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Switched Keys - Category: "Tax Accounting" https://tylerhosting.com/b2e/dbell.php Switched Keys, the blogs of Dana Bell of Tyler, Texas en-US http://blogs.law.harvard.edu/tech/rss 60 Taxability of Home Sales https://tylerhosting.com/b2e/dbell.php/taxability-of-home-sales Sun, 30 Jul 2017 02:55:00 +0000 Dana Bell Tax Accounting Financial Planning 390@https://tylerhosting.com/b2e/
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<p>While enjoying a round of disc golf this week one of the players was talking about someone who had to live in a house he inherited for three years in order to avoid paying tax on the sale of the house. I may not have all the relevant details but it seemed confusing enough that I thought it would be a good idea to relay some tax information to others concerning home sales and a warning about tax traps.</p> <h2>Home Sale Tax Facts</h2> <p>There are three basic facts you should remember about home sales. The first thing should remember is that you only have to pay tax on the profit from a sale. The profit is based on the difference between the basis and the selling price. Generally, the basis is what the house was purchased for plus amounts paid for improvements. So, if you purchased the house at $75,000 and sold at $100,000, the profit would be only $25,000. It's only natural that you would make a profit on a home sale since inflation and appreciation increases the value of your home.</p> <p>Secondly, current tax law allows owners to exclude $250,000 ($500,000 if married) of gain on a home sale. To qualify, the home must have been owned for two of the last five years, and used as a main home for two years out of the prior five years. So that taxable $25,000 becomes zero. Incidentally, that hasn't always been the case. See <a href="http://www.tylerhosting.com/b2e/dbell.php/income-averaging-and-transitions-in">Income Averaging and Transitions in Tax Law</a> for an interesting comparison with 1964 tax law.</p> <p>Third, property inherited receives a basis equal to the fair market value of the home at the time of the decedent's death (with some exceptions). In this case, the heir would not qualify for the exclusion mentioned above since he didn't live there. However, even though he may not have paid anything for the house he inherited, his basis for calculating profit is the value at death, which should be close to the actual selling price. By definition, it's not likely that someone will purchase the house at very much over the "fair market value", so it should be rare to owe any tax on the sale. It's much more likely that you would be selling below fair market value just to get it sold.</p> <p>Most people probably understand that you only pay tax on the profit, but many will not know about the exclusion or the treatment of inherited property. Of course, there may be other aspects of the sale to consider, but remembering these three facts may come in handy for you or someone you know. </p> <h2>Tax traps</h2> <p>There are many tax traps where you are liable for taxes you didn't know about, but there's probably more "traps" that involve taxes you paid that you didn't have to or credits you didn't claim.</p> <h3>Education Tax Credits</h3> <p>For many years people, including many tax preparers were not aware of the benefits of education credits. You may think that's just for low-income taxpayers, but if you make less than $80,000 ($160,000 joint), you could qualify for up to $2500 in AOTC, often even if you received financial aid, and even if you didn't pay anything out of pocket. Plus, there are several other tax credits.<br />Education Tax Credits were so overlooked that I wrote a book on the subject two years ago. See <a href="http://www.tylerhosting.com/dbell/books/etc.html">Education Tax Credits</a>. A few things have changed (technically) since then, but the credit is essentially the same. For example, you now have to have a 1098T, but the institutions will now have to provide one to you. If they don't you can still claim as if they did. You can see a summary article at <a href="http://www.tylerhosting.com/b2e/dbell.php/education-credits-beyond-the-basics">Education Credits: Beyond the Basics</a>.</p> <h3>Inherited IRAs</h3> <p>One of the basic concepts of inheritance of property is that it gets a step-up in basis which usually means no taxes. Although inherited property gets a step-up in basis, if you receive an IRA as an inheritance, it is taxable and there is a significant penalty for cashing it in. There are other rules related to IRA management, and the institution may not warn you about them. Read more about <a href="http://www.tylerhosting.com/b2e/dbell.php/common-ira-traps">Common IRA Traps</a>. </p> <h3>You can amend</h3> <p>Yet another thing that many people are not aware of is that taxpayers can normally amend (change) their tax returns for up to three years to get benefits they didn't claim when they first filed. Of course, there are some things you can't easily change with an amended return, such as uncashing in an IRA distribution.</p> <p>In many tax cases you can consult a tax professional, but in some cases it may not be enough to consult one or two professionals. If it involves a large amount or tax, research it yourself and ask a lot of questions. Start with googling if you want, but refer to taxpayer <a href="https://www.irs.gov/forms-pubs">publications </a>or the <a href="https://www.law.cornell.edu/uscode/text/26/">tax code</a> to verify what others are saying. Don't blindly rely on a website or even a tax preparer. Many times the tax forms and instructions will guide you through the calculations, while tax preparers way speedily just fill in the blanks.</p><div class="item_footer"><p><small><a href="https://tylerhosting.com/b2e/dbell.php/taxability-of-home-sales">Original post</a> blogged on <a href="http://www.tylerhosting.com/b2e/">Switched Keys</a>.</small></p></div>
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While enjoying a round of disc golf this week one of the players was talking about someone who had to live in a house he inherited for three years in order to avoid paying tax on the sale of the house. I may not have all the relevant details but it seemed confusing enough that I thought it would be a good idea to relay some tax information to others concerning home sales and a warning about tax traps.

Home Sale Tax Facts

There are three basic facts you should remember about home sales. The first thing should remember is that you only have to pay tax on the profit from a sale. The profit is based on the difference between the basis and the selling price. Generally, the basis is what the house was purchased for plus amounts paid for improvements. So, if you purchased the house at $75,000 and sold at $100,000, the profit would be only $25,000. It's only natural that you would make a profit on a home sale since inflation and appreciation increases the value of your home.

Secondly, current tax law allows owners to exclude $250,000 ($500,000 if married) of gain on a home sale. To qualify, the home must have been owned for two of the last five years, and used as a main home for two years out of the prior five years. So that taxable $25,000 becomes zero. Incidentally, that hasn't always been the case. See Income Averaging and Transitions in Tax Law for an interesting comparison with 1964 tax law.

Third, property inherited receives a basis equal to the fair market value of the home at the time of the decedent's death (with some exceptions). In this case, the heir would not qualify for the exclusion mentioned above since he didn't live there. However, even though he may not have paid anything for the house he inherited, his basis for calculating profit is the value at death, which should be close to the actual selling price. By definition, it's not likely that someone will purchase the house at very much over the "fair market value", so it should be rare to owe any tax on the sale. It's much more likely that you would be selling below fair market value just to get it sold.

Most people probably understand that you only pay tax on the profit, but many will not know about the exclusion or the treatment of inherited property. Of course, there may be other aspects of the sale to consider, but remembering these three facts may come in handy for you or someone you know. 

Tax traps

There are many tax traps where you are liable for taxes you didn't know about, but there's probably more "traps" that involve taxes you paid that you didn't have to or credits you didn't claim.

Education Tax Credits

For many years people, including many tax preparers were not aware of the benefits of education credits. You may think that's just for low-income taxpayers, but if you make less than $80,000 ($160,000 joint), you could qualify for up to $2500 in AOTC, often even if you received financial aid, and even if you didn't pay anything out of pocket. Plus, there are several other tax credits.
Education Tax Credits were so overlooked that I wrote a book on the subject two years ago. See Education Tax Credits. A few things have changed (technically) since then, but the credit is essentially the same. For example, you now have to have a 1098T, but the institutions will now have to provide one to you. If they don't you can still claim as if they did. You can see a summary article at Education Credits: Beyond the Basics.

Inherited IRAs

One of the basic concepts of inheritance of property is that it gets a step-up in basis which usually means no taxes. Although inherited property gets a step-up in basis, if you receive an IRA as an inheritance, it is taxable and there is a significant penalty for cashing it in. There are other rules related to IRA management, and the institution may not warn you about them. Read more about Common IRA Traps

You can amend

Yet another thing that many people are not aware of is that taxpayers can normally amend (change) their tax returns for up to three years to get benefits they didn't claim when they first filed. Of course, there are some things you can't easily change with an amended return, such as uncashing in an IRA distribution.

In many tax cases you can consult a tax professional, but in some cases it may not be enough to consult one or two professionals. If it involves a large amount or tax, research it yourself and ask a lot of questions. Start with googling if you want, but refer to taxpayer publications or the tax code to verify what others are saying. Don't blindly rely on a website or even a tax preparer. Many times the tax forms and instructions will guide you through the calculations, while tax preparers way speedily just fill in the blanks.

