CPE Credit Service

Sidney Kess and Barbara Weltman

FOCUS: Debt: A Tax PerspectivePRACTICE MANAGEMENT TIP: Handling Household

EmployeesRECENT DEVELOPMENTS

FILING DEADLINES and REMINDERS

ONLINE GRADINGINSTANT TEST SCORES

AND NO EXPRESSGRADING FEE

SEE PAGE 49 FORDETAILS

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CPE CREDIT SERVICE

November 2015

IntroductionThis CPE Course, developed by noted tax authorities Sidney Kess and BarbaraWeltman, provides you with an overview of recent tax developments. This seriesreviews what is happening or is about to happen on the tax scene and highlightsplanning tips and techniques to help you in your practice. Citations to CCH’sFEDERAL TAX GUIDE REPORTS® (FTG), STANDARD FEDERAL TAX REPORTS® (FED), andTAX RESEARCH CONSULTANT® (TRC) are provided to assist you in locating informa-tion for further review. More importantly, however, a Quizzer is contained in theback of the Course and can be completed for CPE credit.

When you have a thorough understanding of the material contained in thisCourse, answer the Quizzer questions. Go to CCHGroup.com/CPECredit tocomplete your Quizzer online for immediate results and no Express Grading Fee.Further information is provided in the CPE Quizzer instructions on page 49.Successful completion of the Quizzer should qualify you for four* hours ofcontinuing education credit. See the Quizzer instructions on page 49 for completedetails.

Please note that CCH’s CPE CREDIT SERVICE is mailed to CCH federal taxsubscribers. Should you be a subscriber to several services, you will receivemultiple copies of this month’s CPE CREDIT SERVICE. Since the information isidentical, please be advised that only one of these Courses can be completed forContinuing Professional Education credit.

Go to CCHGroup.com/CPECredit to complete your Quizzer online for immedi-ate results and no Express Grading Fee. Further information is provided in theCPE Quizzer instructions on page 49.

* CPE requirements vary from state to state. Please contact your CPE governingbody for information on the CPE credit that is accepted for self-study.

November 2015

CCH CPE CREDIT SERVICE

This Course material is designed to be used in conjunction with your CCHreporters. We refer you to the specific paragraphs in the reporters, where eachsubject is covered in greater detail.

FTG paragraph (¶) numbers refer to the FEDERAL TAX GUIDE®. FED paragraph (¶)numbers refer to the STANDARD FEDERAL TAX REPORTS®. TRC topic identifiers andnumbers refer to TAX RESEARCH CONSULTANT®.

Please see page 57 for the CPE Course Spotlight on the CCH Learning Center.

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ABOUT THIS ISSUEThis edition of the CPE CREDIT SERVICE focuses on debt and what it meansfor tax purposes. It looks at key provisions, developments, and potential changeson the horizon that will affect individuals and businesses.

We will also provide those of you who are tax practitioners with a practicemanagement tip.

Further, we will tell you about some important cases, regulations, rulings, andother IRS pronouncements that can be useful for your clients and can help you inyour practice or business.

Finally, we will remind you of some key filing deadlines that are coming up.

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ContentsI. FOCUS: Debt: A Tax Perspective . . . . . . . . . . . . . . . . . . . . 4

Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4B. Overview of the Interest Deduction . . . . . . . . . . . . . . . . 4C. Residence Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . 6D. Business Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12E. Passive Activity Interest . . . . . . . . . . . . . . . . . . . . . . . . 14F. Investment Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . 15G. Student Loan Interest . . . . . . . . . . . . . . . . . . . . . . . . . 16H. Other Consumer Interest . . . . . . . . . . . . . . . . . . . . . . . 17I. Cancellation of Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . 18J. Other Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . 22K. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

II. PRACTICE MANAGEMENT TIP: Handling HouseholdEmployees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24B. Employer Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . 24C. Writing off the Cost of Household Employees . . . . . . . . . 26D. State Law Considerations . . . . . . . . . . . . . . . . . . . . . . . 27E. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

III. RECENT DEVELOPMENTS . . . . . . . . . . . . . . . . . . . . . . . . 29Learning Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29A. Identity Theft Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . 29B. Section 83(B) Election . . . . . . . . . . . . . . . . . . . . . . . . . 30C. Developments on Charitable Contributions and Gifts . . . . 31D. Taxation of Distributions from IRAS and Annuities . . . . . 33E. Appellate Court Developments . . . . . . . . . . . . . . . . . . . 34F. Interest Rates on Corporate Refunds . . . . . . . . . . . . . . . 36G. Law School Costs Not Deductible . . . . . . . . . . . . . . . . . 36H. High-Low Substantiation Method for Business Travel Costs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37I. Arbitration Program Ended . . . . . . . . . . . . . . . . . . . . . . . 39J. Interest Rates for Q4 2015 . . . . . . . . . . . . . . . . . . . . . . 39

IV. FILING DEADLINES AND REMINDERS . . . . . . . . . . . . . . . 41A. December 15, 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . 41B. December 31, 2015 . . . . . . . . . . . . . . . . . . . . . . . . . . . 41C. January 15, 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41D. February 1, 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43Answers to Study Questions . . . . . . . . . . . . . . . . . . . . . . . . . 44CPE Quizzer Instructions . . . . . . . . . . . . . . . . . . . . . . . . . . . 49Quizzer Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

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I. FOCUS: Debt: A Tax Perspective

LEARNING OBJECTIVES

Upon completing this section, participants will be able to:

• Apply the tracing rules to interest expenses

• Select the dollar limit for residential interest for different types oftaxpayers

• Identify which types of cancellation of debt result in excludable income

A. Introduction

The focus of this edition of the CPE CREDIT SERVICE is on debt and what itmeans for tax purposes. A Pew Study found that eight in 10 Americans are indebt (http://www.pewtrusts.org/~/media/assets/2015/07/reach-of-debt-re-port_artfinal.pdf). In 2015, total American consumer debt was $11.85 trillion, or1.7% higher than in the previous year (https://www.nerdwallet.com/blog/credit-card-data/average-credit-card-debt-household/). The average amount of creditcard debt per household is now $15,706. Mortgage debt averages $156,333. Andstudent loan debt is currently pegged at $32,953 on average.

Consumers aren’t the only debtors. Businesses borrow money to startup andexpand, making interest reported on business returns considerable. For example,the 23.5 million returns for sole proprietorships showed total interest paid of $3.6billion (exclusive of mortgage interest) (http://www.irs.gov/pub/irs-soi/soi-a-inpr-id1503.pdf). And the 3.4 million partnership returns in 2012 showed totalinterest paid of $81 billion (http://www.irs.gov/pub/irs-soi/soi-a-pa-id1504.pdf).

There are two basic tax issues for debt: deducting interest and the treatment ofdebt forgiveness. There is no tax deduction for the repayment of principal, butinterest payments may be fully deductible, partially deductible, or nondeduct-ible, depending on the nature of the debt. By the same token, the cancellation ofdebt usually gives rise to income, but it may be tax free in certain circumstances.This focus addresses the general rules for deducting interest and reportingcancellation of debt income. Recent developments in these areas are featured.

B. Overview of the Interest Deduction

Interest is an amount determined by multiplying a rate to an amount of principalthat has been borrowed. In nearly all cases, interest payments received by alender are taxable (there are some exceptions, such as interest on municipalbonds). However, from the borrower’s perspective interest may or may not betax deductible. What’s more, deductibility may be limited and can depend on theborrower’s income.

Categories of interest. Prior to the Tax Reform Act of 1986, most interest was fullydeductible. That law changed the rules for many types of interest. In order to

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determine whether interest is deductible and what limitations apply, first deter-mine the type of interest involved. There are six basic categories:

• Residence interest

• Business interest

• Passive-activity interest, such as interest on mortgaged rental property

• Investment interest on loans to buy or carry investment property

• Student loan interest

• Consumer (personal) interest, such as credit card debt and loans forpersonal vehicles

Each of these categories is explained further in this FOCUS.

Tracing rules. Residence interest has its own rules and is exempt from the tracingrules. However, the treatment of other types of interest (the five other categorieslisted above) depends on the purpose for which the loan is taken. This determi-nation is made under the tracing rules that allocate interest according to the wayin which the proceeds of a loan are used (Reg. §1.163-8T). The allocation of debt,and interest on it, is made automatically within 30 days of receiving the loanproceeds, depending on how the proceeds are used. If an allocation is not madewithin the 30-day period because the proceeds are not used for any purpose (e.g.,they sit in the borrower’s bank account), the loan is assumed to be proceeds usedfor personal expenditures.

EXAMPLE: A taxpayer borrows money to start a corporation. Because theloan is used to buy stock in the corporation, the interest on the loan is treated asinvestment interest.

EXAMPLE: A taxpayer borrows money to start a limited liability company.Because the loan is used to buy an unincorporated business, the interest on theloan is treated as business interest.

PLANNING POINTER: If a single loan is used for multiple purposes, thetracing rules are applied to make an allocation of the loan amount, and theinterest on it. It is advisable to keep the funds separated for the differentpurposes. For example, a loan that is used for both business and investmentpurposes should be kept in separate accounts so that the tax treatment of theinterest is clear.

If proceeds from a second loan are used to pay off an outstanding loan, theinterest on the second loan is treated in the same way as the interest on the firstone. If the second loan is greater than the balance on the outstanding loan that ispaid off, the additional proceeds, and the interest on this portion of the secondloan, are allocated according to their use.

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Special rules apply to the repayment of a loan the proceeds of which were usedfor more than one purpose. Instead of using tracing or any allocation, repaymentis applied in this order:

• Personal debt

• Investment debt

• Passive activity debt associated with rental realty in which the taxpayeractively participates

• Former passive activity debt

• Trade or business debt

EXAMPLE: A taxpayer borrows $20,000, $15,000 of which is used in herbusiness and $5,000 is used to take a vacation. She repays $8,000. The payoffis applied first to personal debt (i.e., all of the $5,000 is treated as having beenrepaid); the balance is applied toward the business debt. Going forward, all of theinterest is now business interest.

Deemed interest. An interest deduction may be allowed even if a payment is notlabeled interest or where interest is imputed. Examples:

• Unstated interest on an installment sale. If the sale fails to provide foradequate interest, a portion of each installment is recharacterized asinterest (i.e., ordinary income rather than capital gain). Adequate interestis measured by the applicable federal rate (AFR). However, a specialinterest rule applies when a nondealer sells real or personal property ifthe sale price is over $150,000 (Code Sec. 453A). Interest under this rule istreated as an additional tax (not interest).

• Imputed interest on below-market loans. If the rate of interest charged isless than AFR for the term of the loan, or if no interest is charged and theloan is not a gift loan, the borrower is deemed to have paid interest at theAFR (the lender is deemed to have received the interest) (Code Sec. 7872).A list of AFRs can be found on the IRS website (http://apps.irs.gov/app/picklist/list/federalRates.html). However, certain employee relocationloans are exempt from the below market loan rules (Temporary Reg.§1.7872-5T(c)(1)).

C. Residence Interest

A deduction for mortgage interest was claimed by 33.3 million taxpayers on 2013returns (the most recent year for statistics) (http://www.irs.gov/pub/irs-soi/soi-a-inpd-id1505.pdf). The amount of these deductions totaled $292.9 billion, which is10.2% lower than the amount claimed on 2012 returns. Mortgages taken out on orbefore October 13, 1987, are not subject to any limitations (this is referred to as“grandfathered debt”); most of this debt has long since been paid off due topayoffs on sales or refinancing. However, mortgages obtained after this date aresubject to a dollar limit on the amount of borrowing. For interest to be deducti-ble, the residential debt must be secured by the home. The amount of thehomeowner’s income has no impact on the initial deduction for residential

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interest, although high-income taxpayers are subject to the phase-out of itemizeddeductions (explained later).

Of course, the taxpayer must actually pay the mortgage interest in order todeduct it. In one case, a couple’s past due interest was capitalized into theprincipal of a modified mortgage loan and the Tax Court barred a deduction forthis interest (Copeland, TC Memo 2014-226). The couple did not pay this capital-ized interest in the year in which they claimed the deduction.

Ownership. To claim a tax deduction, the home must be owned by the taxpayerclaiming the interest deduction. Usually, ownership means having legal title tothe residence. In one recent case, a couple who deducted mortgage interest on ahome in Syria were denied the write off because they failed to show that theyowned the home and that it was their principal residence (Al-Soufi, TC Memo2015-68; 15FED ¶47,991(M)).

PLANNING POINTER: If a taxpayer is divorced or separated and continuesto jointly own a residence with a former spouse or spouse who pays all of theinterest, the taxpayer does not deduct interest. Instead the payment of interest inthis case may constitute taxable alimony.

Where a person is jointly and severally liable on the mortgage with a co-owner,that person can deduct all of the interest if he or she pays it. Funds from a jointaccount used to pay the mortgage entitle each equal co-owner to an equalinterest deduction (e.g., 50% of the total payment). The IRS provides threeexamples (CCA 201451027):

EXAMPLE #1: Taxpayers are a married couple and are jointly and severallyliable on a mortgage, but one spouse is deceased at the end of the tax year andthe bank issues a Form 1098 under the deceased spouse’s Social Securitynumber. The surviving spouse files a separate return. Payment may be madefrom a joint account or from separate funds of either taxpayer. The survivingspouse can deduct 50% of the interest payments in the year of the deceasedspouse’s death and 100% in subsequent years.

