Rental Property and the Tax Gap

Rental Property and the Tax Gap

FS-2007-21, July 2007 Not reporting or under-reporting rental income contributes to the tax gap. Landlords need to be aware of everything that counts as income so they pay their fair share of taxes. They also need to be aware of all deductible expenses so they don’t overpay their taxes. This fact sheet is the 14th in a series to help reduce the tax gap by helping taxpayers better understand the tax code. The tax gap is the difference between the amount of taxes that should be paid in a given year and the amount actually paid voluntarily and in a timely way. Rental Income In the simplest terms, rental income is any payment received for the use or occupation of property. Most landlords operate on a cash basis. That means they count payments as income in the period they are received and deduct expenses in the period they are paid. Landlords also need to be aware of other forms of rental income that may need to be declared. Rental income may also include: Advance rent payments Early-termination fees on lease agreements Expenses paid by tenant for the landlord (These may also be deductible as rental expenses.) Property or services received in lieu of money (This is based on the fair market value of the property or services.) Lease payments with option to buy (These payments are usually counted at rental income. If the tenant buys the property, payments received after the sale date are generally counted as part of the selling price.) Payments for renting a portion of your home may or may not be taxable income depending on certain thresholds. See IRS Publication 527, Residential Rental Property. Security deposits are not counted as income if they are to be refunded at the end of a lease period per an agreement. Landlords sometimes retain portions of security deposits because tenants don’t live up to the terms of a lease. Any funds withheld from a deposit are counted as income in the year they are retained. Deposits used as final lease payments are considered advance rents and counted as income in the period they are received. Rental Expenses Landlords can deduct the ordinary and necessary expenses for managing, conserving, and maintaining their rental property. Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities and insurance. Other deductible expenses may include: Expenses incurred from the time a property is made available for rent and is actually rented. Some or all of the original investment in the rental property may be recovered through depreciation using Form 4562, Depreciation and Amortization. Subsequent improvements may also be depreciated. The cost of repairs may also be deductible. This may include the cost of labor and materials. However, landlords cannot deduct the value of their own labor. Improvements that add to the value of a property or prolong its useful life are considered capital expenses and generally must be depreciated. Discussion about whether an expense is an improvement or a repair is included in Publication 946, How to Depreciate Property. Expenses may be deductible on rental property also used for personal use, but only on a proportional basis. Landlords are permitted to use any reasonable method for calculating what portion of a property should be considered rental. Using square footage is a common method and frequently the most accurate. Some property is rented out at times and used for personal use other times, such as a beach house. In this case, deductible expenses must be calculated based on the number of days the property is used for each purpose. Deductible rental expenses can not exceed gross rental income for property used for both personal use and as a rental in a given year. Expenses incurred while property is vacant but available for rent may be deductible. Lost rental income while a property is vacant is not deductible. Information on other rental expenses and reporting requirements is available in Publication 527. Related Item: The Tax Gap

Reporting Farm Income and Expenses

Reporting Farm Income and Expenses

FS-2007-20, June 2007 To educate taxpayers about their filing obligations, this fact sheet, the thirteenth in a series, highlights some income sources and deductible business expenses of farmers. Incorrect reporting of farm income and expenses accounts for part of the estimated $345 billion per year in unpaid taxes, according to IRS estimates. Income Sources Farmers may receive income from many sources, but the most common source is the sale of livestock, produce, grains, and other products raised or bought for resale. The entire amount a farmer receives, including money and the fair market value of any property or services, is reported on IRS Schedule F, Profit or Loss From Farming. Bartering is another income source for farmers. Bartering occurs when farm products are traded for other farm products, property, someone else’s labor or personal items. For example, if a farmer helps another farmer build a barn and receives a cow for his work, the recipient of the cow must report its fair market value as ordinary income. If the farmer uses this cow for business purposes, he may be able to claim depreciation over its useful life as well as deduct the expenses incurred for the cow. However, if the cow is for personal use, no depreciation or expenses for the cow would be deductible. Other income sources include: Cooperative distributions Agricultural program payments Commodity Credit Corporation (CCC) loans Crop insurance proceeds and federal crop disaster payments Custom hire (machine work) income Deductible Expenses The ordinary and necessary costs of operating a farm for profit are deductible business expenses. An ordinary expense is an expense that is common and accepted in the business. A necessary expense is one that is appropriate for the business. Among the deductible expenses are amounts paid to farm labor. If a farmer pays his child to do farm work and a true employer-employee relationship exists, reasonable wages or other compensation paid to the child is deductible. The wages are included in the child’s income, and the child may have to file an income tax return. These wages may also be subject to social security and Medicare taxes if the child is age 18 or older. Another deductible expense is depreciation. Farmers can depreciate most types of tangible property –– except land –– such as buildings, machinery, equipment, vehicles, certain livestock and furniture. Farmers can also depreciate certain intangible property, such as copyrights, patents, and computer software. To be depreciable, the property must Be property the farmer owns Be used in the farmer’s business or income-producing activity Have a determinable life Have a useful life that extends substantially beyond the year placed in service Some expenses paid during the tax year may be partly personal and partly business. Examples include gasoline, oil, fuel, water, rent, electricity, telephone, automobile upkeep, repairs, insurance, interest and taxes. Farmers must allocate these expenses between their business and personal parts. Generally, the personal part of these expenses is not deductible. For example, a farmer paid $1,500 for electricity during the tax year. He used one-third of the electricity for personal purposes and two-thirds for farming. Under these circumstances, two-thirds of the electricity expense, or $1,000, is deductible as a farm business expense. Records must be maintained to document the business portion of the expense. Information about other deductible expenses and reporting requirements can be found in IRS Publication 225, Farmer’s Tax Guide.

Reporting Capital Gains

Reporting Capital Gains

FS-2007-19, May 2007 In order to educate taxpayers about their filing obligations, this fact sheet, the twelfth in a series, provides information with regard to capital gains reporting. Incorrect reporting of capital gains accounts for part of an estimated $345 billion per year in unpaid taxes, according to Internal Revenue Service estimates. Almost everything you own and use for personal purposes, pleasure, business or investment is a capital asset, including: Your home Household furnishings Stocks or bonds Coin or stamp collections Gems and jewelry Gold, silver or any other metal, and Business property Understanding Basis The difference between the amount for which you sell the capital asset and your basis, which is usually what you paid for it, is a capital gain or a capital loss. You have a capital gain if you sell the asset for more than your basis. You have a capital loss if you sell the asset for less than your basis. Your basis is generally your cost plus improvements. You must keep accurate records that show your basis. Your records should show the purchase price, including commissions; increases to basis, such as the cost of improvements; and decreases to basis, such as depreciation, non-dividend distributions on stock, and stock splits. While all capital gains are taxable and must be reported on your tax return, only capital losses on investment or business property are deductible. Losses on sales of personal property are not deductible. More information about increases and decreases to basis can be found in Publication 551, Basis of Assets. Schedule D Capital gains and deductible capital losses are reported on Form 1040, Schedule D, Capital Gains and Losses, and then transferred to line 13 of Form 1040, U.S. Individual Income Tax Return. Capital gains and losses are classified as long-term or short term. If you hold the asset for more than one year, your capital gain or loss is long-term. If you hold the asset one year or less, your capital gain or loss is short-term. To figure the holding period, begin counting on the day after you received the property and include the day you disposed of the property. You may have to make estimated tax payments if you have a taxable capital gain. Refer to Publication 505, Tax Withholding and Estimated Tax, for additional information. Other Rules Home –– If you sell your residence, you may be able to exclude from income any gain up to a limit of $250,000 ($500,000 on a joint return in most cases). To exclude the gain, you must have owned and lived in the property as your main home for at least 2 years during the 5-year period ending on the date of sale. Generally, you cannot exclude gain on the sale of your home if, during the 2-year period ending on the date of the sale, you sold another home at a gain and excluded all or part of that gain. If you cannot exclude gain, you must include it in income. To determine the maximum dollar limit you can exclude and for additional information, refer to Publication 523, Selling Your Home. You cannot deduct a loss on the sale of your home. Property outside U.S. –– U.S. citizens who sell property located outside the United States must also report gains from these sales, unless the property is exempt by U.S. law. Reporting is required whether you reside inside or outside the United States and whether or not you receive a Form 1099 from the payer. Installment sales –– If you sold property (other than publicly traded stocks or securities) at a gain and will receive any payments in a year after the year of sale, you generally must report the sale on the installment method using Form 6252, Installment Sale Income. You can elect out of the installment method by reporting the entire gain in the year of sale. Investment Transactions –– Gains from sales and trades of stocks, bonds, or certain commodities are usually reported to you on Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, or an equivalent statement. Your basis, the sales price, and the resulting capital gain or loss is entered on Form 1040, Schedule D, Capital Gains and Losses. Gains from the sale of business property are reported on Form 4797, Sales of Business Property and flow to Form 1040, Schedule D. See Publication 544, Sales and Other Dispositions of Assets for additional information on the sale of business property. Capital gain distributions from mutual funds are reported to you on Form 1099-DIV, Dividends and Distributions. Capital gain distributions are taxed as long-term capital gains regardless of how long you have owned the shares in the mutual funds. If capital gain distributions are automatically reinvested, the reinvested amount is the basis of the additional shares purchased. For additional information about reporting gains from investments see Publication 17, Your Federal Income Tax; Publication 550, Investment Income and Expenses; and Publication 564, Mutual Fund Distributions. Answers to Frequently Asked Questions about capital gains may also be helpful.

