tax .......................... 73

Residential & Commercial Energy Property Credits & Deductions ... 74-76

Capital Gains Rates ............................................. 77-85

Broker Reporting Rules .......................................... 86-89

Additional Medicare .9% Tax (Form 8959) ......................... 90-92

Net Investment Income Tax (NIIT) (Form 8960) .................... 93-102

Health Savings Accounts (HSAs) .................................. 103-111

Health Reimbursement Arrangements (HRA) ......................... 112-113

Cafeteria (Flexible Spending Account) Plans ..................... 114

Cafeteria (FSA) Plans (Modifications to Use-it-or-lose-it Rule) ................... 115-116

EMPLOYEE ANNUITIES Basis Recovery Rules for Annuities. The IRS has developed a table to determine the basis recovery rules for annuities on the life of one or more annuitants. The table applies to benefits based on the life of multiple annuitants even if the amount of the annuity varies by annuitants. Thus, it encompasses the 50 percent joint and survivor annuitant. I.R.C. §72(d)(1)(B)(iii) & (iv). The table for a single annuitant was updated, but otherwise remains the same as under prior law.

SINGLE ANNUITANT If the age at AND your annuity starting date was -- annuity starting before Nov. 19, 1996 and after Nov. 18, 1996 date was…. enter on Line 3 ….. enter on Line 3 ….. 55 or under 300 360 56-60 260 310 61-65 240 260 66-70 170 210 71 or older 120 160

ANNUITY BASED ON MORE THAN ONE ANNUITANT FUND DISTRIBUTIONS AFTER 12/31/97

If the combined ages at annuity starting date was….. Then enter on Line 3 ….. 110 and under 410 111-120 360 121-130 310 131-140 260 141 or older 210 On Worksheet A, Simplified Method contained in IRS Publication 575, compute the total costs of the annuity. Divide such cost by the number arrived at by using the above tables. Use the birthday preceding the annuity starting date. The result is the tax-free portion of each payment which continues until the total cost is recovered. Thereafter, all payments are taxable. If the taxpayer dies before all the cost is recovered, take an itemized deduction on decedent’s final return. See Simplified Method, Pension and Annuity Income Worksheet in Election and Computation Forms section of the Tax Manual. For taxable years after December 31, 2010, the Small Business Jobs Act of 2010 allows a portion of an annuity, as long as it is being paid out over ten years or more, to be annuitized while the balance is not annuitized. See IRC §72(a)(2).

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LONG-TERM CARE (LTC) INSURANCE – FUNDING WITH ANNUITY CONTRACTS AND/OR LIFE INSURANCE POLICIES

The Pension Protection Act of 2006 added provisions to the Code pertaining to funding of long-term care (LTC) insurance utilizing the built-up value in annuity contracts and/or life insurance policies. For contracts/policies issued after 12/31/1996, but only effective with respect to taxable years beginning after 12/31/2009, LTC insurance may be provided as a rider to an annuity contract or a life insurance policy. Any withdrawal against the cash value of the annuity contract or the cash surrender value (CSV) of the life insurance policy used to pay for coverage under a qualified LTC insurance contract that is part of, or a rider on, these products is excludable from income. IRC §6050U & §72(e)(11). EFFECT ON ANNUITY CONTRACT – DEDUCTIBILITY OF LTC PERMIUMS: The withdrawal or charge against the cash value of the annuity contract used to pay the LTC premiums reduces the taxpayer's investment in the annuity contract, but not below zero. Because the charge against the annuity contract is nontaxable, no deduction is allowed for Schedule A medical expense purposes or the 100% self-employed health insurance deduction for any portion of the cost of the LTC insurance premium paid in this manner IRC §7702B(e)(2). EXAMPLE: Betty, age 68, invested $50,000 in an annuity contract with a LTC insurance rider in 2004. The current value of the annuity contract is $72,000. Betty can withdraw the entire $72,000 of cash value tax-free if it is used to pay for qualified LTC coverage associated with the rider. Betty will report no taxable income from the $22,000 gain on the annuity contract.

NOTE: If a taxpayer withdraws smaller amounts from a hybrid annuity on an annual basis to pay for LTC premiums, the withdrawals are deemed to derive from the principal of the annuity contract and not from the contract earnings, again resulting in tax-free treatment to the taxpayer. EXCHANGE OF LIFE INSURANCE POLICIES OR ANNUITY CONTRACTS FOR LTC POLICIES. The Pension Protection Act of 2006 also liberalized the rules associated with IRC §1035 life insurance policy exchanges, allowing life insurance policies or annuity contracts to be exchanged for a qualified LTC insurance contract. IRC §1035(a). This change in tax law will allow more taxpayers to acquire LTC insurance, particularly retirees who may have older (and perhaps unneeded) life insurance policies or annuity contracts. EFFECTIVE DATE: Contract/policy exchanges for taxable years beginning after December 31, 2009.

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ADEQUATE DISCLOSURES FOR GIFTS The Taxpayer Relief Act of 1997 and the Restructuring and Reform Act of 1998 provided that a gift for which the statute of limitations period had expired cannot be revalued for purposes of determining estate tax, so long as the gift is adequately disclosed on a gift tax return filed by the taxpayer [Act Sec. 506 of P.L. 105-206, amending IRC Sec. 2001(f)]. For gifts made after August 5, 1997, the period of assessment will not close if the gift is not adequately disclosed. See 2017 IRS Field Attorney Advice (FAA 2017 2801F [July 14, 2017]) for a concise example of the period of assessment remaining open when the taxpayer fails to adequately disclose the gift on a filed gift tax return. The IRS has issued final regulations on what constitutes adequate gift tax disclosure. [Treas. Regs. 20.2001-1, 25.2504-2 and 301.6501(c)-1, and Amendments of Treas. Regs. 2504-1 and 25.2511-2, TD 8845, 12/3/99]. Effective for gifts made after August 5, 1997, once a gift is adequately disclosed, the IRS cannot attempt to later re-determine the value of the gift after the statute of limitations has expired, such as when computing gift tax on later gifts or computing estate tax after the death of the donor. Even if adequate disclosure is not found, the IRS may not make adjustments regarding other “legal” issues [Treas. Reg. 20.2001-1; Reg. 25.2504-2]. The required information to be deemed adequate disclosure is set forth by Treas. Reg. 301.6501(c)-1(f) as well as in the Instruction for Form 709 and provides that the return must completely and accurately describe the transaction and is met only if the gift tax return includes the following: 1. A description of the transferred property and any consideration received by the transferor, (For example, if real estate is being transferred, the legal description, a listing of improvements and a short description of the property should be included. For stock or bonds, give the number transferred, name of Corporation, type, etc.). 2. The identity of, and relationship between, the transferor and the transferee; 3. The value of the transferred property and either a detailed description of the method used to determine the fair market value of the property transferred including relevant financial information and description of discounts or a qualified appraisal setting forth any restrictions on the transferred property that were considered in determining its valuation meeting the requirements as set forth in Treas. Reg. 301.6501(c)-1(f)(3). The description of any discounts shall set out discounts for lack of marketability, minority interest, etc. 4. If the property is transferred in trust, the trust’s tax identification number and a description of the trust terms or a copy of the trust. 5. A statement disclosing any contrary position to any proposed temporary or final treasury regulations or Revenue Rulings, published as of the date of transfer. Appraisals should set forth the appraiser’s qualifications and the appraisal should contain the date of appraisal, date of transfer, a description of the property and all methods and procedures used in the appraisal process. Schedule A of Form 709 includes a question asking if the value of any item listed reflects a valuation discount for which the disclosure rules will apply. Under the regulations, it is clear

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that all gifts, including those within the $14,000 annual exclusion must be reported to start the running of the statute of limitations. Therefore, gift tax returns should be filed to report gifts within the annual exclusion amount, if there are potential valuation issues. If no gift tax is payable, there is no penalty for filing a late gift tax return. The actual filing date is the start of the three-year statute of limitations. Taxpayers may wish to file delinquent gift tax returns in order to start the statute of limitations and to comply with the rules regarding adequate disclosure. Taxpayers may wish to file gift tax returns, even if the value of the gift is less than the $14,000 annual exclusion, if a question could be raised at a later date regarding its valuation. A revenue procedure has been issued to set forth how to amend a return where adequate disclosure was not present. (Rev. Proc. 2000-34, IRB No. 2000-34). This procedure is effective for all amended returns filed after August 21, 2000, and the statute of limitation will expire 3 years after the filing of the amended return. The top of the first page of the amended return must contain the words “Amended Form 709 for gifts made in [year] – In accordance with Rev. Proc. 2000-34, 2000-34 I.R.B. 186.” A transfer between family members in the ordinary course of business is adequately disclosed if reported on each member’s tax return. [Reg. 301.6501(c)-1(f)(4)]. In a Chief Counsel Advice, IRS legal counsel determined the statute of limitations remains open and the gift tax return contains a substantial omission where the taxpayer filed a delinquent gift tax return disclosing gifts of units of an LLC having a fair market value and an adjusted basis of $200,000, when the IRS claimed a fair market value of $14,000,000. Even though this gift predated the effective dates, the Chief Counsel Advice held that Paragraphs 1-4 set forth above needed to be satisfied [CCA 2002 21010 (February 12, 2002)]. In a 2016 Chief Counsel Advice, the IRS legal counsel determined that a failure to adequately disclose gifts in a previous year does not keep the statute of limitations open for failing to accurately report the sum of prior year gifts on returns filed for subsequent years, “even if that resulted in underreported gift tax for those subsequent years.” [CCA 2016 14036 (April 1, 2016)].

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CASUALTY LOSSES A casualty loss is a loss, destruction or damage resulting from a sudden, unexpected or unusual event and must be unforeseen. Casualty losses are deductible so long as they are not compensated for by insurance. The loss is equal to the difference in the fair market value of the item before and after the loss and cannot exceed the adjusted cost basis of the property. The Tax Court denied a non-business casualty loss deduction where the taxpayer did not present an appraisal of the property showing the fair market value of the property before the casualty. Perry H. Kay, Sr. v. Commissioner, T.C. Memo 2002-197. The amount of the adjusted costs basis of the property used in the calculation of the casualty loss deduction is limited to the single identifiable property item damaged or destroyed. Cziraki v. Comm., T. C. Memo 1998-439 (deduction was limited to the basis of a destroyed road and not the adjoining real estate). Taxpayers have the burden of proving the adjusted cost basis. Also see McLune v. Comm., T.C. Memo 2005-47 where casualty loss was limited to adjusted basis. Insurance proceeds received also reduce the loss. Losses are deductible if incurred in a trade or business, incurred in a transaction entered into for profit, and for property not connected with a trade, business, or profit activity if such losses arise from fire, storm, shipwreck or other casualty or theft. If the loss is a non-business loss, the deductibility is further limited in that the initial $100 of the loss is non-deductible and the loss must exceed 10% of the taxpayer's adjusted gross income. Deductions for casualty losses have been allowed for destruction caused by fire, drought, flood, car collision, earthquakes, theft, blasting, wind, freezing, insect damage and mistaken use of herbicides. No deduction was allowed where no physical damage to the property occurred and the loss claim was based on the taxpayer’s residence being located near the O.J. Simpson residence. Cuan v. Comm., 99-1 U.S.T.C. 50349. The Tax Court found a similar result with a different neighbor. Chamales v. Comm., T. C. Memo 2000-33. A casualty loss was denied to the taxpayer where a decrease of appraised value resulted from a likelihood of avalanches. The Court found this not to be a permanent change and not deductible. Lund v. U.S., 2000-1 U.S.T.C. 50234. The loss is deductible in the year in which the loss occurs unless the President has declared the loss area to warrant assistance under the Disaster Relief and Emergency Assistance Act. The taxpayer may then claim the loss in the year preceding the loss year. I.R.C. Sec. 165(i). This election must be made by the due date of the tax return in the year of loss, without extension. If a personal residence is subject to a casualty loss, amounts received from insurance are non-taxable if used to compensate for the loss of occupancy. Expenses incurred in restoring business property to the pre-casualty loss condition was held not to be deductible as a casualty loss, but was a currently deductible repair expense under IRC Sec. 162(a). The expenses did not need to be treated as a capital expenditure under IRC Sec. 263 so long as the repair neither materially added to the value of the property nor to its life. PLR 9903030 (Nov. 24, 1998). For a cash basis farmer, farm inventory items have a zero basis. If these items are lost, no deduction is available. If insurance proceeds are received, the proceeds will be reported on Schedule F, unless the item is subject to replacement. For example, if a farmer received insurance proceeds for hay destroyed in a fire, which would be fed, the farmer may defer the reporting of the insurance proceeds into income if the hay is replaced within two years and then reduces the future hay expense by the amount of the proceeds. If a Sec. 1231 asset, such as a combine, is subject to a loss, insurance proceeds received must be reported on Form 4684, as well as on Form 4797, Part III, unless the combine is replaced and the replacement cost is in excess of the insurance proceeds received. If business or investment property is involuntarily converted in an area the President has declared a disaster area, replacement property need not be related or similar in use, but may be any tangible business property.

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The expense of removing trees, rubbish, debris, etc., as well as the decrease in value to farm land due to flooding, may be claimed as a loss. If the flooding removed soil, a casualty loss may be claimed for the decrease in value to the land, if the decrease in value can be substantiated. Casualty losses have been allowed for losses caused by flood, wind, insects, herbicides, freezing, drought, fire, and soil losses. Casualty losses must be caused by an identifiable event which is sudden, unexpected or unusual. The loss cannot be progressive or gradual. A loss caused by the excessive summer-long rainfalls may not qualify as a casualty loss, whereas a loss caused by a flash flood will qualify as a casualty loss. In order to prove a loss, the taxpayer must provide the following: (a) Nature of loss. (d) Adjusted cost basis. (b) Date of loss. (e) Fair market value before and after the loss. (c) Description of property lost. (f) Insurance proceeds received. The Court has ruled in Johnson vs. U.S. 74 FED.C1 360 (2006) that taxpayers are not entitled to a casualty loss deduction if the recovery process was not complete. Taxpayers were not entitled to deduct an estimated theft loss of $58,000,000. In Estate of Moragne v. Comm., T.C. Memo 2011-299 (December 27, 2011) a Tax Court memorandum decision the Tax Court ruled that funds spent from husband's joint account by his wife was not a deductible theft loss where evidence showed that husband had given his wife authority to write and sign checks. The Tax Court recently ruled that a husband and wife, both tax attorneys, were subject to fraud penalties for claiming a $121,065 casualty loss on four floating boat docks. The taxpayers purchased these docks in February for $144,600. After flooding on the Missouri and Mississippi Rivers during that summer, the taxpayers signed a contract to sell these same docks for $142,000. This contract to sell the docks was signed eleven days prior to signing their tax return where they took the position that the docks were worthless due to the flooding. Kohn v. Commissioner, T.C. Memo 2017-159 (August 14, 2017).

EXAMPLE: Assume Melissa's residence was destroyed by a flood on June 16, 2017 and Melissa’s AGI for 2017 is $20,000. The following information has been collected by Melissa: Ins. Proceeds Adj. Cost Basis FMV Before FMV After Residence $60,000 $70,000 $80,000 0 Personal Property 30,000 45,000 33,000 2,000 Combine 60,000 30,000 50,000 0 Living Expense 5,000 As to the residence, Melissa has a loss equal to the lesser of the cost or the decrease in fair market value of the residence. The loss of $70,000 is also reduced by the insurance proceeds received of $60,000, for an unreimbursed loss of $10,000. As to the personal property, the loss is the lower of cost or the decrease in fair market value. This loss of $31,000 is reduced by insurance proceeds for an unreimbursed loss of $1,000. If Melissa is in a federal declared disaster area, she may elect to report these losses in 2016. IRC Sec. 165(i). These losses from the residence and the personal property are combined on Melissa’s return and placed on Form 4684. They are subject to a $100 reduction, as well as a deduction of 10% of AGI. If Melissa had realized a gain on unscheduled personal property, the gain does not have to be recognized, per I.R.C. Sec. 1033(h)(l)(A)(i). If living expenses are in excess of the proceeds received, there is no tax consequence to Melissa. If Melissa does not replace the combine, she will have a taxable gain of $30,000 ($60,000 insurance proceeds less the $30,000 adjusted basis) to report on Form 4684, Section B, as well as on Form 4797, Part III.

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I.R.C. SECTION 1250 RECAPTURE/CAPITAL GAINS and QUALIFIED DIVIDENDS TRA 1997/2003 ACT

Due to the Taxpayer’s Relief Act of 1997 and the “Jobs and Growth Tax Relief Reconciliation Act of 2003, the reporting of the sale of capital gain property and qualified dividends has become much more complicated even though taxable at lower marginal rates. We now have: 1. Long term capital gains and qualified dividends are taxed at 0%/15%/20% (plus the additional 3.8% tax on net investment income, when applicable) maximum marginal rates with the tax calculated on the Qualified Dividends and Capital Gain Tax Worksheet on page D-15 of the Instructions for Schedule D (and Form 8949). 2. Recapture of depreciation as per I.R.C. Sec. 1245 as before, being computed on Part III of Form 4797. 3. Recapture of depreciation as per I.R.C. Sec. 1250 where there was depreciation on buildings in excess of straight line, with the same being computed on Part III of Form 4797. 4. Recapture of depreciation as per Section 1250, which will recapture all straight-line depreciation at a maximum marginal tax rate of 25%. This recapture of depreciation now must be reported separately on Line 19 in Part III of Schedule D and computed as shown on page D-9 of the instructions for Schedule D. The 2003 Tax Act significantly reduced the marginal tax rates on capital gains from 8%, 10%, or 20% to 5% or 15% for sales or proceeds of installment contracts received after May 5, 2003. After December 31, 2007 taxpayers in the 10/15% marginal rate do not pay any tax on capital gains including qualified dividends. For example, a married couple filing jointly who have a capital gain and taxable income of $75,900 or less will pay 0% tax on long term capital gains or qualified dividends in 2017. The American Taxpayer Relief Act of 2012 (ATRA-2012) installed a new tax rate of 20% on capital gains and qualified dividends for those taxpayers in the highest (39.6%) tax bracket. The 2003 Tax Act further provided that dividends received after December 31, 2002, which were previously taxed at ordinary income tax rates, are now taxed at long term capital gain rates. Dividends and long term capital gains receive these preferential rates for alternative minimum tax as well. Qualified dividends are only taxed at the lower capital gain rates. Dividends will not offset capital losses anymore than any other non-capital gain income. In order to receive the benefit of the lower marginal rates for qualified dividends, the shareholder must own the shares for more than 60 days during the 120-day period beginning 60 days before the ex-dividend date. The shares of stock must be held for at least 61 days and must include the last day before the ex-dividend date. Although dividends from preferred stock qualify for the lower marginal tax rates as well, the holding period is increased to 90 out of 180 days. For example, assume Kevin purchased 500 shares of ABC common stock on March 20, 2017 which has an ex-dividend date of April 28, 2017. On June 9, 2017 Kevin sells the shares. As Kevin did not hold the shares at least 60 days during the February 27, 2017 to June 28, 2017 period (i.e. the 120-day period), he will not receive the benefit of the (qualified dividend/long term capital gain) rate. If the Taxpayer elects to treat an amount of dividends as investment income for purposes of deducting investment interest expense, the amount will not be taxed at the lower capital gain rates. This is similar to the treatment of capital gains in the past. For example, assume Melissa has $800 of margin interest expense in 2017 and $600 of dividend income. If Melissa elects to take a $600 investment interest expense deduction, none of the dividends will receive the 0%/15%/20% rates. The I.R.C. Sec. 1250 straight line depreciation recapture will be allocated as a front-end load basis. Treas. Reg. Sec. 1.453-12(a). For example, when reporting an installment contract and only a portion of the installment gain is reportable as I.R.C. Sec. 1250 recapture at a 25% marginal rate, this amount of the gain must be reported prior to the long term capital gain portion being taxed at 15%. Similarly, it will be

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assumed that all prior payments received on sales prior to May 7, 1997 will assume the 25% gain being reported first, and then the 15% long term capital gain, Treas. Reg. Sec. 1.450-12(b). The IRS will not challenge a prorata method of reporting prior to the effective date of the final regulations of August 23, 1999. Assume the following facts: Able and Grace Farmer sell their farm on October 1, 2017. Assume they have owned the farm since 1980. Total long term gain to be reported in 2017 is $25,000 of which $10,000 is subject to Section 1250 straight line depreciation recapture. Qualified dividend income of $6,000 is also reported into income in 2017. After deducting standard deduction or itemized deduction and personal exemptions, taxable income levels of $75,000, $100,000 and $125,000 are assumed as indicated and the results are as follows. $75,000 Taxable Income (Line 43 of Form 1040): $18,650 @ 10% $ 1,865.00 First $18,650 at 10% $35,350 @ 15% 5,303.00 Next $35,350 at 15%/ord. inc. 25,350 + §1250 of $10,000 $21,000 @ 0% 0.00 Uses up 15% bracket at 0% long term gain $75,000 $7,168.00 The 25% rate does not come into play $100,000 Taxable Income (Line 43 of Form 1040): $ 18,650 @ 10% $1,865.00 First $18,650 at 10% $ 57,250 @ 15% 8,588.00 Next $57,250 at 15%/ord. inc. 50,350 + §1250 of $6,900 $ 21,000 @ 15% 3,150.00 Qualified Dividend and Long Term Gain at 15% $ 3,100 @ 25% 775.00 remaining $3,100 of §1250 recapture at 25% $100,000 $14,378.00 $125,000 Taxable Income (Line 43 of Form 1040): $ 18,650 @ 10% $1,865.00 Full $18,650 at 10% $ 57,250 @ 15% 8,588.00 Full benefit of 15% bracket $ 18,100 @ 25% 4,525.00 Amount over $75,900 at 25% $ 21,000 @ 15% 3,150.00 Qualified Dividend and Long Term Gain at 15% $ 10,000 @ 25% 2,500.00 $10,000 §1250 recapture at 25% $125,000 $20,628.00

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HOME OFFICE EXPENSE I.R.C. Sec. 280A provides that no deduction shall be allowed in regards to a personal residence, with the exception of regular deductions for mortgage interest, real estate taxes and casualty losses, unless the dwelling unit is used "exclusively" and on a "regular" basis as the principal place of business of the taxpayer, as a place where business customers meet with the taxpayer in the normal course of business or a separate structure used in connection with the trade or business. The Tax Court held that the exclusive use limitation of IRC Sec. 280A(A)(f)(1)(b) applied and disallowed all deductions for dual use areas in a bed and breakfast. See Anderson v. Commissioner T. C. Memo 2006-33. Inventory storage and daycare services are exceptions to the necessity of "exclusive" use of the dwelling unit. Deductions will be allowed so long as the space for inventory storage is used on a regular basis and the dwelling unit is the sole location of the business. See IRC Sec. 280A(c)(2) for tax years beginning after December 31, 1995, allowing a home office deduction for space used on a regular basis for inventory storage if the home is the sole fixed location of the business. The space need not be exclusively used for this purpose. Similarly, if the dwelling unit is used on a "regular" basis for providing daycare, deductions will be allowed. IRS Notice 93-12 addresses the results of the Soliman case, Commissioner v. Soliman, 113 S. Ct. 701 (1993). This case dealt with the issue of whether the home office was the principal place of business for purpose of the office in the home deduction and interpreted IRC Sec. 280A very narrowly. In order to be entitled to a deduction, the office in the home must be used exclusively and regularly (1) as the principal place of business and (2) as a place to meet or deal with patients, clients or customers in the normal course of business. The Soliman case relied upon (1) the relative importance of the activities performed by the taxpayer at each business location and (2) the amount of time spent by the taxpayer at each location. The characteristics of each business must be taken into account. In Chong v. Comm., 71 T.C.M. 3036 (1996), the Court denied a home office deduction where a self-employed anesthesiologist administered medical treatment at a hospital even though he had no private office on the hospital premises. A professional musician, who not only performed with the band, but spent up to 30 hours a week as the band’s manager, was allowed home office deduction for her role as the band’s manager as the office constituted her primary place of business. See Genck v. Comm., T.C. Memo 1998-105, 75 T.C.M. 1984 (1998) (CCH Dec 52621(M)) A 1998 tax court case dealt with an attorney who operated a law practice out of his home. He used a portion of the basement to store legal materials and also claimed home office related deductions for two enclosed porches, a portion of the living room, kitchen, dining room, hall and bathroom, based on the taxpayer’s exclusive use of those areas for the law practice during the day. Except for the porches and the storage area in the basement, the areas were used in the evenings by the taxpayer and family. The court held that the exclusive use of an area in a residence had to be 100% of the time; thus, only the areas used solely for business purposes were eligible for the deduction. Sengpiehl v. Comm., T.C. Memo. 1998-23. Those taxpayers who provide qualified daycare services may deduct business expenses for the portion of the home used on a regular basis, even though the portion of the home is not used exclusively for daycare. The deductions for the use of the home are limited to the gross income from the daycare services less the sum of the direct business expenses. The home business expenses are reduced to the portion of time the home is used to provide daycare services.

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The Tax Court has held that a movie and television writer met the exclusive use test, as there was no personal use of the home office area, the area was used on a regular basis and was the writer’s principal place of business. See Radnitz v. Commissioner, T.C. Summary Opinion 2003-29. A taxpayer may meet the "regular" and "exclusive" tests, but if the taxpayer is an employee, deductions will be disallowed unless the use of the home is for the employer's convenience and the employee does not rent any of the premises to the employer. The employee must use the office regularly and the employer must require or expect the employee to use the home office. See Sherri A. Mulne, 72 T.C.M. 111 (1996), where the taxpayer employee was denied a home office deduction as it was not her principal place of business. If the office in the home is utilized in meeting customers in the normal course of business, the home office need not be the "principal place" of the business. Regardless of not meeting the Soliman criteria, deductions should be allowed. See Figure A following as set forth in IRS Publication 587 for a flow chart analysis of deductibility of expenses.

I.R.C. Sec. 280A (c)(1) was amended in 1998 to provide for tax years beginning after December 31, 1998, that the definition of “principal place of business” be expanded to include a home

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office that is used exclusively and regularly by the taxpayer to conduct administrative or management activities, if there is no other fixed location where the taxpayer conducts substantial administrative or management activities. These activities would include maintaining the books and records, ordering supplies, making appointments, etc. This change will also permit qualifying taxpayers to deduct the cost of traveling between the residence and other business locations. The taxpayer may have another office away from home and still claim the deduction so long as the taxpayer chooses to do the work at home. The Tax Court found that the taxpayer was not able to deduct home office expenses where the taxpayer was found not to exclusively use a portion (25%) of her 400 square foot apartment for business purposes, the apartment was not her principal place of business as she was employed at a clinic and also worked out of a separately rented office at other times and did not meet with clients at the apartment. Mullin v. Commissioner, T.C. Memo 2001-121. IRS Publication 587 gives the following examples of activities that will not disqualify a home as a "principal place of business": 1. Taxpayer has others conduct some administrative or management activities at locations away from the home office. (For example, another company may do the billing from its place of business.) 2. Taxpayer conducts administrative or management activities at places that are not fixed locations of the business, such as in a car, plane or a hotel room. 3. Taxpayer occasionally conducts minimal administrative or management activities at a fixed location outside of the taxpayer’s home. 4. Taxpayer conducts substantial non-administrative or non-management business activities at a fixed location outside of the home. (For example, the taxpayer meets with or provides services to customers, clients or patients at a fixed business location outside of the home.) 5. Taxpayer chooses to conduct the business’s administrative or management activities in a home office even though suitable space outside the home is available for that purpose. The following examples give further guidance in determining the taxpayer's "principal place of business": Example 1. Jane is a self-employed anesthesiologist. She spends 30-35 hours a week administering anesthesia and postoperative care in three hospitals. One of the hospitals provides her with a small shared office where she could conduct administrative or management activities. However, she chooses instead to use a room in her home that she has converted to an office 10-15 hours per week. The room is used regularly and exclusively to schedule procedures, prepare and maintain billing records and patients logs and to read medical journals and books. Prior to 1999, Jane would not have been entitled to a deduction for her home office expenses because the activities performed there are less important than the services she performed at the hospitals. However, beginning in 1999, her home office will qualify as a principal place of business because of the administrative and management activities she conducts there. Her choice to use her home office rather than the one provided by one of the hospitals does not disqualify her deduction.

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Example 2. Bob is employed as a teacher. Bob is required to teach and meet with students at the school and to grade papers and tests. The school provides him with a small office where he can work on his lesson plans, grade papers and tests and meet with parents and students. The school does not require him to work at home. Bob spends approximately 30 hours per week at school and uses his home office exclusively and regularly 35 hours per week. As Bob is an employee and this office is not used at the convenience of the employer, he is not entitled to a home office deduction. As a result of the Soliman case, the IRS issued Rev. Rul. 94-47 setting forth that the IRS will not follow Walker v. Commissioner, 101 T.C. 537 (1993). Walker was a self-employed logger, his home was his regular place of business but clearly was not his principal place of business under the Soliman tests. The Tax Court allowed deduction of transportation expense to his temporary work locations. Rev. Rul. 94-47 and the IRS interpretation of the Soliman case deny these previously deductible transportation expenses. In Rev. Rul. 94-47, daily transportation expenses from a taxpayer's residence to a work location are non-deductible unless: 1. The expenses are incurred going from the taxpayer's residence to a temporary work

location outside the Metropolitan area where the taxpayer lives. 2. The expenses are incurred going from the taxpayer's residence to a temporary work

location within the Metropolitan area only so long as the taxpayer has one or more regular work locations away from the residence.

3. The expenses are incurred going from the taxpayer's residence, if the residence is the

taxpayer's principal place of business, to another work location whether such location is regular or temporary.

However, in Rev. Rul. 99-7, the IRS provides that it will permit taxpayers to deduct daily transportation expenses incurred in going from the taxpayer’s residence to a temporary work location (regardless of the distance) if the taxpayer has one or more regular work locations (in the same trade or business) away from the residence. A farmer should be able to deduct all expenses in connection with the office where it is used regularly and exclusively as an office to do farm business. This would seem to be the case where there is one room set aside for a farm office. The Farmers Tax Guide indicates that the principal place of business is the farm, the entire farm. The home office is on the farmer's farm and the surrounding farm ground is considered as one place of business. Therefore, the Soliman case should not be applicable and deduction allowed for the expenses attributable to that particular part of the house. Pro-rating expenses on a square footage basis is probably most appropriate. Gross income from a business must first be reduced by non-residential expenses to calculate the limit of deductible home office expenses. IRC Sec. 280A requires that the home office deduction be limited to the gross income from the activity reduced as follows: Non-residential business expenses, the business portion of interest, taxes and casualty loss, the business portion of maintenance, utilities, insurance and depreciation. Deductions for the business portion of insurance, utilities, maintenance and depreciation may not create a net loss. Disallowed deductions may be carried over to

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succeeding years and retain their character. See Michael H. Visin v. Comm., TC Memo 2003-246, August 18, 2003, where the Court disallowed claimed home office deductions that exceeded Schedule C income. Taxpayers need to review the benefits of home office deductibility against the resulting tax consequences upon the sale of the personal residence. Final regulations provide that if the personal residence is sold after May 6, 1997, all depreciation taken on the residence, after that date, is subject to the 25% Section 1250 recapture rate, even if all of the residence had been converted to personal use for more than two years prior to sale. A Tax Court Memo decision illustrates the need for documenting business expenses, particularly home office expenses. Taxpayer did not introduce any documentation or evidence to substantiate his Schedule C expenses and the Court disallowed all $15,889 of expenses. Victor Woods v. Comm., T.C. Memo 2004-114, May 11, 2004. SIMPLIFIED METHOD

Rev. Proc. 2013-13 provides an optional safe harbor method, for tax years beginning in 2013, to determine the amount of deductible expenses attributable to certain business use of a residence. This simplified method eliminates the calculation, allocation and substantiation requirements of the traditional method of claiming these expenses.

The taxpayer may choose to use either the simplified method or the traditional method for any taxable year. The election is made by using that method on a timely filed, original return for the taxable year. Once a method is elected for a taxable year, it cannot later be changed to the other method for that same year. If the simplified method is elected for one year and the traditional method for any subsequent year, the taxpayer must calculate the depreciation deduction for the subsequent year using the appropriate optional depreciation table.

Under the simplified method the taxpayer is allowed a standard deduction of $5 per square foot of home used for business, up to a maximum of 300 square feet. Any otherwise allowable home-related itemized deductions, such as mortgage interest and real estate taxes may still be claimed in full on Schedule A. There is no depreciation deduction for the home when using the simplified method, and therefore no recapture of depreciation for the years the simplified method is used.

The election to use the simplified method is made by entering the required information on Line 30 of the Schedule C (no Form 8829 is required). If a taxpayer used the simplified method in 2016 but elects to not use the simplified method in 2017, the taxpayer can use any unused carryover amount from their 2015 Form 8829, Lines 42 and 43.

EXAMPLE 1: Assume the taxpayer works from home and uses a 200 square foot room in her 1500 square foot home exclusively for her business. She has $18,000 of gross revenue and $2,000 of business expenses (not related to the use of her home) and chooses to use the simplified method for calculating her home office deduction in 2017. (see Schedule C Following):

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If the taxpayer chooses not to use the simplified method, then the taxpayer would use the traditional method as illustrated below. EXAMPLE 2: Assume the following set of facts that use of the office in the home is qualified (and see Form 8829 and Schedule C following): Gross income from Schedule C activity $18,000 Non-residential business expenses 16,000 $ 2,000 Total Bus. % Interest ($5,000) & property taxes ($1,000) $6,000 $1,500 Insurance ($1,000), repairs ($600) & utilities ($2,400) 4,000 1,000 Depreciation 753 Total office in home expense 3,253 Deductible office in home expense - 2,000 Net income $ - 0 –

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EXAMPLE 3: Assume the following set of facts and that use of the office in the home is qualified (and see Form 8829 and Schedule C following): Gross income from Schedule C activity $17,000 Non-residential business expenses 16,000 $ 1,000 Total Bus. % Interest & property taxes $6,000 $1,500 Insurance, maintenance & utilities 4,000 1,000 Depreciation 753 Total office in home expense $3,253 Deductible office in home expense - 1,500 Net loss $ ( 500)

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QUALIFIED PRINCIPAL RESIDENCE INDEBTEDNESS (EXCLUSION FROM GROSS INCOME)

IRC §108(a)(1)(E).

Solvent (and insolvent) debtors outside bankruptcy can exclude up to $2 million of qualified discharged (forgiven) home mortgage “acquisition indebtedness" ($1 million MFS) pertaining to their principal residence. The 2015 PATH Act extended this provision. Thus, the exclusion applies to discharges of home mortgage debt occurring between 1/1/07 and 12/31/16 (unless further extended) under IRC §108. For this purposes, the definition of a principal residence is the same as under the IRC §121 home sale gain exclusion rules. NOTE – Interaction With IRC §121: The IRC §121 exclusion provisions for gain on the sale of a personal residence can be utilized prior to this provision to initially avoid gain on the difference between sale proceeds and the cost basis of the residence. NOTE – Insolvent Debtors: This provision will apply to insolvent debtors, unless the insolvent debtor elects to have the new exclusion not apply and rely on the general IRC §108(a)(1)(B) discharge of indebtedness exception for insolvent taxpayers. Eligible Indebtedness: Debt that is incurred in the acquisition, construction, or substantial improvement of an individual’s principal residence and that is secured by that residence. This includes refinanced debt, but only up to the extent that the principal balance of the old mortgage, immediately before the refinancing, would have qualified. Second mortgages or home equity loans also qualify for this exclusion, provided the proceeds were used to buy, build or improve the taxpayer’s principal residence and are secured by the principal residence. NOTE: The exclusion is not available for vacation homes, rental residence, business property, credit card or car loan debt. While home equity debt can include a home equity line of credit used to purchase vehicles, etc.; this type of debt does not qualify for the $2 million exclusion. The exclusion also does not apply if the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the value of the residence or to the taxpayer’s financial condition. Ordering Rule: If only part of a loan is qualified principal residence indebtedness, the exclusion applies only to the extent the discharged amount exceeds the amount of the loan immediately before the discharge that is not qualified principal residence indebtedness. IRC §108(h)(4).

EXAMPLE: Gregg and Lori’s principal residence is secured by a debt of $1 million. Of this amount, $800,000 is considered qualified principal residence indebtedness. The residence sold for $700,000 and $300,000 of debt is discharged. Therefore, only $100,000 of the debt may be excluded ($300,000 discharged debt less $200,000 nonqualified debt).

