IRS begins 401(k) compliance check questionnaire

 401(k) plans represent the most preferred vehicle for retirement savings today - making up more than 60 percent of retirement plans, according to the IRS. However, 401(k) plans are also the most non-compliant type of retirement plan as well, according to a study by IRS Employee Plans Examinations. In light of the popularity and non-compliance of 401(k) plans, the IRS has launched a 401(k) “Compliance Check Questionnaire Project.”

The objective of the repost is to identify the areas where additional education, guidance, and outreach regarding 401(k) compliance are needed. The responses will also enable the IRS to determine where the agency needs to focus its enforcement efforts in order to address non-compliance related to the plans. Although the IRS has indicated that the questionnaire is not an audit or an investigation of the plans selected to complete the questionnaire, the agency has indicated that a plan sponsor’s failure to respond may result in further enforcement action.

Random sample

As part of the project, the IRS has randomly selected 1,200 401(k) plans from among plans that filed a Form 5500 for the 2007 plan year. These plans will receive a letter from the IRS with instructions to complete the 401(k) questionnaire using a website established for this purpose, or mailing the questionnaire back to the IRS. Recipients of the questionnaire have 90 days to complete and return the questionnaire. If a plan sponsor receives a letter to complete the questionnaire, they must follow the instructions included in the letter. Plan sponsors that wish to complete the questionnaire on-line will receive personal identification numbers and other information needed to create an on-line profile for purposes of providing the information on-line.

Categories

The questionnaire includes the following categories:

• Demographics;
• 401(k) plan participation;
• Employer and employee contributions;
• Top heavy and nondiscrimination rules;
• Distributions and plan loans;
• Other plan operations;
• Automatic contribution arrangements;
• Designated Roth features;
• IRS voluntary compliance programs; and
• Plan administration.

FAQ: What constitutes income from the cancellation of debt?

FAQ: What constitutes income from the cancellation of debt?   Debt that a borrower no longer is liable for because it is discharged by the lender can give rise to taxable income to the borrower. Debt forgiveness income or cancellation of debt income (”COD” income) is the amount of debt that a lender has discharged or canceled. However, in many situations, the canceled debt is excluded from taxable income.Credit cards, car loans and mortgage debt are three of the most common consumer debts, yet many individuals don’t know the tax rules surrounding discharges of these debts by lenders. In general, almost all types of discharged debt will be includable in the borrower’s taxable income, unless a specific exclusion applies. The creditor will generally report COD income to the IRS and to the debtor, using Form 1099-C, Cancellation of Debt, even if an exclusion applies. The creditor may not be aware that the debtor can exclude the COD income. We can help you determine whether an exclusion applies. Exclusions and reduction of attributes There are four situations where cancelled debt does not result in taxable income: 1. The debt has been discharged through a bankruptcy proceeding under Title 11; 2. Insolvency (your total debts exceed your total assets); 3. The debt is due to a qualified farm expense (”qualified farm indebtedness”); and 4. The debt is due to certain real property business losses (”qualified real property business indebtedness”). When canceled debt is excluded from income, the debtor may be required to reduce tax attributes, such as a net capital loss or the basis of property. The reduction of attributes must be reported on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attached to your federal income tax return. Other exclusions may apply to student loans, disaster victims, gifts, general welfare payments, and payments that would have been deductible. Mortgage debt forgiveness For a limited period of time, certain mortgage debt that is discharged by the lender is excludable from COD income and therefore does not result in taxable income to homeowners. This debt is generally referred to as “qualified principal residence indebtedness.” The cancellation of qualifying mortgage debt is excludable from income if it is incurred with respect to the taxpayer’s principal residence for “acquisition” debt forgiven on or after January 1, 2007 and before January 1, 2013. Acquisition debt is indebtedness secured by the residence and incurred in the acquisition, construction or substantial improvement of the residence. Certain debt used to refinance the debt is also eligible. Debt forgiven on a second home or rental property does not qualify for the exclusion. Example. Anne’s principal residence is subject to a $300,000 mortgage debt. Anne’s creditor forecloses on the property in September 2010. Due to the depressed real estate market, Anne’s home sold for $220,000. The creditor forgives the other $80,000 of debt. Anne has COD income totaling $80,000 ($300,000 - $220,000). Credit card and car loan debt Noticeably absent from the specific exceptions to COD income are two of the biggest consumer debt items: credit cards and car loans. Credit card debt or an unpaid debt on a car loan that is forgiven by the lender is includable in gross income, unless the debtor is bankrupt or insolvent. The lender will report the amount of forgiven debt on Form 1099-C, Cancellation of Debt. Example. Michael has an outstanding credit card bill of $7,400. Michael cannot pay the total amount but reaches a compromise with his credit card company in which he settles the debt for $4,000. Assuming the debtor is not bankrupt or insolvent, the Internal Revenue Code treats him as having realized a personal net gain (and COD income) of $3,400, even though he did not actually receive any money. The credit card company will report the $3,400 as COD income on Form 1099-C, and the debtor must include it in his gross income. Reporting If you had debt discharged in 2009 that does not qualify for an exception, you must include the amount of cancelled debt in your gross income on your tax return. If you have questions about COD income, the exclusions from income, or your reporting responsibilities, please contact our office.   Â

