Vernoia, Enterline + Brewer, CPA LLC

Archive for February, 2014

How Do I? Gather the right paperwork for a charitable deduction

Taxpayers must generally provide documentation to support (or to “substantiate”) a claim for any contributions made to charity that they are planning to deduct from their income. Assuming that the contribution was made to a qualified organization, that the taxpayer has received either no benefit from the contribution or a benefit that was less than the value of the contribution, and that the taxpayer otherwise met the requirements for a qualified contribution, then taxpayers should worry next whether they have the proper records to prove their claim.

Cash donations

The taxpayer must provide records to prove a donation of any amount of cash (including payments by cash, check, electronic funds transfer or debit, and credit card). Acceptable records for cash donations of less than $250 generally include:

  • An account statement or canceled check;
  • A written letter, e-mail or other properly issued receipt from the qualified organization bearing the name of the organization and the date and amount of the contribution; and/or
  • A pay stub, Form W–2, or other payroll document showing the amount of a contribution made from payroll.

Caution: A taxpayer cannot substantiate deductions through written records it has prepared on its own behalf, such as a checkbook or personal notes.

Cash donations of more than $250. If a taxpayer donated $250 or more in cash at any one time, the taxpayer must provide a contemporaneous written acknowledgment of the donation from the qualified organization. For each donation of $250 or more, the taxpayer must obtain a separate written acknowledgment. Furthermore, this written acknowledgement must:

  • State the amount of the contribution; and
  • State whether the qualified organization provided the taxpayer with any goods or services in exchange for the donation, and if so estimate their value; and
  • Be received by the taxpayer before the earlier of (1) the return’s filing date or (2) the due date of the return, plus any extensions.

Note: The written acknowledgment ideally would also show the date of the contribution. If it does not, the taxpayer must also provide a bank record that indicates the date.

The acknowledgment must contain a statement of whether or not a taxpayer received any goods or services as a result of the donation, even if no goods or services were received. Even if the donation was for tithes to a religious organization, such as a church, synagogue, or mosque, the acknowledgment should state that the only goods and services received were of intangible religious value. The Tax Court has upheld the disallowance of charitable contribution deductions where the written acknowledgment omitted such a statement regarding goods or services provided.

Noncash contributions

As with cash contributions, the requirements for substantiating noncash contributions increase with the value of the contribution. For example, to substantiate noncash contributions of less than $250, taxpayers must show a receipt or other written communication from the charitable organizations.

To substantiate a noncash contribution between $250 and $500, the taxpayer must obtain a written acknowledgment of the contribution from the qualified organization prior to the earlier of the filing date or due date of its return. The acknowledgment must also describe the type and value of the goods and services, if any, provided to the taxpayer as a result of the donation.

To substantiate noncash contributions totaling between $500 and $5,000 or donations of publically traded securities, a taxpayer must complete Section A of Form 8283, Noncash Charitable Contributions. To substantiate noncash contributions of $5,000 or more (for example, donations of art, jewelry, vehicles, qualified conservation contributions, or intellectual property) the taxpayer must complete Section B of Form 8283. Generally, this would also require the taxpayer to obtain a qualified appraisal of the property’s fair market value.

A word about valuation. A charity is not obligated to provide a value to any noncash contribution; its written receipt only needs to describe the item(s) and note the date of the contribution. The taxpayer, however, is not relieved from making a good-faith estimate of value, which of course the IRS may dispute on any audit. “Thrift-shop” value is often used to value donations of clothing and household goods.

Caution: Last year the Treasury Inspector General for Tax Administration (TIGTA) issued a report finding that the IRS was not accurately monitoring the reporting of noncash contributions requiring completion of Form 8283. The IRS responded that it agreed that it needed to initiate more correspondence audits with taxpayers claiming noncash contributions without the necessary Form 8283 and appraisal.

Vehicles. A taxpayer who donates a motor vehicle, boat, or airplane to charity must deduct either the gross proceeds from the qualified organization’s sale of the vehicle or, if the vehicle is used within the charity’s mission, the fair market value of the vehicle on the date of the contribution, whichever is smaller. The taxpayer must also obtain and attach Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, to its return in addition to Form 8283.

FAQ: What is a cost-segregation study of business assets?