Debt at time of foreclosure $1,000,000 $1,000,000 Sale price (700,000) Debt forgiven $ 300,000 Qualified principal indebtedness (800,000) Nonqualified debt $ 200,000 (200,000) Excludable debt $ 100,000

Basis Reduction Required: The basis of the taxpayer’s principal residence is reduced (but not below zero) by the amount that is excluded under this exception. IRC §108(h)(1). If the excluded indebtedness amount exceeds the basis of the taxpayer’s principal residence, no further attribute reduction is required. See Form 982 following. NOTE- Form 1099-C: Borrowers whose debt is forgiven in whole or in part will receive a Form 1099-C from their lender. The IRS urges taxpayers to carefully check their Forms 1099-C and immediately report any errors to their lender. In

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particular, taxpayers should check the amount of debt forgiven (box 2) and the value listed for their home (box 7). NOTE – Accrued But Unpaid Interest: Discharge of indebtedness income does not include accrued but unpaid interest. To the extent a forgiven loan balance consists of accrued interest that the borrower could have deducted had it been paid (mortgage interest), no discharge of indebtedness income is recognized. Form 1099-C should be reviewed to assure that no accrued interest is included in the amount of debt shown as forgiven (box 2).

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SALE OF PRINCIPAL RESIDENCE Sale of Principal Residence. For sales after May 6, 1997, a taxpayer may generally exclude up to $250,000 ($500,000 on a joint return) of gain realized on the sale or exchange of a principal residence. IRC §121. The exclusion applies to only one sale every two years. IRC §121(d)(5) provides that the destruction, seizure or condemnation of a principal residence may be treated as a sale. In CCC 2007 34021 the IRS found that it is a question of fact whether a residence is completely destroyed. The IRS found when a residence was damaged by a natural disaster, could not be rebuilt due to land use regulations without total destruction and rebuilding, it was to be treated as a sale. A partial destruction will not qualify as a sale of a principal residence since IRC§121 does not so provide. The exclusion replaces both the rollover provisions of former IRC §1034 and the one-time $125,000 over the age 55 exclusion. Thus, if a taxpayer wishes to sell a home with a realized gain of greater than $250,000 ($500,000 on a joint return), there is no longer a deferral provision to avoid recognizing taxable gain above the exclusion levels. Residence (Definition). IRC §121 does not define exactly what a principal residence is; however, the final regulations provide that a principal residence may include a houseboat, house trailer, an apartment in a cooperative housing corporation, etc., so long as cooking, sleeping and bathroom facilities are present. Treas. Reg. §1.1034-1(c)(3). In addition to the taxpayer’s use of the property, relevant factors in determining a taxpayer’s principal residence include, but are not limited to (1) the taxpayer’s place of employment; (2) the principal place of abode of the taxpayer’s family members; (3) the address listed on federal and state tax returns, driver’s license, automobile registration and voter registration card; (4) the taxpayer’s mailing address for bills and correspondence; (5) the location of the taxpayer’s banks; and (6) the location of religious organizations and recreational clubs with which the taxpayer is affiliated. Treas. Reg. §1.121-1(b)(2) Multiple Residences. The Arizona Federal District Court applied the §121 regulations and held that a taxpayer’s Wisconsin home did not qualify as the taxpayer’s principal residence, when spending more days at two other homes in the 5 year period prior to the sale. The Court considered other relevant factors including the fact that the taxpayers were not registered to vote in Wisconsin, did not have Wisconsin driver’s licenses and did not file Wisconsin tax returns. James M. & Jean M. Guinan v. United States, U.S. District Court of AZ, 2003-1 USTC Par. 50475 (April 9, 2003). Taxpayers who own two residences may be eligible to claim the exclusion on both residences by alternating their use as a primary residence.

EXAMPLE 1. [Multiple Residences] Assume Paul & Beth own a residence in Minnesota and a residence in Hawaii. Assume they use their Minnesota residence as their primary residence in years 2013, 2014 and 2017 and use the Hawaii residence as their primary residence in 2015 and 2016. They could claim the exclusion for the gain from the sale of either the Minnesota residence or the sale of the Hawaii residence in 2017 if all other tests are met.

Vacant Land. The final regulations provide that vacant land may qualify as part of the principal residence if: (1) the vacant land is adjacent to land containing the dwelling unit of the taxpayer’s principal residence; (2) the taxpayer owned and used the vacant land as part of the taxpayer’s principal residence; (3) the taxpayer sells or exchanges the dwelling in a sale or exchange that meets the requirements for the exclusion within two years before or two years after the date of the sale or exchange of the vacant land; and (4) the requirements have otherwise been met for the exclusion with respect to the vacant land. Treas. Reg. 1.121-1(b)(3) The sale of the vacant land is treated as a single sale for purposes of the gain limitation

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($250,000/$500,000) and the one sale every two years limitation.

EXAMPLE 2. [Vacant Land] Assume Beth purchased a residence and 2 acres of land in 2001 and the same were used as her principal residence. Further, assume she purchased 10 acres adjacent to the residence in 2003. In 2017 Beth sold the residence and 2 acres realizing a gain of $165,000 and sold the 10 acres realizing a loss of $15,000. Beth may exclude gain in the amount of $150,000. Query: Can Beth argue that she was holding this property for investment and recognize a loss?

If the vacant land is sold in a year prior to the sale of the personal residence the taxable gain realized must be reported and tax must be paid in the year of sale. An amended return may be filed when the personal residence is sold to claim a refund.

EXAMPLE 3. [Vacant Land] Assume Melissa purchased a residence and 8 acres in 2004 and the same were used as her principal residence. Melissa sold 6 acres in 2016 and realized a gain of $85,000. In 2017 Melissa sold the residence and 2 acres and realized a gain of $185,000. Melissa would have recognized the gain on the sale of the 6 acres and paid tax on the same in 2016. In 2017 Melissa may exclude the gain of $185,000 on the sale of the residence and 2 acres and file for a refund on her 2015 return as she will be able to exclude from income $65,000 ($185,000 + $65,000 = $250,000 maximum exclusion) of the $85,000 taxable gain reported on the original return.

An issue that is not settled directly by the regulations is what occurs when vacant land is sold as part of the residence and the vacant land had previously been used in the farming operation. Query: If the taxpayers had pasture ground previously used in their livestock operation and the livestock operation was discontinued more than two years ago, can the gain on the sale of vacant land be excluded as part of the personal residence exclusion? See Rev. Rul. 82-26. Partial Interest. A taxpayer may claim the exclusion on the sale of a partial interest in the taxpayer’s dwelling, up to the full exclusion and may exclude the gain from the sale of the remaining partial interest, up to the remaining part of the exclusion left after the initial sale.

EXAMPLE 4. [Sale of Partial Interest] Assume Melissa buys a house in 1996, uses it as her residence and in 2016 sells her friend Sarah a one-half interest realizing a gain of $150,000. This gain is excludable. If in 2017 Melissa sells her remaining 50% interest to Sarah for a gain of $165,000, she may exclude $100,000 of the gain. ($150,000 + 100,000 = $250,000 maximum exclusion). In Sung Huey Mei Hsu v. Commissioner, TC Summ. Op. 2010-68 (June 7, 2010) the Tax

Court concluded that a taxpayer who owned a 50% interest in her personal residence was entitled to use the entire $250,000 exclusion under §121 contrary to the IRS position that she should only be entitled to use 50% ($125,000) of the full exclusion.

Ownership And Use Requirements. Under the general rule, the taxpayer(s) must have owned and occupied the residence as a principal residence for at least two for the last five years prior to the sale or exchange. Only one spouse needs to meet the ownership requirement but both spouses must meet the occupancy requirement to exclude the full $500,000. For joint filers not sharing a principal residence, an exclusion of $250,000 is available on a qualifying sale or exchange of a principal residence of one of the spouses. If a single taxpayer, otherwise eligible for the exclusion, married someone who has used the exclusion within the 2 years prior to the marriage, the newly married taxpayer is allowed a maximum exclusion of $250,000. Once both spouses satisfy the eligibility rules and 2 years have passed since the last exclusion was allowed to either of them, they may exclude $500,000 of gain on their joint return.

EXAMPLE 5. [Separate $250,000 Exclusions For Joint Filers] Assume Kevin and Jane

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owned and lived in separate homes for more than two years prior to their marriage in October of 2016. Kevin and Jane each sold their prior homes in November of 2017, and purchased a new jointly owned home. Kevin realized a gain of $125,000 and Jane realized a gain of $275,000. Kevin may exclude his entire $125,000 of gain. Jane may exclude $250,000 of her gain. Jane will need to recognize the remaining $25,000 of gain. It does not matter whether they file jointly or separately, they do not qualify for the $500,000 exclusion, as both spouses have not lived in the homes for 2 of the last 5 years. EXAMPLE 6. [Exclusion Choices For Joint Filers] Assume the same facts as in Example 5 except that Kevin and Jane lived together in Jane's own house for 3 years before their marriage. Kevin and Jane now have two choices. They can either exclude the $275,000 gain on Jane's house (because they qualify for the $500,000 exclusion based on having occupied the house for 2 of the last 5 years) or they can treat the transactions as in Example 5. NOTE: If Kevin and Jane elect the first option (exclusion of the gain on Jane's residence), the gain on Kevin's house would not be excludable because the $500,000 exclusion applies to one residence

The days aggregating the two year period can be nonconsecutive. Periods of residence in a licensed care facility (e.g. nursing home) count as if the individual were living at home if the taxpayer is physically or mentally incapable of self-care. In this instance, the individual must occupy the residence for an aggregate period of at least one year during the 5-year period before the property is sold or exchanged to be eligible for exclusion. IRC §121(d)(7). For widowed taxpayers, the period of ownership includes the period during which the taxpayer's deceased spouse owned the residence. Reg. 1.121-4(a). Prior to 2008, if the surviving spouse sold the house in the year of death, the taxpayer would qualify for the entire $500,000 exclusion. However, if the sale occurred after the year of death, only a $250,000 exclusion was available. As of January 1, 2008 the Mortgage Forgiveness Debt Relief Act of 2007 gives an unmarried surviving spouse the entire $500,000 exclusion if the sale of the principal residence occurs within 2 years of the date of death.

EXAMPLE 7. [Holding Period-Widower] Assume Grace purchased her residence in 2004. Grace and George married on July 1, 2014 and George moved into Grace’s residence. Grace died January 8, 2016, and George sold the residence May 1, 2017. Grace’s use and ownership is attributable to George and the sale will qualify for the exclusion.

For taxpayers owning a residence transferred incident to a divorce, the time during which the spouse or former spouse owned the residence is added to the taxpayer's period of ownership. Similarly, a taxpayer owning a residence is deemed to use it as a principal residence while the spouse or former spouse of the taxpayer is using the residence under the terms of a divorce or separation agreement.

EXAMPLE 8. (A) [Marriage Dissolution] Monica and Andy own a home they've used as their principal residence for the last 20 years. They purchased the home for $200,000 (basis), and it's now worth over $1 million. Unfortunately, Monica and Andy are getting a divorce. The divorce decree specifies that they both remain co-owners of the residence, but that Monica is to retain the use of their home until their youngest child reaches age 18 in three years. At that time, the house is to be sold and the proceeds split equally between Monica and Andy. Shortly after Andy moves out, Tony moves in. Monica and Tony get married several years later, just a few months before Monica and Andy's youngest child turns 18 and the house is sold for $1.2 million. How much of the $1 million gain ($1,200,000 - $200,000) qualifies for the IRC §121 exclusion? At the time of the sale, Andy, Monica and Tony have all used the house as a principal residence for a least two of the last five years.

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NOTE: To satisfy the use test, Andy is allowed to count not only his actual use but also Monica's use because such use is pursuant to their divorce decree (IRC §121(d)(3)(B)). Andy and Monica also satisfy the two-year ownership test. As a result, Andy and Monica are each allowed to exclude $250,000 of the $500,000 gain allocated to them. In addition, if Tony and Monica file a joint return for the year of the sale, presumably an additional $250,000 of gain could be excluded on that return because only one spouse has to meet the ownership test. IRC §121(b)(2)(B). Thus, it appears a total of $750,000 of gain can be excluded, 100% of the $500,000 of gain reportable by Monica and Tony, and $250,000 of the gain reportable by Andy.

EXAMPLE 8 (B) Assume that on March 20, 2016, Monica and Andy marry and move into Andy’s house, which he has owned since 2001. The couple divorce in 2017. The divorce decree gives the house to Monica. The basis in the house is $120,000. Monica immediately remarries and moves into her new husband’s home on March 20, 2017. She sells the house for $230,000. Sale Price $230,000 Adjusted Basis 120,000 Gain realized 110,000 §121 exclusion = 365/730 x $250,000 =($125,000) Gain recognized -0- Monica gets the benefit of Andy’s holding period, but has not lived in the residence two years, but should qualify for the reduced §121 exclusion (see Partial Exclusion below) because divorce could be treated as an unforeseen circumstance.

The personal residence may be owned by the taxpayer’s grantor trust, the taxpayer’s single- member LLC or other disregarded non-corporate entity or a bankruptcy estate and the sale of the residence will still qualify for exclusion.

EXAMPLE 9. [LLC Ownership] Assume Kevin is single and purchased his personal residence in 2013 and transferred it to his single-member, LLC in 2017. If the LLC has not elected to be taxed as a Corporation, Kevin will be treated as the owner and the sale of the residence will qualify for gain exclusion up to $250,000.

Partial Exclusion Exception. An important exception exists to the previously described two year ownership, and use rules and the rule prohibiting claiming an exclusion if a prior exclusion has been claimed within two years of the last sale. The ($250,000 / $500,000) exclusion is limited or prorated based on the following calculation: The numerator of the fraction is the shortest of: • The number of days the taxpayer(s) owned the property during the five-year period ending on the

date of the sale, • The number of days the taxpayer(s) used the property as the principal residence during the five-year

period ending on the date of sale, or • The number of days between the date of prior sale of property for which the taxpayer(s) excluded

gain under IRC Sec. 121 and the date of the current sale. The denominator of the fraction is 730 days. (See Reg. 1.121-3).

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EXAMPLE 10. [Calculation of Partial Exclusion Amount] Assume Beth paid $180,000 for her house on September 22, 2016. She sold it for $200,000 on May 4, 2017. If she does not qualify for the prorated exclusion, she cannot exclude any of the $20,000 gain from income. If she qualifies for the prorated exclusion, the exclusion limit is calculated by multiplying the full $250,000 exclusion by the number of days she owned and used the home divided by the 730 days or $250,000 x 225/730 = $77,055. Beth can exclude all of her $20,000 gain.

The partial exclusion exception is available only when the taxpayer(s) fails to meet the use, ownership and timing rules of IRC Sec. 121. The final regulations provide that the home sale will qualify for the pro-rated gain exclusion if one of the following safe harbors are met as to the reason the sale occurred (a) change in place of employment (b) health reasons or (c) unforeseen circumstances. The regulations go on to establish a number of specific safe harbors in which the taxpayer will be deemed to automatically be eligible for the reduced gain exclusion.

SAFE HARBORS:

Change of Employment. The safe harbor regarding a change in place of employment, occurs if the change in place of employment occurs during the period of the taxpayer’s ownership and use of the property and the new place of employment is at least 50 miles farther from the former place of employment or, if there was no former place of employment, the distance between the new place of employment and the residence sold or exchanged is at least 50 miles. Treas. Reg. 1.121-3(c)(2). If the taxpayers do not meet this safe harbor, they may still qualify if the facts and circumstances prove the sale was due primarily to a change of employment.

EXAMPLE 11. [Employment Safe Harbor] Melissa is unemployed and owns a house that she has owned and used as her principal residence since 2016. In 2017, Melissa obtained a job that is 55 miles from her house and sold the house. Because the distance between the new place of employment and her principal residence is at least 50 miles, the sale is within the distance safe harbor and Melissa is entitled to claim a reduced maximum exclusion.

Health Reasons. The safe harbor, regarding health reasons, occur if the sale is based upon a physician’s recommendations. A sale is held to be primarily for health reasons when the facts and circumstances show the sale is to obtain, provide or facilitate the diagnosis, cure, mitigation or treatment of disease, illness or injury of a “qualified individual” or to obtain or provide medical or personal care for a “qualified individual” suffering from a disease, illness or injury. Treas. Reg. 1.121-3(d)(1). A “qualified individual” is (1) the taxpayer, (2) the spouse, (3) co-owner of the property in question (4) person whose principal place of abode is the taxpayer’s household, (5) an individual who bears a relationship identified in IRC Sec. 152(a)(1) through (a)(8) to any person listed in (1) through (4) or (6) a descendent of the taxpayer’s grandparent (such as first cousin of the taxpayer). Treas. Reg. 1.121-3 (f). A sale is deemed to be by reason of health if a physician recommends a change in residence due to health issues. Treas. Reg. 1.121-3(d)(2)

EXAMPLE 12. [Health Reasons Safe Harbor] In 2016, Beth bought a house that she used as her principal residence. She was injured in an accident and is unable to care for herself. As a result, Beth sold her house in 2017 and moved in with her sister, Melissa, so that she can provide the care Beth needs. Because, under the facts and circumstances, the primary reason for the sale of Beth’s house is her health, Beth is entitled to claim a reduced maximum exclusion.

Unforeseen Circumstances. The safe harbors regarding unforeseen circumstances found in Treas. Reg 1.121-3(e)(2) are as follows: Involuntary conversion of the residence.

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A natural or man-made disaster or act of war or terrorism resulting in a casualty to the residence.

Death of a qualified individual

A qualified individual’s cessation of employment making him or her eligible for unemployment

compensation. A qualified individual’s change in employment or self-employment status that results in the

taxpayer’s inability to pay housing costs and reasonable basic living expenses for the taxpayer’s household although not a rich and famous lifestyle.

A qualified individual’s divorce or legal separation under a decree of divorce or separate

maintenance. Multiple births resulting from the same pregnancy of a qualified individual, and also

An event determined by the Commission and published. Treas. Reg. 1.121-3 (e)(3).

EXAMPLE 13. [Unforeseen Circumstances Safe Harbor] Paul works as a teacher and Beth works as an accountant. In 2016 Paul and Beth purchased a house which is their principal residence. Later that year, Beth was furloughed from her job for 6 months. Paul and Beth were unable to pay their mortgage during the period. Paul and Beth sold their residence in 2017. The sale is within the safe harbor, and Paul and Beth are entitled to claim a reduced maximum exclusion.

The unforeseen circumstances test may still be met if the “primary reason for the sale or exchange is the occurrence of an event that the taxpayer could not have reasonably anticipated before purchasing or occupying the residence.” [Treas. Reg. 1.121-3(e)(1)]. However, the regulation also provides that “improving financial circumstances” does not qualify [Treas. Reg. 1.121-3(e)(1)]. Facts and Circumstances. If the safe harbors are not met, facts and circumstances are to be reviewed to see whether the primary reason for the early sale of the residence meets one of the three eligibility standards [Treas. Reg. 1.121-3(b)]:

1. The sale and the circumstances giving rise to the sale are proximate in time, 2. The suitability of the property as the taxpayer’s principal residence materially changes, 3. The taxpayer’s financial ability to maintain the property is materially impaired, 4. The taxpayer uses the property as the taxpayer’s residence during the period of ownership, 5. The circumstances giving rise to the sale are not reasonable foreseeable when the taxpayer

begins using the property as the principal residence, and 6. The circumstances giving rise to the sale occurred during the period of the taxpayer’s

ownership and use of the property as the principal residence. The IRS, in Letter Ruling 200504012 (January 28, 2005) concluded that a townhouse purchased before and sold after a police officer became a K-9 officer (since he was required to care for and kennel the dog which was not possible at the townhouse) would be eligible for a reduced exclusion under IRC Sec. 121(c) as an unforeseen circumstance. The following examples are set forth in Treas. Reg. 1.121-3(e)(4) and illustrate unforeseen circumstances:

a. Taxpayer buys a condo and six months later the condo association’s fee doubles because of building improvements, causing the new condo to be unaffordable for taxpayer.

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b. Two individuals become engaged and buy a home together. Subsequently, they cancel their

wedding plans and one taxpayer moves out of the house. The broken engagement is an event that could not reasonably have been anticipated.

c. A police officer buys a condominium as his residence. He is subsequently assigned to a K-9 unit

and required to care for a police service dog at his residence. His condominium does not permit owners to have a dog, and he sells the condominium.

The IRS has issued additional private rulings illustrating “unforeseen circumstances”: a. Taxpayers who sold their residence and moved after they became aware of various criminal

activities having occurred in their neighborhood and were assaulted, were permitted a partial exclusion (PLR 200601009).

b. Taxpayers who were unable to provide a younger child transportation to attend school in their

prior school district were permitted a partial exclusion. (PLR 200601022).

c. Taxpayers who had to sell their residence due to age restrictions in their housing development when their daughter (who had lost her job and was going through a divorce) and grandchild moved in with them, were permitted a partial exclusion. (PLR 200601023).

d. Taxpayers who needed to move to a larger home to accommodate needs of their adopted child

were permitted a partial exclusion. (PLR 200613009).

e. Taxpayer was a narcotics police officer and had been involved in a highly publicized arrest of an alleged drug dealer and feared for his life was permitted a partial exclusion. (PLR 200615011).

f. Taxpayer sold the principal residence shortly after it’s purchase, due to “substantial noise from

airplanes”. IRS concluded the taxpayer did a reasonable investigation prior to purchase and held this to be an unforeseen circumstance (PLR 200702032).

g. Taxpayer who sold their principal residence due to taxpayers’ marriage and resulting need to

suitably accommodate their blended family, were unforeseen circumstances and were permitted a partial exclusion. (PLR 200725018). See also PLR 200826024 and PLR 200841022.

The Private Letter Rulings appear to indicate that the IRS is being sympathetic in its interpretation of “unforeseen circumstances”. Taxpayers should be reminded that a private ruling only has application to the specific taxpayer, does not become a safe harbor and may not be relied upon by others. Like-Kind Exchange Issue. The American Job Creation Act of 2004 (AJCA) provided new rules on the sale of a principal residence if the residence was involved in a like-kind exchange within the past 5 years. The exclusion of gain on sale of a principal residence does not apply if the residence was acquired in a Section 1031 exchange in which gain was not recognized within the prior five year period. The five year period begins on the date of the acquisition of the residence. No prorata exclusion is provided. See Act Sec. 840 amending IRC Sec. 121(d)(10).

EXAMPLE 14. [Sale of Residence After Like-Kind Exchange] Melissa owned a partially depreciated commercial building that she desired to sell. When Melissa learned that the federal and Iowa marginal tax rates would be in excess of 32% on the gain from the sale, she arranged to dispose of the building in a Section 1031 exchange. On February 15, 2013, Melissa acquired a condo as the replacement property for the Section 1031 like-kind

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exchange. Melissa rented the condo to unrelated parties during 2013 and 2014, and on February 15, 2015, moved into the condo and used it as her personal residence until it was sold on February 15, 2017. As the condo was acquired through a Section 1031 like-kind exchange within five years of the date of the sale, the new five-year holding period of IRC Sec. 121(d)(10) is not satisfied. Therefore, Melissa must recognize the gain on the sale of the condo. EXAMPLE 15. Assume the above facts from Example 15, but Melissa uses the condo as her personal residence until it is sold on March 15, 2018. Since more than five years has passed before the date of the sale, Melissa may exclude the gain on the sale of the condo.

Mixed Use Properties. A significant change in the final regulations is the treatment of personal residences that were partially used for business or rental purposes. The prior thought was that gain from a mixed-use property would need to be allocated and the portion allocated to the business or rental portion of the residence would not be eligible for exclusion. The final regulations do not require allocation so long as the residential and non-residential portions are within the same structure. However, any post May 6, 1997 depreciation cannot be excluded and must be reported into income.

EXAMPLE 16. [Mixed Use Property before 12/31/08] Kevin, an accountant, purchased a residence in 1997. The residence is a single dwelling unit but Kevin used a portion of it as his office and claimed $2,000 of depreciation after May 6, 1998. He sold the house in 2008 and realized $23,000 gain. Kevin must recognize $2,000 of the gain as unrecaptured I.R.C. §1250 capital gain, using Forms 4797 and Schedule D (Form 1040). He may exclude the remaining $21,000 of the gain from the sale of his residence because he is not required to allocate gain to the business use within the dwelling unit.

Allocation Between Residential and Non-Residential. If the non-residential portion of the property is in a separate structure or separate dwelling unit, gain must be allocated between both the residential and non-residential portion of the property and only the residential portion is excludable. The allocation of the sale proceeds and tax basis must be according to the same method used to determine depreciation adjustments. (See 2011 Tax Court case Wickersham v. Comr., T.C. Memo 2011-178).

EXAMPLE 17. [Allocation Between Residential and Non-Residential] In 2006 Kevin purchased a two-story house and converted the basement level, which has a separate entrance, into a separate apartment. After the conversion, the property constituted two separate dwelling units. Kevin resided on the first and second floors of the house as his principal residence and rented out the basement level from 2010 to 2017. Kevin claimed $2,000 of depreciation deductions with respect to the basement apartment. Kevin sold the entire property in 2017 and realized a gain of $180,000. Kevin must allocate the gain between the portion of the property that he used as his principal residence and the portion of the property that he used for the separate dwelling unit sale. After allocating the basis and the sale proceeds between the residential and non-residential portions of the property, Kevin determines that $50,000 of the gain is allocable and recognizable to the non-residential portion of the property and that $130,000 of the gain is excludable. Of the $50,000 gain recognized, $2,000 is unrecaptured I.R.C.§1250 capital gain and $48,000 is net capital gain. EXAMPLE 18. Assume Paul and Beth sell their farm building site and move to town. Paul and Beth have been strictly row crop farming the last five years. The farm building site consists of their residence, machine shed, barn, silo, well and pump and grain facility. Paul and Beth sell approximately 10 acres of adjacent pasture land that has not been used since

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they sold out their dairy herd five years prior. If all the property is sold for $282,500, the proceeds need to be allocated between the residence and pasture and the balance of the farm buildings used in the farm operation. Assume $182,500 of the proceeds are allocated to the residence and pasture and are excluded under IRC §121. The balance of $100,000 will be allocated to the balance of the buildings and reported on Form 4797.

Application of Like-Kind Exchange Rules and the Principal Residence Exclusion. The IRS has provided guidance in Rev. Proc. 2005-14, IRB No. 2005-7, to taxpayers who wish to complete an exchange with respect to property that qualifies for both the §121 principal residence gain exclusion and the deferral of gain on the exchange of like-kind properties under IRC Sec. 1031.

Rev. Proc. 2005-14, IRB No. 2005-7 is applicable only if both the former residence and the

replacement property have a portion of said property used in a trade or business or held for investment. Rev. Proc. 2005-14, provides that the §121 principal residence gain exclusion is applied before

the §1031 like-kind exchange rules and the §121 gain exclusion cannot apply to gain attributable to depreciation of the residence after May 6, 1997; however, the §1031 like-kind exchange provisions may apply to such gain.

Rev. Proc. 2005-14 further provides that under §1031 rules, any boot or non-like-kind property

received is considered as taxable only to the extent the boot exceeds the gain excluded under the principal residence rule and when determining the basis of the property received in the exchange, any gain excluded under IRC §121 on the former property is treated as providing basis to the taxpayer in the replacement property.

EXAMPLE 19. [Residence Converted to Rental] Melissa, a single taxpayer, purchased a home for $210,000 that was her principal residence from 2012-2014. During 2015 and 2016 Melissa rented the house and claimed depreciation of $20,000. In early 2017, Melissa exchanges the house, receiving a townhouse with a fair market value of $460,000 and $10,000 of cash. Melissa will rent the townhouse property to tenants. Melissa’s residential property qualifies for the principal residence gain exclusion of IRC §121 because she had owned and occupied this property as her principal residence for at least two years during the five-year period prior to the exchange. As the residential property is investment property at the time of the exchange, Melissa may also defer $30,000 gain on this property under IRC Sec. 1031, calculated as follows:

Amount realized (FMV of townhouse of $460,000 + $10,000 cash) $ 470,000 Less adjusted basis ($210,000 cost - $20,000 depreciation) (190,000) Realized gain $ 280,000 Less maximum Section 121 gain exclusion (single) (250,000) Gain deferred under Section 1031 exchange $ 30,000

Melissa’s basis in the townhouse replace property is calculated as follows:

Basis of relinquished residence $ 190,000 Plus gain exclusion under IRC Sec. 121 250,000 Less boot received (10,000) Adjusted basis of replacement townhouse $ 430,000

The Military Family Tax Relief Act of 2003 changed the two out of five year test for the exclusion

of gain on sale of a principal residence under IRC Section 121. Active duty personnel away from home may elect to suspend the five year test for a maximum of 10 years, retroactively for sales made after May 6, 1997. This election to suspend the five year test may be made only on one property at a time. The duty station must be at least 50 miles from the residence and the personnel must be away for a period of

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at least 90 days or for an indefinite period. The Tax Relief and Health Care Act of 2006 extended this suspension period to members of the United State Intelligence Community.

EXAMPLE 20. [Active Duty Military Election] Kevin purchased and moved into a home March 15, 2009. He resided in his home for 2½ years through October 15, 2011. Kevin was on qualified official extended duty away from home with the Army for the next six years. He sold the home at a profit in November 2017. Under the general rules for IRC §121, Kevin failed to meet the two out of five year test. However, if Kevin chooses to suspend the five-year test period for the six years he was on qualifying official extended duty, he will qualify for the exclusion. The five-year test period consists of the five years prior to Kevin being on qualifying official extended duty. Kevin meets the ownership and use tests as he owned and lived in the home for 2 ½ years during this test period.

The IRS issued Rev. Rul. 2005-74 which sets forth the tax implications of employer relocation programs. The tax consequences depend on when the benefits and burdens of ownership are transferred. 1) If the benefits and burdens of ownership are transferred when the home is sold to the

employer (or its agent), the entire amount paid to the employee is considered proceeds from the sale of the residence and subject to the Section 121 exclusion. Amounts paid by the employer regarding the property until eventual sale are disregarded for tax purposes by the employee.

2) Alternatively, if the benefits and burdens of ownership do not transfer until the home is eventually sold to a buyer, only the amounts paid by the buyer are considered sale proceeds. Amounts paid by the employer regarding the property until the sale, are taxable compensation to the employee. 3) Under the IRS guidance, the following factors are relevant as to whether the benefits and burdens have transferred: a. Has legal title transferred? b. How did the parties treat the transfer? c. Was an equity interest acquired in the property? d. Does the contract create present obligations on the parties to execute and deliver a deed and make payments? e. Who is in possession? f. Who pays the property taxes? g. Who bears the risk of loss? h. Who receives the rents and/or profits from the sale?

TAX PLANNING: The law rewards those who have the knowledge or skill to buy and sell residences at a gain ("fixer uppers", etc.), and are willing to change homes as frequently as every two years. Previously, such individuals needed to constantly reinvest at greater amounts to shelter their gains. TAX PLANNING: For taxpayers with residence gains exceeding the exclusion limit, they may want to remain in their homes and achieve a step-up in basis at the time of death. Obviously, taxpayers with gains in residences exceeding the exclusion amount, who formerly could have used IRC §1034 to reinvest in a higher cost residence, are adversely affected by the new provision. For sales AFTER December 31, 2008. The Housing and Economic Recovery Act of 2008 has made a significant change in the section 121 exclusion provisions for mixed use properties. Applicable for sales occurring after December 31, 2008, the exclusion is no longer available for the periods of “nonqualified use” that occur after December 31, 2008. The gain on the sale of such a residence is allocated based

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on the percentage of time there was nonqualified use. EXAMPLE 22. [Mixed Use after 12/31/08] Andy purchases a property on January 1, 2012 for $200,000 and rents it out during all of 2012 and 2013. During this period of time he claims a depreciation deduction of $10,000. Andy then moves into the property and uses it as his personal residence for all of 2014 through 2016. On January 1, 2017 he sells the property for $500,000. Andy has a taxable gain of $310,000 ($500,000 – ($200,000 - $10,000)). He has $10,000 of unrecaptured §1250 gain. The $300,000 balance of the gain must be allocated between the qualified (60% of the time) and nonqualified (40% of the time) uses. Thus $180,000 (60% x 300,000) is excludible under §121 and the remaining $120,000 (300,000 x 40%) is taxable as long term capital gain. NOTE: The nonqualified use is any use of the property that is not as the taxpayer’s principal residence (for example used as a vacation home, used as a rental property, or simply not lived in by the taxpayer). There are three exceptions that apply in calculating what are the periods of nonqualified use:

1. When sold, the period of time between the taxpayer’s last use of the property and the date that it is finally sold.

2. For members of the uniformed services, foreign service, and the intelligence community when they are on extended tour of duty greater than 50 miles from the property.

3. Temporary absences for periods of up to 2 years that are a result of illness, employment,

or other unforeseen circumstances. In Rev. Proc. 2007-12 IRB 2007-4, IRS issued new procedures for exceptions from filing Form 1099S information return reporting the sale of a residence as real estate. The revenue procedure requires the seller to provide, in writing, subject to penalties for perjury, assurances that each seller (1) owned and used the residence as their principal residence for periods aggregating two years or more of the five years before the sale; (2) the sellers did not sell or exchange another principal residence during the two year period before the sale; (3) no portion of the residence was used for business or rental purposes after May 6, 1997; and (4) (a) the sale or exchange was $250,000 or less (b) the sellers are married and the sale or exchange was $500,000 or less and the gain on the sale was $250,000 or less, or (c) the seller is married, the sale or exchange is $500,000 or less and the seller intends to file a joint return for the year of sale and the seller’s spouse meets the requirements of (1) and (2) above. See certification form following.

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CERTIFICATION FOR NO INFORMATION REPORTING ON THE SALE OR EXCHANGE OF A PRINCIPAL RESIDENCE

This form may be completed by the seller of a principal residence. This information is necessary to determine whether the sale or exchange should be reported to the seller, and to the Internal Revenue Service on Form 1099-S, Proceeds From Real Estate Transactions. If the seller properly completes Parts I and III, and makes a “true” response to assurances (1) through (6) in Part II (or a “not applicable” response to assurance (6)), no information reporting to the seller or to the Service will be required for that seller. The term “seller” includes each owner of the residence that is sold or exchanged. Thus, if a residence has more than one owner, a real estate reporting person must either obtain a certification from each owner (whether married or not) or file an information return and furnish a payee statement for any owner that does not make the certification. Part I. Seller Information 1. Name 2. Address or legal description (including city, state, and ZIP code) of residence being sold or exchanged 3. Taxpayer Identification Number (TIN) Part II. Seller Assurances Check “true” or “false” for assurances (1) through (5), and “true”, “false”, or “not applicable” for assurance (6). True False [ ] [ ] (1) I owned and used the residence as my principal residence for periods aggregating 2 years or more during

the 5-year period ending on the date of the sale or exchange of the residence. [ ] [ ] (2) I have not sold or exchanged another principal residence during the 2-year period ending on the date of

the sale or exchange of the residence. [ ] [ ] (3) I (or my spouse or former spouse, if I was married at any time during the period beginning after May 6,

1997, and ending today) have not used any portion of the residence for business or rental purposes after May 6, 1997.

[ ] [ ] (4) At least one of the following three statements applies:

The sale or exchange is of the entire residence for $250,000 or less. OR I am married, the sale or exchange is of the entire residence for $500,000 or less, and the gain on the sale or exchange of the entire residence is $250,000 or less. OR I am married, the sale or exchange is of the entire residence for $500,000 or less, and (a) I intend to file a joint return for the year of the sale or exchange, (b) my spouse also used the residence as his or her principal residence for periods aggregating 2 years or more during the 5-year period ending on the date of the sale or exchange of the residence, and (c) my spouse also has not sold or exchanged another principal residence during the 2-year period ending on the date of the sale or exchange of the principal residence.

[ ] [ ] (5) During the 5-year period ending on the date of the sale or exchange of the residence, I did not acquire the

residence in an exchange to which section 1031 of the Internal Revenue Code applied. True False N/A [ ] [ ] [ ] (6) If my basis in the residence is determined by reference to the basis in the hands of a person who acquired

the residence in an exchange to which section 1031 of the Internal Revenue Code applied, the exchange to which section 1031 applied occurred more than 5 years prior to the date I sold or exchanged the residence.

Part III. Seller Certification Under penalties of perjury, I certify that all the above information is true as of the end of the day of the sale or exchange. Signature of Seller Date ___________________ _______

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VACATION PROPERTY ISSUES Taxpayers who own a condominium or house as a “vacation property” may rent the property for a portion of the year. If the vacation property is rented out for less than 15 days, the income received is tax free and no rental deductions are allowed. If otherwise qualified, mortgage interest and real estate taxes may be deducted as itemized deductions. If the taxpayer’s personal use does not exceed the greater of 14 days or 10% of the total rental days, rental expenses may be deducted in excess of rental income. If the vacation property is rented out for 15 or more days and the owner’s personal use exceeds the greater of 14 days or 10% of the days the property is rented, the “vacation property rules” apply. The tax treatment required, if the owner is subject to the “vacation property rules” (too much personal use), provides that expenses must be allocated between the rental of the property and the personal use of the property. No deductions in excess of the rental income will be allowed from the rental share of the property. EXAMPLE: Assume Paul and Beth own a cabin on Pelican Lake. They use the property for a total of 21 days during 2017. They are able to rent the property for a total of 182 days. As they used the property more than 10% of the days the property was rented, their Schedule E deductions are limited to the gross rental income.

