Seniors Warned of Rising Impersonation Scams, IR-2024-164 The IRS has issued a warning about the increasing threat of impersonation scams targeting seniors. These scams involve fraudsters posing as government officials, including IRS agents, to steal s...
The IRS has providedguidance on two exceptions to the 10 percent additional tax under Code Sec. 72(t)(1) for emergency personal expense distributions and domesticabusevictimdistributions. These exceptions were added by the SECURE 2.0 Act of 2022, P.L. 117-328, and became effective January 1, 2024. The Treasury Department and the IRS anticipate issuing regulations under Code Sec. 72(t) and request comments to be submitted on or before October 7, 2024.
The IRS hasprovidedguidanceon two exceptions to the 10 percent additional tax underCode Sec. 72(t)(1)foremergencypersonal expensedistributionsanddomesticabusevictimdistributions. These exceptions were added by the SECURE 2.0 Act of 2022,P.L. 117-328, and became effective January 1, 2024. The Treasury Department and the IRS anticipate issuing regulations underCode Sec. 72(t)and request comments to be submitted on or before October 7, 2024.
DistributionsforEmergencyPersonal Expenses
Code Sec. 72(t)(2)(I)provides an exception to the 10 percent additional tax for adistributionfrom an applicable eligibleretirementplan to an individual foremergencypersonal expenses. The term"emergencypersonal expensedistribution"means anydistributionmade from an applicable eligibleretirementplan to an individual for purposes of meeting unforeseeable or immediate financial needs relating to necessary personal or familyemergencyexpenses. The IRS specifically noted thatemergencyexpenses could be related to: medical care; accident or loss of property due to casualty; imminent foreclosure or eviction from a primary residence; the need to pay for burial or funeral expenses; auto repairs; or any other necessaryemergencypersonal expenses.
The IRS provides that a plan administrator or IRA custodian may rely on a written certification from the employee or IRA owner that they are eligible for anemergencypersonal expensedistribution. Furthermore, the IRS provides that anemergencypersonal expensedistributionis not treated as a rolloverdistributionand thus is not subject to mandatory 20% withholding. However, thedistributionis subject to withholding, the IRS said. If theemergencypersonal expensedistributionis repaid, it is treated as if the individual received thedistributionand transferred it to an eligibleretirementplan within 60 days ofdistribution.
If an otherwise eligibleretirementplan doesnotofferemergencypersonal expensedistributions, the IRS indicated that an individual may still take an otherwise permissibledistributionand treat it as such on their federal income tax return. The individual claims on Form 5329 that thedistributionis anemergencypersonal expensedistribution, in accordance with the form’s instructions. The individual has the option to repay thedistributionto an IRA within 3 years.
DistributionstoDomesticAbuseVictims
Code Sec. 72(t)(2)(K)provides an exception to the 10 percent additional tax for an eligibledistributionto adomesticabusevictim(domesticabusevictimdistribution). Theguidancedefines a"domesticabusevictimdistribution"as anydistributionfrom an applicable eligibleretirementplan to adomesticabusevictimif made during the 1-year period beginning on any date on which the individual is avictimofdomesticabuseby a spouse ordomesticpartner."Domesticabuse"is defined as physical, psychological, sexual, emotional, or economicabuse, including efforts to control, isolate, humiliate, or intimidate thevictim, or to undermine thevictim’s ability to reason independently, including by means ofabuseof thevictim’s child or another family member living in the household.
As withdistributionsforemergencypersonal expenses, aretirementplan may rely on an employee’s written certification that they qualify for adomesticabusevictimdistribution. Similarly, if an otherwise eligibleretirementplan doesnotofferdomesticabusevictimdistributions, the IRS indicated that an individual may still take an otherwise permissibledistributionand treat it as such on their federal income tax return. The individual claims on Form 5329 that thedistributionis adomesticabusevictimdistribution, in accordance with the form’s instructions. The individual has the option to repay thedistributionto an IRA within 3 years.