Business or Hobby? Answer Has Implications for Deductions

Business or Hobby? Answer Has Implications for Deductions

FS-2007-18, April 2007 The Internal Revenue Service reminds taxpayers to follow appropriate guidelines when determining whether an activity is a business or a hobby, an activity not engaged in for profit. In order to educate taxpayers regarding their filing obligations, this fact sheet, the eleventh in a series, explains the rules for determining if an activity qualifies as a business and what limitations apply if the activity is not a business. Incorrect deduction of hobby expenses account for a portion of the overstated adjustments, deductions, exemptions and credits that add up to $30 billion per year in unpaid taxes, according to IRS estimates. In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business. Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit. In order to make this determination, taxpayers should consider the following factors: Does the time and effort put into the activity indicate an intention to make a profit? Does the taxpayer depend on income from the activity? If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business? Has the taxpayer changed methods of operation to improve profitability? Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business? Has the taxpayer made a profit in similar activities in the past? Does the activity make a profit in some years? Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity? The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year — at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses. If an activity is not for profit, losses from that activity may not be used to offset other income. An activity produces a loss when related expenses exceed income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations. Deductions for hobby activities are claimed as itemized deductions on Schedule A (Form 1040). These deductions must be taken in the following order and only to the extent stated in each of three categories: Deductions that a taxpayer may take for personal as well as business activities, such as home mortgage interest and taxes, may be taken in full. Deductions that don’t result in an adjustment to basis, such as advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category. Business deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories. Link: Further information is available in IRS Publication 535, Business Expenses

FS-2007-17, March 2007

The Internal Revenue Service has issued a number of educational fact sheets reminding taxpayers to know the rules for deducting several specific business expenses. This fact sheet, the tenth in the series, reminds taxpayers to follow appropriate guidelines when deducting expenses that fall under the category of “Other” on the Schedule C, Profit or Loss from Business.

“Other” business expenses account for just part of the overstated adjustments, deductions, exemptions and credits that add up to $30 billion per year in unpaid taxes, according to IRS estimates.

In general, taxpayers may deduct ordinary and necessary expenses incurred in conducting a trade or business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business. Although many common expenses are deducted on designated lines of the tax schedule, some expenses may not fit into a particular category. Taxpayers can deduct these as “other” expenses. A breakdown of “other” expenses must be listed on line 48 of Form 1040 Schedule C. The total is then entered on line 27.

Examples of “other” expenses include:

• Amortization of certain costs, such as pollution-control facilities, research and experimentation, and intangibles including goodwill.
• Bad debts. Business bad debts must be directly related to sales or services provided by the business, must have been previously included in income and must be worthless (non-recoverable). If a taxpayer deducts a bad debt expense and later recovers it, the amount must be included in income in the year collected.
• Business start-up costs. These are costs related to creating an active trade or business, or investigating the creation or acquisition of an active trade or business. Generally these costs are amortized. However, taxpayers who started a business in 2006 may elect to deduct up to $5,000 of certain start up costs, subject to limitations. Refer to chapter 7 of Publication 535, Business Expenses, for more information.
• Gulf Opportunity (GO) Zone clean-up costs. Fifty percent of qualified clean-up costs for the removal of debris from, or the demolition of structures on, real property located in the GO Zone which are paid or incurred in 2006 are deductible as “other” expenses. The property must be held for use in a trade or business, for the production of income, or as inventory.

Personal, living and family expenses, do not qualify as deductible “other” business expenses.

Further information is available in IRS Publication 535, Business Expenses.

Link:

• IRS Publication 535, Business Expenses ( html, pdf)