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Education Credits: Beyond the Basics https://tylerhosting.com/b2e/dbell.php/education-credits-beyond-the-basics Wed, 18 Jan 2017 20:28:00 +0000 Dana Bell Professional Tax Accounting Today's CPA 378@https://tylerhosting.com/b2e/
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<p>Note: This article was previously published in Today's CPA, the publication of the Texas Society of Certified Public Accountants. At that time, proposed treasury regulations were not released which change the effect of 1098-T requirements. Buried in the proposed regulations is this reprieve for students who do not receive a 1098-T.</p> <p style="padding-left: 30px;"><em>Until the proposed regulations under §§ 1.25A–1(f) and 1.6050S–1(a) are published in the Federal Register as final regulations, a taxpayer (or the taxpayer’s dependent) (other than a non-resident alien) who does not receive a Form 1098–T because its institution is exempt from furnishing a Form 1098–T under current § 1.6050S–1(a)(2) may claim an education tax credit under section 25A(a) if the taxpayer (1) is otherwise qualified, (2) can demonstrate that the taxpayer (or the taxpayer’s dependent) was enrolled at an eligible educational institution, and (3) can substantiate the payment of qualified tuition and related expenses.</em></p> <p>Also not mentioned in that article are the new due diligence requirements. Effective in 2017 paid preparers claiming the American Opportunity Tax Credit are required to answer the questions in the AOTC column on Form 8867. </p> <hr /> <p>Tax incentives for education may be the most overlooked and most abused items on an individual tax return. They are frequently criticized for their complexity, with each form of education credit or deduction having different rules. With some credits as easy targets for fraud some practitioners are leery of education credit claims. Other problems with these incentives are not so obvious. Software support is limited and taxpayers are not always aware of the benefits or may have false notions about the requirements.</p> <p>This article focuses on the American Opportunity Tax Credit (AOTC) with incidental mentions of the Lifetime Learning Credit (LLC) and other benefits. It then goes beyond the frequently published basic requirements with a look at IRS regulations that enhance the credits.</p> <p>The AOTC is an expansion of the Hope Credit, which was created by the Taxpayer Relief Act of 1997, along with the Lifetime Learning Credit. The credits are governed chiefly by IRC § 25A.</p> <h4>Taxpayer Qualifications</h4> <p>In general taxpayers can receive a credit for qualifying educational expenses paid during a tax year. The credit is equal to 100% of the first $2,000, and 25% of the next $2,000, with 40% of the total credit refundable. It is phased out between $80,000 ($160,000 joint) and $90,000 MAGI ($180,000 joint). Also, the taxpayer must not file married filing separately.</p> <p>The taxpayer must be claiming a dependency exemption for the student which can be any dependent for which the taxpayer is allowed to take a dependency exemption, including individuals that meet the test for dependency exemption as a qualifying relative.<a href="#_edn1" name="_ednref1">[1]</a> So, it’s possible to claim the credit for a student who is a parent or a person whom the taxpayer supports and who lives with him all year.</p> <p>The taxpayer must not be claimed by someone else as a dependent. One of the quirks in this requirement is that dependency and the dependency exemption amount are separate issues.<a href="#_edn2" name="_ednref2">[2]</a> Clarifying the exemption amount Chief Counsel Advice in 2002 determined that a taxpayer who could have been claimed as a dependent could have a zero exemption amount and claim the credit if nobody claims the exemption.<a href="#_edn3" name="_ednref3">[3]</a></p> <h4>Student Qualifications</h4> <p><a href="/b2e/media/blogs/dbell/aotcstudentqualtest.png?mtime=1484776828"><img style="float: right; margin: 10px;" src="/b2e/media/blogs/dbell/aotcstudentqualtest.png?mtime=1484776828" alt="" width="60%" /></a></p> <p>Generally, once dependency is determined, the rest of the qualifications relate to the student and the expenses used to claim the credit.</p> <ul> <li>Student must be pursuing an undergraduate degree or other recognized education credential</li> <li>Student must be enrolled at least half time for at least one academic period beginning during the year</li> <li>No felony drug conviction on student’s record</li> <li>Available for first 4 years of post secondary education</li> <li>Cannot be claimed more than 4 tax years</li> </ul> <h4>Qualifying Expenses</h4> <p>Expenses that can be used to claim the credits include costs of tuition and required fees, as well as required books and course materials. When available the 1098-T can provide the amount of qualifying expenses for the AOTC though preparers should verify the amounts reported. A 1098-T is not always provided.</p> <p>Currently books and other course materials have to be required, but they do not have to be purchased at the institution to qualify. If an institution or degree program requires the student to have a computer it may also be considered a qualifying expense. Expenses unrelated to the educational program are not qualifying expenses.<a href="#_edn4" name="_ednref4">[4]</a> Non-qualifying expenses include</p> <ul> <li>Room and board</li> <li>Insurance</li> <li>Medical Expenses (including student health fees)</li> <li>Transportation (including parking fees)</li> <li>Living expenses</li> </ul> <h4>Qualifying Payments</h4> <p>In addition to having qualifying expenses, the taxpayer must have made payments for those expenses in the tax year. Payments for qualifying expenses include amounts paid by the student, the taxpayer, or through student loans. Special rules apply to certain qualified installment agreements which could affect the recognition of payments.<a href="#_edn5" name="_ednref5">[5]</a></p> <p>Payments made by a third party may also qualify as paid by the taxpayer if paid directly to the institution. In that case, the taxpayer is treated as receiving the payment from the third party and, in turn, paying the qualified tuition and related expenses.” <a href="#_edn6" name="_ednref6">[6]</a> So if a grandparent pays the institution for part of the cost of attending college, the taxpayer can claim the credit using those amounts. Those payments (tuition only) are also exclusions from the gift tax and without regard to relationship.<a href="#_edn7" name="_ednref7">[7]</a> Also considered paid by the taxpayer are amounts paid by certain scholarships that the student includes in income.</p> <p>Generally payments must be made in the year the term begins. Payments made for educational expenses for the first three months of the following year can also be considered as qualifying in the year paid. Qualifying expenses are also limited to amounts for attendance at an eligible educational institution. The institution must be an eligible to participate in Title IV programs such as Pell grants and federally insured student loans.<a href="#_edn8" name="_ednref8">[8]</a></p> <p>It is important to be familiar with all the nuances of 1098-T reporting and verify its accuracy. For example, although 1098-T may indicate graduate student status, the requirement is that the student has not earned a four-year degree, but that test is made based on the beginning of the tax year, not the end of the tax year. If a student graduated in May, all expenses for the year still qualify for the AOTC. In fact, prepaying for the first semester of graduate school in the next year is also an option.</p> <h4>Refundable Qualifications</h4> <p><a href="/b2e/media/blogs/dbell/aotcrefundcredittest.png?mtime=1484776819"><img style="float: right; margin: 10px;" src="/b2e/media/blogs/dbell/aotcrefundcredittest.png?mtime=1484776819" alt="" width="60%" /></a></p> <p>Additional qualifications exist for the refundable portion of the credit. Students age 24 and over qualify for the refundable portion of the credit, as well as parents of children under the age of 24 if they claim the child as a dependent.</p> <p>Publication 970 lists those who <strong>do not</strong> qualify for the refundable credit but it may be easier to reverse the logic to see which taxpayers do qualify. While many students under the age of 24 do not qualify for the refundable portion of the credit, it is important to review the regulations that apply to each case as there are several exceptions.</p> <div class="image_block">Filing a joint return or when both parents are deceased are two cases where a student under age 24 could qualify. Students that are age 18 and over may also qualify if they provide more than half of their support through earned income. Students over 18 and only attending half-time may also qualify.</div> <p>The Refundable Credit Test flowchart can help in evaluating whether the refundable qualifications are met. Publication 970 already has a flowchart to identify eligible students for the AOTC.</p> <h4>Lifetime Learning Credit</h4> <p>The LLC is not as generous as the AOTC but it does not have as stringent student qualifications. While it must be for attendance at an eligible educational institution, it does not require the student to be seeking a degree credential. The expenses can be used to pay for expenses to simply help the student acquire or improve a job skill. The LLC does not require half-time attendance and isn’t limited by a drug felony conviction.</p> <p>Up to $10,000 of expenses can be considered in calculating the 20% credit for a maximum credit of $2,000, and the taxpayer can take the credit for an unlimited number of years. Qualifying expenses for the LLC include costs of tuition and required fees, as well as required books. Books DO have to be required and purchased at the institution to be qualified expenses for the LLC.</p> <p>Whether the taxpayer uses the LLC or decides to use a tuition deduction may depend on his income and marginal tax rate. The credit is phased out for modified MAGI between $52,000 ($104,000 joint), and $62,000 ($124,000 joint).</p> <h4>General Scholarship Treatment</h4> <p>For both the AOTC and LLC, scholarships are often treated as tax-free when applied to qualified expenses, in which case the qualified expenses for the credits are reduced by that amount. The tax code defines the term qualified scholarship as any amount used for qualifying expenses and refers to both scholarships and grants.<a href="#_edn9" name="_ednref9">[9]</a></p> <p>Scholarships (or fellowships) that are paid for services rendered to the institution, such as teaching or research, are not qualified scholarships and should be reported to the taxpayer on a W-2 and included in income. There are some exceptions to this requirement.<a href="#_edn10" name="_ednref10">[10]</a></p> <h3>Scholarship Inclusion</h3> <p>While scholarships generally offset expenses, the regulations do allow taxpayers to treat some scholarships differently in order to increase their qualifying expenses. Treas. Reg. § 1.25A-5 enhances/clarifies the options taxpayers have when claiming education credits and gives the procedure for calculating expenses for the credit.</p> <h4>Three Types of Scholarships</h4> <p>Although not defined as such in the code, scholarships can be defined as exclusive, taxable, or elective based on the terms of the scholarship. <strong>Exclusive</strong> scholarships are those scholarships, by the terms of scholarship, which must be used exclusively to pay qualified expenses. The full amount of the scholarships must reduce the amount of qualified expenses and are tax-free up to the amount of those expenses.</p> <p>A <strong>taxable</strong> scholarship is one that must be used exclusively for <strong><em>other than</em></strong> qualified expenses, or is taxable for other reasons. Room and board is not a qualifying expense, so scholarships that cover only that is normally taxable. Scholarships in excess of qualifying expenses are also taxable.</p> <h4>Elective Scholarships</h4> <p>The third type of scholarship is the <strong>elective</strong> scholarship. If any amount of a scholarship “may or must be used” for other than qualified expenses the taxpayer can elect to treat it as tax-free and offset qualified expenses or include it in income. When treated as income, the amount of qualified expenses is not reduced and the taxpayer may qualify for a higher education credit.