How Do I? Report gambling, hobby and other miscellaneous taxable income?

During economic downturns, many people often look for ways to supplement their regular employment compensation. Or, you may be engaging in an activity - such as gambling or selling items on an online auction - that is actually earning you income: taxable income. Many individuals may not understand the tax consequences of, and reporting requirements for, earning these types of miscellaneous income. This article discusses how you report certain types of miscellaneous income.

Reporting your miscellaneous taxable income

For most people, gambling winnings and hobby income are uncommon types of taxable income. Gambling winnings and hobby income, as well as prizes and awards, represent “miscellaneous income” and are reported on Line 21 of your Form 1040 as “other income.”

Hobby income

Hobbies are generally considered under the tax law as activities that are not pursued “for profit.” However, the tax law provides that if your hobby shows a profit in at least three of the last five tax years, including the current year, you are assumed to be trying to make money. However, you can rebut the assumption — that you are not out to run a profitable business even if you regularly have losses — with evidence to the contrary. Just because you love what you are doing in a sideline business does not mean it’s a hobby for tax law purposes. In fact, one secret to business success is often enjoying your work. Profits you receive from an activity that is a hobby and not a for-profit business are reported as “other income” on Line 21 of your Form 1040.

Hobby losses and expenses

You cannot deduct your hobby expenses in excess of income you derived from the hobby, and you can only deduct qualifying expenses if you itemize your deductions. Expenses that you incurred in generating hobby income are generally deductible as miscellaneous itemized deductions, subject to the two-percent floor, on Schedule A. If you incurred losses in connection with your hobby activities, you may generally be able to deduct these “hobby losses” but only to the extent of income produced by the activity.

However, some expenses that are deductible whether or not they are incurred in connection with a hobby (such as taxes, interest and casualty losses) are deductible even if they exceed hobby income. These expenses, however, will reduce the amount of your hobby income against which your hobby expenses can be offset. Your hobby expenses then offset the reduced income in the following order:

1. Operating expenses, generally;

2. Depreciation and other basis adjustment items.

As mentioned above, your itemized deduction for hobby expenses is subject to the two-percent floor on miscellaneous itemized deductions.

Gambling winnings

Gambling winnings, whether legal or illegal, are included in your gross income. If you have winnings from a lottery, raffle, or other types of gambling activities, you must report the full amount of your winnings on Line 21 of your Form 1040 as “other income.” The taxable gains are the amount by which your winnings exceed the amount you wagered. If any taxes were withheld from your winnings, you should receive a Form W-2G showing the total paid to you in Box 1, and the amount of income taxes withheld in Box 2. You need to include the amount in Box 2 in the amount of taxes paid on Line 59 of your 1040.

