Q What is the basis of property received as a gift?
A To figure the basis of property you receive as a gift, you must know 3 amounts:
The adjusted basis to the donor just before it was given to you.
The fair market value (FMV) at the time it was given to you.
The amount of any gift tax paid.
If the FMV of the property at the time of the gift is less than the donor's adjusted basis, your basis depends on whether you have a gain or loss when you dispose of the property.
Your basis for figuring a gain is the same as the donor's adjusted basis, plus or minus any required adjustments to basis while you held the property.
Your basis for figuring a loss is the FMV of the property when you received the gift, plus or minus any required adjustments to basis while you held the property.
NOTE: If you use the donor's adjusted basis for figuring a gain and get a loss, and then use the FMV for figuring a loss and get a gain, you have neither a gain nor loss on the sale or disposition of the property.
If the FMV is equal to or greater than the donor's adjusted basis, your basis is the donor's adjusted basis at the time you received the gift. If you received a gift after 1976, increase your basis by the part of the gift tax paid on it that is due to the net increase in value of the gift. To figure the net increase in value or for more information on gifts received before 1977, see Publication 551, Basis of Assets. Also, for figuring gain or loss, you must increase or decrease your basis by any required adjustments to basis while you held the property.
Q I sold my principal residence this year. What form do I need to file?
A For home sales after May 6, 1997, you will generally only need to report the sale of your home if you realized a gain on the sale and either you did not own and use the home as your principal residence for a total of at least two years during the five year period that ended on the date of the sale or you realized a gain of more than $250,000 ($500,000 for certain joint returns). To determine the amount of gain that can be excluded from income refer to Publication 523, Selling Your Home.
You may be entitled to exclude the gain realized on sale of your principal residence from income if during the 5-year period ending on the date of the sale:
You owned the home for a total of at least 2 years; the 2 year period need not be continuous (the ownership test).
You must have lived in the home as your main home for a total of at least 2 years; the 2 year period need not be continuous (the use test).
During the 2-year period ending on the date of sale, you did not exclude gain from the sale of another home.
If you owned and lived in the property as your main home for less than 2 years, you may still be able to claim a reduced exclusion in some cases. See Publication 523, Selling Your Home for more information.
If you are required or choose to report a gain on the sale of your principal residence, it is reported on Form 1040, Schedule D (PDF), Capital Gains and Losses.
NOTE: If you were on qualified extended duty in the U.S. Armed Services, Foreign Service, or the intelligence community (sales or exchanges after December 20, 2006) you may suspend the five-year test period for up to 10 years. You may use this provision for only one property at a time. You are on qualified extended duty when you are assigned to a duty station at least 50 miles from your former principal residence or are residing in government housing under orders and the duty lasts for more than 90 days or for an indefinite period.
Q How do you report the sale of a second residence?
A Your second home is considered a capital asset. Use Form 1040, Schedule D (PDF) to report sales, exchanges, and other dispositions of capital assets.
Q How do I figure the cost basis when the shares I'm selling were purchased at various times and at different prices?
A If you can identify which shares of stock you sold, your basis is:
What you paid for the shares sold plus any costs of purchase.
The total of all the acquisition costs of all the shares sold if you sell a block of the same kind of stock and you report all the shares sold at the same time as one sale.
If you cannot adequately identify the shares you sold and you bought the shares at various times for different prices, the basis of the stock sold is:
The basis of the shares you acquired first (first-in first-out). Except for certain mutual fund shares, you cannot use the average price per share to figure gain or loss on the sale of stock.
Q I purchased stock from my employer under an employee stock purchase plan. Now I have received a Form 1099-B from selling it. How do I report this?
A The holding period requirement is satisfied if:
You do not sell the stock within 1 year after the option is exercised.
You do not sell the stock within 2 years after the option is granted.
If the special holding period requirement:
Is satisfied, the sale of stock is treated generally as giving rise to capital gain or loss. You may have compensation income if the option price was below the stock's fair market value at the time the option was granted; or
Is not satisfied, the compensation income that you should report in the year of the sale is the amount by which the fair market value of the stock at the time of purchase (or vesting, if later) exceeds the exercise price. Any additional gain or loss is treated as capital gain or loss.