Taxpayers using real estate in their business often can generate significant tax savings and increase cash flow by using the technique of cost segregation. Cost segregation is the identification and separate depreciation of personal property components and land improvements. Like its predecessor, component depreciation, cost segregation allows a taxpayer to separately depreciate various elements of a building more rapidly than the underlying building itself.

Real and personal property

Under MACRS, a building must be depreciated over 27.5 years (residential rental property) or 39 years (nonresidential real property), using the straight-line method. Cost segregation allows depreciation and recovery of the cost of personal property elements of the building over five to seven years, using an accelerated depreciation method (200-percent declining balance). Components that are not classified as personal property must be included in the building’s basis and depreciated over the appropriate period as real property.

Building elements are eligible for cost segregation if they are considered personal property under Code Sec. 1245 and under the former investment tax credit rules of Code Sec. 38. Classification as personal property under state law can also avoid state and local real property taxes.

Cost segregation study

To use cost segregation, the taxpayer must obtain a cost segregation study, which may be conducted by a cost segregation specialist. The specialist will conduct a feasibility study to determine whether a cost segregation study can provide tax savings. The building must be inspected, and the study must identify the components that may qualify as depreciable personal property. The actual installed cost of the component must be obtained.

The items of personal property must be identified in the study. The study should also provide the legal authority (regulations, cases, rulings, etc.) for treating an item as personal property or a land improvement, and should explain the methodology for determining the property’s depreciable basis.

Ideally, the study should be conducted before the building is placed in service (e.g. when the building is under construction or at the time of purchase), although the study can be conducted after a building is placed in service. The building does not have to be new. If the building is being purchased, the sales contract can allocate the sales price between real and personal property.

IRS guidelines

The IRS has provided unofficial guidance to its examiners for reviewing cost segregation studies – Audit Technique Guide for Cost Segregation, dated March 2008. The guide explains why studies are prepared, how studies are prepared, and what to look for in reviewing a study. The guide is available on the IRS website. The IRS also described cost segregation methodology in a private letter ruling, PLR 7941002. Both guidance documents remain in current use by both taxpayers and IRS agents in assessing the correctness of any particular cost segregation study.

IRS regulations focus on partnership built-in losses and duplicated loss transactions

The IRS has issued comprehensive proposed regulations that would limit duplicated losses and inappropriate transfers of built-in losses between partners. The regulations seek to implement and fine-tune tax code provisions enacted in the American Jobs Act of 2004. They will have a significant impact as partnerships grow as the entity of choice for many business enterprises. Although labeled “proposed,” taxpayers should consider the IRS’s interpretation of the rules set forth in these regulations as current audit policy unless otherwise indicated.

Built-in loss property

Property has a built-in loss if its basis exceeds its fair market value. Congress determined that where a partner had contributed built-in loss property to a partnership, and then transferred a partnership interest to another partner, both partners could claim the same loss. The problem also occurs when a partnership distributes the built-in loss property to another partner, and when a partnership makes liquidating distributions to the partner who contributed the built-in loss property.

Proposed regulations

The proposed regulations would restrict the loss deduction to the partner who contributed the built-in loss property to the partnership. If the partner who contributed the built-in loss property disposes of its partnership interest, the transferee does not succeed to the transferor partner’s basis adjustment (built-in loss). The regulations impose certain reporting requirements for the appropriate basis adjustments.

Scope of rules

For the regulations to apply, the built-in loss must exceed $250,000 immediately after a distribution of partnership property or a transfer of a partnership interest. The regulations would not apply if the partnership interest is transferred in certain nonrecognition transactions, such as tax-free reorganizations. Gifts do not qualify for this exception.

Tiered partnerships

Where there are tiered partnerships, the proposed regulations would also require mandatory basis adjustments. The adjustments must be pushed down to the lower tier where the built-in loss property is. Practitioners have indicated that it may be difficult to implement the basis adjustments where the upper-tier partnership does not control the lower-tier partnership. The IRS acknowledged that these requirements may not be particularly administrable.

Enron transactions

The regulations also address abusive transactions that allow a partnership to increase the basis of depreciable assets while decreasing tax-free the basis of preferred stock of a corporate partner held by the partnership. These types of transactions were developed by Enron Corporation and enabled a partnership to take duplicated tax deductions at no economic cost.