RENTAL PERSONAL TOTAL SHARE SHARE

Rental Income $9,000 $9,000 -0- Utilities 4,000 2,000 2,000 Real Estate Taxes 4,000 2,000 2,000 Mortgage Interest 8,000 4,000 4,000 Depreciation 6,000 3,000 3,000 Total Expenses 22,000 11,000 11,000 Deductible Expenses 9,000* 6,000** * Deductible expenses limited to rental income – Ordering rules provide that real estate taxes and mortgage interest are deducted first, other allowable expenses such as insurance, utilities and repairs are second and depreciation is last. [Prop. Reg. 1.280A-3(d)(3)] ** Only mortgage interest and real estate taxes will be allowed as an itemized deduction Use by family members, even if they pay a fair market rent, will be considered as part of the owner’s personal use. Similarly if the owner donates the right to use the property to a charity, the “charity” use is also considered to be the owner’s personal use. Use by a pass-through entity and reciprocal rental arrangements are also deemed to be personal use by the owner. The Tax Court has held that vacation homes will not qualify for Like Kind Exchange treatment where the vacation homes were never rented to third parties. The Court acknowledged the properties were purchased with an eye to future appreciation, but did not allow exchange treatment. Moore v. Commissioner, T.C. Memo 2007-134, May 30, 2007. For vacation homes that have been for personal and rental use, the IRS has issued safe harbor guidelines in Rev. Proc. 2008-16 where the IRS will not challenge whether the vacation home qualifies for Like Kind Exchange treatment.

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SELF-RENTAL AND PASSIVE ACTIVITY ISSUES The general rule is that all rental income and loss is passive. However, the self-rental regulation (Treas. Reg. §1.469-2(f)(6)) prohibits using net income from self-rentals to offset other passive losses if the rented property is used in a trade or business in which the taxpayer materially participates. See also Sidell v. Comm., 2000-2 USTC 50.761 CA-1, 9/22/2000, where the First Circuit affirmed a Tax Court memo Decision holding that an individual that leased a building to a ‘C’ Corporation, must characterize the net rental income as non-passive. The Tax Court reached a similar holding where the taxpayers leased a portion of their residence to two ‘C’ Corporations in which they materially participated. Cal Interiors, Inc. v. Comm., T. C. Memo 2004-99, April 7, 2004. The Tax Court has also held that taxpayers who leased heavy construction equipment to their ‘C’ Corporation and created losses were subject to the passive loss restrictions. Kenneth Hairston v. Comm., T. C. Memo 2000-3856, December 20, 2000. See also Veriha v. Comr., 139 T.C. No. 3 (August 9, 2012) The regulations contain an opportunity that permit a taxpayer to group multiple businesses or multiple rentals as a single activity for all purposes under IRC Sec. 469. The definition of an “activity” under the passive activity loss limitation rules is important as the taxpayer’s material participation in a business is measured on a per-activity basis and the rule allowing a taxpayer to claim suspended losses upon disposition requires the taxpayer to dispose of the entire activity. According to Treas. Reg. 1.469-4(c)(1), one or more businesses or one or more rental activities may be treated as a single activity if the activities constitute “an appropriate economic unit”. Taxpayers are allowed to use any reasonable method in applying the relevant facts and circumstances to make this grouping decision. The regulations suggest that the following factors are the most important: 1. Similarities and differences in the types of trades or businesses, 2. The extent of common control and ownership, 3. Geographical location, and 4. Interdependencies between or among the activities. According to Treas. Reg. 1.469-4(e), a taxpayer has a duty of consistency with respect to the grouping decision. Thus, once a taxpayer has grouped or separately reported activities for this purpose, the taxpayer may not regroup those activities in subsequent taxable years. In 2010 the IRS issued Rev. Proc. 2010-13 wherein the IRS specifies how a taxpayer must report changes in the way activities are grouped. For tax years beginning on or after January 25, 2010 a taxpayer must report any new groupings, additions to existing groupings, and regroupings. Failure to report these changes will result in each activity treated as a separate activity for purposes of the passive activity rules. In a case which causes great concern for closely held business owners, the taxpayer’s grouping of passive activities, which allows the taxpayer to group multiple rentals as a single activity, does not preempt the self-rental regulations. See Carlos v. Comm., 123 T.C. No. 16 dated September 20, 2004. The result is that rental losses may not be grouped to offset self-rental income. The self-rental income will be reported as non-passive income and the rental loss remains a passive activity loss and may not be deductible. The Tax Court concluded that the self-rental recharacterization took priority over the grouping election. Taxpayers, after Carlos v. Comm., will not be able to combine a self-rental income property with any other passive loss rental property, whether the passive loss rental property is a self-rental loss or other rental loss property. This separation of a self-rental property with income from other

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passive properties is only harmful if other passive properties produce a loss. The First, Fifth, Seventh and Ninth Circuit have all upheld the self rental recharacterization.

Example 1: [Combining of Self Rental Properties Not Allowed]. Paul and Beth who are married and file a joint income tax return, own two commercial buildings, each of which is leased to a separate S Corporation. Paul and Beth own all of the stock of the two S corporations, one a manufacturing company and the other is a BBQ restaurant. Paul and Beth materially participate in the operations of both of these businesses. The building rented to the manufacturing corporation produces $90,000 of annual net rental income and the building leased to the BBQ restaurant results in an annual $50,000 loss. In preparing the Schedule E for the rental income within their Form 1040, Paul and Beth wish to group the two rental buildings together as a single activity, resulting in annual net rental income of $40,000.

Using the authority of the self-rental regulations, the IRS would separate the two rental properties. This regulation requires that a self-rental property with net income is recharacterized as nonpassive, while a self-rental property producing a loss remains a passive activity loss. As a result, the $90,000 net income from the manufacturing company building is not available to offset the $50,000 loss from the BBQ restaurant building. The $50,000 restaurant building loss becomes a suspended passive activity loss on their Form 1040 and the $90,000 is reported into income. Taxpayers may want to minimize self-rental loss activities by adjusting rental income, expense, etc.

Taxpayers may also consider grouping a self-rental loss with the business activity if there is identical ownership and if the taxpayer participates in the business activity. Reg. 1.469-4(d)(1) allows grouping of a business activity and a rental activity if each owner has the same proportionate ownership interest in the rental activity and the business activity. Also, a rental activity may be grouped with a business activity if the rental activity is insubstantial in relation to the business activity. There is no bright line test as to what would be “insubstantial”. By grouping the rental and business together, the rental activity loss is no longer treated as passive if the owner materially participates in the business. In Misko v. Comm., T.C. Memo 2005-166, the Court held an attorney could net losses from equipment leased to his Firm with earned income derived from the Firm. The Court held for the taxpayer, in that the equipment leasing activity met the 2% ”incidental” exception in the rental activity regulations, resulting in the activity deemed a business [Temp. Reg. 1.469-1T(e)(3)(ii)(D)] and because the taxpayer was the only individual involved in the leasing activity, he met the material participation test of the regulations and the loss from the leasing activity was deductible to the taxpayer [Temp. Reg. 1.469-5T(a)(2)]. In Assaf v. Comm., T.C. Memo 2005-14, the Tax Court held that payments made by the attorney-tenants were mainly for use of extraordinary personal services with property leasing being incidental to the services offered by the LLC. The taxpayers materially participated in the LLC leasing activities. Therefore, the losses were not passive activities for purposes of the passive loss rules thereby allowing the losses to offset other income. The LLC provided its attorney-tenants with a support staff of at least three (3) employees, a current law library, computers, along with conference rooms. The employees of the LLC answered phones, took messages, filed documents at the Courthouse, typed briefs, took dictation, did client intake cards and maintained the facilities. Further, the IRS regulations provide an exception from passive rental status in situations in which extraordinary personal services are provided [Temp. Reg. 1.469-1T(e)(3)(v)]. Where self-rental of personal property results in net income, the net income is not only not passive, but may result in self-employment tax for the taxpayer.

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ISSUES REGARDING MINISTERS A minister that is paid a salary is treated as an employee for income tax purposes and is not treated as a sole proprietor of a trade or business. The salary is fully taxable for federal income tax purposes, but is not subject to withholding unless voluntarily withheld. See Weber v. Comm., (95-2 U.S.T.C. Paragraph 50,409) where the U.S. Court of Appeals affirmed a Tax Court Decision that a Methodist minister was held to be an employee. Also see Raddle v. Comm., 74 T.C.M. 1072, T. C. Memo 1997-490, CCH 52,330(M). However, in Alford v. Commissioner, 97-2 U.S.T.C. Paragraph 89,045 (June 20, 1997), the Eighth Circuit Court of Appeals held that an ordained minister was an independent contractor. The 8th Circuit distinguished Alford from Weber based on the question of control. In a recent Tax Court Case amounts received from the congregation were held to be income and not gifts. Swaringer v. Comm., T.C. Summary Opinion 2001-37. For Social Security/Self-employment Tax purposes, the salary is treated as income from a trade or business and is subject to self-employment tax after certain adjustments are made. The fair rental value of a residence, provided by the church, a housing allowance, utility allowance, utilities paid by the church, excess reimbursed auto allowance, social security allowance if paid by the church and the net profit from weddings, funerals, etc. would all be added together with the salary for self-employment tax purposes. Unreimbursed deductible professional expenses may be deducted for self-employment tax purposes even if not deductible for income tax purposes, such as robes, unreimbursed automobile expense, etc. Pension payments and health insurance premiums paid by the church are not included into income for self-employment tax purposes. Retirement benefits and rental value of a parsonage furnished to a retired minister are not subject to self-employment taxes. See I.R.C. Sec. 1402. House rental and utility allowances are excludable from income for income tax purposes if used to rent a house and the same do not exceed reasonable compensation for services provided by the minister. See I.R.C. Sec. 107. This exemption, the "parsonage allowance" was challenged in Freedom from Religion Foundation, Inc., et al. v. Lew, et al., 983 F. Supp. 2d 1051 (2013), where the Federal District Court in Wisconsin originally ruled §107(2) to be unconstitutional as it violated the establishment clause of the First Amendment. However, on November 13, 2014, the 7th Circuit Court of Appeals concluded that the Plaintiffs in that case lacked standing to challenge §107(2) and therefore the issue of the constitutionality of the parsonage allowance was dismissed. Back in the courts again, the Federal District Court for the Western District of Wisconsin recently again ruled that §107(2) violates the establishment clause of the First Amendment because the exclusion of a rental allowance gives a tax benefit only to ministers of the gospel. In response to the 7th Circuit’s 2014 reversal for lack of standing, the plaintiffs, members of the Freedom from Religion Foundation, amended their 2012 individual income tax returns claiming a housing exclusion with the statements that they are “not clergy” and that their “employer is not a church.” In 2015, the IRS denied their claim for refund. The District Court found this denial of refund gave the plaintiffs standing. The Court did not grant a remedy, but asked the parties to submit briefs on the matter and whether relief should be stayed pending appeal by November 6, 2017. Gaylor (Freedom from Religion Foundation) v. Mnuchin No. 16-cv-215-bbc (W.D. WI October 6, 2017). The IRS has interpreted this §107 exemption as the lesser of actual expenditures, the amount designated as the allowance or the fair rental value of the residence. Rev. Rul. 71-280. Although the Tax Court has found the fair rental value limitation invalid, Warren V. Comm., 114 T.C. 23, (5/16/2000), the Clergy Housing Allowance Clarification Act of 2002 (P.L. 107-181, 5/20/02) codifies Rev. Rul. 71-280 and provides that the clergy exclusion for housing is limited to the fair rental value of the residence. The Service appealed this decision but the 9th Circuit Court of Appeals dismissed the appeal in August

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2002. In 2012, the 11th Circuit Court of Appeals ruled that the excludible housing allowance applies only to one house and does not include the ministers second "lake home." Comm v. Driscoll, No. 11-12454 (February 8, 2012). If a non-taxable housing allowance or utility allowance is received for income tax purposes the tax court has held the minister will need to decrease his unreimbursed professional expenses proportionately. Pension payments and health insurance premiums paid by the church are not included into income for income tax purposes. Expenses relating to a minister's house are not deductible, as the housing allowance was exempt from income tax, even if subject to self-employment tax. McFarland v. Comm., 64 T.C.M. 374, T.C. Memo 1992-440 (CCH) 48395. Also see Young v. Comm., T.C. Summary Opinion 2005-75, where the expenses are disallowed for SE Tax purposes as well, regardless of IRS Pub. 517 language. The IRS has ruled that teachers and staff of a religious grade school are not “ministers of the gospel” and do not qualify for a parsonage allowance. Priv. Ltr. Rul. 200318002 (January 7, 2003). However, see Priv. Ltr. Rul. 200803008 (October 18, 2007) where the IRS ruled that such rental allowance was excludable from gross income for faculty, managers, executives and administrators who are ordained, licensed or commissioned ministers employed by a university. Self-employed ministers may participate in a church retirement plan. The earned income of the self-employed minister is treated as his or her compensation. See I.R.C. Sec. 414. Example: Assume Able Minister receives a cash salary of $35,000, a housing allowance of $500 per month and a utility allowance of $150 per month. Further, assume the church pays his health insurance premiums of $250 per month and makes a pension contribution in the amount of $5,000 per year. Assume the actual rental cost and utility expense is in excess of the allowances. Further assume that Able Minister has $4,000 of unreimbursed professional expenses. For income tax purposes only the salary of $35,000 will be taxed. The sum of $3,271 will be deductible as a Form 2106 expense computed as follows ($35,000/$42,800) x $4,000 = $3,271. For self-employment tax purposes the sum of the salary, housing allowance and utility allowance less the deductible unreimbursed professional expense or $35,000 + $6,000 + $1,800 - $3,271 or the sum of $39,529 will be taxed. IRS Publication 517 Social Security and Other Information for Members of the Clergy and Religious Workers contains the following worksheets with examples designed to calculate taxable ministerial income, allowable deductions and net self-employment income: Worksheet 1. Figuring the Percentage of Tax-Free Income Worksheet 2. Figuring the Allowable Deduction for Schedule C or C-EZ Expenses Worksheet 3. Figuring the Allowable Deduction for Form 2106 or 2106-EZ Expenses Worksheet 4. Figuring Net Self-Employment Income for Schedule SE (Form 1040)

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MILITARY ISSUES

Members of the United States Armed Forces (which includes members of the Army, Navy, Air Force, Marines and Coast Guard) are recipients of various benefits and pay categories. See Tables 1 & 2 from IRS Pub. 3, Armed Forces Tax Guide (2016) following. Generally, the basic pay and bonuses are taxable, unless earned in a combat zone. Allowances for subsistence, housing, family, moving and other fringe benefits are tax free whether or not the military personnel are in a combat zone.

All pay received by an enlisted person or a warrant officer while serving in a combat zone for any part of the month is excluded from gross income. Officer’s pay up to the highest pay for an enlisted member (this is $8,165.10 per month for 2017) plus the amount of hostile fire/imminent danger pay (this is $225.00 per month in 2017) is excluded. The exclusion also applies to any pay received while the member is recuperating in the hospital from injuries received or illness incurred in the combat zone (limited to two years after the date of termination of the combatant activities in the combat zone).

EXAMPLE 1: Kevin, an officer, was paid January 5, 2017 while stationed outside of the combat zone. The pay was for December 1 – December 31, 2016 when he was in a combat zone for one day. At the time of service in the combat zone, he received pay of $8,563.80 per month including the hostile fire/imminent danger pay of $225. He may exclude $8,390.10 for that month's pay even though received after he has left the combat zone.

Civilian contractors, the American Red Cross and the U.S. Merchant Marine do not qualify for the exclusion if compensation is earned in a combat zone. The Form W-2 should show the correct amount of taxable income. If not, a corrected W-2 is required.

For tax years 2004 - 2007 combat pay, although not taxable for income tax purposes, may be included for earned income tax purposes. (See Section 104(b) of the Working Family Tax Relief Act of 2004). This provision was made permanent by the Heroes Earnings Assistance and Relief Tax Act of 2008 (“HEART 2008”).

EXAMPLE 2: Melissa has one child and no spouse. Box 1 (wages) of her 2017 Form W-2 shows $3,000. She served in a combat zone during 2017 and received combat pay of $16,000. She had no other income during 2017. Assume Melissa does not make the election to include her $16,000 of combat pay as earned income, her 2017 EIC based on $3,000 would be $1,029. Assume Melissa does make the election to include the nontaxable combat pay as earned income, Melissa’s EIC increases to $3,291 based on $19,000 of earned income with one qualifying child.

Section 104(a) makes a similar change for purposes of computing the refundable portion of the child credit.

The Heroes Earned Retirement Opportunity Act of 2006 (“HERO Act”) provides that military service members receiving non-taxable combat pay may treat such pay as compensation for

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traditional and Roth IRA limitation rules. This provision may qualify military personnel who make an IRA contribution eligible for the IRC Section 25(B) Savers Credit.

When military personnel are in a combat zone, all filing deadlines, payment of tax due, making contributions to traditional or Roth IRAs and statutes of limitation are suspended for the period of time they are in the combat zone plus 180 days. These extensions are for all taxpayers on military business in the combat zone, including military personnel, civilian contractors, American Red Cross and the U.S. Merchant Marine. The extensions also apply to the personnel’s spouse and dependent children. To notify the IRS for the need of these extensions, one needs only to write “Combat Zone” on any notice received.

Military personnel stationed overseas with an APO or FPO address should mail their tax returns to the Internal Revenue Service Center in Austin, TX. For more information see IRS Publication 3, Armed Forces Tax Guide.

The Military Family Tax Relief Act of 2003 allows an above the line deduction for tax years after December 31, 2002 for National Guard and Reservists unreimbursed expenditures for travel where travel of over 100 miles requires an overnight stay. The amount of the expense cannot exceed the general Federal per diem rate. This deduction is to be claimed on Line 24 of Form 1040.

The Military Family Tax Relief Act of 2003 also changed the two out of five year test for the exclusion of gain on sale of a principal residence under IRC Section 121. Active duty personnel away from home may elect to suspend the five year test for a maximum of 10 years, retroactively, for sales made after May 6, 1997. HEART 2008 gives this same benefit to members or the spouse of a member of the Peace Corps serving outside the United States. This election to suspend the five year test may be made only on one property at a time. The duty station must be at least 50 miles from the residence and the personnel must be away for a period of at least 90 days or for an indefinite period.

EXAMPLE 3: Kevin purchased and moved into a home March 15, 2009. He resided in his home for 2½ years through October 15, 2011. Kevin was on qualified official extended duty away from home with the Army for the next six years. He sold the home at a profit in November 2017. Under the general rules for IRC §121, Kevin failed to meet the two out of five year test. However, if Kevin chooses to suspend the five-year test period for the six years he was on qualifying official extended duty, he will qualify for the exclusion. The five-year test period consists of the five years prior to Kevin being on qualifying official extended duty. Kevin meets the ownership and use tests as he owned and lived in the home for 2 ½ years during this test period.

The First-Time Homebuyer Credit repayment requirement is waived for members of the uniformed services, members of the Foreign Service and employees of the intelligence community. This relief applies where the residence is sold or stops being the taxpayer’s principal residence after Dec. 31, 2008, in connection with government orders received by the individual (or their spouse) for qualified official extended duty service.

Income taxes are forgiven for the year of death and any earlier years served by the taxpayer in a combat zone, if a member of the military dies during combat or as a result of injuries received in a combat zone. A CCA Letter Ruling 200447035 assumes a scenario that a deceased

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member of the military served in a combat zone in Year 1 and was killed while serving in a different combat zone in Year 12. The member of the military served in multiple combat zones between years 1 and 12. The Ruling provides the claims for refund for years 7-12 fell within the statute of limitations and were granted.

Disability pension payments can be excluded from income tax for military personnel who initially received disability pensions prior to September 25, 1975 and for members of the military who are receiving disability pensions as a direct result of combat related injuries suffered after September 24, 1975.

Death benefit payments received by survivors of military personnel who die in a designated combat zone as a result of training, performing hazardous duty or “hostile actions” may be excludable from income tax. HEART 2008 also grants the survivor the ability to contribute these amounts into a Roth IRA or Coverdale ESA regardless of other contribution limits. For deaths after September 11, 2001, this amount was increased to $12,240 for deaths in 2005 and later years and passes tax free to the next of kin. The 2005 Emergency Supplemental Appropriations Act increased this amount to $100,000 and if passing to a survivor, that the deceased was responsible for supporting, will be entirely tax free.

The American Recovery and Reinvestment Act of 2009 created a tenth targeted group for the work opportunity tax credit. This category initially included unemployed veterans who began work for the employer in 2009 or 2010. The work opportunity credit was extended for veterans who began work after November 21, 2011 and before January 1, 2013. On December 19, 2014 the Tax Increase Prevention Act of 2014 extended this to workers hired before January 1, 2015. The Protecting Americans from Tax Hikes Act of 2015 (“PATH Act 2015”) retroactively restored this credit for 2015 and extended it through 2019. Because this was extended late so in 2015, the IRS issued Notice 2016-22 and Notice 2016-40 which granted employees additional time; through June 29, 2016 for employment that started by May 31, 2016 and through September 28, 2016 for employment that started by August 31, 2016; to submit Form 8850 for employee certification.

To qualify the veteran must have at least four weeks of unemployment in the year before being hired. The instructions to Form 8850 list the requirements of a qualified veteran to include:

1. A member of a family receiving assistance under Supplemental Nutrition Assistance Program (SNAP) (food stamps) for at least a 3-month period during the 15-month period ending on the hiring date. 2. Unemployed for a period or periods totaling at least 4 weeks (whether or not consecutive) but less than 6 months in the 1-year period ending on the hiring date. 3. Unemployed for a period or periods totaling at least 6 months (whether or not consecutive) in the 1-year period ending on the hiring date. 4. Entitled to compensation for a service-connected disability and is hired not more than 1 year after being discharged or released from active duty in the U.S. Armed Forces. 5. Entitled to compensation for a service-connected disability and was unemployed for a period or periods totaling at least 6 months (whether or not consecutive) in 1-year period ending on the hiring date.

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Differential payments (voluntary payments paid to a former employee equal to the difference between their previous regular salary and their active duty military salary) are not considered wages subject to withholding or employment taxes. These payments are to be reported on Form 1099-MISC Box 3 as other income and should be reported on Form 1040, Line 21. However, beginning in 2009, HEART 2008 made these payments subject to withholding and eligible for a variety of types of retirement plans. Employers must treat rehired service members as if they had never left their employment and fund non-elective employer pension contributions as if the employee had never been activated. Employees may also contribute as a make-up contribution to the employee’s retirement plan. Both the employers and the employees have a period of three times the activated period of service to fund their make-up contributions.

Rev. Rul. 2009-11 the IRS explained that differential wage payments made to an individual while on active duty in the United States uniformed services for more than 30 days are subject to income tax withholding, but are not subject to FICA or FUTA taxes.

The PATH Act 2015 made permanent the up to $4,000 per employee credit for employers providing salary continuation payments (20% of up to $20,000 in salary continuation payments) to employees who are on active duty for at least 30 days.

The Pension Protection Act of 2006 eliminates the 10% early distribution penalty for eligible reservists called to active duty between September 11, 2001 and December 31, 2007. HEART 2008 has made these provisions permanent for individuals called to active duty after December 31, 2007. Regular income tax will still apply. If an eligible reservist has already paid the early distribution penalty, the reservist may file for a refund.

The Military Spouses Residency Relief Act of 2009 impacts residency and income of a military person’s spouse for purposes of state and local taxation. Under the Act, a military member's spouse will not lose or acquire domicile or residence by reason of being absent or present in any taxing jurisdiction to be with the military member in compliance with the military member's orders if the residence or domicile is the same for both the military member and spouse. Additionally, income earned by a military member's spouse is not deemed to be income earned in the United States if the spouse is not a resident or domiciliary of the jurisdiction in which the income is earned because the spouse is in that jurisdiction solely to be with the military member serving in compliance with military orders.

One of the best research sources for information regarding military tax issues is IRS Pub 3 (Armed Forces’ Tax Guide).

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WHETHER A PERSON IS SELF-EMPLOYED AS AN INDEPENDENT CONTRACTOR OR IS AN EMPLOYEE CONTINUES TO BE A DILEMMA

1. VOLUNTARY CLASSIFICATION SETTLEMENT PROGRAM (VCSP) On October 11, 2011 the IRS issued Announcement 2011-64, 2011-41 I.R.B. 503, which was modified and superseded on December 12, 2012 by Announcement 2012-45, 2012-51 I.R.B. 724 which provides partial relief from federal employment taxes for employers who have misclassified their workers as independent contractors when the employer agrees to treat them as employees going forward. The VCSP grants eligible employers to pay 10% of the employment taxes that may have been due on compensation paid to the workers in the most recent tax year. The employer will not be liable for any penalties, interest or employment taxes for prior years. To be eligible the employer must have consistently treated the workers as nonemployees, must have filed all required Forms 1099 for the workers for the three previous years, and cannot be currently under an employment tax audit concerning the classification of the workers. IRS Form 8952 Application for Voluntary Classification Settlement Program is used by an eligible employer to apply for the program.

2. CASES AND RULINGS IN THE TRUCKING INDUSTRY: Truck drivers were held to be independent contractors where the common carrier and the driver would agree on the price of the load, the drivers had the discretion to decline a load and were free to choose their own hours and routes, even though the truck owner provided the truck, performed routine maintenance and the drivers work was critical to the owner’s business. Sam, Peter G. v. United States of America, 90 AFTR 2d 2002-7628(2002) Truck drivers who receive 40% of the gross revenues generated by their trucks as compensation are employees, even though required to pay all truck operating expenses. The truck drivers' wages subject to FICA were their share of gross revenue and were not reduced by truck operating expenses. A surprising result, but indicative of these rulings. Priv. Ltr. Rul. 93-07-003 (Oct. 14, 1992). However, owner operators who furnished their own vehicles, paid all expenses and were paid a flat fee for each package delivered, are to be treated as independent contractors. Tech. Adv. Mem. 98-14-001. Truck drivers who owned their own trucks and reported part of the contract payments received as wages and part as rental income were required to report all payments received as wages. Escobar de Paz, T.C. Memo 2000-176 (May 26, 2000). The Court held that all expenses were to be deducted on Form 2106. Truck drivers were held to be employees as opposed to independent contractors where the company maintained considerable control over the drivers, oversaw the drivers and determined which loads were to be hauled. Drivers were paid a percentage of the load’s receipts, but paid none of the costs of the truck. Peno Trucking, Inc. v. Commissioner., T.C. Memo 2007-66. Further, the Court held that Section 530 relief was not available. This case was appealed to the Sixth Circuit and the Court of Appeals reversed the Tax Court’s decision and held that the company was entitled to the protections of Section 530 despite having misclassified its drivers as independent contractors. The case reaffirms the right to Section 530 tax relief based on a reasonable reliance upon the common law independent contractor factors, even if those factors are established by a state agency or court. Peno Trucking, Inc. v. Commissioner (6th Cir. Oct. 3, 2008) Van drivers were held to be employees where the drivers did not control their schedules, routes, fees and had no authority to make business decisions. TAM 2004-07-014.

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3. CASES AND RULINGS IN OTHER INDUSTRIES: In Priv. Ltr. Rul. 93-05-001 (Sept. 8, 1992), individuals who had finished a course in hairdressing and stayed with the firm for a percentage of their gross were held to be employees. The hairdressers could make their own appointment schedule, accept or reject clients, schedule their own working day and had to have their own liability insurance. Cosmetologists who had signed chair lease agreements, were charged a percentage of gross weekly receipts as rent, set their own schedules and furnished their own equipment were held to be independent contractors. Ren-Lyn Corp. v. United States, 97-1 U.S.T.C. 87,901 (N.D. Ohio, April 4, 1997). Manicurists that did not lease booths, did not purchase supplies from the taxpayer and did not resolve customer complaints were held to be employees of the taxpayer. L.A. Nails, Inc. v. U.S., U.S. District Ct. 98-1 U.S.T.C. 84,213. [CCH Dec. 50,438] In Priv. Ltr. Rul. 93440l8 (Aug. 18, 1993), insurance agents paid on a commission basis were found to be independent contractors. The workers were retained for an indefinite period, were not required to follow any set schedule and performed their services in their own place of business. See also Ware v. U.S., 95-2 U.S.T.C. 50,553 (6th Cir. 1995); Butts v. Commissioner, 49 F.3d 713 (11th Cir. 1995) (95-1 U.S.T.C. Paragraph 50,213); Mosteirin v. Commissioner, 70 T.C.M. (CCH) 305 (1995) CCH Dec. 50,800 (M). Lozon v. Commissioner, T.C. Memo 1997-250, 73 T.C.M. 2914 (1997). The IRS is also claiming all fringe benefits received will be taxable for income tax purposes if the individuals are treated as an independent contractor. An accountant that was hired on an hourly basis as a comptroller of a firm was held to be an independent contractor where the Court found that the firm did not control how the job was performed, that the accountant was hired job by job and often worked at home. The accountant was held liable for additional income tax and self-employment tax. Youngs v. Commissioner, 69 T.C.M. (CCH) 2032 (1995) CCH Dec. 50504(M). In a surprising result, a U.S. State Department worker (an industrial hygienist) was found to be an independent contractor, which permitted the worker a SEP contribution, even though the worker was issued a W-2 and had income and FICA taxes withheld from her contract payments. The Tax Court reviewed eleven factors and found her to be an independent contractor. Levine v. Comm., T.C. Memo 2005-86. In a 2016 case, the Tax Court determined that a taxpayer working in the television industry creating sets, who worked for several different production companies, used his own tools, hired additional employees as needed, had a large degree of control over the production process and could accept or reject any project, was an independent contractor and could therefore deduct his related business expenses on Schedule C even though he received several W-2’s from the numerous production companies. Quintanilla v. Comm., TC Memo 2016-5. A sole shareholder was held to be an employee for federal employment tax purposes and was not entitled to Section 530 relief where the sole shareholder performed services to generate revenue, signed checks and hired employees. Western Management, Inc. v. Commissioner 9th Circuit of Appeals, No. 04-70795, April 12, 2006. A realtor who incorporated his sole proprietorship business was held to be an employee of the business. Martin v. Commissioner, T.C. Memo 2009-234 (October 13, 2009). See also Hwynn v. Commissioner, T. C. Summary Opinion 2009-88. Two secretarial workers who worked for a personal injury lawyer at a rate $10 per hour, where the lawyer provided all equipment and supplies, were held to be employees and the lawyer was liable for failure to timely file employment returns and for failure to deposit penalties. Frederick C. Kumpel v. Comm., TC Memo 2003-265, (September 10, 2003). In 1998 the U.S. Supreme Court failed to review a Ninth Circuit decision which had held that Microsoft freelancers were employees entitled to fringe benefits. The Ninth Circuit has now determined that even if a worker is considered to be an employee of a temporary agency, that this employment status does not preclude the individual from also being found to be a common law employee of Microsoft. The Court determined that it was irrelevant if the worker was considered an employee of the temporary agency, as this had no bearing whether the individual was a common law employee of Microsoft. Vizcaino v. Microsoft Corp, 99-1 U.S.T.C. 50531 (9th Cir. 1999).

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Taxpayer demonstrated that a significant segment of used car businesses treated their sales persons as independent contractors and the Court held that the taxpayer was proper in treating his sales persons as independent contractors. Martin L. Springfield v. United States, 96-2 U.S.T.C. 50,354 (9th Cir. 1996). See also Douglas Motors v. United States, 96-2 U.S.T.C. 85,173 (9th Cir. 1996). IRC Sec. 3508, effective for tax years beginning after December 31, 1995, clarifies the status of newspaper distributors and carriers qualifying them as direct sellers and to be treated as independent contractors. 4. IRC §530 For tax years commencing after December 31, 1996, Section 530 of the Revenue Act of 1978 has been amended to make several changes to the industry practice safe harbor. Section 530 gives limited protection to the employer if the employer meets the consistency and reasonable basis tests. If certain safe harbor tests are met, the IRS may not retroactively reclassify any individual as an employee if the taxpayer had not previously treated that individual as an employee for employment tax purposes. Section 530 does not alter the status of workers but merely relieves employers of liability for employment tax. Statutory requirements that must be met to avoid employer tax liability under Section 530 are as follows:

(1) A “reasonable basis” for treating the worker as an independent contractor; (2) Treatment consistent with the treatment that took place for all periods beginning after

December 31, 1977; and (3) The filing of all required federal tax returns on a basis consistent with an independent

contractor classification. The reasonable basis test can be met by an employer if he placed reasonable reliance upon one of the following authorities in determining the status of workers:

(1) Judicial precedent, published rulings, a technical advise memorandum with respect to the taxpayer, or a letter ruling issued to the taxpayer;

(2) A past IRS audit of the taxpayer in which there was no assessment of employment tax

deficiencies for amounts paid to individuals holding positions substantially similar to a position held by the employee; or

(3) A long-standing recognized practice of a significant segment of the industry in which such

individual was employed.

The Court in 303 West 42nd Street Enterprises, Inc. v. Comm., 99-2 U.S.T.C. 50611, (2nd Cir. 1999) interpreted the definition of a “long-standing recognized practice of a significant segment of the industry,”. In the industry (adult entertainment) some employers classified performers as tenants while others classified performers as independent contractors. The Second Circuit reversed a District Court decision and ruled that uniformity within the industry was not required, assuming that some significant segment of the industry could be shown to treat the workers the same as the particular taxpayer. The Second Circuit returned the Case to District Court to analyze whether the taxpayer reasonably relied upon this practice, which found that the business had not reasonably relied upon this practice. 303 West 42nd St. Enterprises, Inc. v. Comm., 2000-1, U.S.T.C. Par. 50, 488, (S.D., N.Y., 5/22/2000). The Tax Court stated in Medical Emergency Care Associates, 120 TC No. 15, 5/19/2003 that the “plain language of section 530(a)(1)(B) denies relief only if the required filing was not made or if the required filing was made on a basis not consistent with treatment of the individual as not being an employee...there is nothing in the language of Section 530(a)(1)(B) that requires timeliness along with consistent filing.” The Tax Court stated that the taxpayer was entitled to Section 530 relief even though the Form 1099’s were not timely filed as the taxpayer had not treated the doctors as employees for any period, filed all tax returns on a basis consistent with such treatment, and had a reasonable basis for not treating them as employees.

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Section 530 relief was available where an employer reasonably relied on legal counsel’s opinion that doctors were to be treated as independent contractors. Said opinion was based on industry practices, IRS Rulings and previous experience. The Court found the reasonable basis test was met. Select Rehab, Inc. v. U.S., 2002-1 USTC 50397, Dist. Ct. MD PA., 4/8/2002. However, Section 530 relief was denied to a sole shareholder dentist as payments received by the dentist were held to be wages. Dennis Katz, DDS, PC v. Comm., TC Memo 2002-118, 5/14/2002) However, the Tax Court held the Taxpayer was not entitled to Section 530 relief where IRS reclassified payments made to the Taxpayers President from royalties to wages and that the payments were to be treated as wages. Charlottes Office Boutique, Inc., 121 TC No. 6 (Tax Ct.) Section 530 relief was found not to be available where the sole corporate officer and sole director of a Subchapter S Corporation was held to be a statutory employee as there was no reasonable basis for not treating the individual as a trustee. See Specialty Transport & Delivery Services, Inc. v. Comm., 3rd Circuit Ct. of Appeals, 03-2732, 2004-1 USTC A 50203 March 12, 2004. Failure to treat an individual as an employee, if there is no reasonable basis to do so, may result in paying all employment taxes for the worker, as well as a penalty equal to 100% of tax. A District Court ruled that a homecare agency’s treatment of its workers as independent contractors was reasonable based on a facts and circumstances test, even though they did not meet the safe harbor test. The Court noted the agency conducted research on the issue by polling other area homecare agencies and they had also relied on an earlier audit where the auditor did not reclassify their workers (although not an employment tax audit). Nelly Home Care, LLC v. U.S., 117 AFTR 2d 2016-1500, DC PA, 2016. Also see I.R.C. Sec. 7436 and IRS Notice 98-43, 1998-33 IRB, which create new procedures for processing employment tax cases and gives the Tax Court jurisdiction to review IRS determinations that workers are employees or the business is not entitled to relief under Section 530 of the Revenue Act of 1978. Only employers may seek this Tax Court review. The IRS will not issue rulings on the prospective employment status of an employee vs. and independent contractor. See Rev. Proc. 2017-3. Rather they will only provide rulings on the employer’s past treatment of workers. 5. The 20 Factor Test: The IRS provides a listing of 20 factors to be used "as an aid to determining whether an individual is an employee under the common law rules." Rev. Rul. 87-41. They are as follows: 1. Instructions. The right of the payor to control compliance with time, place, and manner restrictions

ordinarily indicate an employee relationship. 2. Training. An independent contractor generally uses their own methods and receives no training from

the payor. 3. Integration. If the worker is integrated into the operations of the payor, he or she normally will be

subject to their direction and control and therefore be an employee. 4. Specifying the worker. If services must be personally rendered and cannot be delegated or

subcontracted by the worker, an employee relationship is indicated. 5. Employing assistants. The employing of assistants to obtain a result is consistent with independent

contractor status. However, employing and discharging workers at the direction of the payor is indicative of an employee acting in the capacity of foreman or representative of the payor.