EXAMPLE #2: Taxpayers are an unmarried couple and are jointly andseverally liable on a mortgage, and the bank either issues a Form 1098 underonly one social security number, or both. One or both taxpayers claim themortgage interest deduction on their individual returns. Payment may be madefrom a joint account or from separate funds of either taxpayer. Because bothtaxpayers are liable on the mortgage both are entitled to claim the mortgageinterest deduction to the extent of the mortgage interest paid by either taxpayer.If the mortgage interest is paid from separate funds, each taxpayer may claim themortgage interest deduction paid from each one’s separate funds. If the mort-gage interest is paid from a joint bank account in which each has an equalinterest, it would be presumed that each has paid an equal amount absentevidence to the contrary (Rev. Rul. 59-66).

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EXAMPLE #3: Related persons co-own a house and are liable on a mort-gage note. A bank may issue a Form 1098 under the name of one or both of theco-obligors. Each taxpayer claims 50% or 100% of the deduction. Payment maybe made from a joint account or from separate funds of either taxpayer. If co-owners of a house are both liable on a mortgage, each one may take a deductionfor the amount each one pays.

Equitable ownership. However, legal title is not necessary where a taxpayer canshow that he or she is the equitable owner of the residence (i.e., the taxpayer hasthe burdens and benefits of ownership) (Reg. §1.163-1(b)). For example, a sonwho helped his mother maintain and pay for the family home with the under-standing that he would be put on the title to the property (something that waseventually done) was treated by the Tax Court as the equitable owner eligible todeduct the mortgage interest that he paid (Van Phan, TC Summary Opinion2015-1; see also Dang, TC Memo 1999-233 and Uslu, TC Memo 1997-551).

However, merely paying the mortgage and other expenses of the home does notestablish equitable ownership. In one case, a sister who paid her brother’smortgage, as well as taxes, insurance, and maintenance on his home, could notdeduct the interest because she could not prove she was the equitable owner; shewas merely helping her financially strapped brother (Puentes, TC Memo2014-224; TC Memo 2013-277).

Qualified acquisition indebtedness. Deductible interest is limited to debt up to$1 million ($500,000 for married persons filing separately), provided the proceedsare used to buy, build, or substantially improve the residence. The dollar limitapplies to the total debt on a principal residence and one other home designatedby the taxpayer. If a taxpayer has more than two homes, the designation of whichis treated as the second home can be changed from year to year.

Applying the dollar limit. The $500,000 limit applies for a married person filingseparately even if the other spouse does not own a home and claim any interestdeduction (Bronstein, 138 TC 382 (2012)).

When unmarried individuals co-own a home, there is a dispute about whichdollar limit each owner should use. According to the Tax Court, the $1 millionlimit applies per residence, so the debt is allocated to the co-owners, and theinterest on this debt accordingly (Sophy, 138 TC 204 (2012)). However, oneappellate court said that the $1 million dollar limit applies per owner, not perresidence (Voss, CA-9, 2015-2 USTC ¶50,427). (This case is discussed in greaterdetail in RECENT DEVELOPMENTS.)

When the debt exceeds the dollar applicable limit, only a portion of the interest isdeductible based on a ratio in the regulations (Temporary Reg. §1.163-10T).Multiply the total interest for the year by a fraction the numerator of which is theapplicable debt limit and the denominator of which is the average annualbalance of the mortgages.

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EXAMPLE: A single homeowner in Silicon Valley has acquisition debt of$2.5 million. His interest payment for the year is $100,000. He can deduct$40,000 ($100,000 x [$1,000,000/$2,500,000]).

Points. Points are an interest charge by the lender typically based on a percent-age of the loan, with one point representing one percent of the loan amount. Forexample, two points on a $100,000 loan is $2,000.

Points are a form of prepaid interest, which usually is deductible over the term ofthe loan. Thus, if a taxpayer pays points to obtain a 15-year mortgage on avacation home, the points must be deducted ratably over 15 years. However,points on a principal residence are deductible in full in the year of payment if thefollowing nine tests are met:

1. The loan is secured by a principal residence.

2. Paying points is an established practice in the area of the home.

3. The points are not more than points generally charged in the area.

4. The taxpayer uses the cash method of accounting.

5. The points are not in lieu of fees for other services (e.g., appraisal fees,inspection fees, title fees, attorney fees, and property taxes).

6. The funds provided by the taxpayer at or before closing, including anypoints, were at least as much as the points charged.

7. The mortgage is used to buy or build the home.

8. The points are figured as a percentage of the mortgage.

9. The amount of points is shown on the settlement statement.

If a seller pays the buyer’s points, the buyer treats them as if he or she had paidthem (i.e., they are fully deductible in the year of the sale provided that all nineconditions are met). However, the buyer must reduce the basis of the home bythe amount of points paid by the seller.

PLANNING POINTER: If the loan is taken to substantially improve thehome, points are deductible if conditions one through six are met.

If a mortgage is refinanced, the points on the refinancing cannot be deducted infull in the year of payment; they are deducted ratably over the term of therefinanced mortgage. However, if the refinanced mortgage is again refinanced,any undeducted interest can be deducted in full in the year of the re-refinancing.

Penalties. Various mortgage-related penalties are treated as deductible interest.For example, prepayment penalties for satisfying the debt before a fixed date aretreated as deductible interest. The same is true for late charges, assuming it is notfor a specific service performed.

Qualified home equity debt. The interest on any other debt secured by aprincipal residence and one other home is limited for debt up to $100,000($50,000 for married filing separately). When acquisition indebtedness exceeds

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the $1 million ($500,000 for married filing separately) limit, up to $100,000($50,000 for married filing separately) of excess acquisition indebtedness can betreated as home equity debt (Rev. Rul. 2010-25, IRB 2010-44, 571).

PLANNING POINTER: The combination of acquisition debt and homeequity debt allows for an interest deduction on financing up to $1.1 million($550,000 for married persons filing separately). However, the home equity debtcannot exceed the fair market value of the home minus any acquisition debt.

Mortgage insurance premiums. The deductibility of mortgage insurance premi-ums applied only to loans obtained prior to December 31, 2014. However,Congress likely will extend this break for 2015, so the following informationabout these payments is included here.

A taxpayer who puts less than 20% down when buying a home usually isrequired to obtain mortgage insurance. Subject to restrictions discussed here, thepremiums are treated as interest payments deductible on Schedule A (Code Sec.163(h)(3)(D)). The mortgage insurance must be issued by the Department ofVeterans Affairs (VA), the Federal Housing Administration (FHA), the RuralHousing Administration (RHA), or obtained through a private mortgage insurer.

While there is no cap on the amount of the premiums that can be taken intoaccount in figuring the deduction, the deduction may be limited or barred by thetaxpayer’s adjusted gross income (AGI). A full deduction is allowed if AGI doesnot exceed $100,000 ($50,000 for married persons filing separately). The deduc-tion is reduced for each $1,000 of AGI ($500 for married filing separately) thatexceeds the AGI limit.

The premiums for prepaid mortgage insurance issued by the VA or RHA aredeductible in the year of payment. However, the premiums for prepaid mortgageinsurance issued by the FHA or a private company must be allocated ratablyover the shorter of (1) the term of the mortgage, or (2) 84 months. If the mortgageis paid off before the end of this deduction period, the undeducted portion of thepremiums does not become deductible (Reg. §1,163-11).

Reverse mortgages. Even though interest accrues during the term of a reversemortgage, no interest deduction can be claimed until the principal and interest ispaid off. At that time, interest is treated as home equity debt; it can only betreated as acquisition debt if the proceeds are used to substantially improve thehome (something that is not the usual situation).

Deducting residential interest. Residential interest is deducted as an itemizeddeduction on Schedule A of Form 1040. There is no need to separate acquisitiondebt from home equity debt; a single mortgage interest entry is made.

The deduction usually is based on the amount reported to the taxpayer on Form1098, Mortgage Interest Statement. The Schedule A entry does separate interestreported on this form from interest that is not reported to the IRS. Note thatstarting with statements issued after December 31, 2016, the lender must includeadditional information: the outstanding principal balance, the address of the

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property, and the loan origination date (Trade Preference Extension Act of 2015, P.L.114-42).

If a home is sold, interest up to but not including the date of sale is taken intoaccount.

A taxpayer receiving tax-free housing assistance, such as a minister or a memberof the uniformed services, can still deduct mortgage interest if otherwise eligibleto do so.

If a homeowner receives a mortgage credit certificate from a state or localgovernment, he or she may be able to claim a tax credit. The credit is figured onForm 8329, Mortgage Interest Credit. The amount of any deductible mortgageinterest is reduced by the amount of the credit.

Phase-out of itemized deductions. The mortgage interest deduction is subject tothe phase-out of itemized deductions for high-income taxpayers (Code Sec.68(b)). The phase-out is 3% for each AGI over a threshold amount. For example,in 2015, the phase-out begins when AGI exceeds $309,000 for joint filers, $284,050for heads of households, $258,250 for singles, and $154,950 for married personsfiling separately. However, itemized deductions cannot be reduced by more than80%. As a result of the phase-out, the full effect of deducting mortgage interestmay be lost.

Legislative proposals. The deduction for home mortgage interest, which iscurrently one of the largest individual tax breaks, initially was created to spurhome ownership. At present, many critics say there is little correlation betweenthe deduction and the expansion of home ownership. If there is tax reform afterthe 2016 presidential election, the rules for residential interest could be changed.Or they may remain unchanged (e.g., Donald Trump’s proposals would notmake any changes in the treatment of residential interest).

Study Questions

1. Which of the following types of interest payments is exempt from the tracingrules?

a. Business interest

b. Investment interest

c. Residence interest

d. Student loan interest

2. A single taxpayer buys a million dollar home with a down payment of$200,000 and a mortgage of $800,000. What is the maximum loan amount onwhich interest is deductible?

a. $50,000

b. $100,000

c. $500,000

d. $800,000

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3. All of the following payments with respect to a home mortgage are deductiblein full as residence interest in the year of payment except:

a. Late payment fees

b. Early payoff penalties

c. Points on a vacation home

d. Points on a principal residence

4. Which statement about residence interest is correct?

a. Mortgage insurance premiums are deductible as residence interest (as-suming the rule that expired in 2014 is extended for 2015).

b. Residence interest is exempt from the phase-out of itemized deductionsfor high-income taxpayers.

c. Accrued interest on a reverse mortgage is deductible annually.

d. A taxpayer receiving tax-free housing assistance cannot deduct mortgageinterest.

D. Business Interest

Like individuals, businesses incur debt for a variety of reasons: for seed money tostart a business, buy equipment and machinery, purchase the building, factory orother facility from which they operate, to buy another company, or for otherpurposes. Businesses are concerned with both the deductibility of the interestthey pay as well as their cash flow to cover the interest expense.

Interest on debt used to buy an interest in a business may be business interest orinvestment interest. The interest on debt to buy shares in a C corporation isinvestment, not business, interest. Interest on funds borrowed to buy an interestin a partnership or S corporation (a passthrough entity) must be allocated basedon the assets of the entity. For example, if all of the assets of the entity areinventory, office furniture, and machinery, then all of the interest on a loan tobuy an interest in the entity is business interest. If the entity holds investmentsecurities, whatever portion of the entity’s assets that this holding represents isthe same portion of total interest that is treated as investment, not business,interest.

The interest on funds borrowed in a trade or business generally is fully deducti-ble (Code Sec. 163). However, there are some limitations on the current deduct-ibility of interest by businesses.

Prepaid interest. Cash basis businesses usually cannot take a current deductionfor prepaid interest. Such interest is deductible over the term of the loan. Forexample, points paid by a business borrower must be deducted ratably over theterm of the loan (Code Sec. 461(g)). The rule is the same for accrual basisbusinesses; they too accrue and deduct the interest ratably over the term of theloan even though the cash outlay for the interest is done upfront (Rev. Rul.68-643, 1968-2 CB 76).

The discount on a discount loan (the difference between the face amount of theloan and the proceeds received) is interest (Rev. Rul. 72-12, 1972-1 CB 440).

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Because it is paid up front, it is prepaid interest deducted ratably over the term ofthe loan.

Interest capitalization rules. Interest paid or incurred during the productionperiod and allocable to real property or tangible personal property produced bythe taxpayer must be capitalized if (Code Sec. 263A(f); Reg. §§1.263A-8 through1.263A-15):

• The property is real property

• The property is tangible personal property that meets any of these thresh-olds (which are applied for each unit of property):

○ It has a class life of at least 20 years and is not inventory in the hands ofthe taxpayer.

○ The property has an estimated production period of more than twoyears.

○ The property has an estimated production period of more than oneyear and a cost exceeding $1 million.

The term “produce” means to construct, build, install, manufacture, develop,improve, create, raise or grow Reg. §1.263a-2(a)(1)(i)). Self-constructed assets andproperty built under contract are treated as property “produced” by thetaxpayer.

Debt to acquire another corporation. Interest on debt used to buy the stock ofanother corporation or two-thirds of its operating assets is deductible only ondebt up to $5 million (Code Sec. 279).

Original issue discount. If a corporation issues debt with original issue discount(OID), special interest deduction rules apply. OID is the excess of the statedredemption price at maturity over the issue price (Code Sec. 1273). If thedifference is less than 0.25% of the redemption price multiplied by the number offull years from the issue date to the maturity date, then the OID is zero (i.e., OIDrules do not apply to the deducting interest expense). For debt instrumentsissued after July 1, 1982, the portion of OID deductible by the issuer is equal tothe aggregate daily portions of OID for days during the tax year (Code Sec.163(e)). The daily portions of OID are determined by allocating to each day inany accrual period a ratable portion of the interest during the accrual period inthe adjusted issue price of the debt instrument (Code Sec. 1272(a)(3)).