Revisions to Form 656, Offer in Compromise

Revisions to Form 656, Offer in Compromise

FS-2007-16, March 2007 The Internal Revenue Service (IRS) has announced the release of Form 656, Offer in Compromise, revision February 2007. The Form 656 package was last revised in 2004 to help taxpayers correctly and completely prepare an offer and reduce the chances of an offer being returned for omissions. The new form retains the taxpayer burden reduction features while adding significant changes as a result of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). These changes include: New payment terms and submission rules; Processability checklist, redefined as a result of TIPRA, which assists taxpayers in determining up front if they are eligible for an offer before investing any preparation time; A new matrix to assist in determining the number of Forms 656, $150 application fee(s), and TIPRA payments to submit to the IRS depending on the number of individuals submitting the offer and the types of liabilities being compromised; A checklist which reduces the chance that the application will be returned by the IRS for omissions, as well as a reminder of the necessary documents to include with the application prior to its submission to IRS; Revised Section V which defines the terms of the offer; OIC Application Fee and Payment Worksheet to determine eligibility for claiming exception to the payment of the $150 application fee and TIPRA payments; Form 656-A, renamed Income Certification for OIC Application Fee and Payment; and Form 656-PPV Offer in Compromise Periodic Payment Voucher. Outlined below is a summary of the major procedural changes implemented as a result of TIPRA and now reflected on the Form 656 revision. In addition, some of the form’s key features are also summarized. Procedural Changes 1. Form 656–L: Doubt as to Liability The February 2007 revision no longer contains a category block for Doubt as to Liability offers. A taxpayer wishing to file a Doubt as to Liability offer will need to complete Form 656-L (Revised January 2006) when claiming that all or part of the assessed tax liability is incorrect. Form 656–L must reflect the amount which the taxpayer believes is the correct amount of the tax liability after credits and payments. This amount must be more than zero and cannot include a refund that is owed to the taxpayer or amounts that have already been paid. A taxpayer must also attach a detailed written statement explaining why it is believed that the tax is incorrect, and include any documentation or evidence to support the claim. Form 656–L also contains information which explains when the form is inappropriate for use, as well as provides the taxpayer with other collection remedies that are less complex than an offer in compromise. Form 656–L, along with the taxpayer’s written statement and any supporting documents, should be mailed to: Brookhaven Internal Revenue Service, COIC Unit, P.O. Box 9088, Holtsville, NY 11742-9008. Taxpayers may obtain Form 656–L by calling the IRS toll free number at 1-800-829-3676, visiting their local IRS office or on this Web site. 2. Doubt as to Liability Offers cannot be filed concurrently to request consideration under a different basis. In the 2004 version of the Form 656, a taxpayer had an option to submit a Doubt as to Liability offer either separately or in combination with a Doubt as to Collectibility or Effective Tax Administration offer. This is no longer an option. A taxpayer will now be required to file a Form 656–L when it is believed that the tax liability is incorrect. Form 656 should be filed only when there is doubt as to collectibility that the tax liability could ever be paid in full, or under the basis of Effective Tax Administration (ETA). A taxpayer is no longer able to file offers concurrently claiming both that the tax liability is incorrect along with the inability to pay it. 3. New rules for offer submissions and processability criteria The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) created major changes to the IRS OIC program. These changes affect all offers received by the IRS on or after July 16, 2006. The legislation amended Section 7122 by adding a new subsection (c) “Rules for Submission of Offers in Compromise.” Form 656 now contains information concerning these rules as they relate to doubt as to collectibility and ETA offers, as well as the new criteria that is used to determine whether these offers are assigned for investigation or returned back to the taxpayer as not processable. Listed below is a synopsis concerning the rules governing the submission of these types of offers and the new processability criteria: Rules for Submission a. Lump sum cash offer — An offer in which the offer amount is paid in five or fewer installments upon written notice of acceptance. Twenty percent of the total amount of the offer must be paid with the Form 656. If the installments will be paid in five months or less, the taxpayer should offer the “realizable value” of his assets plus the total that could be collected over 48 months of payments (or the remainder of the statutory period for collection, whichever is less). If the installment payments will be paid in more than five months, the taxpayer should offer the realizable value of his assets plus the total that could be collected over 60 months of payments (or the remainder of the statutory period for collection, whichever is less). Note: “Realizable value” is defined as the quick sale value (amount that a taxpayer could reasonably expect from the sale of an asset if sold quickly, typically in 90 days or less) minus what the taxpayer owes a secured creditor. b. Short Term Periodic Payment Offer — An offer in which the taxpayer must submit the first payment with the offer and must continue to make regular payments during the offer investigation. The offer amount must be paid within six to 24 months from the date the IRS receives Form 656. The offer amount must reflect the taxpayer’s realizable value of assets plus the amount that could be collected over 60 months of payments (or the remainder of the statutory period of collection, whichever is less). Failure to make the periodic payments during the offer investigation will cause the offer to be treated as a withdrawal. c. Deferred Periodic Payment Offer — An offer in which the amount must be paid over the remaining statutory period for collecting the tax. As with the short term periodic payment offer, the taxpayer must submit the first payment along with Form 656, and must continue to make regular payments during the offer investigation. The offer amount must reflect the taxpayer’s realizable value on assets, plus the amount that could be collected through monthly payments during the remaining life of the collection statute. Failure to make the periodic payments during the offer investigation will cause the offer to be treated as a withdrawal. d. Taxpayers may designate in writing how the IRS should apply the payments made while the offer is under investigation by specifying how the payment(s) are to be applied to specific taxable years or periods and to the type of tax. Without a written designation request, the IRS will apply the payments in the best interest of the government. The $150 application fee reduces the assessed tax or other amounts due and cannot be designated by the taxpayer. e. All offer payments are considered “payments on tax” and are not refundable regardless of whether the IRS declares the offer not processable or later returns, rejects, withdraws, or terminates the offer as a result of its investigation. When this happens, the IRS will apply the payment(s) to the taxpayer’s outstanding liability. f. A taxpayer who has an approved installment agreement payment plan with the IRS and is making payments under this plan may stop remitting the installment payments at the time that a short term or deferred periodic payment offer is filed. However, this procedure does not apply to lump sum cash offers. A taxpayer that submits a lump sum cash offer and is currently making installment agreement payments must continue to make the installment agreement payments until the offer is accepted. If it not accepted, the installment agreement payments must continue. Processability Criteria As a result of TIPRA legislation, the IRS revised the offer processability criteria. In order for a Form 656 to be declared processable and assigned for investigation, a taxpayer must now meet the following criteria: Is not a debtor in an open bankruptcy proceeding; Submitted the $150 application fee, or Form 656-A, Income Certification for Offer in Compromise Application Fee and Payment; Submitted 20 percent payment with the lump sum offer, or a signed Form 656-A, Income Certification for Offer in Compromise Application Fee and Payment; and Submitted the first installment payment on a short term or deferred periodic payment offer, or a signed Form 656-A, Income Certification for Offer in Compromise Application Fee and Payment. Before the IRS will begin to investigate an OIC, the taxpayer must be current on filing all tax returns, estimated tax payments and federal tax deposits. Form 656 — Key Features 1. New guidelines for defining a low-income taxpayer for purposes of determining exception to application fee and TIPRA initial payment Prior to the issuance of the new Form 656 version, IRS defined a low-income taxpayer as an individual whose income falls at or below poverty levels based on standards established by the U.S. Department of Health and Human Services (HHS). The IRS has established new guidelines to determine eligibility for this waiver. Based on the new guidelines, a low-income taxpayer is one whose income falls at or below 250 percent of the 2006 HHS Poverty Guidelines. These new standards are incorporated into the IRS OIC Monthly Low Income Guidelines. These new guidelines are effective with the revision of the Form 656. Under the Notice 2006-68, taxpayers qualifying as low-income or filing Form 656-L based on doubt as to liability, qualify for a waiver of the 20 percent payment on a lump sum offer, or the required payment on a short term or deferred periodic payment offer. In addition, the waiver also exempts a taxpayer from the payment of the $150 application fee. The waiver for taxpayers qualifying as low-income applies solely to individuals and does not apply to other entities such as corporations or partnerships. 2. New worksheet to determine eligibility for claiming exception to the payment of the $150 application fee and TIPRA initial payments The OIC in Compromise Application Fee and Payment Worksheet is designed to assist a taxpayer in determining eligibility for the low-income waiver. The worksheet also clarifies Item 2 to reflect Total Household Monthly Income, and now requires self-employed individuals to adjust their total monthly income in Item 2. 3. Certification of eligibility for waiver of application fee and first TIPRA payment The new Form 656 also contains Form 656-A, renamed Income Certification for Offer in Compromise Application Fee and Payment. Taxpayers claiming the low-income exception must complete Form 656 and attach Form 656-A and the OIC Application Fee and Payment Worksheet. All three documents must be submitted to the IRS at the same time. Eligibility for the low-income waiver exempts a taxpayer from paying the $150 application fee and all other required TIPRA payments. 4. Payment Voucher The new revision now includes Form 656-PPV, Offer in Compromise Periodic Payment Voucher, which is a removable form designed to be used by a taxpayer to remit to the IRS the required short term or deferred periodic payments while the offer is under investigation. The form contains a section which gives the taxpayer the option to designate a specific tax liability where the payment should be applied. It also contains instructions to assist in its completion, as well as the proper address to mail the payments as it is different from the address location which was used to file the original Form 656 application. Form 656-PPV should be mailed to the IRS accompanied by a check or money order payable to the “United States Treasury.” Taxpayers should not send cash. 5. Revised Section V defines the terms of the offer Form 656, Section V, defines the terms of an Offer in Compromise. Listed below is a summary of the new terms: Section V (a) — outlines that TIPRA payments are not refundable even if the taxpayer were to withdraw the offer prior to acceptance or the IRS were to return, or reject the offer. Section V (b) — outlines that all payments made while the offer is under investigation will be applied to the tax liability unless the taxpayer specifies in writing that they be treated as a deposit. Only amounts that exceed the mandatory TIPRA payments can be treated as a deposit. Such a deposit will be refundable if the offer is rejected or returned by the IRS or is withdrawn by the taxpayer. The IRS will not pay interest on the deposit. Section V (c) — outlines that the $150 application fee will be kept by the IRS unless the offer is declared not processable. The new Form 656 can be obtained by calling IRS toll free l-800-829-3676 (1-800-TAX-FORM), visiting your local IRS office, or on this Web site by searching under Offer in Compromise or OIC. Related Items: Form 656, Offer in Compromise Form 656-A, Income Certification for OIC Application Fee and Payment Form 656-L (Doubt as to Liability) Form 656-PPV, Offer in Compromise Periodic Payment Voucher Payment Plans, Installment Agreements Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) IR-2007-50, IRS Revises Form 656, Offer in Compromise