Gambling losses

You can deduct your gambling losses as an itemized deduction for the year on Schedule A (Form 1040), line 28. However, you cannot deduct gambling losses that exceed your winnings. Thus, you can deduct losses from gambling up to the amount of your gambling winnings. You cannot reduce your gambling winnings by your gambling losses and report the difference. You must report the full amount of your winnings as income and claim your losses (up to the amount of winnings) as an itemized deduction. Therefore, your records should show your winnings separately from your losses.

You can reduce your gambling winnings by your wagering losses regardless of whether the underlying transactions are legal or illegal. Moreover, gambling losses may be offset against all gains arising out of wagering transactions, and not merely against gambling winnings. However, gambling losses can only be used to offset gambling gains during the same year.

Moreover, you cannot use your gambling losses to reduce taxable income from non-gambling sources, and they cannot be used as a carryover or carryback to reduce gambling income from other years. For example, the value of complimentary goods you might receive from a casino as an inducement to gamble are gains from which gambling losses can be deducted.

Casinos, lotteries and other payers of gambling winnings of $600 or more ($1,200 for bingo or slot machines and $1,500 for keno) report the winnings on Form W-2G, Certain Gambling Winnings.

If you have any questions about tax and reporting requirements in connection with hobby activities and other sources of income, please call our office.

Claiming losses on individual retirement accounts

A consequence of the economic downturn for many investors has been significant losses on their investments in retirement accounts, including traditional and Roth individual retirement accounts (IRAs). This article discusses when and how taxpayers can deduct losses suffered in Roth IRAs and traditional IRAs …and when no deduction will be allowed.

Traditional IRAs

Losses on investments held in a traditional IRA, funded only by contributions that you deducted when you made them, are never deductible. Even when you cash out the IRA after retirement, losses cannot be deducted. The theory behind this rule is that you already received a tax benefit in your deduction for making contributions and any loss lowers the amount of taxable income you must realize when you make retirement withdrawals. The technical explanation is that you are presumed to have a zero basis in your account.

On the other hand, if you make nondeductible traditional IRA contributions, and liquidate all of the investments in your traditional IRA, a loss can be recognized if the amounts distributed are less than the remaining unrecovered basis in the traditional IRA. You claim a loss in a traditional IRA on Schedule A, Form 1040, as a miscellaneous itemized deduction subject to the two percent AGI floor.

Example. During 2008, you made $2,000 in nondeductible contributions to a traditional IRA. Your basis in the IRA at the end of 2008 is $2,000. During 2008, the IRA earned $400 in dividend income and you withdrew $600 from the account. As a result, at the end of 2008 the value of your IRA was $1,800 ($2,000 contributed plus $400 dividends minus $600 withdrawal). You compute and report the taxable portion of your $600 withdrawal and your remaining basis on Form 8606, Nondeductible IRA.

In 2009, the year you retired, your IRA lost $500 in value. At the end of 2009, your IRA balance was $1,300 ($1,800 balance at the end of 2008 minus the $500 loss). Your remaining basis at that time in your IRA is $1,500 ($2,000 nondeductible contributions minus the $500 basis in the prior withdrawal). You withdraw the $1,300 balance remaining in the IRA. You can claim a loss of $200 (your $1,500 basis minus the $1,300 withdrawn) on Form 1040, Schedule A. The allowable loss is further subject to the two percent adjusted gross income (AGI) floor on miscellaneous itemized deductions.

If you made significant nondeductible contributions to an IRA over the last few years, and may be considering withdrawing the entire balance in all of your traditional IRAs before the end of the year in order to recognize a loss, keep in mind doing so will mean losing the opportunity to defer gain if the value of your investments in the accounts increases. Those withdrawn amounts cannot be recontributed at a later date.

Roth IRA losses

When you experience losses on Roth IRA investments, you can only recognize the loss for income tax purposes, if and when all the amounts in the Roth IRA accounts have been distributed and the total distributions are less than your basis (e.g. regular and conversion contributions).