Thin capitalization. When corporations seek funding, they may use equity(sharing ownership in the business) or debt (borrowing money). Sometimes it isnot easy to determine which type of funding is being used. In some cases,corporations may characterize the funding as debt in order to claim deductionsfor repayments. For example, when shareholders advance funds to their corpora-tion, it may treat disbursements to shareholders as deductible interest rather thanas nondeductible dividends. Large liabilities in relation to capital stock mayindicate thin capitalization. When this occurs, the IRS may recharacterize thefunding in order to bar an interest deduction (i.e., recharacterize the interest asdividends) (Code Sec. 385).

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The IRS looks at whether a true debtor-creditor relationship exists, based oncertain factors (Code Sec. 385(b)):

1. Whether there is a written unconditional promise to pay on demand oron a specified date a certain sum of money in return for an adequateconsideration in money or money’s worth, and to pay a fixed rate ofinterest

2. Whether there is subordination to or preference over any indebtednessof the corporation

3. The ratio of debt to equity of the corporation. As a rule of thumb, thincapitalization results when the debt-to-equity ratio is 4:1 or greater.

4. Whether there is convertibility into the stock of the corporation.

5. The relationship between holdings of stock in the corporation andholdings of the interest in question

Applying these five factors, the IRS concluded that a corporation’s quarterlypayments on instruments that it had issued were not interest (FSA 200131015).

E. Passive Activity Interest

Interest expense related to a passive activity may be limited under the passiveactivity loss (PAL) rules (Code Sec. 469). (C corporations other than certainclosely held corporations and personal service corporations are not subject to thePAL rules.) So-called portfolio interest is not part of passive activity income andexpenses; it is investment interest. The term “portfolio” is used in tax law underthe PAL rules (there are certain other situations in which the term is used) ratherthan “investment” to clarify what is exempt from the PAL rules since the passiveactivities are, by definition, investments.

While there is no specific cap on such interest deduction, overall expenses,including interest, usually is limited to the extent of income from passiveactivities. Unused expenses can be carried over and used in subsequent years tothe extent of passive activity income or when there is a complete disposition of apassive activity. Once again, when expenses are carried over, interest is notspecifically broken out.

Self-charged interest rule. If a taxpayer loans money to a passive activity inwhich he or she has an interest, the income from the loan is not treated as passiveactivity income (Reg. §1.469-7). The lender has interest income. The borrower,however, has passive interest.

EXAMPLE: A taxpayer’s S corporation performed management services forreal estate partnerships owned by the taxpayer. He received nonpassive incomefrom the S corporation and passive income from the partnerships. The manage-ment fees paid by the partnerships were characterized as nonpassive under theself-charged interest rule and management expenses, which were passive, couldnot be deducted from them (the court noted that the management expenseswere treated the same as interest deductions) (Hillman, 118 TC 323 (2002)).

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Passive activity expenses, including interest, are taken into account on Form8582, Passive Activity Loss Limitations. However, there is no line on the formdevoted to interest expenses.

F. Investment Interest

Investment interest is interest on a loan to buy or hold (carry) investmentproperty, including stocks and bonds, realty that does not fall under the residen-tial interest rules or passive activity rules. Investment interest also includesinterest that may be passed through to a partner, an S corporation shareholder, orbeneficiary by a partnership, limited liability company filing a partnershipreturn, an S corporation, trust, or estate. Deductions for investment interesttotaled about $14.9 billion on 2013 returns (the most recent year for statistics)(http://www.irs.gov/pub/irs-soi/soi-a-inpd-id1505.pdf).

PLANNING POINTER: Interest on loans to buy or carry tax-exempt bondsor other tax-exempt securities is not deductible; it is not treated as investmentinterest. For example, no deduction is allowed for interest on a loan used to buyshares in a mutual fund that distributes only tax-exempt interest.

Investment interest is deductible to the extent of net investment income. Netinvestment income is investment (i.e., gross income from property held forinvestment, such as interest, dividends, annuities, and royalties) income minusinvestment expenses (e.g., investment expenses claimed as miscellaneous item-ized deductions subject to the 2%-of-AGI floor). Investment income does notinclude:

• Alaska Permanent Fund dividends

• Passive activity income and losses

• Capital gains, capital gain distributions, or qualified dividends unless thetaxpayer elects to do so. If the election is made to include the items thatwould otherwise be taxed at favorable capital gain rates (15% for those intax brackets over 15%; 20% for those in the 39.6% tax bracket) as part ofinvestment income, then the favorable rates cannot be used for theseitems; they are treated as ordinary income.

If a parent elects to include a child’s investment income on his/her return ratherthan completing a tax return for the child, the parent can use this income as his/her own investment income (subject to the same limitations on Alaska Perma-nent Fund dividends, capital gains, and qualified dividends).

PLANNING POINTER: The election to treat items that would be taxed atfavorable rates as ordinary income should be made only if it produces a greatertax savings than using the capital gains tax rate for the income items.

Any interest that is nondeductible because of net investment income limit can becarried forward and used in the subsequent year. There is no limit on thecarryforward period for unused investment interest.

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Deducting investment interest. The deduction for investment interest is figuredon Form 4952, Investment Interest Expense Deduction. The form does not have to becompleted if there are no investment interest carryovers and certain other condi-tions are met. The deduction is claimed as an itemized deduction.

PLANNING POINTER: Investment interest is not subject to the phase-out ofitemized deductions for high-income taxpayers (discussed later).

G. Student Loan Interest

Even though student loan interest is a personal (consumer) debt (explainedbelow), there is a special deduction rule for it (Code Sec. 221). A deduction forstudent loan interest was claimed by 11.6 million taxpayers on 2013 returns (themost recent year for statistics) (http://www.irs.gov/pub/irs-soi/soi-a-inpd-id1505.pdf). The amount of these deductions totaled $11.7 billion, which was 9%higher than the amount claimed on 2012 returns.

The deduction for student interest is an above-the-line deduction which can beclaimed whether or not the taxpayer itemizes other personal deductions. Theamount of the interest deduction is limited to $2,500 per year. There is no limit onthe number of years in which the deduction can be claimed.

Qualified interest. To be qualified interest, the debt must be incurred solely topay for qualified higher education expenses. The loan must not have been madefrom a related person or a qualified employer plan.

The taxpayer can deduct interest on a loan for him/herself, a spouse, or depen-dent that is enrolled at least half-time in a degree program. A person is consid-ered to be a dependent for this purpose even though the taxpayer is someoneelse’s dependent, the dependent files a joint return with another person, or thedependent has gross income higher than the amount allowed in order to qualifyas a dependent (e.g., $ 4,000 in 2015; $4,050 in 2016).

The funds must be used to pay qualified higher education expenses. The amountof these expenses must be reduced by the following tax-free items:

• Employer-provided education assistance

• Tax-free distributions from 529 plans and Coverdell ESAs

• U.S. savings bond interest that is excluded

• Tax-free scholarships and fellowships

• Veterans’ education assistance

• Any other tax free payments (other than gifts or inheritances)

PLANNING POINTER: Claiming the interest deduction does not bar ataxpayer from claiming an education credit. For example, a taxpayer who isrepaying a loan for college while attending graduate school may be eligible forthe lifetime learning credit while deducting the interest on the loan.

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Income limit. However, there is an income limit that restricts or bars a deductionfor student loan interest. For 2015, a full deduction (up to the $2,500 limit) isallowed if modified adjusted gross income (MAGI) does not exceed $65,000($130,000 on joint returns). The deduction phases out for MAGI up to $80,000($160,000 for joint filers).

Reporting student loan interest. Because this is not an itemized deduction, it canbe claimed on Form 1040 or 1040A. Student loan interest is reported to thetaxpayer on Form 1098-E, Student Loan Interest Statement. This form shows theamount of student loan interest received by the lender during the year.

Employer payments. PriceWaterhouseCoopers announced it will pay $1,200 peryear for six years to employees to help them pay off student loan debt (http://www.bloomberg.com/news/articles/2015-09-22/pricewaterhousecoopers-will-give-employees-7-200-for-student-debt). The payment is taxable compensation.It is also subject to employment taxes. Whether other companies begin offeringsimilar help with student loan debt remains to be seen.

Legislative proposals. Because of the tremendously high amount of student loanoutstanding, there have been several measures proposed to alleviate the problem.Here are some examples of proposed legislation:

• Eliminate the cap on the deduction (S. 1973)• Exempt from the MAGI calculation any income during an income-share

arrangement (H.R. 3432)• Increase the deduction limit to $5,000 ($10,000 on a joint return (H.R. 509)

H. Other Consumer InterestPersonal interest, other than some types discussed earlier (e.g., residential inter-est, student loan interest) is not deductible (Code Sec. 163(h)). This includesinterest on:

• Car loans (where the vehicles are not used for business), and otherconsumer debt is not deductible

• Credit cards• Federal, state, or local income taxes. This includes state income tax owed

on a business deficiency (Robinson III, 119 TC 44 (2002)). It also includesestimated tax penalties.

Study Questions5. Which of the following types of business-related interest is fully deductiblebusiness interest in the year of payment?

a. Interest on a loan to buy the assets of a sole proprietorship consisted onlyof inventory, office furniture, and machinery.

b. Interest on a loan to buy C corporation stock.c. Points on a 10-year business loan.d. Interest on a construction loan to build a factory.

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6. With respect to passive activity interest, which of the following statements isnot correct?

a. Portfolio interest is not treated as passive activity interest.

b. Passive activity interest is entered separately on Form 8582.

c. The self-charged interest rule recharacterizes passive activity interest asbusiness interest.

d. There is no dollar limit on interest for purposes of the PAL rules.

7. Which of the following is not treated as investment income for purposes of thelimitation on investment interest?

a. Alaska Permanent Funds dividends

b. Investment income of a child reported on a parent’s tax return

c. Investment income passed through to a trust beneficiary

d. Qualified dividends when the taxpayer elects to subject them to ordinaryincome

8. Which statement about the deduction for student loan interest is not correct?

a. There is a modified adjusted gross income limit.

b. Taxpayers must itemize to claim it.

c. The maximum annual deduction is $2,500.

d. The amount of interest is reported to the taxpayer on Form 1098-E,Student Loan Interest Statement.

I. Cancellation of Debt

When borrowers cannot repay what they owe, lenders may be willing to forgivesome or all of the outstanding debt. The debtor (borrower) usually has to reportthe cancellation of debt (COD) as income (Reg. §1.61-12). This is so even thoughthe interest on the forgiven debt may not have been deductible by the debtor(e.g., consumer credit card debt). Lenders usually are required to report CODincome of $600 or more on Form 1099-C, Cancellation of Debt.

When a taxpayer has credit card insurance and uses the insurance proceeds topay off credit card debt, this results in COD income (e.g., Bunker, TC SummaryOpinion 2005-35).

PLANNING POINTER: A taxpayer who pays a company to settle credit carddebt on his behalf cannot deduct the fee nor use it as an offset to COD income(Melvin, TC memo 2009-199). The fee is not incurred for business (Code Sec.162) or investment (Code Sec. 212) purposes.

Car repossessions. When a car is repossessed because the taxpayer is delinquenton a car loan, the cancellation of the debt following the repossession is CODincome (see e.g., Fuller, TC Summary Opinion 2009-91).

The timing of forgiveness may impact whether a debtor has cancellation of debtincome. In one recent case, a taxpayer had a personal car loan that she defaulted

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upon; her car was repossessed. A collection agency tried for several years torecoup the outstanding balance without any success. It gave up collection activi-ties after about four years. In 2011, it sent her Form 1099-C reporting the unpaidamount that was effectively forgiven by the fact that there would be no futurecollection actions. The Tax Court held that she did not have any COD income in2011. COD income results when there is an “identifiable event” that fixes the loss.Regulations have rebuttable presumption that this is 39 months after nonpay-ment. Because this was not rebutted, the 36 months occurred in 2008, whichbecame the year for COD income (Clark, TC Memo 2015-175; 15FED¶48,108(M)).

Recourse versus nonrecourse debt. As a general rule, the cancellation of nonre-course debt does not trigger COD income. In contrast, COD income arises inconnection with the cancellation of recourse debt (i.e., debt on which the bor-rower is personally liable).

When there is a foreclosure involving nonrecourse debt, gain or loss results onthe transaction; the amount realized is the full amount of the debt. No CODincome results. When there is a discharge of nonrecourse debt in a loan modifica-tion, COD income can result (see Rev. Rul. 91-31 and Rev. Rul. 92-99).

However, it is possible for nonrecourse debt to produce COD income. Forexample, a discharge from an undersecured nonrecourse obligation through acash settlement resulted in COD income (Gershkowitz, 88 TC 984 (1987)). Even ifForm 1099-C indicates that the loan is not recourse by checking a box, thetaxpayer can still have COD income because the credit arrangement indicatedthat he was individually and severally liable for repayment of the line of creditextended to his company (Dunnigan, TC Memo 2015-190, 15FED ¶60,416(M)).The court in this case refused him a “hardship exception” to COD incomebecause the tax law does not provide for one.

Lack of a promissory note does not demonstrate that there is no personalliability. For example, where a loan made pursuant to an employment contractwas forgiven, the taxpayer had COD income (Wyatt, TC Summary Opinion2015-31). In the court’s view, the lack of a separate promissory note is notcontrolling here because the facts indicated that the lender would have pursuedcollection against the taxpayer if there had been a default rather than forgiveness.

Exclusion for COD income. There are certain situations in which debt forgive-ness, also called discharge of indebtedness and cancellation of debt income, arenot included in gross income at the taxpayer’s election (Code Sec. 108). These fiveexclusion situations include:

1. A debt discharged in bankruptcy. This is a discharge in a Title 11 bankruptcyaction where the discharge is granted by a court or under a plan approved by thecourt.

