Quickfinder - Thomson Reuters · Quickfinder ® 1040 Quickfinder® Handbook (2012 Tax Year) Updates...

Quickfinder ®

1040 Quickfinder® Handbook(2012 Tax Year)

Updates for the American Taxpayer Relief Act of 2012

Replacement Pages for Two-Sided (Duplex) Printing

Instructions: This packet contains “marked up” changes to the pages in the 1040 Quickfinder® Handbook that were affected by the American Taxpayer Relief Act of 2012, which was enacted after the handbook was published.

This is a specially designed update packet for owners of the 3-ring binder version of the handbook who have access to a printer that prints two-sided (duplex). Simply print the entire PDF file (make sure to select two-sided or duplex printing), three-hole punch the pages, and then replace the pages in your handbook. It’s that easy.

2012 Tax Year | 1040 Quickfinder® Handbook Cover-1Replacement Page 01/2013

TAX PREPARATION

2012 Key AmountsStandard Deduction Earned Income Credit (Maximum)

MFJ or QW1 ........................ $ 11,900 No children ............................ $ 475Single2 ................................ 5,950 1 child .................................... 3,169HOH2 .................................. 8,700 2 children ............................... 5,236MFS1 ................................... 5,950 >2 children ............................. 5,891Dependent2 ......................... 9503 Investment income limit ......... 3,200

Personal Exemption Kiddie Tax Threshold$3,800 $1,900

Gift Tax Annual Exclusion Elective Deferral Limits$13,000 SIMPLE IRA Plan

Estate and Gift Tax Exclusion Amount < age 50 ................................ $ 11,500$5,120,000 ≥ age 50 ................................ 14,000

Standard Mileage Rates401(k), 403(b) and 457 PlansBusiness ............................. 55.5¢

Medical/moving ................... 23¢ < age 50 ................................ $ 17,000Charitable ........................... 14¢ ≥ age 50 ................................ 22,500

Profit-Sharing Plan/SEPContribution limit ....................................................................................... $ 50,000Compensation limit4 .................................................................................. $250,000

Health Savings Accounts (HSAs)Self-only coverage Contribution (deduction) limit ................... $ 3,100

Plan minimum deductible ........................ 1,200Plan out-of-pocket limit ............................ 6,050

Family coverage Contribution (deduction) limit ................... $ 6,250Plan minimum deductible ........................ 2,400Plan out-of-pocket limit ............................ 12,100

Additional contribution amount if age 55 or older ..................................... $ 1,0001 Add $1,150 for age 65 or older or blind, each.2 Add $1,450 for age 65 or older or blind, each.3 If greater, amount of earned income plus $300 (but not to exceed $5,950).4 For computing employer contributions.

Form 10402012 Tax Year

10402012 Quick Tax Method1

MFJ or QW Taxable Income$ 0 – $ 17,400 × 10% minus $ 0.00 = Tax

17,401 – 70,700 × 15 minus 870.00 = Tax70,701 – 142,700 × 25 minus 7,940.00 = Tax

142,701 – 217,450 × 28 minus 12,221.00 = Tax217,451 – 388,350 × 33 minus 23,093.50 = Tax388,351 and over × 35 minus 30,860.50 = Tax

Single Taxable Income$ 0 – $ 8,700 × 10% minus $ 0.00 = Tax

8,701 – 35,350 × 15 minus 435.00 = Tax35,351 – 85,650 × 25 minus 3,970.00 = Tax85,651 – 178,650 × 28 minus 6,539.50 = Tax

178,651 – 388,350 × 33 minus 15,472.00 = Tax388,351 and over × 35 minus 23,239.00 = Tax

HOH Taxable Income$ 0 – $ 12,400 × 10% minus $ 0.00 = Tax

12,401 – 47,350 × 15 minus 620.00 = Tax47,351 – 122,300 × 25 minus 5,355.00 = Tax

122,301 – 198,050 × 28 minus 9,024.00 = Tax198,051 – 388,350 × 33 minus 18,926.50 = Tax388,351 and over × 35 minus 26,693.50 = Tax

MFS Taxable Income$ 0 – $ 8,700 × 10% minus $ 0.00 = Tax

8,701 – 35,350 × 15 minus 435.00 = Tax35,351 – 71,350 × 25 minus 3,970.00 = Tax71,351 – 108,725 × 28 minus 6,110.50 = Tax

108,726 – 194,175 × 33 minus 11,546.75 = Tax194,176 and over × 35 minus 15,430.25 = Tax

1 Assumes taxable income is all ordinary income. Multiply taxable income by the applicable tax rate and subtract the amount shown.

Caution: IRS Tax Tables must be used for taxable income under $100,000. To calculate the exact tax using the Quick Tax Method for taxable income under $100,000, round taxable income to the nearest $25 or $75 increment before using the formula. Round $50 or $100 increments up.

Quickfinder Handbook

®

2012 AGI Phase-Out Amounts/RangesFiling Status

Tuition and Fees Deduction1

Student Loan Interest Deduction

Education Savings Bond Interest Exclusion

Lifetime Learning Credit

American Opportunity Credit

Education Savings Account (ESA)

MFJ $130,000 / $160,000 $125,000 – $155,000 $109,250 – $139,250 $104,000 – $124,000 $160,000 – $180,000 $190,000 – $220,000QW 65,000 / 80,000 60,000 – 75,000 109,250 – 139,250 52,000 – 62,000 80,000 – 90,000 95,000 – 110,000

Single 65,000 / 80,000 60,000 – 75,000 72,850 – 87,850 52,000 – 62,000 80,000 – 90,000 95,000 – 110,000HOH 65,000 / 80,000 60,000 – 75,000 72,850 – 87,850 52,000 – 62,000 80,000 – 90,000 95,000 – 110,000MFS Do Not Qualify Do Not Qualify Do Not Qualify Do Not Qualify Do Not Qualify 95,000 – 110,000

Child Tax Credit 2

Saver’s Credit 3

Earned Income Credit3 Traditional IRA Deduction4 Roth IRA Contribution Passive Loss in Active

Rental Real EstateNo Child 1 Child 2 Children >2 ChildrenMFJ $ 110,000 $ 57,500 $ 19,190 $ 42,130 $ 47,162 $ 50,270 $ 92,000 – $112,000 $173,000 – $183,000 $100,000 – $150,000QW 75,000 28,750 13,980 36,920 41,952 45,060 92,000 – 112,000 173,000 – 183,000 100,000 – 150,000

Single 75,000 28,750 13,980 36,920 41,952 45,060 58,000 – 68,000 110,000 – 125,000 100,000 – 150,000HOH 75,000 43,125 13,980 36,920 41,952 45,060 58,000 – 68,000 110,000 – 125,000 100,000 – 150,000MFS 55,000 28,750 Do Not Qualify 05– 10,000 05– 10,000 50,000 – 75,000

1 Caution: Deduction expired 12/31/11, but has been reinstated in the past. Amounts shown are thresholds for $4,000 and $2,000 deduction, respectively.

2 Amount at which phase-out begins.3 Amount at which phase-out is complete.4 Phase-out only applies if taxpayer is covered by an employer retirement plan. For MFJ, phase-out range for non-covered spouse is

$173,000–$183,000.5 Married individuals filing MFS who live apart at all times during the year are treated as single.

Replacement Page 01/2013

1040 Quickfinder® HandbookCopyright 2012 Thomson Reuters. All Rights Reserved. ISSN 1945-3035 ISBN 978-0-7646-6222-8 PO Box 966, Fort Worth TX 76101-0966 Phone 800-510-8997 Fax 817-877-3694 Quickfinder.thomson.comThe 1040 Quickfinder® Handbook is published by Thomson Reuters. Reproduction is prohibited without written permission of the publisher. Not assignable without consent.The 1040 Quickfinder® Handbook is to be used as a first-source, quick reference to basic tax principles used in preparing individual income tax returns. The focus of this handbook is to present often-needed reference information in a concise, easy-to-use format. The summaries, highlights, tax tips and other information included herein are intended to apply to the average individual taxpayer only. Information included is general in nature and we acknowledge the existence of many exceptions in the area of income tax. The information this handbook contains has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. The author/publisher is not engaged in rendering legal, accounting or other advice and will not be held liable for any actions or suit based on this handbook. For further information regarding a specific situation, see applicable IRS publications, rulings, regulations, court cases and Code sections. This handbook is not intended to be used as your only reference source.

2013 Key AmountsTraditional IRA Deduction

Phase-Out Begins at AGI ofElective Deferral Limits

SIMPLE IRAMFJ,1 QW1 ......................... $ 95,000 < age 50 .............................. $ 12,000MFJ2 .................................. 178,000 ≥ age 50 .............................. 14,500Single1 ............................... 59,000 401(k), 403(b) and 457 PlansHOH1 ................................. 59,000 < age 50 .............................. $ 17,500MFS1 .................................. 0 ≥ age 50 .............................. 23,000

Gift Tax Annual Exclusion Kiddie Tax Threshold$14,000 $2,000

Profit-Sharing Plan/SEPContribution limit ........................................................................................ $ 51,000Compensation limit (for computing employer contributions) ...................... 255,000

Health Savings Accounts (HSAs)Self-only coverage Contribution (deduction) limit .................... $ 3,250

Plan minimum deductible ......................... 1,250Plan out-of-pocket limit ............................. 6,250

Family coverage Contribution (deduction) limit .................... $ 6,450Plan minimum deductible ......................... 2,500Plan out-of-pocket Limit ............................ 12,500

Additional contribution amount if age 55 or older ...................................... $ 1,0001 Covered by an employer retirement plan. 2 Noncovered spouse.

Tax Rules By Age for 2012Age Rule13 Cannot claim a child care credit for children age 13 or older.

17 Cannot claim $1,000 child tax credit for children age 17 or older.

18 • Children working for parents’ unincorporated business subject to FICA.• Generally cannot contribute to an ESA for children age 18 or older.• Adoption credit or exclusion generally unavailable for children age 18 or

older.• Taxpayer qualifies for saver’s credit (if neither a dependent nor student).• Kiddie tax no longer applies at age 18 (or 19–23 and full-time student) if

child’s earned income is greater than half of his support.19 Exemption for dependent children who are not full-time students expires.

21 Children working for parents’ unincorporated business subject to FUTA.

24 • Exemption for dependent children who are full-time-students expires.• Can purchase savings bonds and exclude income used for education.• Kiddie tax no longer applies.

25 Taxpayers with no children qualify for EIC.

27 Income exclusion for health insurance coverage and self-employed health insurance deduction for coverage of children age 26 and younger expires.

30 Generally must distribute ESA when beneficiary reaches age 30.

50 • Eligible for catch-up contributions to IRAs, SIMPLE-IRAs, 401(k), 403(b) and 457 plans.

• Qualified public safety employees eligible for penalty-free withdrawals from a governmental defined benefit pension plan, if retired.

55 • Eligible for penalty-free withdrawal from employer retirement plan (but not an IRA) if separated from service.

• Eligible for catch-up contributions to HSAs.59½ • Penalty for early withdrawal from retirement accounts expires.

• Roth IRA distributions are tax-free (if any Roth held for at least five years).65 • Non-itemizers become eligible for a higher standard deduction.

• Taxpayers with no children no longer qualify for EIC.• HSA and MSA withdrawals not used for medical costs are taxed but no

longer subject to a 20% penalty.• Eligible for credit for the elderly.

70½ • Contributions no longer allowed to traditional IRAs.• Required minimum distributions from retirement plans (other than Roth

IRAs) must begin.

Who Must File a 2012 Return?1

Filing Status

Must file if gross

income is at least: Filing Status

Must file if gross

income is at least:

Single: MFS: Under 65 ................................ $ 9,750 Any Age ................................ $ 3,80065 or older ................................11,200 HOH: MFJ: Under 65 ................................. 12,500Both spouses under 65 ............ 19,500 65 or older .............................. 13,95065 or older (one spouse) ......... 20,650 QW:65 or older (both spouses) ....... 21,800 Under 65 ................................. 15,700

65 or older .............................. 16,8501 See Children and Other Dependents—Filing Requirements (2012) and Other Filing

Requirements (2012) on -5 for exceptions.

Social Security Highlights2013 2012

Maximum Earnings Subject to:Social Security tax ........................................................ $113,700 $110,100Medicare tax ................................................................. No Limit No Limit

Maximum Earnings and Still Receive Full Benefits:Under full retirement age (FRA) ................................... $ 15,120 $ 14,640Year FRA reached ........................................................ 40,080 38,880FRA or older ................................................................. No Limit No Limit

For supplemental information to the material in this handbook, please refer to the Updates section of our website: Quickfinder.thomson.com

Updates

We welcome comments and questions from readers. However, our response is limited to verification of specific information presented in the Quickfinder® Handbooks. We cannot give advice on a client’s tax situation or provide information beyond the contents of this publication. Questions must be submitted in writing by mail, fax or online at Quickfinder.thomson.com (Content Questions on the Contact Us page). Research editors are not available to answer questions over the phone.

If you have any questions

Do you have a client-specific question? Visit Quickfinder.thomson.com and post your question on the Quickfinder Message Board!

Join in on our Message Board

Copyright 2012 Thomson Reuters. All Rights Reserved. The Quickfinder logo and Quickfinder® Handbooks are trademarks of Thomson Reuters.

2012 Tax Year | 1040 Quickfinder® Handbook 3-1Replacement Page 01/2013

Quick Facts, Worksheets, Where to FileAll worksheets included in Tab 3 may be copied and used in your tax practice.

Table continued on the next page

Tab 3 TopicsQuick Facts Data Sheet .......................................... Page 3-1Business Use of Home Worksheet ......................... Page 3-4Capital Loss Carryover Worksheet (2012) .............. Page 3-5Child Tax Credit Worksheet (2012) ......................... Page 3-5Donations—Noncash .............................................. Page 3-6Donated Goods Valuation Guide ............................ Page 3-6Donations Substantiation Guide ............................. Page 3-7Earned Income Credit (EIC) Worksheet (2012) ...... Page 3-8Forms 1098 and 1099—What’s Reported .............. Page 3-9Net Operating Loss Worksheet #1 ........................ Page 3-10Net Operating Loss Worksheet #2—

Computation of NOL ........................................... Page 3-11

Net Operating Loss Worksheet #3—NOL Carryback ........................................................... Page 3-11

Social Security Benefits Worksheet (2012) ........... Page 3-12Reporting Capital Gains and Losses—

Form 8949 .......................................................... Page 3-13State and Local General Sales Tax Deduction

Worksheet .......................................................... Page 3-13Student Loan Interest Deduction Worksheet ........ Page 3-13Where to File 2012 Form 1040, 1040A,

1040EZ ............................................................... Page 3-14Where to File Form 1040-ES for 2013 .................. Page 3-14Where to File Form 4868 for 2012 Return ............ Page 3-14

Quick Facts Data Sheet2013 2012 2011 2010 2009

General Deductions and CreditsStandard deduction:

MFJ or QW $ 12,200 $ 11,900 $ 11,600 $ 11,400 $ 11,400Single 6,100 5,950 5,800 5,700 5,700HOH 8,950 8,700 8,500 8,400 8,350MFS 6,100 5,950 5,800 5,700 5,700Additional for age 65 or older or blind each (MFJ, QW, MFS) 1,200 1,150 1,150 1,100 1,100Additional for age 65 or older or blind each (Single, HOH) 1,500 1,450 1,450 1,400 1,400

Itemized deduction phase-out begins at AGI of:MFJ, QW, Single or HOH $ * N/A N/A N/A $ 166,800MFS 150,000 N/A N/A N/A 83,400

Personal/dependent exemption $ 3,900 $ 3,800 $ 3,700 $ 3,650 $ 3,650Personal exemption phase-out begins at AGI of:2

MFJ or QW $ 300,000 N/A N/A N/A $ 250,200Single 250,000 N/A N/A N/A 166,800HOH 275,000 N/A N/A N/A 208,500MFS 150,000 N/A N/A N/A 125,100

Earned income credit:Earned income and AGI must be less than (MFJ):3

No qualifying children $ 19,680 $ 19,190 $ 18,740 $ 18,470 $ 18,440One qualifying child 43,210 42,130 41,132 40,545 40,463Two qualifying children 48,378 47,162 46,044 45,373 45,295Three or more qualifying children 51,567 50,270 49,078 48,362 48,279

Maximum amount of credit (all filers except MFS):No qualifying children $ 487 $ 475 $ 464 $ 457 $ 457One qualifying child 3,250 3,169 3,094 3,050 3,043Two qualifying children 5,372 5,236 5,112 5,036 5,028Three or more qualifying children 6,044 5,891 5,751 5,666 5,657

Investment income limit 3,300 3,200 3,150 3,100 3,100Child tax credit:

Credit per child $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000Additional (refundable) credit—earned income floor 3,000 3,000 3,000 3,000 3,000

Adoption credit/exclusion:Maximum credit/exclusion (and amount allowed for adoption of special needs child) $ 12,970 $ 12,650 $ 13,360 $ 13,170 $ 12,150Credit/exclusion phase-out begins at AGI of:

All taxpayers except MFS $ 194,580 $ 189,710 $ 185,210 $ 182,520 $ 182,180MFS Not Allowed Not Allowed Not Allowed Not Allowed Not Allowed

Kiddie tax unearned income threshold $ 2,000 $ 1,900 $ 1,900 $ 1,900 $ 1,900Foreign earned income exclusion $ 97,600 $ 95,100 $ 92,900 $ 91,500 $ 91,400* $300,000 (MFJ, QW); $250,000 (Single); $275,000 (HOH).

