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LOISELLE,
GOODWIN & HINDS
CERTIFIED PUBLIC ACCOUNTANTS
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The following is a summary of the most important tax developments that have occurred in the past few months that may affect you, your family, your investments, and your livelihood. Some of these developments may be favorable to you while others may be unfavorable. Please contact us for more information about any of these developments and what steps you should take to take advantage of favorable developments and to minimize the impact of those that are unfavorable.
Comprehensive rules issued on education credits. The IRS has issued comprehensive rules explaining the HOPE scholarship credit of up to $1,500 per eligible student (applies for qualifying expenses paid after 1997 for post –1997 academic periods), and the Lifetime Learning credit of up to $1,000 per eligible taxpayer (applies for qualifying expenses paid after June 30, 1998, for academic periods beginning after that date). Both credits for higher education costs phase out over $40,000 to $50,000 of modified adjusted gross income (AGI) (for taxpayers filing jointly, $80,000 to $100,000).
The new rules say that for education credit purposes, if a third party (someone other than the taxpayer, the taxpayer’s spouse, or a claimed dependent) makes a payment directly to an eligible educational institution for a student’s qualified tuition and related expenses, the student is treated as receiving the payment from the third party, and, in turn, paying the qualified tuition and related expenses. In turn, qualified tuition and related expenses paid by a student are treated as paid by the taxpayer if the student is a claimed dependent of the taxpayer. Thus, for example, if one divorced parent pays qualified tuition to a college for a child, but the other parent has custody of the child (and is eligible to claim the child as a dependent), the custodial parent is treated as having paid the tuition directly to the college.
The rules also say that if a taxpayer is eligible to but does not claim a student as a dependent, only the student can claim the education credit for the student’s qualified tuition and related expenses.
Suggestion. It may pay for you to not claim a student as a dependent if (1) you can’t claim education credits because of high modified AGI, and (2) the student pays (or is treated as paying) the expense and has enough tax liability to claim the credit. Note, however, that a child can’t claim a dependency exemption deduction for himself or herself, even if the parent doesn’t take the dependency exemption.
New rules issued on education loan interest deduction. The IRS has issued rules explaining the above-the-line deduction for interest paid on qualified education loans. The maximum deduction is $1,000 for tax years beginning in 1998, and increases at a rate of $500 a year until it reaches $2,500 for tax years beginning after 2000. The deduction is phased-out for taxpayers with modified AGI between $40,000 and $55,000 ($60,000 and $75,000 for joint return filers). Married taxpayers must file jointly to claim the deduction.
The IRS explains that the deduction is not allowed in a tax year to an individual who is properly claimed as a dependent on another’s return for that year, and may only be claimed by a taxpayer legally obligated to make the tax payments. For example, a student who pays interest and is not claimed as a dependent by her parents for that year may claim the deduction. However, where a student who pays education loan interest during a tax year is claimed as a dependent by his parents for that year, neither the student nor his parents may claim a deduction for the interest paid by the dependent student.
Final regulations clarify the Roth IRA rules. IRS has issued comprehensive final regs on Roth IRAs. Although the final regs generally adopt the approach taken by proposed regulations issued in 1998, they clarify and modify a number of important rules. Following are a few examples:
Final regulations explain FICA tax consequences of nonqualified deferred compensation plans. The IRS has issued final regulations explaining the FICA tax treatment of nonqualified deferred compensation plans. Wages usually are subject to FICA tax when actually paid. By contrast, an amount deferred under a nonqualified deferred compensation plan is treated as wages for FICA purposes on the later of (1) the date when the employee performed the services creating the right to the deferred amount, or (2) the date when the right to the deferred amount is no longer subject to a substantial risk of forfeiture. This special FICA rule can produce beneficial results when there are no forfeiture provisions in a nonqualified deferred compensation plan.
Proposed regulations would lower the tax cost of group term life insurance. In general, up to $50,000 of employer-provided group-term life insurance plan coverage is tax-free to employees. Additional coverage is taxable, with the value determined using rates found in a table in the IRS regulations (which gives values per month for each $1,000 of face amount of coverage depending on the insured’s age) less any amount paid by the employee. The current rates have been in place since ’83, except that new factors were added in ’89 for ages 65 and above. In the interim, there have been significant improvements in mortality, causing term-life premiums to decrease. The IRS has concluded that the table used to value additional coverage should be revised to reflect this fact and has issued proposed regulations that generally would be effective for group-term life insurance provided after June 30, 1999. The new uniform premium rates would be lower than the current rates in all age groups.