</p> <p>Scholarships that are available for elective treatment include Pell grants. Most other federal aid, as well as Coverdell Educational Savings Accounts and Qualified Tuition Plans (Section 529) can also be effectively treated as elective scholarships.<a href="#_edn11" name="_ednref11">[11]</a></p> <p>If a scholarship covers both specific qualified and non-qualified expenses such as tuition or room and board, the taxpayer can choose how to allocate the amounts, but may be limited by the amount of actual expenses. If the scholarship is $6,000 and room and board is $5,000, $5,000 is the most that can be applied to non-qualified expenses.</p> <h4>Measured Scholarships</h4> <p>There is no regulation that addresses scholarships that are <strong><em>measured by</em></strong> the amount of tuition, as opposed to <strong><em>must be used for</em></strong> tuition, but IRS rulings do support the elective nature of such scholarships. In 1999 the Louisiana legislature went from a system that required a TOPS award to be used for tuition to a system that measures the amount of the award by the amount of tuition. That change in the wording was the defining characteristic that allowed scholarship inclusion in the Louisiana TOPS program. In the IRS private letter ruling (PLR) related to the Louisiana Tuition Opportunity Program for Students (TOPS) program in Louisiana, it was determined that the TOPS awards could be used for either qualifying or non-qualifying expenses and the exclusion of the grant was determined by the tax reporting of the taxpayer.<a href="#_edn12" name="_ednref12">[12]</a></p> <p>Following the ruling, the Louisiana Law Review published an article encouraging recipients of the TOPS grant to amend their returns to claim prior year education credits.<a href="#_edn13" name="_ednref13">[13]</a> The terms of the Texas Grant now contains similar wording and although PLRs cannot be used as precedent, the same reasoning can be used to consider that as elective in the same manner.</p> <p>The focus of scholarship inclusion is often on the AOTC, but elective scholarships can be treated the same way in calculating the LLC.  The LLC is not refundable so the benefit is limited to the amount of tax owed. Scholarship inclusion will also incur an increase in tax at the taxpayer’s tax bracket while only generating a 20% credit.</p> <h3>Scholarship Calculations</h3> <p>The IRS provides several examples of adjusting qualifying expenses using scholarship inclusion in Treas. Reg. § 1.25A-5 and Publication 970. For instance, in two examples in Publication 970 the taxpayer includes $4,000 of his Pell grant in income in order to claim that amount for the AOTC.<a href="#_edn14" name="_ednref14">[14]</a></p> <p>One of the problems with calculating education credits is that software doesn’t handle the calculations when scholarship inclusion is involved or when coordinating benefits. Where only scholarships are considered, the AOTC worksheet provided here can calculate the maximum credit amount, by adjusting qualifying expenses to equal the maximum $4,000.</p> <p><a href="/b2e/media/blogs/dbell/aotc_worksheet_only.png?mtime=1422203429"><img src="/b2e/media/blogs/dbell/aotc_worksheet_only.png?mtime=1422203429" alt="AOTC Worksheet" width="100%" /></a></p> <h3>Coordinating With Other Benefits</h3> <p>Just as taxpayers can coordinate their credit with scholarships, they can coordinate with other educational benefits with different qualifications. For example, room and board is a qualifying expense for Section 529, but not for AOTC. By systematically considering each benefit and making adjustments to qualifying expenses, it is possible to determine the best claiming strategy. Consider the following example:</p> <p>Taxpayer has AGI of $48,000 and is claiming AOTC for a dependent child. AOTC qualifying expenses (QE) were $8,000, and room and board was $3,000. He received $4,000 from a Section 529 account. The student also took a $5,000 student loan. After acceptance, he received a $5,000 Pell grant and a $4,000 scholarship that was required to be used for tuition, fees, and room and board. Because his scholarships and grants exceeded his qualifying expenses, he did not receive a 1098-T.</p> <p><a href="/b2e/media/blogs/dbell/aotc_qualpmts.png?mtime=1484776744"><img class="loadimg" style="float: right; margin: 10px;" src="/b2e/media/blogs/dbell/aotc_qualpmts.png?mtime=1484776744" alt="" width="50%" /></a></p> <p>The first step is to allocate $3,000 of the Section 529 to cover room and board (tax-free). Next the $4,000 scholarship can be allocated to tuition and fees, reducing QE to $4,000. Instead of using the Pell grant to offset the remaining expenses, the student can include that $5,000 in income and the taxpayer can claim AOTC on the remaining $4,000 of expenses paid. The taxable portion of the remaining $1,000 of Section 529 is also taxable to the beneficiary, pro-rated based on earnings.</p> <p>The scholarship is not used for room and board because it is not tax-free for that purpose. Section 529 was not used to cover part of the tuition because it is only partially taxable. No penalty applies to the Section 529 distribution because both the scholarships and qualified expenses were more than the distribution amount.<a href="#_edn15" name="_ednref15">[15]</a></p> <h3>IRAs for Education</h3> <p>IRA distributions can also be used for educational expenses without incurring a penalty and they do not have to be for education expenses when taken. If an IRA distribution was for home improvement and later in the tax year the taxpayer incurs education expenses, the amounts can be allocated to the education. Unlike Section 529, amounts are taxable and the amount qualifying for penalty exclusion is reduced by other payments for qualified expenses. In the above example, if an IRA distribution was used instead of Section 529, the $1,000 would also be subject to the 10% penalty. With Roth IRAs, distributions up to the amount of contributions are tax-free.</p> <h3>Family Coordination</h3> <p>One of the quirks of education credits involves coordinating returns of the taxpayer and student. If the taxpayer claims an education credit based on including scholarships in income, it is the student, not the taxpayer, who must include the scholarship in income. Paid expenses can be used by whoever claims the credit but scholarships are always the student's responsibility.</p> <p>The challenge is that the student may be increasing his taxable income, while the parent is enjoying the credit. In order to avoid family conflict it is possible to file Form 8888 to allocate part of the refund to the student by depositing an amount in her bank account that offsets the student’s sacrifice.</p> <p>One factor to consider when only the refundable credit is being claimed is the credit percentage.  The refundable credit can be viewed as 40% of the first $2,000 and 10% (40% * 25%) of the next $2,000. This 10% is important when student must include taxable scholarships in income and tax is owed on it. With the minimum tax rate at 10% the credit from the second $2,000 is wiped out by the scholarships being taxed.</p> <h3>Education Tax Update</h3> <p>Education was addressed Congress on two occasions during in 2015. In June the Trade Preferences Extension Act of 2015 added a provision requiring taxpayers to have a 1098-T payee statement to claim an education credit.<a href="#_edn16" name="_ednref16">[16]</a> The law is effective for tax years beginning after enactment, i.e. the 2016 calendar tax year.</p> <p>Then in December, with the passage of the Protecting Americans from Tax Hikes (PATH) Act of 2015, the AOTC was made permanent and due diligence requirements were added. That law also enhances Section 529 benefits with the most notable change being that expenses for computer equipment, software, and Internet access are now tax-free if used primarily by the beneficiary.<a href="#_edn17" name="_ednref17">[17]</a> Since Coverdell rules refer to this code section, computers will also be tax-free expenses. Section 529 account rules were also changed to eliminate the distribution aggregation requirements, and account owners can now avoid penalties due to tuition refunds by contributing the amount back to a 529 account within 60 days of the date of the refund.</p> <p>The IRS is also addressing the regulations in light of the legislation requiring a 1098-T. Because current regulations allow institutions to forego sending the 1098-T to many students, some taxpayers may not be able to claim the credit they would otherwise have qualified for. Proposed regulations<a href="#_edn18" name="_ednref18">[18]</a> will address that discrepancy by requiring institutions to send 1098-T to most students. Comments are being received until October 31 and a public hearing is not scheduled until November 30, so changes may not be final until into 2017. In the interim, the regulations provide the following reprieve:</p> <p><em>Until the proposed regulations under §§ 1.25A–1(f) and 1.6050S–1(a) are published in the Federal Register as final regulations, a taxpayer (or the taxpayer’s dependent) (other than a non-resident alien) who does not receive a Form 1098–T because its institution is exempt from furnishing a Form 1098–T under current § 1.6050S–1(a)(2) may claim an education tax credit under section 25A(a) if the taxpayer (1) is otherwise qualified, (2) can demonstrate that the taxpayer (or the taxpayer’s dependent) was enrolled at an eligible educational institution, and (3) can substantiate the payment of qualified tuition and related expenses.</em></p> <h3>Education Tax Planning</h3> <p>The many incentives available make education tax planning a complex area but the benefits available allow prudent taxpayers to save on ever-increasing education expenses for themselves, children, and grandchildren. An education saving and spending plan is almost as important as a retirement plan. In both cases, it is important to consider all of the options available and the consequences (or benefits) of distributions, credits, exclusions, and deductions throughout the process. </p> <h3><em>About the Author: </em></h3> <p><em>Dana Bell, EA – Tyler, Texas – is author of the book Education Tax Credits: And Other Educational Incentives. </em> </p> <p> </p> <p><a href="#_ednref1" name="_edn1">[1]</a> IRC § 25A(f)(1)(A)(iii)</p> <p><a href="#_ednref2" name="_edn2">[2]</a> IRC § 151(d)(2) and Treas. Reg. § 1.25A-1(f)</p> <p><a href="#_ednref3" name="_edn3">[3]</a> PLR 200236001 &lt;http://www.irs.gov/pub/irs-wd/0236001.pdf&gt;</p> <p><a href="#_ednref4" name="_edn4">[4]</a> Treas. Reg. § 1.25A-2(d)(3)</p> <p><a href="#_ednref5" name="_edn5">[5]</a> Treas. Reg. § 1.25A-5(e)(4)</p> <p><a href="#_ednref6" name="_edn6">[6]</a> Treas. Reg. § 1.25A-5(b)(2)</p> <p><a href="#_ednref7" name="_edn7">[7]</a> Treas. Reg. § 25.2503-6(b)(1)(i)</p> <p><a href="#_ednref8" name="_edn8">[8]</a> 20 USC § 1088(b)</p> <p><a href="#_ednref9" name="_edn9">[9]</a> IRC § 117(b)(1)</p> <p><a href="#_ednref10" name="_edn10">[10]</a> IRC § 117(c) and (d)</p> <p><a href="#_ednref11" name="_edn11">[11]</a> IRC § 530(d)(2)(C)</p> <p><a href="#_ednref12" name="_edn12">[12]</a> PLR 200137006 &lt;http://www.irs.gov/pub/irs-wd/0137006.pdf&gt;</p> <p><a href="#_ednref13" name="_edn13">[13]</a> Kalinka, Susan. "TOPS Scholarship Recipients Who Failed to Claim the Education Tax Credits for 1998 Should Consider Filing Amended Returns." <em>Louisiana Law Review</em> 60.1 (1999): 281-91. &lt;http://digitalcommons.law.lsu.edu/cgi/viewcontent.cgi?article=5806&amp;context=lalrev&gt;.</p> <p><a href="#_ednref14" name="_edn14">[14]</a> https://www.irs.gov/publications/p970/ch02.html#en_US_2014_publink1000300227</p> <p><a href="#_ednref15" name="_edn15">[15]</a> IRC § 530(d)(4)(B)(iii) and (v)</p> <p><a href="#_ednref16" name="_edn16">[16]</a> IRC § 25A(g)(8)</p> <p><a href="#_ednref17" name="_edn17">[17]</a> IRC § 529(e)(3)(A)(iii)</p> <p><a href="#_ednref18" name="_edn18">[18]</a> <a href="https://www.irs.gov/irb/2016-33_IRB/ar11.html" class="linebreak">https://www.irs.gov/irb/2016-33_IRB/ar11.html</a></p><div class="item_footer"><p><small><a href="https://tylerhosting.com/b2e/dbell.php/education-credits-beyond-the-basics">Original post</a> blogged on <a href="http://www.tylerhosting.com/b2e/">Switched Keys</a>.</small></p></div>
Note: This article was previously published in Today's CPA, the publication of the Texas Society of Certified Public Accountants. At that time, proposed treasury regulations were not released which change the effect of 1098-T requirements. Buried in the proposed regulations is this reprieve for students who do not receive a 1098-T.