6. Continuing relationship. An ongoing relationship between a worker and a payor indicates an

employee relationship. 7. Hours of work. Payor's control of worker hours indicates an employee relationship. The right of the

worker to set his or her own hours is indicative of an independent contractor.

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8. Full time effort. If the worker devotes full time to the business of the payor and the payor restricts a worker's other work, then the relationship is that of employee. An independent contractor may work when and for whom they choose.

9. Job location. Working at the premises of the payor, even though the work can be done elsewhere,

indicates an employee relationship. 10. Sequence of work. The right of a payor to set the order or sequence of the work to be performed

indicates an employee relationship. 11. Reporting. The payor's requirement of the worker submitting reports indicates an employee

relationship. 12. Fixed payment. Periodic payments generally indicate an employee relationship. Payment by the job

or by commission generally indicates an independent contractor. A lump sum if computed by the number of hours required to do a job at a certain rate per hour indicates an employee relationship.

13. Reimbursements. The payor's payment of workers business and/or traveling expenses indicates an

employee relationship. Payment by the job when the worker pays any incidental expenses, indicates that the person is an independent contractor.

14. Tools, materials and supplies. An independent contractor ordinarily furnishes his or her own tools. A

payor furnishing tools, materials, etc, tends to show the existence of an employee relationship. 15. Substantial investment. A worker's investment in facilities is a factor that indicates an independent

contractor. For investment to be significant it must be real, substantial, essential, and adequate. 16. Risk of loss. If the worker can, due to their work, realize a profit or suffer a loss, he or she is

generally an independent contractor. 17. Outside work. The worker's ability to work for multiple payors at the same time indicates an

independent contractor. 18. Available to the general public. If a worker makes his or her services available to the general public,

it is indicative of an independent contractor. 19. Right to discharge. The right of the payor to discharge the worker is indicative of an employee

relationship. An independent contractor may not be discharged so long as he or she is not in breach of contract.

20. Right to terminate. When a worker has the right to terminate the relationship with the payor, without

a current liability, normally an employee relationship is indicated. However, since 1996 the IRS looks more at three categories of evidence (instead of the 20 Factor Test) those categories being (1) behavioral control, (2) financial control, and (3) the relationship of the parties. While many of the 20 factors are within those categories, some are of lesser importance than others. If a worker has received a 1099-MISC, but believes that he or she is really an employee, the worker should pay only the employee portion of FICA taxes of 7.65% and not the full self-employment tax rate of 15.3%. The worker will need to file Form 8919 Uncollected Social Security and Medicare Taxes on Wages. The worker will need to disclose the name of the payor. If such disclosure is not made, the worker will need to pay the self-employment tax rate of 15.3%.

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RETIREMENT SAVINGS CONTRIBUTION CREDIT “THE SAVERS CREDIT”

The 2001 Tax Act added IRC Sec. 25B, a new individual tax credit for tax years beginning in 2002. This credit is nonrefundable and is intended to induce low and middle income taxpayers to save for retirement. While originally set to expire after 2006, Congress made this credit permanent in 2006. Taxpayers may claim the credit if: 1) The taxpayers make elective contributions to a traditional or Roth IRA, a 401(k) plan, a

403b Tax Sheltered Annuity (TSA), a 457 Plan for state and local government employee, a simple IRA, a salary reduction SEP Plan or after tax employee contributions to a qualified Plan and;

2) The taxpayers AGI (as indexed for inflation for 2017) is less than $31,000 (if filing single or married filing separately) $46,500 (if filing as head of household) or $62,000 if married filing jointly.

Taxpayers may not claim the credit or the full credit if:

1) The taxpayer is under age 18 as of the end of the year, is claimed as a dependent on

another’s return or is a full-time student, or; 2) If the taxpayer receives or has received distributions from a Qualified Plan during the

past two tax years, the current tax year or the period after the end of the current tax year and prior to due date of the return, the amount of the contributions eligible for the credit is decreased by such distribution amount. For example: If distributions are received from a traditional IRA or a Qualified Plan and even though only part of the distribution is taxable, the total of the distribution reduces the eligible contribution.

The Savers Credit is in addition to any deduction or income exclusion received by the

plan contribution. Therefore, the taxpayer not only receives a decrease in taxable income, but the taxpayer may receive a tax credit. The credit, although nonrefundable, does offset regular and alternative minimum tax. The maximum qualified deferral per taxpayer is $2,000 with a maximum credit of $1,000 per taxpayer. Although a married couple filing jointly may not qualify, one spouse filing as married filing separately may qualify.

The amount of the credit ranges from 50% down to 10% of the qualified deferral amount

and is based on the taxpayer’s modified adjusted gross income. Adjusted gross income is modified by adding miscellaneous exclusions for foreign earned income.

SAVER’S CREDIT FOR RETIREMENT PLAN CONTRIBUTIONS MODIFIED AGI LIMITS FOR 2017

Single and Joint Head of Household Married-Separate Credit Rate $ 0 –$37,000 0 – $27,750 0 –$18,500 50% 37,001 – 40,000 27,751 – 30,000 18,501 – 20,000 20% 40,001 – 62,000 30,001 – 46,500 20,001 – 31,000 10% Over $62,000 Over $46,500 Over $31,000 0%

Example 1. Beth and Paul are recently married, are each eligible to claim a Saver’s Tax Credit for tax year 2017. Assume their modified AGI is $44,000, Beth has made 401(k)

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salary reduction of $2,000 and Paul has made a 401(k) salary reduction of $1,000. They would be entitled to a $300 credit for their joint income tax return for 2017. Beth’s credit is limited to $200 and Paul’s credit is limited to $100. Example 2. Assume John and Sue are age 60 and 57 respectively and are semi-retired. They have not received any distributions from qualified plans during the past two years, the current year or prior to the filing date of their 2017 return, effectively a three year, three month, 15 day period. Assume John has wages of $18,800 and Sue has wages of $3,000. If the following incomes are assumed, see the differences in tax liability before and after a $3,000 IRA contribution is made. Before IRA Contribution After IRA Contribution W-2 Income $21,800 $21,800 Interest Income 17,000 17,000 IRA deduction - 0 - (3,000) AGI 38,800 35,800 Taxable income 18,000 15,000 Income tax 1,800 1,500 Less: Savers Credit - 0 - (1,500) Net Tax 1,800 -0- By making a $3,000 IRA contribution, John and Sue have reduced their taxes by $1,800. This is a 60% return on their investment into their IRA, just by making the contribution.

H-50

MATERIALS & SUPPLIES; REPAIRS AND IMPROVEMENTS: CAPITALIZE OR DEDUCT CURRENTLY?

Generally, any expenditure with a useful life of less than one year, is incidental and does not add to the value of the property or it’s life, is deductible currently [See Treas. Reg. § 1.162-4]. Capitalization is required if the expenditure has a useful life of more than one year, substantially increases the value of the property, changes the use of the property or does more than just restore the property to it’s original condition. [See Treas. Reg. §1.263(a)-1(b)]. The problem has always been that neither the IRS nor the Courts have been consistent. The IRS proposed regulations on August 21, 2006 regarding IRC Sec. 263, which were later withdrawn. The IRS proposed a second set of regulations on May 5, 2008 which were also recently withdrawn. The IRS issued a set of temporary regulations on December 23, 2011, effective for tax years beginning January 1, 2012, governing the deduction or capitalization of repairs. In 2012 the IRS moved the effective date of these temporary regulations to January 1, 2014. On September 13, 2013, these temporary regulations have been modified and made final. The final regulations have an effective date of January 1, 2014. These final regulations apply to amounts paid to produce, acquire or improve tangible property, including land, land improvements, machinery, equipment, furniture, fixtures, etc. The regulations limit expensing and require capitalization of items that have in the past been thought of as a deductible repair cost. A. UNIT OF PROPERTY. A Unit of Property of real (other than a building) and personal property is defined by the regulations as all the components that are functionally interdependent. [Treas. Reg. §1.263(a)-3(e)(3)]. In the case of a building, each building and its structural components is a single Unit of Property. [Treas. Reg. §1.263(a)-3(e)(2)(i)]. B. MATERIALS AND SUPPLIES. Materials and supplies are defined in Treas. Reg. §1.162-3(c)(1) as tangible property that is used or consumed in the operations that is not inventory, and that: 1. is a component acquired to maintain, repair, or improve a unit of tangible property owned, leased, or serviced by the taxpayer and that is not acquired as part of any single unit of tangible property; 2. consists of fuel, lubricants, water, and similar items, reasonably expected to be consumed in 12 months or less, beginning when used in the taxpayer's operations; 3. is a unit of property that has an economic useful life of 12 months or less, beginning when the property is used or consumed in the taxpayer's operations; 4. is a unit of property that has an acquisition cost or production cost of $200 or less; or 5. is identified in published guidance in the Federal Register or in the Internal Revenue Bulletin as materials and supplies. The deductibility of materials and supplies is broken into two categories. (1) Non-incidental materials and supplies, which are deductible when they are first used or consumed in the business operations; and (2) Incidental materials and supplies, which are deductible went paid for, provided there is no record of consumption kept, no physical inventories kept, and taxable income is clearly reflected (does not distort income). [Treas. Reg. §1.162-3(a)(1)and (2)]. ROTABLE AND TEMPORARY SPARE PARTS. Rotable materials and supplies are acquired for installation on a unit of property, removable from that unit of property, generally repaired or improved, and either reinstalled on the same or other property or stored for later installation.

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Temporary spare parts are materials and supplies that are used temporarily until a new or repaired part can be installed and then are removed and stored for later installation. The costs of rotable and temporary spare parts are generally deductible in the year the spare part is disposed of. However, a taxpayer can elect to capitalize the cost and depreciate them over the applicable recovery period. Another option allows the taxpayer to elect to deduct the cost when it is first installed on a unit of property. Thereafter, if the spare part is removed, the taxpayer includes the fair market value of the part in income. If the part is repaired, the costs of repairs are added to the basis of the part, and then once reinstalled, the new basis of the part is deducted again (to the extent not previously deducted). If the part is not reinstalled, but disposed of, the taxpayer can then deduct any basis that had not been deducted previously. [Treas. Reg. §1.162-3(e)(2)]. DE MINIMIS SAFE HARBOR RULES OF §1.263(a)-1(f). These safe harbor rules allow a taxpayer to currently deduct the costs of assets that the taxpayer currently expenses for book purposes under a written policy. If a taxpayer has an Applicable Financial Statement, the safe harbor limit is $5,000. If the taxpayer does not have an Applicable Financial Statement, the safe harbor limit for tax years after 2015 is $2,500 previously a $500 safe harbor limit). IRS Notice 2015-82. An Applicable Financial Statement is defined as: 1. a financial statement required to be filed with the Securities and Exchange Commission (SEC) (the 10-K or the Annual Statement to Shareholders); 2. a certified audited financial statement that is accompanied by the report of an independent certified public accountant (or in the case of a foreign entity, by the report of a similarly qualified independent professional) that is used for (a) credit purposes; (b) reporting to shareholders, partners, or similar persons; or (c) any other substantial non-tax purpose; or 3. a financial statement (other than a tax return) required to be provided to the federal or a state government or any federal or state agency (other than the SEC or the Internal Revenue Service). A taxpayer makes the election by attaching a statement to the timely filed tax return (including extensions) for the taxable year in which these amounts are paid. The statement must be titled “Section 1.263(a)-1(f) de minimis safe harbor election” and include the taxpayer's name, address, taxpayer identification number, and a statement that the taxpayer is making the de minimis safe harbor election under §1.263(a)-1(f). An election may not be made through the filing of an application for change in accounting method or, before obtaining the Commissioner's consent to make a late election, by filing an amended Federal tax return. A taxpayer may not revoke an election made under this paragraph (f). C. REPAIRS AND MAINTENANCE. A taxpayer may deduct amounts paid for repairs and maintenance to tangible property if the amounts paid are not otherwise required to be capitalized (i.e. not an "improvement"). Optionally, Treas. Reg. §1.263(a)-3(n) provides an election to capitalize amounts paid for repair and maintenance consistent with the taxpayer's books and records. SAFE HARBOR FOR ROUTINE MAINTENANCE FOR BUILDINGS. Routine maintenance for buildings under the safe harbor provisions of Treas. Reg. §1.263(a)-3(i) are deemed not improvements and thus are currently deductible. This type of maintenance consists of the recurring activities that a taxpayer expects to perform as a result of the taxpayer's use of a building to keep the building structure or each building system in its ordinarily efficient operating condition. Routine maintenance activities include inspection, cleaning, testing of the building structure or each building

H-52

system, and the replacement of damaged or worn parts with comparable parts. "Routine" means the taxpayer reasonably expects to perform the activities more than once during the 10-year period beginning when the building is placed in service. Factors considered to determine whether a taxpayer's expectation is reasonable include the recurring nature of the activity, industry practice, manufacturers' recommendations, and the taxpayer's experience with similar or identical property. [Treas. Reg. §1.263(a)-3(i)(1)(i)]. SAFE HARBOR FOR ROUTINE MAINTENANCE FOR PROPERTY OTHER THAN BUILDINGS. Routine maintenance for property other than buildings under the safe harbor provisions of Treas. Reg. §1.263(a)-3(i) are also deemed not improvements and thus are currently deductible. This type of maintenance consists of the recurring activities that a taxpayer expects to perform as a result of the taxpayer's use of the unit of property to keep the unit of property in its ordinarily efficient operating condition. Routine maintenance activities include inspection, cleaning, and testing of the unit of property, and the replacement of damaged or worn parts of the unit of property with comparable replacement parts. "Routine" means the taxpayer reasonably expects to perform the activities more than once during the class life of the unit of property. Factors to be considered to determine whether a taxpayer's expectation is reasonable include the recurring nature of the activity, industry practice, manufacturers' recommendations, and the taxpayer's experience with similar or identical property. [Treas. Reg. §1.263(a)-3(i)(1)(ii)]. SAFE HARBOR FOR SMALL TAXPAYERS (BUILDINGS). This safe harbor in Treas. Reg. §1.263(a)-3(h) allows qualifying taxpayers to elect to currently deduct amounts paid for repairs, maintenance and improvements on an eligible building up to the lesser of 2% of the unadjusted basis of the building or $10,000. This is a building by building election. A qualifying taxpayer is one who has average annual gross receipts for the three preceding tax years of $10,000,000 or less. An eligible building is one that has an unadjusted basis of $1,000,000 or less. If the annual total amounts paid for repairs, maintenance, improvements on an eligible building exceed the safe harbor limitations (lesser of 2% of unadjusted basis and $10,000), then the safe harbor election is not available for that eligible building. However, because this is a building by building election, the election is still available for the taxpayer's other eligible buildings. A taxpayer makes the election by attaching a statement to the taxpayer's timely filed original tax return (including extensions). The statement must be titled, “Section 1.263(a)-3(h) Safe Harbor Election for Small Taxpayers” and include the taxpayer's name, address, taxpayer identification number, and a description of each eligible building to which the taxpayer is applying the election. In the case of an S corporation or a partnership, the election is made by the S corporation or by the partnership. D. IMPROVEMENTS. Amounts paid to improve a unit of property must be capitalized. Improvements are made up of expenditures that better, restore or adapt the unit of property after it has been placed in service by the taxpayer. [Treas. Reg. §1.263(a)-3(d)]. BETTERMENT. [Treas. Reg. §1.263(a)-3(j)(1)]. An amount is paid for a betterment to a unit of property only if it: 1. ameliorates a material condition or defect that either existed prior to the taxpayer's acquisition of the unit of property or arose during the production of the unit of property, whether or not the taxpayer was aware of the condition or defect at the time of acquisition or production;

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2. is for a material addition, including a physical enlargement, expansion, extension, or addition of a major component to the unit of property or a material increase in the capacity, including additional cubic or linear space, of the unit of property; or 3. is reasonably expected to materially increase the productivity, efficiency, strength, quality, or output of the unit of property. RESTORATION. [Treas. Reg. §1.263(a)-3(k)(1)]. An amount restores a unit of property only if it: 1. is for the replacement of a component of a unit of property for which the taxpayer has properly deducted a loss for that component, other than a casualty loss; 2. is for the replacement of a component of a unit of property for which the taxpayer has properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component; 3. is for the restoration of damage to a unit of property for which the taxpayer is required to take a basis adjustment as a result of a casualty loss; 4. returns the unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use; 5. results in the rebuilding of the unit of property to a like-new condition after the end of its class life; or 6. is for the replacement of a part or combination of parts that comprise a major component or a substantial structural part of a unit of property. ADAPTATION. [Treas. Reg. §1.263(a)-3(l)(1)]. An amount is paid to adapt a unit of property to a new or different use if the adaptation is not consistent with the taxpayer's ordinary use of the unit of property at the time originally placed in service by the taxpayer. For example, an amount is paid to improve a building if it is paid to adapt the building structure or any one of its buildings systems to a new or different use. E. ACCOUNTING METHOD CHANGES. Based on these regulations, many taxpayers may find that they need to adjust the way in which they have expensed or capitalized certain repairs. To correct this requires a change in accounting method. The IRS issued three Rev. Proc.'s in early 2015 to answer some of the questions about when a Form 3115 needs to be filed, new simplified procedures for completing Form 3115 and which types of accounting method changes can be filed using these new procedures. Rev. Proc, 2015-13 is an update on existing procedures to get IRS consent to change a taxpayer's method of accounting This has been modified and clarified by Rev. Procs. 2015-33 and 2016-1. Rev. Proc. 2017-30 is an updated listing of Automatic Accounting Changes to which the procedures of Rev. Proc. 2015-13 (as modified) apply. Rev. Proc. 2015-14 sets out many method of accounting changes that can be obtained using automatic change procedures. Rev. Proc. 2016-29 modified and amplified Rev. Proc 2015-14 to include additional automatic consent to method of accounting changes. Rev. Proc. 2015-20 provides two simplified procedures for small business taxpayers to make a change in their method of accounting to become compliant with the new regulations. A small business taxpayer is defined as those with less than $10,000,000 in total assets as of the first day of

H-54

the year of change; or those with average annual gross receipt of $10,000,000 or less for the prior three years. The first simplified procedure allows qualifying taxpayers to make a change of accounting method simply by adopting it on their 2014 income tax return, requires no Form 3115 and no §481(a) adjustment. This method is no longer available for calendar year filers. The second simplified method allows taxpayer to make a change of accounting method by filing Form 3115, but the §481(a) adjustment is limited to only those transactions occurring after January 1, 2014.

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Reprinted/copied with permission: 2016 Agricultural Tax Issues

published by Tax Insight, LLC, Greenville, WI 54942

H-56

TAX-FREE IRA TRANSFERS TO CHARITY (TAXPAYERS AGE 70½ OR OLDER)

IRC §408(D)(8)

(PROVISION MADE PERMANENT – 2015 PATH ACT) Taxpayers age 70½ or older at date of distribution can directly transfer IRA distributions (traditional or Roth IRA) to a qualified charity without income recognition from the IRA distribution. The IRA funds must be moved directly by the IRA trustee to a qualified charity as described in IRC §170(b)(1)(A). Private foundations, as described in IRC §509(a)(3), and donor advised funds are not allowed as qualified charities. CAUTION: Distributions made to an individual and then transferred to the charity represent taxable income to the recipient. A direct transfer by the IRA trustee to the charity must occur. NOTE - IRS GUIDANCE: IRS has provided detailed guidance, in a Q&A Format, regarding the nontaxable transfer of IRAs to charity. Notice 2007-7. YEARLY LIMITATION ON CHARITABLE TRANSFERS: The income exclusion for IRA distributions directed to charity is limited to a maximum of $100,000 per year, per taxpayer (i.e., a husband and wife could transfer up to $200,000 per year). Notice 2007-7, Q&A-34. NOTE: The privilege only applies to IRAs (IRS Notice 2007-7) and does not extend to ongoing SIMPLE IRAs or SEPs. These and other types of retirement plan accounts must generally first be rolled over to an IRA before a charitable transfer can be completed. NOTE – SATISFIES MRD REQUIREMENT: Distributions directed to charity count toward the post age 70½ minimum required distribution (MRD) obligation of the taxpayer. NOTE: No charitable contribution deduction is allowed for the income portion of the IRA distribution that avoids taxation. Amounts directed to charity are deemed to come from income amounts first, and from basis second, with the charitable contribution only allowed on amounts from basis. All IRAs of the taxpayer are to be aggregated for this purpose. Thus, nondeductible contributions to traditional IRA's would be left intact within the IRA allowing a greater amount to avoid taxation upon later distribution. IRC §408(d)(8)(D). EXAMPLE: Marge, age 71, has a current balance of $100,000 in her IRA. $80,000 represents income and $20,000 represents basis from nondeductible contributions. Marge transfers $85,000 of the IRA directly to charity. Marge will not recognize any income from the transaction (as $80,000 of the $85,000 contribution is deemed to come entirely from the income portion first). Marge will be entitled to a $5,000 charitable contribution deduction since $5,000 of her basis in the IRA was utilized to make the charitable gift. The remaining balance of her IRA account will represent $15,000 of basis from prior nondeductible IRA contributions. NOTE: The income exclusion for the IRA transfer applies only if the entire charitable contribution would otherwise be allowable as a charitable deduction under IRC §170, except that the charitable contribution is not subject to AGI percentage limitations. Accordingly, if the charitable deduction would be reduced because of a "quid pro quo" benefit received in exchange (e.g. charitable ball tickets, etc.), or if a deduction would not be allowable because the donor did not obtain a receipt, the income exclusion is not available with respect to any part of the IRA distribution. IRC §408(d)(8)(C).

H-57

CAUTION: If the direct payment of an amount from an IRA to a charity fails to satisfy the requirements of the provision, it results in a deemed taxable distribution from the IRA to the IRA owner, followed by a charitable contribution by the IRA owner subject to the charitable contribution limitations of IRC §170 (Q&A 44). NOTE - IRA Beneficiaries Eligible: The IRS has confirmed that an IRA beneficiary (person who inherits an IRA from the original account owner) is eligible to make a qualified charitable distribution if they have attained age 70½ before the distribution is made. Notice 2007-7, Q&A-37. TAX PLANNING - POSSIBLE TAX SAVINGS FROM TAX-FREE TRANSFERS TO CHARITY:

• Retirees who normally use the standard deduction would benefit at the federal and state marginal tax rate from direct contribution of an IRA to charity.

• By minimizing or avoiding MRD income amounts, lower taxability of social security benefits may result. Other phase-in and phase-out calculations based on AGI may be positively impacted.

• By reducing the IRA balance via the contribution, future MRD distribution amounts are minimized or eliminated.

• Any deductible charitable contribution avoids the charitable contribution AGI percentage limitations (generally 50% of AGI). Accordingly, taxpayers with charitable contribution carryovers would benefit from this provision.

• By reducing IRA balance, future income-in-respect-of-a-decedent (IRD) amounts are minimized for beneficiaries of retiree/decedent's IRA.

• Making a qualified charitable deduction will reduce the decedent's taxable estate.

Effective Date: IRA distributions made in taxable years beginning after December 31, 2005. The 2015 PATH Act made this provision permanent for qualified charitable distributions made in 2015 and after. IRC §408(d)(8). NOTE – IOWA COUPLING ISSUES: Iowa has coupled for 2010-2015. Iowa did not couple with federal law regarding the tax treatment of qualified charitable deductions from IRAs for 2008-2009 or for 2016. Without coupling, Iowa tax law requires 100% inclusion of the qualified charitable IRA distribution in Iowa gross income. If the additional taxable income cannot be offset by the Iowa pension exclusion, a charitable deduction will be allowed subject to the 50% (30% or 20%) of AGI limitation rules and the 5-year charitable contribution carryover.

H-58

CHARITABLE CONTRIBUTIONS: USED MOTOR VEHICLES, BOATS AND AIRPLANES

(Substantiation And Valuation Requirements)

The American Jobs Creation Act of 2004 imposed new substantiation and valuation requirements on contributions of used motor vehicles, boats, and airplanes where the proposed deduction is greater than $500. The new requirements apply to contributions made after December 31, 2004.

If the charity sells the donated item without first using it significantly for charitable purposes or materially improving it, the deduction is limited to the sales proceeds. There are two exceptions to this rule:

(1) The charity sells or otherwise transfers the vehicle (or boat or plane) to a needy individual for less than FMV in furtherance of the charity’s charitable purpose. IRC §170(f)(12)(F).

(2) The charity keeps the used vehicle (or boat or plane) and uses it significantly for charitable purposes or the charity makes material improvements to the item before ultimately selling it. IRC §170(f)(12)(A)(ii).

When one of these exceptions is applicable, the deduction is equal to fair market value of the item on the date of contribution to the charity.

The substantiation requirements must be met for the deduction to be allowed. Form 1098-C is filed by the charity to fulfill these requirements. Form 1098-C may also be used by a charity to provide a donor with a contemporaneous written acknowledgement of the contribution if the value is under $500. If the property donation is valued at more than $5,000, the donation must also be supported by a qualified appraisal; and the appraiser must sign Part B of the taxpayer’s Form 8283. IRC §170(f)(11) & IRC Reg. §1.170A-13(c).

The gross sales proceeds is reported on Line 4C. Applicability of one of the two exceptions is shown by checking box 5a or 5b and providing an appropriate description.

Form 1098-C or equivalent information must be given the donor by the charity within 30 days of the sale of the donated item. If either of the two exceptions applies, Form 1098-C or equivalent information must be given the donor by the charity within 30 days of the donation.

The charity must file a copy of the Form 1098-C with the IRS by the last day of February of the year following the year in which the deduction is to be claimed. The donor should attach a copy of the 1098-C to his or her Federal and state income tax returns for the year in question.

H-59

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tr

aded

stoc

k A

rece

ipt w

ith th

e ch

arity

’s

nam

e an

d th

e da

te, l

ocat

ion,

an

d de

scrip

tion

of th

e do

natio

n or

relia

ble

writ

ten

reco

rds

Ack

now

ledg

men

t fro

m th

e ch

arity

f, j

Writ

ten

reco

rds

c

Sam

e as

pre

cedi

ng c

olum

n,

plus

writ

ten

reco

rds

f, j

Form

828

3, S

ectio

n A

f , k

Sa

me

as p

rece

ding

col

umn,

ex

cept

Sec

tion

B o

f For

m

8283

Sam

e as

pre

cedi

ng c

olum

n, p

lus

the

dono

r mus

t hav

e a

qual

ified

ap

prai

sal p

repa

red

befo

re th

e ta

x re

turn

is d

ue g

H-60

A

MO

UN

T G

IVE

N IN

A S

ING

LE

DO

NA

TIO

N a

TY

PE O

F G

IFT

L

ess t

han

$250

$2

50 to

$50

0 O

ver

$500

to $

5,00

0 O

ver

$5,0

00 to

$10

,000

O

ver

$10,

000

b

c. I

nven

tory

or

depr

ecia

ble

prop

erty

do

nate

d by

a C

co

rpor

atio

n fo

r ca

re o

f the

ill,

need

y, o

r in

fant

s

Writ

ten

stat

emen

t tha

t the

ch

arity

inte

nds t

o co

mpl

y w

ith c

erta

in re

stric

tions

re

late

d to

the

dona

tion

Sam

e as

pre

cedi

ng c

olum

n,

plus

a p

rope

r ack

now

ledg

-m

ent f

rom

the

char

ity

h c

Writ

ten

reco

rds

Sam

e as

pre

cedi

ng c

olum

n

f, j

Sam

e as

pre

cedi

ng c

olum

n Fo

rm 8

283,

Sec

tion

B

i Sa

me

as p

rece

ding

col

umn

d.

Art

wor

k A

rece

ipt w

ith th

e ch

arity

’s

nam

e, th

e da

te, l

ocat

ion,

and

de

scrip

tion

of th

e do

natio

n or

relia

ble

writ

ten

reco

rds

Ack

now

ledg

men

t fro

m th

e ch

arity

f, j

Writ

ten

reco

rds

c Sa

me

as p

rece

ding

col

umn

f, j

Form

828

3, S

ectio

n A

Sa

me

as p

rece

ding

col

umn,

ex

cept

Sec

tion

B o

f For

m

8283

, plu

s the

don

or m

ust

have

a q

ualif

ied

appr

aisa

l pr

epar

ed b

efor

e th

e ta

x re

turn

is

due

Sam

e as

pre

cedi

ng c

olum

n, p

lus

for i

ndiv

idua

l obj

ects

val

ued

at

$20,

000

or m

ore,

atta

ch th

e ap

prai

sal t

o th

e re

turn

and

kee

p a

phot

ogra

ph o

f suf

ficie

nt si

ze a

nd

qual

ity to

fully

show

the

obje

ct

e.

Veh

icle

s, bo

ats,

and

airp

lane

s

• C

harit

y se

lls

with

out

sign

ifica

nt

use

or

mat

eria

l im

prov

emen

t

Rec

eipt

or r

elia

ble

writ

ten

reco

rds

Form

109

8-C

or o

ther

ac

know

ledg

men

t fro

m th

e ch

arity

f,

j c

Writ

ten

reco

rds

Form

109

8-C

or o

ther

ac

know

ledg

men

t with

sam

e in

form

atio

n (a

ttach

ed to

tax

retu

rn)

f, j

Rel

iabl

e w

ritte

n re

cord

s

f

Form

828

3, S

ectio

n

f

Sam

e as

pre

cedi

ng c

olum

n,

exce

pt S

ectio

n B

of F

orm

82

83

A

Sam

e as

pre

cedi

ng c

olum

n

• C

harit

y gi

ves

or se

lls a

t a

sign

ifica

ntly

di

scou

nted

pr

ice

to

need

y in

divi

dual

in

a qu

alifi

ed

trans

fer

Rec

eipt

or r

elia

ble

writ

ten

reco

rds

Form

109

8-C

or o

ther

ac

know

ledg

men

t fro

m th

e ch

arity

f,

j c

Writ

ten

reco

rds

Form

109

8-C

or o

ther

ac

know

ledg

men

t with

sam

e in

form

atio

n (a

ttach

ed to

tax

retu

rn)

f , j

Rel

iabl

e w

ritte

n re

cord

s Fo

rm 8

283,

Sec

tion

A

f

Sam

e as

pre

cedi

ng c

olum

n,

exce

pt S

ectio

n B

of F

orm

82

83, p

lus a

qua

lifie

d ap

prai

sal

Sam

e as

pre

cedi

ng c

olum

n

• Si

gnifi

cant

us

e or

m

ater

ial

impr

ovem

ent

by c

harit

y

Rec

eipt

or r

elia

ble

writ

ten

reco

rds

Form

109

8-C

or o

ther

ac

know

ledg

men

t fro

m th

e ch

arity

f,

j

Writ

ten

reco

rds

c

Form

109

8-C

or o

ther

ac

know

ledg

men

t with

the

sam

e in

form

atio

n (a

ttach

ed to

ta

x re

turn

) f,

j R

elia

ble

writ

ten

reco

rds

Form

828

3, S

ectio

n A

f

Sam

e as

pre

cedi

ng c

olum

n,

exce

pt S

ectio

n B

of F

orm

82

83, p

lus a

qua

lifie

d ap

prai

sal

Sam

e as

pre

cedi

ng c

olum

n

H-61

A

MO

UN

T G

IVE

N IN

A S

ING

LE

DO

NA

TIO

N a

TY

PE O

F G

IFT

L

ess t

han

$250

$2

50 to

$50

0 O

ver

$500

to $

5,00

0 O

ver

$5,0

00 to

$10

,000

O

ver

$10,

000

b

f.

All

othe

r

nonc

ash

do

natio

ns

Rec

eipt

or r

elia

ble

writ

ten

reco

rds

Ack

now

ledg

men

t fro

m th

e ch

arity

f,

j c

Writ

ten

reco

rds

Sa

me

as p

rece

ding

col

umn,

pl

us w

ritte

n re

cord

s f,

j Fo

rm 8

283,

Sec

tion

A

f, k

Sam

e as

pre

cedi

ng c

olum

n,

exce

pt S

ectio

n B

of F

orm

82

83,

plus

a q

ualif

ied

appr

aisa

l

Sam

e as

pre

cedi

ng c

olum

n

g.

Pat

ents

and

ot

her

inte

llect

ual

prop

erty

• D

onor

’s

state

men

t of

inte

nt at

tim

e of

co

ntrib

utio

n

A re

ceip

t with

the c

harit

y’s

nam

e, th

e dat

e, lo

catio

n, an

d de

scrip

tion

of th

e don

atio

n or

re

liabl

e writ

ten

reco

rds

Ack

now

ledg

men

t fro

m th

e ch

arity

f

c

Writ

ten

reco

rds

f

Sam

e as

pre

cedi

ng c

olum

n

D

onor

mus

t pro

vide

to th

e ch

arity

a sta

tem

ent i

dent

ifyin

g:

• hi

s or h

er n

ame,

addr

ess,

and

TIN

; •

a det

aile

d de

scrip

tion

of

the i

ntel

lect

ual p

rope

rty;

• th

e dat

e of t

he

cont

ribut

ion;

and

•

the d

onor

’s in

tent

to tr

eat

the c

ontri

butio

n as

a qu

alifi

ed in

telle

ctua

l pr

oper

ty d

onat

ion.

Form

828

3, S

ectio

n A

Sam

e as

pre

cedi

ng c

olum

n,

exce

pt S

ectio

n B

of F

orm

82

83

Sam

e as

pre

cedi

ng c

olum

n

• D

onee

’s

annu

al

ackn

owle

dg-

men

t of

inco

me

gene

rate

d

A re

ceip

t with

the

char

ity’s

na

me,

the

date

, loc

atio

n, a

nd

desc

riptio

n of

the

dona

tion

or b

ank

reco

rds (

canc

eled

ch

eck)

Ack

now

ledg

men

t fro

m th

e ch

arity

W

ritte

n re

cord

s

Sam

e as

pre

cedi

ng c

olum

n

f, j

The

done

e m

ust r

epor

t on

Form

889

9:

• th

e do

nor’

s nam

e,

addr

ess,

and

TIN

; •

a de

taile

d de

scrip

tion

of

the

inte

llect

ual

prop

erty

; •

the

date

of t

he

cont

ribut

ion;

and

•

the

amou

nt o

f the

net

in

com

e al

loca

ble

to th

e do

nate

d pr

oper

ty

Form

828

3, S

ectio

n A

Sam

e as

pre

cedi

ng c

olum

n,

exce

pt S

ectio

n B

of F

orm

82

83

Sam

e as

pre

cedi

ng c

olum

n

H-62

Not

es:

a If

a do

nor r

ecei

ves s

omet

hing

oth

er th

an d

e m

inim

is it

ems (

such

as a

cal

enda

r or k

ey c

hain

) in

retu

rn fo

r a d

onat

ion

of m

ore

than

$75

, the

cha

rity

mus

t pro

vide

a st

atem

ent i

nfor

min

g th

e do

nor

that

the

char

itabl

e de

duct

ion

is li

mite

d to

the

exce

ss o

f the

con

tribu

tion

over

the

valu

e of

the

good

s or s

ervi

ces

prov

ided

by

the

char

ity (w

ith a

goo

d fa

ith e

stim

ate

of th

e va

lue

of th

e go

ods

or

serv

ices

pro

vide

d).

b M

ultip

le n

onca

sh it

ems

dona

ted

durin

g a

tax

year

mus

t be

aggr

egat

ed to

det

erm

ine

whe

ther

the

$5,0

00 th

resh

old

is m

et if

the

item

s ar

e of

the

sam

e ge

neric

cat

egor

y (e

.g.,

stam

ps, c

oins

, lit

hogr

aphs

, pai

ntin

gs, b

ooks

, non

publ

icly

trad

ed st

ock,

land

, or b

uild

ings

). Th

is ru

le a

pplie

s eve

n if

the

item

s are

not

all

dona

ted

to th

e sa

me

char

ity.

c Th

e ac

know

ledg

men

t mus

t inc

lude

(1) t

he a

mou

nt o

f cas

h an

d a

desc

riptio

n of

any

oth

er p

rope

rty g

iven

, (2)

a st

atem

ent i

ndic

atin

g w

heth

er th

e ch

arity

pro

vide

d an

y go

ods o

r ser

vice

s in

retu

rn

for t

he d

onat

ion,

and

(3) i

f goo

ds o

r ser

vice

s wer

e pr

ovid

ed, a

des

crip

tion

and

good

faith

est

imat

e of

thei

r val

ue, p

lus a

stat

emen

t tha

t onl

y th

e co

ntrib

utio

n in

exc

ess o

f thi

s val

ue is

ded

uctib

le.