Foreign Financial Accounts Reporting Requirements

Foreign Financial Accounts Reporting Requirements

FS-2007-15, February 2007 With the globalization of the economy, more and more people in the U.S. have foreign financial accounts. While there are many legitimate reasons to own foreign financial accounts, there are also responsibilities that go along with owning such accounts. Foreign account owners must remember that they may have to report their accounts to the government, even if the accounts do not generate any taxable income. Who is required to report their foreign accounts to the government, and how do they do so? The Bank Secrecy Act requires U.S. persons who own a foreign bank account, brokerage account, mutual fund, unit trust, or other financial account to file a Form TD F 90-22.1, Report of Foreign Bank and Financial Authority (FBAR), if: The person has financial interest in, signature authority, or other authority over one or more accounts in a foreign country, and The aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year. A U.S. person is: A citizen or resident of the United States, or Any domestic legal entity such as a partnership, corporation, estate or trust. A foreign country includes all geographical areas outside the United States, the Commonwealth of Puerto Rico, the Commonwealth of the Northern Mariana Islands, and the territories and possessions of the United States (including Guam, American Samoa, and the United States Virgin Islands). An account in an institution known as a United States “military banking facility” is not considered to be an account in a foreign country. The FBAR is not an income tax return and should not be mailed with any income tax returns. The FBAR must be mailed on or before June 30 of the following year to: U.S. Department of the Treasury, P.O. Box 32621, Detroit, MI 48232-0621. Unlike with federal income tax returns, requests for an extension of time to file an FBAR are not granted. A person having signature or other authority over, but no financial interest in, a foreign financial account may be excepted from filing an FBAR if they are an officer or employee of a federally-regulated bank or a federally-regulated publicly traded corporation. See the FBAR instructions for more information about this exception. Why is it important to file the FBAR? The FBAR is required because foreign financial institutions that do not conduct business in the United States may not be subject to the same reporting requirements that domestic financial institutions are subject to (such as the requirement to file a Form 1099 to report interest paid to an account holder). Although there are legitimate purposes for having a foreign account, the FBAR is a tool to help the U.S. government identify persons who may be using foreign financial accounts to circumvent U.S. law. Such individuals may be participating in economic crimes such as income tax evasion or embezzlement, or they may be trying to fund other illegal activity like drug trafficking or even terrorist activities. Also, there are serious consequences for foreign account holders who choose not to honor their FBAR filing requirements. Account holders who do not comply with the FBAR reporting requirements may be subject to civil penalties, criminal penalties or both. For an FBAR violation occurring after Oct. 22, 2004, the maximum civil penalty for a willful violation of the FBAR reporting and recordkeeping requirements is the greater of $100,000 or 50% of the balance in the account at the time of the violation. Non-willful violations can result in a penalty as high as $10,000 for each violation. Criminal violations of the FBAR rules can result in a fine and/or five years in prison. More information on FBAR filing exceptions can be obtained on this Web site, the Money Services Businesses’ Web site at www.msb.gov and the Financial Crimes Enforcement Network’s Web site at www.fincen.gov. Help in completing Form TD F 90-22.1 is available at 1-800-800-2877, option 2. The form is available online at www.irs.gov and www.msb.gov or may be ordered by telephone at 1-800-829-3676. Questions regarding the FBAR may also be sent to FBARquestions@irs.gov.

Deducting Rent and Lease Expenses

Deducting Rent and Lease Expenses

FS-2007-14, February 2007 The Internal Revenue Service reminds taxpayers to follow specific guidelines when deducting rent and lease expenses incurred as part of a trade or business. In order to educate taxpayers regarding their filing obligations, this fact sheet, the ninth in a series, explains the rules for deducting these expenses. Rent and lease expenses account for just part of the overstated adjustments, deductions, exemptions and credits that add up to $30 billion per year in unpaid taxes, according to IRS estimates. In general, taxpayers may deduct ordinary and necessary expenses for renting or leasing property used in a trade or business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business. Rented or leased property includes real estate, machinery, and other items that a taxpayer uses in his or her business and does not own. Payments for the use of this property may be deducted as long as they are reasonable. However, special rules and limitations apply to business use of the taxpayer’s rented personal residence and leased automobiles. More information on these topics is in Publication 587, Business Use of Your Home and Publication 463, Travel, Entertainment, Gift, and Car Expenses. Conditional Sales Contract Sometimes payments are listed as “rent” when in reality they are actually for the purchase of the property. A conditional sales contract generally exists when at least part of the payments are applied toward the purchase or entitle the taxpayer to acquire the property under advantageous terms. Payments made under a conditional sales contract are not deductible as rent expense but qualify for depreciation expense over the useful life of the asset. Chapter 4 of Publication 535, Business Expenses, discusses the circumstances under which a conditional sales contract generally exists. Capitalizing Rent Expenses Under certain conditions taxpayers who are in the business of producing real property or tangible personal property for resale, or who purchase property for resale, may not claim rental or lease expenses as a current deduction. Instead, they must include some or all of these costs in the basis of the property they produce or acquire for resale under the uniform capitalization rules. These costs are recovered when the property is sold. More information on this topic is in Publication 538, Accounting Periods and Methods. Business and Personal Use If a taxpayer has both business and personal use of rented or leased property he or she may deduct only the amount used for business. To compute the business percentage, compare the size of the property used for business to the entire size of the property. Use the resulting percentage to figure the business portion of the rent expense. Two commonly used methods for figuring the percentage are: Divide the area (length multiplied by width) used for business by the total area of the property. If the rooms in the property are all about the same size, divide the number of rooms used for business by the total number of rooms. Further Information Further information on this subject is available in the following IRS publications: Publication 535, Business Expenses Publication 587, Business Use of Your Home Publication 463, Travel, Entertainment, Gift, and Car Expenses Publication 538, Accounting Periods and Methods

Eligibility Rules Outlined for EITC

Eligibility Rules Outlined for EITC

FS-2007-13, February 2007 The Earned Income Tax Credit (EITC) is a tax credit for people who work but do not earn high incomes. The EITC is a valuable tool helping eligible taxpayers to lower their taxes or to claim a refund. The IRS wants all eligible taxpayers to claim this credit. Many taxpayers who qualify for EITC may also be eligible for free tax preparation and electronic filing by participating tax professionals and volunteers. Taxpayers and tax professionals should review the rules before attempting to claim the EITC. Do You Qualify for EITC? To qualify, you must meet certain requirements and file a U.S. Individual Income Tax Return. As described below, some EITC rules apply to everyone. There are also special rules for people who have children and for those who do not. Individuals and families must meet certain general requirements: You must have earned income. You must have a valid Social Security Number for yourself, your spouse (if married filing jointly) and your qualifying child. Investment income is limited to $2,800. Your filing status cannot be “married filing separately.” Generally, you must be a U.S. citizen or resident alien all year. You cannot be a qualifying child of another person. You cannot file Form 2555 or Form 2555-EZ (related to foreign earned income). Your income cannot exceed certain limitations. For Tax Year 2006, you must have adjusted gross income of less than: $36,348 ($38,348 if married filing jointly) with two or more qualifying children. $32,001 ($34,001 if married filing jointly) with one qualifying child. $12,120 ($14,120 if married filing jointly) with no qualifying children. If you claim a child, he or she must meet three eligibility tests: Residency Test — The child must have lived with you in the United Statesfor more than half of 2006. Relationship Test — The child must be your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, or a descendant of any of them. Your child includes: A foster child who was placed with you by an authorized placement agency, or by judgment, decree, or other order of any court of competent jurisdiction. A legally adopted child or a child lawfully placed with you for legal adoption Age test — At the end of 2006, the child must have been under age 19, a full-time student under age 24 or any age if permanently and totally disabled at anytime during 2006. Your qualifying child cannot be used by more than one person to claim EITC. If a child meets the rules to be a qualifying child of more than one person, only one person can treat that child as a qualifying child and claim EITC. If you don’t have a child, you must meet three additional tests: At the end of 2006, you must have been at least age 25, but under age 65. You cannot qualify as the dependent of another person. You must have lived in the United States for more than half of 2006. Credit Limits for 2006 Tax Year Income and family size determine the amount of the EITC. The Earned Income Credit Table, which shows the credit amounts, is included in the Instruction booklet for Form 1040 and in Publication 596, Earned Income Credit. For 2006, the maximum credit amounts are: Two or more children — $4,536 One child — $2,747 No children — $412 Combat Zone Pay Members of the military have the option to include their tax exempt combat zone pay when computing their earned income for EITC. The combat pay remains exempt for federal taxes. However, families should be aware that they must include all of the combat pay or none of it. For example, if the inclusion of combat pay would push a taxpayer’s adjusted gross income above the EITC income limit, taxpayers should leave it out of their EITC calculations. If, however, the inclusion of combat pay would enable a taxpayer to obtain a higher refund, then combat pay should be included. On-Line Tools If you are in doubt about your eligibility, you or your tax preparer may use the new EITC Assistant on the IRS Web site. The EITC Assistant, available in English and Spanish, will help you determine your eligibility by answering a few simple questions. For tax professionals, there is an electronic tool kit at www.eitcfortaxpreparers.com. Avoid Common Errors You are responsible for the accuracy of your tax return. The rules for EITC can be complicated, so you should seek assistance if you are unsure of your eligibility. Some common EITC errors are: Claiming a child who is not a qualifying child. Filing as “single” or “head of household” when the taxpayer actually is married. Reporting incorrect income amounts. Missing or Incorrect Social Security numbers — for both taxpayers and qualifying children. The IRS continues to work on ways to reduce these errors. If you receive a letter from the IRS requesting additional information about your EITC, please reply immediately to avoid delaying your EITC refund. If you need assistance or if you have questions, you should call the number included in the IRS letter. Beware of Scams A deliberate error can have lasting impact on your eligibility to claim EITC. Beware of scams that claim to increase your EITC refund. Scams that create fictitious qualifying children or inflate income levels to get the maximum EITC could leave you with a penalty. If your EITC claim was reduced or denied after tax year 1996 for any reason other than a mathematical or clerical error, you must file Form 8862, Information To Claim Earned Income Credit After Disallowance, with your next return if you wish to claim the credit. How to Claim EITC Publication 596, Earned Income Credit, explains the process. The publication is available at IRS.gov or by calling 1-800-829-3676. Pub. 596 also is available in Spanish. The Instructions for Form 1040 can help you determine your eligibility. The instructions contain a worksheet and the earned income credit table to help you determine the amount of your credit. If you are claming the EITC with a qualifying child, you must complete Schedule EIC and attach it to your tax return. Schedule EIC provides IRS with information about your qualifying children, including their names, ages, SSNs, relationship to you and the amount of time they lived with you during the year. How to Get Tax Help Taxpayers can find help in determining eligibility by using the new EITC Assistant on the IRS Web site. Taxpayers who qualify for EITC should explore available free tax preparation services. The IRS provides assistance to low-income taxpayers at more than 400 IRS offices nationwide. We also partner with local community and non-profit organizations to provide free tax return preparation for low-income and elderly taxpayers at more than 12,000 volunteer sites nationwide. Other options include the use of Free File, the free tax preparation and electronic filing program provided by software companies. Many e-file software providers and tax professionals also provide free services for low income taxpayers. To find a free tax site in your area, call the IRS at 1-800-906-9887. EITC recipients should remember they can get faster access to their refund by using direct deposit. If you use IRS e-file and direct deposit, you could have your refund in half the time of a paper return. Advance Earned Income Tax Credit If you received advance EITC payments in 2006, you must file a tax return to report the payments. Your W-2 form will report your advance EITC amount. You cannot use a Form 1040-EZ to report advance payments. The advance EITC payment program allows you to receive part of the credit through your employer. If you would like to participate for 2007, you must work and receive taxable wages. If you qualify for EITC and you have at least one qualifying child for 2006, give your employer a Form W-5, Earned Income Credit Advance Payment Certificate, and your employer will include part of the credit regularly in your pay. Related Items: IR-2007-24, Paulson, IRS Launch Campaign to Help Low-Income Taxpayers Take Advantage of Tax Credit, Free Tax Help EITC Press Kit IR-2007-23, Free Tax Help Available at Sites Nationwide