To report a loss in a Roth IRA, all the investments held in your Roth IRA (but not traditional IRAs) must be liquidated. Moreover, the loss is an ordinary loss for income tax purposes, not a capital loss, and can only be claimed as a miscellaneous itemized deduction subject to the two percent of AGI floor that applies to miscellaneous itemized deductions on Form 1040, Schedule A.

Since all Roth IRAs must be completely liquidated to generate a loss deduction, it generally provides only a small comfort to investments gone sour. Closing all your Roth IRAs generally forgoes future appreciation on that amount.

If you are considering liquidating your Roth IRA or traditional IRA to take the loss, please contact our office and we can discuss the tax and financial consequences before finalizing any plans.

How Do I? Qualify for and claim the saver’s credit?

The saver’s credit is a retirement savings tax credit that can save eligible individuals up to $1,000 in taxes just for contributing up to $2,000 to their retirement account. The saver’s credit is an additional tax benefit on top of any other benefits available for your retirement contribution. It is a nonrefundable personal credit. Therefore, like other nonrefundable credits, it can be claimed against your combined regular tax liability and alternative minimum tax (AMT) liability.

Who qualifies for the saver’s credit

To qualify for the credit, you must be 18 years old (as of the close of the tax year of the contribution), not a full-time student, and not claimed as a dependent on another’s return. The calculation of the credit amount depends on a percentage of your adjusted gross income (AGI).

The credit can be claimed for contributions or deferrals made to a number of retirement plans, including: traditional and Roth IRAs (other then rollover contributions), voluntary “after-tax” employee contributions to Section 403(b) annuities and qualified retirement plans, qualified cash or deferred arrangements, including elective contributions made to 401(k) plans, tax sheltered annuities, SIMPLE plans, simplified employee pensions (SEPs), and eligible deferred compensation plans of governmental employers.

Determining your credit amount

IRS Form 8880, Credit for Qualified Retirement Savings Contributions, is used to calculate the amount of the saver’s credit, which is then reported on Line 51 of Form 1040. The credit is determined as a percentage of your “qualifying contribution.” A taxpayer’s qualifying contribution is limited to $2,000 per year. The percent varies depending on your adjusted gross income (AGI).

For 2009, the credit is 50 percent of the maximum $2,000 ceiling for married couples filing jointly with a combined AGI of $33,000 or less. For example, if each spouse makes the maximum $2,000 contribution for the credit, for a total of $4,000, they can claim a total saver’s credit of $2,000 ($4,000 x 50 percent) on their joint return). If AGI for 2009 is above $33,000 but not over $36,000, the credit is 20 percent of qualifying contributions ($800 in the above example: $4,000 x 20 percent). If AGI for 2009 is above $36,000 but not over $55,500, the credit is 10 percent of qualifying contributions.

For single taxpayers, if AGI for 2009 is $16,500 or less, the percentage is 50 percent. If AGI for 2009 is above $16,500 but not over $18,000, the credit is 20 percent of qualifying contributions. If AGI for 2009 is above $18,000 but not over $27,750, the credit is 10 percent of qualifying contributions. For 2009, the credit is phased out when AGI exceeds $55,000 for joint return filers, $41,625 for heads of households, and $27,750 for single and married filing separately.

Contribution reductions

The amount of contributions to be taken into account in determining the credit, however, must be reduced by any distributions from such qualified retirement plans over a “test period.” The test period includes the current tax year, two preceding tax years, and the following tax year up to the due date of the return including extensions. A qualifying contribution is also reduced by nontaxable distributions received from Roth IRAs during the testing period (unless you roll them over). The contribution reduction rule even applies to “special” distributions, such as those taken to pay first-time homebuyer expenses or higher education costs.

Exceptions apply for certain distributions, such as trustee-to-trustee transfers or rollover distributions to other qualified retirement accounts (for example, a rollover from a traditional IRA to a Roth IRA).

Example. Jenny contributes $2,500 to her 401(k) during Year 4, but took a $1,000 taxable IRA withdrawal during Year 2. Her qualifying contribution for purposes of computing her saver’s credit for Year 4 is $1,500 ($2,500-$1,000).