Request for Comments
The Treasury Department and the IRS invite comments on theguidance, and specifically on whether the Secretary should adopt regulations providing exceptions to the rule that a plan administrator may rely on an employee’s certification relating toemergencypersonal expensedistributionsand procedures to address cases of employee misrepresentation. Comments should be submitted in writing on or before October 7, 2024, and should include a reference toNotice2024-55.
On June 17, 2024, the U.S. Department of the Treasury and the Internal Revenue Service announced a new regulatory initiative focused on closing taxloopholes and stopping abusivepartnershiptransactions used by wealthy taxpayers to avoid paying taxes.
On June 17, 2024, theU.S. Department of the Treasuryand theInternal Revenue Serviceannounced a new regulatoryinitiativefocused on closingtaxloopholesand stoppingabusivepartnershiptransactionsused by wealthy taxpayers to avoid payingtaxes.
Specifically targeted by this newtaxcompliance effort arepartnershipbasis shiftingtransactions. In thesetransactions, a single business that operates through many different legal entities (related parties) enters into a set oftransactionsthat manipulatepartnershiptaxrules to maximizetaxdeductions and minimizetaxliability. These basis shiftingtransactionsallow closely related parties to avoidtaxes.
The use of theseabusivetransactionsgrew during a period of severe underfunding for theIRS. As such, the audit rates for these increasingly complex structures fell significantly. It is estimated that theseabusivetransactions, which cut across a wide variety of industries and individuals, could potentially cost taxpayers more than $50 billion over a 10-year period, according to anIRSNews Release.
"Using Inflation Reduction Act funding, we are working to reverse more than a decade of declining audits among the highest income taxpayers, as well as complexpartnershipsand corporations,"IRSCommissioner Danny Werfel said during a press call discussing the new effort on June 14, 2024.
"This announcement signals theIRSis accelerating our work in thepartnershiparena, which has been overlooked for more than a decade and allowedtaxabuse to go on for far too long,"saidIRSCommissioner Danny Werfel."We are building teams and adding expertise inside the agency so we can reverse long-term compliance declines that have allowed high-income taxpayers and corporations to hide behind complexity to avoid payingtaxes. Billions are at stake here".
This multi-stage regulatory effort announced by theTreasuryandIRSincludes the following guidance designed to stop the use of basis shiftingtransactionsthat use related-partypartnershipsto avoidtaxes:
proposed regulationsunder existing regulatory authority to stop related parties in complexpartnershipstructures from shifting thetaxbasis of their assets amongst each other to takeabusivedeductions or reduce gains when the asset is sold;
proposed regulation to require taxpayers and their material advisers to report if they and their clients are participating inabusivepartnershipbasis shiftingtransactions; and
aRevenue Rulingproviding that certain related-partypartnershiptransactionsinvolving basis shifting lack economic substance.
"Treasuryand theIRSare focused on addressing high-endtaxabuse from all angles, and the proposed rules released today will increasetaxfairness and reduce the deficit,"said U.S. Secretary of theTreasuryJanet L. Yellen.
In the June 14, 2024, press call, Commissioner Danny Werfel also noted that there will be an increase in audits of largepartnershipswith average assets over $10 billion dollars and larger organizational changes taking place to support compliance efforts, including the creation of a new associate office that will focus exclusively onpartnerships, S corporations, trusts, and estates.
By Catherine S. Agdeppa, Content Management Analyst
A savingsaccount with the tax benefits of a health savingsaccount or an educations savingsaccount but without the singular restricted focus could be something that gains traction as Congress addresses the tax provision of the Tax Cuts and Jobs Act that expire in 2025.
Asavingsaccountwith the tax benefits of a healthsavingsaccountor an educationssavingsaccountbut without the singular restricted focus could be something that gains traction as Congress addresses the tax provision of the Tax Cuts and Jobs Act that expire in 2025.
The concept was promoted by multiple witnesses testifying during a recentSenateFinanceCommitteehearingon the subject of childsavingsaccountsand other tax advantagedaccountsthat would benefit children. It also is the subject of a recently releasedreportfrom The Tax Foundation.