Until the proposed regulations under §§ 1.25A–1(f) and 1.6050S–1(a) are published in the Federal Register as final regulations, a taxpayer (or the taxpayer’s dependent) (other than a non-resident alien) who does not receive a Form 1098–T because its institution is exempt from furnishing a Form 1098–T under current § 1.6050S–1(a)(2) may claim an education tax credit under section 25A(a) if the taxpayer (1) is otherwise qualified, (2) can demonstrate that the taxpayer (or the taxpayer’s dependent) was enrolled at an eligible educational institution, and (3) can substantiate the payment of qualified tuition and related expenses.

Also not mentioned in that article are the new due diligence requirements. Effective in 2017 paid preparers claiming the American Opportunity Tax Credit are required to answer the questions in the AOTC column on Form 8867. 


Tax incentives for education may be the most overlooked and most abused items on an individual tax return. They are frequently criticized for their complexity, with each form of education credit or deduction having different rules. With some credits as easy targets for fraud some practitioners are leery of education credit claims. Other problems with these incentives are not so obvious. Software support is limited and taxpayers are not always aware of the benefits or may have false notions about the requirements.

This article focuses on the American Opportunity Tax Credit (AOTC) with incidental mentions of the Lifetime Learning Credit (LLC) and other benefits. It then goes beyond the frequently published basic requirements with a look at IRS regulations that enhance the credits.

The AOTC is an expansion of the Hope Credit, which was created by the Taxpayer Relief Act of 1997, along with the Lifetime Learning Credit. The credits are governed chiefly by IRC § 25A.

Taxpayer Qualifications

In general taxpayers can receive a credit for qualifying educational expenses paid during a tax year. The credit is equal to 100% of the first $2,000, and 25% of the next $2,000, with 40% of the total credit refundable. It is phased out between $80,000 ($160,000 joint) and $90,000 MAGI ($180,000 joint). Also, the taxpayer must not file married filing separately.

The taxpayer must be claiming a dependency exemption for the student which can be any dependent for which the taxpayer is allowed to take a dependency exemption, including individuals that meet the test for dependency exemption as a qualifying relative.[1] So, it’s possible to claim the credit for a student who is a parent or a person whom the taxpayer supports and who lives with him all year.

The taxpayer must not be claimed by someone else as a dependent. One of the quirks in this requirement is that dependency and the dependency exemption amount are separate issues.[2] Clarifying the exemption amount Chief Counsel Advice in 2002 determined that a taxpayer who could have been claimed as a dependent could have a zero exemption amount and claim the credit if nobody claims the exemption.[3]

Student Qualifications

Generally, once dependency is determined, the rest of the qualifications relate to the student and the expenses used to claim the credit.

  • Student must be pursuing an undergraduate degree or other recognized education credential
  • Student must be enrolled at least half time for at least one academic period beginning during the year
  • No felony drug conviction on student’s record
  • Available for first 4 years of post secondary education
  • Cannot be claimed more than 4 tax years

Qualifying Expenses

Expenses that can be used to claim the credits include costs of tuition and required fees, as well as required books and course materials. When available the 1098-T can provide the amount of qualifying expenses for the AOTC though preparers should verify the amounts reported. A 1098-T is not always provided.

Currently books and other course materials have to be required, but they do not have to be purchased at the institution to qualify. If an institution or degree program requires the student to have a computer it may also be considered a qualifying expense. Expenses unrelated to the educational program are not qualifying expenses.[4] Non-qualifying expenses include

  • Room and board
  • Insurance
  • Medical Expenses (including student health fees)
  • Transportation (including parking fees)
  • Living expenses

Qualifying Payments

In addition to having qualifying expenses, the taxpayer must have made payments for those expenses in the tax year. Payments for qualifying expenses include amounts paid by the student, the taxpayer, or through student loans. Special rules apply to certain qualified installment agreements which could affect the recognition of payments.[5]

Payments made by a third party may also qualify as paid by the taxpayer if paid directly to the institution. In that case, the taxpayer is treated as receiving the payment from the third party and, in turn, paying the qualified tuition and related expenses.” [6] So if a grandparent pays the institution for part of the cost of attending college, the taxpayer can claim the credit using those amounts. Those payments (tuition only) are also exclusions from the gift tax and without regard to relationship.[7] Also considered paid by the taxpayer are amounts paid by certain scholarships that the student includes in income.

Generally payments must be made in the year the term begins. Payments made for educational expenses for the first three months of the following year can also be considered as qualifying in the year paid. Qualifying expenses are also limited to amounts for attendance at an eligible educational institution. The institution must be an eligible to participate in Title IV programs such as Pell grants and federally insured student loans.[8]

It is important to be familiar with all the nuances of 1098-T reporting and verify its accuracy. For example, although 1098-T may indicate graduate student status, the requirement is that the student has not earned a four-year degree, but that test is made based on the beginning of the tax year, not the end of the tax year. If a student graduated in May, all expenses for the year still qualify for the AOTC. In fact, prepaying for the first semester of graduate school in the next year is also an option.

Refundable Qualifications

Additional qualifications exist for the refundable portion of the credit. Students age 24 and over qualify for the refundable portion of the credit, as well as parents of children under the age of 24 if they claim the child as a dependent.

Publication 970 lists those who do not qualify for the refundable credit but it may be easier to reverse the logic to see which taxpayers do qualify. While many students under the age of 24 do not qualify for the refundable portion of the credit, it is important to review the regulations that apply to each case as there are several exceptions.

Filing a joint return or when both parents are deceased are two cases where a student under age 24 could qualify. Students that are age 18 and over may also qualify if they provide more than half of their support through earned income. Students over 18 and only attending half-time may also qualify.

The Refundable Credit Test flowchart can help in evaluating whether the refundable qualifications are met. Publication 970 already has a flowchart to identify eligible students for the AOTC.

Lifetime Learning Credit

The LLC is not as generous as the AOTC but it does not have as stringent student qualifications. While it must be for attendance at an eligible educational institution, it does not require the student to be seeking a degree credential. The expenses can be used to pay for expenses to simply help the student acquire or improve a job skill. The LLC does not require half-time attendance and isn’t limited by a drug felony conviction.

Up to $10,000 of expenses can be considered in calculating the 20% credit for a maximum credit of $2,000, and the taxpayer can take the credit for an unlimited number of years. Qualifying expenses for the LLC include costs of tuition and required fees, as well as required books. Books DO have to be required and purchased at the institution to be qualified expenses for the LLC.

Whether the taxpayer uses the LLC or decides to use a tuition deduction may depend on his income and marginal tax rate. The credit is phased out for modified MAGI between $52,000 ($104,000 joint), and $62,000 ($124,000 joint).

General Scholarship Treatment

For both the AOTC and LLC, scholarships are often treated as tax-free when applied to qualified expenses, in which case the qualified expenses for the credits are reduced by that amount. The tax code defines the term qualified scholarship as any amount used for qualifying expenses and refers to both scholarships and grants.[9]

Scholarships (or fellowships) that are paid for services rendered to the institution, such as teaching or research, are not qualified scholarships and should be reported to the taxpayer on a W-2 and included in income. There are some exceptions to this requirement.[10]

Scholarship Inclusion

While scholarships generally offset expenses, the regulations do allow taxpayers to treat some scholarships differently in order to increase their qualifying expenses. Treas. Reg. § 1.25A-5 enhances/clarifies the options taxpayers have when claiming education credits and gives the procedure for calculating expenses for the credit.

Three Types of Scholarships

Although not defined as such in the code, scholarships can be defined as exclusive, taxable, or elective based on the terms of the scholarship. Exclusive scholarships are those scholarships, by the terms of scholarship, which must be used exclusively to pay qualified expenses. The full amount of the scholarships must reduce the amount of qualified expenses and are tax-free up to the amount of those expenses.

A taxable scholarship is one that must be used exclusively for other than qualified expenses, or is taxable for other reasons. Room and board is not a qualifying expense, so scholarships that cover only that is normally taxable. Scholarships in excess of qualifying expenses are also taxable.

Elective Scholarships

The third type of scholarship is the elective scholarship. If any amount of a scholarship “may or must be used” for other than qualified expenses the taxpayer can elect to treat it as tax-free and offset qualified expenses or include it in income. When treated as income, the amount of qualified expenses is not reduced and the taxpayer may qualify for a higher education credit.

Scholarships that are available for elective treatment include Pell grants. Most other federal aid, as well as Coverdell Educational Savings Accounts and Qualified Tuition Plans (Section 529) can also be effectively treated as elective scholarships.[11]

If a scholarship covers both specific qualified and non-qualified expenses such as tuition or room and board, the taxpayer can choose how to allocate the amounts, but may be limited by the amount of actual expenses. If the scholarship is $6,000 and room and board is $5,000, $5,000 is the most that can be applied to non-qualified expenses.

Measured Scholarships

There is no regulation that addresses scholarships that are measured by the amount of tuition, as opposed to must be used for tuition, but IRS rulings do support the elective nature of such scholarships. In 1999 the Louisiana legislature went from a system that required a TOPS award to be used for tuition to a system that measures the amount of the award by the amount of tuition. That change in the wording was the defining characteristic that allowed scholarship inclusion in the Louisiana TOPS program. In the IRS private letter ruling (PLR) related to the Louisiana Tuition Opportunity Program for Students (TOPS) program in Louisiana, it was determined that the TOPS awards could be used for either qualifying or non-qualifying expenses and the exclusion of the grant was determined by the tax reporting of the taxpayer.[12]

Following the ruling, the Louisiana Law Review published an article encouraging recipients of the TOPS grant to amend their returns to claim prior year education credits.[13] The terms of the Texas Grant now contains similar wording and although PLRs cannot be used as precedent, the same reasoning can be used to consider that as elective in the same manner.

The focus of scholarship inclusion is often on the AOTC, but elective scholarships can be treated the same way in calculating the LLC.  The LLC is not refundable so the benefit is limited to the amount of tax owed. Scholarship inclusion will also incur an increase in tax at the taxpayer’s tax bracket while only generating a 20% credit.