(If t

he o

nly

good

s or

ser

vice

s pr

ovid

ed w

ere

inta

ngib

le re

ligio

us b

enef

its, s

uch

as a

dmitt

ance

to a

wor

ship

ser

vice

, the

n a

stat

emen

t to

that

effe

ct c

an b

e m

ade

in li

eu o

f val

uing

the

bene

fits.)

Th

e ac

know

ledg

men

t mus

t be

rece

ived

by

the

earl

ier

of (1

) the

dat

e th

e do

nor’

s re

turn

for t

he y

ear o

f the

don

atio

n is

file

d or

(2) t

he e

xten

ded

due

date

of t

hat r

etur

n. T

he $

250

thre

shol

d is

appl

ied

to e

ach

cont

ribut

ion

sepa

rate

ly [R

eg. 1

.170

A-1

3(f)(

1)].

Ther

efor

e, if

a d

onor

mak

es m

ultip

le c

ontri

butio

ns to

the

sam

e or

gani

zatio

n to

talin

g $2

50 o

r mor

e in

a si

ngle

yea

r, bu

t eac

h gi

ft is

less

than

$25

0, w

ritte

n ac

know

ledg

men

t is n

ot re

quire

d un

less

the

smal

ler g

ifts a

re p

arts

of a

serie

s of r

elat

ed c

ontri

butio

ns m

ade

to a

void

the

subs

tant

iatio

n re

quire

men

ts.

d A

ple

dge

card

or o

ther

writ

ten

docu

men

t fro

m th

e ch

arity

that

incl

udes

a st

atem

ent s

ayin

g th

e or

gani

zatio

n di

d no

t pro

vide

goo

ds o

r ser

vice

s in

retu

rn fo

r don

atio

ns m

ade

by p

ayro

ll de

duct

ion

satis

fies t

he w

ritte

n ac

know

ledg

men

t req

uire

men

t. Th

e $2

50 th

resh

old

is a

pplie

d by

trea

ting

each

pay

roll

dedu

ctio

n as

a se

para

te c

ontri

butio

n [R

eg. 1

.170

A-1

3(f)(

11)]

. The

refo

re, t

his

writ

ten

ackn

owle

dgm

ent m

ust b

e ob

tain

ed o

nly

if $2

50 o

r mor

e is

with

held

from

eac

h pa

yche

ck.

e

The

ackn

owle

dgm

ent f

rom

the

char

ity m

ust i

nclu

de (1

) a d

escr

iptio

n of

the

serv

ices

rend

ered

, (2)

a s

tate

men

t ind

icat

ing

whe

ther

the

char

ity p

rovi

ded

any

good

s or s

ervi

ces i

n re

turn

for t

hese

se

rvic

es,

and

(3)

if go

ods

or s

ervi

ces

wer

e pr

ovid

ed,

a de

scrip

tion

and

good

fai

th e

stim

ate

of t

heir

valu

e (o

r a

stat

emen

t th

at o

nly

inta

ngib

le r

elig

ious

ben

efits

wer

e pr

ovid

ed).

The

ackn

owle

dgm

ent m

ust b

e re

ceiv

ed b

y th

e ea

rlier

of t

he d

ate

the

volu

ntee

r’s t

ax re

turn

for t

he y

ear o

f the

ded

uctio

n is

file

d or

the

retu

rn’s

ext

ende

d du

e da

te.

f Th

e do

nor’

s w

ritte

n re

cord

s m

ust i

nclu

de: (

1) th

e na

me

and

addr

ess

of th

e ch

arity

; (2)

a d

etai

led

desc

riptio

n of

the

dona

ted

prop

erty

; (3)

the

date

and

loca

tion

of d

onat

ion;

(4) t

he d

onat

ion’

s fa

ir m

arke

t val

ue, h

ow it

was

det

erm

ined

, and

a c

opy

of th

e ap

prai

sal i

f one

was

obt

aine

d; (5

) the

pro

perty

’s c

ost o

r bas

is (i

f ord

inar

y in

com

e or

shor

t-ter

m c

apita

l gai

n pr

oper

ty);

(6) t

he te

rms

or c

ondi

tions

atta

ched

to th

e gi

ft, if

any

; (7)

info

rmat

ion

rela

ted

to c

ontri

butio

ns o

f par

tial i

nter

ests

; if a

ny. I

f the

don

atio

n is

ove

r $50

0, w

ritte

n re

cord

s m

ust a

lso

incl

ude

how

and

whe

n th

e ta

xpay

er g

ot th

e pr

oper

ty a

nd th

e pr

oper

ty’s

cos

t or b

asis

(bas

is in

form

atio

n no

t req

uire

d fo

r pro

perty

hel

d 12

mon

ths o

r mor

e).

g

If th

e do

natio

n is

gre

ater

than

$50

0,00

0, a

qua

lifie

d ap

prai

sal m

ust b

e at

tach

ed to

the

retu

rn.

h

Bus

ines

ses

that

don

ate

inve

ntor

y an

d ot

her

ordi

nary

inc

ome

or s

hort-

term

cap

ital

gain

pro

perty

nor

mal

ly a

re l

imite

d to

a c

harit

able

ded

uctio

n eq

ual

to t

he p

rope

rty’s

bas

is, e

ven

if th

e pr

oper

ty’s

val

ue is

gre

ater

. How

ever

, cor

pora

te d

onor

s (o

ther

than

S c

orpo

ratio

ns) m

ay d

educ

t som

e of

the

valu

e ov

er b

asis

if th

e pr

oper

ty is

don

ated

to a

pub

lic c

harit

y (o

r priv

ate

oper

atin

g fo

unda

tion)

and

cer

tain

oth

er re

quire

men

ts a

re m

et.

i

Sole

ly fo

r det

erm

inin

g if

a co

rpor

ate

dono

r’s n

onca

sh c

ontri

butio

ns m

ust c

ompl

y w

ith th

e do

cum

enta

tion

rule

s for

don

atio

ns e

xcee

ding

$5,

000,

gift

s of (

1) in

vent

ory

for t

he c

are

of th

e ill

, the

ne

edy,

or i

nfan

ts a

nd (2

) sci

entif

ic e

quip

men

t use

d fo

r res

earc

h ar

e on

ly c

ount

ed to

the

exte

nd th

eir v

alue

exc

eeds

wha

t wou

ld h

ave

been

incl

uded

in c

ost o

f goo

ds s

old

if th

e ite

ms

had

been

so

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H-63

QUALIFIED CONSERVATION CONTRIBUTIONS (PROVISION MADE PERMANENT – 2015 PATH ACT)

The Pension Protection Act of 2006 (PPA) raised the charitable deduction limit for individuals on qualified conservation contributions from 30% of AGI to 50% of AGI. The charitable deduction limit was raised to 100% of AGI for qualified farmers and ranchers, provided that such contribution does not prevent the use of the donated land for farming or ranching purposes. IRC §170(b)(1)(E). Qualified Farmer. Taxpayer whose gross income from farming (within the meaning of IRC §2032A(e)(5)) is greater than 50% of the gross income of the taxpayer for the year. Non-publicly traded corporations that are engaged in farming or ranching activities would be entitled to deduct up to 100% of adjusted taxable income for such contributions, provided that the terms of the gift did not limit the farming activities on the property. IRC §170(f)(2)(B). NOTE: With respect to a qualified conservation contribution of agricultural or livestock production property, the qualified real property interest must include a restriction that the property generally remain available for such production. No specific requirement regarding actual agricultural use exists, but merely that the property remain available for such purposes. NOTE: Qualified conservation contributions exceeding the AGI limits are eligible for a 15-year carryover. Other contributions are considered before qualified conservation contributions in calculating the AGI limits.

TAX PLANNING - FARM CORPORATIONS: This type of charitable contribution might provide certain "C" corporate farm and ranch operations with an attractive way to liquidate low basis farm real estate from the "C" corporation at little or no tax cost if shareholders have charitable intentions.

TAX PLANNING CAUTION - INDIVIDUALS: The 100%-of-AGI limit for qualified farming and ranching individuals may be counterproductive. If a qualified conservation contribution exceeds current AGI, some of the tax savings of the contribution will be realized at the lower 10% and 15% federal brackets. Further, by eliminating all taxable income due to a large charitable contribution, other Schedule A itemized deductions and the personal exemptions of the taxpayer will produce no benefit (effectively, they are wasted). There is no mechanism in the law to decline the 100%-of-AGI limit and drop back to either the 50% or 30% limit. Qualified farming individuals subject to the 100% limit may be better served to defer a qualified conservation contribution to a year when they are not a qualified farmer or rancher (i.e., have 50% or less of their gross income from farming or ranching sources), so that the 50%-of-AGI limit applies. Effective Date: Contributions made in taxable years beginning after December 31, 2005. The 2015 PATH Act made this provision permanent for qualified conservation contributions made in 2015 and after.

*********************************************

CONTRIBUTIONS OF FOOD INVENTORY (PROVISION MADE PERMANENT – 2015 PATH ACT)

The 2015 PATH Act made permanent the deduction for food inventory donations for any trade or business (including C corporations). The food must be “apparently wholesome food,” intended for human consumption, and meet all quality and labeling standards imposed by federal, state and local laws and regulations, even though it may not be readily marketable due to appearance, age, freshness, grade, size, surplus or other conditions. IRC §170(e)(3)(C).

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NOTE – Deduction/Limitation: The value of the charitable deduction is equal to the lesser of 2 times basis; or basis plus one-half of the ordinary income recognized if the inventory is sold at fair market value (FMV). IRC §170(e)(3)(B). (See also: Deemed Basis Election discussion below). The aggregate amount of charitable deduction for contributions of food inventory for any taxable year beginning in 2016 and after is limited to 15% of the taxpayer’s aggregate net income for the year from all businesses from which the contributions were made, with the net income computed without regard to the charitable deduction itself. If the current year contribution exceeds the 15% limit, then any excess contribution is carried forward for up to 5 years. Current year contributions are applied against the yearly 15% limitation before any usage of carryovers. Carryovers are applied (subject to the 15% limitation) on a FIFO basis. IRC §170(e)(d)(C)(ii)&(III).

NOTE: For “C” corporations, the food inventory contribution is applied first to reduce the corporate overall 10% charitable limitation to $-0- before other charitable contributions are considered.

NOTE: The food inventory charitable deduction was limited to 10% of aggregate net income for 2015 and prior years.

Fair Market Value Definition: The fair market value (FMV) of the food inventory contribution is not to be negatively adjusted in the case of food which cannot be sold by reason of internal standards of the taxpayer, lack of market or similar circumstances. FMV is determined by taking into account the price at which the same or substantially the same food items, both as to type and quality, are sold by the taxpayer at the time of the contribution. If the item has been discontinued, the price is the amount at which the taxpayer sold the item in the recent past. IRC §170(e)(3)(C)(v).

Deemed Basis Election: The deemed basis provision is particularly advantageous for vegetable producers and other cash method farmers producing edible crops. In the past, they received no deduction for donated inventory because 2 times basis of $-0- was always the lower amount for charitable contribution purposes.

Under this election, if a taxpayer does not account for inventories, the taxpayer may elect to treat the basis of donated food inventory as equal to 25% of the FMV of the food inventory. The effect of this rule is to allow an electing taxpayer, to ultimately claim a charitable donation of 50% of the FMV of donated food inventory, based upon the charitable deduction formula allowing 2 times the deemed basis. (i.e., 2 x 25% of FMV = 50% of FMV). IRC §170(e)(3)(C)(iv). NOTE: The 50% of FMV computation would equal the same amount as the basis plus one-half of the ordinary income recognized if the inventory was sold at FMV computation.

TAX PLANNING: Taxpayer’s should obtain a written statement from any charity to which food inventory donations are made stating that its use and disposition of the food inventory will be in accordance with its exempt purpose, and solely for the care of the ill, needy, or infants. The statement should also indicate that the inventory was not transferred by the charity in exchange for money, other property or services.

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SELECTED CHARITABLE PROVISIONS

(Pension Protection Act of 2006 (PPA), as amended) A. SUBSTANTIATION OF CASH CONTRIBUTIONS. All cash contributions, regardless of

amount, must be substantiated via bank record (cancelled check) or a written communication from the donee showing the name of the donee organization, the date of the contribution, and the amount of the contribution. IRC §170(f). NOTE – SUBSTANTIATION OF CREDIT CARD CONTRIBUTIONS: A contribution made to a qualified charity by credit card is deductible in the year the charge is made, regardless of when the creditor is paid. Rev. Rul. 78-38. Contributions by credit card are considered similar to cash contributions. Thus, the taxpayer must keep the credit card statement showing the name of the charitable organization, the amount of the contribution, and the date of the contribution. INFO 2010-0153.

B. SUBSTANTIATION OF CONTRIBUTIONS OF $250 OR MORE. Pursuant to IRC §170(f)(8)(C), no deduction is allowed for contributions of $250 or more unless the taxpayer receives written contemporaneous acknowledgment from the charity which includes all of the following:

1. The name and address of the charity.

2. The date of the contribution.

3. The amount of cash and/or a description (but not an estimate of value) of any property contributed.

4. Whether the charity provided the donor with any goods or services in exchange for the contribution; and, if so a description and good faith estimate of the value of the goods or services provided. NOTE: If the only goods or services provided were intangible religious benefits, include a statement to that effect.

To be contemporary, the acknowledgement must be obtained by the taxpayer on or before the earlier of (1) the date the donor files their original return for the year the donation was made; or (2) the return’s extended due date.

C. CONTRIBUTIONS OF USED CLOTHING & HOUSEHOLD ITEMS. No deduction is allowed for a charitable contribution of clothing or household items unless the clothing or household item is "in good used condition or better". IRC §170(f)(16). The Conference Committee Report authorizes regulatory guidance to deny a deduction for any contribution of clothing or a household item that has minimal monetary value, "such as used socks and used undergarments". Household Items Defined. Furniture, furnishings, electronics, appliances, linens, and other similar items. Food, paintings, antiques, and other items of art, jewelry and gems, and collections are excluded. EXCEPTION: A deduction is allowed for a charitable contribution of clothing or household items not in good used condition or better, if the amount claimed for the item was more than $500 and a qualified appraisal is included with the taxpayer's Form 1040.

D. BASIS ADJUSTMENT TO "S" CORPORATE STOCK - CONTRIBUTED PROPERTY: A shareholder's tax basis in "S" corporate stock will only be reduced by their pro-rata share of the corporation's tax basis in property donated to charity, instead of their pro-rata share of the passed-through deduction. NOTE: This temporary rule benefits "S" corporate shareholders by leaving them with higher tax basis in their stock. Effective Date: Contributions made in taxable years beginning after 12/31/05. The PATH Act made this provision permanent for 2015 and after.

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E. QUALIFIED APPRAISER. Taxpayers are required to obtain a qualified appraisal for donations of property (other than cash or publicly traded securities) when the value exceeds $5,000. Form 8283, Noncash Charitable Contributions (Section B), is used to satisfy the appraisal requirement and provide the appraiser's signature. IRC §170(f)(11). A qualified appraiser is defined as an individual who:

1. Has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements to be set forth in IRS regulations;

2. Regularly performs appraisals for compensation;

3. Can demonstrate verifiable education and experience in valuing the type of property subject to the appraisal;

4. Has not been prohibited from practicing before the IRS at any time during the 3 years preceding the appraisal; and

5. Meets other requirements as may be prescribed by the IRS in regulations or other guidance. IRC §170(f)(11)(E).

A qualified appraisal must meet the following standards:

• Prepared no earlier than 60 days prior to the donation (no later than the due date, including extensions, for the return in which the donation is claimed);

• Signed and dated by a qualified appraiser who prepares it in accordance with generally accepted appraisal standards; and

• Not prepared in return for an appraisal fee based on a percentage of the value of the appraised property, unless paid to a generally recognized association that regulates appraisers (and certain other conditions apply). IRC §170(f)(11)(E)(i) & Notice 2006-96.

F. ACCURACY RELATED PENALTIES - CHARITABLE CONTRIBUTIONS. PPA lowered the thresholds at which the accuracy-related substantial valuation and gross valuation misstatement penalties apply with regard to property valuations in charitable giving.

1. The 20% accuracy-related penalty will apply to a substantial valuation misstatement, defined as occurring when the claimed value of any property is 150% or more of the amount determined to be the correct value. IRC § 6662(e)(1)(A).

2. The 40% penalty will apply to a gross valuation misstatement, defined as occurring when the claimed value of any property is 200% or more of the amount determined to be the correct value. IRC 6662(h)(2)(A).

NOTE: For gross valuation misstatements with respect to charitable deduction property, the reasonable cause exception for relying on an appraisal does not apply. IRC §6664(c)(2).

G. INCORRECT APPRAISAL PENALTY - (APPRAISER). If a person prepares an appraisal used in a tax matter (income, estate and/or gift taxation, refund claims; etc.) and the appraisal results in a substantial or gross valuation misstatement, penalty is the greater of $1,000 or 10% of the understatement of tax. IRC §6695A(b). NOTE: Returns filed after 2/16/07 must include a statement that the appraiser understands that an appraisal resulting in substantial or gross valuation misstatement may be subject to the IRC §6695A civil penalty. Notice 2006-96. NOTE: The penalty is limited to 125% of the gross income received by the person preparing the appraisal.

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CHILD DAY CARE PROVIDERS: STANDARD MEAL/SNACK RATES

The standard meal/snack rates which child day care providers can now use to calculate deductible meal/snack costs are as follows:* 2013 2014 2015 2016 2017 2018 Breakfast: $1.27 $1.28 $1.31 $1.32 $1.31 $1.31 Lunch/dinner: $2.38 $2.40 $2.47 $2.48 $2.46 $2.46 Snack: $ .71 $ .71 $ .73 $ .74 $ .73 $ .73

If standard meal rates are utilized, providers will no longer need to keep receipts for all their food purchases. However, substantiation records must still be maintained referencing (1) the name of each child (2) dates and hours of attendance, and (3) the type and quantity of meals served. The standard meal rate method is available whether or not the day care provider is licensed, registered, or regulated by a state or local government. The standard meal and snack rates can be used for a maximum of one breakfast, one lunch, one dinner, and three snacks per eligible child per day. However, providers who are reimbursed for meal costs by a government or other program can only deduct the amount by which the standard rate exceeds the reimbursement. The standard meal/snack rates are equal to the Tier 1 reimbursement rates of the Child and Adult Care Food Program (CACFP) of the Department of Agriculture in effect on December 31st of the preceding year. These rates include beverages but not nonfood supplies such as containers, paper products, and utensils. The CACFP reimbursement rates, which are adjusted annually, can be found at the following web site:

https://www.gpo.gov/fdsys/pkg/FR-2017-07-28/pdf/2017-15950.pdf *NOTE: Child day care providers in Alaska and Hawaii use higher rates

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(Revised 11/17)

TAX PLANNING FOR THE SOCIAL SECURITY RECIPIENT

The following chart summarizes the federal marginal tax rate increases experienced as a result of the taxation of social security benefits:

Possible Marginal Rate ImpactTAX BRACKETS

15% 25% 28% 33% 35% 39.6%SS benefits phase-in:50% tier85% tier

+7.50%+12.75%

+12.50%+21.25%

------

------

------

------

Rental loss phase-out --- +12.50% +14.00% --- --- ---

Higher income retired taxpayers will be subjected to unusually high marginal taxrates on incremental income. For example, an additional dollar of non-capitalgain income for a retired taxpayer in the 25% bracket could result in a 46.25% marginal federal tax rate for the additional dollar of income considering the 85% benefit taxation rate (25% + (85% x 25%) = 46.25%). To the extent planning can be done, tax savings can be accomplished at some of the highest marginal rates experienced under current tax law.

Unfortunately tax planning for individuals at retirement is somewhat difficultdue to leveling of income and lack of involvement in a business or businesses.In addition, tax exempt income is added into the computation of "provisional income" in computing the taxation of social security benefits, so this tax planning vehicle is of no value.

50% Threshold 85% ThresholdSingle/Head of Household $25,000 to $34,000 $34,000 and over

Married Filing Jointly $32,000 to $44,000 $44,000 and over

Married FilingSeparately NO THRESHOLD EXEMPTION

MARRIED INDIVIDUALS FILING SEPARATELY -- the lesser of 85% of Social Security/Railroad Retirement Tier 1 benefits or 85% of the taxpayer's "provisional income" is generally includible in gross income. There is nothreshold exemption unless an individual who is married filing separately has lived apart from his or her spouse for the entire taxable year.

TAX PLANNING SUGGESTIONS

CAPITAL LOSSES: If taxpayer has already recognized capital gains during the year, consider sale of other assets/investments that will produce a loss.

U.S. SERIES EE/I BOND INVESTMENTS: Taxation of interest earnings can be deferred at the taxpayer’s option.

INSTALLMENT SALE CONTRACTS: May wish to recognize all gain in year of sale depending on the effect that yearly profit inclusions would have on social security.

RETIREMENT ACCOUNTS -- LUMP SUM PAYMENTS: May wish to recognize all income in year of sale depending on the effect that yearly distribution inclusions would have on social security.

COMPENSATION ADJUSTMENTS: Consider salary bonuses or deferred compensation arrangements to avoid high marginal bracket inclusion of social security in all tax years.

INDIVIDUAL RETIREMENT ACCOUNTS (IRA's): If taxpayer has some earned income and is under age 70½ may wish to consider contribution to a traditional deductible IRA to avoid high marginal bracket inclusion of social security.

MUTUAL FUND INVESTMENTS: If the taxpayer anticipates large year-end capital gain distributions, consider utilizing these investments for gifting or charitable purposes before the record date for payment of year-end dividends.

INDIVIDUAL RETIREMENT ACCOUNTS (IRA’s) – CHARITABLE CONTRIBUTIONS (AGE 70½):Those individuals age 70½ may wish to take advantage of the ability to directly fund charitable contributions from their IRAs. A direct charitable contribution of an individual’s yearly required minimum distribution (RMD) will avoid taxationon the RMD distribution and may also indirectly limit the amount of social security benefits subject to taxation.

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IRC §183 -- HOBBY LOSSES There is a presumption that a taxpayer entered into an activity for profit if the activity shows a profit in 3 out of 5 years. IRC §183(d). For breeding, training, showing or racing horses, the presumption is met if there is a profit in 2 out of 7 years. If these threshold tests are not met, the taxpayer has the burden of showing that the activity was entered into with a profit motive. In order to meet the taxpayer's burden of proof, the nine (9) factors listed below must be considered. If the burden of proof is not met, the expenses from the activity are limited to income derived from the activity. While income is reported as additional gross income on Form 1040, deductions (other than home mortgage interest or property taxes) are only allowed to the extent of revenue reported, and may only be claimed as miscellaneous itemized deductions on Schedule A. Deductibility will be lost if the taxpayer does not itemize and/or to the extent that deductions are lost to the 2% of AGI floor limitation. In addition, AMT may apply since miscellaneous itemized deductions cannot be utilized when calculating AMTI. HOBBY LOSS FACTORS: 1. Manner in which the taxpayer carries on the activity. The fact that the

taxpayer carries on the activity in a businesslike manner and maintains complete and accurate books and records may indicate that the activity is engaged in for profit. Similarly, where an activity is carried on in a manner substantially similar to other activities of the same nature which are profitable, a profit motive may be indicated. A change of operating methods, adoption of new techniques, or abandonment of unprofitable methods in a manner consistent with an intent to improve profitability may also indicate a profit motive.

2. The expertise of the taxpayer or his advisors. Preparation for the activity by extensive study of its accepted business, economic, and scientific practices, or consultation with those who expert therein, may indicate that the taxpayer has a profit motive where the taxpayer carries on the activity in accordance with such practices. Where a taxpayer has such preparation or procures such expert advice, but does not carry on the activity in accordance with such practices, a lack of intent to derive profit may be indicated unless it appears that the taxpayer is attempting to develop new or superior techniques which may result in profits from the activity.

3. The time and effort expended by the taxpayer in carrying on the activity. The fact that the taxpayer devotes much of his or her personal time and effort to carrying on an activity, particularly if the activity does not have substantial personal or recreational aspects, may indicate an intention to derive a profit. A taxpayer’s withdrawal from another occupation to devote most of his or her energies to the activity may also be evidence that the activity is engaged in for profit. The fact that the taxpayer devotes a limited amount of time to an activity does not necessarily indicate a lack of profit motive where the taxpayer employs competent and qualified persons to carry on such activity.

4. Expectation that assets used in the activity may appreciate in value. The term “profit” encompasses appreciation in the value of assets, such as land, used in the activity. Thus, the taxpayer may intend to derive a profit from the operation of the activity and may also intend that, even if no profit from current operations is derived, an overall profit will result when appreciation in the value of land used in the activity is realized, since income from the activity together with the appreciation of land will exceed expenses of operation. See, however, IRC Reg. §1.183-1(d) for the definition of an activity in this connection.

5. The success of the taxpayer in carrying on other similar or dissimilar activities. The fact that the taxpayer has engaged in similar activities in the past and converted them from unprofitable to profitable enterprises may indicate that he or she is engaged in the present activity for profit, even though the activity is presently unprofitable.

6. The taxpayer’s history of income or losses with respect to the activity. A

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series of losses during the initial or start-up stage or an activity may not necessarily be an indication that the activity is not engaged in for profit. However, where losses continue to be sustained beyond the period which is customarily necessary to bring the operation to profitable status, such continued losses, if not explainable as due to customary business risks or reverses, may be indicative that the activity is not being engaged in for profit. If losses are sustained because of unforeseen or fortuitous circumstances which are beyond the control of the taxpayer, such as drought, disease, fire, theft, weather damages, other involuntary conversions, or depressed market conditions, such losses would not be an indication that the activity is not engaged in for profit. A series of years in which net income was realized would, of course, be strong evidence that the activity is engaged in for profit.

7. The amount of occasional profits, if any, which are earned. The amount of profits in relation to the amount of losses incurred and in relation to the amount of the taxpayer’s investment and the value of the assets used in the activity may provide useful criteria in determining the taxpayer’s intent. An occasional small profit from an activity generating large losses or from an activity in which the taxpayer has made a large investment would not generally be determinative that the activity is engaged in for profit. However, substantial profit, though only occasional, would generally be indicative that an activity is engaged in for profit, where the investment or losses are comparatively small. Moreover, an opportunity to earn a substantial ultimate profit in a highly speculative venture is ordinarily sufficient to indicate that the activity is engaged in for profit even though losses or only occasional small profits are actually generated.

8. The financial status of the taxpayer. The fact that the taxpayer does not have substantial income or capital from sources other than the activity may indicate that an activity is engaged in for profit. Substantial income from sources other than the activity (particularly if the losses from the activity generate substantial tax benefits) may indicate that the activity is not engaged in for profit especially if there are personal or recreational elements involved.

9. Elements of personal pleasure or recreation. The presence of personal motives in carrying on of an activity may indicate that the activity is not engaged in for profit, especially where there are recreational or personal elements involved. On the other hand, a profit motivation may be indicated where an activity lacks any appeal other than profit. It is not, however, necessary that an activity be engaged in with the exclusive intention of deriving a profit or with the intention of maximizing profits. For example, the availability of other investments which would yield a higher return or which would be more likely to be profitable is not evidence that an activity is not engaged in for profit. An activity will not be treated as not engaged in for profit merely because the taxpayer has purposes or motivations other than solely to make a profit. Also, the fact that the taxpayer derives personal pleasure from engaging in the activity is not sufficient to cause the activity to be classified as not engaged in for profit if the activity is in fact engaged in for profit as evidenced by other factors whether or not listed in this paragraph.

TAX PLANNING - FORM 5213 (Election to Postpone Determination as to Whether the Presumption Applies that an Activity is Engaged in for Profit): Taxpayers can utilize Form 5213 to elect to postpone the profit motive determination for application of IRC §183 hobby loss rules until the end of the 4th year after a new “business activity” was initiated (6th year for horse activities). If this election is made, the taxpayer creates a presumption that the activity was entered into for profit and the IRS is precluded from disallowing losses from the activity until the end of the 5th (7th for horses) year. The downside of making this election is that it automatically extends the statute of limitations for IRS audit purposes (but only with regard to deductions which might be disallowed under IRC §183) for all tax years in the five/seven year period. The statute of limitations is extended until two (2) years after the due date of the return for the last year in the hobby loss determination time frame (e.g. 5th year (7th for horses). Once the election to extend the statute of limitations is made, it cannot be revoked. The statute of limitations is extended because an IRC §183(e)(4) election on Form 5213 meets the requirements of an IRC §6501(c)(4). Wadlow v. Commr., 112 T.C. No. 18 (May 11, 1999).

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The election is made by filing Form 5213 by the earlier of:

(1) Three (3) years after the due date (without extensions) of the tax year for the first year of the activity; or

(2) Sixty (60) days after receipt of a written notice from the IRS of the intent to disallow deductions under IRC §183.

HOBBY LOSS CASES Courts analyze hobby loss issues by reviewing the above 9 hobby loss factors. Major emphasis in current cases seems to be focusing on the following common factors: (1) The taxpayers have limited experience with regard to the business and

do not seek expert advice;

(2) The activities are part-time and recreational;

(3) The history of the business shows consistent losses with few, if any, occasional profits;

(4) The taxpayers are otherwise financially secure; and

(5) The taxpayers do not keep adequate records, no established business plan.

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HOUSEHOLD EMPLOYMENT TAXES ("NANNY TAX") FICA/FUTA TAXES

FICA WAGE THRESHOLD INCREASED. The wage threshold for FICA taxes on domestic employees is $2,000 annually for 2016-2017; $2,100 for 2018. If the payment to any household employee is $2,000 or more in a calendar year, all payments (including the first $2,000) are subject to FICA taxes. FICA TEST: The $2,000 threshold test is applied to each household employee. Thus, if the taxpayer employs more than one household worker and each worker is paid less than $2,000 during the tax year, the $2,000 threshold test is not met and all employees are exempt from FICA tax.

UNDER AGE 18 EXEMPTION. Domestic workers under the age of 18 are exempted from any employment taxes, unless said employment is their principal occupation. Being a student is considered to be an occupation for purposes of this test. Thus, for example, the wages of a 16-year old student who also babysits are exempt from the reporting and payment requirements, while the wages of a 17-year old single mother who leaves school and goes to work as a domestic to support her family will be subject to the requirements. Forms W-2 would still be required from the employer. IRC §3121(b)(21).

FUTA TEST: The FUTA test may still be met even though the taxpayer is not liable for FICA tax. FUTA tax applies if the employer paid $1,000 or more in total cash wages to household employees in any calendar quarter for the current or prior tax year (e.g. 2017 or 2016). The same test applies for purposes of Iowa unemployment tax liability. NOTE: Payments to domestic workers under age 18 are not per se exempt from FUTA/Iowa unemployment tax unless the payments are made to the taxpayer’s child. Thus, this test differs from the test for FICA taxation. NOTE: The FUTA wage limit is not adjusted for inflation. DOMESTIC HOUSEHOLD EMPLOYEE. Any person who does household work is a household employee if you can control what will be done and how it will be done. Household work includes work done in or around your home by babysitters, nannies, health aides, maids, yard workers, and similar domestic workers. HOUSEHOLD EMPLOYMENT TAXES -- FORM 1040, SCHEDULE H. For tax returns filed since 1995, household employers have been able to pay domestic employment taxes with the filing of their individual income tax returns. Schedule H is used to compute FICA tax, federal withholding tax and FUTA liabilities. The Schedule H liability is added to Form 1040 (line 60a -- 2017 return). Prior to 1998, this tax liability was not taken into consideration in determining underestimation penalties. However, for tax years beginning in 1998 and thereafter, employment taxes on domestic workers must be taken into consideration for purposes of determining underestimation penalties. TIN REQUIRED. Domestic household employers will be required to obtain an employer identification number (Form SS-4) when filing Schedule H and Forms W-2. IRC §3121(a)(7)(B), IRC §3121(x) and IRC §3510.

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RESIDENTIAL & COMMERCIAL ENERGY PROPERTY CREDITS AND DEDUCTIONS

A. PRINCIPAL RESIDENCE ENERGY CREDIT – IRC §25C (Extended by the 2015 PATH Act,

provision expires 12/31/16 unless further extended): As revised by the 2010 Tax Relief Act and extended by subsequent extender legislation, this $500 maximum aggregate credit only applies to new expenditures on the taxpayer’s existing (not newly constructed) principal residence (not vacation homes) placed in service on or before December 31, 2016 unless extended. The credit is applied on a per taxpayer (not per dwelling unit) basis. The credit rate equals 10% of the cost of new qualified energy efficiency improvements, and/or 100% of qualified residential energy property (subject to separate credit caps), with all credit allowances subject to a maximum overall credit of $500, which is then reduced by any IRC §25C credit taken between 2006-2012. PRIOR YEARS’ CREDITS: For the 2009-2010 tax years, a $1,500 aggregate credit limit applied on a per taxpayer (not per dwelling unit) basis. The credit rate was 30% of the cost of new qualified energy efficiency improvements, and/or qualified residential energy property (without separate credit caps). The list of property eligible for the 2011-2016 credit (and also the 2009-2010 credits) is set forth below:

Qualified Energy Efficiency Improvements -: (must meet applicable efficiency standards and be expected to remain in use for at least 5 years)

Metal roofs coated with heat-reduction pigments and asphalt roofs with cooling granules

Exterior windows (including those in skylights) – For 2013-2016, $200 lifetime credit cap ($2,000 x 10%) applies considering the 2006-2012 years

Exterior doors

Insulation materials or systems (including vapor retarder or seal) designed to reduce heat loss or gain. A component that provides structural support or a finished surface, such as drywall or siding, does not qualify for the credit. IRS Notice 2006-53.

NOTE: Taxpayers can generally rely on existing manufacturer certifications or the Energy Star label in purchasing qualifying products

Qualified Residential Energy Property:

Energy efficient building property – qualified electric heat pumps; electric heat pump water heaters and central air conditioners - $300 credit cap for 2011-2016 only.

Qualified natural gas, propane, and/or oil water heaters or furnaces, qualified biomass fuel stoves and qualified hot water boilers - $150 credit cap for 2011-2016 only.

Advanced main air circulating fans - $50 credit cap for 2011-2016 only.

NOTE – LABOR COSTS: Expenditures for labor costs allocable to on-site preparation, assembly and original installation do qualify for credit purposes for energy property improvements. These same expenditures do not qualify for credit purposes for energy efficiency improvements. IRC §25C(d)(2)(B)&(C). NOTE: The taxpayer’s tax basis in improvements and/or property eligible for the credit shall be reduced by the amount of any credit taken.

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TAX PLANNING NOTES: This credit has no high income phase-out range. Taxpayers can utilize this credit at all AGI levels. The credit is not refundable but will offset regular tax and AMT for 2009-2016. There is no provision for carryover of unused credits. The new law supercedes the prior $500 lifetime credit cap available during 2006-2007, and the prior $1,500 cap available during 2009-2010. No credit was available in 2008. NOTE: Principal residence energy credits from 2006-2007 were not counted toward the 2009-2010 maximum credit.

B. HIGH TECH RESIDENTIAL ENERGY CREDITS – IRC §25D – (Provision Expires 12/31/16 Unless Further Extended): The American Recovery and Reinvestment Act of 2009 extended the residential alternative energy credit for tax years 2009 through 2016 and removed the individual dollar caps for qualified solar hot water property, geothermal heat pumps and wind energy property. The credit rate is 30% of the cost of the eligible residential improvements, including labor costs allocable to onsite preparation, assembly, or original installation. A $500 per .5 kilowatt of capacity credit cap remains for qualified fuel cell property expenditures. The credit is restricted to equipment placed in service in the taxpayer’s residence. The residence must be located in the U.S., with no credit being allowed for equipment used to heat swimming pools or hot tubs. IRC §25D(e)(3). NOTE: The qualified fuel cell property expenditure credit must involve a U.S. dwelling unit used by the taxpayer as his or her principal residence. The other two credits are available for expenditures in a dwelling unit used as a residence, but not necessarily the principal residence of the taxpayer (i.e.: vacation home). TAX PLANNING NOTE: This credit has no high income phase-out range. The credit is not refundable but will offset regular tax and AMT. Any excess credit may be carried forward to future years. NOTE: The taxpayer’s tax basis in property eligible for the credit shall be reduced by the amount of any credit taken.

C. ENERGY EFFICIENT COMMERCIAL BUILDING DEDUCTION – IRC §179D (Extended by the 2015 PATH Act, provision expires 12/31/16 unless further extended): An immediate first-year expense deduction will be allowed for the cost of qualified energy saving improvements to U.S. commercial buildings. Eligible improvements include those installed as part of interior lighting systems; heating, cooling and ventilation systems; hot water systems; or the building envelope (e.g. windows, siding, etc.). To qualify, the improvements must meet a 50% reduced energy consumption standard and be certified as installed pursuant to a plan to reduce and power costs by 50% or more compared to a reference building which meet the minimum requirements of Standard 90.1-2001 of the American Society of Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of North America. (See: IRS Notice 2006-52 and 2008-40 for certification details). EXAMPLE: IRS Info 2012-0004 describes the following three ways that a taxpayer can qualify for a deduction under IRC §179D for energy efficient lighting upgrades in several of his stores: (1) the interior lighting system is certified to reduce the total annual energy and power costs for the building’s combined HVAC and interior lighting systems by at least 50%; 2) total energy and power costs are reduced by at least 20%, allowing for a partial deduction; or (3) the interior lighting system is certified to achieve a reduction in lighting power density.