If the holding period requirement is satisfied but the option exercise price is below the fair market value of the stock at the time the option was granted:
You report the discount as compensation income (wages) when you sell the stock on Form 1040, Line 7.
If your gain is more than the amount you report as compensation income, the remainder is a capital gain reported on Form 1040, Schedule D (PDF).
If you sell the stock for less than the sum of the amount you paid for it plus the amount reported as compensation, your loss is a capital loss, but you still may have ordinary income.
Q Do I need to pay taxes on the additional stock that I received as the result of a stock split?
A No, a stock split does not increase your wealth; you merely receive more stock certificates evidencing the same ownership interest in the company that issued the stock.
Your overall cost basis is not changed as a result of a stock split, but your per share basis is changed.
You will need to adjust your basis per share of the stock. If you realize a gain when you sell the stock, you will have to include the gain in income. Gain is the amount by which the proceeds from the sale, minus sales commissions, exceed the adjusted basis of the stock sold.
Q How do I calculate the average basis for the sale of mutual fund shares?
A In order to figure your gain or loss using an average basis:
You must have acquired the shares at various times and prices.
Have left them on deposit in an account handled by a custodian or agent who maintains an account for the acquisition or redemption of these shares.
There are two average basis methods:
First, add up the cost of all the shares you own in the mutual fund.
Divide that result by the total number of shares you own.
This gives you your average per share. Multiply that number by the number of shares sold.
First, divide your shares into two categories, long-term and short-term.
Shares held for 1 year or less are short-term.
Shares held for more than 1 year are long-term.
Then use the steps described under the single-category method to get an average basis for each category.
The average basis for that category is then the basis of each share sold from that category.
Once you elect to use an average basis method:
You must continue to use it for all accounts in the same fund.
You must clearly identify on your tax return the average basis method that you have elected to use.
You indicate the identification by including "AVGB" in column (a) of Form 1040, Schedule D (PDF), Capital Gains and Losses.
Q I received a 1099-DIV showing a capital gain. Why do I have to report capital gains from my mutual funds if I never sold any shares?
A A mutual fund is a regulated investment company that pools funds of investors allowing them to take advantage of a diversity of investments and professional asset management.
You own shares in the fund, but the fund owns assets such as shares of stock, corporate bonds, government obligations, etc. One of the ways the fund makes money for you is to sell these assets at a gain. If the asset was held by the mutual fund for more than one year, the nature of the income is capital gain, which gets passed on to you. These are called capital gain distributions, which are distinguished on Form 1099-DIV (PDF) from other types of income such as ordinary dividends.
Capital gains distribution are taxed as long term capital gains regardless of how long you have owned the shares in the mutual fund. If your capital gains distribution is automatically reinvested, the reinvested amount is the basis of the additional shares purchased.
Q Is the loss on the sale of your home deductible?
A The loss on the sale of a personal residence is a nondeductible personal loss.
Q Can the entire acquisition cost of a computer that I purchased for my business be deducted as a business expense or do I have to use depreciation?
A The acquisition cost of a computer purchased for business use:
Can be expensed under Code section 179 in the first year, if qualified, by electing to recover all or part of the cost up to a dollar limit, by deducting it in the year you place the property in service, and any remaining cost is depreciated over 5 years.
Can be depreciated over a 5-year recovery period.
May be eligible for a 50-percent special depreciation allowance if the computer meets certain conditions.
NOTE: Increased section 179 limits. The maximum section 179 deduction you can elect for qualified property placed in service in 2008 has increased to $250,000 ($285,000, for qualified zone and qualified renewal property). This limit is reduced by the amount by which the cost of qualified section 179 property placed in service during the tax year exceeds $800,000. For qualified section 179 Gulf Opportunity (Go) Zone property, the maximum section 179 deduction is higher than the deduction for most other section 179 property. You may also see the IRS site for Code Section 179 for the expanded definition.
Q What form and line do I deduct the standard mileage rate for my business travel and do I need to figure depreciation of the vehicle, too?
A The standard mileage rate:
May be used in calculating your car or truck expense
Already includes depreciation expense
Instead of the standard mileage rate, you can use the actual expense method. If you use this method, you need to figure depreciation for the vehicle.