The saver’s credit is available in addition to other benefits you receive contributing to a retirement plan. For example, if you make a $1,000 deductible contribution to a traditional IRA, you may also qualify to take the saver’s credit for that contribution. In fact, since your deduction for the IRA contribution reduces AGI, you may even qualify for a higher credit percentage.

Determining the amount of the saver’s credit can be complex but very rewarding if you or a family member qualifies. Please call our office if you have questions about the credit.

How Do I? Calculate per diem travel expenses under the ‘high-low’ method

Employers commonly use per-diem allowance arrangements to reimburse employees for business expenses incurred while traveling away from home on business. Each year, the IRS publishes per-diem rates for travel within the continental U.S. The per-diem rates for meals, lodging and incidental expenses can be used instead of using your actual expenses. There are two approved methods for substantiating your per-diem expenses, including the “high-low” method (found in IRS Publication 1542). This article is intended to help you calculate your per-diem travel expenses under the “high-low” method.

What is required under a per-diem plan?

Per diems require only that your employee substantiate the time, place, and business purpose of these expenses. When you use the “high-low” method for calculating the per-diem rate allowance, your expenses under this method will be deemed substantiated as long as it does not exceed IRS-established federal per diem rates for two categories:

1. Lodging; and

2. Meals.

The federal per-diem rates for these two categories are listed in IRS Publication 1542.

The high-low method

As mentioned, one of the two approved methods for using the per-diem rates is the “high-low” method. The high-low method is a simplified method for figuring your lodging, meals and incidental expenses. This method requires employers to use only two per-diem rates to reimburse employee travel expenses–one for high-cost locations and one for low-cost locations. For 2009, the per-diem rate for travel to a “high-cost” locality is $296 ($198 for lodging and $58 for meals and incidental expenses). The 2009 per-diem rate for travel to “low-cost” areas is $158 ($113 for lodging and $45 for meals and incidental expenses).

Under the high-low method, there are a significant number of localities (published n Publication 1542) that qualify for a “high” 2009 per diem rate of $296. Any locality not listed as “high” is automatically considered “low cost” and qualifies for a per diem rate of $158. The federal per-diem rates are deemed substantiated as long as they do not exceed the high or low cost set by the IRS for the area.

How Do I? Compute the reduction of my itemized deductions under the Pease limitation?

For 2009, higher-income individuals whose adjusted gross income (AGI) exceeds a threshold level must reduce the amount of their otherwise allowable itemized deductions. This limitation is often referred to as the “Pease limitation.” The Pease limitation applies only to individuals; it does not apply to estates or trusts. The phase-out for itemized deductions for higher income individuals is scheduled to disappear completely after 2009. It has been gradually phasing out since 2006 in anticipation of total elimination in 2010, unless Congress acts to reinstate it. This article will help you determine how much you must reduce your itemized deductions if your adjusted gross income is high enough to subject you to the Pease limit.

Adjusted gross income limits

For tax years beginning in 2009, the phase-out for itemized deductions begins when AGI exceeds $166,800 for married taxpayers filing jointly, single taxpayers, and heads of household, and $83,400 for married taxpayers filing separately. Thus, for 2009, higher-income individuals whose AGI exceeds these threshold levels must reduce the amount of otherwise allowable itemized deductions.

Percentage reduction

Under the Pease limitation, itemized deductions that would otherwise be allowable are reduced for 2009 by the lesser of:

• 3 percent of the amount by which your AGI exceeds $166,800 (or $83,400 if married filing separately); or
• 80 percent of the itemized deductions otherwise allowable for the tax year.

Itemized deductions

For 2009, itemized deductions that are not included for purposes of the phase-out include deductions for:

• Medical expenses;
• Investment interest expenses;
• Casualty or theft losses;
• Allowable wagering losses; and
• Qualified charitable donations.

However, the common itemized deductions for state and local sales tax, income tax, and real property tax, home mortgage interest, and job expenses are included.

Computing your reduction in itemized deductions

When computing the amount of the reduction of total itemized deductions, all other limits applicable to those deductions, such as the 2 percent floor for miscellaneous itemized deductions, are applied first. Then, the otherwise allowable total amount of deductions is reduced under the Pease limit provision.

