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topten March, 2011

This is a monthly reference source. By providing samples of questions and answers, we hope to help you understand that we provide a superior service in our ability to get answers to your questions. There are some general caveats that go along with this presentation. Understand that tax law is fluid and always changing; the answer that is correct today may be incorrect tomorrow. Also be aware that changing one small fact may change the entire answer. We are not trying to give a complete outline of any particular subject. We are attempting to give a general direction that can be taken to resolve a problem or obtain an answer. You should discuss your particular situation with your Fiducial Business Advisor to answer your specific problem or concerns. (You may not rely on any answer given to avoid a penalty.)


Q.1 I just read in my local paper that my employer paid health benefits are going to be included on my W-2 for 2011. The article did not say it directly, but gave the impression that employer paid health insurance will be taxed in 2011. Is that true?

A.1 Under the provisions of health care reform, employers are to report to employees the value of the health benefits provided to the employee on Form W-2. The employer paid health insurance is only reported on Form W-2 as an item of information - it is not reported as taxable income.  
Q.2 I own a duplex that has been a rental property (both units) for many years. I am thinking about moving into one of the units now while renting the other and would be in it at least 2-3 years before I sell the duplex. Could I then exclude the gain on the sale (up to the $250,000 limit) of the entire duplex?

A.2 You may qualify to exclude gain on the sale of a principal residence for the unit you own and occupy for at least two of the five consecutive years prior to its sale. However, use of the property as a rental property for 2009 and after is considered “nonqualified use” and the gain allocable to nonqualified use may not be excluded. Therefore, in addition to the deprecation recapture that must be recognized as you previously used the unit as a rental property, a portion of the gain on the unit used as your principal residence would also not be excluded. The amount of gain that is not eligible for exclusion is determined by using a fraction calculated by dividing the nonqualified use (i.e., use as a rental property for 2009 and after) period by the total period the property was owned. The sale of the rental unit that was not converted to your principal residence would not be covered under the residence exclusion at all and is taxable as the sale of a rental property and would be reported as such.

Q.3 I live with my sister and we jointly own the house we are living in. Her name comes first on the title and even though we both pay the mortgage (for which we are both liable) and real estate taxes equally, the 1098 comes only to her. Can we each report our half of the mortgage interest?

A.3 As you both have equitable as well as legal title to the property, and are both subject to the mortgage, you are each entitled to a deduction for the payment you make of mortgage interest and real estate taxes. Your sister should attach a statement to her return noting both your names and SSNs and that you jointly own the property and each pay one-half the mortgage and real estate tax. You should attach the same statement to your return. You should contact your mortgage company and try and get the situation corrected for future years.

Q.4 Last year I bought the stock of an S corporation from my employer, who retired and moved away. I just got a letter from a creditor for non-payment of an invoice for supplies to the business from two years ago. Can I just send them proof that I bought the stock last year?

A.4 In general, if you buy the stock of a corporation rather than its assets, there is no change at the corporate level. The corporation remains liable for its pre-existing debts. In addition, if the cost of the supplies was incorrectly deducted two years ago, you are obligated to amend the return to remove the deduction and send a corrected K-1 to the former shareholder. Check your sales agreement for the stock- there may be a right of restitution from the seller (in which case the corporation may not deduct the payment currently even if the corporation did not deduct the expense in the prior year unless the claim can be shown to be an unenforceable bad debt- i.e., the seller of the stock is bankrupt or the debt is otherwise uncollectible).

Q.5 A few years ago I prepared my own return and included the cost of my health insurance as a deductible expense on Schedule C. I was audited the next year and the deduction was thrown out (although I did get a deduction for self-employed health insurance on page 1 of my return). Now I heard IRS may have been wrong- can I amend?

A.5 What you may have heard is that for 2010 a taxpayer may deduct health insurance costs paid for the individual and immediate family against both self-employment tax and income tax. However, that deduction is available ONLY for 2010, and was not available for prior years.

Q.6 Did I hear right that there is a new Form 1099 requirement for owners of rental property?

A.6 Yes; generally anyone receiving rental income from real property is subject to filing information returns with IRS and to service providers reporting payments of $600 or more during the year effective for payments after December 31, 2010.

Q.7 I am going to sell my farm in the near future. I do not live on the farm- I rent a residence nearby. My intent is to move into the city. My friend is saying that unless I buy another farm I cannot use the like-kind exchange provisions. Is this true?

A.7 Under the Section 1031 like-kind exchange provisions, the definition of “like kind” for real property is broad. Improved property may be exchanged for unimproved property, or rural farmland for improved urban property. You should contact an exchange facilitator. To accomplish an exchange, you may not have access to the sales proceeds from your farm. Procedurally, you will transfer the right to sell your farm to the facilitator, the proceeds will be held in a special trust or escrow account from which the purchase of the replacement property will be made, and then the replacement property will be transferred to you. The replacement property must be identified within 45 days of the initial transfer and the replacement property must be received within 180 days (or the due date of the return plus valid extension for the initial transfer year if sooner). The property given up and received must be held for use in a trade or business or for the production of income, so if you exchange your farm for a rental property it will qualify as like-kind. If you trade the farm for a new residence used personally, that property will not qualify.

Q.8 I am the sole shareholder of an S corporation. The corporation has been paying the premiums on key man life insurance. My prior preparer recorded the premium payments as a deductible expense. May I continue to deduct the life insurance premiums?

A.8 If the insurance is owned by the corporation, the payment of the insurance premiums is non-deductible. The corporation would adjust its accumulated adjustments account by the amount of the premiums, but may not reduce taxable income. If the policy is owned by you individually, the premium payments by the corporation are deductible by the corporation, but only if they are additional compensation to you subject to all payroll taxes and withholding. The premium payments should then be included as compensation on Form W-2. Otherwise, the premium payments are treated as a distribution.

Q.9 Today I wrote a check to a partnership of my three daughters for $90,000 ($30,000 for each daughter). I gave them a gift letter indicating I intended the gift to be equal between the three. Do I have to report the gift? Do they have income?

A.9 If as you state you intended to give each daughter a gift of $30,000 you are obligated to report the gift on Form 709. An annual exclusion of up to $13,000 per donee applies. You will therefore lose the equivalent of $51,000 (3 x $13,000 = $39,000; $90,000 - $39,000 = $51,000) of unified gift/estate tax credit assuming you make no other gifts to them during the year. For 2011 and 2012, the unified gift/estate tax credit is $5,000,000. The recipients of the gift have no income, but should maintain the gift letter with their tax return should IRS audit to show IRS the deposit to the partnership account was not an item of income to the partnership, but that the partnership was merely being used as a conduit for the gift.

Q.10 My brother is a citizen of Israel and he is a permanent resident of the United States. He is not a US citizen. May he own stock in an S corporation?

A.10 A US citizen OR US resident individual may own stock in an S corporation. A non-resident alien may not own S corporation stock. Given your brother is a US resident he may own stock in an S corporation.

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