The exclusion of COD income comes with a price. The debtor must reducecertain tax attributes (tax benefits in current or future years), which has the effectof merely deferring the income. The following tax attributes must be reduced inthis set order (Code Sec. 1017):

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• Net operating loss (NOL) for the year of the discharge (dollar for dollar)

• General business credit carryover to or from the year of the discharge(33-1/3¢ per dollar)

• Minimum tax credit as of the beginning of the year immediately after theyear of the discharge (33-1/3¢ per dollar)

• Net capital loss for the year of the discharge (dollar for dollar)

• Basis of property (dollar for dollar)

• Passive activity loss (dollar for dollar) and credit (33-1/3¢ per dollar)carryovers from the year of the discharge

• Foreign tax credit carryover to or from the year of the discharge (33-1/3¢per dollar)

2. A debt that is canceled when the taxpayer is insolvent. If the taxpayer isinsolvent at the time that debt is forgiven, COD income is excluded. Insolvencyfor this purpose means that the taxpayer’s liabilities exceed his/her assets at thetime of the forgiveness. The exclusion of COD income is limited to the amount ofinsolvency (the extent to which liabilities exceed assets). When nonrecourse debtin excess of the fair market value of the property securing it is forgiven, the debtis parsed into two parts: The excess nonrecourse debt forgiven is treated as aliability for purposes of insolvency. The excess debt that is not forgiven is nottreated as a liability for purposes of insolvency (Rev. Rul. 92-53, 1992-2 CB 48; seealso Rev. Rul. 2012-14, IRB 2012-24, 1012, for a partner’s insolvency whenpartnership debt is discharged).

Again, tax attributes must be adjusted to the extent of the debt forgiveness.

3. Qualified farm indebtedness. A farmer whose debt is forgiven is not taxed ifcertain conditions are met:

• The debt must be incurred directly or indirectly with a farming business.

• At least 50% of the taxpayer’s gross receipts for the three prior years areattributable to the farming business.

The exclusion of cancellation of debt income is limited to the amount that can beabsorbed by tax attributes, as explained earlier in conjunction with a bankruptcy.

4. Qualified real property business indebtedness. Taxpayers, other than Ccorporations can exclude COD income on debt incurred to acquire, construct,reconstruct, or substantially improve real property used in a trade or businesswhere the property secures the debt. The exclusion is limited to the excess of theoutstanding principal over the fair market value of this debt. The exclusioncannot exceed the aggregate adjusted bases of depreciable real property held bythe taxpayer at the time of the discharge.

The taxpayer does not reduce tax attributes as in the case of certain otherexcludable COD income. Instead the taxpayer must reduce the basis of deprecia-ble real property.

5. Qualified principal residence indebtedness. Forgiveness of acquisition in-debtedness on a principal residence is tax free for debt up to $2 million ($1million for married persons filing separately) (Code Sec. 108(a)(1)(E)). The basis

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of the residence is reduced by the amount of debt forgiven. This COD exclusiondoes not apply to home equity debt (Koriakos, TC Summary Opinion 2014-70).

NOTE: This rule expired at the end of 2014 but is expected to be extendedfor 2015.

Reporting for excludable debt. An election to exclude this COD income is madeon a timely filed income tax return for the year of the discharge; Form 982,Reduction of Tax Attributes Due to Discharge of Indebtedness, must be attached to thereturn. The election generally is irrevocable. If a taxpayer fails to make theelection on a timely filed return, he or she can request consent to file a lateelection (Reg. §301.9100-3). For example, the IRS granted a request where thetaxpayer wanted to make the election and discussed it with his preparer, but thepreparer failed to submit Form 982 (Letter Ruling 201528003).

Special rule for the reacquisition of corporate debt. Indebtedness discharged inconnection with the reacquisition of corporate debt in 2009 or 2010 receivedspecial treatment. A C corporation did not have to report any COD income forfive years; it could then spread the COD income over the next five years. Thus,there are some C corporations that opted for this treatment and are now report-ing their COD income.

Special rule for COD income for S corporations. When S corporation debt isforgiven and the corporation elects to reduce its tax attributes, any disallowedlosses or deductions are included in the S corporation’s deemed NOL (it isdeemed because NOLs are not reported at the corporate, but rather the share-holder, level). If the deemed NOL exceeds the COD income, the excess deemedNOL is allocated to the shareholders as disallowed losses and deductions that theshareholders can take into account. The character of the excess deemed NOLallocated to the shareholders consists of a proportionate amount of each item ofthe shareholder’s loss or deduction that is disallowed for the year of the debtdischarge. S corporations are required to provide income to shareholders aboutthe deemed NOL and disallowed losses and deductions.

Special rules for student loan forgiveness. It is not easy to escape student loandebt. It is not dischargeable in bankruptcy unless repayment “would impose anundue hardship on the debtor” (11 U.S. Code §523(a)(8)). Undue hardship is noteasy to prove, as shown in the following case:

Facts: A 56-year old taxpayer living with his 85-year old mother, had studentloan debt outstanding of $260,000 and filed for Chapter 7 bankruptcy. He soughtto have the debt discharged, claiming that repayment constituted an “unduehardship” under bankruptcy law; he and his mother subsisted on her SocialSecurity checks (11 U.S. Code §523(a)(8)). The bankruptcy court ruled that hecould not rely on the hardship exception to obtain a discharge.

Appellate court. A district court affirmed the bankruptcy court, and the SeventhCircuit affirmed the district court (Tetzlaff, CA-7, 794 F.3d 756 (2015)). Given hiseducation (he had an MBA and law degree), age (in his 50s), and prior work

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experience, he could not demonstrate that he would be unable to repay the loans.Thus, the debt could not be discharged.

Under the Treasury Office Program, the IRS has the authority to apply a taxrefund to delinquent student debt (https://fiscal.treasury.gov/fsservices/gov/debtColl/dms/top/debt_top.htm).

However, forgiveness of student loan debt is excludable if the loan is made by acertain type of lender (below) and the discharge is given because the studentperforms certain types of work in a certain area for a certain time (Code Sec.108(f)). Generally, this means being a doctor, nurse, or teacher working in anunderserved area or an inner city. The loan must be made by:

• A federal, state, or local government, or its agency

• A tax-exempt public benefit corporation that runs a public hospital

• An educational institution receiving funds from a government or tax-exempt public benefit corporation described above

• An institution or tax-exempt organization that refinances any of the aboveloans.

Student loan repayment on behalf of the borrower or loan forgiveness is nottaxable if any of the following situations apply:

• The loan was made by a government agency, a government-funded loanprogram of an educational institution, or a qualified hospital organizationand the cancellation is because the student works for a period of time in acertain geographical area in certain professions.

• Law school graduates with loans under the Loan Repayment Assistanceprogram that are canceled if they work for a specified period of time inlaw-related public service positions in government or with tax-exemptcharitable organizations (Rev. Rul. 2008-34, 2008-2 CB 76).

• Health care professionals who have loans forgiven because they work inunderserved communities. This applies to loans repaid or forgiven underthe National Health Services Corps Loan Repayment Program, state loanrepayment programs eligible for funding under the Public Health ServicesAct, and any state loan repayment or forgiveness program intended toincrease the availability of healthcare in underserved areas.

There has been much discussion in Washington about relief for student loan debt.Proposed legislation would provide an exclusion for the discharge of studentloan debt where the student works for a broader class of employers thancurrently allowed (Student Loan Tax Debt Relief Act, H.R. 2429).

J. Other ConsiderationsDebt appears in various tax contents. Here are some issues to consider:

Basis for S corporations. S corporation shareholders can deduct losses passedthrough to them to the extent of their basis (Code Sec. 1366(d)(1)). For thispurpose, basis includes both their basis in stock and in debt. Basis for debt can beincreased only if there is bona fide indebtedness (T.D. 9692, 7/23/14). Thisdepends on the facts and circumstances.

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Merely guaranteeing the corporation’s debt does not give rise to basis; it iscreated only when and to the extent shareholders make good on the guarantee.In this situation, there must be an actual economic outlay in order to create basis.

Basis for partnerships. Partners (and members in limited liability companies), incontrast to S corporation shareholders, can take debt into account for basispurposes under certain conditions (Code Sec. 752). An increase in basis for ashare of partnership liabilities is, in effect, treated as a cash contribution thatincreases the partner’s interest in the partnership. This rule generally applies torecourse and nonrecourse debt, although there are some differences in taxtreatment. Of course, the partnership’s repayment of liabilities has the oppositeeffect; the partners’ basis is reduced.

K. ConclusionAs Thomas Carlyle said, “Debt is a bottomless sea.” The tax law helps to ease thepain of repayment so that taxpayers can, hopefully, reach the shore. However,when lenders forgive debt obligations, borrowers usually have income. Treadcarefully here.

Study Questions9. Which statement regarding payoffs of debt is not correct?

a. Cancellation of debt income is taxable unless an exception applies.b. A repossession of a car subject to a loan results in cancellation of debt

income.c. Form 982 is used to elect out of current reporting for cancellation of debt

income.d. A taxpayer who pays a company to settle her credit card debt can deduct

the fee to the company for this service.

10. Student loan debt can be forgiven in all of the following situations except:

a. A teacher with a loan from a government-funded loan program worksfor a set time in a certain geographical area.

b. A law school graduate with a loan under the Loan Repayment Assis-tance program works for a set time in a public service position.

c. Bankruptcy where the taxpayer cannot prove undue hardship for aneventual repayment.

d. A nurse whose loan is forgiven under the National Health ServicesCorps Loan Repayment Program because of working in an underservedarea.

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II. PRACTICE MANAGEMENT TIP: Handling HouseholdEmployees

LEARNING OBJECTIVES

Upon completion of this section, participants will be able to:

• Determine whether a household worker is an employee

• Calculate the taxes on wages paid to a household worker

• Select the write-offs that can be used for payments to household help

A. Introduction

In the past, domestic help was the purview of the wealthy, who had a staff thatoften included a housekeeper, cook, chauffeur, and gardener. Today, the wealthycontinue to have various types of help, but so do many middle class individualswho may be your clients. Working parents may engage a nanny to care for ayoung child. Seniors who cannot manage many tasks on their own may havehome health aides or practical nurses to assist them. Sometimes, the householdhelp lives in, essentially on call 24 hours a day.

From a tax perspective, there are responsibilities for being an employer. Theremay also be opportunities to write off some or all of the cost of a householdemployee. And there are some state-level issues to consider.

The IRS refers to those who do work around a client’s home as householdworkers. These include babysitters, caretakers, house cleaning workers, domesticworkers, drivers, health aides, housekeepers, maids, nannies, private nurses, andyard workers. The U.S. Department of Labor refers to these same workers asdomestic workers.

B. Employer Obligations

Workers who come into a client’s home may be employees of the client, employ-ees of an employment agency or firm, or independent contractors. It is up to theclient, with your help, to make the determination about a worker’s status. If theworker is on the payroll of a company that provides domestic help, such as anagency supplying home health aides, the matter is clear; the client pays the feecharged by the agency and the agency must meet all employer responsibilities.

If the client engages the worker directly (not through an agency), the situationmay be cloudy. Some workers may be independent contractors running theirown businesses. This is often the case with landscapers and cleaners whoprovide their own tools, offer their services to multiple customers, and run theiroperations as a business. If the client determines that the worker is his/heremployee, then employer obligations kick in. In tax parlance this is referred to asthe “nanny tax.”

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PLANNING POINTER: The basic tax rules about control over the workerare used to determine employment status. It does not matter whether the workeris part time or full time, or whether the worker is paid hourly, daily, weekly, or bythe job. It does not matter what the job title is (e.g., housekeeper, nanny).

Federal FLSA rules. Generally, the same minimum wage and overtime rules thatapply to business employees apply to household workers. However, there is anexemption from the federal FLSA rules for live-in domestic service workers(http://www.dol.gov/whd/regs/compliance/whdfs79b.htm). These are workerswho permanently reside in the client’s home or reside there for an extendedperiod of time, which means living and sleeping for five days a week (120 hours).State laws, explained later, may have special rules for live-in workers.

Whether or not a household employee is live-in, the client must keep certainrecords about the employees. The Department of Labor has a Fact Sheet aboutrecordkeeping requirements (http://www.dol.gov/whd/regs/compliance/whdfs79c.htm).

Employer tax identification number. A client employing a household workermust obtain a federal employer identification number (EIN), which is used forreporting employment taxes for the worker. The client cannot use his or herSocial Security number for this purpose.

FICA. Social Security and Medicare taxes (FICA) apply to the wages of ahousehold employee only if they exceed a threshold amount $1,900 in 2015. Ifwages exceed the threshold, then the employer client owes 15.3% of all wages(not merely the amount over the threshold). Half is the employee’s share, but theclient may choose to pay it rather than withholding it from the wages. Wages forthis purpose include only cash wages; the value of room and board is not takeninto account.

PLANNING POINTER: Wages paid to the client’s spouse, child under age21, parent, or any employee under the age of 18 are exempt from all FICA taxes.

The client is required to withhold an additional 0.9% on wages over $200,000.However, paying a household worker this amount of compensation is ratherunusual.

FUTA. Federal unemployment taxes (FUTA) must be paid if wages are $1,000 ormore in any calendar quarter in the current or prior year. If so, the client pays 6%of the wages up to $7,000 per year (this dollar limit is not indexed for inflation).The client may also owe state unemployment taxes (discussed below).

Income tax withholding. The client is not required to withhold federal incometaxes unless the worker asks for withholding and the client agrees; this should beput in writing. In this case, the worker should complete Form W-4, Employee’sWithholding Allowance Certificate, so the client can figure the amount ofwithholding.

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Paying employment taxes. A client with a household employee is not required todeposit employment taxes as are business employers. The tax can be paid whenthe client files his or her tax return.

