Vernoia, Enterline + Brewer, CPA LLC

Archive for June, 2014

NJ and NY on IRS report of adjusted gross income over $200K

The IRS Statistics of Income (SOI) Division has released statistics on 2011 Individual Income Tax ZIP Code and County Data, which is broken down by income categories within particular zip codes. The statistics-which are the most recent from the IRS-were based on records of the 2011 Forms 1040, U.S. Individual Income Tax, filed from January 1, 2012 to December 31, 2012. They provide data on selected types on income, total returns claiming itemized deductions and types and amounts of deductions claimed.

Processing systems

Zip code data is one of the factors used by the IRS’s computerized Individual Masterfile (IMF) tax return processing system to select returns for audit. A return might appear suspect if, for example, a taxpayer’s income seems low or itemized deductions too high when compared to the average income and deductions of other households in the same zip code.

Findings

The states with the highest percentage of total tax filers reporting $200,000 or more in adjusted gross income for 2011 include: California (4.31 percent of all filers reported more than $200,000 in AGI), Connecticut (5.89 percent), the District of Columbia (6.13 percent), Illinois (3.64 percent), Maryland (4.74 percent), Massachusetts (5.28 percent), New Jersey (3.47 percent), New York (4.23 percent), Virginia (4.47 percent), and Washington (3.57 percent).

IRS 2011 Individual Income Tax ZIP Code and County Data overlayed on US Census Median Household Income

IRS 2011 Individual Income Tax ZIP Code and County Data overlayed on US Census Median Household Income. Stars represent highest percentage of total tax filers reporting $200K or more in gross adjusted income for 2011 (either by state or by specific zipcode).

Among the zip codes reporting the highest amount of AGI were:

  • California, 90049: $5.0 billion total AGI; with a total 7,447 filers reporting income of $100,000 or more, 95 percent of whom itemized their deductions. Filers with income between $100,000 and $200,000 claimed an average amount of $40,358 in itemized deductions; Filers with income of $200,000 or more itemized an average amount of $203,901 in deductions.
  • Connecticut, 06830: $6.1 billion total AGI; with a total 4,296 filers reporting income of $100,000 or more, 93 percent of whom itemized their deductions. Filers with income between $100,000 and $200,000 claimed an average amount of $35,774 in itemized deductions; Filers with income of $200,000 or more itemized an average amount of $371,812 in deductions.
  • New York, 10021: $10.2 billion total AGI; with a total 10,443 filers reporting income of $100,000 or more, 99 percent of whom itemized their deductions. Filers with income between $100,000 and $200,000 claimed an average amount of $32,833 in itemized deductions; Filers with income of $200,000 or more itemized an average amount of $351,843 in deductions.
  • Other localities. Other notable higher-income zip codes include: Ala. (35242); Calif. (94010); D.C. (20009, 20016); Fla. (33496); Ga. (30327); Ill. (60611); Md. (20817, 20854); Minn. (55347); N.Y. (10011; 10023); Texas (78746, 77024); Wash. (98052); and Va. (22101).

IRS 2011 Individual Income Tax ZIP Code and County Data

How do I compute the accuracy-related penalty?

If a taxpayer makes a mistake resulting in paying less federal tax to the IRS than actually owed, that taxpayer could be subject to the accuracy-related penalty under Code Sec. 6662. According to the IRS, the two most common accuracy-related penalties are the “substantial understatement” penalty and the “negligence or disregard of the rules or regulations” penalty. These penalties are calculated as 20-percent of the net understatement of tax.

20-percent penalty

The Tax Code defines the words “substantial understatement” differently for individuals and corporations. For individuals, a substantial understatement of tax is an amount that exceeds the greater of (1) 10 percent of the tax required to be shown on the return for the tax year; or (2) $5,000. For corporate taxpayers (other than S corporations and personal holding companies), an understatement is substantial if it exceeds the lesser of: (1) the greater of 10 percent of the taxpayer’s proper tax liability or $10,000; or (2) $10 million.

Negligence generally includes any failure to make a reasonable attempt to comply with the Tax Code. For example, negligence occurs when a taxpayer fails to include on a return an amount of income shown on an information return or fails to make a reasonable attempt to ascertain the correctness of a deduction, credit or exclusion on a return that would appear to be too good to be true to a reasonable and prudent person under the circumstances. Negligence may be excused if the taxpayer had a reasonable basis.

40-percent penalty

The penalty is increased to 40-percent in certain circumstances. For example, the penalty could be increased to 40 percent to the extent that a portion of the underpayment is attributable to a gross valuation misstatement. A gross valuation misstatement exists if the actuarial determination is 400 percent or more of the correct amount.