The business use of a car or truck is claimed on:
Line 9 and Part IV of Form 1040, Schedule C (PDF), Profit or Loss from Business or, if eligible, line 2 of Form 1040, Schedule C-EZ (PDF), if you are a sole proprietor.
Form 2106 (PDF), Employee Business Expenses or, if eligible, line 1 of Form 2106-EZ (PDF), Unreimbursed Employee Business Expenses, and then with other employee business expenses on line 20, Form 1040 Schedule A (PDF), Itemized Deductions.
Q I purchased a rental property last year. What closing costs can I deduct?
A The only deductible closing costs are those for interest and deductible real estate taxes.
Other settlement fees and closing costs for buying the property become additions to your basis in the property and part of your depreciation deduction, including:
Charges for installing utility services
Any amounts the seller owes that you agree to pay (such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions).
Q I rent my home out for two weeks each year. Do I have to show the income on my return?
A You must first consider if you use any dwelling as a home.
You are considered to use a dwelling as a home if you use it for personal purposes during the tax year for more than the greater of:
10% of the total days it is rented to others at a fair rental price
There is a special rule if you use a dwelling as a home and rent it for fewer than 15 days. In this case:
Do not report any of the rental income.
Do not deduct any expenses as rental expenses.
If you itemize your deduction on Form 1040, Schedule A (PDF), Itemized Deductions, you may be able to deduct mortgage interest, property taxes, and any casualty losses.
It is possible that you will use more than one dwelling unit as a home during the year. For example, if you live in your main dwelling unit for 11 months and in your vacation home for 30 days, your main dwelling unit is a home and your vacation dwelling unit is also a home unless you rent your vacation dwelling unit to others at a fair rental value for more than 300 days during the year.
Q What forms do we file to report a loss on the sale of a rental property?
A The loss on the sale of rental property is reported on Form 4797 (PDF), (Sale of Business Property) as an ordinary loss.
Q Can a husband and wife run a business as a sole proprietor or do they need to be a partnership?
A For a business to be classified as a sole proprietorship:
Either the husband or the wife would be the ownerof the business.
Either of the spouses can work in the business as an employee.
If a married couple who file a joint tax return elects to conduct their business activities as a qualified joint venture:
The husband and wife must materially participate in the trade or business.
The spouses must divide the items of income, gain, loss, deduction, credit and expenses in accordance with their respective interests in such venture.
For more information see Election for Husband and Wife Unicorporated Businesses.
This is effective for taxable years beginning after December 31, 2006.
Also, see Rev. Proc. 2002-69 for Special Rules for Spouses in Community States.
Q Must a partnership or corporation file a tax form even though it had no income for the year?
A A domestic partnership must file an income tax form unless it neither receives gross income nor pays or incurs any amount treated as a deduction or credit for federal tax purposes.
A domestic corporation must file an income tax form whether it has taxable income or not.
Q What is the difference between a Form W-2 and a Form 1099-MISC?
A Both of these forms are called information returns.
The Form W-2 is used by employers to:
Report wages, tips and other compensation paid to an employee.
To report the employee's income tax and Social Security taxes withheld and any advanced earned income credit payments.
To report wage information to the employee, the Internal Revenue Service and the Social Security Administration.
A Form 1099-MISC is:
Used to report payments made in the course of a trade or business to another person or business who is not an employee.
Required among other things, when payments of $10 or more in gross royalties or $600 or more in rents or compensation are paid.
Provided by the payer to the IRS and the person or business that received the payment.
Q How do you determine if a person is an employee or an independent contractor?
A The determination is complex, but is based on who has the right to control how, when, and where the person performs services. It is not based on how the person is paid, how often the person is paid, or whether the person works part-time or full-time.
There are three basic areas which determine employment status:
Financial control and
Relationship of the parties
For more information on employer-employee relationships, refer to Publication 15, Circular E, Employer's Tax Guide and Publication 15-A (PDF), Employer's Supplemental Tax Guide.
If you would like the IRS to determine whether services are performed as an employee or independent contractor, you may submit Form SS-8 (PDF), Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.
Generally you should report your nonemployee compensation on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship), or Form 1040, Schedule C-EZ (PDF), Net Profit From Business. You need to pay self-employment tax on your net earnings from self-employment on Form 1040, Schedule SE (PDF), Self-Employment Tax if you had net earnings from self-employment of $400 or more.
