Recent Tax Developments 1/17/2008

The tax news last quarter was dominated by several important new tax laws that were passed in late 2007. They include relief for 2007 only from the AMT (alternative minimum tax) for middle class taxpayers, relief for individuals who might otherwise have owed tax from foreclosure of their home or a debt workout with their lender, other tax benefits for homeowners, and a new tax break for voluntary responders, such as volunteer firefighters. But a number of other important tax developments occurred in the past three months. Because they may affect you, your family, and your livelihood, we have summarized them below. Please call us for more information about any of them and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

Eased health insurance deduction rule for solely owned S corporations.

In 2006, IRS guidance had con­cluded that an S corporation's sole shareholder who was also its sole employee couldn't buy health insurance in his or her own name and deduct the premiums above­ the-line in arriving at adjusted gross income under a spe­cial provision that applies for self-employed persons, partners and more-than-2% shareholder-employees of S corporations. Last quarter, the IRS changed its tune and now allows the deduction if the sole shareholder makes the premium payments and furnishes proof of payment to the corporation and it then reimburses him or her. The changed position may make it possible to file an amend­ed return claiming a refund for someone who was denied a deduction under the old rule.

Alternative motor vehicle credit.

The IRS has announced that its website lists certain large trucks, buses and other heavy vehicles that qualify as either qualified alternative fuel motor vehicles (QAFMV) or qualified heavy hybrid vehicles. Buyers of QAFMVs can claim a credit of up to $32,000, and buyers of heavy hybrid vehicles can claim a credit of up to $12,000. IRS's web site also lists conventional sized vehicles that qualify for the alternative motor vehicle credit. In this regard, it should be noted that the IRS has announced the beginning of the phase out of the hybrid vehicle credit and the advanced lean burn tech­nology vehicle credit for vehicles manufactured by Honda that are bought on or after Jan. 1, 2008. Honda vehicles bought on or after Jan. 1, 2008, and on or before June 30, 2007 will only qualify for 50% of the otherwise allowable credit amount. Vehicles bought on or after July 1, 2008 and on or before Dec. 31, 2008 will only qualify for 25% of the credit. Vehicles bought on or after Jan. 1, 2009 will not qualify for any I credit. Toyota and Lexus vehicles purchased on or after Oct. 1, 2007 do not qualify for any credit. A full credit is still allowed for eligible Ford, GM, Nissan and Mazda vehicles.

Misclassified workers notify IRS on new form.

The IRS has developed a new form for employees who have been misclassified as independent contractors by an employer. Form 8919, Uncollected Social Security and Medicare Tax on Wages, is now used to figure and report the employee's share of uncollected social secu­rity and Medicare taxes due on their compensation. Generally, a worker who receives a Form 1099 for ser­vices provided as an independent contractor must report the income on Schedule C and pay self-employment tax on the net profit, using Schedule SE. However, a worker may be incorrectly treated as an independent contrac­tor when he is actually an employee. When this hap­pens, Form 8919 is used to figure and pay the worker's share of social security and medicare taxes. The amount to be paid will be much lower than if the worker had to pay self-employment taxes.

Self-prescribed diagnostic tests qualify as deductible medical expenses.

The IRS has issued guid­ance making it clear that healthy individuals who item­ize their deductions can deduct as medical expenses amounts they pay for medical tests they undergo at their own initiative. For example, if you have a full body electronic scan to identify any potential diseases or organ abnormalities, you can deduct its cost as an itemized medical expense deduction, subject to applic­able limits, even if your physician didn't prescribe it. Because they qualify as medical expenses, these items also can be reimbursed under a tax-favored flexible spending account.

New simplified method for allocating prepaid mort­gage insurance premiums.

Taxpayers may claim a new itemized deduction on their 2007 returns for premiums paid or accrued on qualified mortgage insurance. Basically, taxpayers may treat amounts paid during the year for qualified mortgage insurance as home mort­gage interest-and thus deductible in most instances. The special rule for home mortgage interest is phased out at higher levels of adjusted gross income (AGI). The insurance must be in connection with home acqui­sition debt, the insurance contract must have been issued after 2006, and the taxpayer must pay the pre­miums for coverage in effect during the year. The IRS has indicated that individuals may use a simplified method to allocate prepaid qualified mortgage insur­ance premiums to determine the amount that may be deducted for 2007. The simplified method allows pre­paid premiums to be allocated ratably over 84 months or if shorter, the term of the mortgage. Originally, this deduction was to apply only for 2007. Late last year a law was passed extending this deduction for three years through 2010.

IRS scuttles technique for avoiding the wash sale rule.

IRS has put a stop to an end run around the wash sale rule. This is the rule that prevents recognition of loss where substantially identical stock or securities are bought and sold within a 61-day period (30 days before or 30 days after the date of sale). Some individ­uals would try to get around this by having their IRA buy the stock or securities they sold at a loss. But the IRS now says that if an individual sells stock or secu­rities at a loss and causes his IRA or Roth IRA to purchase substantially identical stock or securities within the 61-day period, the loss on the sale of the stock or securities is disallowed by the wash sale rule. Usually, there's a basis adjustment for the disallowed loss. For example, say you bought at $100, sold it for $50 and bought it back within 60 days at $50. The basis of the new stock ordinarily is increased by the $50 disal­lowed loss. But the IRS says that the stock purchased through the IRA does not get a basis adjustment in these cases.

How losing gambler won important tax breaks.

An individual who lost a lot of money playing slot machines came up a winner in her fight with the IRS. Against the IRS's strenuous objection, she convinced a court that she was in the "trade or business" of gam­bling. While the result may seem peculiar due to the nature of slot machines where no particular skill seem­ingly is needed to win, this case shows that slot play­ers can implement strategies and techniques to bolster their prospects of being treated as engaged in a trade or business for tax purposes. While for tax purposes, gambling losses are limited to gambling winnings whether or not a gambler is engaged in a trade or busi­ness, a business gambler gets to deduct them above-­the-line rather than as an itemized deduction. This is preferable to including winnings in income and deducting losses as an itemized deduction because the increased adjusted gross income can cause loss or reduction of other tax breaks, such as deductions for medical expenses or IRA contributions.

Tax break for disabled veterans.

The IRS wants dis­abled veterans to know that payments under the Veterans Affairs (VA) Compensated Work Therapy (CWT) program are no longer taxable and that veter­ans who paid tax on these benefits in tax years 2004-­2006 ought to claim refunds on Form 1040X. According to the VA, more than 19,000 veterans received CWT payments in fiscal year 2007.