Furthermore, the 40-percent penalty would apply to the amount of an underpayment attributable to a nondisclosed transaction lacking economic substance. Finally, the 40-percent penalty applies in the case of any underpayment attributable to an undisclosed foreign financial asset understatement.

Some limitations

Throughout this article, we have referred to the Code Sec. 6662 provision as a “penalty.” It is more accurate to call it an addition to tax. This means that the amounts tacked on to a taxpayer’s total tax owed under Code Sec. 6662 are also considered tax, and interest accrues on those amounts just as it accrues on the unpaid tax liability. This can result in a hefty tax bill!

There are limitations on the penalty, however. First, the IRS cannot impose more than one accuracy-related penalty on the same portion of an underpayment. For example, if the taxpayer negligently made a substantial valuation misstatement that caused a $6,000 underpayment of tax, the IRS cannot impose a 20-percent penalty once for the negligence and a second time for the substantial valuation misstatement.

Second, the IRS cannot impose both the Code Sec. 6662 penalty and the Code Sec. 6663 penalty for civil fraud on the same portion of an underpayment. Penalty stacking is prohibited.

Finally, a taxpayer may be able to have the penalty removed from any portion of an underpayment if it can prove that it had a reasonable cause for that portion of an underpayment and acted in good faith with respect to it. Successful advocacy of this defense is complicated, and taxpayers should seek professional advice.

For more information on what taxpayers can do to avoid or reduce a penalty, please contact our offices at (908) 725-4414.

FAQ: What are current amounts of employer-provided tax-free transit benefits?

Transit IncentivesTransit incentives are a popular transportation fringe benefit for many employees. Although the costs of commuting to and from work are not tax-deductible (except in certain relatively rare cases), transportation fringe benefits help to offset some of the costs, including the expenses of riding mass transit or taking a van pool to work. Under current law, the value of qualified transportation fringe benefits provided to an employee is excluded from the employee’s gross income and wages for income and payroll tax purposes.

Qualified benefits

Only certain transit benefits qualify for this special tax treatment. They are:

  • Transportation in a commuter highway vehicle if the transportation is in connection with travel between the employee’s residence and place of employment (for example, van pooling),
  • Transit passes,
  • Qualified parking, and
  • Qualified bicycle commuting reimbursements.

Employers have some latitude regarding which, if any, transit benefits they want to offer. An employer may simultaneously provide an employee with any one or more of the first three qualified transportation fringes. However, an employee may not exclude a bicycle commuting reimbursement for any month in which he or she receives any of the other incentives.

Excluded from gross income

As long as the amount of the transit pass, qualified parking or other benefit does not exceed the statutory monthly limits, the amounts are not wages for purposes of Social Security and Medicare, the Federal Unemployment Tax Act (FUTA), and federal income tax withholding. However, if the amounts do exceed the statutory limits, the excess must be included in the employee’s gross income.

Amounts

For 2014, the maximum that may be excluded is $250 per month for qualified parking, but only $130 for transit passes and van pooling. The exclusion for qualified bicycle commuting reimbursement is limited to a per employee limitation of $20 per month multiplied by the number of qualified bicycle commuting months during the calendar year.

At the end of 2013, the monthly cap on the transit passes and van pools of the commuter benefit dropped to $130 per month-from $240 per month-because transit benefits parity expired. The amount of qualified parking, however, increased to $250 per month, from $240 per month, because of an adjustment for inflation required under the Tax Code.

Pending legislation

Parity could be restored and made retroactive to January 1, 2014. In April, the Senate Finance Committee approved the EXPIRE Act, which would restore parity by increasing the transit pass and van pool benefits to $250 per month – the same amount as parking. The EXPIRE Act is not a permanent fix. The bill would extend parity through the end of 2015. On January 1, 2016, parity would again expire.

The EXPIRE Act also includes special treatment for bikeshare costs. In 2013, the IRS announced that bikeshare arrangements would not be treated as a transportation fringe benefit unless Congress makes them so. The EXPIRE Act modifies the definition of qualified bicycle commuting reimbursement to include expenses associated with the use of a bikesharing arrangement.

Both the House and Senate must pass legislation in order to extend transit benefits parity. At this time, transit benefits parity has not moved in the House. One deterrent is the cost of extending parity. According to the Joint Committee on Taxation, a two-year extension of parity (through 2015) would cost $180 million over 10 years.

Retroactive extension

Retroactive extension of transit benefit parity would create some administrative challenges for employers. The last time there was a retroactive extension, the IRS provided special guidance to employers on how to account for the retroactive change when filing employment tax returns and Forms W-2. The IRS would likely do the same if there is a retroactive extension of transit benefit parity to January 1, 2014.