Tax Return Preparer Fraud

Tax Return Preparer Fraud

FS-2007-12, January 2007 Return preparer fraud generally involves the preparation and filing of false income tax returns by preparers who claim inflated personal or business expenses, false deductions, unallowable credits or excessive exemptions on returns prepared for their clients. This includes inflated requests for the special one-time refund of the long-distance telephone tax. Preparers may also manipulate income figures to obtain tax credits, such as the Earned Income Tax Credit, fraudulently. In some situations, the client (taxpayer) may not have knowledge of the false expenses, deductions, exemptions and/or credits shown on their tax returns. However, when the IRS detects the false return, the taxpayer — not the return preparer — must pay the additional taxes and interest and may be subject to penalties. The IRS Return Preparer Program focuses on enhancing compliance in the return-preparer community by investigating and referring criminal activity by return preparers to the Department of Justice for prosecution and/or asserting appropriate civil penalties against unscrupulous return preparers. While most preparers provide excellent service to their clients, the IRS urges taxpayers to be very careful when choosing a tax preparer. Taxpayers should be as careful as they would be in choosing a doctor or a lawyer. It is important to know that even if someone else prepares a tax return, the taxpayer is ultimately responsible for all the information on the tax return. Helpful Hints When Choosing a Return Preparer Be careful with tax preparers who claim they can obtain larger refunds than other preparers. Avoid preparers who base their fee on a percentage of the amount of the refund. Stay away from preparers who claim that many, if not most, phone customers can get hundreds of dollars or more back under the telephone tax refund program. Use a reputable tax professional who signs your tax return and provides you with a copy for your records. Consider whether the individual or firm will be around to answer questions about the preparation of your tax return months, or even years, after the return has been filed. Review your return before you sign it and ask questions on entries you don't understand. No matter who prepares your tax return, you (the taxpayer) are ultimately responsible for all of the information on your tax return. Therefore, never sign a blank tax form. Find out the person’s credentials. Only attorneys, CPAs and enrolled agents can represent taxpayers before the IRS in all matters including audits, collection and appeals. Other return preparers may only represent taxpayers for audits of returns they actually prepared. Find out if the preparer is affiliated with a professional organization that provides its members with continuing education and resources and holds them to a code of ethics. Ask questions. Do you know anyone who has used the tax professional? Were they satisfied with the service they received? Reputable preparers will ask to see your receipts and will ask you multiple questions to determine your qualifications for expenses, deductions and other items. By doing so, they are trying to help you avoid penalties, interest or additional taxes that could result from an IRS examination. Further, tax evasion is a risky crime, a felony, punishable by five years imprisonment and a $250,000 fine. Criminal Investigation Statistical Information on Return Preparer Fraud FY 2006 FY 2005 FY 2004 Investigations Initiated 197 248 206 Prosecution Recommendations 153 140 167 Indictments/Informations 135 119 121 Sentenced 109 118 90 Incarceration Rate* 89.0% 85.6% 84.4% Avg. Months to Serve 18 18 19 *Incarceration may include prison time, home confinement, electronic monitoring or a combination. Criminal and Civil Legal Actions Some return preparers have been convicted of, or have pleaded guilty to, felony charges. Additionally, the courts have issued 175 permanent injunctions against abusive tax scheme promoters and abusive return preparers since 2003. The following case summaries are excerpts from public record documents on file in the court records in the judicial district in which the legal actions were filed. California Tax Preparers Sentenced to Prison Terms for Operating Tax Fraud Schemes On Oct. 6, 2006, in San Diego, Calif., Susan E. O’Brien, a professional tax preparer who operated “The O'Brien Group,” was sentenced to ten years and five months in prison and ordered to pay $113,179 in restitution. She was convicted on May 2, 2006, for tax evasion, defrauding the United States and aiding and assisting in the filing of fraudulent tax returns. Co-defendants Robert Richard Evans and William Dean Cook were also sentenced to prison terms of 78 and 24 months, respectively. In July 2003, O'Brien, Evans, Cook and five others were charged in a 78 count indictment with various tax crimes related to tax years 1996-2002. According to the indictment and trial evidence, O'Brien prepared numerous income tax returns that claimed false business deductions and Evans promoted, sold and managed domestic trusts used by clients to hide their income and assets from the IRS. O'Brien also was convicted of evading the payment of tax on her own income. The tax evasion scheme resulted in a tax loss to the United States of more than $1 million. Two Sentenced for Preparing False Tax Returns On Sept. 20, 2006, in Monroe, La., Eddie Ferrand and William Kennedy were sentenced for aiding and assisting in the preparation of false income tax returns and conspiracy. Ferrand was sentenced to 60 months in prison to be followed by three years supervised release. Ferrand was also ordered to pay $255,890 in restitution to the IRS and a $900 assessment. Kennedy was sentenced to 27 months in prison to be followed by three years supervised release. Kennedy was also ordered to pay $39,020 in restitution to the IRS and an $800 assessment. According to the indictment, Ferrand, as the owner and operator of Mr. Ed’s Tax Service, hired, trained and supervised tax preparers employed at Mr. Ed’s, including co-defendant Kennedy. Ferrand, Kennedy and other co-defendants prepared income tax returns and amended prior year returns by inflating Schedule A deductions and creating false Schedule C businesses in order to increase taxpayer’s refund. The defendants prepared more than three thousand returns expanding over 26 states and generating refunds in excess of $6 million. Minnesota Tax Preparer Sentenced for Filing False Tax Returns On March 23, 2006, in Minneapolis, Minn., Richard Reiss was sentenced to 41 months in prison for aiding and assisting in the preparation of 84 false tax returns. Reiss was also ordered to pay a $7,500 criminal fine and $198,958 in back taxes. Reiss prepared tax returns for more than 30 clients and claimed fraudulent and false deductions such as unreimbursed employee business expenses, mileage expenses, meals and entertainment, charitable contributions, medical expenses and tax preparation fees, and business losses resulting from business expenses that were fabricated or inflated. In total, he overstated expenses and deductions for numerous clients by more than $1 million, which resulted in tax losses of about $198,000. Tax Preparer Who Used Bogus Business Losses to Wipe Out Clients’ Income Taxes Sentenced to 11 Years in Prison On Feb. 21, 2006, in Los Angeles, Calif., James Earl Wynn was sentenced to 11 years in federal prison following his April 22, 2005 conviction of 24 counts of aiding and advising in the preparation of false income tax returns. Evidence presented in court showed that Wynn solicited his clients by telling them that he operated a number of businesses in which they could invest. Wynn told his clients that if the businesses turned a loss, the clients could claim the loss on their tax return. As part of this arrangement, Wynn offered to prepare the clients’ tax returns charging his clients a percentage of their tax refunds in addition to a return preparation fee. Wynn did not tell his clients that many of the businesses listed on their tax returns did not exist at all. None of the businesses listed on their tax returns as part of the tax fraud scheme ever existed as a partnership, ever filed a partnership tax return or ever sustained the losses claimed on the taxpayers’ returns. Wynn caused more than 2,000 tax returns to be filed with the IRS claiming more than $75 million in false partnership losses. The tax loss to the government exceeded $10 million. On July 18, 2005, Linda M. Hall, who once worked for Wynn, was sentenced to 70 months imprisonment and was ordered to pay restitution of $6,339,023. Rockford Tax Preparer Sentenced to 56 Months in Federal Prison for Preparing False Tax Returns On Feb. 13, 2006, in Rockford, Ill., John H. Bell was sentenced to 56 months in prison, followed by one year supervised release, for preparing false federal income tax returns for others and for filing a false federal income tax return for himself. According to the indictment, Bell, the owner of Bell's Income Tax Service and of Real Estate Investors (REI) #2462, Inc., prepared false income tax returns for others. In order to support the returns, Bell attached W-2s to the returns that falsely stated the amounts of income the taxpayers received from REI and falsely stated the REI had withheld federal income tax from the taxpayers when, in fact, no such taxes had been withheld by Bell or his corporation. The indictment also charged that Bell filed an income tax return for himself that falsely stated that $8,360 in federal income tax had been withheld from him, when no federal income tax had been withheld by REI. As a result of his own false return, Bell wrongfully attempted to obtain a refund of $8,701. Former City of Houston Employee Sentenced to Prison On Jan. 27, 2006, in Houston, Tex., Jerome Harris was sentenced to 57 months in prison followed by one year supervised release. The judge further ordered that, effective immediately, Harris be prohibited from preparing tax returns or assisting tax payers in audits. Harris was convicted of 21 counts of willfully preparing fraudulent income tax returns for his clients in September 2005. Harris, a full time employee for the City of Houston, also owned and operated Jay’s Bookkeeping and Tax Service, located at his residence. It was found that Harris had prepared hundreds of false tax returns for the 1995 through 2000 tax years, resulting in claims for fraudulent tax refunds by his clients totaling almost $1.3 million. Michigan Man Sentenced For Preparing Tax Returns in Violation of Court Order On Feb. 16, 2006, in Grand Rapids, Mich., Robert L. Mosher, of Cedar Springs, Mich., was sentenced to 105 days in prison for contempt of court after violating injunctions that barred him from preparing tax returns for customers. Two injunctions were obtained after the Justice Department sued Mosher in 2003 for promoting a tax scheme involving sham trusts and preparing fraudulent returns understating customers’ tax liabilities. Mosher continued to prepare income tax returns after these orders were entered. Federal Court Permanently Shuts Down Louisiana Tax Preparer On April 18, 2006, Eddie Ferrand of Monroe, La., and two of his employees, Glenda Faye Elliott of Monroe, La., and William Nathaniel Kennedy of Rayville, La., were permanently barred from preparing tax returns. The court found that Ferrand, Elliott and Kennedy regularly understated customers’ tax liabilities, by claiming false dependents, reporting fictitious business expenses and deductions and inflating other deductions. Federal Judge Stops Tax Refund Fraud by Two Florida Tax Return Preparers On Aug. 8, 2006, a federal court permanently barred Jean-Marie Boucicaut and Marie Thelemarque of Orlando, Fla., and Boucicaut’s company, Tax Review Corporation, from preparing federal tax returns for others. The court found that the defendants filed amended income tax returns for persons without their authorization and directed the IRS to send the requested refund checks to them. Federal Court Bars Louisiana Tax Preparers from Claiming Inflated Deductions on Income Tax Returns On Oct. 5, 2006, in New Orleans, La., Rodney G. Bourg and Cynthia M. Bourg of Houma, La., were permanently barred from preparing federal income tax returns claiming inflated deductions or asserting unrealistic positions. The court found the Bourgs prepared federal income tax returns with improper per diem expense deductions for customers who worked as mariners, fishermen, merchant seamen and ferry workers. Where Do You Report Suspected Tax Fraud Activity? If you suspect tax fraud or know of an abusive return preparer, report this activity using IRS Form 3949-A, Information Referral. You can download Form 3949-A from this Web site or call 1-800-829-3676 to order by mail. Send the completed form, or a letter detailing the alleged fraudulent activity, to Internal Revenue Service, Fresno, CA 93888. Please include specific information about who you are reporting, the activity you are reporting and how you became aware of it, when the alleged violation took place, the amount of money involved and any other information that might be helpful to an investigation. Although you are not required to identify yourself, it is helpful to do so. Your identity can be kept confidential. You may also be entitled to a reward. Related Items: Form 3949-A, Information Referral Compliance & Enforcement Tax Scams/Consumer Alerts Standards of Practice for Tax Professionals