3-2 2012 Tax Year | 1040 Quickfinder® Handbook Replacement Page 01/2013

Quick Facts Data Sheet (Continued)2013 2012 2011 2010 2009

FICA/SE TaxesMaximum earnings subject to tax:

Social Security tax $ 113,700 $ 110,100 $ 106,800 $ 106,800 $ 106,800Medicare tax No Limit No Limit No Limit No Limit No Limit

Maximum tax paid by:Employee—Social Security $ 7,049.40 $ 4,624.20 $ 4,485.60 $ 6,621.60 $ 6,621.60Self-employed—Social Security 14,098.80 11,450.40 11,107.20 13,243.20 13,243.20Employee or self-employed—Medicare No Limit No Limit No Limit No Limit No Limit

Business DeductionsSection 179 deduction—limit $ 500,000 $ 500,000 $ 500,000 $ 500,000 $ 250,000Section 179 deduction—SUV limit (per vehicle) 25,000 25,000 25,000 25,000 25,000Section 179 deduction—qualified real property limit 250,000 250,000 250,000 250,000 N/ASection 179 deduction—qualifying property phase-out threshold 2,000,000 2,000,000 2,000,000 2,000,000 800,000Depreciation limit—autos (1st year) 1 3,1605 3,0605 3,0605 2,9605

Depreciation limit—trucks and vans (1st year) 1 3,3605 3,2605 3,1605 3,0605

Standard mileage allowances:Business 56.5¢ 55.5¢ 51¢ / 55.5¢ 50¢ 55¢Charity work 14¢ 14¢ 14¢ 14¢ 14¢Medical/moving 24¢ 23¢ 19¢ / 23.5¢ 16.5¢ 24¢

Health Care DeductionsHealth savings accounts (HSAs):

Self-only coverage: Contribution limit $ 3,250 $ 3,100 $ 3,050 $ 3,050 $ 3,000Plan minimum deductible 1,250 1,200 1,200 1,200 1,150Plan out-of-pocket limit 6,250 6,050 5,950 5,950 5,800

Family coverage: Contribution limit 6,450 6,250 6,150 6,150 5,950Plan minimum deductible 2,500 2,400 2,400 2,400 2,300Plan out-of-pocket limit 12,500 12,100 11,900 11,900 11,600

Additional contribution limit—age 55 or older 1,000 1,000 1,000 1,000 1,000Long-term care insurance—deduction limits:

Age 40 and under $ 360 $ 350 $ 340 $ 330 $ 320Age 41 – 50 680 660 640 620 600Age 51 – 60 1,360 1,310 1,270 1,230 1,190Age 61 – 70 3,640 3,500 3,390 3,290 3,180Age 71 and older 4,550 4,370 4,240 4,110 3,980

Long-term care—excludible per diem $ 320 $ 310 $ 300 $ 290 $ 280Medical savings accounts (MSAs):

Self-only coverage: Plan minimum deductible $ 2,150 $ 2,100 $ 2,050 $ 2,000 $ 2,000Plan maximum deductible 3,200 3,150 3,050 3,000 3,000Plan out-of-pocket limit 4,300 4,200 4,100 4,050 4,000

Family coverage: Plan minimum deductible 4,300 4,200 4,100 4,050 4,000Plan maximum deductible 6,450 6,300 6,150 6,050 6,050Plan out-of-pocket limit 7,850 7,650 7,500 7,400 7,350

Education Tax IncentivesEducation savings accounts (ESAs) phase-out begins at AGI of:

MFJ $ 190,000 $ 190,000 $ 190,000 $ 190,000 $ 190,000Single, HOH, QW and MFS 95,000 95,000 95,000 95,000 95,000

Hope/American Opportunity Credit—maximum credit (per student) $ 2,500 $ 2,500 $ 2,500 $ 2,500 $ 2,500Lifetime learning credit (LLC)—maximum credit (per return) $ 2,000 $ 2,000 $ 2,000 $ 2,000 $ 2,000Education credit phase-out begins at AGI of:

MFJ: Hope/American Opportunity $ 160,000 $ 160,000 $ 160,000 $ 160,000 $ 160,000LLC 107,000 104,000 102,000 100,000 100,000

Single, HOH and QW: Hope/American Opportunity 80,000 80,000 80,000 80,000 80,000LLC 53,000 52,000 51,000 50,000 50,000

MFS Not Allowed Not Allowed Not Allowed Not Allowed Not AllowedStudent loan interest deduction limit $ 2,500 $ 2,500 $ 2,500 $ 2,500 $ 2,500Student loan interest deduction phase-out begins at AGI of:

MFJ $ 125,000 $ 125,000 $ 120,000 $ 120,000 $ 120,000Single, HOH and QW 60,000 60,000 60,000 60,000 60,000MFS Not Allowed Not Allowed Not Allowed Not Allowed Not Allowed


Quick Facts Data Sheet (Continued)2013 2012 2011 2010 2009

Savings bonds income exclusion phase-out begins at AGI of:MFJ and QW $ 112,050 $ 109,250 $ 106,650 $ 105,100 $ 104,900Single and HOH 74,700 72,850 71,100 70,100 69,950MFS Not Allowed Not Allowed Not Allowed Not Allowed Not Allowed

Tuition deduction phase-out begins at AGI of:MFJ $ 130,000 $ 130,000 $ 130,000 $ 130,000 $ 130,000Single, HOH and QW 65,000 65,000 65,000 65,000 65,000MFS Not Allowed Not Allowed Not Allowed Not Allowed Not Allowed

Alternative Minimum Tax (AMT)AMT exemption:

MFJ or QW $ 80,800 $ 78,750 $ 74,450 $ 72,450 $ 70,950Single or HOH 51,900 50,600 48,450 47,450 46,700MFS 40,400 39,375 37,225 36,225 35,475Child subject to kiddie tax—earned income plus $ 7,150 $ 6,950 6,800 6,700 6,700

Retirement PlansIRA contribution limits:

Under age 50 at year end $ 5,500 $ 5,000 $ 5,000 $ 5,000 $ 5,000Age 50 or older at year end 6,500 6,000 6,000 6,000 6,000

Traditional IRA deduction phase-out begins at AGI of (taxpayer or spouse covered by employer retirement plan):MFJ and QW (covered spouse) $ 95,000 $ 92,000 $ 90,000 $ 89,000 $ 89,000MFJ (non-covered spouse) 178,000 173,000 169,000 167,000 166,000Single and HOH 59,000 58,000 56,000 56,000 55,000MFS 0 0 0 0 0

Roth IRA contribution phase-out begins at AGI of:MFJ and QW $ 178,000 $ 173,000 $ 169,000 $ 167,000 $ 166,000Single and HOH 112,000 110,000 107,000 105,000 105,000MFS 0 0 0 0 0

Roth IRA conversion—AGI limit:MFJ, Single and HOH N/A N/A N/A N/A $ 100,000MFS N/A N/A N/A N/A Not Allowed

SIMPLE IRA plan elective deferral limits:Under age 50 at year end $ 12,000 $ 11,500 $ 11,500 $ 11,500 $ 11,500Age 50 or older at year end 14,500 14,000 14,000 14,000 14,000

401(k), 403(b), 457 and SARSEP elective deferral limits:Under age 50 at year end $ 17,500 $ 17,000 $ 16,500 $ 16,500 $ 16,500Age 50 or older at year end 23,000 22,500 22,000 22,000 22,000

Profit-sharing plan/SEP contribution limits $ 51,000 $ 50,000 $ 49,000 $ 49,000 $ 49,000Compensation limit (for employer contributions to profit sharing plans) $ 255,000 $ 250,000 $ 245,000 $ 245,000 $ 245,000Defined benefit plans—annual benefit limit $ 205,000 $ 200,000 $ 195,000 $ 195,000 $ 195,000Retirement saver’s credit phased-out when AGI exceeds:

MFJ $ 59,000 $ 57,500 $ 56,500 $ 55,500 $ 55,500HOH 44,250 43,125 42,375 41,625 41,625Single, MFS and QW 29,500 28,750 28,250 27,750 27,750

Key employee compensation threshold $ 165,000 $ 165,000 $ 160,000 $ 160,000 $ 160,000Highly compensated threshold $ 115,000 $ 115,000 $ 110,000 $ 110,000 $ 110,000

Social SecurityMaximum earnings and still receive full Social Security benefits:

Under full retirement age (FRA) at year-end, benefits reduced by $1 for each $2 earned over

$ 15,120 $ 14,640 $ 14,160 $ 14,160 $ 14,160

Year FRA reached, benefits reduced $1 for each $3 earned over (months up to FRA only)

40,080 38,880 37,680 37,680 37,680

Month FRA reached and later No Limit No Limit No Limit No Limit No LimitEstate and Gift Taxes

Estate and gift tax exclusion $ 5,250,0008 $ 5,120,0008 $ 5,000,0008 $ 5,000,0009 $ 3,500,0009

GST tax exemption $ 5,250,000 $ 5,120,000 $ 5,000,000 $ 5,000,000 $ 3,500,000Gift tax annual exclusion $ 14,000 $ 13,000 $ 13,000 $ 13,000 $ 13,0001 Amount not released by IRS at publication time. Tax professionals should watch for developments.2 Regardless of AGI, the exemption cannot be reduced below $2,433 (2009).3 To get earned income/AGI phaseout amount for all other filers (except MFS), reduce amount shown by: $5,210 in 2012; $5,080 in 2011; $5,010 in 2010; $5,000 in 2009.4 Amount could be affected by legislation. Watch for developments.5 Add $8,000 if special depreciation claimed.6 Caution: Expired on 12/31/2011 but has been reinstated in the past. Watch for developments.7 Congress has consistently raised this amount in the past. When the 2012 amount is available, an update will be posted at www.quickfinder.com.8 Plus the amount, if any, of deceased spousal unused exclusion amount.9 The lifetime gift tax exclusion was limited to $1,000,000.

$5,340 in 2013;


Business Use of Home WorksheetCaution: Schedule C filers must use Form 8829, Expenses for Business Use of Your Home. Use this worksheet if Schedule F is filed or if the individual is an employee (result to Schedule A) or a partner (result to Schedule E).Part 1—Part of Home Used for Business:

1) Area of home used for business ............................................................................................................. 1) 2) Total area of home .................................................................................................................................. 2) 3) Percentage of home used for business (divide line 1 by line 2 and show result as percentage) ........... 3) %

Part 2—Allowable Deductions:4) Gross income from business .................................................................................................................. 4)

(a) (b)Direct Expenses Indirect Expenses

5) Casualty loss .................................................... 5) 6) Deductible mortgage interest (including

qualified mortgage interest premiums) ............. 6) 7) Real estate taxes .............................................. 7) 8) Total of lines 5 through 7 .................................. 8) 9) Multiply column (b) of line 8 by line 3 ......................................................... 9)

10) Add column (a) of line 8 and line 9 ............................................................. 10) 11) Business expenses not related to business use of home............................ 11) 12) Add lines 10 and 11 ................................................................................................................................ 12) 13) Deduction limit. Subtract line 12 from line 4 ........................................................................................... 13) 14) Excess mortgage interest and qualified

mortgage insurance premiums .......................... 14) 15) Insurance ........................................................... 15) 16) Rent ................................................................... 16) 17) Repairs and maintenance.................................. 17) 18) Utilities ............................................................... 18) 19) Other expenses related to use of home ............ 19) 20) Add lines 14 through 19..................................... 20) 21) Multiply column (b) of line 20 by line 3 ........................................................ 21) 22) Carryover of operating expenses from prior year ........................................ 22) 23) Add column (a) of line 20, line 21 and line 22 ........................................................................................ 23) 24) Allowable operating expenses. Enter the smaller of line 13 or line 23 ................................................... 24) 25) Limit on excess casualty losses and depreciation. Subtract line 24 from line 13 ................................... 25) 26) Excess casualty losses................................................................................ 26) 27) Depreciation of home from line 39 below .................................................... 27) 28) Carryover of excess casualty losses and depreciation from prior year ....... 28) 29) Add lines 26 through 28.......................................................................................................................... 29) 30) Allowable excess casualty losses and depreciation. Enter the smaller of line 25 or line 29 .................. 30) 31) Add lines 10, 24 and 30 .......................................................................................................................... 31) 32) Casualty losses included on lines 10 and 30.......................................................................................... 32) 33) Allowable expenses for business use of home. (Subtract line 32 from line 31.) .................................... 33) Part 3—Depreciation of Home:34) Smaller of adjusted basis or fair market value of home when first used for business ............................ 34) 35) Basis of land (or FMV, if FMV of home used on line 34) ........................................................................ 35) 36) Depreciable basis of building (subtract line 35 from line 34) .................................................................. 36) 37) Business basis of building (multiply line 36 by line 3)............................................................................. 37) 38) MACRS depreciation percentage ........................................................................................................... 38) 39) Depreciation allowable (multiply line 37 by line 38) ................................................................................ 39) Part 4—Carryover of Unallowed Expenses to Next Year:40) Operating expenses. Subtract line 24 from line 23. If less than zero, enter -0- ..................................... 40) 41) Excess casualty losses and depreciation. Subtract line 30 from line 29. If less than zero, enter -0- ..... 41)


Reporting Capital Gains and Losses—Form 8949

For 2012, sales and exchanges of capital assets (if not reported on Form 4684, 4797, 6781 or 8824) are reported on Form 8949, even if some or all of the gain or loss is not recognized. The totals from Form 8949 are carried to Schedule D.

In some cases, an adjustment to the gain or loss will also be reported on Form 8949 along with a code indicating the type of adjustment. At the date of publication, the IRS had not released the final list of codes to be used. When available, the codes

will be posted to the Updates section of Quickfinder.com.

State and Local General Sales Tax Deduction Worksheet

For 2011, taxpayers could elect to deduct state and local sales taxes instead of state and local income taxes (see Electing to Deduct Sales Tax on Page 5-5). Instead of deducting their actual expenses, taxpayers could use optional sales tax tables

[based on the taxpayer’s state(s) of residence] provided by the IRS. The deduction for state and local general sales taxes expired on December 31, 2011 and, at the time of publication, had not been extended to 2012. If the deduction is extended to 2012, The tables and a worksheet to figure the state and local sales tax deduction for 2012 will be posted to the Updates

section of Quickfinder.com when they are available.

Student Loan Interest Deduction WorksheetCaution: Do not use this worksheet if taxpayer filed Form 2555 or 2555-EZ (related to foreign earned income) or Form 4563 (income exclusion for residents of American Samoa) or if taxpayer is excluding income from sources within Puerto Rico. Use the worksheet in IRS Pub. 970 instead.

1) Enter the total interest paid in 2012 on qualified student loans. Do not enter more than $2,500 ...................... 1)

2) Enter the amount from Form 1040, line 22 ......................................................................................................... 2)

3) Enter the total of the amounts from Form 1040, lines 23 through 32, plus any write-in adjustments entered on the dotted line next to line 36 ........................................................................................................... 3)

4) Subtract line 3 from line 2 ................................................................................................................................... 4)

5) Enter the amount shown below for taxpayer’s filing status:•Single,HOHorQW—$60,000.•MFJ—$125,000................................................................................................................................................ 5)

6) Is the amount on line 4 more than the amount on line 5?

No Skip lines 6 and 7, enter -0- on line 8 and go to line 9.

Yes Subtract line 5 from line 4 ....................................................................................................................... 6)

7) Divideline6by$15,000($30,000ifMFJ).Entertheresultasadecimal(roundedtoatleastthreeplaces). If the result is 1.000 or more, enter 1.000........................................................................................................... 7)

8) Multiply line 1 by line 7 ....................................................................................................................................... 8)

9) Student loan interest deduction. Subtract line 8 from line 1. Enter the result here and on Form 1040, line 33. Do not include this amount in figuring any other deduction on taxpayer’s return (such as on Schedules A, C, E, etc.)...................................................................................................................................... 9)

2012 cancan


Where to File 2012 Form 1040, 1040A, 1040EZDue Date: April 15, 2013

Address to: “Department of the TreasuryInternal Revenue Service”

Address to: “Internal Revenue Service”

Taxpayer lives in:Without payment— Form 1040

Without payment— Form 1040EZ

Without payment— Form 1040A

With payment— Form 1040, 1040A, 1040EZ

AL, GA, KY, MO, NC, NJ, SC, TN, VA Kansas City, MO 64999-0002 Kansas City, MO 64999-0014 Kansas City, MO 64999-0015 P.O. Box 1000Louisville, KY 40293-1000

CT, DC, DE, MA, MD, ME, NH, NY, PA, RI, VT, WV

Kansas City, MO 64999-0002 Kansas City, MO 64999-0014 Kansas City, MO 64999-0015 P.O. Box 37008Hartford, CT 06176-0008

FL, LA, MS, TX Austin, TX 73301-0002 Austin, TX 73301-0014 Austin, TX 73301-0015 P.O. Box 1214Charlotte, NC 28201-1214

AK, AZ, CA, CO, HI, ID, NM, NV, OR, UT, WA, WY

Fresno, CA 93888-0002 Fresno, CA 93888-0014 Fresno, CA 93888-0015 P.O. Box 7704San Francisco, CA 94120-7704

AR, IA, IL, IN, KS, MI, MN, MT, ND, NE, OH, OK, SD, WI

Fresno, CA 93888-0002 Fresno, CA 93888-0014 Fresno, CA 93888-0015 P.O. Box 802501Cincinnati, OH 45280-2501

A foreign country, U.S. possession or territory1 or uses an APO or FPO address or files Form 2555, 2555-EZ or 4563 or is a dual-status alien.

Austin, TX 73301-0215 Austin, TX 73301-0215

Austin, TX 73301-0215 P.O. Box 1303Charlotte, NC 28201-1303

1 See Pub. 570 if taxpayer lives in America Samoa, Puerto Rico, Guam, the U.S. Virgin Islands or the Northern Mariana Islands.

Where to File Form 1040-ES for 2013Due Dates: See Page 16-5


Taxpayer lives in: Send to:AL, GA, KY, MO, NC, NJ, SC, TN, VA P.O. Box 1100 Louisville, KY 40293-1100CT, DC, DE, MA, MD, ME, NH, NY, PA ,RI, VT, WV P.O. Box 37007 Hartford, CT 06176-0007FL, LA, MS, TX P.O. Box 1300 Charlotte, NC 28201-1300AK, AZ, CA, CO, HI, ID, NM, NV, OR, UT, WA, WY P.O. Box 510000 San Francisco, CA 94151-5100AR, IA, IL, IN, KS, MI, MN, MT, ND, NE, OH, OK, SD, WI P.O. Box 802502 Cincinnati, OH 45280-2502

A foreign country, U.S. possession or territory1 or uses an APO or FPO address or files Form 2555, 2555-EZ or 4563 or is a dual-status alien or nonpermanent resident of Guam or the Virgin Islands.

P.O. Box 1300 Charlotte, NC 28201-1300 USA


Where to File Form 4868 for 2012 ReturnDue Date: April 15, 2013

Address to: “Department of the Treasury Internal Revenue Service”


Taxpayer lives in: Without payment With paymentAL, GA, KY, MO, NC, NJ, SC, TN, VA Kansas City, MO 64999-0045 P.O. Box 1300 Louisville, KY 40293-1300CT, DC, DE, MA, MD, ME, NH, NY, PA, RI, VT, WV Kansas City, MO 64999-0045 P.O. Box 37009 Hartford, CT 06176-0009FL, LA, MS, TX Austin, TX 73301-0045 P.O. Box 1302 Charlotte, NC 28201-1302AK, AZ, CA, CO, HI, ID, NM, NV, OR, UT, WA, WY Fresno, CA 93888-0045 P.O. Box 7122 San Francisco, CA 94120-7122AR, IA, IL, IN, KS, MI, MN, MT, ND, NE, OH, OK, SD, WI Fresno, CA 93888-0045 P.O. Box 802503 Cincinnati, OH 45280-2503

A foreign country, U.S. possession or territory1 or uses an APO or FPO address or files Form 2555, 2555-EZ or 4563 or is a dual-status alien or nonpermanent resident of Guam or the Virgin Islands.