Please contact our office if you have any questions about transportation fringe benefits. Our office will keep you posted of developments.

Alimony tax filing to receive increased scrutiny

The IRS needs to significantly improve its oversight of alimony deductions, the Treasury Inspector General for Tax Administration (TIGTA) has cautioned in a recent audit report. Alimony paid to or for a spouse or former spouse under a divorce or separation instrument is generally deductible from the payer’s income and taxable to the recipient’s income. TIGTA estimated the “alimony compliance gap” at more than $2.3 billion.

In Tax Year (TY) 2010, approximately 570,000 taxpayers claimed alimony deductions totaling more than $10 billion, TIGTA reported. TIGTA discovered that the IRS did not properly oversee these deductions. Some individuals improperly claimed deductions for alimony that they did not pay and others did not report the alimony they received.

Background

Payments that qualify as alimony or separate maintenance are included in the payee-spouse’s gross income, just as are wages, salary, dividends, and the like, and are deductible from the payer-spouse’s gross income. The inclusion and the deduction are intended to be reciprocal. Among other requirements, only payments made under a divorce or separation instrument are deductible as alimony; voluntary payments are not deductible as alimony.

TIGTA’s investigation

TIGTA’s discovered that 47 percent of TY 2010 returns contained a claim for an alimony deduction for which the corresponding income was either not reported on a recipient’s return or the amount of alimony income reported did not agree with the deduction. TIGTA’s investigation also revealed improper enforcement of the requirement that the payor include the Taxpayer Identification Number (TIN) of the recipient on his or her tax return.

The IRS will reject a return filed electronically if the recipient’s TIN is missing or incomplete. In the case of paper returns, the IRS will suspend processing of the return and contact the filer. The IRS may impose a $50 penalty when a taxpayer fails to provide a valid recipient TIN.

However, TIGTA discovered that approximately 3,700 returns claiming an alimony deduction did not provide the recipient’s TIN and 2,700 returns contained an invalid TIN. In addition, due to errors in the processing instructions, the IRS failed to assess nearly $325,000 in penalties on individuals who did not provide a valid recipient TIN as required.

Recommendations

TIGTA recommended, and the agency agreed, that the IRS enhance its examination selection filters for high-risk returns with questionable alimony deduction claims. Additionally, the IRS agreed with TIGTA’s recommendation that penalties are not being assessed in all cases where a return lacks a valid recipient TIN and would work to improve the assessment of penalties.

For more information, please contact our offices at (908) 725-4414.

June 30 approaches for FBAR filings

Currency worldU.S. taxpayers with foreign financial accounts must file an FBAR (Report of Foreign Bank and Financial Accounts) if the aggregate value of their accounts exceeds $10,000 at any time during the calendar year. The FBAR must be filed by June 30 of the current year to report the taxpayer’s financial accounts for the prior year.

A U.S. taxpayer must report the account not only if the taxpayer has a financial interest in the account, but also if the taxpayer has signature authority over the account. The account must be reported even if it produces no income, and whether or not the taxpayer receives any distributions from the account.

FinCEN

Reporting is required by the Bank Secrecy Act (BSA), not by the Internal Revenue Code. Taxpayers submit the proper form to Treasury’s Financial Crimes Enforcement Network (FinCEN), not the IRS. The form is not submitted with a tax return. However, FinCEN has delegated FBAR enforcement authority to the IRS.

New Form 114

In the past, taxpayers reported their accounts on Form TD F 90-22.1. However, effective for 2014 and subsequent years, taxpayers must report their accounts on new FinCEN Form 114. The June 30 deadline is firm; there is no extension for filing the form late. However, persons who belatedly discover the need to file an FBAR for a previous year can file on Form 114.

In the past, too, taxpayers reported their accounts on a paper form, but Form 114 is only available online, through the BSA E-Filing System website. Paper Form TD F 90-22.1 has been discontinued. This BSA E-Filing System allows the taxpayer to designate the year being reported, so taxpayers may use the same form to file late reports for a prior year. In addition, persons can now authorize a tax professional, such as an attorney, CPA, or enrolled agent, to file on their behalf, by designating an agent on BSA Form 114a.

If two persons jointly maintain an account, each must file an FBAR. However, spouses now qualify for an exception, and can file only one FBAR, provided the nonfiling spouse only owns accounts jointly with the filing spouse. The couple can complete a Form 114a, to authorize one spouse to file for the other, because the electronic system only accepts one signature for an FBAR.

Signature authority

Signature authority is authority to control the disposition of assets held in a foreign financial account. A person with a power of attorney over a foreign account must file an FBAR, even if the person never exercises the power of attorney.