For example, under the current table, the cost per $1,000 of protection in excess of $50,000 is 29 cents a month for those age 45 to 49; under the proposed regulations, the cost would drop to 15 cents a month per $1,000 of excess coverage.
Besides saving income taxes for employees, the decrease in the table rates would reduce employer and employee FICA costs for excess employer-paid group-term coverage.
Electronic tax deposit rules to be liberalized. The IRS has issued proposed regulations that would raise the annual tax deposit threshold triggering the requirement to deposit taxes by electronic funds transfer (EFT) after 1999 to $200,000 up from the current $50,000 level. Only 9% of business taxpayers that make Federal tax deposits would be required to deposit by EFT under the new rules, and would not have to use EFT unless they exceed the $200,000 threshold in 1998 or a later calendar year. The fresh start rule would allow 65% of taxpayers currently subject to the EFT requirement to resume making paper coupon deposits beginning in 2000. The IRS also announced that it would continue to waive penalties through the end of 1999 for smaller businesses currently required to use the electronic federal tax payment system (EFTPS) that make timely deposits using paper tax deposit coupons.
New definition of "temporary workplace." The IRS has revised its definition of what is a "temporary" workplace for purposes of determining whether transportation between home and a work location outside the home is deductible. Formerly, a "temporary" work location was any location at which a person performed services on an irregular or short-term basis. Under the new definition, a work location is temporary, in the absence of facts and circumstances indicating otherwise, if employment at that location is realistically expected to last (and does in fact last) for one year or less. The revised definition affects business-auto deductions of self-employed taxpayers. It also impacts tax-free working condition fringe and taxable personal use valuation of employer-provided autos, and an employer’s tax-free (if properly substantiated) reimbursement of business-connected mileage on an employee-provided vehicle.
Refund opportunity. The IRS has made it clear that taxpayers who are affected by the new definition of "temporary workplace" can file an amended return (form 1040X) for any open year affected by the change. However, the amended return must generally be filed within three years from the time the taxpayer filed the return or within two years from the time the tax was paid, whichever is later.
Social Security taxes withheld and paid over on reimbursements treated as compensation under the old rules but treated as tax-free under the new rules also can be recovered.
1999 luxury auto depreciation dollar limits and lease income add-backs released. Annual depreciation and expensing deductions for so-called luxury autos are limited to specific dollar amounts. These amounts are inflation-adjusted each year. The IRS has announced that for auto first placed in service during 1999, the dollar limit for the first year an auto is in service is $3,060; for the second tax year $5,000; for the third tax year, $2,950; and for each succeeding year, $1,775. Separate rules apply to electric autos.
The dollar limits artificially cap the depreciation deductions normally available for five-year property. For example, without the dollar caps, first year MACRS depreciation on a $25,000 non-electric auto used 100% for business generally would be $5,000 (i.e., 20% of $25,000).
A taxpayer that leases a business auto may deduct the part of the lease payment representing its business/investment use. If business/investment use is 100%, the full lease cost is deductible. So that auto leases can’t avoid the effect of the luxury auto limits, however, taxpayers must include a certain amount in income during each year of the lease to partially offset the lease deduction. The amount varies with the initial fair market value of the leased auto and the year of the lease, and is adjusted for inflation each year. The IRS has released a new inclusion amount table for non-electric autos first leased during 1999. The amounts in the new table are in many instances lower than the figures in the table that applied to autos first leased in 1998. A separate inclusion amount table applies to electric autos.
Cents-per-mile valuation of personal use. An employee’s personal use of an employer-provided auto must be treated as fringe benefit income and valued using one of several methods. One of the acceptable methods allows employers to value personal use at the mileage allowance rate (32.5¢ through March 31, 1999, 31¢ beginning in April of 1999). However, the cents-per-mile method may be used only if the auto’s fair market value does not exceed $12,800, as adjusted for inflation. The IRS has announced that the inflation-adjusted figure for 1999 is $15,500 or $100 less than the $15,600 figure that applied for 1998.
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