Scholarship Calculations

The IRS provides several examples of adjusting qualifying expenses using scholarship inclusion in Treas. Reg. § 1.25A-5 and Publication 970. For instance, in two examples in Publication 970 the taxpayer includes $4,000 of his Pell grant in income in order to claim that amount for the AOTC.[14]

One of the problems with calculating education credits is that software doesn’t handle the calculations when scholarship inclusion is involved or when coordinating benefits. Where only scholarships are considered, the AOTC worksheet provided here can calculate the maximum credit amount, by adjusting qualifying expenses to equal the maximum $4,000.

AOTC Worksheet

Coordinating With Other Benefits

Just as taxpayers can coordinate their credit with scholarships, they can coordinate with other educational benefits with different qualifications. For example, room and board is a qualifying expense for Section 529, but not for AOTC. By systematically considering each benefit and making adjustments to qualifying expenses, it is possible to determine the best claiming strategy. Consider the following example:

Taxpayer has AGI of $48,000 and is claiming AOTC for a dependent child. AOTC qualifying expenses (QE) were $8,000, and room and board was $3,000. He received $4,000 from a Section 529 account. The student also took a $5,000 student loan. After acceptance, he received a $5,000 Pell grant and a $4,000 scholarship that was required to be used for tuition, fees, and room and board. Because his scholarships and grants exceeded his qualifying expenses, he did not receive a 1098-T.

The first step is to allocate $3,000 of the Section 529 to cover room and board (tax-free). Next the $4,000 scholarship can be allocated to tuition and fees, reducing QE to $4,000. Instead of using the Pell grant to offset the remaining expenses, the student can include that $5,000 in income and the taxpayer can claim AOTC on the remaining $4,000 of expenses paid. The taxable portion of the remaining $1,000 of Section 529 is also taxable to the beneficiary, pro-rated based on earnings.

The scholarship is not used for room and board because it is not tax-free for that purpose. Section 529 was not used to cover part of the tuition because it is only partially taxable. No penalty applies to the Section 529 distribution because both the scholarships and qualified expenses were more than the distribution amount.[15]

IRAs for Education

IRA distributions can also be used for educational expenses without incurring a penalty and they do not have to be for education expenses when taken. If an IRA distribution was for home improvement and later in the tax year the taxpayer incurs education expenses, the amounts can be allocated to the education. Unlike Section 529, amounts are taxable and the amount qualifying for penalty exclusion is reduced by other payments for qualified expenses. In the above example, if an IRA distribution was used instead of Section 529, the $1,000 would also be subject to the 10% penalty. With Roth IRAs, distributions up to the amount of contributions are tax-free.

Family Coordination

One of the quirks of education credits involves coordinating returns of the taxpayer and student. If the taxpayer claims an education credit based on including scholarships in income, it is the student, not the taxpayer, who must include the scholarship in income. Paid expenses can be used by whoever claims the credit but scholarships are always the student's responsibility.

The challenge is that the student may be increasing his taxable income, while the parent is enjoying the credit. In order to avoid family conflict it is possible to file Form 8888 to allocate part of the refund to the student by depositing an amount in her bank account that offsets the student’s sacrifice.

One factor to consider when only the refundable credit is being claimed is the credit percentage.  The refundable credit can be viewed as 40% of the first $2,000 and 10% (40% * 25%) of the next $2,000. This 10% is important when student must include taxable scholarships in income and tax is owed on it. With the minimum tax rate at 10% the credit from the second $2,000 is wiped out by the scholarships being taxed.

Education Tax Update

Education was addressed Congress on two occasions during in 2015. In June the Trade Preferences Extension Act of 2015 added a provision requiring taxpayers to have a 1098-T payee statement to claim an education credit.[16] The law is effective for tax years beginning after enactment, i.e. the 2016 calendar tax year.

Then in December, with the passage of the Protecting Americans from Tax Hikes (PATH) Act of 2015, the AOTC was made permanent and due diligence requirements were added. That law also enhances Section 529 benefits with the most notable change being that expenses for computer equipment, software, and Internet access are now tax-free if used primarily by the beneficiary.[17] Since Coverdell rules refer to this code section, computers will also be tax-free expenses. Section 529 account rules were also changed to eliminate the distribution aggregation requirements, and account owners can now avoid penalties due to tuition refunds by contributing the amount back to a 529 account within 60 days of the date of the refund.

The IRS is also addressing the regulations in light of the legislation requiring a 1098-T. Because current regulations allow institutions to forego sending the 1098-T to many students, some taxpayers may not be able to claim the credit they would otherwise have qualified for. Proposed regulations[18] will address that discrepancy by requiring institutions to send 1098-T to most students. Comments are being received until October 31 and a public hearing is not scheduled until November 30, so changes may not be final until into 2017. In the interim, the regulations provide the following reprieve:

Until the proposed regulations under §§ 1.25A–1(f) and 1.6050S–1(a) are published in the Federal Register as final regulations, a taxpayer (or the taxpayer’s dependent) (other than a non-resident alien) who does not receive a Form 1098–T because its institution is exempt from furnishing a Form 1098–T under current § 1.6050S–1(a)(2) may claim an education tax credit under section 25A(a) if the taxpayer (1) is otherwise qualified, (2) can demonstrate that the taxpayer (or the taxpayer’s dependent) was enrolled at an eligible educational institution, and (3) can substantiate the payment of qualified tuition and related expenses.

Education Tax Planning

The many incentives available make education tax planning a complex area but the benefits available allow prudent taxpayers to save on ever-increasing education expenses for themselves, children, and grandchildren. An education saving and spending plan is almost as important as a retirement plan. In both cases, it is important to consider all of the options available and the consequences (or benefits) of distributions, credits, exclusions, and deductions throughout the process. 

About the Author:

Dana Bell, EA – Tyler, Texas – is author of the book Education Tax Credits: And Other Educational Incentives.  

 

[1] IRC § 25A(f)(1)(A)(iii)

[2] IRC § 151(d)(2) and Treas. Reg. § 1.25A-1(f)

[3] PLR 200236001 <http://www.irs.gov/pub/irs-wd/0236001.pdf>

[4] Treas. Reg. § 1.25A-2(d)(3)

[5] Treas. Reg. § 1.25A-5(e)(4)

[6] Treas. Reg. § 1.25A-5(b)(2)

[7] Treas. Reg. § 25.2503-6(b)(1)(i)

[8] 20 USC § 1088(b)

[9] IRC § 117(b)(1)

[10] IRC § 117(c) and (d)

[11] IRC § 530(d)(2)(C)

[12] PLR 200137006 <http://www.irs.gov/pub/irs-wd/0137006.pdf>

[13] Kalinka, Susan. "TOPS Scholarship Recipients Who Failed to Claim the Education Tax Credits for 1998 Should Consider Filing Amended Returns." Louisiana Law Review 60.1 (1999): 281-91. <http://digitalcommons.law.lsu.edu/cgi/viewcontent.cgi?article=5806&context=lalrev>.

[14] https://www.irs.gov/publications/p970/ch02.html#en_US_2014_publink1000300227

[15] IRC § 530(d)(4)(B)(iii) and (v)

[16] IRC § 25A(g)(8)

[17] IRC § 529(e)(3)(A)(iii)

[18] https://www.irs.gov/irb/2016-33_IRB/ar11.html

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IRS Proposes Revised Education Credit Regulations https://tylerhosting.com/b2e/dbell.php/irs-proposes-revised-education-credit Thu, 08 Sep 2016 20:36:00 +0000 Dana Bell Tax Accounting 373@https://tylerhosting.com/b2e/
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<p>With several tax law changes to education credit requirements over the past two years, the IRS regulations have become outdated. One of the changes requires that taxpayers have received a 1098-T in order to claim the credit, although currents regulations do not always require institutions to provide that form to taxpayers. The proposed regulations primarily addresses that inconsistency.</p> <p>I wrote about this in a blog post <a title="Education Credit Alert" href="/b2e/dbell.php/education-credit-alert" target="_blank">Education Credit Alert</a>, and sent letters to the IRS to encourage changing the regulations. More than a year passed since that alert and then last month the IRS released <a title="Proposed Education Credit Regulations" href="https://www.irs.gov/irb/2016-33_IRB/ar11.html" target="_blank">proposed regulations</a> amending sections related to education credits and reporting requirements. Comments are being received until October 31 and a public hearing is not scheduled until November 30, so changes may not be final until into 2017. However, buried in the middle of the proposal is a section that taxpayers and preparers can rely on if the regulations do not become final before the next tax year. </p> <blockquote> <p><em>Until the proposed regulations under §§ 1.25A–1(f) and 1.6050S–1(a) are published in the Federal Register as final regulations, a taxpayer (or the taxpayer’s dependent) (other than a non-resident alien) who does not receive a Form 1098–T because its institution is exempt from furnishing a Form 1098–T under current § 1.6050S–1(a)(2) may claim an education tax credit under section 25A(a) if the taxpayer (1) is otherwise qualified, (2) can demonstrate that the taxpayer (or the taxpayer’s dependent) was enrolled at an eligible educational institution, and (3) can substantiate the payment of qualified tuition and related expenses. </em></p> </blockquote> <p>This essentially reverses the requirement for a 1098-T until the regulations become final. Since the 1098-T requirement does not become effective until 2017, this apparently anticipates that the regulations will not be final before then. This is a benefit to taxpayers, but only partially alleviates the issues with selective 1098-T reporting. If a taxpayer does not receive a 1098-T they may not be aware of the benefits of a tax credit. Still, preparers can be vigilant about advising clients about education credits. </p> <p>Regulations affected include 25A and 6050S. Similar changes are proposed for Section 222 (Tuition Deduction). The basic changes proposed by the IRS include:</p> <h3>Section 25A</h3> <h4>1098-T Requirement</h4> <p>Requires that the student has received a 1098-T statement from the institution in order to claim a credit. The amounts to claim however, are not limited to the amounts reported. Other qualifying expenses can be included. Provides exceptions to the 1098T requirement. The 1098T is not required if it is not received by Jan 31 and </p> <ul> <li>the taxpayer has requested the form, and</li> <li>has cooperated with the institution by providing necessary information.</li> </ul> <p>The proposed regulations do not, however, provide an exception if  only non-institutional payments have been made in the three months year prior to a qualifying tax year.</p> <h4>TIN effective</h4> <p>The proposed regulations also include the requirement that the taxpayer must have had a valid TIN for the tax year the credit was being claimed. This requirement primarily affects the ability to claim credits on an amended return following the receipt of a TIN.</p> <h4>EIN required</h4> <p>Taxpayers must now provide the EIN of the institution when claiming the credits. This is an expansion of the previous requirement that taxpayers provide the EIN if they received a 1098-T. Since the proposal enables all students to receive a 1098-T, this is not an additional a burden. This also will help track and analyse education credit claims.</p> <h3>Section 6050S</h3> <p>The biggest change in education credit regulations is in changes to Section 6050S. While the other modifications are in response to congressional action, this changes the institutional requirements to make those congressional changes practical.</p> <p>The proposed regulations eliminate three of the four exceptions to reporting of education expenses. Previously many students did not receive a 1098-T because their financial aid covered all of their expenses. That is the biggest change. Institutions will no longer have the option of providing information with respect to</p> <ul> <li>courses for which no academic credit is awarded</li> <li>qualified tuition and related expenses are paid entirely with scholarships under</li> <li>qualified tuition and related expenses are paid under a formal billing arrangement  </li> </ul> <p>Institutions still have the option of not reporting for non-credit courses. </p> <h4>Amounts paid</h4> <p>The regulations will also include the change in law that requires institutions to report paid amounts with no options to report amounts billed during the tax year.</p> <h3>Timing</h3> <p>With the proposed regulations coming at such a late date, it is unlikely that they will be effective for the 2017 tax year, and just as unlikely that institutions can change their processes to provide universal 1098-Ts. As a result preparers can rely on the exception buried in the middle of the proposed regulations to submit education credit claims under the old rules.</p> <h3>Congressional Intent</h3> <p>The intent of the law to require the 1098-T in order to claim the education credit was to likely alleviate excess payments due to possible fraud and to save the government money.  I suspect the reverse will be true. Many taxpayers presume they do not qualify for education credits because they did not receive a 1098-T so they don't even try claim it. With a knowledge of current regulations and scholarship inclusion, many more taxpayers will be able to claim that credit. Cost analysis takes years so we may not see the additional cost until 2020. At one point I suspect the law will be changed to limit scholarship inclusion, and possibly require that taxpayers allocate scholarship to qualifying expenses first. Many people believe that's already a requirement.</p> <p>P. S. There is one drawback of all taxpayers receiving a 1098-T. Whether or not a student receives a 1098-T, the excess of scholarships and grants over  expenses is taxable income to the student. In the past, students conveniently forgot about their education if they did not receive a 1098-T. For most people it won't be a burden. For a few, it will be an unpleasant surprise.</p><div class="item_footer"><p><small><a href="https://tylerhosting.com/b2e/dbell.php/irs-proposes-revised-education-credit">Original post</a> blogged on <a href="http://www.tylerhosting.com/b2e/">Switched Keys</a>.</small></p></div>
With several tax law changes to education credit requirements over the past two years, the IRS regulations have become outdated. One of the changes requires that taxpayers have received a 1098-T in order to claim the credit, although currents regulations do not always require institutions to provide that form to taxpayers. The proposed regulations primarily addresses that inconsistency.