Rather thanpushnew limited-usesavingsaccounts,"policymakers may want to consider enacting a more comprehensivesavingsprogram such as auniversalsavingsaccount,"Veronique de Rugy, a research fellow at George Mason University, testified before thecommitteeduring the May 21, 2024, hearing."Universalsavingsaccountswill allow workers to save in one simpleaccountfrom which they would withdraw without penalty for any expected or unexpected events throughout their lifetime."
She noted that, like other more focusedsavingsaccounts, like healthsavingsaccounts, it would have"the benefit of sheltering some income from the punishing double taxation that our code imposes."
De Rugy added thatuniversalsavingsaccounts"have a benefit that they do not discouragesavingsfor those who are concerned that the conditions for withdrawals would stop them from addressing an emergency in their family."
Adam Michel, director of tax policy studies at the Cato Institute, who also promoted the idea ofuniversalsavingsaccounts. He said theseaccounts"would allow families to save for their kids or any of life’s other priorities. The flexibility of theseaccountsmake them best suited for lower and middle income Americans."
He also noted that they are promotingsavingsin countries that have implemented them, including Canada and United Kingdom.
"For example, almost 60 percent of Canadians own tax-freesavingsaccounts,"Michel said."And more than half of thoseaccountholders earned the equivalent of about $37,000 a year. Theseaccountshave helped increasesavingsand support the rest of the Canadiansavingsecosystem."
De Rugy noted that in countries that have implemented it, they function like a Rothaccountin that money that has already been taxed can be put into it and not penalized or taxed upon withdrawal.
Michel also noted that the if the tax benefits extend to corporations as they do with deposits to employee healthsavingsaccounts,"to the extent that you lower the corporate income tax, you’re going to encourage a different additional investment intosavingsby those entities."
Simulating TheUniversalSavingsAccountImpact
The Tax Foundation in its report simulated how auniversalsavingsaccountcould work, based on how they are implemented in Canada. The simulation assumed theaccountscould go active in 2025 for adults aged 18 years or older.
On a post-tax basis, individuals would be allowed to contribute up to $9,100 on a post-tax basis annually, with that cap indexed for inflation. Any unused"contribution room"would be allowed to be carried forward. Earnings would be allowed to grow tax-free and withdrawals would be allowed for any purpose without penalty or further taxation. Any withdrawal would be added back to that year’s contribution room and that would be eligible for carryover as well.
"The fiscal cost of this USA policy would be offset by ending the tax advantage of contributions to HSAs beginning in 2025,"the report states."As such, future contributions to HSAs would be given normal tax treatment, i.e. included in taxable income and subject to payroll tax with subsequent returns on contributions also included in taxable income."
In this scenario, the Tax Foundation report estimates that"this policy change would on net raise tax revenue by about $110 billion over the 10-year budget window."
As for the impact on taxpayers, the"after-tax income would fall by about 0.1 percent in 2025 and by a smaller amount in 2034, reflecting the net tax increase in those years,"the report states."Over the long run, and accounting for economic impacts, taxpayers across every quintile would see a small increase in after-tax income on average, but the top 5 percent of earners would continue to see a small decrease in after-tax income on average."
The Internal Revenue Service’s use of artificial intelligence in selecting tax returns for National Research Program audits that areused to estimate the taxgapneeds more documentation and transparency, the U.S. Government Accountability Office stated.
The Internal Revenue Service’s use of artificial intelligence in selectingtaxreturns for National Research Programauditsthat areused toestimatethetaxgapneedsmore documentation andtransparency, the U.S.Government Accountability Officestated.
In areportissued June 5, 2024, the federal government watchdog noted that while the agency usesAIto improve the efficiency andselectionofauditcases to help identify noncompliance,"IRS has not completed its documentation of several elements of itsAIsampleselectionmodels, such as key components and technical specifications."