Austin, TX 73301-0215 P.O. Box 1302 Charlotte, NC 28201-1302 USA

Note: All Form 1040-SS, 1040-PR, 1040 NR and 1040-NR-EZ filers should send Form 4868 to this address: Austin, TX 73301-0045 P.O. Box 1302 Charlotte, NC 28201-1302


—End of Tab 3—


Contributions: •CanbemadefortheentireyeariftheindividualisHSA-eligible

on the first day of the last month of the year. The HSA contribu-tion limit is the full-year amount (but see Recapture below).

•Mustbemadeincashorthroughacafeteriaplan.•Canbemadeinoneormorepayments,butcannotbemade

before the beginning of the tax year.•For2012,mustbemadebyApril15,2013.[IRC§223(d)(4)]

Example: Jennifer enrolls in a HDHP on December 1, 2012, and is otherwise an eligible individual for that month. She was not an eligible individual in any other month in 2012. Jennifer may make HSA contributions as if she had been enrolled in the HDHP for all of 2012. If she ceases to be an eligible individual (for example, if she ceases to be covered under the HDHP) at any time dur-ing 2013, an amount equal to the HSA deduction attributable to treating her as an eligible individual for January through November 2012 is included in her income in 2013. In addition, a 10% additional tax applies to the includible amount. (See Recapture below.)

Excess contributions: •Arenotdeductibleifmadebyorforanindividual,•Are included ingross incomeof theemployee ifmadebyan

employer and•Aresubjecttoa6%excisetaximposedontheaccountbenefi-

ciary unless withdrawn (with earnings) by the return due date (including extensions).

Reporting:•ReportHSAcontributionsonForm8889,Health Savings Ac-

counts (HSAs). The deductible amount of the contribution is carried to Form 1040, line 25.

•TaxpayersshouldreceiveForm5498-SAfromtheHSAtrusteeshowing the HSA contributions during the year.

•Anemployer'scontributionstoanemployee’sHSAareshownin box 12 of Form W-2 with code W. Note: A more-than-2% shareholder is not treated as an employee for this purpose. See S corporation shareholders on Page 4-16.

Rollovers. A rollover is a distribution of as-sets from one HSA or MSA that is deposited in another HSA. Generally, the rollover must be completed within 60 days. Amounts rolled over are not taxable (or deductible) and do not affect the annual limit on contributions or deductions. Only one rollover contribution can be make to an HSA during a one-year period. Exception: An unlimited number of trustee-to-trustee transfers between HSAs can be made.Recapture. All or part of a deductible HSA contribution or other-wise nontaxable transfer to an HSA (from an HRA, FSA or IRA) is included in income and subject to a 10% penalty tax if the taxpayer fails to remain HSA-eligible (for any reason other than death or disability) for a required length of time following the contribution or transfer. Report the income on line 21 and the penalty tax on line 60 of Form 1040.•Part-year HDHP coverage. An HSA contribution made by an

individual who is not HSA-eligible the entire year is recaptured to the extent allocable to the ineligible months if the individual fails to qualify for an HSA anytime during the following year.

•Tax-free transfers from an HRA, FSA or IRA. Individual must remain HSA-eligible from the month the funds are transferred into the HSA until the last day of the 12th following month.

High deductible health plan (HDHP). A HDHP is one with higher annual deductibles than typical health plans. Only HDHPs with the following deductibles qualify for HSA purposes.

2012 HSA High Deductible Health Plan (HDHP) LimitsType of

CoverageMinimum Annual

DeductibleMaximum Annual Deductible and Out-of-Pocket Expenses (other than for premiums)1

Self-Only $ 1,200 $ 6,050Family 2,400 12,100

1 Only the deductible and out-of-pocket expenses for services within the network should be used to figure whether the limit applies. The limit does not apply to deductibles and expenses for out-of-network services if the plan uses a network of providers.

•Non-HDHP health insurance. An individual (or spouse if filing jointly) generally cannot have any other health plan that is not an HDHP. However, an individual may have additional insurance that only covers the following items:

– Accidents.– Disability.– Dental care.– Vision care.– Long-term care.– Liabilities related to workers’ compen-

sation laws, torts or ownership or use of property.– Specific diseases or illnesses.– A fixed amount per day (or other period) of hospitalization.

•Prescription drug benefits. In general, if an individual is covered by both an HDHP that does not cover prescription drugs and by a separate prescription drug plan that provides benefits before the minimum annual deductible of the HDHP has been satisfied, the individual is not eligible to contribute to an HSA. (Rev. Rul. 2004-38)

•Preventive care. A plan that provides preventive care without a deductible or with a deductible below the HSA requirements can still be treated as a HDHP. Preventive care includes: (IRS Notice 2004-23)

– Periodic health evaluations, including tests and diagnostic procedures ordered in con-nection with routine examinations.

– Routine prenatal and well-child care.– Child and adult immunizations.– Tobacco cessation programs.– Obesity weight-loss programs.– Many screening services.

•State-mandated benefits. If a state requires health plans to pro-vide certain benefits without a deductible or with a deductible below the HSA limitations, the plan will not be an HDHP.

•Other employee health plans. A taxpayer covered by his (or his spouse’s) employer’s medical expense reimbursement plan, a healthcare flexible spending account (FSA) plan or a health re-imbursement arrangement (HRA) is generally ineligible to make HSA contributions.

HRA or FSA Transfers Expired Provision Alert: The ability to transfer funds tax-free from an HRA or FSA to an HSA expired after 2011. It’s possible that Congress will extend this provision to 2012, but it had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.Before 2012, an employer could make a one-time direct transfer from an employee’s HRA account or health FSA account to the employee’s HSA. The maximum transfer is the smaller of the amount in those accounts on September 21, 2006, or the date of the transfer. For the employee, the amount transferred is not taxable, is not deductible as an HSA contribution and does not reduce his HSA contribution limit for the year.


Moving ExpensesIRS Publication 521 Form 3903, Moving Expenses. Form 3903 is filed to deduct quali-fied moving expenses in excess of any employer reimbursements. The deduction is an adjustment to income on line 26 of Form 1040.Deductible moving expenses: [IRC§217(b)]1) Costs of moving household goods and personal effects (includ-

ing in-transit or foreign-move storage expenses) and2) Travel expenses (including lodging but not meals) for one trip

by the taxpayer and each member of the household. Household members do not have to travel together or at the same time.

2012 Moving Expense Standard Mileage RateDate Driven Rate per mile1

1/1–12/31 23¢1 Plus parking and tolls.

Storage. For moves within or to the U.S., deductible costs include storing and insuring household goods for up to 30 days after the day goods are moved from the former home and before they are delivered to the new home.Employer reimbursements. Reimbursements paid under an accountable plan are not included in Box 1 (Wages, tips, other compensation) of Form W-2. They are reported in Box 12, with Code P. Reimbursements under a nonaccountable plan are included in wages reported in Box 1 of Form W-2. This applies even if the reimbursement is for a deductible moving expense. See Accountable Plan/Nonaccountable Plan on Page 9-7.Nondeductible moving expense reimbursements, whether paid to a third party or directly to the employee, are included in income reported in box 1 of Form W-2.Nondeductible expenses include:•Expensesofbuyingand/orsellingahome.•Mealexpenses.•Pre-movehousehuntingexpenses.•Leaseterminationpayments.•Temporarylivingexpenses.

Reporting Moving Expenses and ReimbursementsIF Form W-2 shows… AND taxpayer has... THEN...

Entire employer reimbursement reported in box 12 with code P

Moving expenses greater than the amount in box 12

File Form 3903 showing all deductible expenses and reimbursements.

Entire employer reimbursement reported in box 12 with code P

Moving expenses equal to the amount in box 12

Do not file Form 3903.

Employer reimbursement is divided between boxes 12 and 1

Moving expenses greater than the amount in box 12

File Form 3903 showing all deductible expenses, but only reimbursements from Form W-2, box 12.

Entire reimbursement reported as wages in box 1

Moving expenses File Form 3903 showing all deductible expenses, but do not show any reimbursements.

No reimbursement Moving expenses File Form 3903 showing all deductible expenses.

General rules for moving expenses:1) Distance test. To deduct moving expenses, the distance be-

tween the taxpayer’s new job location and former house must be at least 50 miles more than the distance between the old job location and former house.

Note for first-time employees or persons returning to work: If there is no established old job location, the distance test is met if the new workplace is at least 50 miles from the former home.

Moving Expenses—Distance Test1) Enter # of miles from old home to new workplace ...................... mi2) Enter # of miles from old home to old workplace ....................... mi3) Subtract line 2 from line 1. If 50 or more, distance test is met ... mi

2) Time test:•Employee. Moving costs are deductible only if the taxpayer

works as a full-time employee at the new location for at least 39 weeks in the 12-month period following arrival. For married taxpayers, only one spouse need satisfy the full-time work test.

•Self-employed individuals must work full-time for at least 39 weeks during the first 12 months and a total of at least 78 weeks during the first 24 months after arriving at the new job location. For this test, the taxpayer can count any full-time work as an employee or as a self-employed person.

•Failure to meet test. If failure occurs in a year after moving expenses are deducted, either (1) report the moving expense deduction as other income or (2) amend the prior-year return.

•Exceptions: The time test will not apply if taxpayer expected the job to last 39/78 weeks but lost it because of involuntary separation—other than for willful misconduct. Other Excep-tions: Death, disability, re-transfer by employer or military.

•IRS ruling: If the employee initiates a transfer before putting in the required 39 weeks of work, moving expenses are not deductible. The transfer must be beyond the employee’s control. (Rev. Rul. 88-47)

•Combine two jobs. If the employee leaves the first job without meeting the time requirements and gets a second job in the same general location, time spent on the two jobs may be combined to meet the 39-week rule.

3) Other considerations. A deduction is allowed only for a move “closely related” in time to the start of work at the new job location. Generally, moving expenses must be incurred within one year from the date a person first reports to work. If more than one year between the start of the job and the move, expenses are not deductible unless circumstances prevented the move within that time. Generally, extra time is justified to allow a spouse to fulfill job commitments in the old location or for children to finish a segment of schooling.

4) Armed Forces. A member of the Armed Forces on active duty who moves because of a permanent change of station does not have to meet the distance and time tests.

Deductible Part of Self-Employment TaxEnter amount from line 6 (Short Schedule SE) or line 13 (Long Schedule SE) on line 27.

Self-Employed SEP, SIMPLE and Qualified PlansSee also Tab 14.Enter deductible contributions to a qualified plan, SEP or SIMPLE plan made for the benefit of a self-employed taxpayer on line 28. Contributions made for the ben-efit of the taxpayer’s employees are deducted on Schedule C or F.

Self-Employed Health Insurance DeductionSee Part II—Expenses on Page 6-6.

Penalty on Early Withdrawal of SavingsEnter penalty from Form 1099-INT or 1099-OID for early withdrawal of savings or certificates on line 30. (Do not deduct the penalty from interest reported on line 8a.)


Insurance ReimbursementsDeductible medical costs must be reduced by any insurance re-imbursements received. Excess reimbursements are taxable only to the extent they were provided for under an employer plan and attributable to the employer’s contribution that was not included in income.

Over-the-Counter Drug Reimbursements From FSAReimbursements for over-the-counter drugs through an employer health flexible-spending arrangement (FSA) or other employer health plan are not tax-free to the employee. Any distributions for non-prescribed drugs are treated as disqualified distributions subject to tax and penalty. Exceptions: Any over-the-counter drug prescribed by a doctor and insulin.

TaxesSee also IRS Pubs. 523, 530 and 535

State and Local Income TaxesState and local income taxes are deductible on Schedule A in the year paid. The tax may be paid either through withholding, esti-mated payments or payments for prior year returns. The IRS may disallow deductions for large estimated state income tax payments made solely to increase itemized deductions (Rev. Rul. 82-208). The prepayment of estimated state income tax should be based on tax liability. Penalties and interest are not deductible.

Court Case: A taxpayer claimed the standard deduction and deducted non-resident state income taxes from royalties on Schedule E. The court found that state income taxes are not expenses incurred in the production of royalty income. [Strange, 88 AFTR 2d 2001-6752 (9th Cir. 2001)]

Electing to Deduct Sales Tax Expired Provision Alert: The election to deduct state and lo-cal sales tax expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.For 2011, taxpayers could elect to deduct state and local sales tax rather than state and local income taxes. Taxpayers who made this election could deduct either: 1) Actual sales tax amounts (based on their records) or2) Predetermined deduction figures from IRS tables.To deduct actual amounts. Add up the nonbusiness general state and local sales taxes (including any compensating use taxes) paid during the year plus any selective sales taxes if the rate is the same as the general sales tax rate. Include selective sales taxes on food, clothing, medical supplies and motor vehicles even if the rate is lower than the general sales tax rate. If the selective sales tax rate on a motor vehicle is higher than the general rate, deduct only the amount that would have resulted from charging the lower general sales tax rate.To deduct amounts from IRS tables. The table amounts depend on the taxpayer’s AGI plus nontaxable income (for example, tax-exempt interest and nontaxable portion of Social Security benefits), the number of exemptions claimed on Form 1040 and the state of residence. If the taxpayer lives in more than one state during the year, pro-rate the amount from the table for each state (based on the number of days spent there divided by 365), add up the pro-rated amounts and deduct the total. Note: In addition to the table amounts, the taxpayer can deduct additional actual sales tax amounts from purchases of motor ve-hicles (including leased vehicles). If the sales tax rate on a motor

vehicle is higher than the general rate, deduct only the amount that would have resulted from charging the lower general sales tax rate. Also add sales taxes paid on boats, airplanes, homes (including mobile and prefabricated) or home building materials if the rate was the same as the general sales tax rate.See Page 3-13 for the State and Local General Sales Tax Deduc-tion Worksheet. Also, a Sales Tax Deduction Calculator can be found at www.irs.gov.

Real Estate TaxesA real estate tax is deductible in the year it is paid to the taxing authority. Prepaid real estate taxes can generally be deducted in the year of the prepayment if the taxpayer is on the cash basis and does not live in an area in which the prepayment would be considered a deposit by the taxing authority. How prepaid taxes are treated varies among local jurisdictions. Taxes placed in escrow are deductible when actually paid to the taxing authority, not when paid to the escrow agent. Penalties and interest on late payments are not deductible. Also, see Electing to Capitalize Taxes and Interest on Page 5-8.Generally, real estate taxes can be deducted only by the owner of the property upon which the tax is imposed. Regulation Section 1.164-3(b) defines real property taxes as “taxes imposed on inter-ests in real property and levied for the general public welfare…” Because of the lack of a detailed definition, the issue has been the subject of several court cases and IRS rulings. For example, the tax imposed on renters by the New York Real Property Tax Law is not deductible for federal tax purposes. Taxes paid under this law are considered rent, not property taxes. (Rev. Rul. 79-180)In contrast, Revenue Ruling 71-49 stated that certain payments made to an educational construction fund by a cooperative housing corporation did qualify as real property taxes, and were deductible by the tenant-shareholders.More than one property. Real estate taxes are deductible for all property owned by a taxpayer.Sale of real estate. The buyer and the seller must divide real estate taxes according to the number of days that each owned the property during the year. Both are considered to have paid their share of taxes, even if one or the other paid the entire amount.•Buyer-paid taxes. Deductible by the buyer only for the period

he owned the property. The buyer cannot deduct the real estate taxes of the seller. The buyer must add these taxes to the basis of the property. The seller treats this as additional sales proceeds.

•Seller-paid taxes. If the seller pays real estate tax owed by the buyer (beginning on the date of sale), the buyer is considered to have paid the tax. The tax is deductible by the buyer. The buyer must reduce the basis in the property by the tax paid. The seller treats this as a reduced selling price.

Equitable owner. Taxpayers who do not have legal title to a prop-erty may still claim a Schedule A deduction for real estate taxes paid if they are equitable owners of the property. An equitable owner is a person who has the economic benefits and burdens of ownership, based on the facts. Occupying and maintaining the home and paying the mortgage and taxes on it are factors that might indicate equitable ownership. See Trans (TC Memo 1999-233), Uslu (TC Memo 1997-551) and Edosada (TC Summ. Op. 2012-17) for situations where taxpayers were equitable owners.

Cooperative Housing Corporations (Co-Ops)Mortgage interest and property taxes allocated to a tenant-share-holder in a co-op are generally treated the same as those paid by other homeowners, provided the following conditions are met.1) The corporation has only one class of stock outstanding.

Continued on the next page

2012

can


2) Each shareholder has the right (but is not required) to occupy a dwelling unit solely because of the ownership of the stock.

3) No shareholder can receive any distribution of capital, except on liquidation of the corporation.

4) During the year, the corporation either (a) receives at least 80% of its gross income from tenant-shareholders, (b) makes available at least 80% of the property’s total square footage for use by tenant-shareholders or (c) pays or incurs at least 90% of its expenditures for the acquisition, construction, manage-ment, maintenance or care of the property for the benefit of the tenant-shareholders.[IRC§216(b)]

The tenant-shareholder’s deductible percentage of interest and taxes paid by the corporation is allocated based on the number of shares owned vs. total shares outstanding. Co-ops usually issue a year-end statement showing the allocated amounts.

Special AssessmentsImprovements. Taxes charged for local benefits or improvements that tend to increase the taxpayer’s property value (such as con-struction of streets, sidewalks or water and sewer systems) are notdeductible[IRC§164(c)(1)].Ataxisconsideredassessedforlocal benefits when property assessed with the tax is limited to propertybenefited[Reg.§1.164-4(a)].Itisnotnecessaryfortheproperty’s value to actually increase.Maintenance, repairs or interest. Assessments to meet mainte-nance or repair costs or interest charges for the local benefit are deductible (if the taxpayer can substantiate them) as taxes on Schedule A because such expenditures do not tend to increase propertyvalues.[Rev.Rul.79-201;Reg.§1.164-4(b)(1)]

Personal Property TaxesPersonal property taxes are deductible if they are a state or local tax:1) Charged on personal property,2) Based only on the value of the personal property and3) Charged on a yearly basis (even if collected more or less than

once per year).Automobile license fees.•Fee based on weight, model, year or horsepower. Not deductible.•Fee based on the value of the car. Deductible, even if the tax is

imposed on the exercise of a privilege of registering a car or for using a car on the road.