PLANNING POINTER: Employment taxes for a household worker must betaken into account for estimated tax purposes. Thus, while the tax can be paidwith a return, the amount of the payment may necessitate estimated tax pay-ments throughout the year in order to avoid estimated tax penalties. Alterna-tively, if the client has a job, he or she can increase withholding to cover theseemployment taxes.

Tax reporting. By January 31 each year (February 1, 2016, for 2015 wages becauseJanuary 31 is on a Sunday), the client must give the worker a Form W-2, Wageand Tax Statement. By the end of February (which is February 29, 2016, for 2015wages), the client must send a copy of the W-2, along with a transmittal, FormW-3, Transmittal of Wage and Tax Statements, to the Social Security Administration.If filing electronically, the due date becomes March 31, 2016.

The client reports employment taxes for a household employee on Schedule H,Household Employment Taxes, of Form 1040. The schedule must be filed even if theclient is not otherwise required to file an income tax return.

PLANNING POINTER: The client should retain all employment tax andother records for a minimum of four years from the due date of the return onwhich taxes were reported or the date they were paid, whichever is later.

C. Writing off the Cost of Household EmployeesWhile employment taxes add to the cost of a household employee, wages and theemployer’s share of employment taxes may be the basis for a tax write-off.

Child and dependent care credit. If the client who works engages an employeeto care for a child under age 13, a spouse, or a dependent incapable of self-care,up to $3,000 of the wages and taxes on them can be taken into account in figuringthe credit. For those with adjusted gross income (AGI) over $43,000, the mini-mum credit is 20% of qualified expenses (e.g., wages) up to $3,000 for onedependent or $6,000 for two or more dependents.

EXAMPLE: Your client is a single parent who employs a babysitter, age 28,to stay with his 10-year old child after school until he comes home. He pays totalwages for the year of $5,500. His AGI is $78,000. His credit is $600 ($3,000 x20%).

Medical deduction. If the client employs a home health aide, wages and employ-ment taxes may be a deductible medical expense. For example, a woman exper-iencing diminished capacity could deduct the cost of home health services as amedical expense because she needed this type of care and it was certified by aphysician (Est. of Baral, 137 TC 1 (2011)).

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PLANNING POINTER: If an expense qualifies for a dependent care creditand a medical expense, decide which tax break provides the greater tax savings.The same cost cannot be used for both purposes. For example, if a spouserequires nursing care in the home so the other spouse can work the wages andrelated employment taxes can qualify for either type of write-off. Both write-offsmay apply but the same expenses cannot be used for each.

D. State Law ConsiderationsThere are various state-level issues to address.

State income tax withholding. The client should determine whether withhold-ing for state income taxes is required.

State unemployment insurance. The client needs to contact the state departmentof labor or other agency regarding unemployment insurance. The state mayassign a special identification number for unemployment insurance purposes,which is different from the EIN. Usually, state unemployment insurance is paidquarterly.

Workers’ compensation. A client may be required to carry workers’ compensa-tion to cover the household employee.

Domestic workers bill of rights. A growing number of states, including Califor-nia, Massachusetts, and New York, have adopted laws providing certain protec-tions for household workers. New York’s law is representative of this trend; itgives domestic workers:

• The right to overtime pay at time-and-a-half after 40 hours of work in aweek, or 44 hours for workers who live in their employer’s home;

• A day of rest (24 hours) every seven days, or overtime pay if they agree towork on that day;

• Three paid days of rest each year after one year of work for the sameemployer; and

• Protection under New York State Human Rights Law, and the creation ofa special cause of action for domestic workers who suffer sexual or racialharassment.

E. ConclusionPractitioners should make sure that clients with household help are in compli-ance with tax rules and state laws.

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Study Questions11. Which factor determines whether a household worker is the client’semployee?

a. Full-time hoursb. Payment on a weekly basisc. Doing a certain type of workd. Control by the client over the worker

12. Which statement regarding Social Security and Medicare (FICA) taxes is notcorrect?

a. The employer can use his/her Social Security number to report FICAtaxes.

b. No FICA is due if total payment to a household employee in 2015 is$1,500 or less.

c. Wages for FICA purposes do not include the value of room and board.d. Wages to the client’s child under age 21 are exempt from FICA.

13. All states have adopted the domestic workers bill of rights. True or False?

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III. RECENT DEVELOPMENTS

LEARNING OBJECTIVES

Upon completion of this section, participants will be able to:

• List the developments related to identity theft

• Determine the taxable portion of distributions from IRAs and annuities

• Identify where the Tax Court has been upheld or reversed in recent cases

A. Identity Theft Issues

In May 2015, the IRS said that its online Get Transcript program had been hacked,impacting about 114,000 taxpayers. In August that number was increased byanother 220,000. This data breach follows other major hacking events at theOffice of Personnel Management (impacting 21.5 million government employ-ees), Target (the retailer), and Anthem (a giant insurance company). The databreach means that affected individuals may have their identities stolen and usedfor fraudulent purposes (e.g., obtaining erroneous tax refund). The IRS sus-pended its online Get Transcript program, which was used by about 23 milliontaxpayers in the past tax return season.

PLANNING POINTER: Taxpayers can still receive transcripts by mail; ittakes five to 10 days to receive them in this manner.

Class action lawsuit. A class action lawsuit has been filed against the IRS bytaxpayers who claim their identities were stolen as a result of the IRS breach(Wellborn v. IRS, DC DC, filed 8/20/15). The taxpayers argue that the IRSshould have known that their computers were vulnerable to cyber-criminals. Thecomplaint references reports from the Government Accountability Office (GAO)and the Treasury Inspector General for Tax Administration that warned the IRSabout its lax computer security.

Extensions for W-2s. The IRS has ended the automatic extension for filing FormW-2, Wage and Tax Statement (T.D. 9730, 8/12/15; 15FED ¶47,027). According tothe preamble in temporary regulations, the change is due to incidents of falsifiedstatements filed by identity thieves using stolen taxpayer information. Untilthese new temporary regulations go into effect, the old rules apply, which allowfor an automatic 30-day extension, with another non-automatic 30-day extensionthat can be granted by requesting it from the IRS. The temporary regulationsmaking this change apply to all forms within the W-2 series other than FormW-2G, Certain Gambling Winnings. As a result of the change, the IRS will grant anextension of up to 30 days only in limited cases where the extension is warrantedbecause of extraordinary circumstances or catastrophe (e.g., destruction ofrecords in a fire or natural disaster). The change takes effect for returns filed in2017 (i.e., W-2s reporting compensation earned in 2016).

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Identity theft protection services. The IRS said that in light of these events, itwould not require taxpayers receiving identity theft protection services to in-clude the value of the coverage in income (Announcement 2015-22, IRB 2015-35,288; 15FED ¶46,381). Identity theft protection services includes credit reportingand monitoring services, identity theft insurance policies, identity restorationservices, or other similar services.

The same tax-free treatment applies to employer-provided identity theft protec-tion services to employees following a data breach at the company. This meansthe value of the services is not included in taxable wages and need not bereported on employees’ Forms W-2.

PLANNING POINTER: Tax-free treatment does not apply to services fur-nished by a company to employees as part of a compensation package and notas a result of a data breach. In this case, the benefit is taxable (i.e., includible inwages and reported on Form W-2).

IRS protections for the 2016 tax season. Commissioner Koskinen announcedsome IRS actions at an industry meeting (9/17/15). He explained that hackerswere not looking for personal identifying information; they already had it. Thehackers were trying to gain access to previous years so they could evade IRSfraud filers. In the upcoming tax season the IRS will be collecting device identifi-cation numbers to see where returns are coming from. If an individual ratherthan a return preparer is submitting the return and more than one return iscoming from the same device, this will attract the IRS’s attention.

The IRS will also standardize its suspicious leads program to identify fraud byflagging concerns and sharing information with the states.

The IRS will be revising Publication 1345, Handbook for Authorized IRS E-FileProviders of Individual Income Tax Returns, and Publication 3112, IRS E-File Applica-tion and Participation, which is for preparers submitting fewer than 2,000 returnsannually. In addition, the IRS may contact preparers to advise them of changes.

B. Section 83(B) Election

Employees who receive restricted stock from their employers usually are nottaxed until there are no restrictions or any substantial risk of forfeiture. However,recipients can elect to report income in the year of receipt; this is called a Sec.83(b) election. Reporting income on receipt means including the current value ofthe restricted stock in income. This election allows all future appreciation tobecome tax-favored capital gains.

The election must be made within 30 days of receiving the restricted stock. It ismade by filing an elections statement with the IRS and providing the companywith a copy of the statement. A sample election statement can be found in Rev.Proc. 2012-29.

Until now, the employee was also required to attach a copy of the statement tohis or her tax return for the year of the election. Proposed regulations wouldeliminate this second IRS filing (Proposed Reg. § 1.83-2(c); REG-135524-14,

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7/17/15; 15FED ¶49,656). The proposed change applies to property transferredon or after January 1, 2016. However, the proposed change can be relied upon forproperty transferred on or after January 1, 2015. Thus, no additional statementneeds to be attached to a 2015 return for a Sec. 83(b) election made in 2015, forrestricted stock received by an employee in 2015.

PLANNING POINTER: A Sec. 83(b) election is advisable only if the stock isexpected to appreciate. If the value of the stock declines, or if the employeeforfeits the stock (e.g., leaves the company before a period of forfeiture has beensatisfied, no loss or other write-off is allowed.

C. Developments on Charitable Contributions and GiftsDonors in the U.S. are very generous. According to Atlas of Giving, totalcharitable giving in the U.S. in 2014 was $456.73 billion, up 9.3% over 2013,fueled in part by an improved economy (http://www.atlasofgiving.com/atlas/9564728G/9564728G_12_14.pdf). In addition many individuals give money andproperty to their family. Tax rules impact the treatment of these gifts.

Contemporaneous written acknowledgments. Donors are required to obtaincontemporaneous written acknowledgments from a charity for any gift of cashand/or property totaling $250 or more (Code Sec. 170(f)(8)(A)). However, the IRSis modifying how this can be done. Until now, charities had to send a receipt todonors. Under proposed regulations, the contemporaneous written acknowledg-ment requirement can be satisfied by using a new form that the IRS will beissuing later in 2015 (REG-138344-12, 9/17/15).

PLANNING POINTER: The IRS indicated that the new form will require thecharity to obtain the donor’s tax identification number. Many tax practitionerslearning of this requirement expressed concerns about potential for increasedidentity theft. Whether the IRS will change this requirement when the form isissued remains to be seen.

Donations with borrowed money. It is well established that a taxpayer can makea deductible donation with borrowed money. The contribution is deductiblewhen the donation is made and not when the loan is repaid (Rev. Rul. 78-38,1978-1 CB 67). Also a donation can be made through an agent acting on behalf ofthe donor (Rev. Rul. 80-335, 1980-2 CB 170). But it is up to the donor to show thatthe economic substance of a transaction comports with a charitable contribution.

Facts: A taxpayer whose S corporation paid his personal expenses claimed acharitable contribution deduction. He routinely reimbursed the corporation forits outlays. However, for donations made from July through December 2005, theTax Court found no credible evidence to show that there was any repayment tothe corporation or any bona fide indebtedness (Zavadil, TC Memo 2013-222).

Appellate court. The Eighth Circuit has affirmed the Tax Court’s decision (CA-8,2015-2 USTC ¶50,385). The taxpayer’s vague testimony regarding the arrange-ment with the corporation was not sufficient to show indebtedness, repayment,

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thereby preventing him from claiming a charitable contribution for transfers thatthe corporation supposedly made on his behalf.

Gift’s value reduced by tax potential. If a donor dies within three years ofmaking a taxable gift, the gift tax is includible in the gross estate; the propertysubject to the gift is also includible in the gross estate.

Facts: An 89-year old mother who had a marital trust valued at nearly $123million entered into a gift tax agreement with her four daughters under whichshe transferred all but $10 million to them in equal shares. They agreed to paygift tax on their shares as well as estate tax liability if she died within three yearsof the gift. In valuing the gift for gift tax purposes, the appraiser reduced thevalue by the potential estate tax. The IRS contested this valuation.

Tax Court. The court allowed the value of the gift to be net of the potential estatetax (Steinberg, 145 TC No. 7 (2015); 15FED ¶48,115). Using a willing buyer andwilling seller test, the court said: “Any hypothetical recipient of the property whoassumed the liabilities would insist on a reduction of the purchase price to reflecthis or her assumption of any Section 2035(b) estate tax liability.”

Conservation easement. A taxpayer who donates a conservation easement cantake a current tax deduction for the value of the donation even though he/shecontinues to use the property (along with the public). However, the donationmust be in perpetuity.

Facts: The taxpayer donated as a conservation easement a 74-acre parcel of landnear Boise, Idaho and claimed a charitable contribution deduction for it of$941,000 spread over three years. At the time of the donation, there was amortgage on the property and the IRS disallowed the deduction. Nearly twoyears after filing a petition with the Tax Court, they subordinated the mortgage.

Tax Court. The grant of the easement was not in perpetuity because at the time ofthe transfer there was a mortgage on the property that could defeat the charity’sinterest if there were a default (Minnick, TC Memo 2012-345). The fact that theyhad always intended to subordinate the mortgage and the bank was alwayswilling does not change anything.

Appellate court. The Ninth Circuit affirmed the Tax Court’s decision (Minnick,CA-9, 2015-2 USTC ¶50,430). In order to enforce the conservation purposes of thegift in perpetuity, it is clear that a mortgagee must subordinate its rights in theproperty to the rights of the qualified organization. Because that was not done inthis case, there was no valid conservation easement within the meaning of the taxlaw.