Higher-income individuals should do two sets of computations to arrive at the reduction of the itemized deductions under the Pease limit. First, compute the regular limit on your itemized deductions. Next, compute the part of the limit that will apply for the 2009 tax year in particular (since the repeal of the limit is phased-in).

As such, after your regular limit is determined, you must take the added step and multiply the limit by one-third (for 2009). This resulting fractional amount of the limit is the amount by which your otherwise allowable itemized deductions must be reduced.

Example

Mike and Jane are married taxpayers who file a joint return. In 2009, they have adjusted gross income of $254,050. Their itemized deductions total $20,000, and are attributable to state and local property taxes, state and local income taxes, tax return preparation fees, and unreimbursed employee business expenses. Because of the phase-out, they must reduce their itemized deduction. They start by comparing two amounts:

1. Their AGI minus the 2009 threshold amount, with the result multiplied by 3 percent ($254,050 - $166,800 = $87,250; $87,250 x .03 = $2,617.50); and
2. 80 percent of their otherwise allowable deduction (.80 x $20,000 = $16,000).

Since $2,617.50 is less than $16,000, the initial amount of the reduction is $2,617.50.

The second big step is for Mike and Jane to reduce the amount of their reduction ($2,617.50) by two-thirds ($1,745), which equals $872.50. Thus, $19,127.50 ($20,000 - $872.50) is the amount they get to actually deduct.

Caution. Although the Pease limitation is set to be completely repealed after 2009, the Obama administration has signaled its support for reinstating the itemized deduction limit for individuals making over $200,000 and families with incomes above $250,000. However, many lawmakers are very weary about imposing limits on the ability of higher income individuals to take certain deductions, such as charitable contribution deductions. With the fate of the Pease limit still up in the air, keep your pencils sharpened and ready for anything come 2010.

How Do I? Calculate carryover capital losses

While the past year has not been stellar for most investors, the tax law in many instances can step in to help salvage some of your losses by offsetting both present and future taxable gains and other income. Knowing how net capital gains and losses are computed, and how carryover capital losses may be used to maximum tax advantage, should form an important part of an investor’s portfolio management program during these challenging times.

Net capital losses

Capital assets yield short-term gains or losses if the holding period is one year or less, and long-term gains or losses if the holding period exceeds one year. The excess of net long-term gains over net short-term losses is net capital gain.

Short-term capital losses, including short-term capital loss carryovers, are applied first against short-term capital gains. If the losses exceed the gains the net short-term capital loss is applied first against any net long-term capital gain from the 28-percent group (collectibles), then against the 25-percent group (recapture property), and last against the 15- (or zero) percent group. Long-term capital losses are similarly netted and then applied against the most highly taxed net gains that a taxpayer has.

If an investor’s capital losses exceed capital gains for the year, he or she may offset losses against ordinary income to the extent of the lesser of: the excess capital loss; or $3,000 ($1,500 for married persons filing separate returns). Although several bills have been introduced to raise these dollar levels, which have not been adjusted for inflation for decades, none has yet to see the light of day.

Carryovers

Individuals may carry net capital losses to future tax years but not back to prior years. There is no limit on the number of years to which net capital losses may be carried over as there is with corporate taxpayers. Short-term and long-term capital losses are carried forward and retain their character. Capital loss carryovers that originate in several years are applied in the order in which incurred.

Dividend offsets. While qualified dividends are taxed at the net capital gains rate, they do not take part in the general computation of net capital gains and, therefore, are not reduced by capital losses, either in the same year or in carried forward years. Although your overall portfolio may have experienced a loss for the year, you must still pay tax on your dividend income.

If you need any advice on how to structure your portfolio over the next year to take advantage of current losses while protecting future gains from as much income tax as possible, please do not hesitate to call this office.

How Do I? Calculate the recovery rebate credit?