•Tax based partly on value and partly on weight or other test. Only the tax attributed to the value is deductible. For example, assume annual registration fee based on 1% of value, plus 40¢ per hundred-weight. The part of the tax equal to 1% of value is deductible.

Foreign TaxesMost income taxes paid to a foreign country or U.S. possession are allowable either as an itemized deduction or as a credit against tax on Form 1116. If available, the credit is usually more advanta-geous. See Foreign Tax Credit on Page 12-10.

Nondeductible Taxes•Customorimportduties.•Federalestateandgifttaxes.•Federalincomeandexcisetaxes.•Finesorpenalties forviolationof the law,suchasparkingor

speeding tickets.•Licensefees(marriage,drivers,dogs,trailers,boats).•SocialSecurity,Medicare,railroadretirementtaxes.

InTeresT TracIngSee also IRS Pub. 535

Taxpayers must track the use of loan proceeds to determine the type of interest paid (for example, personal, business, etc.) (Reg. §1.163-8T).Strategy: Keep loan proceeds totally separate from other funds whenever possible. This can avoid reallocation by the IRS, and may save important tax deductions.

Interest Expense—TypesBusiness interest. Interest on debts incurred in a trade or business is deductible as a business expense on Schedule C or F or on Schedule E, Part II, if used to purchase stock in an S corporation or a partnership interest.Capitalized interest. Interest subject to capitaliza-tion rules, such as that incurred on manufacture or production of certain long life assets, is recovered through depre-ciation. (Form 4562)Student loan interest. Deducted as an adjustment to income on Form 1040 (available whether or not the taxpayer itemizes deductions). The deduction is limited to $2,500. See Student Loan Interest Deduction on Page 13-4 for more information.Interest paid to purchase or carry tax-exempt securities. Not deductible.Investment interest. Deductible up to the amount of net invest-ment income (Schedule A, Form 4952). See Investment Interest Expense on Page 5-7.Mortgage interest (Schedule A). See Qualified Residence Inter-est on Page 5-8.Passive activity interest. Interest on debts incurred in a passive activity. Passive activity loss limitations apply (Form 8582). See Tab 8.Nondeductible personal interest:•Interestpaidoncar loans (except forbusinessuseofcarby

self-employed individuals).•Interestpaidonataxpayer’sForm1040taxdeficiency,evenif

the deficiency was caused by an understatement of business (Schedule C) income.

•Creditcardinterestfornonbusinesspurchases.•Interestonhomeequitydebtover$100,000(orlessifFMVlimit

applies—see Qualified Residence Interest on Page 5-8).•Interestpaidonlifeinsurancepolicyloans.[IRC§264(a)(4)]•Homeacquisition intereston loansnot securedby residence

(unless properly allocated to another category). See Interest Allocation Rules below.

•Interestpaidonpersonalbillsandexpenditures.•Financechargesarisingrelatedtopersonalexpenditures.•Bankoverdraft feesor interestchargesonpersonalaccounts

not used for business.•Interestpaidonloansusedforpersonalexpenditures(unless

properly allocated to another category). See Interest Allocation Rules below.

Interest Allocation RulesThe following rules determine the category in which to place inter-est paid on loan proceeds until the debt is repaid or the debt is reallocated (see Rules for Reallocating Debt on Page 5-7).30-day rule:•Loanproceedscanbeallocatedtoexpensespaidfromanyaccount

(or from cash) if expenses are paid within 30 days before or


3) Loan proceeds must be directly traceable to home construction expenses, including the purchase of a lot.

4) Before construction begins, the loan does not qualify as acqui-sition debt and interest incurred during that period is treated generally as personal interest.

5) 90-day rule. A loan incurred within 90 days after construction is complete may also qualify, provided the debt is secured by the home. Construction expenses made within the period starting 24 months before completion of the house and ending on the date of the loan qualify.

TimesharesHomes owned under a time-sharing plan can be considered second homes for deducting interest expense. A time-sharing plan is an arrangement between two or more people that limits each person’s interest in the home or right to use it to a certain part of the year. However, if any portion of the timeshare is rented to a third party, the ability to claim a deduction for the personal portion of the mortgage interest may be lost.

Boats, Mobile Homes and House TrailersFor the qualified residence mortgage interest deduction, a quali-fied home includes a boat, mobile home, house trailer or similar property that has sleeping, cooking and toilet facilities. However, local law must allow for such use. A houseboat would not qualify if moored at a marina where overnight sleeping is prohibited.

Prepaid Mortgage InterestMortgageinterestprepaidin2012thatfullyaccruesbyJanuary15,2013, may be included in Form 1098, box 1. However, this prepaid interest is not deductible in 2012; it should be deducted in 2013. Note: Some lenders apply prepaid amounts to both interest and principal; others apply prepayments to principal only.

Reverse MortgagesA reverse mortgage is used to convert home equity into cash. The homeowner receives payments (as a line of credit, a lump sum, monthly payments for a specified number of years, or payments over his life). The amount received is a loan, so it is tax-free and will not affect Social Security benefits.When a reverse mortgage comes due, the lender recovers the amount owed from the borrower (or the heirs).Mortgage interest deduction. Mortgage interest is added to the loan balance over the term of the loan, but is not deducted under the personal residence interest rules until the loan is repaid.

Mortgage Insurance Premiums Expired Provision Alert: The deduction for mortgage insur-ance premiums expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.For 2011, mortgage insurance premiums paid or accrued dur-ing the year in connection with acquisition debt on a taxpayer’s primary or second home are deductible as residence interest. The deduction phases out ratably by 10% for each $1,000 (or portion thereof) by which the taxpayer’s AGI exceeds $100,000. Phase-out amounts are halved for married filing separately. Thus, it is not available for taxpayers with AGI greater than $109,000 ($54,500 for MFS). Only amounts paid on mortgage insurance contracts issued after 2006 qualify.

Amortizing PointsAmortization is per month, not per year. Thus, if a taxpayer incurs $2,000 in points on a 30-year loan of 360 monthly payments and the first payment is for November of 2012, only $11.12 is deductible for 2012 ($2,000 ÷ 360 = $5.56 × 2 months = $11.12).Home equity line-of-credit points. Points paid initially for a line of credit of up to $100,000 secured by the home are deductible as home equity debt interest over the period of time until the credit line expires. However, if funds from a line of credit are used for home improvements for the principal residence, the points are fully deductible the first year.Business or investment property. Amortize the points over the life of the loan.

Second HomeAssuming the home is treated as the second home under the quali-fied residence interest expense rules, points are treated as follows.Personal use only. Points are amortized as mortgage interest expense over the entire loan period.Rental and personal use:1) If personal use is not more than the greater of 14 days or 10%

of the days the home is rented, the second home is treated as a rental property. Amortize and deduct the rental portion of the points over the life of the loan. Points allocated to personal use are non-deductible.

2) If personal use exceeds the 14-day or 10% use rule, divide the points proportionately based on rental and personal use. Amortize and deduct the amount attributable to the rental ac-tivity against the rental income, and amortize and deduct the balance as qualified residence interest expense.

Note: See Renting Out a Home on Page 8-1.

OTher MOrTgage InTeresT DeDucTIOn rules

Late Payment ChargesLate payment charges are generally deductible as mortgage inter-est if they are not for a specific service such as a collection fee.

Land Rent (Redeemable Ground Rent)Periodic lease payments made for the use of land on which a house is located can be deductible as mortgage interest. To be deductible, all of the following must be true.1) The land lease term is more than 15 years, including renewal

periods, and is freely assignable by the lessee,2) The lessee has the right to terminate the lease and purchase

the lessor’s land by paying a specific amount and3) The lessor’s interest in the land is a security interest to protect

the entitlement to rental payment.

Construction LoansInterest on construction loans or loans to buy a lot is qualified residence interest if the following requirements are met:1) A home under construction is treated as a qualifying home for

up to 24 months provided that when ready for occupancy, the house is used as a main or second home. The deduction was allowed even when the home was never completed because the taxpayers could not obtain financing. [Rose, TC Summary Opinion 2011-117 (2011)]

2) If the construction period exceeds 24 months, the interest for the remaining months is considered personal interest.

2012


charITable cOnTrIbuTIOnsSee also IRS Pubs. 526 and 561 and

Donation Guides in Tab 3

Deductible ContributionsIncludes money or property given to:•Churches,synagogues,temples,mosquesandotherreligious

organizations.•Federal,stateandlocalgovernments,ifcontributionissolelyfor

public purposes.•Nonprofitschools,hospitalsandvolunteerfirecompanies.•Publicparksandrecreationfacilities.•Public charities such asSalvationArmy,RedCross,CARE,

Goodwill Industries, United Way, Boy/Girl Scouts, Boys/Girls Clubs of America, etc.

•Warveterans’groups.Charitable travel. Travel expenses such as transportation, meals and lodging are deductible if there is not a significant element of personal pleasure, recreation or vacation in the travel. Car ex-penses can be deducted using actual cost or a standard mileage rate of 14¢ per mile.

Court Case: Charitable deductions were allowed for the cost of lodging in deluxe hotels while traveling on behalf of a charitable organization. These costs were considered reasonable because the taxpayer was an important person in the organization and to effectively perform his job, he needed to stay at or near the hotel where the function was being held. (Cavalaris, TC Memo 1996-308)

Volunteer out-of-pocket expenses when serving a qualified organization. For example, scout leaders can deduct the cost of uniforms (and cleaning) that are worn when performing donated services, but that are not suitable for everyday wear.Delegate to a church convention. Deduct the unreimbursed ex-penses of attending. A person must be a delegate and not merely attending on his own. Exchange students. Deduct up to $50 per school month for housing an exchange student (grade 12 or lower) sponsored by a qualified organization. The student does not have to be a foreign student as long as the student becomes a member of the taxpayer’s household under a written agreement between the taxpayer and the charitable organization.Foster parents. If there is no profit or profit motive, deduct expenses exceeding payments received from a charitable orga-nization for providing support for qualified foster care individuals placed in the home.Canadian, Mexican and Israeli charities. Donations to certain Canadian, Mexican and Israeli charities may be deductible under an income tax treaty with that country. Special rules or limits may apply. U.S. income tax treaties with these countries can be found on the IRS website.

Nondeductible ContributionsMoney or property given to:•Civicleagues,socialandsportsclubs,laborunionsandchambers

of commerce.•Foreignorganizations(otherthancertainCanadian,Mexi-

can and Israeli charities).•Groupsthatarerunforpersonalprofit.•Groupswhosepurposeistolobbyforlawchanges.•Homeowners’associations.•Individuals.•Politicalgroupsorcandidatesforpublicoffice.

Cost of raffle, bingo or lottery tickets.Dues, fees or bills paid to country clubs, lodges, fraternal orders or similar groups.Tuition (secular or religious).Value of blood given to a blood bank.Value of time or services rendered by the taxpayer.Rental value of a timeshare donated to char-ity, such as the right to stay at it for one week. The ownership interest in the timeshare must be donated to charity to make the contribution deductible.Charitable distribution from IRA. See Qualified Charitable Dis-tributions (QCDs) on Page 14-13.

Limits on Charitable ContributionThe deduction for charitable contributions cannot exceed 50% of the taxpayer’s AGI. A reduced limit of 30% or 20% applies for certain contributions.æ Practice Tip: Most organizations know whether they qualify for the 50% limit. Also, the deduction limit percentage for many charities is available online as part of the Exempt Organizations Select Check tool at www.irs.gov. Up to 50%-of-AGI limit. Donation of cash or property (other than capital gain property) to a publicly supported charity or foundation qualifying as a 50% limit organization. Examples of 50% limit organizations: Churches, educational orga-nizations, hospitals, medical research organizations, publicly sup-ported organizations that receive a substantial amount of support from the general public or governmental units, private operating foundations, private nonoperating foundations that distribute 100% of the contributions to qualified charities within 21/2 months after the end of the tax year, private foundations that pool contributions into a common fund and allow contributors to name the charities to receive their gifts if the income is distributed within 21/2 months after the end of the tax year.Up to 30% of AGI limit:•Donationofcapitalgainproperty toa50% limitorganization.

Property is capital gain property if its sale at FMV on the date of the contribution would have resulted in long-term capital gain. Exception: 30% limit does not apply if donor elects to deduct only the property’s cost or other basis rather than its FMV.

•Donationofcashorproperty(otherthancapitalgainproperty)to any qualified organizations other than 50% limit organizations (includes veterans’ organizations, fraternal societies, nonprofit cemeteries, certain private nonoperating foundations).

Up to 20% of AGI limit. Donation of capital gain property to any qualified organizations other than 50% limit organizations. For multiple contributions subject to different limits, use the worksheet in IRS Pub. 526 to compute the deduction.

Five-Year Contribution CarryforwardContributions that exceed the AGI limit in the current year can be carried forward to each of the five succeeding years. Carryover contributions are subject to the original percentage limits in the carryover years, and are deducted after deducting allowable con-tributions for the current year. If there are carryovers from two or more years, use the earlier year carryover first.Contribution deductions disallowed due to NOL carryovers are added to the unused NOL as additional NOL and no longer treated ascontributions[Reg.§1.170A-10(d)]Standard deduction claimed. If the taxpayer claims the standard deduction in any of the carryover years (including the contribution year), the carryover amount is reduced by the amount that would havebeendeductibleifitemizing.(Reg.§1.170A-10)


Deceased spouse. Carryovers allocable to the excess contribu-tions of a deceased spouse may only be claimed on the final return of the deceased spouse, not by the surviving spouse. [Reg. §1.170A-10(d)(4)(iii)]

Qualified Conservation Contributions Expired Provision Alert: Special rules for qualified conserva-tion contribution expired at the end of 2011. It’s possible Congress will extend them to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on -1 for more information.For 2011, the deduction for qualified conservation contributions is limited to 50% of AGI (100% of AGI for qualified farmers and ranch-ers) minus the deduction for all other charitable contributions. Any excess amount is carried forward 15 years. Absent these rules, a qualified conservation contribution is subject to the 30%-of-AGI limit and a five-year carryforward period.

Contributions That Benefit the Taxpayer Contributions that are made partly for goods or services provided by the organization are deductible if:1) The amount of the payment exceeds the FMV of goods and

services received, and2) The donor intends to make a payment in excess of the FMV

of goods and services.

Example: Anita makes a large contribution to a charity that has a history of sponsoring a dinner-dance for donors making substantial contributions. The charitable deduction is limited to amount of the donation less the FMV of the anticipated dinner-dance even if the dance takes place in the following year.

Refused benefits. A donor can claim a full deduction if all benefits are actively refused (such as checking off a refusal box on a form sent by the charity). (Rev. Rul. 67-246)Gifts of more than $75. If the donor receives some benefit, the charity must provide a statement as to the deductible amount of the contribution. The charity must make a “good faith estimate” of the FMV of goods/services provided to the donor.Token benefits. A donor can disregard benefits if either:•Thebenefitsreceiveddonotexceedthelesserof

2% of the contribution or $99 (for 2012) or•Thegiftis$49.50ofmoreandthebenefitreceived

bears the charity’s name or logo and has an ag-gregate cost not more than $9.90 (for 2012).

Membership benefits. Certain benefits can be dis-regarded if the annual payment is $75 or less. A payment of more than $75 can be made if the organization does not require a larger payment to receive these benefits. Benefits may include rights or privileges that members can exercise frequently (such as free or discounted admission and parking) or admission to member-only events if the cost is $9.90 (for 2012) or less per person.Tickets to college games. A payment made to a college or university in exchange for a right to buy tickets to a sporting event qualifies for a charitable deduction of 80% of the amount paid. Any amount actually paid for tickets is not deductible. [Reg. §1.170A-13(f)(14)]

Cash Donations—SubstantiationNo deduction is allowed unless the taxpayer has either (1) bank records (for example, a canceled check or account statement) or (2) written acknowledgment from the charity documenting the contribution’samountanddate.[IRC§170(f)(17)].Thismeansthatdonors who give cash will need to get written acknowledgement from the charity to claim a deduction. Using a check for small donations, rather than cash, may be preferable.

$250 or more. Charitable contributions of $250 or more in any one day to any one organization must have written acknowledg-mentfromtheorganization[IRC§170(f)(8)].Theacknowledgmentmust be received by the earlier of the date the tax return is filed for the contribution year or the extended due date for filing. It must state whether the charitable organization provided any goods or services in exchange for the contribution (and if so, an estimate of the FMV of the goods or services provided). Payroll deduction contributions: Employees can substantiate a payroll deduction of $250 or more with (1) a Form W-2 or other document from the employer showing payroll deduction and (2) a pledge card or other document prepared by the charity.

Noncash Donations—SubstantiationGeneral recordkeeping requirements for noncash contribu-tions:1) Name of charitable organization.2) Date and location of contribution.3) Reasonably detailed description of contributed

property.4) Fair market value and method of valuing the

property.5) Cost or other basis of the property if FMV must be reduced. See

Required Reductions in FMV—Donating Appreciated Property on Page 5-14.

Specific requirements. See the Donations Substantiation Guide on Page 3-7 for specific requirements based on the type and amount of the donation. Form 8283, Noncash Charitable Contributions. Must be filed if noncash property donations are in excess of $500. Note: Special rules apply to donations of less than a tax-payer’s entire interest in a property. See Pub. 526, Charitable Contributions.Out-of-pocket expenses. Acknowledgment from the charity is required if a volunteer claims a deduction for a single contribution of $250 or more in the form of out-of-pocket expenses. The acknowl-edgement must contain a description of the service provided and a statement about whether goods or services were provided by the charity to reimburse the taxpayer for the expenses incurred (includ-ing an estimate of the FMV of any goods or services provided). The charity must substantiate the type of services performed (not dates or amounts of expenses).Clothing and household items. No deduction is allowed for donat-ing clothing or household items unless they are in good used condi-tion or better. Exception: Deduction is allowed for an item of clothing or a household item that is not in good used condition or better if the deduction is more than $500 and a qualified appraisal of it is included with the tax return. Household items include furniture and furnishings, electronics, appliances, linens and other similar items.

ValuationFor guidelines on the value of donated goods, see the Donated Goods Valuation Guide table on Page 3-6.

AppraisalsA written appraisal is required for charitable contributions of prop-erty for which the claimed value exceeds $5,000 if an income tax deduction is claimed. Also, the recipient organization must file an information return if it disposes of the property within two years of receipt. See Notice 2006-96 for guidance on qualified appraisals and qualified appraisers. Exception: Publicly traded securities do not require written appraisal. (Nonpublicly traded securities must be appraised if the claimed value is more than $10,000.)Fees paid to determine the FMV of donated property are not deductible as contributions. Claim them on Schedule A as miscel-laneous deductions subject to 2% of the AGI limitation.