GAOnoted that the IRS began usingAIin a pilot intaxyear 2019 for samplingtaxreturns for NRPaudits. The current plan is to useAIto create a sample size of 4,000 returns to measure compliance and help informtaxgapestimates, althoughGAOexpressed concerns about the accuracy of theestimateswith that sample size.
"For example, NRP historically included more than 2,500 returns that claimed the Earned IncomeTaxCredit, but the redesigned sample has included less than 500 of these returns annually,"the report stated.
IRS toldGAOthat it"is exploring ways to combine operationalauditdata with NRPauditdata when developing itstaxgapestimates. IRS officials also told us that if IRS can reliably combine these data fortaxgapanalysis, IRS might be better positioned to identify emerging trends in noncompliance and reduce the uncertainty of theestimatesdue to the small sample size."
The report also highlighted the fact that the agency"has multiple documents that collectively provide technical details and justifications for the design of theAImodels. However, no set of documents contains complete information and IRS analyst could use to run or update the models, and several key documents are in draft form."
"Completing documentation would help IRS retain organizational knowledge, ensure the models are implemented consistently, and make the process more transparent to future users,"the report stated.
Maintaining good financial records is an important part of running a successful business. Not only will good records help you identify strengths and weaknesses in your business' operations, but they will also help out tremendously if the IRS comes knocking on your door.
Maintaining good financial records is an important part of running a successful business. Not only will good records help you identify strengths and weaknesses in your business' operations, but they will also help out tremendously if the IRS comes knocking on your door.
The IRS requires that business owners keep adequate books and records and that they be available when needed for the administration of any provision of the Internal Revenue Code (i.e., an audit). Here are some basic guidelines:
Copies of tax returns. You must keep records that support each item of income or deduction on a business return until the statute of limitations for that return expires. In general, the statute of limitations is three years after the date on which the return was filed. Because the IRS may go back as far as six years to audit a tax return when a substantial understatement of income is suspected, it may be prudent to keep records for at least six years. In cases of suspected tax fraud or if a return is never filed, the statute of limitations never expires.
Employment taxes. Chances are that if you have employees, you've accumulated a great deal of paperwork over the years. The IRS isn't looking to give you a break either: you are required to keep all employment tax records for at least 4 years after the date the tax becomes due or is paid, whichever is later. These records include payroll tax returns and employee time documentation.
Business assets. Records relating to business assets should be kept until the statute of limitations expires for the year in which you dispose of the asset in a taxable disposition. Original acquisition documentation, (e.g. receipts, escrow statements) should be kept to compute any depreciation, amortization, or depletion deduction, and to later determine your cost basis for computing gain or loss when you sell or otherwise dispose of the asset. If your business has leased property that qualifies as a capital lease, you should retain the underlying lease agreement in case the IRS ever questions the nature of the lease.
For property received in a nontaxable exchange, additional documentation must be kept. With this type of transaction, your cost basis in the new property is the same as the cost basis of the property you disposed of, increased by the money you paid. You must keep the records on the old property, as well as on the new property, until the statute of limitations expires for the year in which you dispose of the new property in a taxable disposition.
Inventories.If your business maintains inventory, your recordkeeping requirements are even more arduous. The use of special inventory valuation methods (e.g. LIFO and UNICAP) may prolong the record retention period. For example, if you use the last-in, first-out (LIFO) method of accounting for inventory, you will need to maintain the records necessary to substantiate all costs since the first year you used LIFO.
Specific Computerized Systems Requirements
If your company has modified, or is considering modifying its computer, recordkeeping and/or imaging systems, it is essential that you take the IRS's recently updated recordkeeping requirements into consideration.
If you use a computerized system, you must be able to produce sufficient legible records to support and verify amounts shown on your business tax return and determine your correct tax liability. To meet this qualification, the machine-sensible records must reconcile with your books and business tax return. These records must provide enough detail to identify the underlying source documents. You must also keep all machine-sensible records and a complete description of the computerized portion of your recordkeeping system.
Some additional advice: when your records are no longer needed for tax purposes, think twice before discarding them; they may still be needed for other nontax purposes. Besides the wealth of information good records provide for business planning purposes, insurance companies and/or creditors may have different record retention requirements than the IRS.
