Federal Tax Research
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Federal tax research
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You make the callBy: NATP Research
June 13, 2024

Question: Erek made contributions to his Roth IRA in 2020, 2021 and 2022. He later found out his modified AGI was over the limit, so he was not eligible to make the contributions. He withdrew all of them in 2023. How should he report this? Does he need to go back and amend to pay the §4963 6% excise tax?

Answer: For a closed year, like 2020, if Erek had no other changes on his original tax return, he could file Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts, independently and pay the 6% penalty by using the prior year’s version of the form. No amended return is needed. For 2021 and 2022, which are open years, he could either amend each year to include the prior year’s Form 5329 along with the Form 1040-X, Amended U.S. Individual Income Tax Return, or file it independently to pay the penalty.

To fix it, if Erek withdraws the excess contribution before the income tax return due date, including extensions, he must withdraw the excess contribution plus earnings. Earnings are required to be included in gross income. However, no 6% excise tax applies. Note that earnings from the excess contribution are included in income in the year in which the contribution was made, not in the year when the earnings were withdrawn. However, if he takes out the excess after the due date, he is not required to withdraw the earnings and the 6% excise tax would apply on the excess contribution, excluding the earnings. The penalty will be imposed for each year the excess contribution remains in the IRA until it is removed from the account.

Due to the enactment of the SECURE 2.0 Act of 2022, Erek is exempt from paying the 10% early distribution penalty on the related earnings. However, he is still required to report the earnings as income for the year he makes the distribution or, if withdrawal occurs before the due date, he will report the earnings in the year the excess contribution was made.

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Federal tax research
Tax season
Tax professional
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Federal tax research
Tax season
Tax professional
Tax preparation
Tax planning
Tax education
You make the callBy: NATP Research
June 6, 2024

Question: The Mmbaga family owns a strip mall in Dallas, Texas. There are five family members who each own 20%. Ezekiel, the father, is elderly, with seemingly not much longer to live. The family devises a plan for the four family members to each gift their entire interest in the property to Ezekiel. Then, he would bequeath it back to them upon his passing and they would each receive a step-up in basis, per IRC §1014. Is this an allowable tactic?

Answer: This is an allowable tax-saving strategy that could be employed. Its execution must be properly planned to achieve the desired results of the step-up in basis and Ezekiel must survive more than one year after the gifts were made.

There are a few things the family should know –

  • If Ezekiel does not live for more than one year after the upward gifts were made to him, the property is not eligible for the step-up in basis upon subsequent return to the giftees. [IRC §1014(e) disallows a step-up in tax basis on assets that were gifted to the decedent within one year of death unless the appreciated property is distributed to someone other than the original donor or their spouse.]
  • The donors would also be subject to gift tax rules upon making the transfers.
  • There is an element of risk involved, as well. Ezekiel may divert the assets to someone other than the original donors — either intentionally by gift or bequest or unintentionally (by creditor claim).

While not a commonly used strategy, upstream gifting can be effective when everything goes according to plan.

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Federal tax research
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Federal tax research
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You make the callBy: NATP Research
May 30, 2024

Question: The Compassionate Hearts Foundation is a §501(c)(3) nonprofit organization that helps individuals pay for medical care. The organization received cash donations from two individuals – $50 was given by one and $85 was given by the other. The individual who made the $85 donation was given a meal voucher to a local restaurant as a thank-you gift. The meal voucher was valued at $25. Is the organization required to provide a written acknowledgment to each donor?

Answer: Not for both. A written acknowledgment is required to be given by the organization to any donor who gives $75 or more. The nonprofit is not required to give a disclosure to the individual who made the $50 cash donation. However, the organization must provide a written acknowledgment to the individual who made the $85 donation, even though the net charitable contribution is only $60 ($85 donation less the $25 thank-you gift).

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Federal tax research
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Federal tax research
Tax season
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You make the callBy: NATP Research
May 23, 2024

Question: Sam received a $15,000 signing bonus in 2023 with an agreement to work for two years. She only worked nine months for the employer and then quit her job. The employer sent a notice stating she must repay $9,000 by end-of-year and adjustments for the repaid bonus would be included on her Form W-2, Wage and Tax Statement. Sam was not able to repay the funds until early 2024. What is the proper way to account for the repayment of income received in one year that was repaid in a later year?

Answer: Since the funds were received in 2023 and repaid in 2024, Sam would use the claim of right adjustment under §1341. In that case, an adjustment is made on the 2024 return. Since the repayment amount is greater than $3,000, Sam can deduct the amount repaid on Schedule A, Itemized Deductions, Line 16. She could instead take a credit (payment) reported on Schedule 3, Additional Credits and Payments, Line 13b. The credit is the difference between the 2023 tax as originally reported and the taxes calculated in 2023 without including the amount repaid. Ideally, run the calculations for both options (a deduction on Schedule A versus a payment on Schedule 3) and use the method that results in the larger tax benefit. If Sam wants a refund of the Social Security and Medicare taxes, the first step is to see if the employer will refund them. If not, she would use Form 843, Claim for Refund and Request for Abatement.

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Federal tax research
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Federal tax research
Tax season
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You make the callBy: NATP Research
May 16, 2024

Question: Shirley has a rental house that she has owned and used in a rental activity for the last 10 years. Shirley now wants to give the property to her son, Joey. Will converting it to personal use be a taxable event, including recognition of depreciation recapture?

Answer: No. Because it is a gift rather than a sale, the transfer does not trigger recognition of unrecaptured §1250 gain. Shirley will, however, need to file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, to report the fair market value of the gift.

With a typical gift, including one formerly used in business, Joey would “step into the shoes” of his mom, and take her adjusted basis in the property.

In this way, a gift of business property doesn’t avoid the depreciation recapture rule; it merely shifts the burden to another taxpayer. Although the property does not get the §1014 step-up it would get upon Shirley’s death when it passed into her estate, the gift may still be worthwhile from a tax viewpoint. By gifting the property to Joey, who is in a lower tax bracket than Shirley, the after-tax return will still be higher if or when it is sold.

Therefore, when the property is sold, Joey will realize the same amount of ordinary income that Shirley would have realized had she retained the property and sold it.

The same rule applies (step into the shoes) if Shirley had gifted the property in trust, donated it to a charitable organization or transferred it in a part gift/part sale transaction, with some nuances in each case.

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