FinCEN has considered amending the rules regarding signature authority. In the meantime, because there is some uncertainty about the meaning of signature authority, FinCEN has deferred FBAR filing by certain individuals that only have signature authority over, but no financial interest in, foreign financial accounts of their employer or a closely related entity. FinCEN Notice 2011-1 first provided an extension for these persons. In Notice 2013-1, FinCEN extended the due date for these persons to file, to June 30, 2015, while FinCEN further considers changes to the rules.

Congress juggles immediate and long-term tax issues

Nearly half-way into the year, tax legislation has been hotly debated in Congress but lawmakers have failed to move many bills. Only one bill, legislation to make permanent the research tax credit, has been approved by the House; its fate in the Senate still remains uncertain. Other bills, including legislation to extend many of the now-expired extenders before the 2015 filing season, have stalled. Tax measures could also be attached to other bills, especially as the days wind down to Congress’ August recess.

Tax extenders

Legislation to extend nearly all of the extenders seemed to be almost assured of passage in the Senate after the Senate Finance Committee (SFC) approved the EXPIRE Act in April. The EXPIRE Act would extend through 2015 many of the popular but temporary tax incentives, including the higher education tuition deduction, the state and local sales tax deduction, the deduction for mortgage premiums, research tax credit, Work Opportunity Tax Credit (WOTC), and more. In May, the EXPIRE Act became bogged down in procedural votes in the Senate. Democrats and Republicans could not agree whether amendments would be allowed and if so, how many amendments.

In the meantime, individual lawmakers have introduced bills to extend some of the extenders. The bills must be referred to committees (the SFC or the House Ways and Means Committee) for action. Committee chairs ultimately determine if the bills will be brought before the committee. SFC Chair Ron Wyden, D-Ore., has signaled that the EXPIRE Act is likely his best attempt to move an extenders bill. Wyden has also said that he will not promote another extenders bill after 2015 (hence the name, EXPIRE Act). Ways and Means Chair Dave Camp, R-Mich., has largely kept the committee’s focus on the proposals outlined in his proposed Tax Reform Act of 2014.

Lawmakers have roughly eight weeks before their month-long August recess to act on the extenders. Our office will keep you posted of developments.

Research tax credit

The research tax credit is a very popular business tax incentive. Its popularity has pushed it to the front of the line in the House for renewal. One drawback is the credit’s cost: estimated at $155 billion over 10 years.

In May, the House approved the American Research and Competitiveness Act of 2014. The bill attracted support from both Democrats and Republicans. The bill makes permanent and enhances the research tax credit. The bill is not offset, which is a stumbling block to winning support from Senate Democrats. In fact, President Obama has said he would veto the bill in its present form if it reaches his desk. There is a possibility, albeit slight, that the Senate could pass its own version of the research tax credit and the House and Senate would try to reach a compromise in conference.

Corporate taxation

President Obama, lawmakers from both parties and many taxpayers agree that the U.S. corporate tax rate should be reduced. They disagree on how to pay, or if to offset, any reduction. President Obama continues to promote the elimination of some business tax preferences, particularly tax incentives for oil, gas and fossil fuel producers, as the way to pay for a corporate tax rate cut. The President also has called for using some of the revenues to fund road and bridge construction.

Democrats in the House and Senate have also honed in on so-called “corporate inversions.” These occur when U.S. companies merge with foreign ones for tax purposes. The merged entity is often located in a low-tax jurisdiction, such as Ireland with a corporate tax rate of 12.5 percent, compared to the U.S. corporate tax rate of 35 percent. House and Senate Democrats have introduced companion bills (Stop Corporate Inversions Act of 2014) to curb these mergers. Under current law, a corporate inversion will not be respected for U.S. tax purposes if 80 percent or more of the new combined corporation (incorporated offshore) is owned by historic shareholders of the U.S. corporation. The bill would reduce the threshold to 50 percent. House and Senate Republicans are not expected to support the bill.

Other bills

On July 1, the interest rate on federal subsidized Stafford loans is set to increase from 3.4 to 6.8 percent. Legislation introduced in the Senate, the Bank on Students Loan Fairness Act, would provide a one-year “fix” by setting the rate at the primary interest rate offered through the Federal Reserve discount window. The bill would be paid for by the so-called “Buffett Rule,” which generally would disallow certain tax preferences to higher income individuals. Along with the student loan bill, lawmakers have on their agenda legislation to renew federal highway spending, as discussed above. A final highway bill with tax-related provisions could be approved before the August recess. Some lawmakers have proposed a hike in the federal gasoline tax but it is unlikely to be approved.

If you have any questions about how these changes may impact your tax situation, please contact our office at (908) 725-4414.