If you did not receive a full economic stimulus check in 2008 or your circumstances changed in such a way that you now qualify for the full payment, you may be entitled to receive a Recovery Rebate Credit (RRC). The RRC is a one-time tax credit allowed to be taken by qualifying individuals who received only a partial stimulus payment last year or no payment at all. The RRC is calculated in the same way as the 2008 economic stimulus payment except that your 2008 income tax information (as opposed to your 2007 tax information) is used to determine the amount of the RRC.

Who can claim the RRC?

You may be able to claim the RRC if:

• You did not receive an economic stimulus payment at all in 2008;
• Your financial situation has significantly changed since last year (for example, you lost your job, started a new job that pays less, or had children);
• You received less than the maximum payment in 2008 ($600 for individuals and $1,200 for joint filers) because your 2007 gross income was either too high or too low;
• You had an additional qualifying child in 2008;
• You could be claimed as a dependent on someone else’s tax return in 2007, but you cannot be claimed as a dependent on someone else’s return in 2008; or
• You did not have a valid Social Security number (SSN) in 2007 but you received one in 2008.

Amount

The RRC is worth up to $600 for individuals with an adjusted gross income (AGI) of up to $75,000 and $1,200 for couples filing joint returns with an AGI of up to $150,000. An additional credit is available of up to $300 per qualifying child. For taxpayers without children, the maximum payment is fully phased out at $87,000 (and at $174,000 for joint filers). Individuals with an AGI of more than $87,000 and joint filers with an AGI of more $174,000 are not eligible for the tax rebate.

Figuring the credit

The RRC is calculated in the same way as last year’s economic stimulus payment, except that you will use your 2008 tax information to determine the credit amount. Any payment amount that you are now eligible for will not be issued as a separate payment, but will be included in any refund you receivefor the 2008 tax year. Your recovery rebate credit is reduced by any economic stimulus payment that you received in 2008. The RRC is claimed on Form 1040, 1040A, or 1040EZ. The RRC is refundable, which means that even those individuals who have income low enough that they are not required to file a 2008 return should file one to get the credit payment.

We can help determine if you qualify for the recovery rebate credit and if so, how much your credit will be. Please contact our office if you would like more information about the recovery rebate credit.

How do I? Calculate ‘luxury auto’ depreciation?

The term “luxury auto” for federal tax purposes is somewhat of a misnomer. The IRS’s definition of “luxury auto” is likely not the same as your definition.

The IRS limits the amount of depreciation that may be claimed on a passenger automobile used for business. These limits are popularly referred to as the “luxury car rules.” Taxpayers who use the IRS standard business mileage rate (which is 55 cents-per-mile in 2009) do not have to worry about the depreciation allowance because the cents-per-mile rate includes depreciation.

MACRS

Taxpayers who choose to take a depreciation deduction for their vehicles start with the regular depreciation tables under the Modified Adjusted Cost Recovery System (MACRS). The vehicle must be used 50 percent or more for business purposes. The cost of a vehicle is depreciated over six years. In Year 1, 20 percent is depreciable; 32 percent in Year 2; 19.2 percent in Year 3; 11.52 percent in Years 4 and 5; and 5.76 percent in Year 6.

Dollar limits

Under Code Sec. 280F, annual dollar limits apply to “luxury autos.” The applicable set of annual dollar amount limits depends on the date on which the vehicle is placed in service. The dollar limits are adjusted for inflation annually.

The annual maximum depreciation amounts for passenger automobiles first placed in service in calendar year 2009 are:

 

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  • $2,960 for the first tax year;
  • $4,800 for the second tax year;
  • $2,850 for the third tax year; and
  • $1,775 for each tax year thereafter.

 

Bonus depreciation

In 2008, Congress authorized bonus depreciation as part of the Economic Stimulus Act of 2008. Fifty percent bonus depreciation applied in 2008 to vehicles unless the taxpayer elected out of it. This resulted in higher dollar limits ($8,000 if bonus depreciation was claimed for a qualifying vehicle placed in service in 2008, for a maximum first-year depreciation of no more than $10,960 for autos). Congress may extend bonus depreciation into 2009.