2012


Cars, Boats and AirplanesFor charitable contributions of motor vehicles in excess of $500, the deduction amount depends on how the donated vehicle is used by the charitable organization. These rules also apply to donations of boats and airplanes.•Outright sale. If the organization sells the vehicle without using it

significantly for charitable purposes or making material improve-ments, the deduction is generally limited to the gross proceeds from the sale. When this general rule applies, the FMV of the donated asset is irrelevant. The gross sale proceeds amount is reported on line 4c of the Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, provided to the donor (and to the IRS) by the charity.

•Transferred to needy individual. The sale-proceeds limitation doesn’t apply if the charity sells or transfers the vehicle to a needy individual for below FMV in furtherance of the organiza-tion’s charitable purpose. In this case, the donor can generally deduct the FMV of the vehicle as of the contribution date—even if FMV exceeds the gross sale proceeds figure. The charity will indicate when this exception applies by checking box 5b on Form 1098-C.

•Significant use or material improvements. The sale-proceeds limitation also doesn’t apply if the charity keeps the donated vehicle and uses it significantly for charitable purposes or makes material improvements before ultimately selling it. In these cases, the donor can generally deduct the FMV of the vehicle as of the contribution date. The charity will indicate when one of these exceptions applies by checking box 5a on Form 1098-C and describing the significant use or material improvements on line 5c. (IRS Notice 2005-44)

Form 1098-C required. The taxpayer cannot claim any deduc-tion above $500 for a donated vehicle unless the recipient charity provides an acknowledgment on Form 1098-C. The Form 1098-C must be provided within 30 days of the sale (or within 30 days after the donation if one of the exceptions explained above applies). Donor must attach Copy B of Form 1098-C to their Form 1040. (IRS Notice 2005-44) Note: When the taxpayer’s noncash charitable donations exceed $500, Form 8283 must also be filed with Form 1040.

Required Reductions to FMV— Donating Appreciated PropertyThe amount allowed as a deduction for donated property may be less than FMV depending on the type of property involved.Ordinary income property. The deduction is generally limited to the adjusted basis of the property. This applies to property that would generate ordinary income if sold at FMV on the date of contribution. The allowable deduction is FMV reduced by the amount that would be ordinary income or short-term capital gain if sold at FMV.Recapture income under Sections 617, 1245, 1250, 1252 and 1254 is also ordinary income for this purpose. Therefore, the deductible amount is the asset’s FMV reduced by the amount of recapture income that would be generated on the asset’s sale.Capital gain property. Generally, the deduction is FMV for prop-erty that would generate long-term capital gain if sold at FMV on the contribution date.Exceptions: FMV must be reduced by any amount that would have been long-term capital gain if the property were sold for FMV if:•Theproperty(otherthanqualifiedappreciatedstock)iscontrib-

uted to a private nonoperating foundation,•Thepropertyistangiblepersonalpropertythatisputtoanunre-

lated use by the charity or

•Thetaxpayerelectstoapplythe50%-of-AGIlimitratherthanthe30%-of-AGI limit that normally applies to donations of capital gain property.

Qualified appreciated stock is corporate stock that is long-term capital gain property for which market quotations are readily available on an established securities market. Quotations from a brokerage firm do not meet this test (Ltr. Rul. 199915053). Quali-fied appreciated stock does not include any stock if the taxpayer and his family have contributed (considering all prior contributions) more than 10% of the value the corporation’s outstanding stock. [IRC§170(e)(5)] Note: Shares in open-ended mutual funds are treated as quali-fied appreciated stock if quotations are readily available in general circulation newspapers. (Ltr. Rul. 199925029)Unrelated-use property. If tangible personal property is put to an unrelated use by the charity, such as donating a painting to a church that then sells it, the deduction is limited to the property’s adjusted basis. Fair market value would be allowed for the deduction if the taxpayer obtains a letter from the charity stating its intention to use the gift in a way that is related to the organization’s charitable purpose. If the deduction for the property is more than $5,000, the charity must agree in writing on Form 8283 to notify the IRS if the property is sold within two years of the donation.

Donating Appreciated PropertyExamples of Ordinary Income

Property—Deduct BasisExamples of Capital Gain

Property—Deduct FMV• Inventory.• Donor’s creative works.• Stocks and other capital assets held

one year or less.• Business-use property to the extent it

would generate ordinary income if sold (such as depreciation recapture).

• Land held more than a year.• Stocks and other capital assets

held more than a year.• Jewelry, artwork, etc. held more

than one year.

@ Strategy: Capital gain property. Donate property and deduct FMV (reduced by any allowable depreciation). Even though ap-preciation of the property is not reported as income, a deduction for full FMV is allowed.@ Strategy: Depreciated business or investment property. Sell the asset and donate the proceeds. This generates a deductible loss from the sale and a deduction for a charitable contribution. If the property itself is donated, the deduction is limited to its FMV and no capital loss is allowed.

Gifts of Remainder InterestsA remainder interest is the legal right to own property at the end of a fixed period of time or at the death of another person. The right to own the property in the interim is an “estate for a term of years” or a “life estate.”To qualify for a charitable deduction, a remainder interest donated to charity must be one of the following.1) Personal residence or farm[IRC§170(f)(3)(B)].Thetaxpayer

retains rights to own and use the property until death.2) Qualified conservation contribution[IRC§170(h)].Acontribution

of real property interests exclusively for conservation purposes, including remainder interests and use restrictions granted in perpetuity.

3) Charitable remainder trusts and pooled-income funds [IRC §170(f)(2),§664and§642(c)(5)].Generally,acharitableremain-der trust is required to make annual payments to noncharitable beneficiaries for life or for a term of years and to pay the remain-der to charity. A pooled-income fund functions like a charitable remainder trust but holds assets from multiple donors.


Business Use of Vehicles—75% RuleFarmers can claim 75% business use for vehicles used primarily for farming business instead of keeping records of business mile-age.[Temp.Reg.§1.274-6T(b)]Once this method is elected, it must be used in future years. Like-wise, if the standard mileage rate or actual expenses method is elected, the farmer cannot revert to the 75% rule.

Conservation ExpensesA farmer may elect to deduct or capitalize certain expenses for soil andwaterconservationortopreventfarmlanderosion(IRC§175).The election must be made in the first year that the farmer pays or incurs such expenditures, and is binding for all subsequent years. Conservation expenses must be allocated if they benefit both land used for farming and land that does not qualify.Deductible conservation expenses. Water and soil conserva-tion expenses are deductible for land used currently or in the past for farming by the farmer or the farmer’s tenant. Water and soil conservation expenses may be deductible if they are consistent with a plan approved by the USDA’s Soil Conservation Service or a comparable state agency. The deduction cannot exceed 25% of gross income from farming. Deductions not allowed in the current year may be carried forward to following years, subject to the 25% limitation. Deductible conservation expenses include:•Treatmentormovementofearth (grading, leveling, terracing,

conditioning, contour furrowing, restoration of fertility).•Eradicationofbrush.•Plantingwindbreaks.•Construction,controlandprotectionof irrigationanddrainage

ditches, diversion channels, earthen dams, outlets, ponds. Notes:•Expensestodrainorfillwetlandsarenotdeductible.•Expenses tomaintain completed soil andwater conservation

structures (for example, the removal of drainage ditch sediment) are deductible farm business expenses.

•Any cost-sharing payments received for deducted expensescannot be excluded.

Depreciable conservation expenses. Expenses for nonearthen items of masonry or concrete must be capitalized. Depreciable conservation expenses include: materials, supplies, wages, fuel, hauling and moving dirt for structures or facilities such as tanks, reservoirs, pipes, conduits, canals, dams, wells or pumps made of masonry, concrete, tile, metal or wood. Exception: Part of an assessment for depreciable property levied against a farm by a soil and water conservation or drainage district may be deductible. Land clearing versus soil and water conservation. Land clear-ing prepares the land for farming, while soil and water conservation preserves the quality of land being farmed. Expenses for land clearing are added to the basis of the land and are not deductible. Land clearing expenses include:•Cuttingtrees,blastingstumps,burningresidualundergrowth.•Levelinglandforplantingorirrigation.•Removingmineralssuchassaltfromthesoil.•Divertingastreamtoanotherwatercourse.•Drainingandfillingaswampormarsh.

Section 179 Deduction—Farm PropertySee Section 179 Deduction on Page 10-9 for general rules. Also see Section 179 Limit for Heavy Vehicles on Page 11-3.Farm property that qualifies for a Section 179 deduction includes:•Tangiblepersonalpropertysuchasmachineryandequipment,milk

tanks, automatic feeders, barn cleaners and office equipment.

•Livestock(horses,cattle,hogs,sheep,goatsandminkandotherfur bearing animals).

•Certainfacilitiesusedforthebulkstorageoffungiblecommodi-ties. This includes grain bins used in connection with the produc-tion of grain or livestock.

•Single-purposeagriculturalandhorticulturalstructures.•Vineyardplantingcosts,includinglandpreparation(otherthan

nondepreciable land costs). (CCA 201234024)Single-purpose agricultural structure. Building or enclosure specifically designed, constructed and used for housing, raising and feeding a particular type of livestock (including poultry but not horses), their produce and the equipment necessary for feeding andcaring for them [IRC§168(i)(13)].This includesstructuresused to:•Breedchickensorhogs.•Producemilkfromdairycattle.•Producefeedercattleorpigs,broilerchickensor

eggs.Single-purpose horticultural structure:1) A greenhouse specifically designed, constructed and

used for the commercial production of plants or2) A structure specifically designed, constructed and used for

commercial mushroom production.

Depreciating Farm AssetsThree-, five-, seven- and 10-year MACRS property used in a farming business must be depreciated using the 150% declining-balance or straight-line method. See MACRS Recovery Periods (2012) on Page 10-2.

Estimated TaxNo penalty for failing to make estimated tax payments for 2012 if at least two-thirds of total gross income was from farming or fishing during 2012 or 2011 and Form 1040 is filed and all the tax due is paid by March 1, 2013. See also Underpayment/Estimated Tax Penalty on Page 16-5.If a farmer or fisherman must pay 2012 estimated tax, only one annualpaymentisrequiredbyJanuary15,2013,usingspecialrules to figure the amount of the payment. See Pub. 225 for details.Farming gross income. Determine if at least two-thirds of total gross income is from farming or fishing as follows:•Grossincomefromfarmingincludes:

– Gross farm income from Schedule F.– Gross farm rental income from Form 4835.– Gross farm income from Schedule E, Parts II and III.– Gains from the sale of livestock used for draft, breeding, sport

or dairy purposes reported on Form 4797.•Grossincomefromfarmingdoesnotinclude:

– Wages received as a farm employee.– Gains from sales of farmland and depreciable farm equipment.– Income received from contract grain harvesting and hauling

with workers and machines furnished by the taxpayer.

Form T (Timber)—Forest Activities ScheduleGenerally, Form T should be filed when standing timber is sold or cut, or when there are other timber transactions.Form T must be completed to claim a deduction for timber deple-tion, to elect to treat the cutting of timber as a sale or exchange under Section 631(a), or to report outright sales of timber under Section 631(b). Note: For more information about the taxation of timber, see Forest Landowners’ Guide to the Federal Income Tax, available at www.fs.fed.us/publications.


Sale or exchange of timber:•Timber sold primarily for sale to customer. Gain or loss is treated

as ordinary income subject to SE tax. Farmers who cut and sell timber on their land in the form of logs, firewood or pulpwood report income and expenses as ordinary income and expenses on Schedule F.

•Standing timber sold from investment property. Treated as a capital gain or loss, reported on Form 8949.

•Outright sales of timber. Outright sales of timber by landowners qualify for capital gains treatment if the timber was held for more than one year before the date of disposal.

Generally, cutting of timber results in no gain or loss until sold or exchanged. Exception: Under Section 631(a) taxpayers can elect to treat the cutting of timber as a sale under Section 1231 in the year it is cut. To qualify for the Section 631(a) election, the timber must be cut for sale or for use in the taxpayer’s trade or business, and the taxpayer must own or hold a right to cut timber for more than one year before the timber is cut.Timber depletion. The depletion deduction for timber must be calculated using cost depletion. The depletion is taken in the year of sale or other disposition of the products cut from the timber, un-less the taxpayer elects to treat the cutting of timber as a sale or exchange. The depletion deduction is limited by the adjusted basis of the timber. The adjusted basis for depletion cannot include the residual value of land and improvements at the end of operations. [Reg.§1.612-1(b)(1)]

Example: Samuel purchases a timber tract for $160,000. The residual value of the land at the time of purchase, assuming all timber has been cut, equals $100,000. The depletable basis of the timber for cost depletion is $60,000 ($160,000 – $100,000). Samuel determines that the standing timber will pro-duce 1,000 units when cut. Samuel’s depletion per unit equals $60 ($60,000 ÷ 1,000). If Samuel sold 300 units during the year, his depletion allowance would be $18,000 (300 × $60).

DOMesTIc PrODucer DeDucTIOn (DPD)

Form 8903

For 2012, the DPD is 9% of the lesser of the business’s:1) Qualified production activities income or 2) Taxable income (AGI for individual taxpayers) determined

without regard to the DPD.The DPD cannot exceed 50% of the wages paid and reported on Form W-2 by the business for the year (and allocable to domestic production gross receipts).Oil and gas activities. Individuals with oil-related qualified pro-duction activities income must reduce their DPD by 3% of the least of their (1) oil-related qualified production activities income, (2) qualified production activities income or (3) AGI (determined withoutregardtotheDPD).[IRC§199(d)(9)]Oil-related qualified production activities income is qualified pro-duction activities income attributable to the production, refining, processing, transportation or distribution of oil, gas or any primary product thereof.

Qualified Production Activities IncomeTo determine the net income that qualifies for the 9% deduction, the taxpayer’s receipts must be divided into those from eligible activities (domestic production gross receipts or DPGR) and non-

DPGR. Then, the taxpayer’s expenses are allocated between the two categories of income. The DPGR less allocable expenses equals qualified production activities income.Eligible activities. The following activities generate DPGR if performedintheU.S.:[IRC§199(c)(4)]•Manufacture,production,growthorextractionof:

– Tangible personal property (for example, clothing, goods, food, agricultural products).

– Computer software.– Sound recordings.

•Certainfilmproduction.•Productionofelectricity,naturalgasorpotablewater.•Constructionorsubstantialrenovationofresidentialandcom-

mercial buildings and infrastructure by taxpayers engaged in the construction business.

•Engineeringandarchitecturalservicesperformedbyataxpayerengaged in the business of performing engineering or architec-ture.N Observation: While most U.S. farming activities will generate DPGR, income from custom farming if the farmer does not have the benefits and burden of ownership of the property is not DPGR. Expired Provision Alert: For 2006–2011, qualified production activities performed in Puerto Rico was included in the domestic production gross receipts calculation as long as the activity in Puerto Rico was subject to U.S. tax. It’s possible Congress will extend this provision to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.Allocating costs. There are three methods for allocating costs to DPGR (that is, income that qualifies for the DPD) and non-DPGR. [Reg.§1.199-4]Small business simplified overall method. Allocate all deductions (including cost of goods sold) and losses between DPGR and non-DPGR based on relative gross receipts. Available to:•Taxpayerswith average gross receipts under

$5 million.•Taxpayerswithaveragegrossreceiptsof$10mil-

lion or less, if they qualify to use the cash method under Revenue Procedure 2002-28.

•Farmersnotrequiredtousetheaccrualmethod.Simplified deduction method. Use gross receipts to allocate all costs and expenses except cost of goods sold. Cost of goods sold must be specifically traced to DPGR and non-DPGR. Available to taxpayers with average annual gross receipts of $100 million or less or total assets of $10 million or less at the end of the year.Section 861 Method. Deductions are allocated to DPGR using the rules under Section 861 for allocating deductions to foreign income. This is the most complex method because it requires tracing each cost to income.

S Shareholders and PartnersThe DPD is determined at the shareholder or partner level so taxpayers should get the information from the S corporation or partnership Schedule K-1. Eligible small S corporations and partnerships can choose to compute qualified production activi-ties income and Form W-2 wages at the entity level and allocate those amounts to the shareholders or partners, who then report the amounts on lines 7 and 17 of Form 8903.

—End of Tab 6—

2013

are


scheDule D/FOrM 8949— general rules

See also IRS Pubs. 544, 550 and 551

Capital Gains and Losses•Asaleorexchangeofacapitalassetproducesacapitalgainor

loss. Exception: Certain small business stock receives ordinary loss treatment. See Section 1244 (Small Business) Stock Losses on Page 7-6.

•Thetaxrateonacapitalgaindependsontheholdingperiod,type of capital asset and taxpayer’s ordinary income tax bracket. See the Capital Gain and Dividend Tax Rates—2012 table on Page 7-1.

•Capital lossesarenettedagainst capitalgains.Up to$3,000($1,500 if MFS) of excess capital losses are deductible against ordinary income each year.

•Unusednetcapital lossesarecarriedforward indefinitelyandmay offset capital gains, plus up to $3,000 ($1,500 if MFS) of ordinary income during each subsequent year.

Ordering rules:Short-Term Capital Losses (use in the following order):•Reduceshort-termcapitalgains.•Reducenetlong-termcapitalgaintaxedat28%.•Reducenetlong-termgaintaxedat25%.•Reducenetcapitalgaintaxedat15%(or0%).Long-Term Capital Losses (use in the following order):•Netcapitallossesfrom28%rateassetsreducelong-termgains

taxed at 25%, then long-term gains taxed at 15% (or 0%).•Netcapital lossesfrom15%(or0%)rateassetsreducelong-

term gain taxed at 28%, and then reduce long-term gain taxed at 25%. Note: Capital losses carried over retain their character as long-term or short-term.Amount. Gain or loss is the difference between the sales price and the taxpayer’s adjusted basis in the asset. See the Basis for Computing Gain or Loss chart on Page 7-1.Personal use. A gain on the sale of property used for personal purposes is taxable as a capital gain. A loss on the sale of property used for personal purposes is not deductible. Deductible losses are limited to business, investment, casualty and theft losses.[IRC§165(c)]

Capital Asset DefinedA capital asset is any property held by a taxpayer exceptthefollowing:(IRC§1221)•Inventoryheldmainlyforsaletocustomersinatradeorbusiness.•Accountsornotesreceivablefromatradeorbusiness.•Depreciablepropertyusedinatradeorbusiness.•Realestateusedinatradeorbusinessorasrentalproperty.•U.S.Governmentpublications received fromthegovernment,

other than by purchase at the normal sales price.•Commodities-derivativefinancialinstrumentsheldbyadealer.