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The maximum deduction is generally limited to a $1.80 per square foot (on a lifetime basis, per building) and is available for qualified energy efficient commercial building improvements placed in service between 1-1-06 and 12-31-16. NOTE: If the building fails to meet the 50% target for reduction in energy and power cost, a reduced deduction expense of 0.60 per square foot may apply, provided the project meets energy-saving targets (16 2/3% energy savings) established by the Secretary of the Department of Energy. NOTE: - Reduced Energy Consumption Standards: Notice 2012-22 provides an additional set of reduced energy savings percentages that may be utilized to meet consumption standard eligibility tests for purposes of the IRC §179D deduction. The applicable energy savings percentages are 25% for interior lighting systems, 15% for HVAC and hot water systems, and 10% for the building envelope. The new reduced percentages are effective for property placed in service after 5/11/12. NOTE – Public Buildings: For public buildings, the deduction is to be available to the “person primarily responsible for designing the property” (e.g. schools, etc.). NOTE: The taxpayer’s tax basis shall be reduced by the amount of the deduction allowed. The amount expensed is treated as IRC §1245 depreciation subject to depreciation recapture. IRC §1245(a)(2)(C).

D. ENERGY EFFICIENT NEW HOMES CREDIT FOR HOME BUILDING CONTRACTORS – IRC §45L

(Extended by the 2015 PATH Act, provision expires 12/31/16 unless further extended): Contractors building new energy efficient homes within the U.S. (site-built or manufactured) are eligible for a $2,000 credit per dwelling unit. The dwelling unit must be certified to show that annual energy consumption for heating and cooling is at least 50% less than comparable units. A credit of $1,000 is available for manufactured homes where the annual heating and cooling energy consumption reduction is 30%, rather than 50%. Substantial reconstruction/rehabilitation of an existing dwelling unit also meets the definition of new construction for purposes of these credits. The credits are only available for homes (including vacation homes) sold by contractors for use as personal residences. Construction must be substantially completed after 8-8-05; and the home must be sold between 1-1-06 and 12-31-16. The contractor’s tax basis in the home will be reduced by the amount of any credit taken.

The credit is available to “eligible contractors” with that term defined as “the person who constructed the qualified new energy efficient home” or a manufactured home producer. The credit is part of the general business credit and reduces regular tax, but not AMT. The credit is not eligible for carryback to tax years ending on or before 12-31-05. Any portion of the credit that remains unused at the end of the carryover period may be deducted. IRC §196(c)(13). NOTE - Certification: The IRS has released two items of guidance, one for manufactured homes and one for all other homes, detailing how an eligible contractor can obtain certification that a dwelling unit qualifies for the new credit. The guidance also provides a public list of software programs that may be used to calculate energy consumption for purposes of obtaining proper certification. IRS Notice 2006-27 and IRS Notice 2006-28.

NOTE: It would appear that an owner-built home would be considered an “eligible contractor” but that will likely not be known for sure until further guidance is published in regulations or otherwise.

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CAPITAL GAINS RATES/HOLDING PERIODS

Transaction Date of Sale

Holding Period

Tax Rate 10% - 15%

Tax Rate 25% - over

Tax Rate 39.6% & over

Prior to 5-7-97 More than 12 months

15% 28% N/A

5-7-97 thru 7-28-97

(Mid-term)

More than 12 months

10% 20% N/A

7-29-97 thru 12-31-97

12 months to 18 months

15% 28% N/A

7-29-97 thru 12-31-97

More than 18 months

10% 20% N/A

1-1-98 thru 5-5-03

More than 12 months

10% 20% N/A

1/01/01 thru 5-5-03

1-1-13 and after

More than 5 years

8% 18%** N/A

N/A

5-6-03 thru 12-31-07

More than 12 months

5% 15% N/A

1-1-08 thru 12-31-12

More than 12 months

0% 15% N/A

1-1-13 and after More than 12 months

0% 15% 20%

**NOTE: The 18% rate only applies to assets whose holding period began after December 31, 2000. Thus, sales eligible for the 18% rate would not occur before January 1, 2006. With the 2003 Tax Act beneficial tax rate change for capital gains, this provision had no application until 1/1/2013 when the highest capital gain rate became 20%. NOTE: For taxpayers eligible for the 8% rate, the asset merely needed to be held for 5 years and sold after December 31, 2000. NOTE: The reduction in capital gains tax rates after May 5, 2003, applies to both regular tax and AMT. Alternate Minimum Tax: For noncorporate taxpayers, the maximum tax rates on adjusted net capital gain of 0%/15%/20% are the same for AMT as for the regular income tax. IRC §55(b)(3)(B)&(C).

(A) Collectibles. Any long-term capital gain from the sale or exchange of collectibles (e.g. coins, stamps, sports card, autographs, etc.) remains at a maximum rate of 28%.

(B) IRC §1250 Property. Any long-term capital gain resulting from

depreciation of IRC §1250 property (to the extent the gain would have been treated as ordinary income if the property had been IRC §1245 property) will be taxed at a maximum rate of 25% (10/15% if the gain does not put the taxpayer into higher brackets).

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NOTE: Final regulations have been issued regarding how to report IRC §1250 depreciation related gain in conjunction with installment sales. The regulations require all IRC §1250 gain from depreciation to be reported first (prior to the reporting of any remaining 0/5/8/10% or 15/20% capital gain from the installment sale). IRC Reg. §1.453-12.

TAX PLANNING NOTE: For 2008-2017 sales of IRC §1250 property held over 12 months, consider allocating as much of the sales price to land as is reasonably possible to maximize the gain subject to the 15% (or 0%) tax rate. Since gain on depreciable property in excess of the depreciation will be taxed at the 15%/20% (or 0%) rate, an aggressive allocation of sales price to the land will cut taxes when the portion of the sales price allocated to the depreciable property is less than the property's original cost.

EXAMPLE: Scott owns an office building purchased several years ago for $190,000 (allocated $160,000 to the building and $30,000 to the land). By the time he sells the property in September, 2017 for $200,000, he has claimed $40,000 of depreciation. The building was recently appraised and valued between $125,000 and $140,000. The land is worth between $60,000 and $90,000. Out of the $200,000 sales price, if Scott allocates $140,000 to the building and $60,000 to the land, then the entire $20,000 gain on the building ($140,000 - ($160,000 - $40,000)) will be subject to the maximum 25% tax rate because of the depreciation claimed on the property. (The balance of the gain will be subject to a 15% rate if Scott's regular tax rate is below the 39.6% bracket. Otherwise, the balance of the gain will be taxed at a 20% rate. However, if Scott has an appraisal that will support an allocation of only $125,000 to the building, the portion of the gain subject to the maximum 25% rate is reduced to $5,000, which is the lesser of the depreciation claimed ($40,000) or the gain on the building ($125,000 - ($160,000 - $40,000) = $5,000).

TAX TRAP - ACCELERATED ACRS DEPRECIATION ON REAL PROPERTY: Watch for ACRS depreciation on sale of buildings acquired between 1/1/1981 and 12/31/1986. If straight-line ACRS depreciation was not elected, all gain will be IRC §1245 recapture; there will be no IRC §1250 depreciation to test.

(C) Qualified Small Business Stock. The American Recovery and

Reinvestment Act of 2009 increased the percentage exclusion for qualified small business (QSBC) stock sold by an individual from 50% to 75% for stock acquired after 2/17/09 and before 1/1/2011. The Small Business Jobs Act of 2010, and subsequent extender legislation, increased the percentage exclusion to 100% for stock acquired after 9/27/10 and before 1/1/2015. The 2015 PATH Act makes the 100% exclusion permanent for stock acquisitions after 9/27/10. IRC §1202. Accordingly, any sale of QSBC stock (IRC §1202 stock) that a taxpayer held for more than 5 years, now will have 100% of the gain excluded from income under this provision if the stock was acquired after 9/27/10 (75% of the gain excluded from income for

H-78

sales of stock acquired between 2/18/09 and 9/27/10; 50% for sales of stock acquired between 8/11/93 and 2/17/09). IRC §1202(a)(4)(C). Any QSBC stock qualifying for the 100%/75% or 50% exclusion does not qualify for the lower capital gain tax rates. Under the statute, any taxable portion of a sale is taxed at a maximum rate of 28%. Thus, for sales of stock between 2/18/09 and 9/27/10, the effective tax rate will be 7% (.28 x .25); for sales of stock acquired after 9/27/10, the effective tax rate will be 0%.

NOTE -- AMT EFFECT: IRC §57(a) provides that the AMT tax

preference resulting from the sale of QSBC stock will effectively be taxed at a 12.88% rate for stock acquired between 2/18/09 and 9/27/10 (14.98% for stock acquired before 2/18/09). There will be no AMT tax preference resulting from the sale of QSBC stock acquired after 9/27/10. The 2015 PATH Act also made this provision permanent.

NOTE: The gain exclusion and rollover breaks for QSBC stock

gains aren’t available to QSBC shareholders that are themselves C corporations. IRC §1202(a)(1). However, gains from selling QSBC stock held by pass-through business entities (LLCs, partnerships, and S corporations) can be passed through to the individual owners and potentially qualify for the gain exclusion and rollover breaks at that level. IRC §1202(g).

ROLLOVER OF GAIN ELECTION: For sales after August 5, 1997,

taxpayers (except corporations) can elect to rollover capital gain from the sale of QSBC stock, if the stock is held for more than 6 months, and other small business stock is purchased by the individual during the 60-day period beginning on the date of sale. If the rollover election is made, gain is recognized only to the extent that the amount realized on the sale exceeds the cost of the replacement QSBC stock purchased during the 60-day period, reduced by the portion of such cost, if any, previously taken into account. The basis of the replacement stock is reduced by the amount of gain not recognized. IRC §1045, §1016(a) and §1223(15).

Replacement Stock. To be eligible for the rollover provision,

the replacement stock must meet the active business requirement during the 6-month period following its purchase.

NOTE: The basis adjustment is applied to the replacement stock

in the order such stock is acquired.

NOTE -- HOLDING PERIOD (TACKING): The taxpayer will be allowed to tack the holding period of the stock sold to the holding period of the stock purchased for purposes of calculating gain and loss on sale. IRC §1223(15).

TAX PLANNING: This provision should be of great interest to venture capital investors. It essentially makes purchasing QSBC stock akin to acquiring personal residences under the provisions of the now repealed IRC §1034.

******************************************************

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2008-2017 TAX PLANNING FOR THE 0% CAPITAL GAINS TAX RATE

Taxpayers holding appreciated stock/securities that would qualify for long-term capital gain treatment and whose taxable income is below the top of the 15% ordinary bracket should be encouraged to sell a sufficient amount of assets to fully utilize the 0% capital gain rate in 2017. An immediate repurchase of the assets would increase the tax basis with no federal tax cost to the taxpayer (state income tax, if applicable, would still need to be paid). NOTE: The wash sale rules of IRC §1091 apply only to losses and repurchases of similar securities, and not to gains and repurchases. CAUTION – RETIREES: Be cautious of attempts to achieve 0% capital gain recognition in the tax returns of retirees. The added AGI from a long-term capital gain transaction may cause taxable phase-in of social security benefits at a 50% or 85% inclusion ratio.

******************************************************

2013-2017 SCHEDULE D CHANGES Form 1040, Schedule D has added lines 1a and 8a to allow reporting without using Form 8949 for transactions correctly reported to IRS with correct basis amounts. There is also no need to report each transaction, they can be aggregated, and no supporting documentation is required. This applies when the basis and sale amounts all tie and are correct.

REVISED FORM 8949 INSTRUCTIONS (REPORTING STOCK SALE TRANSACTIONS)

Instead of reporting each of your transactions on a separate row of Part I (short-term transactions) or Part II (long-term transactions), you can report them on an attached statement containing all the same information as Parts I and II and in a similar format (i.e., description of property, dates of acquisition and disposition, proceeds, basis, adjustment and code(s), and gain or (loss)). You may use as many attached statements as you need. Enter the combined totals from all your attached statements on Parts I and II with the appropriate box checked. For example, report on Part I (with box A checked) all short-term gains and losses from transactions your broker reported to you on a statement showing that the basis of the asset sold was reported to the IRS. Enter the name of the broker followed by the words “See attached statement” in column (a). Leave columns (b) and (c) blank. Enter “M” in column (f). If other codes also apply, enter all of them in column (f). If you have statements from more than one broker, report the totals from each broker on a separate row. Do not enter “Available upon request” and summary totals in lieu of reporting the details of each transaction on Part I or II or attached statements. E-FILING: If you e-file your return but choose not to report each transaction on a separate row on the electronic return, you must either:

(a) Include Form 8949 as a PDF attachment to your return; or

(b) Attach Form 8949 to Form 8453 (or the appropriate form in the Form 8453 series) and mail the forms to the IRS.

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SCHEDULE D (Form 1040)

Department of the Treasury Internal Revenue Service (99)

Capital Gains and Losses▶ Attach to Form 1040 or Form 1040NR.

▶ Go to www.irs.gov/ScheduleD for instructions and the latest information. ▶ Use Form 8949 to list your transactions for lines 1b, 2, 3, 8b, 9, and 10.

OMB No. 1545-0074

2017Attachment Sequence No. 12

Name(s) shown on return Your social security number

Part I Short-Term Capital Gains and Losses—Assets Held One Year or Less

See instructions for how to figure the amounts to enter on the lines below. This form may be easier to complete if you round off cents to whole dollars.

(d) Proceeds

(sales price)

(e) Cost

(or other basis)

(g) Adjustments

to gain or loss from Form(s) 8949, Part I,

line 2, column (g)

(h) Gain or (loss) Subtract column (e) from column (d) and

combine the result with column (g)

1a Totals for all short-term transactions reported on Form 1099-B for which basis was reported to the IRS and for which you have no adjustments (see instructions). However, if you choose to report all these transactions on Form 8949, leave this line blank and go to line 1b .

1b Totals for all transactions reported on Form(s) 8949 with Box A checked . . . . . . . . . . . . .

2

Totals for all transactions reported on Form(s) 8949 with Box B checked . . . . . . . . . . . . .

3

Totals for all transactions reported on Form(s) 8949 with Box C checked . . . . . . . . . . . . .

4 Short-term gain from Form 6252 and short-term gain or (loss) from Forms 4684, 6781, and 8824 . 4 5

Net short-term gain or (loss) from partnerships, S corporations, estates, and trusts from Schedule(s) K-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

6

Short-term capital loss carryover. Enter the amount, if any, from line 8 of your Capital Loss Carryover Worksheet in the instructions . . . . . . . . . . . . . . . . . . . . . . . 6 ( )

7 Net short-term capital gain or (loss). Combine lines 1a through 6 in column (h). If you have any long-term capital gains or losses, go to Part II below. Otherwise, go to Part III on the back . . . . . 7

Part II Long-Term Capital Gains and Losses—Assets Held More Than One Year

See instructions for how to figure the amounts to enter on the lines below. This form may be easier to complete if you round off cents to whole dollars.

(d) Proceeds

(sales price)

(e) Cost

(or other basis)

(g) Adjustments

to gain or loss from Form(s) 8949, Part II,

line 2, column (g)

(h) Gain or (loss) Subtract column (e) from column (d) and

combine the result with column (g)

8a Totals for all long-term transactions reported on Form 1099-B for which basis was reported to the IRS and for which you have no adjustments (see instructions). However, if you choose to report all these transactions on Form 8949, leave this line blank and go to line 8b .

8b Totals for all transactions reported on Form(s) 8949 with Box D checked . . . . . . . . . . . . .

9

Totals for all transactions reported on Form(s) 8949 with Box E checked . . . . . . . . . . . . .

10

Totals for all transactions reported on Form(s) 8949 with Box F checked. . . . . . . . . . . . . .

11

Gain from Form 4797, Part I; long-term gain from Forms 2439 and 6252; and long-term gain or (loss) from Forms 4684, 6781, and 8824 . . . . . . . . . . . . . . . . . . . . . . 11

12 Net long-term gain or (loss) from partnerships, S corporations, estates, and trusts from Schedule(s) K-1 12

13 Capital gain distributions. See the instructions . . . . . . . . . . . . . . . . . . 13 14

Long-term capital loss carryover. Enter the amount, if any, from line 13 of your Capital Loss Carryover Worksheet in the instructions . . . . . . . . . . . . . . . . . . . . . . . 14 ( )

15

Net long-term capital gain or (loss). Combine lines 8a through 14 in column (h). Then go to Part III onthe back . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

For Paperwork Reduction Act Notice, see your tax return instructions. Cat. No. 11338H Schedule D (Form 1040) 2017

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(e)

from

col

umn

(d) a

nd

com

bine

the

resu

lt w

ith c

olum

n (g

)

2T

ota

ls.

Ad

d t

he a

mou

nts

in c

olum

ns (d

), (e

), (g

), an

d (h

) (su

btr

act

nega

tive

amou

nts)

. E

nter

eac

h to

tal

here

and

inc

lud

e on

you

r S

ched

ule

D, l

ine

1b

(if

Bo

x A

ab

ove

is c

heck

ed),

lin

e 2

(if

Bo

x B

ab

ove

is c

heck

ed),

or li

ne

3 (i

f Bo

x C

ab

ove

is c

heck

ed)

No

te:

If yo

u ch

ecke

d B

ox A

ab

ove

but

the

bas

is r

epor

ted

to

the

IRS

was

inco

rrec

t, e

nter

in c

olum

n (e

) th

e b

asis

as

rep

orte

d t

o th

e IR

S,

and

ent

er a

n ad

just

men

t in

col

umn

(g) t

o co

rrec

t th

e b

asis

. See

Col

umn

(g) i

n th

e se

par

ate

inst

ruct

ions

for

how

to

figur

e th

e am

ount

of t

he a

dju

stm

ent.

Fo

r P

ap

erw

ork

Re

du

cti

on

Ac

t N

oti

ce

, se

e y

ou

r ta

x r

etu

rn in

str

uc

tio

ns.

Cat

. No.

377

68Z

Form

8949

(201

7)

Form

894

9 (2

017)

Att

achm

ent

Seq

uenc

e N

o. 1

2A

Pag

e 2

Nam

e(s)

sho

wn

on re

turn

. Nam

e an

d S

SN

or t

axpa

yer i

dent

ifica

tion

no. n

ot re

quire

d if

show

n on

oth

er s

ide

So

cia

l se

cu

rity

nu

mb

er

or

taxp

aye

r id

en

tifi

ca

tio

n n

um

be

r

Bef

ore

you

chec

k B

ox D

, E, o

r F b

elow

, see

whe

ther

you

rece

ived

any

For

m(s

) 109

9-B

or s

ubst

itute

sta

tem

ent(s

) fro

m y

our b

roke

r. A

sub

stitu

te

stat

emen

t will

hav

e th

e sa

me

info

rmat

ion

as F

orm

109

9-B

. Eith

er w

ill s

how

whe

ther

you

r bas

is (u

sual

ly y

our c

ost)

was

repo

rted

to th

e IR

S by

you

r br

oker

and

may

eve

n te

ll yo

u w

hich

box

to c

heck

.

Pa

rt I

IL

on

g-T

erm

. Tra

nsac

tions

invo

lvin

g ca

pita

l ass

ets

you

held

mor

e th

an 1

yea

r ar

e lo

ng t

erm

. For

sho

rt-t

erm

tr

ansa

ctio

ns, s

ee p

age

1.

No

te: Y

ou m

ay a

ggre

gate

all

long

-ter

m t

rans

actio

ns r

epor

ted

on

Form

(s) 1

099-

B s

how

ing

bas

is w

as r

epor

ted

to

the

IRS

and

for

whi

ch n

o ad

just

men

ts o

r co

des

are

req

uire

d. E

nter

the

tot

als

dire

ctly

on

Sch

edul

e D

, lin

e 8a

; you

are

n't

req

uire

d t

o re

por

t th

ese

tran

sact

ions

on

Form

894

9 (s

ee in

stru

ctio

ns).

Yo

u m

ust

ch

ec

k B

ox D

, E

, or

F b

elo

w.

Ch

ec

k o

nly

on

e b

ox.

If m

ore

than

one

box

ap

plie

s fo

r yo

ur lo

ng-t

erm

tra

nsac

tions

, com

ple

te

a se

par

ate

Form

894

9, p

age

2, fo

r ea

ch a

pp

licab

le b

ox. I

f you

hav

e m

ore

long

-ter

m t

rans

actio

ns t

han

will

fit

on t

his

pag

e fo

r on

e or

m

ore

of t

he b

oxes

, com

ple

te a

s m

any

form

s w

ith t

he s

ame

box

che

cked

as

you

need

.

(D) L

ong-

term

tra

nsac

tions

rep

orte

d o

n Fo

rm(s

) 109

9-B

sho

win

g b

asis

was

rep

orte

d t

o th

e IR

S (s

ee N

ote

ab

ove)

(E) L

ong-

term

tra

nsac

tions

rep

orte

d o

n Fo

rm(s

) 109

9-B

sho

win

g b

asis

wa

sn

't r

epor

ted

to

the

IRS

(F) L

ong-

term

tra

nsac

tions

not

rep

orte

d t

o yo

u on

For

m 1

099-

B

1

(a)

Des

crip

tion

of p

rop

erty

(E

xam

ple

: 100

sh.

XY

Z C

o.)

(b)

Dat

e ac

quire

d (M

o., d

ay, y

r.)

(c)

Dat

e so

ld o

r di

spos

ed o

f (M

o., d

ay, y

r.)

(d)

Pro

ceed

s (s

ales

pric

e)

(see

inst

ruct

ions

)

(e)

Cos

t or

oth

er b

asis

. S

ee t

he N

ote

bel

ow

and

see

Col

umn

(e)

in t

he s

epar

ate

in

stru

ctio

ns

Ad

justm

en

t, if

an

y, to

ga

in o

r lo

ss.

If yo

u en

ter a

n am

ount

in c

olum

n (g

),

ent

er a

cod

e in

col

umn

(f).

Se

e t

he

se

pa

rate

in

str

uc

tio

ns.

(f)

Cod

e(s)

from

in

stru

ctio

ns

(g)

Am

ount

of

adju

stm

ent

(h)

Ga

in o

r (lo

ss).

Sub

trac

t col

umn

(e)

from

col

umn

(d) a

nd

com

bine

the

resu

lt w

ith c

olum

n (g

)

2T

ota

ls. A

dd

the

am

ount

s in

col

umns

(d),

(e),

(g),

and

(h) (

sub

trac

t ne

gativ

e am

ount

s). E

nter

eac

h to

tal h

ere

and

incl

ude

on y

our

Sch

edul

e D

, lin

e 8

b (i

f Bo

x D

ab

ove

is c

heck

ed),

lin

e 9

(if B

ox E

ab

ove

is c

heck

ed),

or li

ne

10 (i

f Bo

x F

ab

ove

is c

heck

ed)

No

te:

If yo

u ch

ecke

d B

ox D

ab

ove

but

the

bas

is r

epor

ted

to

the

IRS

was

inco

rrec

t, e

nter

in c

olum

n (e

) th

e b

asis

as

rep

orte

d t

o th

e IR

S,

and

ent

er a

n ad

just

men

t in

col

umn

(g) t

o co

rrec

t th

e b

asis

. See

Col

umn

(g) i

n th

e se

par

ate

inst

ruct

ions

for

how

to

figur

e th

e am

ount

of t

he a

dju

stm

ent.

Form

8949

(201

7)

H-82

Page 7 of 10 Fileid: … ions/I8949/2017/A/XML/Cycle08/source 16:52 - 31-Oct-2017The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

How To Complete Form 8949, Columns (f) and (g)For most transactions, you don't need to complete columns (f) and (g) and can leave them blank. You may need to complete columns (f) and (g) if you got a Form 1099-B or 1099-S (or substitute statement) that is incorrect, if you are excluding or postponing a capital gain, if you have a disallowed loss, or in certain other situations. Details are in the table below. If you enter more than one code in column (f), see More than one code in the instructions for column (g).

IF . . . THEN enter this code in column (f) . . . AND. . .

You received a Form 1099-B (or substitute statement) and the basis shown in box 1e is incorrect . . . . . . . . . . . . . . . . . . . . . . .

B

If this transaction is reported on a Part I with box B checked at the top or if this transaction is reported on a Part II with box E checked at the top, enter the correct basis in column (e), and enter -0- in column (g).

If this transaction is reported on a Part I with box A checked at the top or if this transaction is reported on a Part II with box D checked at the top, enter the basis shown on Form 1099-B (or substitute statement) in column (e), even though that basis is incorrect. Correct the error by entering an adjustment in column (g). To figure the adjustment needed, see the Worksheet for Basis Adjustments in Column (g). Also see Example 4—adjustment for incorrect basis in the instructions for column (h).

You received a Form 1099-B (or substitute statement) and the type of gain or (loss) shown in box 2 is incorrect . . . . . . . . . . .

TReport the transaction on the correct Part of Form 8949, and enter -0- in column (g) on that Part of the form if there are no adjustments needed for the transaction.

TIPIf you received a Form 1099-B

(or substitute statement) with the Ordinary box in box 2 checked and the security is a taxable contingent payment debt instrument subject to the noncontingent bond method, enter code “O” for the transaction in column (f) of the appropriate Part of Form 8949 and complete the Worksheet for Contingent Payment Debt Instrument Adjustment in Column (g), later, to figure the amount to enter in column (g).You received a Form 1099-B or 1099-S (or substitute statement) as a nominee for the actual owner of the property . . . . . . . . . .

N

Report the transaction on Form 8949 as you would if you were the actual owner, but also enter any resulting gain as a negative adjustment (in parentheses) in column (g) or any resulting loss as a positive adjustment in column (g). As a result of this adjustment, the amount in column (h) should be zero. However, if you received capital gain distributions as a nominee, report them instead as described under Capital Gain Distributions in the Instructions for Schedule D (Form 1040).

You sold or exchanged your main home at a gain, must report the sale or exchange on Part II of Form 8949 (as explained in Sale of Your Home in the Instructions for Schedule D (Form 1040)), and can exclude some or all of the gain . . . . . . . . . . . . . .

H

Report the sale or exchange on Form 8949 as you would if you weren't taking the exclusion. Then enter the amount of excluded (nontaxable) gain as a negative number (in parentheses) in column (g). See the example in the instructions for column (g).

H-83

Page 8 of 10 Fileid: … ions/I8949/2017/A/XML/Cycle08/source 16:52 - 31-Oct-2017The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

IF . . . THEN enter this code in column (f) . . . AND. . .

You received a Form 1099-B showing accrued market discount in box 1f . . . . .

D

Use the Worksheet for Accrued Market Discount Adjustment in Column (g), later, to figure the amount to enter in column (g). However:

If you received a partial payment of principal on a bond, don't use the worksheet. Instead, enter the smaller of the accrued market discount or your proceeds in column (g). Also report it as interest on your tax return.

If you chose to include market discount in income currently, enter -0- in column (g). Before figuring your gain or (loss), increase your basis in the bond by the market discount you have included in income for all years. See the instructions for code B above.If the disposition of a market discount bond results in a loss subject to the wash sale rules, enter “W” in column (f) and follow the instructions for code “W” below.

You sold or exchanged qualified small business stock and can exclude part of the gain . . . . . . . . . . . . . . . . . . . . . . . . . . . Q

Report the sale or exchange on Form 8949 as you would if you weren't taking the exclusion and enter the amount of the exclusion as a negative number (in parentheses) in column (g). However, if the transaction is reported as an installment sale, see Gain from an installment sale of QSB stock in the Instructions for Schedule D (Form 1040).

You can exclude all or part of your gain under the rules explained in the Schedule D instructions for DC Zone assets or qualified community assets . . . . . . . . . . . . . . . . .

XReport the sale or exchange on Form 8949 as you would if you weren't taking the exclusion. Then enter the amount of the exclusion as a negative number (in parentheses) in column (g).

You are electing to postpone all or part of your gain under the rules explained in the Schedule D instructions for any rollover of gain (for example, rollover of gain from QSB stock or publicly traded securities) . . . . .

R

Report the sale or exchange on Form 8949 as you would if you weren't making the election. Then enter the amount of postponed gain as a negative number (in parentheses) in column (g).

You have a nondeductible loss from a wash sale . . . . . . . . . . . . . . . . . . . . . . . . . . .

W

Report the sale or exchange on Form 8949 and enter the amount of the nondeductible loss as a positive number in column (g). See the Schedule D instructions for more information about wash sales generally and Pub. 550 for more information on wash sales involving substantially similar stock or securities. If you received a Form 1099-B (or substitute statement) and the amount of nondeductible wash sale loss shown in box 1g is incorrect, enter the correct amount of the nondeductible loss as a positive number in column (g). If the amount of the nondeductible loss is less than the amount shown on Form 1099-B (or substitute statement), attach a statement explaining the difference. If no part of the loss is a nondeductible loss from a wash sale transaction, enter -0- in column (g).

You have a nondeductible loss other than a loss indicated by code W . . . . . . . . . . . . L

Report the sale or exchange on Form 8949 and enter the amount of the nondeductible loss as a positive number in column (g). See Nondeductible Losses in the Instructions for Schedule D (Form 1040).

H-84

Page 9 of 10 Fileid: … ions/I8949/2017/A/XML/Cycle08/source 16:52 - 31-Oct-2017The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

IF . . . THEN enter this code in column (f) . . . AND. . .

You received a Form 1099-B or 1099-S (or substitute statement) for a transaction and there are selling expenses or option premiums that aren't reflected on the form or statement by an adjustment to either the proceeds or basis shown . . . . . . . . . . . . E

Enter in column (d) the proceeds shown on the form or statement you received. Enter in column (e) any cost or other basis shown on Form 1099-B (or substitute statement). In column (g), enter as a negative number (in parentheses) any selling expenses and option premium that you paid (and that aren't reflected on the form or statement you received) and enter as a positive number any option premium that you received (and that isn't reflected on the form or statement you received). For more information about option premiums, see Gain or Loss From Options in the Instructions for Schedule D (Form 1040).

You had a loss from the sale, exchange, or worthlessness of small business (section 1244) stock and the total loss is more than the maximum amount that can be treated as an ordinary loss . . . . . . . . . . . . . . . . . .

S

See Small Business (Section 1244) Stock in the Schedule D (Form 1040) instructions.

You disposed of collectibles (see the Schedule D instructions) . . . . . . . . . . . . C Enter -0- in column (g). Report the disposition on Form

8949 as you would report any sale or exchange.You report multiple transactions on a single row as described in Exception 2 or Special provision for certain corporations, partnerships, securities dealers, and other qualified entities under Exceptions to reporting each transaction on a separate row . . . . . . . . . . . . . . . . . . . . . . . . . . .

M

See Exception 2 and Special provision for certain corporations, partnerships, securities dealers, and other qualified entities under Exceptions to reporting each transaction on a separate row. Enter -0- in column (g) unless an adjustment is required because of another code.

You have an adjustment not explained earlier in this column . . . . . . . . . . . . . . . O Enter the appropriate adjustment amount in column (g).

See the instructions for column (g).None of the other statements in this column apply . . . . . . . . . . . . . . . . . . . . . . . . . .

Leave columns (f) and (g) blank.

Column (h)—Gain or (Loss)Figure gain or (loss) on each row. First, subtract the cost or other basis in column (e) from the proceeds (sales price) in column (d). Then take into account any adjustments in column (g). Enter the gain or (loss) in column (h). Enter negative amounts in parentheses.

Example 1—gain. Column (d) is $6,000 and column (e) is $2,000. Enter $4,000 in column (h).

Example 2—loss. Column (d) is $6,000 and column (e) is $8,000. Enter ($2,000) in column (h).

Example 3—adjustment. Column (d) is $6,000, column (e) is $2,000, and column (g) is ($1,000). Enter $3,000 in column (h).

Example 4—adjustment for incorrect basis. You sold stock for $1,000. You had owned the stock for 3 months. Your correct basis for the stock is $100, but you receive a Form 1099-B that shows your basis is $900 and shows your broker reported that basis to the IRS. Enter $900 on line 1 of the Worksheet for Basis Adjustments in Column (g). Enter $100 on line 2 of the worksheet. Since

line 1 is larger than line 2, leave line 3 blank and enter $800 ($900 − $100) as a positive number on line 4. Also enter $800 in column (g) of a Part I with box A checked at the top. Enter “B” in column (f). Enter $1,000 in column (d) and $900 in column (e). To figure your gain or (loss), subtract $900 from $1,000. Combine the result, $100, with the $800 adjustment in column (g). Your gain is $900 ($100 + $800). Enter $900 in column (h).

H-85

BROKER REPORTING RULES

(IRC §6045)

Pursuant to legislation adopted in the Emergency Economic Stabilization Act of 2008,

beginning with 2011 (for “covered securities”), brokers are required to report the

adjusted basis of stocks and securities sold, as well as, whether the gain/loss from

the sale is long-term or short-term. IRC §6045(g). This information is reported on

Form 1099-B. Adjusted basis and gain/loss reporting for mutual fund shares and stock

held in dividend reinvestment accounts (DRIPs) was required beginning with 2012.

COVERED SECURITIES: The term “covered securities” refers to corporate stock acquired

after 2010, and mutual fund shares and dividend reinvestment plan (DRIP) stock/shares

acquired after 2011. IRC §6045(g) requires brokers to report cost basis information

for these securities to IRS utilizing Form 1099-B.

NOTE: Brokers may, but are not required to, report basis for any securities acquired

before the dates noted in the table below (“noncovered securities”).

Broker Cost Basis Reporting

Type of

Shares/Investments

Covered Shares:

(Acquired on or

after)

Cost Basis Reporting Default Method

(NOTE: Taxpayer can use another

permissible method by notifying broker.)

Corporate stock 1/1/11 FIFO

Mutual fund shares 1/1/12 Broker determined*

DRIP stock 1/1/12 Broker determined*

Debt Instruments

(Fixed Yield &

Maturity)

1/1/14 Broker determined

(See below)

Complex Debt

Instruments

1/1/16 Broker determined

(See below)

*FIFO, average basis, or specific identification.

NOTE: Investors generally receive correspondence from their security brokers

requesting an election as to how basis will be computed on future sales of mutual

funds or from DRIP accounts (e.g. average cost basis, first-in-first-out, etc.).

AVERAGE BASIS METHOD – MUTUAL FUND SHARES & DRIPs: Taxpayers may average the basis

of stock held in a DRIP acquired on or after 1/1/11. An election is not necessary

for DRIPs or mutual fund shares if the average basis method is the broker’s default

method, unless the taxpayer previously elected a different method.

For sales of mutual fund shares acquired before 2012 (“noncovered securities”)

taxpayers could elect to utilize the average basis method by electing this method on

their return for the year the election was first effective. The election then

applied to all identical shares the taxpayer held in any account. IRC Reg. §1.1012-

1(e)(9)(ii).

For sales of mutual fund shares acquired after 2011 (“covered securities”), taxpayers

elected the average basis method for chosen accounts by notifying the custodian or

agent in writing by any reasonable means, including electronic format.

NOTE: Taxpayers can elect the average basis method at any time. The election takes

effect for sales that occur after the election is made. IRC Reg. §1.1012-1(e)(9)(i).

H-86

Taxpayers who elected to average the basis of mutual fund shares will compute

separate averages for fund shares held in different accounts. Taxpayers can elect to

average the basis of mutual fund shares in one account, but not average them in

another account.

TAXPAYER ELECTIONS FOR DEBT INSTRUMENTS – BROKER ASSUMPTIONS: Brokers are directed

to assume that a taxpayer has not made the following elections when reporting basis

and gain, unless the customer has notified the broker of the election:

1) The election to currently include accrued market discount under IRC §1278(b).

2) The election to accrue market discount based on a constant yield under IRC §1276(b)(2).

3) The election to treat all interest as OID under IRC Reg. §1.1271-3.

4) The election to translate interest income and expense at the spot rate under IRC Reg. §1.988-2(b).

However, a broker is required to assume that a customer has made the election to

amortize bond premium under IRC §171. IRC Reg. §1.6049-9(b). A customer is

permitted to notify a broker in writing that the customer does not want the broker to

take into account the election to amortize bond premium. IRC Reg. §1.6045-1(n)(5).

NOTE: The election to amortize bond premium generally benefits the holder of a debt

instrument and accordingly the regulations require brokers to assume that customers

have made this election. The election is generally advantageous because it reduces

taxable income by offsetting amortized bond premium against interest income. Without

the election, a capital loss is recognized for the premium amount when the bond

matures. A taxpayer may make the election under IRC §171 to amortize bond premium at

any time. However, once made, the election is binding for all bonds held at the

beginning of the year of the election and all bonds acquired thereafter.