Study Questions14. To deal with identity theft the IRS has done all of the following except:

a. Suspended its online Get Transcript program.

b. Settled a class action lawsuit against the government for IRS databreaches.

c. Ended the automatic extension for W-2s.

d. Agreed not to tax identity theft protection services offered to customersand employees after a data breach.

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15. Which statement about the Sec. 83(b) election not correct?

a. A taxpayer must file two copies of the election with the IRS.

b. The election applies to the receipt of restricted stock.

c. An election generally is irrevocable.

d. The election must be made within 30 days of receiving restrictedproperty.

16. All of the following are recent developments concerning gifts to charities andindividuals except:

a. The IRS has finalized regulations eliminating the need for donees toobtain written acknowledgments for contributions of $250 or more.

b. A taxpayer cannot take a charitable contribution deduction for donationsmade by his corporation where there is no proof that he was required torepay the corporation for these outlays.

c. A gift’s value for gift tax purposes can be reduced by potential estate tax.

d. An appellate court affirmed the Tax Court’s decision disallowing adeduction for a conservation easement where there was an un-subordinated mortgage on the property.

D. Taxation of Distributions from IRAS and Annuities

Earnings on investments in qualified retirement plans, IRAs, and annuities aretax deferred; they are not taxed until distributions or withdrawals are taken fromthe plan or the contract. However, the funds disbursed may be fully or partiallytaxable. Here are some recent cases grappling with taxation of distributions andwithdrawals.

IRAs. All disbursements from a traditional IRA are fully taxable. This is sowhether the disbursements are voluntary or involuntary. Take the following case.

Facts: A plan administrator for a union was convicted of various felonies,including mail fraud and money laundering. In addition to jail time, he wasordered to pay a fine to the government and make restitution to the union. Hisonly asset to satisfy these monetary obligations was the money in his qualifiedretirement plan account. In order to gain time to raise other funds, he rolled hisplan account over to an IRA. After several years and no success in finding otherfunds, a court ordered the IRA custodian to turn over the funds in the IRA to thegovernment; some of the funds were then transferred to the union. He did notinclude any of the IRA disbursement in income, arguing that he never receivedthe funds.

Tax Court. The court rejected this argument (Rodrigues, TC Memo 2015-178;15FED ¶48,111(M)). While the funds did not pass through his hands, he was inconstructive receipt of them. There is no penalty exception for this type ofinvoluntary disbursement.

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PLANNING POINTER: There are two types of involuntary disbursementsthat are penalty free: disbursements for IRS levies and qualified domesticrelations orders (QDROs). The penalty exception for IRS levies applies disburse-ments from both qualified retirement plans and IRAs; QDROs only applies todisbursements from qualified retirement plans and not to IRAs.

Variable annuities. Variable annuities allow the contract holder to invest thecontract in a menu of investment options; the earnings dictate the amount ofannuity payments that will be received in excess of a fixed promise. Whenwithdrawals or distributions taken impact the rules that apply for determiningtaxation:

• For withdrawals prior to the annuity starting date withdrawals, in simpleterms all of the payments are taxed as ordinary income to the extent ofearnings in the contract; any excess is a tax-free return of capital.

• For distributions following the annuity starting date, a portion of eachpayment represents taxable earnings and tax-free return of the taxpayer’sinvestment in the contract.

Facts: A taxpayer who bought a joint variable annuity with his spouse took adistribution of $575,000 prior to the annuity starting date. He had purchased itwith $575,000; it had earnings at the time of the distribution of $186,000. Heargued that the taxable portion could be offset by a loss he sustained on the saleof securities to purchase the contract.

Tax Court. The Tax Court rejected this argument (Tobias, TC Memo 2015-164;15FED ¶48,096(M)). The source of the funds used to purchase an annuity isirrelevant to the tax treatment of the distribution from the annuity. Thus,$186,000 of the $575,000 distribution was taxed as ordinary income.

The distribution was also subject to a 10% early distribution penalty becauseneither he nor his spouse was age 59-1/2 at the time. He argued that the penaltyshould not apply because of the disability exception. His spouse had resignedher job as a school administrator due to rheumatoid arthritis. However, merelyhaving a condition does not amount to disability for purposes of the exception.She was still capable of substantial gainful activity, albeit with limitations for hercondition.

E. Appellate Court Developments

The Tax Court is not always the final word on a subject. Taxpayers who areunhappy with the outcome in the Tax Court may appeal. The appellate courtmay agree with the Tax Court by affirming the decision. Or the appellate courtmay reverse the decision. In still other circumstances, taxpayers may win partialvictories in the higher court. Here is a roundup of some recent appellate courtdecision.

Residential mortgage interest. As discussed earlier in the FOCUS, when unmar-ried individuals co-own a home, there is a dispute about which dollar limit eachowner should use. Here is the most recent resolution of this dispute:

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Facts: Domestic partners in California owned two homes: one in Beverly Hillsand the other in Rancho Mirage near Palm Springs. The total mortgage balanceson the two homes was about $2.7 million. The IRS disallowed mortgage interestdeductions on the debt exceeding a combined limit of $1.1 million (acquisitionindebtedness and home equity debt). These taxpayers argued that the $1.1million should be applied for each of them.

Tax Court. The $1 million limit applies per residence, so the debt is allocated tothe co-owners, and the interest on this debt accordingly (Sophy, 138 TC 204(2012)).

Appellate court. The Ninth Circuit reversed the Tax Court and held that the $1million dollar limit applies per owner, not per residence (Voss, CA-9, 2015-2USTC ¶50,427).

PLANNING POINTER: The IRS has yet to respond to this latest decision.Unmarried co-owners in jurisdictions outside of the Ninth Circuit may have tolitigate in order to obtain the same favorable results as the Ninth Circuit.

Reacquisition of residence. A homeowner who sells a residence, takes the homesale exclusion, and then reacquires the residence, usually must recognize gain onthe reacquisition (Code Sec. 1038(b)). Are there situations in which gain recogni-tion is not required?

Facts: A homeowner sold his principal residence with an installment agreementin 2006 and excluded gain of $500,000 (his spouse died within two years of thesale, allowing him to use the exclusion amount for joint filers). When the buyersdefaulted in 2009, the homeowner reacquired the home. The IRS said he wasrequired to recognize long-term capital gain on the reacquisition.

Tax Court. The IRS is correct (DeBough, 142 T.C. 297 (2014)). The homeownermust recognize the gain that was previously excluded under Code Sec. 121.There is an exception from this income recognition rule: no gain is recognized ifthe home is resold within one year of the reacquisition (Code Sec. 1038(e)). Thatdid not happen here. The court analyzed the interplay between 121 to find thatpreviously excluded gain must be recognized on the reacquisition.

Appellate court. The Eighth Circuit affirmed the Tax Court decision (DeBough v.Shulman, CA-8, 2015-2 USTC ¶50,455 (2015)). The purpose of Code Sec. 1038 isto restore the taxpayer to the pre-sale condition when property is repossessed insatisfaction of a debt secured by the property. Any “payments received” beforethe repossession are taxed as gain to the extent they have not previously beenreported as income. In effect, Code Sec. 1038 is an override to Code Sec. 121 whenthere is a reacquisition.

Recouping litigation costs from the government. A taxpayer who is the prevail-ing party against the government may be eligible to recover the costs of pursuingthe claim (Code Sec. 7830). The question is when a taxpayer can be treated as theprevailing party.

Facts: A wife who was a homemaker requested equitable innocent spouse relieffrom liability arising from her husband’s income (he was an attorney who

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reported income but did not pay taxes). The wife offered to settle with the IRS for$200. Initially the offer was rejected, but the IRS later conceded that she wasentitled to full relief. She sued to recover litigation costs.

Tax Court. The IRS concession was an offer to settle the dispute, which sheaccepted. Thus, she could not recover litigation costs (Knudsen, TC Memo2013-87).

Appellate court. The Ninth Circuit reversed the Tax Court (Knudsen, CA-9, 2015-2USTC ¶50,383). The wife in this case can be deemed to be the prevailing party.While a person cannot be the prevailing party if there is a judgment pursuant to asettlement, this rule does not apply in this case. There was no negotiation for asettlement; the IRS made a unilateral decision. Thus, she can recover costs. Thecase was remanded for the Tax Court to determine reasonable litigation costs.

F. Interest Rates on Corporate RefundsInterest rates on refunds to S corporations. Each quarter, the IRS sets interestrates applicable to overpayments and underpayments. Special, less favorable,rates apply to corporate overpayments; even less favorable rates apply to over-payments exceeding $10,000. The question is whether the interest rates onoverpayments applicable to C corporations apply to S corporations as well.

Facts: Mining companies operating as S corporations overpaid excise taxes andwere entitled to a refund of $6 million. They filed for a refund, including interest.At the time, the rate was 3% for noncorporate overpayments; it was 2% forcorporate overpayments, and 0.5% for corporate overpayments exceeding$10,000. However, the interest rate for corporate underpayments is specificallyrestricted to C corporations.

Federal Claims Court. The court held that the rates on corporate overpaymentsapply to S corporations (Eaglehawk Carbon, Inc., Fed. Cl., 2015-2 USTC ¶50,387).The plain language of the statute refers to “corporations” without any distinc-tion. What’s more, there was no clear statement in the legislative history indicat-ing Congress’ intention to exclude S corporations from the term “corporations”for purposes of the interest rates on overpayments. The fact that S corporationsare passthrough entities does not change their treatment for interest ratepurposes.

G. Law School Costs Not DeductibleA taxpayer can deduct education costs, such as tuition, books, travel, lodging,and other costs, if certain conditions are met (Code Sec. 162; Reg. §1.162-5(a)):

• The education maintains or improves skills required by the individual inhis employment or other trade or business, or

• The taxpayer meets the express requirements of the individual’s em-ployer, or the requirements of applicable law or regulations, imposed as acondition to the retention by the individual of an established employmentrelationship, status, or rate of compensation.

Facts: A taxpayer who completed his legal studies in Germany took a three-month elective with a German firm in Utah. Deciding to stay in the U.S., he

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enrolled in and graduated from a law school in California. He then took andpassed the New York bar and deducted his law school costs.

Tax Court. No deduction is allowed (O’Connor, TC Memo 2015-155; 15FED¶48,087(M)). A taxpayer must be established in a trade or business at the timethe education costs are paid. The taxpayer tried to show that he already metminimum job requirements because New York does not require a law schooldegree in order to sit for the bar. However, in order to do this, an applicant mustmeet certain requirements, including proof that the foreign legal education wassubstantially the same as a U.S. education; he did not provide such proof.Therefore, no deduction can be claimed.

PLANNING POINTER: A deduction for education costs as a miscellaneousitemized deduction subject to the 2%-of-adjusted-gross-income floor producegreater tax savings than claiming the lifetime learning credit. This credit onlytakes into account the first $10,000 of qualified education expenses (which doesnot include travel and lodging).

Study Questions

17. In which of the following scenarios is the 10% penalty not exempted?

a. Disbursements from a qualified retirement plan for a QDRO

b. Disbursements from an IRA for an IRS levy

c. Disbursements from an IRA to meet a court-ordered restitution payment

d. Disbursements from a qualified retirement plan for an IRS levy

18. In which recent case was the Tax Court reversed?

a. Reporting income on the reacquisition of a principal residence followinga default on installment payments where gain had originally beenexcluded.

b. Claiming a charitable contribution for an easement where the mortgagewas subordinated after the time of the gift.

c. Deducting law school costs by a foreign-trained attorney.

d. Recouping litigation costs from the government where a claim for inno-cent spouse was dropped by the IRS.

H. High-Low Substantiation Method for Business Travel Costs

Certain government-set rates can be used to substantiate costs for business travelin lieu of retaining receipts to prove the actual costs for lodging, meals, andincidental expenses. The IRS sets rates for business travel within the continentalU.S. (CONUS) using a high-low method. The higher rate applies to areas desig-nated by the IRS to be high-cost areas; the lower rate applies to all other areaswithin CONUS. The IRS has set the rates for the government’s fiscal yearbeginning on October 1, 2015, and ending September 30, 2016 (Notice 2015-63,IRB 2015-40; 15FED ¶46,404).

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Rates. The per diem rate starting October 1, 2015, for high-cost areas hasincreased to $275 (up from $259 the previous fiscal year). The rate for low-costareas also increased to $185 (up from $172 in the previous fiscal year. Of theseper diem rates, $68 is for meals in high-cost localities (up from $65 the previousfiscal year), $57 is for meals in low-cost localities (up from $52 the previous fiscalyear); only 50% of meal costs are deductible. The rate for incidental expenses is$5 per day, which is unchanged from the previous fiscal year.

PRACTICE POINTER: Incidental expenses include only fees and tips givento porters, baggage carriers, hotel staff, and staff on ships. Transportationbetween places of lodging and business and places where meals are taken, andthe mailing costs of filing travel vouchers and paying employer-sponsored creditcard bills may be separately deducted or reimbursed as transportation andmailing expenses.

New high-cost areas. The following locations have been added to the list of high-cost areas:

• Mammoth Lakes, CA

• Grand Lake, CO

• Silverthorne/Breckenridge, CO

• Traverse City/Leland, MI

• Hersey, PA

• Wallops Island, VI

Locations removed from high-cost areas. The following locations are no longertreated as high-cost areas:

• Sedona, AZ

• Santa Cruz, CA

• New Orleans, LA

• Baltimore City, MD

• Cambridge/St. Michaels, MD

• Glendive/Sidney, MT

• Conway, NH

• Glens Falls, NY

• Tarrytown/White Plains, NY

• New Rochelle, NY

• Kill Devil, NC

• Williston, NC

Changes in the portion of the year for a high-cost designation. The followinglocations have had the period of the year changed:

• Napa, CA

• Telluride, CO

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• Miami, FL

• Martha’s Vineyard, MA

• Nantucket, MA

• Jamestown/Middletown/Newport, RH

• Charleston, SC

• Jackson/Pinedale, WY

PRACTICE POINTER: Employers can opt to continue reimbursements forthe balance of the 2015 calendar year using the rates that went into effect onOctober 1, 2014, as well as the localities in effect under Notice 2014-57.