Certain exceptions apply.•Certainhedgingtransactionsenteredintointhenormalcourse

of a trade or business.•Suppliesregularlyusedinatradeorbusiness.•Theright toreceive futureordinary incomepayments(forex-

ample, right to lottery winnings).•Self-createdcopyrights,literary,musicalorartisticcompositions,

letters or memoranda or similar property.

Musical compositions. Taxpayers can elect to treat musical compositions they created (or copyrights to the work) as a capital asset, qualifying any gain on the sale for the 15% maximum rate iftheassetwasheldoveroneyear[IRC§1221(b)(3)].Thiselection also applies to works or copyrights received as a gift from the person who created them.

Holding PeriodCapital gains and losses must be separated according to howlongthepropertywasheld.(IRC§1222)Short-term. The holding period is one year or less.Long-term. The holding period is more than one year.To figure the holding period, begin counting on the day after the day the property is acquired and include the date of disposi-tion (Rev. Rul. 66-7). Exceptions: Property that is acquired by inheritance (other than from a decedent for whom the special 2010 election was made) is treated as long-term property, regardless of howlongactuallyheld[IRC§1223(9)].Anonbusinessbaddebtmustbetreatedasashort-termcapitalloss.[IRC§166(d)]Securities traded on an established market. For securities traded on an established securities market, the holding period begins the day after the trade date the securities are purchased, and ends on the trade date the securities are sold. Note: The trade date is different than the settlement date, which is the date the stock must be delivered and payment must be made.

Example: Eric purchased stock (which is traded on an established market) that has a trade date of August 28, 2011. In order to qualify for the long-term holding period, the stock would have to be sold with a trade date on or after August 29, 2012.

Capital Gain Tax Rates for Sales in 2012For 2012, the long-term capital gains tax rates are 0%, 15%, 25% or 28%. See the Capital Gain and Dividend Tax Rates—2012 table on Page 7-1.Alternative minimum tax (AMT). The long-term capital gain tax rates also apply for AMT purposes.28% rate. The 28% maximum tax rate applies to gain from the sale of (1) collectibles held more than one year, and (2) Section 1202 qualified small business stock held more than five years (the por-tion of the gain that is not excluded from income). To the extent a taxpayer is in a tax bracket below 28%, the lower tax rate applies.25% rate. The 25% maximum tax rate applies to unrecaptured Section 1250 gain on sales of property held more than one year. To the extent a taxpayer is in a tax bracket below 25%, the lower tax rate applies.15% rate. The 15% rate (0% for taxpayers in the 10% and 15% brackets) applies to long-term gains and qualified dividends. See Dividends on Page 5-23 for definition of qualified dividends.U Caution: The 0% capital gains tax rate applies when ordinary taxable income (Form 1040 line 43 less qualified dividends and long-term capital gain) is less than the beginning of the 25% tax bracket. However, should line 43 exceed the beginning of the 25% tax bracket, any long-term capital gains contributing to the amount in excess of the 25% tax bracket will be taxed at 15%. See Planning for the 0% Capital Gain Rate in Tab 6 of the Tax Plan-ning for Individuals Quickfinder® Handbook for more information.Installment payments. The tax rate that applies under the install-ment method is determined by the rates in effect on the date an installment payment is received, not the rate that applies at the time of sale. See Installment Sales on Page 7-11.


Reporting Different Long-Term RatesAll long-term capital gains and losses are entered on Part II of Form 8949, regardless of whether they are subject to the 0%, 15%, 25% or 28% rates. The totals from Form 8949 carry to Schedule D, where long-term and short-term gains and losses are combined or netted.If the taxpayer has a net capital gain (that is, net long-term capital gain exceeds net short-term capital loss):•UnrecapturedSection1250gainsarecarriedtothe

Unrecaptured Section 1250 Gain Worksheet in the Schedule D (and Form 8949) instructions to calculate the net gain subject to the 25% rate. This amount is then carried to Line 19 of Schedule D.

•Gainssubjecttothe28%ratearecarriedtothe28% Rate Gain Worksheet in the Schedule D (and Form 8949) instructions to calculate the net gain subject to the 28% rate. This amount is then carried to Line 18 of Schedule D.

Taxpayers with any net capital gains subject to the 25% or the 28% rates must use the Schedule D Tax Worksheet in the Schedule D (and Form 8949) instructions.Partnerships and S corporations. Pass-through entities must provide the necessary information on Schedule K-1 to determine gains eligible for the different maximum tax rates.

Unrecaptured Section 1250 GainFor sales of Section 1250 property (most depreciable real prop-erty), any long-term capital gain attributable to depreciation (other than depreciation recaptured as ordinary income) is taxed at a maximum rate of 25%. In general, unrecaptured Section 1250 gain is the gain to the extent of straight-line (SL) depreciation allowed.Calculation. Generally, the unrecaptured Section 1250 gain is the smaller of (1) depreciation claimed or (2) total gain less any recaptured depreciation that is taxed at ordinary rates (that is, accelerated depreciation in excess of SL). This amount is then limited to the net Section 1231 gain. Finally, any net 28% rate loss is used to offset the unrecaptured Section 1250 gain.

Example: Harry sold rental property for $150,000. He paid $100,000 for the property several years ago and had depreciated $20,000 under MACRS (SL depreciation). Of his total $70,000 gain ($150,000 proceeds – $80,000 adjusted basis), $50,000 is attributable to appreciation (which is taxed at a maximum rate of 15%), and $20,000 is attributable to depreciation (which is taxed as unrecaptured Section 1250 gain at a maximum rate of 25%).

28% Rate GainCollectibles gain or loss. A collectibles gain (loss) is any long-term gain or deductible long-term loss from the sale or exchange of a collectible that is a capital asset. Collectibles include works of art, rugs, antiques, metals (such as gold, silver and platinum bullion), gems, stamps, coins, alcoholic beverages and certain other tangible property. Also include any gain (but not loss) from the sale or exchange of an interest in a partnership, S corporation or trust held for more than one year and attributable to unrealized appreciation of collectibles.Qualified small business stock. Up to 50% (60% for certain empowerment zone business stock) of the gain from the sale of Section 1202 qualified small business stock (QSBS) is excluded from gross income if held for more than five years. The taxable portion of the gain is included in income as long-term capital gain subject to the 28% rate.

Note: A 75% gain exclusion rate applies to QSBS (including QSBS stock in certain empowerment zone businesses) acquired from February 18, 2009–September 27, 2010. A 100% gain ex-clusion applies to QSBS acquired from September 28, 2010–De-cember 31, 2011. However, the 75% and 100% gain exclusions will not apply to 2012 sales since the five-year holding period will not be met. Under Section 1045, gain from the sale of QSBS held over six months may be rolled over by acquiring the stock of another quali-fied small business within 60 days. If a partnership or S corporation sells such stock and does not elect to defer the gain on the sale, a non-corporate partner or shareholder can purchase replacement stock within 60 days of the date of the sale and elect to defer his distributive share of the pass-through entity’s gain.See AMT for Individuals—Adjustments and Preferences on Page 12-14 for AMT rules on QSBS. Also see Small Business Stock in Tab C in the Small Business Quickfinder® Handbook.

Related-Party TransactionsIn general, a loss on the sale of property between related parties isnotdeductible(IRC§267).Ifthepropertyislatersoldtoanun-related party, gain is recognized only to the extent that it is more than the loss not allowed from the previous transfer.

Example: Colin sells stock with a cost basis of $10,000 to his brother Finn for $7,600. Colin’s $2,400 loss is not deductible. Finn later sells the same stock to an unrelated person for $10,500. Although Finn has a gain of $2,900, his taxable gain is only $500, the amount the gain exceeds Colin’s unallowed loss.

If the property is later sold to an unrelated party at a loss, the loss disallowed to the related party cannot be recognized.Definition. A related party is a family member who is a brother or sister (whether by whole or half blood), spouse, ancestor (parent, grandparent, etc.) or lineal descendant (child, grandchild, etc.) of a taxpayer. A cousin, aunt, uncle, nephew, niece, stepchild, step-parent or in-law is not a related party for this purpose.For related party rules between individuals, corporations, trusts, fiduciaries and other organizations, see Related-Party Transactions in Tab O in the Small Business Quickfinder® Handbook.

Deceased Spouse’s Capital Loss CarryoverA surviving spouse cannot claim a deceased spouse’s capital loss carryover from joint return years (Ltr. Rul. 8510053). The annual $3,000 net capital loss limitation applies to the final Form 1040 of the deceased taxpayer (if a joint return is filed). Any remaining capital losses allocable to the deceased spouse are lost and cannot be carried over to the surviving spouse’s Form 1040, the Form 1041 filed by the decedent’s estate or to any other beneficiary’s return.@ Strategy: In Letter Ruling 8510053, the property sold was the decedent spouse’s separate property. If the property was owned jointly by decedent and surviving spouse or owned by a decedent and surviving spouse residing in a community property state at the time of decedent’s death, the survivor would be entitled to half the loss carryforward.

Schedule D/Form 8949 Reporting Tips•Gains and lossesare reportedonForm8949and totals are

carried to Schedule D. Separate Forms 8949 are completed for (1) transactions reported on Form 1099-B with basis reported to the IRS (amount in box 3 and box 6b checked), (2) transactions reported on Form 1099-B but basis not reported to the IRS (box 6a checked) and (3) transactions for which a Form 1099-B was not received.

•Reportasaleofaprincipalresidenceonlyifrequired(seeTax Reporting Rules on Page 7-16).

2013


ReimbursementsWhen an employer reimburses an employee for travel, meals or entertainment expenses, the reimbursement is excluded from the employee’s income if the reimbursement arrangement is an accountable plan. Similar rules apply to independent contractors [Temp.Reg.§1.274-5T(h)(2)].Employeescannotdeductmealandentertainment expenses if the employer reimburses the expenses under an accountable plan and does not treat the reimbursement as wages. See Accountable Plan/Nonaccountable Plan below. Independent contractors cannot deduct meals and entertainment expenses if the customer or client makes direct reimbursement for the expenses and adequate records are submitted to the customer or cli-ent. See Elements to Prove Certain Business Expenses on Page 9-6. Note: If reimbursements for meals are excluded from the income of the employee or independent contractor, the employer (or customer/client) is generally subject to the 50% deduction limit. See 50% Limit on Page 9-2.Failure to claim reimbursement. Employees may not deduct busi-ness expenses that are eligible for reimbursement from the employer.

Accountable Plan/Nonaccountable PlanAccountable plan. Reimbursements made to an employee under an accountable plan are not included in the employee’s income, and the employee does not deduct the expenses.Nonaccountable plan. Reimbursements made to an employee under a nonaccountable plan are treated as taxable wages and re-ported in box 1 of Form W-2. The employee deducts the expenses on Form 2106, subject to the 2%-of-AGI limitation on Schedule A.An employee who receives payments under a nonaccountable plan cannot convert the payments to an accountable plan by voluntarily accounting to the employer or returning excess payment.Accountable plan requirements: [IRC§62(c)]1) Business Connection. The reimbursement must be for job-

related expenses the employee would reasonably be expected to incur. A plan that reimburses personal expenses does not qualify as an accountable plan. Caution: An arrangement that recharacterizes wages as nontaxable reimbursements or allow-ances does not satisfy the business connection requirement. (Rev. Rul. 2012-25)

2) Substantiation. The employee must substantiate the expense by providing receipts or other documentation to the employer within a reasonable period of time.

3) Return of Excess Reimbursement. The employee must be required to return any excess reimbursement to the employer within a reasonable period of time.

Reasonable period of time. The following situations will be considered within a reasonable period of time for purposes of accountable plans.1) The employee receives an advance within 30 days of the time

the expense is incurred.2) The employee adequately accounts for the expense within 60

days of the time the expense was paid or incurred.3) Any excess reimbursement is returned to the employer within

120 days after the expense was paid or incurred.4) The employer provides a statement to the employee (at least

quarterly) asking the employee to either return or adequately account for outstanding advances, and the employee complies within 120 days of the statement.

If the above requirements are not met, the plan is considered a nonaccountable plan.Part accountable plan or part nonaccountable plan. If an employer makes reimbursements to an employee under an ac-countable plan, but some reimbursements do not qualify under accountable plan rules, only the reimbursements falling under the nonaccountable plan are considered taxable wages. Each plan is viewed separately, and the employer treats the employee as having received reimbursements under two different plans.

abOve-The-lIne DeDucTIOn FOr cerTaIn eMPlOyees

Government officials paid on a fee basis, qualified performing art-ists, Armed Forces reservists and educators can claim business expensesasanadjustmenttoincome.[IRC§62(a)(2)and162]Government fee basis officials (FBOs). Individuals who are employed by a state or local government and paid in whole or in part on a fee basis.Qualified performing artists (QPAs):1) Perform services as an employee in performing arts for at least

two employers during the tax year and receive at least $200 from any two of the employers,

2) Incur performing arts-related business expenses of more than 10% of the gross income from performing arts and

3) Have AGI of $16,000 or less before deducting performing arts expenses. To qualify, married individuals must file a joint return unless they lived apart for all of the tax year.

Armed Forces reservists. National Guard members and Armed Forces reservists who must travel more than 100 miles away from home and stay overnight to fulfill their training and service com-mitments can claim an above-the-line deduction for the cost of transportation, meals (subject to the 50% disallowance rule) and lodging. The deductible amounts are limited to general federal government per diem amounts for the applicable locale.Form 2106 is completed to report eligible expenses for FBOs, QPAs and reservists. The expenses are then entered on line 24 of Form 1040.Educators. For 2011 grades K–12 teachers, instructors, counsel-ors, principals and aides can deduct up to $250 of unreimbursed expensesonline23ofForm1040(upto$500ifMFJandbothspouses are educators). Only expenses in excess of excludable U.S. bond interest, nontaxable qualified tuition plan distributions and nontaxable Coverdell ESA distributions are allowable. The taxpayer must spend at least 900 hours during a school year as an educator. Qualified expenses include amounts paid for books, supplies (other than nonathletic supplies for courses of instruction in health and PE), computer software and equipment, and other equipment and materials used in the classroom. Amounts that can-not be deducted above the line can be deducted as unreimbursed employee business expenses, subject to the 2%-of-AGI limit. Expired Provision Alert: The educator’s expense deduction expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.

Per DIeM raTesSee also IRS Pub. 1542

Per Diem Substantiation MethodsThe federal per diem rates accepted by the IRS for meals, lodging and other incidental expenses vary depending on the travel location. The per diem rates for travel are revised each year on October 1. For the last three months of the year, taxpayers use either the per diem rates effective October 1 of the preceding year or the revised rates effec-tive October 1 of the current year. They must use either the current rates or the revised rates consistently for all travel during that period.Meals and incidental expenses (M&IE) rate. Instead of deduct-ing actual expenses incurred for M&IE while traveling for business, employees and self-employed individuals may deduct the per diem amounts, if they document the time, place and business purpose for the travel. Also, employees and self-employed individuals who are reimbursed for their meals and incidental expenses are treated as substantiating the amount of those expenses up to the IRS per

2012


diem rate (or actual reimbursement, if smaller) if they substantiate the time, place and business purpose. If the reimbursement is made under an accountable plan, only amounts over the per diem rate are reported as taxable income on Form W-2.See the Meals and Incidental Expenses Per Diem Rates table on Page 9-9.U Caution: Only 50% of the M&IE rate is deductible.Incidental expenses. Employees and self-employed individuals who do not incur meal expenses while traveling can use the per diem al-lowance for incidental expenses (IE) only (for any location, $5 per day for 2012). Through September 30, 2012, incidental expenses include fees and tips given to porters, baggage handlers, maids and others, plus the cost of transportation to get meals if suitable meals are not available at the lodging or temporary duty site. Beginning October 1, 2012, incidental expenses no longer include transportation to get meals or mailing costs for travel vouchers and credit card payments. These amounts may be separately deducted or reimbursed from incidental expenses. In both periods, expenses for laundry, lodging taxes and telephone calls are not incidental expenses.Lodging expense. A per diem allowance for lodging may only be used by employers for determining employee reimbursements and income exclusion (if paid under an accountable plan). Sole proprietors and employees may not use the per diem allowance to substantiate a lodging deduction; actual receipts are needed. (Bracey, TC Memo 1998-254)

Who Can Use Per Diem Rates?

Taxpayer M&IE and Lodging

M&IE Only

IE Only

Self-employed (Schedule C or F) No Yes YesUnreimbursed employee (Form 2106) No Yes YesEmployer reimbursement to unrelated employee Yes Yes YesEmployer reimbursement to 10% related employee No Yes YesPayer reimbursement to partner Yes Yes YesPayer reimbursement to volunteer Yes Yes Yes

Trucks with sleepers. A trucking company reimbursed drivers at the federal per diem rate for lodging, even though the drivers usually slept in their trucks. The IRS found no reasonable basis for the employer to believe the drivers were incur-ring lodging expenses. Instead, the amounts designated as per diem for lodging should be treated as wages. (Ltr. Rul. 9146003)

Switching MethodsTaxpayers can use either the M&IE rate or keep records of actual expenses for each business trip. However, the taxpayer must use the same method for all days within any single business trip.

High-Low Per Diem MethodThe high-low method is a simplified per diem substantiation method with only two sets of rates. It can be used to reimburse employees for travel within the continental U.S. (CONUS). This method may be used both when lodging expenses are incurred and when only meal and incidental expenses are incurred.An employer may use the high-low rate for some employees and the federal travel per diem for others, but for a particular employee, the same method must be used for all trips during the year. Notes:•Usedonlybyemployerstocalculateaperdiemallowance.•Only50%oftheperdiemrateformealsisdeductible.The high-low rates and localities are revised on October 1 of each year.Taxpayerswhousedthehigh-lowmethodduringJanuary–September of 2012 can continue to use the rates in effect for those months for the remainder of the year. Or, they can use the rates and localities effective October 1, 2012 for the last three months

of 2012. However, either the existing or the revised rates must be used for all employees for the last three months of the year.

High-Low Per Diem RatesLocation Lodging Meals Total

Effective 10/1/11 – 9/30/12High-cost $177 $65 $242All other 111 52 163

Effective 10/1/12 – 9/30/13High-cost $177 $65 $242All other 111 52 163

The high-low per diem rates and the list of high-cost localities effective 10/1/12 are the same as those in effect starting 10/1/11 (Notice 2012-63). So for 2012, taxpay-ers will use the rates shown above and the high-cost localities listed at Page 9-9 for the entire year.

Outside Continental U.S.Federal per diem rates for nonforeign (AK, HI, Puerto Rico, Northern Mariana Islands and U.S. possessions) and foreign localities outside CONUS are available at www.state.gov. Click on the “Travel” tab.