Generally, there is no tax withholding on this income. Thus, you may have been subject to the requirement to make quarterly estimated tax payments. If you did not make timely estimated tax payments, you may be assessed a penalty for an underpayment of estimated tax. Employees pay into the social security and Medicare trust funds, as well as income tax withholding, through payroll deductions.
Q As an employer, do I have any liability if my employees receive tips but don't report them to me?
A You have a liability to withhold and pay Social Security and Medicare tax on your employees' reported tips, to the extent that wages or other employee funds are available.
Employees who customarily receive tips are required to report their cash tips to their employers at least monthly, if they receive $20 or more in the month. Cash tips are tips received directly in cash or by check, and charged tips.
If the employee does not report tips to you, it places you at risk of possible assessment of the employer’s share of the Social Security and Medicare taxes on the unreported tips.
If you are a large food or beverage establishment (more than 10 employees on a typical day and food or beverages consumed on the premises), you are required to allocate tips if the total tips reported to you are less than 8% of gross sales. Report the allocated amount on the employee's W-2 at the end of the year.
Beginning January 01, 2007, IRS is offering a three-year-pilot program, "The Attributed Tip Income Program (ATIP)," for food and beverage employers.
This reduces industry recordkeeping burdens, has simple enrollment requirements and promotes reporting tips on Federal Income tax returns.
This benefits both the employer and employee.
This information may be found in Revenue Procedure 2006-30.
Q If an employee claims more than 10 exemptions on their Form W-4, does the employer have to report this to the IRS?
A This requirement has been eliminated:
In the past, employers had to routinely send the IRS any Form W-4 (PDF), Employee's Withholding Allowance Certificate, claiming more than 10 allowances or claiming complete exemption from withholding if $200 or more in weekly wages was expected.
Forms W-4 are still subject to review.
Employers may be directed (in a written notice or in future published guidance) to send certain Forms W-4 to the IRS.
The IRS also will be reviewing employee withholding compliance and you may be required to withhold income tax at a higher rate if notified to do so by the IRS.
Q Does a small company need a tax ID number?
A A sole proprietor who does not have any employees and who does not file any excise or pension plan tax returns is the only business person who does not need an employer identification number. In this instance, the sole proprietor uses his or her social security number as the taxpayer identification number.
Q If I pay personal expenses out of my business bank account, should I count the money used as part of my income, or can I write these expenses off?
A You would include the money in your income.
You would not write the amounts off as expenses.
Only business related expenses can be deducted from your business income.
It is recommended that you not mix business and personal accounts as this makes it easier to keep records.
Q For business travel, are there limits on the amounts deductible for meals?
A Meal expenses are deductible only if your trip is overnight or long enough that you need to stop for sleep or rest to properly perform your duties.
The amount of the meal expenses must be substantiated.
However, instead of keeping records of the actual cost of your meal expenses you can generally use a standard meal allowance. The amount allowed varies, depending on where and when you travel.
The deduction for unreimbursed business meals is limited to 50% of the cost that would otherwise be deductible.
Q I am a U.S. citizen. If I move to Canada to live and work there as a Canadian permanent resident, do I pay both U.S. and Canadian Taxes?
A United States citizens living abroad:
Are required to file annual U.S. income tax returns.
Must report their worldwide income if they meet the minimum income filing requirements for their filing status and age.
Must contact the Canadian Government to determine whether you must file a Canadian tax return and pay Canadian taxes.
Will have the option to exclude some or all of your foreign earned income or to claim a foreign tax credit if Canadian taxes must be paid.
Q Is there an Internet site with the exchange rates to convert foreign currencies to American dollars?
A You can obtain currency exchange rates at several web sites referenced below.
Q Do I have to meet the 330-day presence test or have a valid working resident visa to meet the requirement for foreign income exclusion?
A To claim the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction:
You must have foreign earned income,
Your tax home must be in a foreign country, and
You must be one of the following:
A U.S. citizen who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year,
A U.S. resident alien who is a citizen or national of a country with which the United States has an income tax treaty with a nondiscrimination article in effect and who is a bona fide resident of a foreign country or countries for an uninterrupted period that includes an entire tax year, or
A U.S. citizen or a U.S. resident alien who is physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.