I wrote about this in a blog post Education Credit Alert, and sent letters to the IRS to encourage changing the regulations. More than a year passed since that alert and then last month the IRS released proposed regulations amending sections related to education credits and reporting requirements. Comments are being received until October 31 and a public hearing is not scheduled until November 30, so changes may not be final until into 2017. However, buried in the middle of the proposal is a section that taxpayers and preparers can rely on if the regulations do not become final before the next tax year. 

Until the proposed regulations under §§ 1.25A–1(f) and 1.6050S–1(a) are published in the Federal Register as final regulations, a taxpayer (or the taxpayer’s dependent) (other than a non-resident alien) who does not receive a Form 1098–T because its institution is exempt from furnishing a Form 1098–T under current § 1.6050S–1(a)(2) may claim an education tax credit under section 25A(a) if the taxpayer (1) is otherwise qualified, (2) can demonstrate that the taxpayer (or the taxpayer’s dependent) was enrolled at an eligible educational institution, and (3) can substantiate the payment of qualified tuition and related expenses. 

This essentially reverses the requirement for a 1098-T until the regulations become final. Since the 1098-T requirement does not become effective until 2017, this apparently anticipates that the regulations will not be final before then. This is a benefit to taxpayers, but only partially alleviates the issues with selective 1098-T reporting. If a taxpayer does not receive a 1098-T they may not be aware of the benefits of a tax credit. Still, preparers can be vigilant about advising clients about education credits. 

Regulations affected include 25A and 6050S. Similar changes are proposed for Section 222 (Tuition Deduction). The basic changes proposed by the IRS include:

Section 25A

1098-T Requirement

Requires that the student has received a 1098-T statement from the institution in order to claim a credit. The amounts to claim however, are not limited to the amounts reported. Other qualifying expenses can be included. Provides exceptions to the 1098T requirement. The 1098T is not required if it is not received by Jan 31 and 

  • the taxpayer has requested the form, and
  • has cooperated with the institution by providing necessary information.

The proposed regulations do not, however, provide an exception if  only non-institutional payments have been made in the three months year prior to a qualifying tax year.

TIN effective

The proposed regulations also include the requirement that the taxpayer must have had a valid TIN for the tax year the credit was being claimed. This requirement primarily affects the ability to claim credits on an amended return following the receipt of a TIN.

EIN required

Taxpayers must now provide the EIN of the institution when claiming the credits. This is an expansion of the previous requirement that taxpayers provide the EIN if they received a 1098-T. Since the proposal enables all students to receive a 1098-T, this is not an additional a burden. This also will help track and analyse education credit claims.

Section 6050S

The biggest change in education credit regulations is in changes to Section 6050S. While the other modifications are in response to congressional action, this changes the institutional requirements to make those congressional changes practical.

The proposed regulations eliminate three of the four exceptions to reporting of education expenses. Previously many students did not receive a 1098-T because their financial aid covered all of their expenses. That is the biggest change. Institutions will no longer have the option of providing information with respect to

  • courses for which no academic credit is awarded
  • qualified tuition and related expenses are paid entirely with scholarships under
  • qualified tuition and related expenses are paid under a formal billing arrangement  

Institutions still have the option of not reporting for non-credit courses. 

Amounts paid

The regulations will also include the change in law that requires institutions to report paid amounts with no options to report amounts billed during the tax year.

Timing

With the proposed regulations coming at such a late date, it is unlikely that they will be effective for the 2017 tax year, and just as unlikely that institutions can change their processes to provide universal 1098-Ts. As a result preparers can rely on the exception buried in the middle of the proposed regulations to submit education credit claims under the old rules.

Congressional Intent

The intent of the law to require the 1098-T in order to claim the education credit was to likely alleviate excess payments due to possible fraud and to save the government money.  I suspect the reverse will be true. Many taxpayers presume they do not qualify for education credits because they did not receive a 1098-T so they don't even try claim it. With a knowledge of current regulations and scholarship inclusion, many more taxpayers will be able to claim that credit. Cost analysis takes years so we may not see the additional cost until 2020. At one point I suspect the law will be changed to limit scholarship inclusion, and possibly require that taxpayers allocate scholarship to qualifying expenses first. Many people believe that's already a requirement.

P. S. There is one drawback of all taxpayers receiving a 1098-T. Whether or not a student receives a 1098-T, the excess of scholarships and grants over  expenses is taxable income to the student. In the past, students conveniently forgot about their education if they did not receive a 1098-T. For most people it won't be a burden. For a few, it will be an unpleasant surprise.

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Income Averaging and Transitions in Tax Law https://tylerhosting.com/b2e/dbell.php/income-averaging-and-transitions-in Fri, 18 Mar 2016 15:18:00 +0000 Dana Bell Tax Accounting Financial Planning 369@https://tylerhosting.com/b2e/
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<p>Over the years tax law has been quite fluid based on changes and incentives Congress intends to provide to taxpayers in each session. This amoeba-like quality is what makes comparisons between different generations of the tax code difficult. It's more than tax rates and deductions. Also, as the tax law takes different shapes benefits come and go some benefits just take on a different form. Following is one example.</p> <h2>Income Averaging</h2> <p>I have a little tax book that I pick up and read on occasion, <em><strong>How to Legally Avoid Paying Taxes</strong></em> by Sidney Walton. This book came out after the tax reform act of 1964. That year, the individual capital loss carryover was $1000 and carried over for unlimited years. Moving expense deduction was new. There was a deduction for political contributions. Capital gain rates were cut to as little as 7%. While some of the benefits of that era are not so impressive considering today's standards, one benefit had a lot of potential, income averaging.</p> <p>For most types of income, taxpayers could have the ability to average their income over a five-year period. The benefit was only beneficial for taxpayers with fluctuations in income or those with windfall profits in a single year. The law did not apply to gambling, capital gains, and certain other income. Today that law doesn't exist except for specific industries. Instead, taxpayers have to effectively average their income by doing such things as taking losses in years they have gains, keeping funds invested, using IRA rollovers or recharacterizations, or grouping deductions in prosperous years.</p> <p>The most discouraging part of this law were the complicated calculations. Remember this was before the introduction of the Personal Computer in the early 1980's. For the knowledgeable, it was a blessing. You could earn $40,000 is one year and average it with the $8,000 for each of the previous four years and you would pay tax based on the rate for less than $15,000 each year.</p> <h2>Home Sales</h2> <p>Years after the 1964 reform permitting income averaging, I remember reading a feature article (hard copy) about how one couple took advantage of the income averaging law. They would buy an old house, live in it and fix it up over several years. When they sold it, they income averaged the profits. Of course, there were issues relating to whether the gain was capital gain or ordinary income that had to be settled.</p> <p>As mentioned, income averaging no longer exists, but those taxpayers may have an even better incentive for that. With the exclusion of captial gain on a home in the current law, that same couple could buy and fix up a house, sell it for a $500,000 gain and pay no taxes on it all. They have to have lived in it for 2 of last 5 years and meet some other requirements, but with proper planning it could be profitable venture.<br />Incidentally, home sales also had a exclusion in the 1964 law as well. That exclusion was a one-time event, and required the owner to live in it five of the last eight years, and be age 65 or older. The limit was based on a modified sales price of $20,000.</p> <h2>Aside: On Loopholes</h2> <p>When Congress writes tax laws that provide a benefit, they generally are providing a reward for some action or activity, or a benefit for someone with a need. Inadvertently, some of those laws are used by others for whom the law was not intended. That's might be referred to as a loophole. The current fixer-upper business is something that some would call a loophole. However, the law was specifically written to permit this type of activity. The exclusion is available every two to five years. It could have been written like the 1964 law for home sales with an age requirement and a one-time limitation. It wasn't. In the end, a subsequent Congress will determine if it was a loophole and then attempt to close it.</p><div class="item_footer"><p><small><a href="https://tylerhosting.com/b2e/dbell.php/income-averaging-and-transitions-in">Original post</a> blogged on <a href="http://www.tylerhosting.com/b2e/">Switched Keys</a>.</small></p></div>
Over the years tax law has been quite fluid based on changes and incentives Congress intends to provide to taxpayers in each session. This amoeba-like quality is what makes comparisons between different generations of the tax code difficult. It's more than tax rates and deductions. Also, as the tax law takes different shapes benefits come and go some benefits just take on a different form. Following is one example.