Travel for Less Than 24 HoursWhen traveling to more than one location in a single day, the last stop of the day dictates the location and the per diem rate to use. On the first and last day of business travel, the standard meal allowance is prorated by either: (Rev. Proc. 2011-47)1) Claiming 75% of the standard meal allowance or2) Using any method that is consistently applied and in accordance

with reasonable business practice.

Example: Axel is on a temporary job assignment. He leaves home at 8 a.m. on April 20th and returns home at 4 p.m. on April 23rd.Method #1. Axel can be reimbursed for 31/2 days: 3/4 day on April 20th, two full days (April 21 and April 22) and 3/4 day on April 23rd.Method #2. Axel can be reimbursed for four days (if applied consistently and in accordance with reasonable business practice). Note: Self-employeds are limited to 31/2 days for purposes of determining their M&IE (or incidentals only) deduction. A federal employee is limited to 31/2 days.

Transportation WorkersSpecial M&IE per diem rate. Transportation workers can use the rates shown below. If these rates are used, they must be used for the entire calendar year. (Notices 2011-81 and 2012-63)

Transportation Workers—Special M&IE RatesTravel Location 10/1/2011 10/1/2012

Within CONUS $59 $59Outside CONUS 65 65

Transportation worker defined. This is an employ-ee or self-employed individual whose work:1) Directly involves moving people or

goods by airplane, barge, bus, ship, train or truck and

2) Requires the worker to travel away from home to areas with different federal per diem rates during any one trip.

Individuals subject to Department of Transportation (DOT) hours of service rules. These workers are allowed an 80% deduc-tionformeals,insteadoftheregular50%limit[IRC§274(n)(3)]. Workers subject to the rules include:1) Certain air transportation employees such as pilots, crew,

dispatchers, mechanics and control tower operators.2) Interstate truck operators and bus drivers.3) Certain railroad employees such as engineers, conductors,

train crews, dispatchers and control operations personnel.4) Certain merchant mariners.


Depreciation

DePrecIaTIOn rulesForm 4562; See also IRC §168 and IRS Pub. 946

What Property Can Be Depreciated?Depreciable property must meet all these requirements:1) It is owned by the taxpayer.2) It is used in the taxpayer’s business or income-producing

activity.3) It has a determinable useful life (it must be something

that wears out, decays, gets used up, becomes obsolete or loses its value from natural causes).

4) It is expected to last more than one year.5) It is not excepted property.Excepted property includes:•Propertyplacedinserviceanddisposedofinthesameyear.•Equipmentusedtobuildcapitalimprovements.•Section197intangibles.•Certainterminterests.

Reporting Depreciation and AmortizationFile Form 4562 if any of the following are claimed:•Depreciation forpropertyplaced inserviceduring thecurrent

year.•Section179deductionorcarryover.•Depreciationforlistedproperty.•Deductionforavehiclereportedonformsotherthan

Schedule C or Form 2106 (such as Schedules E and F).

•Amortizationofcostsbeginninginthecurrentyear.

File a separate Form 4562 for each business activity. However, complete only one Form 4562, Part I, for the Section 179 expense deduction claimed for all business activities.

MACRS Depreciation SystemsMACRS applies to assets placed in service after 1986. See IRS Pub. 534 for assets placed in service before 1987.MACRS provides two depreciation systems:1) General depreciation system (GDS). 200% declining balance

(DB), 150% DB or straight-line (SL), depending on the type of property and the method elected.

2) Alternative depreciation system (ADS). SL over a longer recovery period. ADS may be elected instead of GDS. However, in some cases, ADS is required. See Alternative Depreciation System on Page 10-9.

The depreciation method is elected on Form 4562 the year the property is placed in service. An election applies to all assets in a property class (for example, three-year, five-year, etc.) placed in service that year. Exception: The elec-tion is made on a property-by-property basis for nonresidential real and residential rental property.

MACRS Depreciation Methods (2012)Type of property Available methods

Nonfarm 3-, 5-, 7- and 10-year property. GDS–200% DBGDS–150% DB

GDS–SLADS–SL

• All farm property (except real property).

• 15- and 20-year property.1

GDS–150% DBGDS–SL

ADS–SL

• Residential rental property.• Nonresidential real property.• Trees or vines bearing fruit or nuts.• Water utility property.

GDS–SLADS–SL

Property for which ADS is required (see When ADS Must Be Used on Page 10-9).

ADS–SL

1 Expired Provision Alert: For 2011, qualified leasehold improvements, retail improvements and restaurant property were 15-year property, but were depreciated SL. See Qualified Real Property on Page 10-13.

Date Placed in ServiceDepreciation begins when property is placed in service (ready and available for use in a trade or business or income-producing activ-ity, regardless of when it was purchased). First-year depreciation is determined by applying the appropriate convention.

ConventionsHalf-year convention. Treats all property placed in service or disposed of during a tax year as placed in service, or disposed of, on the midpoint of that tax year. The half-year convention applies to all property except:1) Residential rental and nonresidential real property and2) Property subject to the mid-quarter convention.Mid-quarter convention. If the depreciable basis of property placed in service in the last three months of the year is more than 40% of the total depreciable basis of property placed in service during the entire year, the mid-quarter convention applies to assets placed in service that year. All property placed in service during that tax year is treated as placed in service, or disposed of, at the midpoint of the quarter it is placed in service or disposed of.

Tab 10 TopicsDepreciation Rules................................................ Page 10-1MACRS Recovery Periods (2012) ........................ Page 10-2MACRS Optional Tables (Various) ........................ Page 10-4Special Depreciation Allowance ............................ Page 10-8Alternative Minimum Tax Adjustments .................. Page 10-8Alternative Depreciation System ........................... Page 10-9Section 179 Deduction .......................................... Page 10-9Section 179 Recapture ....................................... Page 10-11Change of Use of MACRS Property ................... Page 10-12Dispositions of MACRS Property ........................ Page 10-12Depreciation Recapture ...................................... Page 10-12Like-Kind Exchanges—Depreciation Rules ........ Page 10-12Computer Software ............................................. Page 10-13Leasehold Improvements.................................... Page 10-13Qualified Real Property ....................................... Page 10-13Correcting Depreciation Errors ........................... Page 10-14Intangible Assets—Amortization Rules ............... Page 10-14

For 2012

are must be


Mid-Quarter PercentagesQuarter Acquisition Year Disposition Year

First 87.5% 12.5%

Second 62.5 37.5

Third 37.5 62.5

Fourth 12.5 87.5

Note: Figure the deduction for the year the asset is placed in service (disposed of) by multiplying full-year depreciation by the applicable percentage, based on the quarter in which the asset was placed in service (disposed of).

Excluded items. To determine if the mid-quarter convention applies, the following items are not counted:1) Property depreciated under a method other than MACRS,2) Residential rental property,3) Nonresidential real property,4) Property placed in service and disposed of in the same tax year

and5) Property expensed under Section 179.Mid-month convention. Treats all property placed in service or disposed of during any month as placed in service or disposed of on the midpoint of that month. This convention applies to residential rental and nonresidential real property.

Computing DepreciationOptional tables. The IRS provides optional tables that incorpo-rate the applicable convention and depreciation method. These tables, based on the property’s recovery period, begin on Page 10-4. Depreciation is calculated by multiplying the property’s unadjusted depreciable basis by the applicable percentage from the table each year. Once the optional table is used for an asset, it generally must be used for that asset’s entire recovery period. Exception: The tables cannot be used after the property’s basis is adjusted for a reason other than depreciation or an addition or improvement to that property that is depreciated as a separate item of property. For example, the optional table cannot be used after a basis reduction for a casualty loss. Note: The optional tables cannot be used for a short tax year. SeeTabJintheSmall Business Quickfinder® Handbook for cal-culating depreciation in a short tax year. If the optional tables are not used, depreciation is computed either using the declining balance or the straight-line method.Declining balance (DB) method. This method applies the same depreciation rate each year to the property’s adjusted basis, switching to straight line (SL) in the year that SL gives an equal or greater deduction.

Declining Balance RatesRecovery Period DB Percentage DB Rate Year SL begins

3-year 200% 66.667% 3rd

5-year 200 40.0 4th

7-year 200 28.571 5th

10-year 200 20.0 7th

15-year 150 10.0 7th

20-year 150 7.5 9th

Note: Compute the DB rate by dividing the DB percentage (150% or 200%) by the number of years in the property’s recovery period.

MACRS Recovery Periods (2012)See IRS Pub. 946 for more recovery periods. Note the

recovery periods assigned to certain assets used in specific activities.

Recovery Period (Years)

GDS ADSAgricultureAgricultural machinery and equipment 7 10Breeding or dairy cattle 5 7Breeding or work horses (12 years old or less) 7 10Breeding or work horses (more than 12 years old) 3 10Race horses 3 12Breeding hogs 3 3Breeding sheep and goats 5 5Farm buildings, other than single purpose 20 25Fences (agricultural) 7 10Grain bins 7 10Single-purpose agricultural or horticultural structures 10 15Trees and vines bearing fruit 101 20Drainage facilities 15 20Distributive Trades and ServicesAssets used in wholesale and retail trade and personal and professional services 5 92

MineralsAssets used in drilling for oil and gas wells (onshore) 5 6Assets used in exploration and production of oil and gas 7 14Office RelatedOffice furniture and fixtures (such as desks, files, safes) 7 10Computers and peripheral equipment 5 5Typewriters, calculators, copiers 5 6Computer software. See Computer Software on Page 10-13.Real PropertyLand improvements (sidewalks, roads, fences, etc.) 15 20Qualified leasehold improvements 151 39Qualified restaurant property 151 39Qualified retail improvement property 151 39Residential rental property—including mobile homes 27.51 40Retail motor fuel outlet 15 20Nonresidential real property 391 40TransportationAirplanes (noncommercial) and helicopters 5 6Automobiles, taxis 5 5Buses 5 9Light general purpose trucks (less than 13,000 lbs.) 5 5Heavy general purpose trucks (13,000 lbs. or more) 5 6Tractor units (for over-the-road use) 3 4Trailers (for over-the-road use) 5 6Water transportation equipment 10 18

OtherAppliances, carpets and furniture used in residential rental property 5 9Personal property with no class life 7 121 Must use SL.2 Five years for high technology medical equipment. 3 Expired Provision Alert: For 2011, qualified leasehold improvements, retail

improvements and restaurant property had a 15-year (39-year for ADS) recovery period. See Qualified Real Property on Page 10-13.


MACRS Nonresidential Real Property (31.5-Year)See Optional Tables on Page 10-2.

For property placed in service after 1986 and before May 13, 1993Straight-Line, Mid-Month Convention

Month Placed in ServiceYear 1 2 3 4 5 6 7 8 9 10 11 12

1............. 3.042% 2.778% 2.513% 2.249% 1.984% 1.720% 1.455% 1.190% 0.926% 0.661% 0.397% 0.132%2 – 7....... 3.175 3.175 3.175 3.175 3.175 3.175 3.175 3.175 3.175 3.175 3.175 3.1758............. 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.175 3.175 3.175 3.175 3.1759............. 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.17510........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174

11 ........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.17512........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.17413........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.17514........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.17415........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175

16........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.17417........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.17518........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.17419........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.17520........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174

21........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.17522........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.17423........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.17524........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.17425........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175

26........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.17427........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.17528........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.17429........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.17530........... 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174

31........... 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.175 3.174 3.17532........... 1.720 1.984 2.249 2.513 2.778 3.042 3.175 3.174 3.175 3.174 3.175 3.17433........... 0 0 0 0 0 0 0.132 0.397 0.661 0.926 1.190 1.455

Note: For an early disposition, pro-rate the depreciation from this table for the number of months in service (using mid-month convention).

MACRS Nonresidential Real Property (39-Year)See Optional Tables on Page 10-2.

For property placed in service after May 12, 1993Straight-Line, Mid-Month Convention


1............. 2.461% 2.247% 2.033% 1.819% 1.605% 1.391% 1.177% 0.963% 0.749% 0.535% 0.321% 0.107%2 – 39..... 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.56440........... 0.107 0.321 0.535 0.749 0.963 1.177 1.391 1.605 1.819 2.033 2.247 2.461


MACRS Straight-Line—40-Year, Mid-Month ConventionSee Optional Tables on Page 10-2.

• Alternative Depreciation System for residential rental or nonresidential real property.• AMT depreciation for residential rental or nonresidential property placed in service before 1999.

• Can be elected for regular tax and AMT.


1............. 2.396% 2.188% 1.979% 1.771% 1.563% 1.354% 1.146% 0.938% 0.729% 0.521% 0.313% 0.104%2 – 40 ..... 2.500 2.500 2.500 2.500 2.500 2.500 2.500 2.500 2.500 2.500 2.500 2.50041........... 0.104 0.312 0.521 0.729 0.937 1.146 1.354 1.562 1.771 1.979 2.187 2.396



sPecIal DePrecIaTIOn allOwanceIRC §168(k)

A special (bonus) depreciation allowance equal to 50% of the de-preciable basis of qualified property is claimed in Part II of Form 4562 for assets placed in service during 2012. Expired Provision Alert: For assets acquired and placed in service September 9, 2010–December 31, 2011, the special depreciation allowance was 100% (rather than 50%). It’s possible that Congress will extend the 100% rate to 2012, but it had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1. The special depreciation allowance equals 50% of the asset’s depreciable basis (cost or other basis less Section 179 deduction and credits). Exception: 100% special depreciation applies to cer-tain long-production period property and noncommercial aircraft placed in service in 2012. The amount of the special depreciation allowance is not affected by a short taxable year or by the applicable convention. (See Conven-tions on Page 10-1.) But, assets for which the special depreciation allowance is claimed are still counted for determining whether the mid-quarter convention applies for the “normal” MACRS deduction.@ Strategy: If the special depreciation allowance is taken, there are no AMT adjustments for depreciation for that asset for the year placed in service or any later year.

Qualified PropertyTo qualify for the special depreciation allowance, the property must be a new asset (see Original use below) that is either:•MACRSpropertywitharecoveryperiodof20yearsorless,•Computersoftware(otherthancomputersoftwarecoveredby

Section 197),•Waterutilitypropertyor•Qualifiedleaseholdimprovementproperty.SeeQualified lease-

hold improvement property Page 10-13.Business vehicles. The Section 280F limit on depreciation that applies to many vehicles is increased in 2012 by $8,000 for ve-hicles for which special depreciation is allowed. See the Business Vehicles—Quick Facts table on Page 11-1.Original use. To qualify for special depreciation, the asset must generally be new, rather than used. However, new property that a taxpayer acquired for personal use and later converted to business use meets the original-use requirement.[Reg.§1.168(k)-1(b)(3)]

Electing OutTaxpayers can elect not to claim special depreciation for any class of property by attaching a statement to the tax return. The election out applies to all additions to an asset class (for example, five-year property) for the year. [IRC§168(k)(2)(D)]

Election Out of Special Depreciation AllowanceTaxpayer elects under IRC Sec. 168(k)(2)(D)(iii) not to claim the special depreciation allowance for the following classes of property placed in service during the tax year ended [insert year-end] : [List property classes for which election is made.]

alTernaTIve MInIMuM Tax aDjusTMenTs

For alternative minimum tax (AMT), depreciation must be com-puted using the AMT method. For assets placed in service after 1998, the GDS recovery period is used for both regular tax and AMT. So for these assets, there is an AMT depreciation adjust-ment only if the AMT and regular tax depreciation methods differ.

AMT Depreciation Adjustment Required

Type of PropertyDepreciation Method

Regular Tax AMT3-, 5-, 7- and 10-yr property 200% DB 150% DBSection 1250 property 150% DB SL

Note: For property place in service after 1986 and before 1999, the ADS recovery period generally applied for AMT. Then, the AMT adjustment is the result of differ-ences in both the depreciation method and recovery period. See MACRS Recovery Periods (2012) on Page 10-2 for ADS recovery periods.

N Observation: For assets placed in service after 1998, no AMT adjustment is required for assets depreciated SL for regular tax. Commonexamplesare:[IRC§168(b)(3)]•Nonresidential realpropertywithaclass lifeof27.5yearsor

more.•Residentialrentalproperty.•Qualifiedleaseholdimprovement,restaurantandretailimprove-

ment property.•Treesandvinesbearingfruit.

Straight-Line PercentagesSee Optional Tables on Page 10-2.

• Alternative depreciation system (use ADS recovery period for regular tax and AMT). See When ADS Must Be Used on Page 10-9.

• SL MACRS depreciation (use GDS recovery period for regular tax and AMT).

YearHalf-Year

ConventionMid-Quarter Convention— Quarter in Which Acquired

1 2 3 4

3-Year Property1................... 16.67% 29.17% 20.83% 12.50% 4.17%2................... 33.33 33.33 33.33 33.33 33.333................... 33.33 33.33 33.34 33.34 33.334................... 16.67 4.17 12.50 20.83 29.17

5-Year Property1................... 10.00% 17.50% 12.50% 7.50% 2.50%2 – 5 ............. 20.00 20.00 20.00 20.00 20.006................... 10.00 2.50 7.50 12.50 17.50

7-Year Property1................... 7.14% 12.50% 8.93% 5.36% 1.79%2................... 14.29 14.29 14.29 14.29 14.293................... 14.29 14.28 14.28 14.28 14.284................... 14.28 14.29 14.29 14.29 14.295................... 14.29 14.28 14.28 14.28 14.286................... 14.28 14.29 14.29 14.29 14.297................... 14.29 14.28 14.28 14.28 14.288................... 7.14 1.79 5.36 8.93 12.50

10-Year Property1................... 5.00% 8.75% 6.25% 3.75% 1.25%2 – 10 ........... 10.00 10.00 10.00 10.00 10.0011 ................. 5.00 1.25 3.75 6.25 8.75


Other property without AMT adjustment:•Property(other thanSection1250property)placed inservice

after 1998 that is depreciated for regular tax using the 150% DB method or the SL method.

•PropertydepreciatedusingADSforregulartax.•Property forwhich the special depreciation allowance under

Sections 168(k) is claimed. See Special Depreciation Allowance on Page 10-8.

•PropertytotheextentaSection179electionismade.•Qualifieddisasterassistancepropertyforwhichaspecialdepre-ciationallowanceunderIRC§168(n)isclaimed.SeeFederally Declared Disasters on Page 5-16.

•Propertyforwhichaspecialdepreciationallowancewasclaimedbecause it replaced property damaged in the New York terrorist acts on September 11, 2001, by Hurricane Katrina or by the Kan-sas storms that occurred in 2007. See Pubs. 4492 and 4492-A for details.

•Motionpicturefilms,videotapesorsoundrecordings.•Propertydepreciatedundertheunit-of-productionmethodorany

other method not expressed in a term of years.•QualifiedIndianreservationproperty.•Qualifiedrevitalizationexpendituresforabuildingforwhichan

election is made to claim the commercial revitalization deduction under Section 1400I.