U.S. tax law does not specifically require a foreign resident visa or work visa for this purpose, but you should comply with the other country's laws.
Q I live in a foreign country. How do I get a social security number for my dependent who qualifies for a social security card?
A Use Form SS-5-FS which may be obtained from and filed with the Social Security Administration.
Q Under my visa as a temporary nonresident alien, I'm not subject to social security and Medicare withholding. My employer withheld the taxes from my pay. What should I do to get a refund of my social security and Medicare?
A Under my visa as a temporary nonresident alien, I'm not subject to social security and Medicare withholding. My employer withheld the taxes from my pay. What should I do to get a refund of my social security and Medicare?
Answer: If social security tax and Medicare were withheld in error from pay received that was not subject to the taxes, you must first contact the employer for reimbursement.
If you are unable to get a refund from the employer, file a claim for refund with the Internal Revenue Service on Form 843 (PDF), Claim for Refund and Request for Abatement.
You must attach the following to your claim:
A copy of your Form W-2 (PDF), Wage and Tax Statement, to prove the amount of tax withheld;
A copy of your valid entry visa;
Copies of the pay stubs that cover the period of exemption from social security taxes if your visa status changed during the tax year;
A copy of INS Form I-94, Arrival/Departure Record if you are still in the United States;
A copy of Form I-20 if you have a F-1 visa;
A copy of Form DS-2019 if you have a J-1 visa;
Form I-766 or Form I-688B if you are engaged in optical practical training, and
Form 8316, Information Regarding Request for Refund of Social Security Tax, a statement from your employer containing identical information, or a signed statement stating that you have requested a refund from the employer and have not been able to obtain one.
Processing of your claim may be delayed if you submit it less than six weeks after you filed Form 1040NR (PDF) or Form 1040NR-EZ (PDF).
Q Are nonresident alien students, with F-1 or J-1 visas and employed by a U.S. company during the summer, required to have federal income taxes withheld from their paychecks?
A Wages and other compensation paid to a nonresident alien for services performed as an employee:
Are usually subject to graduated withholding at the same rates as resident aliens and U.S. citizens.
Is subject to graduated withholding unless it is specifically excluded from the term "wages" by law, or is exempt from tax by treaty.
Nonresident aliens must follow modified instructions when completing Form W-4 (PDF). Please refer to Publication 519, U.S. Tax Guide for Aliens, for directions on completing Form W-4 (PDF), Employee's Withholding Allowance Certificate.
Q How do I deduct the administration expenses of my father's estate?
A Expenses of administering an estate can be deducted either from the gross estate in figuring the federal estate tax on Form 706 (PDF), United States Estate (and Generation-Skipping Transfer) Tax Return, or from the estate's gross income in figuring the estate's income tax on Form 1041 (PDF), U.S. Income Tax Return for Estates and Trusts.
However, these expenses cannot be claimed for both estate tax and income tax purposes.
In most cases this rule also applies to expenses incurred in the sales of property by the estate. For more information, refer to Publication 559, Survivors, Executors, and Administrators, designed to help those in charge of the property (estate) of an individual who has died. Also, refer to to Publication 950, Introduction to Estate and Gift Taxes.
In general, administration expenses deductible in figuring the estate tax include: fees paid to the fiduciary for administering the estate; attorney, accountant, and return preparer fees; expenses incurred for the management, conservation, or maintenance of property; expenses in connection with the determination, collection, or refund of the estate's tax liability.
Q I am considering a tax shelter investment. How can I recognize an abusive tax shelter?
A The IRS allows some tax shelters, but will not allow a shelter which is "abusive."
Tax shelters reduce current tax liability by offsetting income from one source with losses or deductions from another source.
An abusive tax shelter:
Generally offers inflated tax savings which are disproportionately greater than your actual investment placed at risk. Generally, you invest money to generate income but an abusive tax shelter generates little or no income.
Exists solely to reduce taxes unreasonably for tax avoidance or evasion. In comparison, a legitimate tax shelter often produces income and involves a risk of loss proportionate to the investment.
Is often marketed in terms of how much you can write off in relation to how much you invest. A series of tax laws have been designed to halt abusive tax shelters.