After your tax returns have been filed, several questions arise: What do you do with the stack of paperwork? What should you keep? What should you throw away? Will you ever need any of these documents again? Fortunately, recent tax provisions have made it easier for you to part with some of your tax-related clutter.
After your tax returns have been filed, several questions arise: What do you do with the stack of paperwork? What should you keep? What should you throw away? Will you ever need any of these documents again? Fortunately, recent tax provisions have made it easier for you to part with some of your tax-related clutter.
The IRS Restructuring and Reform Act of 1998 created quite a stir when it shifted the "burden of proof" from the taxpayer to the IRS. Although it would appear that this would translate into less of a headache for taxpayers (from a recordkeeping standpoint at least), it doesn't let us off of the hook entirely. Keeping good records is still the best defense against any future questions that the IRS may bring up. Here are some basic guidelines for you to follow as you sift through your tax and financial records:
Copies of returns. Your returns (and all supporting documentation) should be kept until the expiration of the statute of limitations for that tax year, which in most cases is three years after the date on which the return was filed. It's recommended that you keep your tax records for six years, since in some cases where a substantial understatement of income exists, the IRS may go back as far as six years to audit a tax return. In cases of suspected tax fraud or if you never file a return at all, the statute of limitations never expires.
Personal residence. With tax provisions allowing couples to generally take the first $500,000 of profits from the sale of their home tax-free, some people may think this is a good time to purge all of those escrow documents and improvement records. And for most people it is true that you only need to keep papers that document how much you paid for the house, the cost of any major improvements, and any depreciation taken over the years. But before you light a match to the rest of the heap, you need to consider the possibility of the following scenarios:
Your gain is more than $500,000 when you eventually sell your house. It could happen. If you couple past deferred gains from prior home sales with future appreciation and inflation, you could be looking at a substantial gain when you sell your house 15+ years from now. It's also possible that tax laws will change in that time, meaning you'll want every scrap of documentation that will support a larger cost basis in the home sold.
You did not use the home as a principal residence for a period. A relatively new income inclusion rule applies to home sales after December 31, 2008. Under the Housing and Economic Recovery Act of 2008, gain from the sale of a principal residence will no longer be excluded from gross income for periods that the home was not used as the principal residence. These periods of time are referred to as "non-qualifying use." The rule applies to sales occurring after December 31, 2008, but is based only on non-qualified use periods beginning on or after January 1, 2009. The amount of gain attributed to periods of non-qualified use is the amount of gain multiplied by a fraction, the numerator of which is the aggregate period of non-qualified use during which the property was owned by the taxpayer and the denominator of which is the period the taxpayer owned the property. Remember, however, that "non-qualified" use does not include any use prior to 2009.
You may divorce or become widowed. While realizing more than a $500,000 gain on the sale of a home seems unattainable for most people, the gain exclusion for single people is only $250,000, definitely a more realistic number. While a widow(er) will most likely get some relief due to a step-up in basis upon the death of a spouse, an individual may find themselves with a taxable gain if they receive the house in a property settlement pursuant to a divorce. Here again, sufficient documentation to prove a larger cost basis is desirable.
Individual Retirement Accounts. Roth IRA and education IRAs require varying degrees of recordkeeping:
Traditional IRAs. Distributions from traditional IRAs are taxable to the extent that the distributions exceed the holder's cost basis in the IRA. If you have made any nondeductible IRA contributions, then you may have basis in your IRAs. Records of IRA contributions and distributions must be kept until all funds have been withdrawn. Form 8606, Nondeductible IRAs, is used to keep track of the cost basis of your IRAs on an ongoing basis.
Roth IRAs. Earnings from Roth IRAs are not taxable except in certain cases where there is a premature distribution prior to reaching age 59 1/2. Therefore, recordkeeping for this type of IRA is the fairly simple. Statements from your IRA trustee may be worth keeping in order to document contributions that were made should you ever need to take a withdrawal before age 59 1/2.