Income Averaging

I have a little tax book that I pick up and read on occasion, How to Legally Avoid Paying Taxes by Sidney Walton. This book came out after the tax reform act of 1964. That year, the individual capital loss carryover was $1000 and carried over for unlimited years. Moving expense deduction was new. There was a deduction for political contributions. Capital gain rates were cut to as little as 7%. While some of the benefits of that era are not so impressive considering today's standards, one benefit had a lot of potential, income averaging.

For most types of income, taxpayers could have the ability to average their income over a five-year period. The benefit was only beneficial for taxpayers with fluctuations in income or those with windfall profits in a single year. The law did not apply to gambling, capital gains, and certain other income. Today that law doesn't exist except for specific industries. Instead, taxpayers have to effectively average their income by doing such things as taking losses in years they have gains, keeping funds invested, using IRA rollovers or recharacterizations, or grouping deductions in prosperous years.

The most discouraging part of this law were the complicated calculations. Remember this was before the introduction of the Personal Computer in the early 1980's. For the knowledgeable, it was a blessing. You could earn $40,000 is one year and average it with the $8,000 for each of the previous four years and you would pay tax based on the rate for less than $15,000 each year.

Home Sales

Years after the 1964 reform permitting income averaging, I remember reading a feature article (hard copy) about how one couple took advantage of the income averaging law. They would buy an old house, live in it and fix it up over several years. When they sold it, they income averaged the profits. Of course, there were issues relating to whether the gain was capital gain or ordinary income that had to be settled.

As mentioned, income averaging no longer exists, but those taxpayers may have an even better incentive for that. With the exclusion of captial gain on a home in the current law, that same couple could buy and fix up a house, sell it for a $500,000 gain and pay no taxes on it all. They have to have lived in it for 2 of last 5 years and meet some other requirements, but with proper planning it could be profitable venture.
Incidentally, home sales also had a exclusion in the 1964 law as well. That exclusion was a one-time event, and required the owner to live in it five of the last eight years, and be age 65 or older. The limit was based on a modified sales price of $20,000.

Aside: On Loopholes

When Congress writes tax laws that provide a benefit, they generally are providing a reward for some action or activity, or a benefit for someone with a need. Inadvertently, some of those laws are used by others for whom the law was not intended. That's might be referred to as a loophole. The current fixer-upper business is something that some would call a loophole. However, the law was specifically written to permit this type of activity. The exclusion is available every two to five years. It could have been written like the 1964 law for home sales with an age requirement and a one-time limitation. It wasn't. In the end, a subsequent Congress will determine if it was a loophole and then attempt to close it.

]]>
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Volunteer Tax Assistance Resources https://tylerhosting.com/b2e/dbell.php/volunteer-tax-assistance-resources Wed, 16 Mar 2016 14:10:00 +0000 Dana Bell Tax Accounting 368@https://tylerhosting.com/b2e/
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<p>During tax season each year I occasionally come across issues that I need to research or verify. That's when I think a complete list of resources would be handy. I've started developing such a list and am making <a title="Volunteer Tax Assistance Resources" href="/voltax/" target="_blank">Volunteer Tax Assistance Resources</a> available on-line. The page is at <a href="http://www.tylerhosting.com/voltax/" class="linebreak">http://www.tylerhosting.com/voltax/</a>. This is a collection of resources I've developed to assist me and others with our volunteer work at VITA and AARP Foundation Tax-Aide programs and includes </p> <ul> <li>Links to IRS publications, forms, and instructions</li> <li>List of tax documents and where to enter in TaxWise</li> <li>List of items and where to enter in TaxWise</li> <li>Other Items</li> </ul> <p>The layout of the boxes may not be that pretty on a desktop right now but on a cellphone the boxes appear in a single column. If you use a separate browser window for this page you can also resize it so that boxes appear in a single column and position it to one side of the screen for quick reference. Most items will open in a separate window or tab. You will note that the publications and resources are generally developed by IRS and others, so I can't guarantee they will be there when you use it.</p> <h3>Filter</h3> <p>This list also has a filter. By entering a number or phrase in the Filter box, you can show only those items with that item being referenced within each category. It's not an intelligent filter, so you will have to try different phrases, forms, subjects to get the items you want. Maybe I can modify that some...</p> <h3>TaxWise Finale</h3> <p>The TaxWise references there will be of limited use since next year VITA/TCE will use TaxSlayer. If I decide to update this next year I'll have the list of items and will only have to update it with the TaxSlayer locations and steps.</p> <h3>EA (SEE) Exam Prep</h3> <p>Although this is primarily for volunteers, the list of publications may be useful in studying for the EA exam (at least the Individual section). Instead of taking a prep course, my preparation for the EA exam consisted of reading all the relevant IRS publications. The IRS actually had such a list of publications to study for the SEE, but it was abandoned a few years ago. Maybe I can use this list as a launching point for an updated list. </p><div class="item_footer"><p><small><a href="https://tylerhosting.com/b2e/dbell.php/volunteer-tax-assistance-resources">Original post</a> blogged on <a href="http://www.tylerhosting.com/b2e/">Switched Keys</a>.</small></p></div>
During tax season each year I occasionally come across issues that I need to research or verify. That's when I think a complete list of resources would be handy. I've started developing such a list and am making Volunteer Tax Assistance Resources available on-line. The page is at http://www.tylerhosting.com/voltax/. This is a collection of resources I've developed to assist me and others with our volunteer work at VITA and AARP Foundation Tax-Aide programs and includes 

  • Links to IRS publications, forms, and instructions
  • List of tax documents and where to enter in TaxWise
  • List of items and where to enter in TaxWise
  • Other Items

The layout of the boxes may not be that pretty on a desktop right now but on a cellphone the boxes appear in a single column. If you use a separate browser window for this page you can also resize it so that boxes appear in a single column and position it to one side of the screen for quick reference. Most items will open in a separate window or tab. You will note that the publications and resources are generally developed by IRS and others, so I can't guarantee they will be there when you use it.

Filter

This list also has a filter. By entering a number or phrase in the Filter box, you can show only those items with that item being referenced within each category. It's not an intelligent filter, so you will have to try different phrases, forms, subjects to get the items you want. Maybe I can modify that some...

TaxWise Finale

The TaxWise references there will be of limited use since next year VITA/TCE will use TaxSlayer. If I decide to update this next year I'll have the list of items and will only have to update it with the TaxSlayer locations and steps.

EA (SEE) Exam Prep

Although this is primarily for volunteers, the list of publications may be useful in studying for the EA exam (at least the Individual section). Instead of taking a prep course, my preparation for the EA exam consisted of reading all the relevant IRS publications. The IRS actually had such a list of publications to study for the SEE, but it was abandoned a few years ago. Maybe I can use this list as a launching point for an updated list. 

]]>
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Common IRA Traps https://tylerhosting.com/b2e/dbell.php/common-ira-traps Thu, 10 Mar 2016 00:07:00 +0000 Dana Bell Tax Accounting Financial Planning 364@https://tylerhosting.com/b2e/
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<p>This tax season has been one for IRA traps. IRAs are great, but meeting the rules can be a challenge. With hefty penalties on large sums, any mistake can be disastrous. Here's a few issues I've encountered this year.</p> <h3>Don't Forget to Take RMDs.</h3> <p>With most companies taking care of making distributions, most people don't have to worry about required minimum distributions (RMDs). But, that does not always happen. If the company doesn't, you have to remember to. The rules make it difficult to calculate and remember the date the RMDs start. The first one begins in the year you turn 70 1/2 (not 70 or 71). That one, and only that one, can be taken as late as April 1. After that, they have to be taken by December 31. Yes, there is forgiveness, but you have to catch up and if two RMDs are taken in the same year, you can end up in a higher tax bracket. Incidentally the penalty is 50% of what should have been taken.</p> <h3>Bad Bank Advice</h3> <p>Even if you don't have an IRA of your own, you may need to know the tax consequences of receiving a IRA due to someone's death. The bank could just send it to you without any further explanation. Then another bank may give you bad advice about what to do with it. That happened to one client. The bank told her to put it into a CD (What is the interest on CD's now?), and the person ended up with a hefty tax bill. If the person would have known, she would have rolled in over into another IRA.</p> <h3>Lump-sum Distributions</h3> <p>Lump-sum distributions come with quite a large tax liability, but there is an apparently a grandfathered rule that allows recipients of an IRA paid due to death to calculate the tax on a 10-year basis. There are specific rules, including that the person must have been born before Jan 2, 1936. That date doesn't change each year. Both times I've encountered this, the tax savings were near $5,000. Who's going to know this rule? You should.</p> <p>This issue also has another component if you are using a certain software package. Although this program calculated the taxable amount correctly based on Form 4972, instead of using that as the tax, it added it to the normal tax amount. No other software that I have used does that. That's another bit of advice. Know what your software is doing; it might not always be right.</p> <h3>Tax is More Than Withholding</h3> <p>Speaking of lump-sum distributions, carefully consider the tax that will be owed on the distribution. Just because a company is required to take 20% withholding on the distribution doesn't mean that is all the tax they will have to pay on it. It may just be a down-payment on their total tax liability. If it's an early distribution and there's not a good reason for it, there may also be an additional 10% penalty.</p> <h3>Roth IRAs (Or Are They?)</h3> <p>Unlike Traditional IRAs, Roth IRAs are not taxable. Usually, the company reports distributions on a 1099-R with a code indicating the type. It usually doesn't say Roth on it anywhere. In one case, a taxpayer came in with a form indicating a normal distribution, with a Code 7. He said it was a Roth IRA, in which case it should have had a different code. He insisted it was a Roth, and had a good argument to back that up. Keep good records, read them, and if it's a rollover know what type of rollover you are making. If it doesn't get tagged as a Roth, it becomes taxable all over again. Not good.</p> <p>The side note here is to know your forms. They are not always right and if the wrong information is put in the software, you get a wrong result.</p> <h3>IRA Opportunities</h3> <p>While there are traps, there are also opportunities with an IRA. There are exceptions for early withdrawals for certain dire needs, such as education, housing, and medical needs. You can also start retirement before 59 1/2 (SEPP) under certain circumstances. The one most overlooked is the Roth rollover. It always worth considering, especially in those years with limited income. If it doesn't work, it may be possible to undo it. The IRS has publications that cover IRAs. If you don't want to download them or read them on-line the IRS will mail them to you free if you request them.<br /><br />The importance of knowing your finances is becoming more crucial with all the options that are available. It's not enough to know you have a good employer package or bank product. You need to know how to use it .. and how not to.</p><div class="item_footer"><p><small><a href="https://tylerhosting.com/b2e/dbell.php/common-ira-traps">Original post</a> blogged on <a href="http://www.tylerhosting.com/b2e/">Switched Keys</a>.</small></p></div>
This tax season has been one for IRA traps. IRAs are great, but meeting the rules can be a challenge. With hefty penalties on large sums, any mistake can be disastrous. Here's a few issues I've encountered this year.