Electronic Payment Options for 2007

Electronic Payment Options for 2007

FS-2007-11, January 2007 Taxpayers can pay taxes electronically by authorizing an e-pay option such as an electronic funds withdrawal from a checking or savings account or by paying with a credit card. Taxpayers making recurring payments may want to enroll in EFTPS. Individuals can use these options to: pay taxes owed on a 2006 income tax return; pay projected tax due when requesting an automatic extension of time to file; pay quarterly estimated taxes for Tax Year 2007; or make a credit card payment for past due tax owed for years 1997 and after. Businesses can use these options to: authorize an electronic funds withdrawal to pay taxes owed on employment, corporate and fiduciary tax returns; authorize an electronic funds withdrawal to pay projected tax due when requesting an extension of time to file; make a credit card payment for taxes owed on employment tax returns (Form 940, 941 and 944). The payment can be made for the balance on the current return that is due; or make a credit card payment for past due tax owed for years 1997 and after (Form 940 and 941). Note, federal tax deposits cannot be paid by credit card. The IRS has entered into partnerships with private industry, including credit card processors and tax preparation software developers, to make these electronic payment options available. More than 3 million people paid their federal taxes by electronic funds withdrawal or credit card during 2006, an increase of 24 percent over the prior year. Electronic Funds Withdrawal Electronic funds withdrawal is free and taxpayers decide when the tax payment is scheduled to be withdrawn from their bank account. Electronic funds withdrawal is available only to those who e-file. Individuals may e-file early and, at the same time, schedule the electronic funds withdrawal as late as April 17, 2007. For returns filed after the filing deadline, the payment is effective on the filing date. When e-filing a 2006 tax return, individuals can initiate Tax Year 2007 estimated tax payments regardless of whether there is a balance due on the return. Taxpayers can now schedule up to four Form 1040-ES payments for withdrawal while e-filing. The quarterly estimated tax payment may be the payment due in April 2007, June 2007, September 2007 or January 2008. In 2006, more than 1.26 million taxpayers paid their taxes through electronic funds withdrawal, an increase of 9 percent over the prior year. Credit Card Payments Taxpayers can make credit card payments whether they file electronically or file a paper return. Credit card payments can be submitted via tax software when filing electronically. Credit Card payments can also be made over the telephone and on line. In 2006, almost 2 million taxpayers paid by credit card, an increase of 36 percent over the prior year. The IRS does not set or collect any type of fee for credit card payments, but the private sector companies the IRS has authorized to process these payments do impose convenience fees. The tax payment sent to the U. S. Treasury and the convenience fee are listed separately on the cardholder’s credit card statement. For those who e-file their taxes, some tax software developers offer integrated e-file and e-pay combinations for those who choose to use a credit card to pay a balance due. The software accepts both the electronic tax return and the credit card information. Subsequently, the tax return and tax payment data are forwarded to the IRS and the credit card data is forwarded to the payment processor. For the 2007 filing season, the IRS has contracts with two companies to accept credit card charges from both electronic and paper filers. Each company offers both phone and Internet payment services and each charges a convenience fee for the service. Fees are based on the amount of the tax payment and may vary between companies. The two companies are: Official Payments Corporation, 1-800-2PAY-TAX (1-800-272-9829), 1-877-754-4413 (Customer Service), www.officialpayments.com, and Link2Gov Corporation, 1-888-PAY-1040 (1-888-729-1040), 1-888-658-5465 (Customer Service), www.PAY1040.com. Anyone may use these services to charge taxes to an American Express Card, Discover Card, MasterCard or VISA card. Electronic Federal Tax Payment System (EFTPS) EFTPS is a free tax payment system provided by the U.S. Department of Treasury, enabling taxpayers to pay federal taxes electronically — on line or by phone 24/7. Taxpayers can enroll by going on line or request an enrollment form by calling the EFTPS Customer Service at 1-800-555-4477. Taxpayers can use EFTPS to make all federal tax payments, including income, employment, estimated and excise taxes. Businesses can schedule payments 120 days in advance and Individuals can schedule payments a year in advance. This is ideal for taxpayers making monthly installment agreement or quarterly 1040ES estimated payments. EFTPS offers taxpayers the convenience and flexibility of making secure tax payments through the Internet or by phone. By 8 p.m. Eastern Time, one calendar day in advance of the due date, taxpayers access EFTPS directly to report tax information. Taxpayers instruct EFTPS to move funds from an account to the Treasury's account for payment of federal taxes. Funds will not move from a taxpayer’s account until the date chosen by the taxpayer, who receives an immediate acknowledgement of payment instructions. The taxpayer’s bank statement will confirm the payment was made. Businesses should enroll in EFTPS to make any tax payments that their Third Party Provider is not making on their behalf. The IRS recommends employers verify EFTPS payments as part of their bank account reconciliation process. For more information on electronic payment options, look for the “electronic IRS” or enter keyword “e-pay” in the search box on this Web site.