There is current information on irs.gov covering abusive tax shelters including:
Notice 2007-57 which covers Loss Importation Transaction
The American Jobs Creation Act of 2004 which contains many provisions that will affect abusive tax shelters
Information on “listed transactions” which gives information on 30 transactions which have been identified as tax avoidance transactions
The Office of Tax Shelter Analysis
Q The IRS corrected my return and sent me an additional refund. Does this mean I am also entitled to an additional refund on my state tax return?
A Whether you are entitled to an additional state tax refund depends on the nature of the change which was made to your federal return. For example, if you used the wrong line on the tax tables to figure your tax on your Federal tax return, this may not have an impact on your state tax return. If, however, the change was made to the amount of your taxable income, it may have an impact on your state tax return.
Q How do I calculate the minimum amount that must be withdrawn from my IRA after age 70 1/2?
A Chapter 1 of Publication 590, Individual Retirement Arrangements (IRAs), gives a complete explanation of how to calculate this amount.
The minimum distribution is computed by dividing the IRA account balance at the close of business December 31 of the preceding year by the life expectancy.
The life expectancy is determined by using one of three tables found in Publication 590.
Table I is used by beneficiaries when there is a sole owner.
Table II is for use by owners who have spouses who are more than 10 years younger.
Table III is generally for use by unmarried owners and owners who have spouses who are not more than 10 years younger and owners whose spouses are not sole beneficiaries.
Q How long do I have to roll over a distribution from a retirement plan to an IRA account?
A You must complete the rollover by the 60th day following the day on which you receive the distribution. (This 60-day period is extended for the period during which the distribution is in a frozen deposit in a financial institution.
A written explanation of rollover must be given to you by the issuer making the distribution.
The IRS may waive the 60-day requirement in certain situations, such as in the event of a casualty, disaster, or other event beyond your reasonable control.
To obtain a waiver in most cases, a request for a ruling must be made including the applicable user fee.
Q If I can't withdraw funds penalty free from my 401(k) plan to purchase my first home, can I roll it over into an IRA and then withdraw that money to use as my down payment?
A You can roll funds from a 401(k) to an IRA to be able to take a penalty free distribution to purchase your first home if:
You are receiving a distribution from a 401(k) that is eligible to roll over into an IRA
You meet all of the qualifications for an IRA distribution for a first-time homebuyer
Your plan administrator is required to notify you before making a distribution from your 401(k) plan whether that distribution is eligible to be rolled over into an IRA.
Q Do I report my nondeductible Roth IRA contributions on Form 8606?
A There are no forms to report a Roth contribution.
The financial institution, which is the trustee of your Roth IRA, will send you and the Internal Revenue Service information on the amount in your Roth IRA.
Use Form 8606 (PDF), Nondeductible IRAs, if you made a nondeductible contribution:
To a traditional IRA
Converted from a traditional IRA, a SEP, or Simple IRA to a Roth IRA
Received a distribution from a traditional IRA, a SEP, or a Simple IRA and made Nondeductible contributions to a traditional IRA
Received a distribution from a Roth or traditional IRA
Q Can a person make a contribution to a SEP-IRA and a Roth IRA, too?
A You can make a contribution to a SEP-IRA and a Roth IRA.
However, neither a SEP IRA or a SIMPLE IRA can be designated as a Roth IRA.
Your SEP IRA contribution and Roth IRA contribution can not be made to the same IRA.
If you have both a Roth IRA and a SEP IRA, it can affect the contribution limits.
See Chapter 2 of Publication 590, Individual Retirement Arrangements (IRAs), for the requirements to contribute to a SEP and a Roth IRA.
Q I want to establish a traditional individual retirement arrangement (IRA) for my spouse, and I need additional information. What is the most I can contribute to a spousal IRA during the tax year?
A If both you and your spouse work and both have taxable compensation, each of you can contribute to a separate traditional IRA.
The amount that you can contribute to each IRA is subject to a limit that can be found in Publication 590.
Contributions can be made even if one spouse has little or no compensation, if you file a joint return.
Your total contribution to both your IRA and the spousal IRA for this year is limited by certain factors such as your taxable compensation, contributions to a traditional or Roth IRA and your age