IRS 2013 audit rates vary significantly among taxpayers

Recently-released statistics from the IRS show a drop in audits among all income groups for fiscal year (FY) 2013 with the overall individual audit coverage rate at its lowest level since FY 2006. At the same time, the number of IRS employees working audits has decreased. However, enforcement revenue increased.

Taxpayer groups

For statistical purposes, the IRS groups taxpayers into particular categories. The IRS generally defines higher income taxpayers as taxpayers with incomes over $200,000. The IRS also identifies taxpayers with incomes above $1 million for statistical purposes. Similarly, the IRS groups businesses into various categories; for example, corporations with assets under $10 million and corporations with assets above $10 million, $50 million, or $100 million. The IRS also identifies S corporations and partnerships for statistical purposes.

Audit types

As it does with taxpayers, the IRS groups different types of audits into various categories. Field audits are generally full audits. Correspondence audits are, as the name suggests, generally audits conducted by correspondence with the taxpayer. Keep in mind that these categories are very broad and a particular taxpayer’s audit experience may be different.

Individuals

In FY 2013 (October 1, 2012 to September 30, 2013), the overall individual audit rate; that is audits of all individuals in all income groups, was less than one percent: 0.96 percent. That compares to an overall individual audit rate of 1.03 percent for 2012 and 1.11 percent for 2011. The last time the overall individual audit rate was below one percent was in 2006.

To put the overall percentage in perspective, the IRS received 145,819,388 individual returns in 2013. The agency selected 1,404,931 individual returns for examination. The vast majority of these audits – 1,060,779 – were correspondence audits. The number of field audits was 344,152.

Higher income individuals

As incomes climb, so does the audit coverage rate. The IRS selected 3.26 percent of returns for examination from taxpayers with incomes above $200,000 in 2013 compared to 0.88 percent for taxpayers with incomes under $200,000. Both percentages reflected a drop from 2012, when the IRS selected 3.70 percent of returns for examination from taxpayers with incomes above $200,000 and 0.94 percent of returns for examination from taxpayers with incomes under $200,000.

The audit rate for taxpayers with incomes over $1 million also fell in 2013. The IRS selected 10.85 percent of returns for examination from taxpayers with incomes above $1 million compared to 12.14 percent in 2012 and 12.48 percent in 2011. In each of these years, the number of returns reporting incomes above $1 million increased but the audit rate declined.

Within the higher income groups, the number of field examinations actually increased in 2013 compared to 2012. However, the number of correspondence examinations decreased. Some of the increase in field examinations could be attributed to the IRS’s emphasis on curbing tax evasion by hiding assets in unreported foreign accounts. The IRS has encouraged taxpayers with unreported foreign accounts to come forward in its offshore voluntary compliance program.

Businesses

Audits of all types of businesses also declined in 2013. The IRS reported that it selected 0.61 percent of all business returns for examination compared to 0.71 percent in 2012. For the first time in three years, the audit rate of both small and large corporations declined. The IRS selected 0.95 percent of returns for examination from corporations with assets under $10 million and 15.84 percent of returns from corporations with assets over $10 million.

S corporations and partnerships are among the most popular business entities for small and mid-size businesses. The IRS received 4,476,307 S corporation returns in 2013 and 3,550,071 partnership returns in 2013. The audit percentage rate for S corporations and partnerships was the same in 2013 at 0.42 percent compared to 0.48 percent for S corporations in 2012 and 0.47 percent for partnerships in 2012.

Enforcement revenue

Overall, the IRS’ enforcement activities generated $53.35 billion in FY 2013, compared to $50.20 billion in FY 2012. In the previous year (2011), enforcement brought in $55.20 billion. The IRS reported that collections, appeals and document matching all showed increases in revenue. However, the amount collected through examination decreased to $9.83 billion for 2013 compared to $10.20 billion in 2012.

IRS staffing

The IRS reported that 19,531 employees – revenue agents, revenue officers and special agents – worked enforcement activities in FY 2013. That compares to 22,710 employees in FY 2010 – a decrease of 3,179 employees. Some of this decrease reflects normal separations from service, such as voluntary terminations of employment and retirements. Others reflect employee buyouts, which the IRS has offered several times in recent years in response to budgetary challenges.

