IRS Clarifies Treatment of Refunds with New SALT Limits. The IRS has provided four examples of the interaction of the new limit on the deduction on state and local taxes (SALT) under Code Sec. 164(b)(6) with the tax benefit rule for refunds under Code Sec. 111. A taxpayer who is impacted by the SALT limit may not be required to include any refund in gross income depending on whether he or she only paid the actual amount of SALT liability. The ruling does not affect tax refunds received in 2018 for tax returns currently being filed.
SALT Deductions and Refunds For tax years 2018 to 2025, the itemized deduction of SALT on Schedule A (Form 1040) by an individual is limited to $10,000 ($5,000 if married filing separately). For all tax years, SALT refunds received by a taxpayer who itemized deductions in a previous tax year may be included in gross income depending on amount of tax benefit received from the deduction. The key is determining the amount the taxpayer would have deducted had the taxpayer only paid the actual SALT liability.
In one of the examples, a single taxpayer itemizes and claims deductions totaling $15,000 on the taxpayer’s 2018 federal income tax return. A total of $12,000 in state and local taxes is listed on the return, including state and local income taxes of $7,000. Because of the limit, however, the taxpayer’s SALT deduction is only $10,000. In 2019, the taxpayer receives a $750 refund of state income taxes paid in 2018, meaning the taxpayer’s actual 2018 state income tax liability was $6,250 ($7,000 paid minus $750 refund). Accordingly, the taxpayer’s 2018 SALT deduction would still have been $10,000, even if it had been figured based on the actual $6,250 state and local income tax liability for 2018. The taxpayer did not receive a tax benefit on the taxpayer’s 2018 federal income tax return from the taxpayer’s overpayment of state income tax in 2018. Thus, the taxpayer is not required to include the taxpayer’s 2019 state income tax refund on the taxpayer’s 2019 return.
Congress is moving forward on tax-related legislation. One proposed law, the “Taxpayer First Act,” would make changes aimed at reforming and modernizing the IRS. On 4/9 the U.S. House of Representatives unanimously passed the bill. Two U.S. Republican senators introduced a companion bill, but a date hasn’t been set for the full Senate to take it up. If enacted, the bill would: restrict the IRS use of private debt collectors; establish an independent appeals office; and improve the IRS whistleblower program. Under the bill, the IRS would also be required to submit plans to Congress to redesign its structure to improve efficiency, modernize technology systems and enhance cybersecurity.
In other action, a group of bipartisan members of Congress introduced legislation on 4/10/19 that would permanently extend the Work Opportunity Tax Credit (WOTC). Employers that hire members of certain targeted groups may get a credit against their income taxes equal to a percentage of a certain amount of first-year wages. The bipartisan bill to make the WOTC permanent was referred to the House Ways and Means committee. The Senate introduced similar legislation on 4/2/19. The WOTC is currently set to expire on 12/31/19.
The House and the Senate are also discussing bills that would help Americans save for retirement. Stay tuned for updates on all tax-related legislation.
Courts rule two business owners must pay the Trust Fund Recovery Penalty (TFRP). Employers who withhold taxes from employee paychecks but willfully fail to pay them over to the IRS may face a harsh penalty. The TFRP is equal to 100% of the unpaid tax and can be assessed personally against responsible parties. In one recent case, a convenience store co-owner paid the TFRP, and then sought a refund, stating that his partner was responsible for payroll. A U.S. District Court denied the refund, finding that, based on the taxpayer’s level of involvement in the business, he should have known of the tax debt. (Danduran, DC ND, 3/12/19)
In another case, a U.S. District Court ruled that a staffing company co-owner was a “responsible person” for purposes of the penalty. He determined financial policy, hired and fired employees and had check-writing authority. He acted willfully because he authorized payment of non-IRS creditors while delinquent taxes were increasing. (Green, DC AZ, 3/11/19)
Pilot is denied write-offs for an activity the U.S. Tax Court calls a hobby. Taxpayers who engage in activities for profit can generally deduct related expenses. In one case, an experienced pilot and mechanical engineer restored a historic plane. He deducted restoration costs against other income on his tax return, listing the endeavor as a leasing activity. However, he never leased the plane out, and so had no related income.
The Tax Court noted the IRS said the activity “was all just a very expensive hobby.” There were factors in favor of the activity being a business, such as great effort devoted to the activity. But those factors didn’t outweigh the lack of income. The court ruled he had no profit motive and denied the deductions. (Kurdziel, TC Memo 2019-20)
A married couple can’t deduct a loss on their house. When a taxpayer sells a personal residence, a loss generally isn’t tax deductible. A loss is deductible if a property is converted to income-producing purposes before a sale. In one case, a couple claimed a loss deduction on their tax return for a home that they’d lived in for eight years before renovating it to sell as an income-producing asset. But the U.S. Tax Court disagreed with that claim.
The court noted that they hadn’t marketed the home publicly. They rented it out at less than fair market value to the husband’s fraternity brother before selling it at a loss. The reason for renting was to satisfy their insurance company, which wanted the home to be occupied in order to insure it. “We find that the reason for renting the … property below market value was solely insurance driven and without profit motive,” the court stated. (Langston, TC Memo 2019-19)
Must the IRS accommodate taxpayers with religious or conscience-based objections to obtaining Social Security numbers (SSN) for their children? No, the tax agency doesn’t have to accommodate these taxpayers, according to recently issued guidance. That’s because a denial doesn’t violate the Religious Freedom Restoration Act of 1993, the IRS explained.
Under the Tax Cuts and Jobs Act, parents are now required to provide an SSN to obtain the child credit. The IRS has no viable alternative to implementing “this clear congressional mandate to require an eligible SSN for a qualifying child,” the IRS stated. (Program Manager Technical Advice 2019-002)