Deducting Travel, Entertainment and Gift Expenses

Deducting Travel, Entertainment and Gift Expenses

FS-2007-10, January 2007 (Updated 2/14/07) WASHINGTON—The Internal Revenue Service reminds taxpayers that there are specific guidelines to be followed when deducting travel, entertainment and gift expenses. In order to educate taxpayers regarding their filing obligations, this fact sheet, the eighth in a series, explains the rules for deducting these expenses. Travel, entertainment and gift expenses account for just part of the overstated adjustments, deductions, exemptions and credits that add up to $30 billion per year in unpaid taxes, according to IRS estimates. In general, taxpayers may deduct ordinary and necessary business-related expenses for traveling away from home, entertaining clients and customers and giving gifts to customers, employees and others with whom they have a business association. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business. Taxpayers who deduct these expenses must exclude personal expenses when computing their deductions and must have documentation for the expense, including statement of the business purpose, names of the persons being entertained, date and location. In addition, generally only 50 percent of business meal and entertainment expenses can be deducted. Travel Taxpayers who travel away from home on business may deduct related expenses, including the cost of reaching their destination, the cost of lodging and meals and other ordinary and necessary expenses. Taxpayers are considered “traveling away from home” if their duties require them to be away from home substantially longer than an ordinary day’s work and they need to sleep or rest to meet the demands of their work. The actual cost of meals and incidental expenses may be deducted or the taxpayer may use a standard meal allowance and reduced recordkeeping requirements. Regardless of the method used, meal deductions are generally limited to 50 percent as stated earlier. Only actual costs for lodging may be claimed as an expense and receipts must be kept for documentation. Expenses must be reasonable and appropriate; deductions for extravagant expenses are not allowable. More information is available in Publication 463, Travel, Entertainment, Gift, and Car Expenses. Entertainment Expenses for entertaining clients, customers or employees may be deducted if they are both ordinary and necessary and meet one of the following tests: Directly-related test: The main purpose of the entertainment activity is the conduct of business, business was actually conducted during the activity and the taxpayer had more than a general expectation of getting income or some other specific business benefit at some future time. Associated test: The entertainment was associated with the active conduct of the taxpayer’s trade or business and occurred directly before or after a substantial business discussion. Publication 463 provides more extensive explanation of these tests as well as other limitations and requirements for deducting entertainment expenses. Gifts Taxpayers may deduct some or all of the cost of gifts given in the course of their trade or business. In general, the deduction is limited to $25 for gifts given directly or indirectly to any one person during the tax year. More discussion of the rules and limitations can be found in Publication 463. Links: Publication 463, Travel, Entertainment, Gift, and Car Expenses Publication 535, Business Expenses Publication 552, Recordkeeping for Individuals The Tax Gap

Credit Available for Taxpayers Who Purchased or Leased Hybrid Vehicles In 2006

Credit Available for Taxpayers Who Purchased or Leased Hybrid Vehicles In 2006

FS-2007-9, January 2007 Taxpayers who purchased or leased any of 44 different models of hybrid vehicles in 2006 may be entitled to a tax credit on their 2006 returns worth as much as $3,150 for the most fuel-efficient models. The precise amount of the credit depends on the make and model of the vehicle and when the vehicle was purchased. Taxpayers may claim the credit on their 2006 tax returns only if they placed a qualified hybrid vehicle in service in 2006. The Alternative Motor Vehicle Credit for hybrid vehicles — powered by both an internal combustion engine and a rechargeable battery — was enacted as part of the Energy Policy Act of 2005. Taxpayers may claim the full amount of the allowable credit only up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th hybrid vehicle. The only manufacturer for whom the credit has been limited in the 2006 tax year is Toyota Motor Sales, USA, which includes Lexus. The credit amount and purchase date limitation for various models of Toyota and Lexus, which sold more than 60,000 hybrid vehicles, is as follows: Qualifying Vehicle Taxpayers May Claim Full Credit If Purchased By 9/30/06 Taxpayers May Claim Half Credit If Purchased From 10/1/06 Through 3/31/07 Taxpayers May Claim Quarter Credit If Purchased From 4/1/07 Through 9/30/07 Taxpayers May Claim No Credit If Purchased After 10/1/07 05, 06, 07 Toyota Prius $3,150 $1,575 $787.50 $0 06, 07 Toyota Highlander 2WD, 4WD $2,600 $1,300 $650 $0 07 Toyota Camry Hybrid $2,600 $1,300 $650 $0 06, 07 Lexus RX 400h 2WD, 4WD $2,200 $1,100 $550 $0 07 Lexus GS450h $1,550 $775 $387.50 $0 Credit amount for other manufacturers’ hybrid vehicles Ford Motor Corp. 05, 06, 07 Ford Escape Hybrid 2WD — $2,600 05, 06, 07 Ford Escape Hybrid 4WD — $1,950 06, 07 Mercury Mariner Hybrid 4WD — $1,950 General Motors Corp. 06, 07 Chevrolet Silverado 2WD Hybrid Pickup Truck — $250 06, 07 Chevrolet Silverado 4WD Hybrid Pickup Truck — $650 06, 07 GMC Sierra 2WD Hybrid Pickup Truck — $250 06, 07 GMC Sierra 4WD Hybrid Pickup Truck — $650 07 Saturn Vue Green Line — $650 American Honda Motor Company, Inc. 05 Honda Accord Hybrid AT and Navi AT — $650 05 Honda Civic Hybrid MT and CVT — $1,700 05, 06 Honda Insight CVT — $1,450 06 Honda Accord Hybrid AT and Navi AT with updated calibration — $1,300 06 Honda Accord Hybrid AT and Navi AT without updated calibration — $650 06 Honda Civic Hybrid CVT — $2,100 07 Honda Accord Hybrid AT — $1,300 07 Honda Accord Hybrid Navi AT — $1,300 07 Honda Civic Hybrid CVT — $2,100 Credit Phase-Out Depends on Vehicle Sales The phase-out period for a manufacturer begins with the second calendar quarter after the calendar quarter in which the manufacturer records its 60,000th sale. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50 percent of the credit. For the fourth and fifth calendar quarters, taxpayers may claim 25 percent of the credit. For quarters after that fifth quarter, taxpayers may not claim the credit. The purchase date determines the amount of credit for which a hybrid vehicle is eligible, but the date the vehicle is placed into service determines when the credit can be claimed for the vehicle. Purchasing and ordering a hybrid vehicle is not enough to claim the credit. The vehicle must be placed in service as well. Used and Leased Vehicles A consumer that leases a hybrid vehicle is not eligible for the credit. The credit is allowed to the vehicle owner, including the lessor of a vehicle subject to a lease. That means that the lessor (the person who leases the vehicle to the consumer) is the person who can claim a credit for the vehicle. A credit for a hybrid vehicle can only be claimed by the original purchaser of the vehicle, that is, the purchaser of a new vehicle. The credit does not apply to a used hybrid vehicle. The Credit and the Alternative Minimum Tax Also the Alternative Motor Vehicle Credit cannot be used to offset the Alternative Minimum Tax (AMT). A taxpayer cannot claim the credit unless the taxpayer's regular tax liability exceeds the taxpayer’s AMT liability. Even if a person is not subject to the AMT, he may not be able to claim the maximum allowable credit, or any credit, for the qualified vehicle that is purchased. The amount of the credit that one can claim depends on the particular facts and circumstances. For example, A, B and C each purchase the same make, model, and model year of qualified hybrid motor vehicle to use as their personal vehicles. At the time that A, B and C purchase their vehicles, the maximum allowable credit for the vehicle is $3,150. A, B and C each have regular tax of $12,000 for the taxable year in which they purchase their vehicles. A’s tentative minimum tax is $8,000, B’s tentative minimum tax is $11,000, and C’s tentative minimum tax is $12,000. Because A’s regular tax ($12,000) exceeds A’s tentative minimum tax ($8,000) by $4,000, A can claim the maximum credit allowable for the qualified hybrid vehicle that A purchases. Because B’s regular tax ($12,000) exceeds B’s tentative minimum tax ($11,000) by only $1,000, B can claim a credit of only $1,000 for the qualified hybrid vehicle that B purchases. Because C’s regular tax ($12,000) does not exceed C’s tentative minimum tax ($12,000), C cannot claim any credit for the qualified hybrid vehicle that C purchases. Also, if you claim the credit as a personal credit, the tax code limits the amount of the credit that you may claim to the amount of your regular tax liability. Therefore, if your regular tax liability is zero, the amount of the credit for which you are eligible will be zero. The credit cannot be used to reduce your regular tax liability below zero, and cannot be carried forward or back to another taxable year. If the vehicle that you purchase is subject to the allowance for depreciation, then the credit is part of the general business credit and the rules applicable to the general business credit apply. Sales to Tax Exempt Entities A person who sells a qualified vehicle to a tax-exempt person or entity and makes a required disclosure can claim the credit. The tax code provides that in the case of a vehicle that is used by a tax-exempt person or entity and is not subject to a lease, the person who sold the vehicle to the tax-exempt person or entity is treated as the taxpayer that placed the vehicle in service. The amount of the credit allowable with respect to the vehicle must be disclosed in writing to the tax-exempt person or entity.