Education IRAs. Because the proceeds from this type of an IRA must be used for a particular purpose (qualified tuition expenses), you should keep records of all expenditures made until the account is depleted (prior to the holder's 30th birthday). Any expenditures not deemed by the IRS to be qualified expenses will be taxable to the holder.
Investments. Brokerage firm statements, stock purchase and sales confirmations, and dividend reinvestment statements are examples of documents you should keep to verify the cost basis in your securities. If you have securities that you acquired from an inheritance or a gift, it is important to keep documentation of your cost basis. For gifts, this would include any records that support the cost basis of the securities when they were held by the person who gave you the gift. For inherited securities, you will want a copy of any estate or trust returns that were filed.
Keep in mind that there are also many nontax reasons to keep tax and financial records, such as for insurance, home/personal loan, or financial planning purposes. The decision to keep financial records should be made after all factors, including nontax factors, have been considered.
With home values across the country at the highest levels seen in years, you may find that you could actually have a gain from the sale of your home in excess of the new IRS exclusion amount of $500,000 ($250,000 for single and married filing separately taxpayers). In order to determine your potential gain or loss from the sale, you will first need to know the basis of your personal residence.
With home values across the country dropping significantly from just a year ago, but still generally much higher then they had been even five years ago, you may find that you could actually have a gain from the sale of your home in excess of the new IRS exclusion amount of $500,000 ($250,000 for single and married filing separately taxpayers). In order to determine your potential gain or loss from the sale, you will first need to know the basis of your personal residence.
Note. The Housing and Economic Recovery Act of 2008 modified the home sale exclusion applicable to home sales after December 31, 2008. Under the new rule, gain from the sale of a principal residence that is attributable to periods that the home was not used as a principal residence (i.e. "non-qualifying use") will be no longer be excluded from income. A transition rule provided in the new law applies the new income inclusion rule to nonqualified use periods that begin on or after January 1, 2009. This is a generous transition rule in light of the new requirement.
The basis of your personal residence is generally made up of three basic components: original cost, improvements, and certain other basis adjustments.
Original cost
How your home was acquired will need to be considered when determining its original cost basis.
Purchase or Construction. If you bought your home, your original cost basis will generally include the purchase price of the property and most settlement or closing costs you paid. If you or someone else constructed your home, your basis in the home would be your basis in the land plus the amount you paid to have the home built, including any settlement and closing costs incurred to acquire the land or secure a loan.
Examples of some of the settlement fees and closing costs that will increase the original cost basis of your home are:
Attorney's fees,
Abstract fees,
Charges for installing utility service,
Transfer and stamp taxes,
Title search fees,
Surveys,
Owner's title insurance, and
Unreimbursed amounts the seller owes but you pay, such as back taxes or interest; recording or mortgage fees; charges for improvements or repairs, or selling commissions.
Gift. If you acquired your home as a gift, your basis will be the same as it would be in the hands of the donor at the time it was given to you. However, the basis for loss is the lesser of the donor's adjusted basis or the fair market value on the date you received the gift.
Inheritance. If you inherited your home, your basis is the fair market value on the date of the deceased's death or on the "alternate valuation" date, as indicated on the federal estate tax return filed for the deceased.
Divorce. If your home was transferred to you from your ex-spouse incident to your divorce, your basis is the same as the ex-spouse's adjusted basis just before the transfer took place.
Improvements
If you've been in your home any length of time, you most likely have made some home improvements. These improvements will generally increase your home's basis and therefore decrease any potential gain on the sale of your residence. Before you increase your basis for any home improvements, though, you will need to determine which expenditures can actually be considered improvements versus repairs.
An improvement materially adds to the value of your home, considerably prolongs its useful life, or adapts it to new uses. The cost of any improvements can not be deducted and must be added to the basis of your home. Examples of improvements include putting room additions, putting up a fence, putting in new plumbing or wiring, installing a new roof, and resurfacing your patio.