H-87

ADDITIONAL REPORTING REQUIREMENTS FOR ACQUISITION PREMIUM AMORTIZATION ON DEBT

INSTRUMENTS: For debt instruments acquired on or after January 1, 2015, brokers must

report original issue discount (OID) adjusted for any acquisition premium based on

the ratable method, even if the taxpayer elected to amortize under the constant yield

method of IRC Reg.§1.1272-3. IRC Reg. §1.6049-9(c).

For tax-exempt obligations acquired on or after January 1, 2017, payors are required

to report annual adjustments to tax-exempt interest income arising from OID and

acquisition premium on tax-exempt obligations. IRC Reg. §1.6049-10T. NOTE: This

change is designed to align with earlier regulations under IRC §6045 requiring basis

reporting on these tax-exempt obligations to take into account OID and premium

amortization.

BASIS OF STOCK ACQUIRED THROUGH COMPENSATORY OPTIONS: New regulations provide

direction to brokerage firms in terms of identifying the cost basis of stock that was

acquired through the exercise of an employer-provided compensatory option. IRC Reg.

§1.6045-1(d)(6)(ii)(A).

For options or other equity-based compensation arrangements granted or acquired

before January 1, 2014, a broker may, but is not required to, increase the

initial basis for income recognized upon exercise of a compensatory option or

the vesting or exercise of other equity-based compensation arrangements.

For options or other equity-based compensation arrangements granted or acquired

on or after January 1, 2014, a broker may not increase the initial basis for

income recognized upon the exercise of an option or the vesting or exercise of

other equity-based compensation arrangements.

NOTE: Tax preparers must now carefully scrutinize the basis amount reported on

Form 1099-B in connection with the sale of stock acquired in a compensatory

option or other equity-based arrangement. For options granted in 2014 and

after, the compensation portion will be added to basis by the broker. For

options granted prior to 2014, the compensation element may or may not have

been used to increase the basis.

*******************************************************************

ESTABLISHING THE WORTHLESSNESS OF STOCK

To obtain a deduction for worthless stock under IRC §165(g), taxpayers must show both

balance sheet insolvency and a complete lack of future potential value. The sale of

assets and distribution to creditors in bankruptcy will establish the absence of

liquidation value for stock. Once the sale of assets has occurred and the

distributions have taken place, taxpayers can use this documentation to establish

they did not receive anything for their stock or show the amount they did receive for

stock. INFO 2010-0157.

H-88

Page 10 of 10 Fileid: … ions/I8949/2017/A/XML/Cycle08/source 16:52 - 31-Oct-2017The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

Worksheet for Basis Adjustments in Column (g) Keep for Your RecordsIf the basis shown on Form 1099-B (or substitute statement) isn't correct, do the following.

If the basis wasn't reported to the IRS, enter the correct basis in column (e) and enter -0- in column (g) (unless you must make an adjustment for some other reason). You don't need to complete this worksheet.

If the basis was reported to the IRS, enter the reported basis shown on Form 1099-B (or substitute statement) in column (e) and use this worksheet to figure the adjustment to include in column (g).1. Enter the cost or other basis shown on Form 1099-B (or substitute statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2. Enter the correct cost or other basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3. If line 1 is larger than line 2, leave this line blank and go to line 4. If line 2 is larger than line 1, subtract line 1 from line 2. Enter the

result here and in column (g) as a negative number (in parentheses) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4. If line 1 is larger than line 2, subtract line 2 from line 1. Enter the result here and in column (g) as a positive number . . . . . . . . 4.

Worksheet for Accrued Market Discount Adjustment in Column (g) Keep for Your RecordsIf you received a Form 1099-B (or substitute statement) reporting the sale or retirement of a market discount bond, enter code “D” for the transaction in column (f) of the appropriate Part of Form 8949 and complete this worksheet to figure the amount to enter in column (g). If, in addition, any of the amounts shown on Form 1099-B (or substitute statement) are incorrect, see How To Complete Form 8949, Columns (f) and (g) for information on how to correct those amounts. Use the corrected amounts when completing this worksheet.1. Enter the proceeds from Form 1099-B, box 1d (or substitute statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2. Enter the basis from Form 1099-B, box 1e (or substitute statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3. Subtract line 2 from line 1. If zero or less, enter -0- . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4. Enter the accrued market discount from Form 1099-B, box 1f (or substitute statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5. Enter the smaller of line 3 or line 4, or, if lines 3 and 4 are the same, enter the amount from line 3. This is the amount of your gain

that is ordinary income. Enter it as a negative amount (in parentheses) in Form 8949, column (g). Also, report it as interest income on your tax return. If zero or less, enter -0- . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.

Worksheet for Contingent Payment Debt Instrument Adjustment in Column (g) Keep for Your Records

If you received a Form 1099-B (or substitute statement) reporting the sale of a taxable contingent payment debt instrument subject to the noncontingent bond method, enter code “O” for the transaction in column (f) of the appropriate Part of Form 8949 and complete this worksheet to figure the amount to enter in column (g). If, in addition, any of the amounts shown on Form 1099-B (or substitute statement) are incorrect, see How To Complete Form 8949, Columns (f) and (g) for information on how to correct those amounts. Use the corrected amounts when completing this worksheet. Don’t use this worksheet if there are no remaining contingent payments on the debt instrument as of the sale, exchange, or retirement of the instrument. See Regulations section 1.1275-4(b)(8)(iii).1. Enter the proceeds from Form 1099-B, box 1d (or substitute statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2. Enter the basis from Form 1099-B, box 1e (or substitute statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.3. Subtract line 2 from line 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.4. If line 3 is more than zero, enter the number from line 3. This is the amount of your gain that is ordinary income. Enter this amount

as a negative amount (in parentheses) in Form 8949, column (g), and enter “O” in column (f). Also, report it as interest income on your tax return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.

5. If line 3 is less than zero, enter the total amount of OID on this debt instrument that you included in income for the entire period that you held the debt instrument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5.

6. Enter the total amount of net negative adjustments on the debt instrument that you took into account as ordinary losses over the entire period that you held the debt instrument. Enter this amount as a negative amount (in parentheses) . . . . . . . . . . . . . . . 6.

7. Add lines 5 and 6 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7.8. Enter the amount from line 3 as a positive amount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.9. Enter the smaller of line 7 or line 8. This is the amount of your loss that is an ordinary loss. Enter it as a positive amount in Form

8949, column (g), and enter “O” in column (f). Also report it as an ordinary loss on your tax return . . . . . . . . . . . . . . . . . . . . 9.

Line 2The total of the amounts in column (h) of line 2 of all your Forms 8949 should equal the amount you get by combining columns (d), (e), and (g) on the corresponding line

of Schedule D. For example, the total of the amounts in column (h) of line 2 of all your Forms 8949 with box A checked should equal the amount you get by combining columns (d), (e), and (g) on line 1b of Schedule D. The total of the

amounts in column (h) of line 2 of all your Forms 8949 with box E checked should equal the amount you get by combining columns (d), (e), and (g) on line 9 of Schedule D.

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ADDITIONAL .9% MEDICARE TAX For 2013 and after, an additional .9% Medicare tax is imposed on an employee’s share of FICA/Medicare payroll taxes to the extent that the employee’s wages exceed $200,000. IRC §3101(b)(2). As discussed below, the .9% Medicare tax also applies to self-employment income. Integration of W-2 Income with Self-Employment Income (Form 1040): The .9% Medicare tax applies to wages in excess of $200,000 for single individuals. IRC §3101(b)(2). The tax applies in similar fashion to self-employment income, except that the additional .9% Medicare tax is paid with the filing of Form 1040. IRC §1401(b)(2). If the taxpayer has both W-2 wages and self-employment income, these income items are combined. The additional .9% Medicare tax is assessed on the combined earned income total in excess of $200,000. For purposes of computing the amount of self-employment income subject to the additional .9% Medicare tax, the $200,000 threshold is reduced (but not below zero) by the amount of W-2 wages. For married filing jointly returns the computation process works in similar fashion as above, except for a higher exemption threshold ($250,000) being applied ($125,000 for married filing separate). The extra .9% Medicare tax is assessed on the combined wages and self-employment income of both spouses. NOTE: For .9% Medicare tax purposes both spouses are treated as one. NOTE – Self-Employment Losses: The statute does not contain a reduction in the computation of the .9% Medicare tax on wages for any self-employment loss. Accordingly, a taxpayer with W-2 income in excess of $200,000 and a self-employment loss will still be subject to the .9% Medicare tax on total the W-2 income above $200,000. NOTE – PIK Wages: Payment-in-kind (PIK) wages are exempt from the .9% Medicare tax. NOTE – Effect on One-Half SE Tax Deduction: The .9% Medicare tax is an additional tax on the employee share only. Accordingly, a self-employed taxpayer will not be allowed to claim any portion of the .9% Medicare tax for income tax purposes. IRC §164(f)(1). The one-half self-employment tax deduction remains at 7.65% of net self-employment income. NOTE – Additional Employer Withholding: The .9% Medicare tax increase is applied entirely on the employee share. However, the employer is required to withhold the tax on wages in excess of $200,000 and is subject to penalties for any failure to withhold and properly remit the tax. If employer withholding is inadequate (i.e., one spouse over $200,000 with .9% withholding, but the other spouse under $200,000 of wages with no withholding), any additional .9% Medicare tax must be remitted with the filing of the taxpayer’s Form 1040. EXAMPLE: Joe and Kathy file a joint return for 2017 reflecting total W-2 wages of $300,000 as their only income (Joe = $200,000; Kathy = $100,000). Neither Joe nor Kathy will have the additional .9% Medicare tax withheld on their wages, as each wage amount does not exceed the $200,000 threshold for a single taxpayer. However, on their 2017 Form 1040, they will owe $450 of additional Medicare tax ($300,000 - $250,000 = $50,000 x .9% = $450).

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Payroll Reporting Requirements:

• An additional line was be added to Form 941, Employer’s Quarterly Federal Tax Return (line 5d), to report the additional .9% Medicare tax.

• Form W-2 has not been revised. All employee Medicare withholding will continue to be reported in box 6 of Form W-2.

• Wages that an employee earns through related companies in a controlled group are not combined for purposes of the $200,000 withholding threshold unless the companies are paid through a common paymaster.

Fringe Benefits: The employer must withhold for the new 0.9% tax when the employee’s total wages, including the value of taxable noncash fringe benefits, exceed $200,000. Group-term Life Coverage in Excess of $50,000: The imputed value of group-term life insurance coverage in excess of $50,000 is subject to the “regular” Medicare tax. The computed value is also subject to withholding for the new 0.9% tax to the extent it plus other wages combined exceeds the $200,000 withholding threshold. Third-party Sick Pay: Wages paid by an employer and by the third party must be aggregated to determine whether the $200,000 withholding threshold for the new 0.9% tax is met. Nonqualified Deferred Compensation: Wages for purposes of withholding for the 0.9% tax on nonqualified deferred compensation payments are calculated in the same way as for purposes of withholding “regular” Medicare tax. If an employee has an amount deferred under a nonqualified deferred compensation plan and the deferred amount counts as wages for FICA tax purposes under the special timing rule explained in IRC Reg. §31.3121(v)(2)-1(a)(2), the deferred amount also counts as wages for purposes of withholding for the new 0.9% tax.

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DO NOT FILEJune 29, 2017DRAFT AS OF

Form 8959 Department of the Treasury Internal Revenue Service

Additional Medicare Tax▶ If any line does not apply to you, leave it blank. See separate instructions.

▶ Attach to Form 1040, 1040NR, 1040-PR, or 1040-SS.▶ Go to www.irs.gov/Form8959 for instructions and the latest information.

OMB No. 1545-0074

2017Attachment Sequence No. 71

Name(s) shown on return Your social security number

Part I Additional Medicare Tax on Medicare Wages1

Medicare wages and tips from Form W-2, box 5. If you have more than one Form W-2, enter the total of the amounts from box 5 . . . . . . . . . . . . . . . . 1

2 Unreported tips from Form 4137, line 6 . . . . . . . 23 Wages from Form 8919, line 6 . . . . . . . . . . 3 4 Add lines 1 through 3 . . . . . . . . . . . . . 4 5 Enter the following amount for your filing status:

Married filing jointly . . . . . . . . . . $250,000Married filing separately . . . . . . . . . $125,000Single, Head of household, or Qualifying widow(er) $200,000 5

6 Subtract line 5 from line 4. If zero or less, enter -0- . . . . . . . . . . . . . . 6 7 Additional Medicare Tax on Medicare wages. Multiply line 6 by 0.9% (0.009). Enter here and

go to Part II . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Part II Additional Medicare Tax on Self-Employment Income

8

Self-employment income from Schedule SE (Form 1040), Section A, line 4, or Section B, line 6. If you had a loss, enter -0- (Form 1040-PR and Form 1040-SS filers, see instructions.) 8

9 Enter the following amount for your filing status:Married filing jointly . . . . . . . . . . . $250,000Married filing separately . . . . . . . . . $125,000Single, Head of household, or Qualifying widow(er) $200,000 9

10 Enter the amount from line 4 . . . . . . . . . . 10 11 Subtract line 10 from line 9. If zero or less, enter -0- . . . 11 12 Subtract line 11 from line 8. If zero or less, enter -0- . . . . . . . . . . . . . . 12 13 Additional Medicare Tax on self-employment income. Multiply line 12 by 0.9% (0.009). Enter

here and go to Part III . . . . . . . . . . . . . . . . . . . . . . . . 13 Part III Additional Medicare Tax on Railroad Retirement Tax Act (RRTA) Compensation14 Railroad retirement (RRTA) compensation and tips from

Form(s) W-2, box 14 (see instructions) . . . . . . . 14 15 Enter the following amount for your filing status:

Married filing jointly . . . . . . . . . . . $250,000Married filing separately . . . . . . . . . $125,000Single, Head of household, or Qualifying widow(er) $200,000 15

16 Subtract line 15 from line 14. If zero or less, enter -0- . . . . . . . . . . . . . 16 17 Additional Medicare Tax on railroad retirement (RRTA) compensation. Multiply line 16 by

0.9% (0.009). Enter here and go to Part IV . . . . . . . . . . . . . . . . . 17 Part IV Total Additional Medicare Tax18 Add lines 7, 13, and 17. Also include this amount on Form 1040, line 62, (Form 1040NR,

1040-PR, and 1040-SS filers, see instructions) and go to Part V . . . . . . . . . . 18 Part V Withholding Reconciliation19

Medicare tax withheld from Form W-2, box 6. If you have more than one Form W-2, enter the total of the amounts from box 6 . . . . . . . . . . . . . . . . 19

20 Enter the amount from line 1 . . . . . . . . . . 2021 Multiply line 20 by 1.45% (0.0145). This is your regular

Medicare tax withholding on Medicare wages . . . . . 2122 Subtract line 21 from line 19. If zero or less, enter -0-. This is your Additional Medicare Tax

withholding on Medicare wages . . . . . . . . . . . . . . . . . . . . 2223 Additional Medicare Tax withholding on railroad retirement (RRTA) compensation from Form

W-2, box 14 (see instructions) . . . . . . . . . . . . . . . . . . . . . 2324

Total Additional Medicare Tax withholding. Add lines 22 and 23. Also include this amount with federal income tax withholding on Form 1040, line 64 (Form 1040NR, 1040-PR, and 1040-SS filers, see instructions) . . . . . . . . . . . . . . . . . . . . 24

For Paperwork Reduction Act Notice, see your tax return instructions. Cat. No. 59475X Form 8959 (2017) H-92

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business activity in which the taxpayer materially participates.

2. Property properly grouped as an economic unit under the provisions of Treas. Reg. §1.469-

4(d)(1).

Any resulting gain from asset sales from either of these activities is not considered investment income.

Under the final regulations, if the rental property was properly grouped with a materially participating

activity or if it was self-rental property, none of the gain is subject to the NIIT.

Note. Rental income is passive for NIIT purposes. However, the self-rental rule is important in agriculture

and allows rental activities to be structured to avoid the NIIT in many situations. However, custom

farming arrangements result in passive income to the landowner. The activity of the agent (farm

management company or other individual that is farming the land) is not imputed to the landowner for

purposes of IRC §469. To avoid having the rental income being subject to the NIIT, the landowner would

need to materially participate.

Example 5. Able Farmer operates his farm as a sole proprietorship and rents land from LandCo

LLC, which he owns with his wife. The cash-rent income that flows from the LLC is considered

nonpassive income to Able because the land owned by LandCo is rented to Able’s farming

activity and he materially participates in that farming activity. The cash-rent income is self-rental

income and is considered nonpassive income for purposes of both income tax and the NIIT.3

Example 6. Amber’s farming operation, Amberwaves Company, is a C corporation.

Amberwaves cash rents farmland owned by an LLC that Amber also owns. The cash-rent income

is self-rental income and is considered nonpassive income for purposes of both income tax and

the NIIT.4

Example 7. Bob’s farming operation, Greenway, Inc., is an S corporation that cash rents

farmland from an LLC that Bob also owns. The cash-rent income is considered nonpassive self-

rental income. Bob could also make an election to group the LLC and Greenway, Inc., as a single

material participation activity. As a result, all income or loss would not be subject to any passive

loss restrictions and would not be subject to the NIIT.5

For farmers who materially participate in a farming operation but have income from other activities in

which they do not materially participate, a grouping election can be made so that all of the activities are

treated as a single activity producing active business income not subject to the NIIT.6

Example 8. George’s corn farming business is conducted through his S corporation. George is an

employee of the S corporation and participates full-time in the farming activities of the

corporation. The corn raised by the S corporation’s activities is sold to an ethanol plant, which is

also an S corporation. George has an ownership interest in the ethanol plant, but does not

participate in any of the ethanol plant’s activities. The income that the ethanol plant generates is

passive to George; thus, the NIIT would potentially apply to George’s income from his

investment in the ethanol plant. However, George can make a grouping election if he satisfies the

conditions of Treas. Reg. §1.469-4(d)(1) to treat the two S corporations as a single activity. The

election will allow George to be deemed as materially participating in the activities of the ethanol

3 Any resulting gain from the sale of assets would be nonpassive.

4 Any resulting gain from the sale of assets would be nonpassive.

5 Any resulting gain from the sale of assets would be nonpassive.

6 Treas. Reg. §1.469-4(c).

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4

plant by virtue of his participation in the farming activities. Consequently, George’s income from

the ethanol plant will not be subject to the NIIT.

B. Regroupings The final regulations address when a taxpayer can redo a grouping election because of the NIIT. The

proposed regulations indicate that a taxpayer could revise any grouping election in the first year that the

taxpayer:

• Meets the income threshold requirements for the NIIT, and

• Has investment income. Both tests must be met.

The final regulations retain these same regrouping provisions; however, they provide additional

clarification regarding amended tax returns and examinations. If a taxpayer had properly made a

regrouping election and it was later determined that adjustments required an amended tax return that

either reduced gross income below the threshold level or eliminated investment income, then the taxpayer

is required to undo the regrouping election and is bound by this until both tests apply in the future.

Conversely, if a taxpayer had not made a regrouping election because their income was under the

threshold level, but additional income was determined after filing the original return, the taxpayer is

allowed to make a regrouping election at that time. When an examination of a taxpayer’s records results

in a redetermination of income, then the taxpayer is subject to the same provisions.

Example 9. Guy Wire is a single taxpayer with Schedule F income of $175,000 and interest

income of

$20,000 for 2013. His total income of $195,000 is under the threshold level for the NIIT. Thus,

Guy is not allowed to make any regrouping elections in 2013. Later, it is determined that $10,000

of additional farm income was not reported on the original return. When the amended tax return

is prepared, Guy can make a regrouping election at that time because his gross income now

exceeds the threshold amount. Guy will then be bound by that election for subsequent years.

Observation. Grouping can cause suspended passive losses to be unavailable until all of thr grouped

activities are disposed.7

C. Relief for Self-Charged Interest Income Treas. Reg. §1.469-7 provides that in the case of self-charged items of interest income received from a

nonpassive entity, the amount of interest income excluded from NII is the taxpayer’s allocable share of

the nonpassive deduction.

Example 10. Evan Keel owns 90% of Farmco, Inc., an S corporation in which he materially

participates. During the year, Evan loaned Farmco $300,000 and received $20,000 of interest

income. Consequently, $18,000 ($20,000 × 90%) of the interest that Evan receives is excluded

from investment income. He only reports $2,000 of interest income as investment income.

Note. If the self-charged interest was deducted in arriving at self-employment (SE) income at the entity

level, then all of the self-charged interest is treated as investment income. That is a relevant consideration

when the entity involved is an LLC. Interest paid by an LLC reduces the SE income of the LLC.

7 IRC §469(g)(1)(A).

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D. Offsetting Other Investment Income with Net Losses Under proposed regulations, losses from the sale of assets could only be used to offset gains from the sale

of assets. For NIIT purposes, if a net loss resulted after netting gains and losses, the loss could not be

used. Although the final regulations essentially retained the same language of the original proposed

regulations regarding limiting net losses to zero, Treas. Reg. §1.1411-4(d)(2) was added, which allows a

net capital loss deduction of $3,000 to offset other investment income.

Note. For individuals, when capital losses exceed capital gains, up to $3,000 ($1,500 for MFS taxpayers)

can be used to reduce other types of income. Any amount of net capital losses in excess of $3,000 is

carried forward to future years.

The final regulations include Treas. Reg. §1.1411-4(f)(4), which essentially states that any losses in

excess of gains may now be used to offset other types of NII, but only to the extent that the losses are

used to currently reduce the taxpayer’s taxable income. This does not mean that a net loss can be created.

However, any losses that exceed net gains and are currently allowable in determining taxable income can

be used to reduce other items of NII.

Example 11. In 2014, Sara sells IBM stock for a $15,000 loss. The stock also generated $5,000

of dividend income during the year. She has no other gains or losses or investment income for the

year. Thus, Sara can deduct $3,000 of the capital losses against other income for the 2014 tax

year. Sara’s NII is $2,000 ($5,000 of dividend income − $3,000 capital loss allowed).

Example 12. Ron invested in an ethanol plant that usually generates $100,000 of passive income

every year. However, in 2013, in addition to the $100,000 of passive ordinary income, the ethanol

plant sold some assets for a net IRC §1231 loss of $100,000. For income tax purposes, Ron can

offset the $100,000 of §1231 losses against his $100,000 of passive income for net taxable

income of zero. The loss is also fully allowed, which results in NIIT of zero.

A net operating loss (NOL) can partially offset investment income. Because NOLs are computed and

carried over each year, a separate ratio must be determined for each year. The portion of an NOL that is

deductible against investment income (the IRC §1411 NOL) is calculated by first determining the

applicable portion of the NOL for each loss year.

Note. Essentially, the taxpayer must determine two NOLs for any loss year. First, the regular NOL

computed under IRC §172 is determined. Second, the §1411 NOL that arises only from NII sources is

determined. This NOL is then divided into the regular NOL to arrive at a factor for that loss year.

E. Sale of Farmland and the NIIT Capital gain income can trigger the application of the NIIT. However, if the capital gain is attributable to

the sale of a capital asset that is used in a trade or business in which the taxpayer materially participates,

the NIIT does not apply. For purposes of the NIIT, material participation is determined in accordance

with the passive loss rules of IRC §469.

If an active farmer sells a tract of land from their farming operation, the capital gain recognized on the

sale is not subject to the NIIT. However, whether the NIIT applies to the sale of farmland by a retired

farmer or a surviving spouse is not so easy to determine. There are two approaches to determining

whether the NIIT applies to such sales.

1. The IRC §469(h)(3) approach

2. The IRC §469 approach

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4

1. IRC §469(h)(3) Approach. IRC §469(h)(3) provides that “a taxpayer shall be treated as

materially participating in any farming activity for a taxable year if paragraph (4) or (5) of IRC

§2032A(b) would cause the requirements of IRC §2032A(b)(1)(C)(ii) to be met with respect to

real property used in such activity if such taxpayer had died during the taxable year.” The

requirements of §2032A(b)(1)(C)(ii) are met if the decedent or a member of the decedent’s family

materially participated in the farming activity five or more years during the eight years preceding

the decedent’s death. In applying the 5-out-of-8-year rule, the taxpayer may disregard periods in

which the decedent was retired or disabled.8 If the 5-out-of-8-year rule is met with regard to a

deceased taxpayer, it is deemed to be met with regard to the taxpayer’s surviving spouse,

provided that the surviving spouse actively manages the farming activity when the spouse is not

retired or disabled.9

A retired farmer is considered to be materially participating in a farming activity if the retired farmer is:

• Continually receiving social security benefits or is disabled, and

• Materially participated in the farming activity for at least five of the last eight years

immediately preceding the earlier of death, disability, or retirement (defined as receipt of

social security benefits).

The 5-out-of-8-year test, once satisfied by a farmer, is deemed to be satisfied by the farmer’s surviving

spouse if the surviving spouse is receiving social security. Until the time at which the surviving spouse

begins to receive social security benefits, the surviving spouse would have to actively participate in the

farming operation to meet the material participation test.

2. “Normal” IRC §469 Approach. IRC §469(h)(3) concerns the recharacterization of a farming

activity, but not the recharacterization of a rental activity. Thus, if a retired farmer is no longer

farming but is engaged in a rental activity, §469(h)(3) does not apply, and the normal material

participation tests under §469 apply. The only one of those tests that is likely to have any

potential application in the context of a retired farmer is whether the taxpayer materially

participated in the farming activity for at least five of the previous 10 years immediately

preceding the sale. This approach would cause more transactions to be subject to NIIT than the

IRC §469(h)(3) approach.

3. Sale of Land Held in Trust. When farmland that has been held in trust is sold, the IRS

position is that only the trustee of the trust can satisfy the material participation tests of §469.

This position has been rejected by the one federal district court that has ruled on the issue,10

but

the IRS, while not appealing the court’s opinion, has continued to assert its judicially rejected

position.

In early 2014, the U.S. Tax Court rejected the IRS’s position.11

The Tax Court held that the conduct of the

trustees acting in the capacity of trustees counts toward the material participation test as well as the

conduct of the trustees as employees. The Tax Court also implied that the conduct of nontrustee

employees would count toward the material participation test.

8 IRC §2032A(b)(4).

9 IRC §2032A(b)(5).

10 Mattie Carter Trust v. U.S., 256 F.Supp.2d 536 (N.D. Tex. 2003). 11

Frank Aragona Trust v. Comm’r, 142 TC 9 (Mar. 27, 2014).

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F. Trading in Commodities and the NIIT The NIIT applies to a trade or business of trading in financial instruments or trading in commodities.

12

The definition of commodities for purposes of the NIIT13

includes the following:

• Actively traded personal property14

• Any option, forward contract, futures contract, short position, and any similar instrument in a

covered commodity15

• A hedge with respect to such commodity

To be subject to the NIIT, the taxpayer must be engaged in the trade or business of trading in

commodities. For taxpayers that are owners of pass-through entities, that determination is made at the

entity level.16

For taxpayers that are directly engaged in a trade or business, the determination of whether

the taxpayer is engaged in the trade or business of trading in commodities is determined at the owner

level. Thus, a sole proprietor farmer’s income from hedging activity or the hedging income of a farming

entity structured as a pass-through entity is not subject to the NIIT. This is because the farmer or entity

is engaged in the trade or business of farming and not the trade or business of trading in commodities.

Hedging gains for a farmer are, therefore, not subject to the NIIT. However, if the farmer’s commodity

trading activity does not satisfy the definition of hedging, the resulting income or loss is speculative in

nature.

Note. Speculative income from trading in commodities is subject to the NIIT under IRC

§1411(c)(1)(A)(iii). That Code section says that the NIIT applies to net gains attributable to the

disposition of property other than property held in a trade or business in which the taxpayer materially

participates. The speculative gains and losses get the standard 60% long-term capital gain (or loss) and

40% short-term capital gain (or loss) treatment. The additional 3.8% NIIT also applies.

G. ENTITY PLANNING ISSUES AND THE ADDITIONAL TAXES UNDER THE ACA In addition to the tax of 3.8% on certain passive income (the NIIT), the ACA also increased the Medicare

tax rate from 2.9% to 3.8% for certain taxpayers. This additional 0.9% tax is often referred to as the

additional Medicare tax. The additional Medicare tax is imposed on taxpayers with wages and/or SE

income above the same threshold amount that applies for purposes of the NIIT.

From an estate planning, business planning, and succession planning perspective, the NIIT and the

additional Medicare tax have implications for trusts and may encourage many entities to adopt the pass-

through tax treatment provided by partnerships, LLCs, and S corporations.

1. Trusts Under proposed regulations, the NIIT threshold for trusts is the top tax rate bracket ($11,950 for 2013 and

$12,150 for 2014). The NIIT applies to the lesser of undistributed NII or the excess of the trust’s AGI

over the threshold. The regulations allocate investment income between distributed and undistributed

income under the usual trust allocation rules. Electing small business trusts (ESBT) must combine their S

corporation and non-S-corporation income for purposes of computing the tax. For charitable remainder

trusts, the proposed regulations treat part of the distributions as investment income.

12

Treas. Reg. §1.1411-5(a)(2). 13

IRC §475(e)(2). 14

See IRC §1092(d)(1). 15

IRC §475(e)(2)(C). 16

Treas. Reg. §1.1411-4(b)(2)(ii).

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Note. Foreign estates and trusts are not normally subject to the NIIT. The proposed regulations state that

the IRS will subject U.S. beneficiaries to the NIIT on their share of distributed investment income.

2. Pass-Through Entities Although pass-through entities are not subject to the additional Medicare tax, direct or indirect owners

(individuals, trusts, and estates) may be subject to taxation on the allocable portion of income and gain

derived from these entities. Taxpayers must include the additional Medicare tax in determining their

estimated tax payments.

3. Partnerships Although the NIIT does not apply to income from a trade or business conducted by a partnership (other

than passive income), the income, gain, or loss on working capital is not considered to be derived from a

trade or business and is subject to the NIIT.64 Gain or loss from a disposition of a partnership interest is

included in a partner's NII only to the extent of the net gain or loss the partner would take into account if

the partnership sold all its property for fair market value (FMV) immediately before the disposition of the

partnership interest. This means that if a taxpayer materially participates in a partnership with trade or

business income, the taxpayer will have SE income that is potentially subject to the additional Medicare

tax of 0.9% and the standard Medicare tax of 2.9%. If the taxpayer does not materially participate in the

partnership, the taxpayer’s share of partnership income will potentially be subject to the NIIT.

4. S Corporations S corporation income reported on Schedule K-1, Shareholder’s Share of Income, Deductions, Credits,

etc., is not subject to SE tax. In addition, the NIIT does not apply to business income earned by active S

corporation shareholders, even if their income is over the threshold amounts. The NIIT does apply,

however, to the income of passive shareholders in an S corporation.

Observation. Generally, an S corporation is favored over a partnership because active S corporation

shareholders can avoid both the SE tax and the NIIT.

5. Limited Liability Companies In general, income that is subject to SE tax is not subject to the NIIT. With respect to an LLC, business

income allocated to the general partners of an LLC taxed as a partnership is generally subject to SE tax

even if it flows to a partner who does not participate in the operations of the LLC.17

There is no guidance

on the SE tax treatment of income flowing to LLC owners (and limited liability partnership (LLP)

owners) who do not participate in the operations of the business. However, to the extent a limited liability

owner (either an LLC member or an LLP partner) receives a guaranteed payment for services, the law is

clear that this payment is subject to SE tax.18

Thus, guaranteed payments for services or capital would

always appear to be subject to SE tax, even if paid to an individual holding a limited liability interest.19

Proposed regulations hold that a limited liability partner is subject to SE tax under any one of three

circumstances.20

1. The individual has personal liability for the debts of, or claims against, the

partnership by reason of being a partner or member.

2. The individual has authority under the statutes of the state in which the

partnership is formed to contract on behalf of the partnership (i.e., the individual

has management authority).

17

Treas. Reg. §1.1402(a)-2(g). 18

IRC §1402(a)(13); and Prop. Treas. Reg. §1.1402(a)-2(g). 19

Treas. Reg. §1.1402(a)-(1)(b). 20

Prop. Treas. Reg. §1.1402(a)-2(h)(2).

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4

3. The individual participated in the entity’s trade or business for more than 500

hours during the entity’s taxable year.

6. Manager-Managed LLC. An LLC may be member-managed or manager-managed.

The owners of the LLC are responsible for managing the company in a member-managed LLC. A

manager-managed LLC is operated by managers who are appointed to run the company. Manager-

managed LLCs operate in a similar fashion to a corporation that has a board of directors to control the

company's affairs. LLC members that adopt a manager- managed structure may prefer to take a more

passive role in terms of operating the company. By hiring third party managers, the members of the

company can concentrate on building the business, as opposed to addressing the needs of the LLC on a

daily basis.

A manager-managed LLC may provide separate classes of membership for managers (who have the

authority to bind the LLC under a contract) and nonmanagers (who have no such authority). From an SE

tax perspective, the use of a manager-managed LLC with two classes of membership provides SE tax

savings to the nonmanaging members.

Note. Both classes provide limited liability protection to the members in their capacity as members.

Nonmanagers who do not meet the 500-hour participation test are not subject to SE tax, except to the

extent of any guaranteed payments they receive. Nonmanagers who exceed the 500-hour test are not

subject to SE tax if they own a substantial continuing interest (i.e., at least 20%) in a particular class of

interest and the individual’s rights and obligations of that class are identical to those held by persons who

satisfy the general definition of limited partner (i.e., fewer than 500 hours for a nonmanager).

Note. Managers are subject to SE tax on income from that substantial continuing interest. If there are

nonmanagers who spend fewer than 500 hours with the LLC and such members own at least 20% of the

interests in the LLC, the nonmanagers in that LLC who spend more than 500 hours are not subject to SE

tax on the pass-through income but are subject to SE tax on the guaranteed payments.

It is possible to structure a manager-managed LLC with the taxpayer holding both manager and

nonmanager interests. In this type of structure, individuals with nonmanager interests who spend fewer

than 500 hours with the LLC must own at least 20% of the LLC interests.

Note. This exception allows the individual who holds both manager and nonmanager interests to be

exempt from SE tax on the nonmanager interest.21

The taxpayer is subject to SE tax on the pass-through

income and guaranteed payments of the manager interest.

Structuring the Manager-Managed LLC. In an LLC that is structured to minimize SE tax and avoid the

NIIT, all of the LLC interests can be owned by nonmanagers (investors) with a third party nonowner

named as manager and some or all of the investors working on behalf of the manager. The manager could

be an S corporation or a C corporation, with the LLC investors owning part or all of the corporation. The

manager must be paid a reasonable management fee and the LLC owners who provide services to the

LLC must be paid reasonable compensation. The LLC owners who do not render services to the LLC do

not have income that is subject to SE tax. The manager earns a 1% manager interest for the services

rendered to the LLC, which generates a guaranteed payment. The guaranteed payment is subject to SE

tax.

In summary, LLC nonmanagers working fewer than 500 hours annually are subject to SE tax only on

guaranteed payments. Nonmanagers who work more than 500 hours annually are subject to SE tax only

on guaranteed payments if the nonmanagers who work fewer than 500 hours annually make up at least

20% of the membership. Although the managers and nonmanagers own interests commensurate with their

21

Prop. Treas. Reg. §1.1402(a)-2(h)(3).

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investment (i.e., nonmanager interests), the managers also receive manager interests as a reward for their

services. Managers recognize SE income on the pass- through income associated with the manager

interests. With the exception of guaranteed payments, nonmanager interests are not subject to SE tax.

With respect to the NIIT, a nonmanager’s interest in a manager-managed LLC is normally considered

passive and is subject to the NIIT.22

However, a spouse may take into account the material participation of

their spouse who is the manager.23

Thus, if the manager spouse materially participates, then all

nonmanager interests owned by both spouses avoid the NIIT. The end result is that a manager-managed

LLC can produce a better NIIT result than use of an S corporation.

7. Other Situations Other farming arrangements may give rise to the possibility of farm income being subjected to the NIIT.

These arrangements include hiring a farm manager and using multiple entities.

a. Hired Farm Manager Not infrequently, farm owners utilize farm management companies to perform all of the day- to-day

management of the farm. The share of the farm income that the owner receives is potentially subject to

the NIIT as passive income. The activity of the agent (farm management company) is not imputed to the

principal (farm owner) for NIIT material participation purposes.

b. Multiple Entities Farmers sometimes structure their farming businesses in multiple entities for estate and business planning

purposes. For instance, a farmer may own an operational entity that contains the business operational

assets and rent land to it that is owned by a different entity (or is owned individually). For land that is

owned jointly by a married couple (either as joint tenants or as tenants in common), when the farming

spouse pays the nonfarm spouse rent to reflect the nonfarm spouse’s one-half interest, a question arises as

to whether the NIIT applies to the rental income. The rental of property to the farming spouse’s business

in which the farmer materially participates is a self- rental that is not subject to the NIIT. Because the

spouses are considered to be a unit for the regular passive loss rules, the rental income is not passive

income in the hands of the nonfarming spouse.