I. Arbitration Program Ended

The IRS has ended its Appeals arbitration program (Rev. Proc. 2015-44, IRB2015-38-354, 15FED ¶46,396, obsoleting Rev. Proc. 2006-44). The program wasinitiated by a directive from Congress to create a pilot program for bindingarbitration to resolve issues at the end of the appeals process without the needfor litigation (Code Sec. 7123(b)(2)). In 2000, the IRS initiated a pilot program; theprogram was finalized in 2006.

The program has been eliminated for lack of demand. During the 14 years inwhich it was in operation, only two cases were settled through arbitration.

PRACTICE POINTER: Alternative dispute resolution (resolution in lieu oflitigation) can still be done through mediation. There are different mediationprograms for large businesses, for small business and self-employed individuals,and for tax-exempt entities (http://www.irs.gov/Individuals/Appeals-Media-

tion-Programs).

J. Interest Rates for Q4 2015

The IRS interest rates on underpayments and overpayments for the fourthquarter of 2015 are unchanged from the third quarter of 2015 (Rev. Rul. 2015-17,IRB 2015-39-358; 15FED ¶46,395). The interest rates for the fourth quarter begin-ning October 1, 2015, are as follows:

• For noncorporate overpayments, the interest rate is 3%.

• For underpayments of both noncorporations and corporations other thanthose with large underpayments, the interest rate is 3%.

• For corporate overpayments, the interest rate is 2%.

• For large corporate underpayments, the interest rate is 5%.

• For the portion of corporate overpayments exceeding $10,000, the interestrate is 0.5%.

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PLANNING POINTER: These IRS interest rates have not changed sinceOctober 1, 2011.

Study Questions19. The per diem rate for travel to high-cost areas in the government’s 2016 fiscalyear beginning October 1, 2015, under the high-low substantiation method is:

a. $172b. $185c. $259d. $275

20. The IRS rate for noncorporate overpayments in the fourth quarter of 2015 is:a. 0.5%b. 2%c. 3%d. 5%

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IV. FILING DEADLINES AND REMINDERS

A. December 15, 2015

Corporate estimated taxes. This is the deadline for the fourth installment of 2015estimated taxes for corporations reporting on a calendar year.

B. December 31, 2015

Setting up qualified retirement plans. This is the last day for businesses andself-employed individuals to establish qualified retirement plans for 2015. Aslong as the paperwork is signed by this date, then contributions can be made upto the extended due date of the taxpayer’s 2015 income tax return.

C. January 15, 2016

Estimated taxes for individuals, trusts, and estates. This is deadline for thefourth installment of 2016 estimated taxes for those reporting on a calendar year.

PLANNING POINTER: The fourth installment is not required if a final 2015income tax return is filed no later than February 1, 2016 (January 31 is aSunday). For farmers and fishermen, a final return must be filed no later thanFebruary 29, 2016.

D. February 1, 2016

Deadline for employers. This is the date on which Form 940, Federal Unemploy-ment Tax, is due. However, if deposits were made in full and on time, then thereturn can be filed as late as February 10th. It is also the filing deadline for thefourth quarter of 2015 for reporting FICA and income tax withholding; Form 941,Employer’s Federal Tax Return, is used for this purpose. However, if deposits forthe quarter were made on time and in full, then the return need not be filed untilFebruary 10th.

PLANNING POINTER: Very small employers notified by the IRS of eligibilityto file an employer return annually must submit it by this date; Form 944 is usedfor this purpose.

Employment taxes for household employees are not separately reported on theseforms. Instead, employers report employment taxes on Schedule H of Form 1040.However, if an employer has both business and household employees, he or shemay choose to report employment taxes for household employees along withemployment taxes for non-household employees.

This is also the date by which large employers must furnish employees withForm 1095-C, Employer-Provided Health Insurance Offer and Coverage. Small em-ployers that have self-insured health plans must provide employees with Form1095-B, Health Coverage; if small employers offer health insurance to employees,the insurance company provides this form.

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This is also the due date by which W-2 forms must be furnished to employees byemployers, reporting their 2015 wages and other payments and withholdings.This deadline applies whether an employer uses paper forms or furnishes themelectronically.

Deadline for 1099s. Date by which payers of interest, dividends, payments toindependent contractors, and certain other payments must furnish Forms 1099,to the recipient. The applicable 1099 form is an information return showing theamount of the payments and the withholding, if any. Again, this deadlineapplies even if the forms are furnished electronically, as now permitted if therecipient consents to receive the form in this manner.

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CONCLUSIONThis concludes this edition of the CPE CREDIT SERVICE. If you are interestedin earning valuable Continuing Professional Education credits, please go toCCHGroup.com/CPECredit to complete your Quizzer online for immediateresults and no Express Grading Fee.

A $56.00 grading fee will be billed to your CCH account or designated chargecard (sales tax may be applicable in your state). See the Quizzer instructions onpage 49 for complete details.

If you prefer to mail or fax your Quizzer, please fill in and send the QuizzerAnswer Sheet on the back cover of this booklet to CCH Continuing EducationDepartment to be graded. The grading fee will be billed to your CCH account ordesignated charge card (sales tax may be applicable in your state) or you may optto enclose a check payable to CCH INCORPORATED. The Answer Sheet may bephotocopied so that others in your firm can use this service for CPE credit.

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Answers to Study Questions

1. a. Incorrect. Tracing rules apply to business interest so that taxpayers candetermine whether all of the interest is fully deductible.

b. Incorrect. Investment interest is subject to the tracing rules in order to applythe net investment income limitation on the interest deduction.

c. Correct. Because special rules apply for determining the deduction forresidence interest, such interest is exempt from the tracing rules.

d. Incorrect. Tracing rules apply to interest on student loans, which may bedeductible as an above-the-line deduction.

2. a. Incorrect. $50,000 is the dollar limit for purposes of the interest deduction onhome equity loans for married persons filing separately.

b. Incorrect. $100,000 is the dollar limit for purposes of the interest deduction onhome equity loans for taxpayers other than married persons filing separately.

c. Incorrect. $500,000 is the dollar limit for purposes of the interest deduction onacquisition indebtedness for a married person filing separately; the taxpayer inthe question is single.

d. Correct. $800,000 is the dollar limit for purposes of the interest deduction forthe taxpayer in the question; up to $1 million of acquisition debt can be takeninto account.

3. a. Incorrect. Late payment fees on mortgage are deductible as interest, pro-vided they are not for services.

b. Incorrect. A penalty such as a prepayment charge for paying off a mortgagebefore the end of the term is treated as deductible residence interest.

c. Correct. Points on a mortgage for a vacation home must be amortized overthe term of the mortgage; they cannot be deducted in full in the year ofpayment.

d. Incorrect. Points on a mortgage for a principal residence are deductible in fullin the year of payment provided that certain conditions are met (e.g., the pointsare reasonable).

4. a. Correct. Mortgage insurance premiums are treated as deductible residenceinterest (assuming the rule is extended for 2015), provided that the home-owner’s income is below an applicable threshold amount.

b. Incorrect. High-income taxpayers are subject to a phase-out of deductibleresidence interest if their modified adjusted gross income exceeds the applicablethreshold for their filing status.

c. Incorrect. Interest that accrues on reverse mortgage is not deductible until themortgage is paid off.

d. Incorrect. Even though a taxpayer receives a tax-free housing allowance, suchas a minister or military personnel, a deduction for residence interest is allowed.

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5. a. Correct. Interest on a loan to buy a sole proprietorship or passthroughentity depends on the underlying assets; if they are business assets such asinventory, office furniture, machinery, and equipment, then all of the interestis deductible as business interest.

b. Incorrect. Interest on a loan to buy stock in a C corporation is investmentinterest.

c. Incorrect. Points on a business loan are prepaid interest amortized over theterm of the loan.

d. Incorrect. Interest on a loan to put up a building must be capitalized.

6. a. Incorrect. Portfolio interest is not treated as passive activity interest; it istreated separately as investment interest.

b. Correct. There is no line on Form 8582 for entering passive activity interest;such interest is taken into account on the form as part of overall expenses.

c. Incorrect. It is true that the self-charged interest rule recharacterizes whatwould otherwise be PAL interest as business interest.

d. Incorrect. Unlike some other types of interest, there is no dollar limit on PALinterest; however, the PAL rules may limit the amount of interest that is currentlydeductible.

7. a. Correct. Alaska Permanent Fund dividends are specifically excluded fromthe definition of investment income for purposes of the investment interestlimitation.

b. Incorrect. A parent who elects to report a child’s income on his/her returntreats the child’s investment income as his/her own.

c. Incorrect. Investment income passed through to owners in passthrough enti-ties, trusts, and estates, is taken into account as the owners’ investment incomefor purposes of the limitation on investment interest.

d. Incorrect. Qualified dividends and long-term capital gains are treated asinvestment income only if the taxpayer elects to subject them to ordinary incomerates rather than favorable capital gains rates.

8. a. Incorrect. The taxpayer’s modified adjusted gross income may limit or bar adeduction for student loan interest.

b. Correct. The deduction for student loan interest is deductible from grossincome; no itemizing is required.

c. Incorrect. It is true that the maximum annual deduction for student loaninterest is capped at $2,500.

d. Incorrect. Form 1098-E, Student Loan Interest Statement, is used to reportstudent loan interest.

9. a. Incorrect. Code Sec 61 and Reg. §1.61-12 requires the inclusion of cancella-tion of debt income in gross income unless a special exception applies.

46

b. Incorrect. Even though the lender recovers the car upon a repossession, thedebt still has cancellation of debt income for the balance of an outstanding loanthat is forgiven.

c. Incorrect. If a taxpayer wants to opt out of current reporting cancellation ofdebt income, Form 982 must be filed.

d. Correct. The fee is not deductible because it is neither a business norinvestment expense.

10. a. Incorrect. Teachers and medical professionals can enjoy an exclusion fordebt forgiveness if they have a specify type of loan program and work for a settime in a specific geographical area.

b. Incorrect. The IRS ruled that law school graduates can qualify for an exclusionfrom cancellation of debt under certain circumstances.

c. Correct. Student loan debt generally cannot be forgiven in bankruptcy.

d. Incorrect. The exclusion for COD income applies for loans forgiven to health-care professionals under the National Health Services Corps Loan RepaymentProgram.

11. a. Incorrect. An employee can work full-time or part-time; the number ofhours does not determine work status.

b. Incorrect. Paying a worker on an hourly, daily, weekly basis, or by the job isnot a criteria for worker or independent contractor status.

c. Incorrect. The nature of the job or job title, such as housekeeper, does not makea worker an employee or independent contractor.

d. Correct. The extent of control that a client has over a worker determineswhether the worker is an employee or independent contractor.

12. a. Correct. A client must obtain an employer identification number underwhich to report FICA taxes; the client’s Social Security number cannot be usedfor this purpose

b. Incorrect. The threshold for FICA taxes on household employees in 2015 is$1,500.

c. Incorrect. FICA is figured on cash wages and does not include the value ofroom and board.

d. Incorrect. No FICA tax is paid on wages to a client’s child under the age of 21.

13. True. Incorrect. As yet, only a handful of states have adopted special protec-tions for household workers.

False. Correct. California, Massachusetts, New York, and a few other stateshave enacted protections for household workers called the domestic workersbill of rights.

47

14. a. Incorrect. It is true that the IRS has suspended its online Get Transcriptprogram, but taxpayers can still obtain transcripts by mail.

b. Correct. A class action lawsuit has been filed against the IRS by thoseclaiming that their identities were stolen as a result of the IRS data breach, butit has not been settled or decided by a the court.

c. Incorrect. Employers can no longer obtain an automatic extension for filingW-2s; they can request a filing extension.

d. Incorrect. The IRS announced that it would not assert that identity theftprotection services were taxable if offered to clients and customers after a databreach.

15. a. Correct. The IRS has eliminated the requirement to attach a second copyof the election with the taxpayer’s return.

b. Incorrect. The election can be made for any type of restricted property, such asrestricted stock, received by an employee.

c. Incorrect. Once made, the election can only be revoked with IRS consent

d. Incorrect. It is true that the Sec. 83(b) election must be made within 30 days ofreceiving restricted property by filing the election statement with the IRS.

16. a. Correct. The IRS has indicated that it will modify current rules requiringcontemporaneous written acknowledgments, but nothing has been finalized.

b. Incorrect. An appellate court has upheld a Tax Court decision barring acorporate owner from taking charitable contribution deductions based on corpo-rate disbursements that he could not provide he repaid.

c. Incorrect. The Tax Court has decided that the value of a gift can be reduced bypotential estate tax that would result if the gift were included in the donor’sestate.

d. Incorrect. A deduction for a conservation easement is allowed only if the gift isin perpetuity, and a mortgage on the property prevents this if it is not subordi-nated to the interests of the charity.

17. a. Incorrect. No 10% early distribution penalty applies if disbursements froma qualified retirement plan are made pursuant to a QDRO.

b. Incorrect. There is an exception from the 10% penalty for involuntary IRAdisbursements for IRS levies.

c. Correct. The Tax Court has made it clear that even though disbursementsfrom an IRA are involuntary, they are not penalty free unless they are coveredby a specific penalty exception in the law.

d. Incorrect. The 10% penalty exception for IRS levies applies to disbursementsfrom a qualified retirement plan.