Repairs, on the other hand, are expenses that are incurred to keep the property in a generally efficient operating condition and do not add value or extend the life of the property. For a personal residence, these costs cannot be do not add to the basis of the home. Examples of repairs are painting, mending drywall, and fixing a minor plumbing problem.
Other basis adjustments
Additional items that will increase your basis include expenditures for restoring damaged property and assessing local improvements. Some common decreases to your home's basis are:
Insurance reimbursements for casualty losses.
Deductible casualty losses that aren't covered by insurance.
Payments received for easement or right-of-way granted.
Deferred gain(s) on previous home sales.
Depreciation claimed after May 6, 1997 if you used your home for business or rental purposes.
Recordkeeping
In order to document your home's basis, it is wise to keep the records that substantiate the basis of your residence such as settlement statements, receipts, canceled checks, and other records for all improvements you made. Good records can make your life a lot easier if the IRS ever questions your gain calculation. You should keep these records for as long as you own the home. Once you sell the home, keep the records until the statute of limitations expires (generally three years after the date on which the return was filed reporting the sale)
The Internet has taken investing to a whole different level: inexpensive online trading and real-time stock market data have made many of us 'armchair investors'. As you actively manage your investments, you will no doubt incur additional expenses. Many of these expenses are deductible investment expenses.
The Internet has taken investing to a whole different level: inexpensive online trading and real-time stock market data have made many of us 'armchair investors'. As you actively manage your investments, you will no doubt incur additional expenses. Many of these expenses are deductible investment expenses.
Tax law allows taxpayers to deduct investment expenses if those expenses are ordinary and necessary for the production or collection of income, or for the management, conservation or maintenance of property held for the production of income.
What are investment expenses? Investment expenses are any expenses that you incur as you manage your investments. Some of these expenses are deductible (e.g. professional fees you paid related to investment activities; custodian fees, safe deposit rental; and subscriptions to investment-oriented publications), and some are not (e.g. costs related to tax-exempt securities; trading commissions (these increase the basis of the investment); and certain convention/seminar costs).
Who can deduct investment expenses? Investment expenses can be deducted by most individuals on their personal income tax returns. How these expenses are claimed depends on what type of investor a person is. Generally, investors fall into two categories: casual investor and professional trader.
Casual Investor
This category of investor describes most people actively managing their own investments. Investment expenses (except interest) are claimed on the taxpayer's return as miscellaneous itemized deductions. These expenses can be deductible on the return to the extent that they, when added to other "miscellaneous itemized deductions", exceed 2% of your adjusted gross income (AGI). The actual tax benefits derived from these excess miscellaneous itemized deductions may be further reduced due to AGI limitations for all itemized deductions and the alternative minimum tax (AMT).
In addition to the expenses noted above, if you use your computer extensively in the management of your investments, there are some other expenses to be aware of:
Online fees: You may deduct the portion of your monthly charges paid to your Internet Service Provider (ISP) incurred to manage your investments. If you subscribe to additional online services geared towards investors (e.g. The Wall Street Journal Interactive Edition) where you can follow your investments, these fees are also deductible investment expenses. Trading fees paid to online brokerages (e.g. E*Trade) are not currently deductible but are added to the basis of your investment, which will result in a reduced gain (or increased loss) upon disposition of the asset.
Software: If you purchase software that helps you manage and/or track your investments, the cost of the software may be depreciated over three years, and written off completely in the year of obsolescence. Programs that are useful for one year or less should be expensed in the year purchased, rather than depreciated.
Depreciation: Since the casual investor's investment-related use of a personal computer (and related equipment) is probably less than 50%, the cost of this equipment must be depreciated over five years using the straight-line method. The Section 179 expense deduction is not available for this type of investor.
A word of caution for self-employed individuals: if you use your home office for both business and investment purposes, you run the risk of losing your home office deduction for business purposes. A home office deduction is not available for the investment-related expenses for the casual investor. To claim a deduction for a home office for business purposes, your home office must be used exclusively for business; if you are performing investment activities in the same office space, you've just violated the "exclusive use" test.