22

IRC §1411(c)(2)(A). 23

IRC §469(h)(5).

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DO NOT FILEJuly 10, 2017

DRAFT AS OF

Form 8960Department of the Treasury Internal Revenue Service (99)

Net Investment Income Tax— Individuals, Estates, and Trusts

▶ Attach to your tax return.▶ Go to www.irs.gov/Form8960 for instructions and the latest information.

OMB No. 1545-2227

2017Attachment Sequence No. 72

Name(s) shown on your tax return Your social security number or EIN

Part I Investment Income Section 6013(g) election (see instructions)Section 6013(h) election (see instructions)Regulations section 1.1411-10(g) election (see instructions)

1 Taxable interest (see instructions) . . . . . . . . . . . . . . . . . . . . . 1 2 Ordinary dividends (see instructions) . . . . . . . . . . . . . . . . . . . . 2 3 Annuities (see instructions) . . . . . . . . . . . . . . . . . . . . . . . 34a Rental real estate, royalties, partnerships, S corporations, trusts,

etc. (see instructions) . . . . . . . . . . . . . . . 4ab Adjustment for net income or loss derived in the ordinary course of

a non-section 1411 trade or business (see instructions) . . . . 4bc Combine lines 4a and 4b . . . . . . . . . . . . . . . . . . . . . . . . 4c

5a Net gain or loss from disposition of property (see instructions) . 5a

b Net gain or loss from disposition of property that is not subject to net investment income tax (see instructions) . . . . . . . 5b

c Adjustment from disposition of partnership interest or S corporationstock (see instructions) . . . . . . . . . . . . . . 5c

d Combine lines 5a through 5c . . . . . . . . . . . . . . . . . . . . . . 5d6 Adjustments to investment income for certain CFCs and PFICs (see instructions) . . . . . 67 Other modifications to investment income (see instructions) . . . . . . . . . . . . 78 Total investment income. Combine lines 1, 2, 3, 4c, 5d, 6, and 7 . . . . . . . . . . . 8

Part II Investment Expenses Allocable to Investment Income and Modifications9a Investment interest expenses (see instructions) . . . . . . 9a

b State, local, and foreign income tax (see instructions) . . . . 9bc Miscellaneous investment expenses (see instructions) . . . . 9cd Add lines 9a, 9b, and 9c . . . . . . . . . . . . . . . . . . . . . . . . 9d

10 Additional modifications (see instructions) . . . . . . . . . . . . . . . . . . 1011 Total deductions and modifications. Add lines 9d and 10 . . . . . . . . . . . . . 11Part III Tax Computation12 Net investment income. Subtract Part II, line 11 from Part I, line 8. Individuals complete lines 13–

17. Estates and trusts complete lines 18a–21. If zero or less, enter -0- . . . . . . . . . 12Individuals:

13 Modified adjusted gross income (see instructions) . . . . . 1314 Threshold based on filing status (see instructions) . . . . . 1415 Subtract line 14 from line 13. If zero or less, enter -0- . . . . 1516 Enter the smaller of line 12 or line 15 . . . . . . . . . . . . . . . . . . . . 1617 Net investment income tax for individuals. Multiply line 16 by 3.8% (.038). Enter here and

include on your tax return (see instructions) . . . . . . . . . . . . . . . . . 17Estates and Trusts:

18a Net investment income (line 12 above) . . . . . . . . . 18ab Deductions for distributions of net investment income and

deductions under section 642(c) (see instructions) . . . . . 18bc Undistributed net investment income. Subtract line 18b from 18a (see

instructions). If zero or less, enter -0- . . . . . . . . . . 18c19a Adjusted gross income (see instructions) . . . . . . . . 19a

b Highest tax bracket for estates and trusts for the year (see instructions) . . . . . . . . . . . . . . . . . . 19b

c Subtract line 19b from line 19a. If zero or less, enter -0- . . . 19c20 Enter the smaller of line 18c or line 19c . . . . . . . . . . . . . . . . . . . 2021 Net investment income tax for estates and trusts. Multiply line 20 by 3.8% (.038). Enter here

and include on your tax return (see instructions) . . . . . . . . . . . . . . . 21For Paperwork Reduction Act Notice, see your tax return instructions. Cat. No. 59474M Form 8960 (2017)

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HEALTH SAVINGS ACCOUNT (HSAs) – IRC §223 Health savings accounts (HSAs) were established as part of the Medicare Prescription Drug and Modernization Act of 2003 signed into law on December 8, 2003. HSAs are effective for taxable years beginning after December 31, 2003. GENERAL: HSAs are targeted for self-employed individuals, small business owners and employees of small to medium-sized firms. They offer tax benefits to qualifying individuals who combine high-deductible health insurance coverage with contributions to IRA-like medical savings accounts. The accounts are similar to medical savings accounts (Archer MSAs) which were introduced on a pilot program basis in 1997 and continue to be available. IRC §220(i)(2) & (3)(B). Existing MSAs are eligible for rollover into HSAs.

HSAs are also similar to flexible spending accounts (FSAs) in tax effect, but are superior to FSAs in that they are not subject to forfeiture rules if the funds in the account are not expended during the year. Since contributions to HSAs are deductible for AGI and distributions used to pay qualified medical expenses are tax-free, the economic effect of a contribution to an HSA is a 100% before AGI deduction for medical expenses incurred on a pre-need basis. Even if the HSA account beneficiary uses every contributed dollar to pay uninsured medical expenses these costs get paid with pre-tax dollars.

A. Structure Of HSA:

(1) An HSA is a trust or custodial account established exclusively for the purpose of paying qualified medical expenses of the account beneficiary (and their spouse and dependents). To be eligible to contribute to an HSA for the current year, the account beneficiary must have been covered under a high-deductible health plan (HDHP) prior to making HSA contributions.

(2) An HSA must be established with a written instrument, with all contributions made in cash. The trustee of an HSA must be a bank, insurance company, or other institution of the type that can sponsor an IRA. Form 5305-B, Trust Agreement and 5305-C, Custodial Agreement are utilized in this regard.

NOTE: The account owner is solely responsible for funding contributions within statutory limits and assuring that withdrawals are properly substantiated as only being expended for qualified medical expenses.

NOTE: No part of HSA trust assets may be invested in life insurance.

B. High-Deductible Health Plan (HDHP):

(1) Individual coverage: A high-deductible health plan is a plan that has an annual deductible of at least $1,300 for 2015-2017 ($1,350 for 2018), for individual coverage, with maximum exposure to annual out-of-pocket expenses of $6,550 for 2016-2017 ($6,650 for 2018).

(2) Family coverage: A high-deductible health plan is a plan that has an annual deductible of at least $2,600 per family (not per person) for 2015-2017 ($2,700 for 2018), with maximum exposure to annual out-of-pocket expenses not to exceed $13,100 for 2016-2017 ($13,300 for 2018). IRC §223(c)(2).

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NOTE: A plan that does not impose any deductible for preventative care (e.g. annual checkups) does not violate the HDHP rule.

(3) Safe-harbor Definition of Preventive Care: IRS Notice 2004-23 provides a safe-harbor definition of “preventive care.” Preventive care for purposes of the IRC §223(c)(2)(C) exception includes, but is not limited to, the following:

(a) Periodic health evaluations, including tests and diagnostic procedures ordered in connection with routine examinations, such as annual physicals.

(b) Routine prenatal and well-child care.

(c) Child and adult immunizations.

(d) Tobacco cessation programs.

(e) Obesity weight-loss programs.

(f) Screening services (Notice 2004-23 provides an extensive list of qualified screening services).

NOTE: Preventive care generally does not include any service or benefit intended to treat an existing illness, injury, or condition.

HDHP Eligibility Problems – Prescription Drug Plans: Some health plans that would otherwise qualify as HDHPs don’t subject prescription drug costs to the same high deductible as other covered medical expenses. Instead prescription drug costs are covered on a “first dollar” basis with only a percentage of the cost for each prescription being paid (or a fixed co-pay being paid) whether or not the overall health plan deductible has been met. Unfortunately, this type of drug benefit renders the individual ineligible for HSA contributions whether the drug benefit is provided under the health plan in question or under a separate plan or rider. IRC §223(c)(1)(A) and Rev. Rul. 2004-38.

(4) Problem with FSAs, HRAs, or Reimbursement Plan Coverage: Taxpayers who are covered by a healthcare flexible spending account plan (FSA), a health reimbursement arrangement (HRA), or a Section 105 medical reimbursement plan will typically be ineligible to make HSA contributions. This is also true when the taxpayer is covered by these arrangements via his or her spouses’ employment. Unfortunately, these arrangements are considered “health plans” under the HSA rules, and they typically provide benefits on a first-dollar basis. As such, they violate the rule that an HSA contributor cannot be covered by a health plan that is not an HDHP. EXCEPTIONS: If the FSA plan, HRA, or Section 105 plan (1) kicks in only after the HDHP’s deductible has been met; or (2) provides coverage only for those limited types of expenses that are allowed to be covered by an HDHP before the deductible is satisfied (e.g., dental and vision care and certain preventive care). In these two circumstances, HSA contributions would be allowed assuming all the other eligibility rules are met. Other exceptions apply when the client is only covered by a suspended HRA (pursuant to an election by the client); or by a retirement HRA that pays or reimburses only for medical expenses incurred after retirement. (See Rev. Rul. 2004-38 and 2004-45, IRS Notice 2004-23, and IRS Notice 2004-50, Q&A-33). EXCEPTION - FSA 2½ MONTH GRACE PERIOD: The Tax Relief and Health Care Act of 2006 provided another exception to the general rule that FSA

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coverage normally makes one ineligible for a HSA. If the employee is considered to be covered under the FSA solely due to the existence of the plan's post-year-end grace period (up to 2½ months after year-end), the post-year-end grace period coverage is ignored for purposes of determining eligibility for HSA contributions. To qualify for this exception, the year-end balance in the employee's FSA must be either $-0- or entirely rolled over into the employee's HSA under the FSA-to-HSA rollover privilege (discussed below); and the employee must cease participating the FSA after year-end. If the first requirement is not met, the employee is ineligible for HSA contributions until the first day of the month following the month during which the grace period expires (generally April 1st for a 2½ month grace period).

C. Eligible Individuals for HSAs:

(1) General: Individual under age 65, who is covered under a high-deductible health insurance plan (HDHP) and, while covered under the HDHP, is not covered under any other non-high deductible plan. The following coverages are not considered to violate this provision.

(a) Coverage under workers’ compensation;

(b) Insurance for a specified disease or illness (e.g. cancer insurance);

(c) Insurance paying a fixed amount per day; or

(d) Insurance coverage for accidents, disability, dental care, vision, or long-term care. IRC §223(c)(3).

(2) Age 65 and Medicare Enrolled Ineligible: An individual is ineligible for an HSA once the individual reaches age 65 and becomes enrolled in Medicare, as the statute prohibits HSA participation for any individual entitled to Medicare benefits. IRC §223(b)(7).

NOTE: An otherwise eligible individual who is eligible for Medicare, but not enrolled in Medicare Part A or Part B can contribute to an HSA and can make the additional catch-up contribution for persons age 55 and older. An individual ceases to be an eligible individual beginning with the month the person is entitled to benefits under Medicare. However, “entitled to benefits under Medicare” means both eligibility and enrollment in Medicare. Notice 2004-50. Also, an otherwise eligible individual who is eligible to receive VA medical benefits, but who has not actually received such benefits during the preceding three months, may contribute to an HSA.

NOTE: The IRS recently released two information letters explaining how to compute the maximum permissible HSA contribution in the first year an individual enrolls in Medicare. The maximum permissible contribution is based on the number of months the person is not enrolled in Medicare for that year. Information Letters 2016-0003 and 2016-0014.

NOTE: Individuals who retroactively enroll in Medicare cannot contribute to an HSA during the period of retroactive coverage. Any excess contributions may be withdrawn without penalty up to the income tax return due date, for the tax year in which the excess contribution was made. A 6% excess contribution penalty (IRC §4973) will apply to amounts not withdrawn in a timely manner. Information Letter 2016-0082.

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(3) Dependents Ineligible: A person who can be claimed as a dependent on another person’s return is ineligible to make an HSA contribution for that tax year.

D. Contributions to HSAs: The Tax Relief and Health Care Act of 2006 liberalized rules relating to HSA contributions. For tax years beginning after 12-31-06, there is no longer any linkage between the annual HSA contribution limit and the amount of the annual deductible for HDHP coverage. In addition, HSA contribution eligibility for the entire year can be determined at year end, not based on month-by-month HDHP coverage and participation. An individual who becomes covered by a HDHP at any time during the year is eligible to make an HSA contribution up to the maximum amount authorized for the tax year. The only restriction on the contribution is that if an individual has not had qualifying HDHP coverage for a 12-month period, a termination of the HDHP coverage within the initial 12-month period (unless due to death or disability) will require a recapture of tax benefits derived from any HSA contribution deduction claimed.

(1) Individual coverage: The maximum annual HSA contribution a taxpayer can make for individual coverage is $3,400 for 2017; $3,450 for 2018.

(2) Family coverage: The maximum annual HSA contribution that can be made for family coverage is $6,750 for 2016-2017, $6,900 for 2018.

(3) As discussed above, prior to the tax law change, the annual contribution limits were converted to monthly amounts, because eligibility for an HSA contribution was dependent on participation in a HDHP for each month of eligibility, tested as of the 1st day of each month.

Example - (Prior to 2007): On August 1, 2006, Julie begins paying for her own individual health insurance coverage (HDHP) that carries a $2,500 deductible. Her maximum eligible HSA contribution for 2006 is $1,041.67 ($2,500 ÷ 12 x 5).

Example - (2007 and After): On November 1, 2017, Julie begins paying for her own individual health insurance coverage (HDHP) that carries a $2,500 deductible. Her maximum eligible HSA contribution for 2017 is $3,400 (the maximum annual amount). Julie must maintain her HDHP coverage until November 1, 2018, unless she dies or becomes disabled. If she terminated her HDHP on June 15, 2018 she would have to report $2,833 (10/12 of $3,400) in her 2018 AGI, and would be subject to a 10% early withdrawal penalty ($283). The $2,833 includable amount for 2018 represents the ten months during 2017 (January - October) for which Julie is treated as an ineligible individual. She is considered ineligible for the entire 2018 year, even though she was covered by a HDHP for 6 months of 2018. NOTE: There is no requirement indicating that the recapture amount must be withdrawn from the HSA account. However, if the eventual distribution is not used to pay qualified medical expenses the distribution will again be taxable and subject to a 10% penalty. IRS Notices 2007-22 and 2008-52.

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(4) In the case of spouses, if either has family coverage, both are treated as having family coverage. If each has family coverage under a separate health plan, the plan with the lowest deductible governs for contribution limits. Notice 2004-2, Q&A-15.

(5) The IRS has ruled that an eligible individual does not fail to be an eligible individual merely because the individual’s spouse has non-HDHP family coverage, if the spouse’s non-HDHP does not cover the individual. Rev. Rul. 2005-25.

(6) HSA contributions for a tax year can be made up to April 15th of the following year.

(7) Contributions to an HSA by another on behalf of an eligible individual account beneficiary are still deductible by the account beneficiary.

(8) A person with no earned income is still eligible to make contributions to an HSA.

(9) Eligibility Contribution Date: Qualified medical expenses may only be paid or reimbursed by an HSA if incurred after the HSA has been established. Notice 2004-2, Q & A-26.

(10) One-Time Direct Transfer from IRA to HSA: Under a provision adopted by the Tax Relief and Health Care Act of 2006, taxpayers are allowed to make a once per lifetime nontaxable transfer from a traditional or Roth IRA to an HSA, via a trustee-to trustee transfer. IRC §223(b)(4)(C). The transfer is irrevocable once made. This privilege applies only to transfers from IRAs and does not apply for transfers from SEPs or SIMPLE IRAs. The transfer amount is limited to the current maximum HSA contribution limit (i.e. $3,400 for 2017 individual coverage, $6,750 for 2017 family coverage). The IRA transfer is excluded from income, and no deduction is allowed for the amount contributed to the HSA from the IRA. The amount transferred reduces the applicable maximum HSA contribution allowed for the year of transfer.

Any basis in the IRA proceeds transferred does not carry over to the HSA. NOTE: Taxpayers who transfer IRA funds to a HSA must maintain the required HDHP for 12 months following the month of the transfer. If not, the transfer is taxable and subject to a 10% penalty, unless the transfer occurs due to death or disability of the participant. NOTE: For purposes of the rules for rollovers to HSAs, a distribution from a taxpayer's traditional IRA is treated as coming first from income to the extent that the IRA consisted of amounts that would otherwise have been taxable upon distribution.

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TAX PLANNING NOTE: Transferring funds from a Roth IRA to an HSA makes little sense because an individual can receive qualified Roth IRA distributions without federal taxation anyway. In contrast, transferring funds from a traditional IRA to an HSA may make more sense because the rolled-over amount is effectively converted into money that can be withdrawn on a tax-free basis to pay eligible medical expenses. The best advice - if the taxpayer has sufficient cash, make a regular deductible HSA contribution. Then there would be no recapture rules to be concerned about.

E. Age 55 Catch-Up Contributions: Taxpayers who have attained age 55 at the end of the taxable year are allowed to contribute an extra $1,000 to an HSA for 2010 - 2018. Spouses must have their own separate HSA to take advantage of this additional contribution deduction. NOTE: The catch-up limitation increased by $100 annually, until it reached $1,000 for 2009 and later years. IRC §223(b)(3). NOTE: The family coverage contribution limit for a spouse is the maximum deductible amount, divided equally between the spouses, unless they agree on a different division. The family coverage limit is reduced further by any contribution to an Archer MSA. However, both spouses may make catch-up contributions for individuals age 55 or over, in addition, without exceeding the family coverage limit.

EXAMPLE: George and Mary established separate HSAs in 2016 and maintained a HDHP with family coverage for all of 2017. Both are age 55 and are self-employed. The maximum combined HSA contribution that can be made by George and Mary for 2017 is $8,750.

Normal HSA contribution (family coverage) $6,750 Additional contribution - George 1,000 Additional contribution - Mary 1,000 Total allowable 2017 HSA contributions $8,750

George and Mary can split the maximum $6,750 normal HSA contribution limit between their accounts in any way they choose, as long as they both agree. However, each must contribute the additional $1,000 to their respective HSAs. NOTE: Even though George and Mary have separate HSAs, they can use funds in their respective accounts to pay qualified medical expenses for either spouse and any dependents.

F. Contributions By An Employer: Employers, in addition to individuals, are permitted to make contributions to HSAs, to the extent an employee is an eligible individual. However, employers must make comparable contributions for the year for all comparably participating employees (comparable in amount, or comparable in percentage of compensation). Failure to comply with the comparability rules can result in a 35% excise tax penalty to the employer based on the employer's total HSA contributions for the year. IRC §4980G. EXCEPTION - Discrimination in Favor of Nonhighly Compensated Employees: For tax years beginning in 2007 and after, employers will be allowed to make larger HSA contributions for nonhighly compensated employees than those being made for highly compensated employees. The comparability rules remain unchanged however. Thus, comparable contributions (amount and/or percentage of compensation) must still be made for any participating nonhighly compensated employees.

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NOTE: For this purpose, a highly compensated employee is one who (1) was a more-than-5% owner at any time during the year or the preceding year; or (2) had compensation exceeding $100,000 for the preceding year and, if elected by the employer, was in the top 20% of employees ranked by compensation. NOTE: Employer contributions are a tax-free fringe benefit to the employee, and are not subject to FICA/MED taxes, income tax withholding or FUTA taxation.

G. Distributions From HSAs:

(1) Pre-Age 65 Distributions. Funds within an HSA grow tax-free with the account beneficiary deciding when distributions are to occur. Distributions used to pay or reimburse out-of-pocket medical expenses for the account beneficiary, their spouse and dependents are tax-free, but any distributions not used for eligible medical costs are taxable and subject to a 20% penalty tax (increased from 10%) for distributions not used to pay qualified medical expenses after 12-31-10). IRC §223(f)(4)(A).

(2) Distributions after Age 65. Taxpayers are allowed to continue holding and accumulating HSA funds after age 65, despite the fact the individual is no longer eligible to contribute to the HSA. Taxpayers age 65 or older are allowed to withdraw HSA funds tax-free to pay certain health insurance premiums (including long-term care premiums and Medicare Part B premiums), as well as, other medical costs.

Any non-medical expense withdrawal after age 65 will be subject to regular income taxation, but not the 20% penalty.

(3) HSA proceeds to pay health insurance premiums: Generally, health insurance may not be purchased from HSA funds. However, certain exceptions apply. The following health insurance premiums are “qualified medical expenses” for HSA distribution purposes:

(a) COBRA health care continuation coverage required under federal law.

(b) Qualified long-term care insurance contract.

(c) A health plan during a period in which the individual is receiving unemployment compensation under federal or state law.

(d) Premiums for Medicare Parts A and B can be paid when a person reaches age 65. The same is true for Medicare HMO premiums and a retired employee’s share of employer-provided health plans. Premiums for a supplemental Medicare policy are not “qualified medical expenses” and may not be paid by HSA distributions.

(4) There is also no 20% penalty on withdrawals if the account owner becomes disabled or dies. IRC §223(f)(2) and (4).

(5) Tax-free rollovers from one HSA to another HSA are permitted once per 12-month period.

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H. Treatment At Death of Participant:

(1) Assuming a surviving spouse is named as the successor beneficiary to the HSA, the surviving spouse succeeds to the HSA account of the deceased spouse. IRC §223(f)(8)(A).

(2) If the surviving spouse is not the successor beneficiary, the account ceases to be an HSA on the account owner’s date of death. The fair market value of the HSA on said date must be included in the income of the individuals who inherit the HSA account (decedent’s beneficiaries), reduced by any medical expenses of the decedent paid out of the HSA within one year of death. IRC §223(f)(8)(B).

NOTE: There is no penalty assessed on any amount included in income of the persons who inherit the HSA.

NOTE: A miscellaneous itemized deduction (not subject to 2% AGI limitation) is allowed to a beneficiary under IRC §691(c) for any estate tax paid by the decedent’s estate on the fair market value of the HSA.

I. Excess Contributions: The maximum annual HSA contribution may be contributed to the individuals’ HSA account at any time during the tax year. This could cause problems if the individual does not remain HSA eligible for all months in the tax year. In this situation, any excess contributions and any net income attributable to such excess must be paid out to the account beneficiary. The deadline for making this payment is the due date (including extensions) for filing that person’s return for the year of the excess contribution (e.g. October 15th for calendar year taxpayers). If the excess is paid out timely, the net income attributable to the excess contributions is not taxable to the account beneficiary until the year in which received by the beneficiary.

NOTE: The excess contribution itself isn’t taxable when received because it would not be allowed as a deduction for the year for which it was made.

NOTE: A 6% excise tax is imposed on the account owner for each taxable year in which the excess contribution remains in the account.

J. Divorce: The transfer of an individual’s interest in an HSA to an individual’s spouse or former spouse under a divorce or separation decree is not considered a taxable transfer. The spouse or former spouse, as transferee, would be treated as the account beneficiary.

K. ERISA Exemption: The Department of Labor clarified that employer contributions to an HSA on behalf of an employee will not be subject to the ERISA rules, as long as the involvement of the employer is limited (DOL Field Assistance Bulletin 2004-1, 4/7/2004). The DOL determined that HSAs meeting the safe harbor conditions for group or group-type insurance programs would not constitute employee welfare benefit plans falling under ERISA, as the employer may be doing little more than contributing funds to an account controlled solely by the employee.

L. Archer MSA Comparison: Rollover of existing Archer MSA Accounts into HSAs should be recommended. HSAs are far superior to Archer MSAs in a number of ways:

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• An HSA has a lower deductible eligibility amount than MSAs on a high-deductible health insurance policy;

• An HSA allows a greater percentage of the deductible to be funded through contributions to the HSA (e.g. 100% rather than 65% or 75%);

• HSAs allow individuals between the ages of 55 and 65 to make catch-up contributions;

M. Partnership Contributions: Partnership contributions to a partner’s HSA are generally treated as distributions of a partner’s capital account. They may, however, be treated as guaranteed payments (deductible by the partnership and subject to self-employment tax by the partner) if desired.

N. “S” Corporation Contributions – More than 2% Shareholder-Employees of “S” Corporations: Contributions by an “S” corporation to an HSA of a more than 2% shareholder-employee are treated as guaranteed payments made by a partnership if made in return for services rendered to the corporation. Thus, the contributions are deductible by the “S” corporation and are includible in the shareholder-employee’s income. While HSA contributions must be included on the shareholder-employee’s W-2 and are subject to income tax withholding, they aren’t subject to FICA. IRC §3121(a)(2)(B).

O. Form 8889, Health Savings Accounts (HSAs): Form 8889 (Part I) will be used to report HSA contributions and the eligible yearly deduction. Part II is to be used to document the taxpayer’s distributions for qualified medical expenses.

P. Additional Guidance – Notice 2008-59, Notice 2004-50 and Notice 2004-2: Notice 2008-59 provides a series of 42 questions and answers related to HSAs. Notice 2004-50 provides 88 questions and answers and supplements Notice 2004-2, which contains 38 previous questions and answers. All three are excellent references for answering HSA inquiries.

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HEALTH REIMBURSEMENT ARRANGEMENTS (HRA) GENERAL: An HRA is a self-insured medical expense reimbursement plan under which an individual health care reimbursement account is set up by an employer with a fixed annual contribution for each covered employee. These accounts are similar to a health care flexible spending account (FSA) because employees can submit their out-of-pocket medical expenses and get reimbursed from the accounts. However, an FSA is funded with the employee’s money that is set aside on a pre-tax basis, while HRAs must be funded solely by the employer.

Contributions an employer makes to the employees’ HRA accounts are tax deductible, and any reimbursements from the accounts are nontaxable to the employees. Any unspent money in an HRA at year-end can be carried forward from year to year until it is needed (even if the employee retires or leaves the company in the meantime). With an FSA, if an employee misjudges how much to put in the account and has some left over at year-end, the excess reverts back to the employer.

An HRA may not be set up to provide benefits directly to a self-employed individual; however, benefits can be indirectly provided if the self-employed individual is a dependent of an eligible employee. The nondiscrimination rules under IRC §105(h) and Reg. 1.105-11 apply.

IRS Notice 2002-45 describes an HRA as an arrangement that: Is funded solely by the employer and not provided pursuant to a salary reduction election or otherwise under an

IRC §125 cafeteria plan;

Reimburses the employee for qualified out-of-pocket medical care expenses only (as defined in IRC §213(d) – including health insurance premiums) incurred by the employee, their spouses or dependents; and

Provides reimbursements up to a maximum dollar amount for a coverage period (generally, the calendar year).

Unlike traditional flexible spending account (FSA) arrangements, any amount left in an HRA at year-end may be carried over to subsequent years to increase the maximum reimbursement amount available in that future period. In addition, if an employee retires or otherwise terminates employment, employers may contribute (but are not required) to make any unused amount in the former employee’s HRA account available to the individual (or dependents) for eligible medical expenses (as defined in IRC §213(d)(A), (B), & (D) -- i.e. any tax deductible medical expenses other than long-term care expenses). Rev. Rul 2002-41.

Reimbursements to former employees for medical expenses are allowed, even if the employee doesn’t elect COBRA continuation coverage (includes retired employees, their spouse and dependents, and a spouse or other dependent of a deceased employee). Thus, an employee who remains in good health and has a cooperative employer could, over a period of several years, build up a sizable HRA account balance to help offset health care costs during retirement. A plan may provide that the maximum reimbursement available after retirement or other termination of employment is reduced for any administrative costs of continuing such coverage. IRS Notice 2002-45.

TAX TREATMENT OF HRAs

Coverage and reimbursements under an HRA for medical care expenses of the employee and dependents are normally nontaxable to the employee under IRC §§105 and 106. To receive this favorable tax treatment, an HRA may only provide benefits that reimburse for qualified medical expenses (as defined in IRC §213(d)). In addition, each medical care expense submitted for reimbursement must be substantiated and must have been incurred both after the HRA was set up and after the employee enrolled in the HRA.

POSSIBLE PROBLEM: IF ANY PERSON HAS A RIGHT TO RECEIVE CASH OR ANOTHER TAXABLE OR NONTAXABLE BENEFIT UNDER AN HRA, OTHER THAN THE REIMBURSEMENT OF MEDICAL

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CARE EXPENSES (CURRENTLY OR IN A FUTURE YEAR), 100% OF THE DISTRIBUTIONS MADE TO ALL OF THE PARTICIPANTS IN THE HRA ARE TAXABLE, REGARDLESS OF WHETHER THE EXPENDITURE WAS FOR REIMBURSEMENT OF A MEDICAL EXPENSE OR NOT. IRS NOTICE 2002-45 AND REV. RUL. 2005-24.

INTERACTION OF HRAs AND SECTION 125 HEALTH FSAs

As stated above, employer contributions to an HRA may not be attributable to salary reductions or otherwise provided under a IRC §125 cafeteria plan. However, employers may offer both types of plans.

If coverage is provided under both an HRA and a Section 125 health flexible spending account (FSA) for the same expense, amounts available under an HRA normally must be exhausted first - before reimbursement may be made from the FSA. However, employers may reverse this order, if desired. NOTE: This should be to the employee’s advantage because unused HRA balances may be carried over to the next year, while unspent FSA amounts revert back to the employer.

The reversal is accomplished by having the plan document for the HRA specify that the HRA is available only after qualifying expenses exceeding the dollar amount of the FSA have been paid. To be effective for a particular year, this provision in the HRA plan document must be in place before the IRC §125 FSA plan year begins. IRS Notice 2002-45.

TAX PLANNING NOTE: Employers appear to be choosing to fund the HRAs with about half the employee’s deductible.

IMPLEMENTATION OF HRA PLAN

While neither Notice 2002-45 nor Rev. Rul. 2002-41 prescribes the formalities required to set up an HRA, the plan, at a minimum, should be in writing, and (1) define the terms of the annual reimbursement by the employer, (2) the coverage period for the medical expense reimbursement, and (3) the eligibility requirements for employees to participate in the HRA.

END OF MOST STAND-ALONE MEDICAL REIMBURSEMENT PLANS

(January 1, 2014 and after) The IRS in conjunction with the DOL and HHS has issued guidance holding that effective on or after January 1, 2014, a stand-alone HRA or other IRC §105 medical reimbursement plan (MRP) that reimburses employee health insurance premiums or other non-excepted health costs violates both the Affordable Care Act (ACA) annual dollar limit prohibition, as well as, the requirement to provide first-dollar preventive care. IRS Notice 2013-54. An HRA will be permitted if it is integrated with a group health plan for purposes of the annual dollar limit prohibition and the preventive services requirement, but only if the HRA is available only to employees who are enrolled in the other group coverage, and the employee is permitted to permanently opt out of the HRA in order to have access to the IRC §36B premium tax credit for participation in the ACA exchange. Imposing the market reform rules on HRAs and other IRC §105 medical reimbursement plans (MRPs) effectively prohibits these arrangements, unless the coverage is limited to ancillary benefits such as dental, vision, disability insurance or long-term care. NOTE: Stand-alone medical reimbursement plans are still available for single employee businesses that are excepted from the ACA market reform rules.

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CAFETERIA (FLEXIBLE SPENDING ACCOUNT) PLANS FSA HEALTH EXPENDITURE CONTRIBUTIONS - INDEXED FOR INFLATION LIMIT: In order for a health FSA to be qualified as a cafeteria plan after December 31, 2012, the maximum amount available for the health FSA plan year cannot exceed $2,500 (indexed for inflation). IRC §125(i). A health FSA can be utilized for reimbursements of medical expenses of an employee, the employee’s dependents, and any other eligible beneficiaries with respect to the employee. NOTE: The $2,500 limit is indexed for inflation for taxable years beginning after 12/31/13. IRC §125(i)(2). The FSA salary reduction limit is $2,550 for 2015-2016; $2,600 for 2017, $2,650 for 2018. NOTE: Spouses Treated Separately: If both husband and wife are eligible to elect salary reduction contributions to a FSA, each spouse may elect contributions of up to $2,600 (for 2017; $2,650 for 2018) to his or her health FSA, even if both spouses participate in the same health FSA sponsored by the same employer. NOTE: Employer Contributions Not Effected: The $2,600 limit applies only to salary reduction contributions by the employee and not to employer non-elective contributions. NOTE: The $2,600 limit only applies to the salary reduction contributions of a health FSA. It does not apply to:

• Salary reduction contributions to a cafeteria plan used to pay the employee share of health coverage premiums or the employee share under a self-insured employer-sponsored arrangement;

• Non-elective contributions made by the employer to the employee’s FSA account;

• Reimbursement under other employer-provided coverage (e.g. salary reduction contributions to a FSA for dependent care assistance);

• Contributions to a Health Savings Account (HSA);

• Amounts funded by an employer under a Health Reimbursement Arrangement (HRA); or

• IRC §105 health/medical reimbursement plans. Cafeteria Plans – Compliance: If the plan does not comply with the $2,500 (adjusted for inflation) limit for tax years beginning after December 31, 2012, the plan will be disqualified. All FSA distributions will be taxed to participating employees. IRS Notice 2012-40.

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MODIFICATIONS TO USE-IT-OR-LOSE-IT RULE

A significant planning issue for cafeteria plan participants (particularly health care and dependent care FSAs) is the so called “use-it-or-lose-it” provision. An employee who elects to put $2,600 (for 2017) of the pre-tax compensation into their health FSA for the year, but only has $1,700 of qualifying expenses, will forfeit the other $900 under this rule. IRS Notice 2005-42 allows employers to amend their cafeteria (flexible spending account) plans to provide for a 2½ month expense grace period immediately following the end of the plan year. The advantage of the grace period is that expenses for qualified benefits incurred during the grace period may be paid or reimbursed from benefits or contributions remaining unused at the end of the immediately preceding plan year. A sample plan 2½ month grace period amendment form follows on the next page. IRS Notice 2013-71 allowed employers to amend their cafeteria (flexible spending account) plans to provide that up to $500 of any amount remaining unused as of the end of the plan year could be carried over to the immediately following plan year. The up to $500 carryover could be used to pay or reimburse medical expenses under the plan incurred during the full plan year to which the carryover is made. Any said carryover amount does not count against or otherwise affect the index salary reduction limit, applicable to each plan year under IRC §125(i) (e.g. $2,600 for 2017; $2,650 for 2018). Any unused amount in excess of $500 (or a lower amount specified in the plan) that remains unused as of the end of the plan year is still forfeited. A sample plan up to $500 carryover amendment form follows on the next page. NOTE: If a plan previously provided for a 2½ month grace period and is amended to add an up to $500 carryover provision, the plan must also be amended to eliminate the 2½ month grace period provision. The amendment to eliminate the 2½ month grace period must be completed no later than the end of the plan year from which amounts may be carried over.

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AMENDMENT TO ____________________________________

CAFETERIA (FLEXIBLE SPENDING ACCOUNT) PLAN (Adoption of 2½ Month Grace Period)

The Cafeteria Plan of ______________________ is hereby amended to incorporate the additional grace period provisions pursuant to IRS Notice 2005-42. Specifically, the Plan is amended to allow an additional grace period of 2½ months (until the 15th day of the 3rd month after the end of the plan year; i.e. March 15th) during which an employee’s expenses for qualified benefits incurred during the grace period can be paid or reimbursed from benefits or contributions remaining unused at the end of the immediately preceding plan year. Dated this _____ day of __________________, 201_____. By: __________________________ NOTE: Pursuant to IRS Notice 2013-17, the above amendment is not permitted for a cafeteria (FSA) plan if the plan contains a provision authorizing a carryover to the immediately following plan year of up to $500 of any remaining unused balance as of the end of the current plan year.

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AMENDMENT TO ____________________________________

CAFETERIA (FLEXIBLE SPENDING ACCOUNT) PLAN (Adoption of up to $500 carryover of any remaining

unused amount at plan year end)

The Cafeteria Plan of ______________________ is hereby amended to incorporate an up to $500 carryover of any remaining unused amount as of the end of the plan year pursuant to IRS Notice 2013-71. Specifically, the Plan is amended to allow an up to $500 carryover of any remaining unused amount to the immediately following plan year during which an employee’s expenses for qualified benefits may be used to pay or reimburse medical expenses under the plan incurred during the full plan year to which the unused amount has been carried. Any such carryover amount shall not count toward an employee’s maximum yearly contribution. Dated this _____ day of __________________, 201_____. By: __________________________ NOTE: The above amendment is not permitted for a cafeteria (FSA) plan if the plan contains a provision authorizing a 2½ month expense grace period for payment or reimbursement of employee medical expense immediately following the end of the plan year.

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