18. a. Incorrect. The Tax Court’s decision regarding reporting capital gain on thereacquisition of a principal residence was not reversed.

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b. Incorrect. The Tax Court’s decision regarding the subordination of a mortgageat the time of a gift of a conservation easement is a prerequisite has beenaffirmed.

c. Incorrect. The case of the law school graduate has only been decided by theTax Court; there has been no appeal as yet.

d. Correct. The appellate court reversed the Tax Court, finding that the tax-payer was the prevailing party where the IRS dropped the matter.

19. a. Incorrect. The per diem rate for travel to areas in CONUS other than high-cost areas under the high-low substantiation method was $172 in the fiscal yearbeginning October 1, 2014.

b. Incorrect. The per diem rate for travel to areas in CONUS other than high-costareas under the high-low substantiation method is $185 in the fiscal year begin-ning October 1, 2015.

c. Incorrect. The per diem rate for travel to high-cost areas in the government’s2015 fiscal year was $259 under the high-low method.

d. Correct. The per diem rate for the government’s 2016 fiscal year is $275 forhigh-cost areas.

20. a. Incorrect. The 0.5% rate applies to the portion of corporate overpaymentsexceeding $10,000.

b. Incorrect. The 2% rate applies to corporate overpayments.

c. Correct. The 3% rate applies to noncorporate overpayments as well asunderpayments.

d. Incorrect. The 5% rate applies to large corporate underpayments.

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CPE Quizzer InstructionsTo obtain CPE Credit, go to CCHGroup.com/CPECredit to complete your Quiz-zer online for immediate results and no Express Grading Fee. There is a gradingfee for each Quizzer submission. A CPE Certificate of Completion will beawarded for achieving a grade of 70 percent or greater.

Processing Fee: $56.00

Recommended CPE: 4 hoursFederal Tax Law: 2 hoursFederal Tax Update: 2 hoursEthics: N/A

IRS Program Number: 4VRWB-T-01489-15-S FederalTax Law4VRWB-U-01488-15-S FederalTax Update

To mail or fax your Quizzer, send the completed Answer Sheet on the back coverof this booklet to CCH Continuing Education Department, 4025 W. PetersonAve., Chicago, IL 60646, or fax it to (773) 866-3084. Each Quizzer Answer Sheetwill be graded and a CPE Certificate of Completion awarded for achieving agrade of 70 percent or greater.

* Recommended CPE credit is based on a 50-minute hour. Participants earningcredits for states that require self-study to be based on a 100-minute hour willreceive 1/2 the CPE credits for successful completion of this course. Because CPErequirements vary from state to state and among different licensing agencies,please contact your CPE governing body for information on your CPE require-ments and the applicability of a particular course for your requirements.

Express Grading: Processing time for your mailed or faxed Answer Sheet isgenerally 8-12 business days. To use our Express Grading Service, at an addi-tional $19 per Quizzer, please check the “Express Grading” box on your AnswerSheet and provide your CCH account or credit card number and your faxnumber. CCH will fax your results and a Certificate of Completion (uponachieving a passing grade) to you by 5:00 p.m. the business day following ourreceipt of your Answer Sheet. If you mail your Answer Sheet for ExpressGrading, please write “ATTN: CPE OVERNIGHT” on the envelope. NOTE:CCH will not Federal Express Quizzer results under any circumstances.

Date of Completion: The date of completion on your Certificate will be the datethat you complete the Quizzer at CCHGroup.com/CPECredit. If you mail or faxyour Quizzer to CCH, the date of completion on your Certificate will be the datethat you put on your Answer Sheet. However, you must submit your AnswerSheet to CCH for grading within two weeks of completing it.

Expiration Date: This course must be submitted for grading within one year ofreceipt.

50

Evaluation: To help us provide you with the best possible products, please take amoment to fill out the course Evaluation located after the Quizzer. A copy is alsoprovided at the back of this course if you choose to mail or fax your QuizzerAnswer Sheets.

51

Quizzer Questions

1. Tracing rules are used for:

a. Determining the amount of student loan interest that is deductible.

b. Limiting the amount of residential debt on which interest can bededucted.

c. Applying the net investment income limitation on investment interest.

d. Determining whether interest is deductible from gross income or as anitemized deduction, or is nondeductible.

2. A married couple owns two homes with combined mortgages (acquisitiondebt and home equity debt) of $1.2 million. What is the maximum loan amounton which interest is deductible?

a. $550,000

b. $1 million

c. $1.1 million

d. $1.2 million

3. For points to be fully deductible in the year of payment, all of the followingconditions must be met except:

a. They must relate to a mortgage on a principal residence.

b. The amount must be reasonable.

c. The charging of points must be customary in the area of the borrowing.

d. The taxpayer cannot have modified adjusted gross income over a setamount.

4. Which statement about reporting mortgage interest is not correct?

a. The amount of interest paid by a taxpayer is reported on Form 1098.

b. A seller cannot deduct mortgage interest for the day of the sale.

c. The taxpayer must compute the amount of deductible interest on aseparate schedule.

d. A single entry on Schedule A is made for acquisition debt and homeequity debt.

5. Which of the following rules apply to the deduction for business interest?

a. Interest capitalization rules

b. Original issue discount

c. Thin capitalization

d. All of the above

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6. Which statement about passive activity interest is correct?

a. Only a set dollar limit of passive activity interest is deductible.

b. The tracing rules are used to isolate this type of interest.

c. Portfolio interest is subject to the PAL limit.

d. Personal service corporations are exempt from the PAL limit on interest.

7. Which type of income can a taxpayer choose to treat as investment income forpurposes of the net investment income limit on investment interest?

a. Qualified dividends

b. Passive activity income

c. Alaska Permanent Fund dividends

d. Business income

8. A taxpayer, who is single, pays interest on her student loans of $3,200 in 2015.Her MAGI is $58,000. How much of the interest payment is deductible?

a. 0

b. $1,250

c. $2,500

d. $3,200

9. Form 982 is used to elect out of reporting cancellation of debt income for whichsituation?

a. Insolvency

b. Qualified farm indebtedness

c. Qualified principal residence indebtedness (assuming this is extended for2015)

d. All of the above

10. Which statement about forgiveness of student loan debt is correct?

a. A taxpayer working as a teacher in an inner city may be able to obtain adischarge.

b. It is automatically discharged in bankruptcy.

c. Income is not recognized from cancellation if the taxpayer’s income isbelow a set amount.

d. A new law has been exacted to discharge all student loan debt.

53

11. Which types of workers can be considered household employees for taxpurposes?

a. Gardeners

b. Chauffeurs

c. Nannies

d. All of the above

12. Which of the following is voluntary with respect to a household employee?

a. Employer share of FICA when wages exceed a set limit

b. Income state withholding

c. FUTA taxes when wages exceed a set limit

d. State unemployment insurance

13. For a household employee, an employer must complete all of the followingexcept:

a. Form W-4

b. Form W-2

c. Schedule H

d. Form W-3

14. Identity theft protection services are taxable in which of the followingsituations?

a. An employee receives them following a data breach of the employer.

b. An employer offers them as a fringe benefit in a compensation package.

c. A patient receives them following a data breach at a hospital.

d. Following a data breach a retailer offers them to customers.

15. A taxpayer makes a timely Sec. 83(b) election. All of the following resultexcept:

a. The current value of the restricted property must be reported as ordinaryincome in the year of the election.

b. The taxpayer can report a loss if he/she forfeits the restricted stock.

c. The taxpayer can treat all future appreciation on restricted stock as capitalgain.

d. The company treats the current value of the restricted property as com-pensation subject to employment taxes.

54

16. With respect to charitable contributions of $250 or more, which of thefollowing is not correct?

a. A written acknowledgment applies to gifts of cash and property.

b. The IRS has promised to create a new form easing reporting for charities.

c. The IRS has increased the written substantiation requirement to $500.

d. Proposed regulations create a new way for charities to substantiate thesecontributions.

17. Which of the following statements is correct?

a. No early distribution penalty applies to an involuntary distribution froman IRA to satisfy a court order for restitution.

b. The corporate interest rate on overpayments applies to both C and Scorporations.

c. A taxpayer who sustains a capital loss on securities sold to purchase avariable annuity can offset income from an annuity distribution by the loss.

d. The same tax rule determines income from distributions from variableannuities before and after the annuity starting date.

18. Unmarried individuals co-own two homes (acquisition debt and home equitydebt) with total mortgages of $2.7 million. What is the maximum amount ofborrowing that each can take into account in determining deductible interest?

a. $550,000

b. $1 million

c. $1.1 million

d. $2.7 million

19. All of the following about the high-low substantiation method for businesstravel in the fiscal year starting October 1, 2015 are correct except:

a. The rates for both high-cost and low-cost areas are higher.

b. There are some new high-cost areas.

c. A dozen areas have been removed from the list of high-cost areas.

d. Employers must use the new rates for travel in the last quarter of 2015.

20. In the fourth quarter of 2015, the IRS interest rate on large corporate under-payments is:

a. 0.5%

b. 2%

c. 3%

d. 5%

55

Evaluation Form

(10027712-0003)

Please take a few moments to fill out and mail or fax this evaluation to CCH sothat we can better provide you with the type of self-study programs you wantand need. Thank you.

About This Program

1. Please circle the number that best reflects the extent of your agreement withthe following statements:

Strongly StronglyAgree Disagree

a. The Course objectives 5 4 3 2 1were met.

b. This Course was 5 4 3 2 1comprehensive andorganized.

c. The content was current 5 4 3 2 1and technically accurate.

d. This Course was timely 5 4 3 2 1and relevant.

e. The prerequisite 5 4 3 2 1requirements wereappropriate.

f. This Course was a 5 4 3 2 1valuable learningexperience.

g. The Course completion 5 4 3 2 1time was appropriate.

2. This Course was most valuable to me because of: Continuing Education credit Convenience of format Relevance to my practice/ Timeliness of subject matter

employment Reputation of author Price

Other (please specify)

3. How long did it take to complete this Course? (Please include the total timespent reading or studying reference materials, and completing CPE Quizzer).

hours

4. What do you consider to be the strong points of this Course?

56

5. What improvements can we make to this program?

General Interests

1. Preferred method of self-study instruction: Text Audio Computer-based/Multimedia Video

2. What specific topics would you like CCH to develop as self-study programs?(Select more than one if appropriate.)

3. Please list other topics of interest to you

About You

1. Your profession: CPA Enrolled Agent

Attorney Tax Preparer Financial Planner Other (please specify)

2. Your employment: Self-employed Public Accounting Firm

Service Industry Non-Service Industry Banking/Finance Government

Education Other

3. Size of firm/corporation: 1 2-5 6-10 11-20 21-50 51+

4. Your Name Firm/Company Name

Address

City, State, Zip Code

E-Mail Address

THANK YOU FOR TAKING THE TIME TO COMPLETE THIS SURVEY!

57

CCH LEARNING CENTERAt CCH, we recognize the value of Continuing Professional Education—toeducate and train your workforce, bring added value to your clients or organiza-tion, and gain a competitive edge in the marketplace. But keeping up withlegislative and regulatory changes and industry developments can be a full-timejob. Let CCH and the CCH Learning Center serve as your gateway to compellingself-study CPE courses and research resources. With the CCH Learning Centeryou get:

• MORE THAN 300 UP-TO-DATE COURSES: The CCH Learning Centeroffers more than 300 informative courses covering tax, financial and estateplanning, and accounting/auditing issues, with new courses being addedall the time. Go to the Course Catalog at cch.learningcenter.com to seedescriptions of all the courses you can take.

• EXPERT AUTHORS AND SUPERIOR CONTENT: Our team of profes-sional analysts, editors, and contributing authors has more experienceand more expertise than any other tax publisher in the country, whichensures you get current, reliable, real-world insights to help you handlethe toughest topics and issues.

• APPROVED CPE: CCH is an approved QAS (Quality Assurance Service)provider with NASBA—one of the first CPE sponsors to be approvedunder the rigorous new CPE requirements.

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To purchase a subscription or learn more about the CCH Learning Center,contact your CCH Representative at 1-888-CCH-REPS or visit the Online Store atwww.CCHGroup.com.

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58

CPE CREDIT SERVICE (10027712-0003)Answer Sheet November 2015

NAME

COMPANY NAME

ADDRESS

CITY, STATE, & ZIP CODE

BUSINESS PHONE NUMBER

E-MAIL ADDRESS

DATE OF COMPLETION

PTIN ID (for Enrolled Agent or RTRP only)

Before completing this Quizzer, please read the instructions located before theQuizzer questions. Please go to CCHGroup.com/CPECredit to complete yourQuizzer online for instant results and no Express Grading Fee. A $56.00 process-ing fee will be charged for each user submitting this Quizzer for grading.

If you prefer to mail or fax your Quizzer, fill in and return this Answer Sheet to:CCH Continuing Education Department, 4025 W. Peterson Ave., Chicago, IL60646-6085 or fax your Answer Sheet to CCH at 773-866-3084. You must alsoselect a method of payment below.

Method of Payment:

� Check Enclosed � Visa � Master � Card � AmEx

�Discover � CCH Account*

Card No. Exp. Date

Signature

EXPRESS GRADING FEE: Please fax my course results to me by 5:00 p.m. thebusiness day following your receipt of this Answer Sheet. By checking this box Iauthorize CCH to charge $19.00 for this service.

Express Grading $19.00 Fax No.

* Must provide CCH account number for this payment option

1. 5. 9. 13. 17. 2. 6. 10. 14. 18. 3. 7. 11. 15. 19. 4. 8. 12. 16. 20.

10027116-0180