Don't Forget to Take RMDs.

With most companies taking care of making distributions, most people don't have to worry about required minimum distributions (RMDs). But, that does not always happen. If the company doesn't, you have to remember to. The rules make it difficult to calculate and remember the date the RMDs start. The first one begins in the year you turn 70 1/2 (not 70 or 71). That one, and only that one, can be taken as late as April 1. After that, they have to be taken by December 31. Yes, there is forgiveness, but you have to catch up and if two RMDs are taken in the same year, you can end up in a higher tax bracket. Incidentally the penalty is 50% of what should have been taken.

Bad Bank Advice

Even if you don't have an IRA of your own, you may need to know the tax consequences of receiving a IRA due to someone's death. The bank could just send it to you without any further explanation. Then another bank may give you bad advice about what to do with it. That happened to one client. The bank told her to put it into a CD (What is the interest on CD's now?), and the person ended up with a hefty tax bill. If the person would have known, she would have rolled in over into another IRA.

Lump-sum Distributions

Lump-sum distributions come with quite a large tax liability, but there is an apparently a grandfathered rule that allows recipients of an IRA paid due to death to calculate the tax on a 10-year basis. There are specific rules, including that the person must have been born before Jan 2, 1936. That date doesn't change each year. Both times I've encountered this, the tax savings were near $5,000. Who's going to know this rule? You should.

This issue also has another component if you are using a certain software package. Although this program calculated the taxable amount correctly based on Form 4972, instead of using that as the tax, it added it to the normal tax amount. No other software that I have used does that. That's another bit of advice. Know what your software is doing; it might not always be right.

Tax is More Than Withholding

Speaking of lump-sum distributions, carefully consider the tax that will be owed on the distribution. Just because a company is required to take 20% withholding on the distribution doesn't mean that is all the tax they will have to pay on it. It may just be a down-payment on their total tax liability. If it's an early distribution and there's not a good reason for it, there may also be an additional 10% penalty.

Roth IRAs (Or Are They?)

Unlike Traditional IRAs, Roth IRAs are not taxable. Usually, the company reports distributions on a 1099-R with a code indicating the type. It usually doesn't say Roth on it anywhere. In one case, a taxpayer came in with a form indicating a normal distribution, with a Code 7. He said it was a Roth IRA, in which case it should have had a different code. He insisted it was a Roth, and had a good argument to back that up. Keep good records, read them, and if it's a rollover know what type of rollover you are making. If it doesn't get tagged as a Roth, it becomes taxable all over again. Not good.

The side note here is to know your forms. They are not always right and if the wrong information is put in the software, you get a wrong result.

IRA Opportunities

While there are traps, there are also opportunities with an IRA. There are exceptions for early withdrawals for certain dire needs, such as education, housing, and medical needs. You can also start retirement before 59 1/2 (SEPP) under certain circumstances. The one most overlooked is the Roth rollover. It always worth considering, especially in those years with limited income. If it doesn't work, it may be possible to undo it. The IRS has publications that cover IRAs. If you don't want to download them or read them on-line the IRS will mail them to you free if you request them.

The importance of knowing your finances is becoming more crucial with all the options that are available. It's not enough to know you have a good employer package or bank product. You need to know how to use it .. and how not to.

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Tax-Aide Repents on Education Credits: I Win! https://tylerhosting.com/b2e/dbell.php/tax-aide-repents-on-education Mon, 18 Jan 2016 20:29:00 +0000 Dana Bell Professional Accounting Tax Accounting 361@https://tylerhosting.com/b2e/
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<p>I know that title sounds childish, but it is meant to get attention. Last year I confronted someone at Tax-Aide corporate headquarters about a spreadsheet on the support website that limited the amount of scholarships by the amount of the taxpayer's own money spent on qualified education expenses. The tax code and IRS regulations do not mention any own money requirement. So, I discussed this in a series of email exchanges about the law and IRS regulations.</p> <p>After a half dozen emails, we couldn't agree. I followed up with a blog entry here that traces the argument. That entry, <a href="/b2e/dbell.php/education-credits-tax-aide-wrong">Education Credits: Tax-Aide Has It Wrong,</a> was one of the most popular blog entries last year. I also mentioned the debate over the "own money" philosophy in my book anonymously. Book plug goes here: <a title="Education Tax Credits" href="/dbell/books/etc.html" target="_blank">http://www.tylerhosting.com/dbell/books/etc.html</a></p> <p>In the end, apparently I won the argument. This year the new Tax-aide worksheet for preparers has no mention of <strong>own money</strong>, and maximizes AOTC much like my own <a title="AOTC Worksheet" href="/dbell/files/EdCredit/AOTC%20Worksheet.pdf" target="_blank">AOTC Worksheet</a>. It includes but doesn't separately show excess scholarships but it does show separate lines for books and course materials which mine didn't. The summary for the AOTC even shows AOTC expenses and Taxable scholarships for different scenarios, including</p> <ul> <li>Use $2,000 toward AOC</li> <li>Max AOC</li> <li>Min AGI</li> </ul> <p>Also displayed with the summary was an optional parameter, "No more than this for taxable scholarship" which could be very useful. This could be the amount of income below filing threshold for a student, or the amount that maintains income for the current EITC credit, or the amount below a certain tax bracket, i.e. 25% for taxpayers. The last two years, keeping the income low to qualify for a ACA exemption is another concern.</p> <p>At the very bottom of the sheet were twin sections for student and parent that help to maximize the net benefit when a student has to include scholarships in income to enable the parent to claim more of the credit. Their spreadsheet was also more universal since it has additional columns for the Lifetime Learning Credit and the tuition deduction.</p> <p>The only problem I had was getting the spreadsheet to open. It failed to open what appeared to be attached files, but finally did open. I am using Excel 2007. I also had to unprotect it to get it to work. However, that enabled me to enter data in all (formula) cells when you should only be able to enter data in non-calculated blue cells. It's an easy fix, though.</p> <p>Still, I have to say, when it comes to education credit aids, they actually win this round. The Tax-Aide support site also refers to an on-line education benefit calculator as an aid to calculating tax credits, but that one is a little too complicated for me, and I generally like complex things. It's new, so I'm sure it will get better as it ages.</p> <p>I was also encouraged this year to see that scholarship inclusion was a noticeable part of the training materials in Tax-Aide this year, and appeared to have a more coverage in the training materials and Pub 4012. I'm still waiting for IRS to resolve the payee statement discrepancy that I mention in the entry <a href="/b2e/dbell.php/education-credit-alert">Education Credit Alert.</a></p><div class="item_footer"><p><small><a href="https://tylerhosting.com/b2e/dbell.php/tax-aide-repents-on-education">Original post</a> blogged on <a href="http://www.tylerhosting.com/b2e/">Switched Keys</a>.</small></p></div>
I know that title sounds childish, but it is meant to get attention. Last year I confronted someone at Tax-Aide corporate headquarters about a spreadsheet on the support website that limited the amount of scholarships by the amount of the taxpayer's own money spent on qualified education expenses. The tax code and IRS regulations do not mention any own money requirement. So, I discussed this in a series of email exchanges about the law and IRS regulations.

After a half dozen emails, we couldn't agree. I followed up with a blog entry here that traces the argument. That entry, Education Credits: Tax-Aide Has It Wrong, was one of the most popular blog entries last year. I also mentioned the debate over the "own money" philosophy in my book anonymously. Book plug goes here: http://www.tylerhosting.com/dbell/books/etc.html

In the end, apparently I won the argument. This year the new Tax-aide worksheet for preparers has no mention of own money, and maximizes AOTC much like my own AOTC Worksheet. It includes but doesn't separately show excess scholarships but it does show separate lines for books and course materials which mine didn't. The summary for the AOTC even shows AOTC expenses and Taxable scholarships for different scenarios, including

  • Use $2,000 toward AOC
  • Max AOC
  • Min AGI

Also displayed with the summary was an optional parameter, "No more than this for taxable scholarship" which could be very useful. This could be the amount of income below filing threshold for a student, or the amount that maintains income for the current EITC credit, or the amount below a certain tax bracket, i.e. 25% for taxpayers. The last two years, keeping the income low to qualify for a ACA exemption is another concern.

At the very bottom of the sheet were twin sections for student and parent that help to maximize the net benefit when a student has to include scholarships in income to enable the parent to claim more of the credit. Their spreadsheet was also more universal since it has additional columns for the Lifetime Learning Credit and the tuition deduction.

The only problem I had was getting the spreadsheet to open. It failed to open what appeared to be attached files, but finally did open. I am using Excel 2007. I also had to unprotect it to get it to work. However, that enabled me to enter data in all (formula) cells when you should only be able to enter data in non-calculated blue cells. It's an easy fix, though.

Still, I have to say, when it comes to education credit aids, they actually win this round. The Tax-Aide support site also refers to an on-line education benefit calculator as an aid to calculating tax credits, but that one is a little too complicated for me, and I generally like complex things. It's new, so I'm sure it will get better as it ages.

I was also encouraged this year to see that scholarship inclusion was a noticeable part of the training materials in Tax-Aide this year, and appeared to have a more coverage in the training materials and Pub 4012. I'm still waiting for IRS to resolve the payee statement discrepancy that I mention in the entry Education Credit Alert.

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