If you have any questions about the IRS audit coverage rate, examinations or enforcement, please contact our office at (908) 725-4414.

FY 2013 IRS Enforcement Statistics

IRS aims for trouble-free processing of returns and refunds

The 2014 filing season opened on January 31 and the IRS’s new Commissioner has emphasized that the agency is focused on making it run smoothly. The agency expects to process more than 140 million individual returns in 2014 and to issue more than 110 million refunds. At the same time, the IRS must balance its customer service and enforcement functions with reduced funding, protect taxpayers from identity theft and more.

Filing season underway

The IRS began processing individual returns on January 31, 10 days later than originally scheduled. The delay was caused by the 16-day government shutdown in October 2013. The IRS needed additional time to reprogram its return processing systems for the filing season. So far, the IRS has not reported any problems or delays with the processing of returns. Unlike the 2013 filing season, there are no additional delays for filers of certain forms.

There are, however, some new forms for the filing season. The IRS has rolled out final Form 8960 for the new 3.8 percent net investment income (NII) tax, which mostly impacts higher income taxpayers. The IRS has also issued final Form 8959 for taxpayers to report the new 0.9 percent Additional Medicare Tax. The Additional Medicare Tax also largely affects higher income individuals.

Taxpayers expecting a refund can track their refund using the IRS’s popular Where’s My Refund? tool. Last filing season, the IRS reported that use of the online tool was so high that it caused some technical problems and delays. The IRS has asked taxpayers to limit their inquiries to once a week. Taxpayers can also check on the status of their refund through the agency’s mobile app: IRS2GO.

Resources

On January 17, President Obama signed the Consolidated Appropriations Act of 2014, which funds the federal government, including the IRS, through the end of September. The good news is that there is no longer any possibility of a government shutdown during the filing season. However, the Act decreases IRS funding. The IRS will receive $11.3 billion, which is $526 million below 2013 levels.

New IRS Commissioner John Koskinen has acknowledged the budgetary challenges. Shortly after being sworn-in, Koskinen said that the agency’s budget is its “most intractable problem.” Koskinen cautioned that budget cuts impact not only customer service; they also affect enforcement. Koskinen, who took office in January, is currently visiting IRS offices nationwide to learn first-hand the challenges employees face.

Because of budgetary pressures, the IRS has reduced some taxpayer services. Taxpayers may also encounter delays in trying to contact the IRS. National Taxpayer Advocate Nina Olson recently reported that only 61 percent of calls to IRS customer service representatives were answered in 2013. The average wait time to speak to a customer service representative was 17.6 minutes when a call was answered. Olson added that in 2014, IRS customer service representatives will only answer “basic” tax law questions during filing season and will not answer any tax law questions after April.

Identity theft and scams

The IRS is on heightened alert for identity theft as the filing season unfolds. Typically, identity thieves file fraudulent returns early in the filing season to claim bogus refunds. When taxpayers file their genuine returns, they learn that their identities have been stolen. To prevent return fraud, the IRS has upgraded its return processing filters. These filters flag suspect returns before refunds are issued. Between 2011 and 2013, the IRS reported that its filters flagged 14.6 million suspicious returns and prevented over $50 billion in fraudulent refunds.

Individuals who believe they have been victims of identity theft should immediately alert the IRS. The IRS is assigning special identity protection individual identification numbers (IP PINs) to victims of identity theft. Use of an IP PIN alerts the IRS that the taxpayer is the rightful filer of the return.

The IRS is also warning taxpayers to be on the lookout for telephone and internet scams. Typically, victims are told they owe money to the IRS and must pay immediately using a prepaid debit card or wire transfer. The IRS never contacts taxpayers by email and never demands payment by a prepaid debit card or wire transfer.

If you have any questions about identity theft and ways to protect your personal information, please contact our office. Identity theft is a growing problem. In 2013, the IRS initiated nearly 1,500 identity theft related criminal investigations, an increase of 66 percent over investigations initiated in 2012.

In coming weeks and months, the IRS will update taxpayers on the progress of the filing season and our office will keep you posted. As always, please contact at (908)  725-4414  if you have any questions or comments.