2007 IRS E-File

2007 IRS E-File

Revised Jan. 19, 2007 FS-2007-8, January 2007 More and more Americans are choosing e-file, which lets them electronically file an accurate tax return or get an extension of time to file without sending any paper to the Internal Revenue Service. More than 73 million Americans chose IRS e-file in 2006 — 6.9 percent more than the year before. The total number of individual tax returns in calendar year 2007 is expected to be about 136 million, and the IRS expects a record number of e-filers this year. E-filers enjoy these benefits: Faster refunds — With IRS e-file, taxpayers can get their refunds in half the time of filing a paper tax return and receiving a refund check, even faster with Direct Deposit. More accurate returns — IRS computers quickly and automatically check for errors or other missing information, making e-filed returns more accurate and reducing the chance of getting an error letter from the IRS. Quick electronic confirmation — e-Filers receive an acknowledgment that the IRS has received their returns. Time saving electronic signatures — Taxpayers can eliminate paperwork by creating their own Personal Identification Number (PIN) and filing a completely paperless return using their tax preparation software or tax professional. There is nothing to mail to the IRS. Easy payment options — E-filers with a balance due can schedule a safe and convenient electronic funds withdrawal from their bank account, or pay with a credit card, or enroll in the Electronic Federal Tax Payment System (EFTPS) to make subsequent payments by phone or Internet. Convenient Federal/State e-filing — Taxpayers in 37 states and the District of Columbia can e-file their federal and state tax returns in one transmission to the IRS. The IRS forwards the state data to the appropriate state tax agency. In 2006, 37 million taxpayers filed federal-state electronic returns in Alabama, Arizona, Arkansas, Colorado, Connecticut, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Utah, Vermont, Virginia, West Virginia, Wisconsin and the District of Columbia. E-file Options Free Internet Filing For the 2007 filing season, 95 million individual taxpayers will be eligible for IRS Free File. Taxpayers must have an adjusted gross income of $52,000 or less to be eligible. Tax software companies and the federal government are teaming up to offer free online tax preparation and electronic filing services to eligible taxpayers. Free services are accessible through IRS.gov. Some companies offer their Free File software in Spanish and some offer Extensions for free. While some companies offer free state income tax preparation and e-filing services, others may charge fees for state tax return preparation and e-filing. Eligibility requirements will be on IRS.gov beginning January 16, 2007. Additionally, taxpayers who are not required to file a return may request the telephone excise tax credit by filing Form 1040EZ-T, which will be available for free through some Free File companies. Free File is made possible through a partnership between the IRS and the Free File Alliance, LLC, a consortium of participating tax software companies. Free File services are provided to eligible taxpayers at no charge. Using a Personal Computer Taxpayers with a computer, a modem or Internet access and tax preparation software can e-file their tax returns from home any time, day or night. To do so, a taxpayer sends a completed, electronic tax return to a transmitter. The transmitter converts the file to an IRS-approved format and then sends it to the IRS. Within 48 hours, the IRS notifies the taxpayer through the transmitter whether or not the return is accepted. In 2006, 20.3 million taxpayers e-filed their returns from home, 18.8 percent more than the year before. Using an Authorized Provider Computer filing through an authorized provider has been the core of e-filing since its debut in 1986. Using this method, tax professionals send clients’ returns electronically to the IRS. Some prepare their clients’ returns and send them, others take returns prepared by their clients, enter the data, then e-file it with the IRS. Authorized providers filed 52.9 million returns in 2006, up 10 percent from the previous year. E-file Extension of Time to File Taxpayers will be able to e-file an extension request using a single IRS form (Form 4868) to get an automatic six-month extension of time to file. No explanation or signature is required. Taxpayers with an extension must still pay any taxes they owe by the tax deadline. Electronic Signatures — Personal Identification Numbers (PINS) For the 2007 Filing Season, taxpayers will be able to select one of the following options for signing their e-filed return: Self-Select PIN The Self-Select Personal Identification Number (PIN) allows taxpayers to electronically sign their e-filed return by entering a five-digit PIN. The five-digit PIN can be any five numbers except all zeros. Receipt of the taxpayer’s PIN eliminates the requirement for Form 8453. The Self-Select PIN method requires the entry of each taxpayer’s date of birth and prior year original adjusted gross income, which are used to authenticate the taxpayer. Paperless filing is available to those who prepare their own returns using tax preparation software or those who use a tax professional. On a joint return, two PINs are required, acting as electronic signatures for both people. The Self-Select PIN Program began in 2001. By 2006, self-select PINs were used to e-file 14.6 million returns, up eight percent over the prior year. Practitioner PIN The Practitioner PIN is an additional electronic signature option for taxpayers who use an electronic return preparer. Taxpayers using a tax professional can sign their return electronically by completing an e-file signature worksheet. The worksheet authorizes an electronic return preparer to enter a taxpayer’s PIN as a signature. 44.8 million taxpayers e-filed through a paid preparer and used a self-select PIN or a practitioner PIN in 2006. Overall, PINs were used to sign 81 percent of all e-filed individual income tax returns in 2006. The e-file section of this Web site has more information about IRS e-file, free internet filing, the self-select PIN, the practitioner PIN and private sector partnerships. Direct Deposit One electronic transaction that is available to both e-filers and those filing a traditional paper tax return is direct deposit. About 53 percent of all refunds were directly deposited in 2006. Choosing direct deposit is easy; paper return filers just enter their account number and routing number in the boxes provided on Form 1040, 1040A or 1040EZ. (There is an illustration explaining how to choose direct deposit in the tax return instructions.) This year, for the first time, taxpayers can split their deposits in up to three different savings or checking accounts. Those who choose direct deposit will get their refunds faster than those who receive a paper check. Also, a refund that is directly deposited in a savings or checking account cannot be stolen or lost in the mail. During 2006, 56.7 million refunds were directly deposited, up from 52.6 million during 2005, an increase of almost 8 percent. The average direct deposit refund in 2006 was $2,612. In 2006, $148.2 billion was deposited electronically, an increase of about 11 percent over the prior year. Related Items: E-file: Filing your taxes was never easier! Form 4868, Application for Automatic Extension of Time to File Form 8453, U.S. Individual Income Tax Declaration for Electronic Filing Free File 1040 Central