Professional Trader
A professional trader is defined by the courts someone in between a dealer and an investor. A professional trader is a person that conducts trading activity focusing on short-term investments in large volumes on a regular and consistent basis, receives no compensation for his services, and does not have any customers. Participating in an investment club or partnership does not qualify a person as a professional trader.
If you meet the tough definition of a professional trader, you will be treated as a self-employed individual and all your investment expenses may be claimed on Schedule C of your return. You can also deduct all of your home office expenses, and you can claim Section 179 expenses for computers and other equipment used more than 50% in your business as a professional trader.
Below is a list of questions and answers to some of the basic topics you come across when reporting the sale of stock. Stock basis, holding periods, wash sale rules and sales of mutual funds are just a few of the items clarified.
Below is a list of questions and answers to some of the basic topics you come across when reporting the sale of stock.
Is stock a capital asset?
As a general rule, any property that is owned and used by an individual for either personal or investment purposes is a capital asset. Some examples of this can be homes, furniture, cars, stocks and bonds. A sale of most capital assets will require reporting to the Internal Revenue Service (IRS) on your tax return. Losses on the sale of personal items, such as a car, furniture or personal residence, are not deductible, but may still be reportable.
What is a "holding period"?
Gains and losses on sales of stock need to be categorized as either long-term or short-term holding periods depending upon the length of time the stock is held. The date of disposition, called the trade date, is the date used for the sale. A short-term holding period would be defined as less than 1 year from date of purchase to date of sale. A long-term holding period would be one year or more.
What is meant by "stock basis"?
The cost of your stock is usually the basis. This will include commissions and recording or transfer fees. The basis of inherited stock is its fair market value (FMV) at the date of the decedent's death (unless a federal estate tax return was filed and an alternate valuation date chosen). To determine the basis of stock you receive as a gift, you must know the adjusted basis in the hands of the donor just before it was given to you, its FMV at the time it was given to you, and the amount of gift tax, if any, paid on it.
Do I need to save the purchase confirmations when I buy stock?
Yes! This helps support your documentation showing the purchase date, price and expenses. With mutual funds and stocks, it is important to keep the last statement of the year as this normally provides a summary for the year of all purchases, dividend reinvestments, etc.
What amount do I report as my sales price?
If you sold your stock through a broker, you should receive Form 1099-B, Statement for Recipients of Proceeds From Broker and Barter Exchange Transactions, by February 1 of the year following the year the transaction occurred. The amount reported to you on Form 1099-B as gross proceeds will usually consists of the total proceeds of the sale less any commissions or fees incurred on the sale. If, for some reason the amount reported as "Gross Proceeds" does not take into account any commissions or fees paid, you should add these selling expenses to the basis of the stock sold.
How important is Form 1099-B?
The amount reported on Form 1099-B is entered into the IRS computer and "matched" against the amount reported on your tax return. As a result, Form 1099-B is very important if you wish to avoid any further correspondence and/or inquiry by the IRS.
What is a wash sale?
A wash sale occurs when you sell a specific stock and, within 30 days before or after the sale, you purchase substantially identical stock. Losses from wash sales are not deductible, but are used to figure the basis of the new stock. Any gain, however, is taxable.
Is there a limit on the amount of capital loss I can deduct?
Yes. If, after combining all your capital gains and losses for the year you end up with a net capital loss, the maximum loss you may deduct would be limited to $3,000 per year ($1,500 if you are married and file a separate return). Net losses in excess of $3,000 can be carried forward to the following years until they are used up.
I frequently switch from one mutual fund to another. Do I have to report these transactions on my tax return?
Yes! If you sell or exchange shares of a mutual fund with a fluctuating share price, the IRS considers the transaction a taxable event, just like the sale of stock. You must calculate a capital gain or loss for each sale or exchange -- whether made by telephone, wire, mail or even a check. You should receive a Form 1099-B for each transaction.
Calculating gain or loss on the sale of mutual fund shares can be quite complex. Please feel free to contact the office for additional information regarding the different methods available for determining basis in your mutual funds.