AMT Taxable Income AdjustmentThe AMT taxable income adjustment is the difference between the depreciation computed for AMT purposes and the depreciation claimed for regular tax.•If theAMT depreciation is less than the

depreciation claimed for regular tax, the difference is added to AMT taxable income.

•IftheAMTdepreciationisgreater than the depreciation claimed for regular tax (which usually occurs in the later years of the re-covery period), the difference is subtracted from AMT taxable income. Note: See Tab 12 for more information on AMT.

alTernaTIve DePrecIaTIOn sysTeMThe alternative depreciation system (ADS) applies SL depreciation over the ADS recovery period. The ADS method may be elected for most property, but is mandatory in some situations. See MACRS Recovery Periods (2012) on Page 10-2 for ADS recovery periods for commonly used assets. See the Straight-Line Per-centages table on Page 10-8 for optional table.

Electing ADS Method•Election is irrevocable, and applies to all

property in that class that is placed in service during the tax year of the election. Exception: The election for residential rental and nonresidential real property is made on a property-by-property basis.

•ElectionmustbemadebycompletingPartIII,SectionCofForm4562 by the due date (including extensions) of the return for the year in which the property is placed in service.

•Thehalf-year,mid-quarterandmid-monthconventionsapply.

When ADS Must Be Used•Listedpropertywith50%orlessbusinessuse.SeeListed Prop-

erty on Page 11-9.

•TangiblepropertyusedpredominantlyoutsidetheU.S.•Tax-exemptuseproperty.•Tax-exemptbondfinancedproperty.•ImportedpropertycoveredbyanexecutiveorderofthePresident

of the U.S.•Propertyusedpredominantlyinafarmingbusinessandplaced

in service during any tax year in which the taxpayer elects out of the Section 263A(d)(2) uniform capitalization (UNICAP) rules.

secTIOn 179 DeDucTIOnSection 179 allows a taxpayer to expense certain property in the year placed in service. To qualify, property must be used more than 50% in a trade or business and be acquired by purchase from an unrelated party.

Section 179 Property (2012)Qualifying Property

• Tangible personal property (such as machines, equipment, furniture).• Certain other tangible property used for specified purposes.• Single-purpose agricultural or horticultural structures.• Certain storage facilities.• Off-the-shelf computer software (see Computer Software on Page 10-13).

Nonqualifying Property• Property not used in a trade or business (investment property, most rentals).1

• Buildings and their structural components, air conditioning and heating units.• Property used in connection with furnishing lodging, except for hotel/motel operations.• Property used 50% or less in a trade or business.• Property acquired by gift, inheritance or trade.• Property purchased from certain related parties.• Property used outside the U.S.• Property used by tax-exempt organizations, governmental units.• Property used by foreign persons or entities.• Property held by an estate or trust.• Intangible property, except for certain computer software.1 Property rented to others generally doesn’t qualify unless the taxpayer purchases it,

the lease term is less than 50% of the property’s class life and for the first 12 months of the lease, business deductions on the property exceed 15% of its rental income.

Property Eligible for Section 179 Expense (2012)Not an Exhaustive List

• Airplanes.• Automobiles.• Billboards (if movable).• Computers.• Drain tiles used to improve the drainage

of a pasture.• Fences used in farming business.• Gasoline storage tanks and pumps and

retail service stations.• Helicopters.• House trailers (movable, wheels

attached).• Livestock (including horses, cattle, hogs,

sheep, goats and mink and other fur-bearing animals).

• Machinery and equipment.• Office equipment—copiers, typewriters,

fax machines, etc.• Office furniture—desks, chairs, file

cabinets, book shelves, etc.

• Off-the-shelf computer software.• Oil and gas well and drilling

equipment.• Paved barnyards to keep livestock

out of mud and load them onto trucks. (Rev. Rul. 66-89)

• Signs (if movable).• Single-purpose agricultural or

horticultural structures.1

• Storage facility with no additional workspace (such as grain bins, corn cribs, silos).

• Store counters.• Tractors.• Trucks.• Vineyards (not including

nondepreciable land improvements). (CCA 201234024)

• Water wells that provide water for raising livestock.

1 See Section 179 Deduction—Farm Property on Page 6-21.


Property Not Eligible for Section 179 Expense (2012)Not an Exhaustive List

• Air conditioning units.• Barns.• Billboards (if not movable).• Bridges.• Buildings.• Car washes.• Docks.

• Elevators.• Escalators.• Fences.• Heating units.• Land.• Landscaping.• Roads.

• Shrubbery.• Sidewalks.• Stables.• Swimming pools.• Trailers (nonmobile). • Warehouses.• Wharves.

Property eligible for the Section 179 deduction does not include that part of the property’s basis that is determined by reference to the basis of other property held at any time by the person acquiring theproperty.[Reg.§1.179-4(d)]

Example: Arnold trades a copier (used in his business) for a new copier that costs $20,000. Arnold is granted a trade-in allowance of $2,000 on his old copier. Arnold’s adjusted basis in his old copier was $1,200. The basis of the new copier is $19,200 ($1,200 basis of old copier plus $18,000 cash expended). Only $18,000 of the basis of the new copier qualifies for Section 179 deduc-tion; the remaining $1,200 is basis determined by reference to other property.

ElectionThe Section 179 election is made on an item-by-item basis for qualifying property by completing Part I of Form 4562. A taxpayer can make or revoke (for 2003–2012) the expensing election on a timely filed amended return. Once the election is revoked, however, it cannot be remade.

Example: In 2012, Ryan placed two machines (each cost $150,000) in service for his sole proprietorship. One of the machines was new and one was used. He elects a $139,000 Section 179 deduction for the new machine. After filing his 2012 return, he realizes he would have been better off electing the Sec-tion 179 deduction for the used machine since it did not qualify for special depreciation (and the new machine did). Ryan can file an amended return for 2012, revoking the Section 179 election for the new machine and making the election for the used machine. Although the total Section 179 expense would not change, Ryan would also refigure depreciation on the assets, claiming special depreciation on the new machine. No IRS consent is required, but the revocation is irrevocable, so Ryan could not later amend his return to elect a Section 179 deduction for the new machine.

A Section 179 election made on an amended return must specify the item of Section 179 property to which the election applies and the portion of the cost of each item to be expensed. If a taxpayer elected to expense only a portion of the cost of an item for a par-ticular taxable year (or did not elect to expense any portion of the item), he may file an amended return and expense any portion of the item that was not previously expensed. Any increase in the amount expensed under Section 179 is not treated as a revocation ofthepriorelectionforthatyear.[Reg.§1.179-5(c)(2)]

Dollar Limit on Section 179 DeductionThe total cost of property that can be expensed any year is limited to a maximum deduction. In addition, for each dollar of Section 179 property placed in service during the year over the qualifying property threshold, the maximum deduction is reduced (but not below zero) by one dollar. A husband and wife, whether filing joint or separate returns, are treated as one taxpayer for the maximum deduction and the qualifying property threshold. The maximum deduction (after any reduction for qualifying property additions over the threshold) is divided equally between the spouses, unless they agree to a dif-ferent allocation.

Section 179 Annual LimitsYear Maximum

DeductionQualifying Property

Threshold 2012................................$ 139,0001 ............................ $ 560,0001

2010 and 2011 ................ 500,000 ............................. 2,000,0002008 and 2009................ 250,000 ............................. 800,000

1 Expired Provision Alert: For 2011, the maximum deduction and qualifying property threshold were $500,000 and $2,000,000, respectively. It’s possible that Congress will extend these higher amounts to 2012, but it had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.

Example: James placed $600,000 of Section 179-eligible property in service in his business in 2012. The maximum amount he can elect to expense under Section 179 is $99,000 ($139,000 – $40,000 qualifying property over the $560,000 threshold).

U Caution: Most vehicles that aren’t subject to the Section 280F depreciation limit are subject to a $25,000 (per vehicle) Section 179 expensing limit. See Section 179 Limit for Heavy Vehicles on Page 11-3.

Section 179 Expensing—Qualified Real Property Expired Provision Alert: For 2011, qualified real property was eligible for Section 179 expensing. It’s possible that Congress will extend this provision to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.For tax years beginning in 2010 and 2011, qualified real property, which is (1) qualified leasehold improvement property, (2) qualified restaurant property and (3) qualified retail improvement property is eligible for Section 179 expensing. See Qualified Real Property on Page 10-13 for definitions.Taxpayers elect to treat qualified real property as Section 179 prop-erty by attaching a statement to their original or amended return. The total Section 179 election for qualified real property is limited to $250,000 per year. Any Section 179 deduction for qualified real property that is unused due to the business taxable income limit (see Business Taxable Income Limit below) cannot be carried to a year after 2011. Any carryforward remaining at the end of the tax year be-ginning in 2011istreatedasplacedinserviceinthatyear.[IRC§179(f)]

Business Taxable Income LimitThe Section 179 deduction is limited to the taxpayer’s total tax-able income from the active conduct of any trade or business. Taxable income is computed without regard to any Section 179 deduction, net operating losses (NOLs), the deduction for self-employment (SE) taxes or any unreimbursed employee business expenses.Activetradeorbusinessincomeincludes:(Reg.§1.179-2)•Wages,salaries,tipsandothercompensation;•Proprietorship(ScheduleCorF)netincome;•Apartner’sorScorporationshareholder’spass-throughshare

of entity business income or loss (if the taxpayer is engaged in the active conduct of at least one of the entity’s trades or busi-nesses);

•Section1231businessassetgains(orlosses)fromatradeorbusiness and

•Section1245and1250depreciationrecaptureincomefromatrade or business.

2013

$150,000

2010–2013

$2,040,000

$460,000 ($500,000

$2,000,000

For 2012,

is

2010–2013

2013 2013


The active conduct of a trade or business for the Section 179 tax-able income limit is not the same as “material participation” under the Section 469 passive activity rules. Income is derived from an active trade or business for the Section 179 test if the taxpayer meaningfully participates in the business’s managementoroperations.[Reg.§1.179-2(c)]@ Strategy: Business taxable income does not have to be generated by the business in which the Section 179 property is used to count toward the business taxable income limit. In fact, the trade or business in which the Section 179 property is used can generate a loss, as long as the taxpayer’s net business taxable income from all sources is positive.

Example: In 2012, Anne received wages of $130,000. She purchased $125,000 worth of equipment to begin a sole proprietorship. Even though she received only $5,500 of net income from her Schedule C operations, she may claim a full $125,000 Section 179 deduction since her business taxable income was $135,500 ($130,000 + $5,500).

Joint return. If a joint return is filed, the business taxable incomes (or losses) of both spouses are aggregated, even though the Section 179 deduction may be related to the activities of only one spouse.

Section 179 CarryoverIf the cost of property for which a current year Section 179 elec-tion is made exceeds the taxable income limitation, the taxpayer may select the properties for which all or a part of the cost will be carried forward. The selections must be supported in the re-cordkeeping. If a selection is not made, the total carryover will be allocated equally among the properties for which Section 179 was elected(Reg.§1.179-3).TheSection179costscarriedforwardare added to the cost of qualifying property placed in service in that tax year. Amounts carried over must be applied on a first-in first-out (FIFO) basis. The maximum deduction limit ($139,000 for 2012) applies to the carryover amount plus any new amounts elected in the carryover year.However, there is no carryover of deductions lost due to the $139,000 (for 2012) deduction limit [reduced, if applicable, by asset additions over the $560,000 (for 2012) qualifying property threshold]. This may occur, for example, if a taxpayer claims Section 179 expense from multiple pass-through entities and the aggregate amounts exceed the maximum deduction limit.U Caution: Special rules apply to carryovers attributable to quali-fied real property. See Qualified Real Property on Page 10-13.

Maximize Benefits of Section 179—PlanningUse one of the methods shown below when the Section 179 deduction is reduced by the taxable income limit. Either method will result in net income of zero for the current year, but will provide different rates of cost recovery in future years. Projections are necessary to determine the best method to use.Method #1: Determine the amount of Section 179 expense that will result in a taxable income of zero when combined with depreciation. Remaining basis is recovered using normal depreciation over future years. This will avoid the possibility that Section 179 carryovers are “locked up” by income limitations in future years. This formula works if the regular MACRS method is used, special depreciation is not claimed and the mid-quarter convention does not apply.

Formula for Section 179 deduction (Method #1)[ (M × N) – A ] ÷ [ 1 – M ] = D

M = MACRS Recovery Period D = Section 179 DeductionN = Net Income Before Depreciation A = Asset Cost

Example: Martha purchased a previously used five-year MACRS asset on March 1, 2012 for $105,000. Her business taxable income was $23,700 before the Section 179 deduction and depreciation.Maximum Section 179 deduction calculation is:

(5 × $23,700) – $105,000=

$13,500= < $ 3,375>

1 – 5 <4>Net income before depreciation ..................................................... $ 23,700Section 179 deduction ................................................................... < 3,375>MACRS depreciation [($105,000 – $3,375) × 20.00%] ............... < 20,325>Net taxable income ........................................................................ $ 0

Method #2: Elect the maximum Section 179 expense available for the tax year. The amount disallowed because of the taxable income limit is reported as a Section 179 carryover in the follow-ing year. This method is beneficial if income increases enough in the next year to absorb most or all of the carried forward Section 179 expense.

Example: Using method #2 for the above example, a Section 179 election is made for the entire $105,000 of the asset placed in service. Only $23,700 is deductible in 2012. The remaining $81,300 ($105,000 – $23,700) carries over and may be deductible as a Section 179 expense in 2013, subject to the business taxable income and maximum deduction limits.

secTIOn 179 recaPTureThe tax benefit derived from a Section 179 election must be re-captured as ordinary income if business use of the property falls to 50% or less during its MACRS recovery period. The basis of the asset is increased by the recaptured amount, which is computed as follows:1) The amount originally deducted as Section

179 expense, 2) Minus: MACRS depreciation (from the year

the property was placed in service through the current year) that would have been allowed on the portion of the asset for which the Section 179 deduction was claimed.

U Caution: If the business use of listed property drops to 50% or less, do not figure recapture under these rules. Instead, use the rules for listed property at Depreciation Recapture on Page 11-5.

Where to ReportWhen the business use of an asset decreases to 50% or less, the Section 179 recapture amount is first entered on Form 4797, Part IV, column (a). This amount is then reported as income on the form where the deductions were originally claimed. Notes:•IftheexpensewasoriginallyclaimedonScheduleCorF,the

recaptured amount is subject to SE tax.•RecaptureonForm4797,PartIV,onlyapplieswhenbusiness-usedropsto50%orless[IRC§280F(b)(2)]andmaybesubjectto SE tax. Depreciation recapture [under Section 1245(a)] trig-gered by the sale (or other dispositions) of Section 179 property before the end of its MACRS recovery period results in ordinary income,butnotSEincome.[Reg.§1.179-1(e)]

$500,000$2,000,000$500,000


change OF use OF Macrs PrOPerTy

Following are rules for how to depreciate MACRS property when the use of the property changes, but the property continues to be held by the same taxpayer.

Conversion to Business or Investment UsePersonal-use property converted to business or investment use is treated as being placed in service by the taxpayer on the date of conversion. The asset’s depreciable basis is the lesser of its FMV or adjusted basis at the time of the conversion.

Example: Kay purchased a house in 1991 that she used as her principal resi-dence. In March 2012, Kay converts the property to residential rental property. At the time of conversion, the property’s FMV, not including land, was $140,000. Its adjusted basis (in this case, cost) not including land, was $160,000.Kay is considered to have placed residential rental property in service in March 2012, with a depreciable basis of $140,000. Kay must depreciate the rental property using the straight-line method, a 27.5-year recovery period and the mid-month convention.

U Caution: Any Section 179 election must be made in the first year property is purchased and placed in service. The election is not available for property converted from personal to business use in a later year.

Conversion to Personal UseA conversion of property from business-use or investment-use to personal-use is treated as a disposition of the property for comput-ing MACRS in the year of change. Depreciation is computed by taking into account the applicable convention. However, no gain, loss or depreciation recapture is recognized upon the conversion. Note: Depreciation recapture may apply when the asset is even-tually disposed. However, excess depreciation on listed property and any Section 179 deduction are recaptured in the year of conversion, because business use is 50% or less. See Depreciation Recapture on Page 11-5 and Section 179 Recapture on Page 10-11.

Business Use ChangeProperty that continues to be used by the same taxpayer whose primary use of the property for the tax year is different from the primary use in the preceding year may have a different recovery period,depreciationmethod,orboth[Reg.§1.168(i)-4(d)].Depre-ciation for the year of change is determined as though the change of use occurred on the first day of that year. The applicable de-preciation method and recovery period depend on how the asset is used after the change in use.Shorter recovery period and/or faster method. If the change results in a shorter recovery period and/or a more accelerated depre-ciation method, depreciation in the year of the change is calculated on the asset’s adjusted basis over the shorter recovery period and/or by using the more accelerated depreciation method. However, if it is more advantageous, the taxpayer can elect to continue to depreciate property as if the change in use had not occurred.Longer recovery period and/or slower method after change in use. If the change results in a longer recovery period and/or slower depreciation method, the asset’s adjusted basis is de-preciated over the longer recovery period and/or by the slower depreciation method.Change in use during placed-in-service year. If a change in use occurs during the tax year the property is placed in service, depreciation generally is determined by the property’s primary use during that year, determined in any reasonable manner.

DIsPOsITIOns OF Macrs PrOPerTyDisposition. Permanent withdrawal of property from use in a trade or business or in the production of income, such as a sale, exchange, retirement, abandonment or destruction.Under MACRS, a depreciation deduction is allowed for the year of disposition using the applicable convention.1) Residential Rental and Nonresidential Real Property. A mid-

month convention is used.2) All Other Property. Either a half-year or mid-quarter convention

is used, depending on the convention used when the property was placed in service.

Mid-quarter convention sale. When depreciable property subject to the mid-quarter convention is sold, the property is treated as sold on the midpoint of the quarter in which it is sold. Depreciation for the year of sale is computed by multiplying the normal year’s depreciation amount by the mid-quarter percentage (based on the quarter during which the property was sold). See the Mid-Quarter Percentages table on Page 10-2. Note: No depreciation deduction is allowed for property placed in service and disposed of in the same year.

DePrecIaTIOn recaPTureGain on the disposition of property, other than residential rental and nonresidential real property, depreciated under MACRS is recaptured as ordinary income to the extent of previously allowed orallowabledepreciationdeductions(IRC§1245).Forthisrule,any Section 179 deduction claimed on the property and any special depreciation allowed for the property (unless an election was made not to claim it) is treated as depreciation. See Tab 7 for details.For residential and nonresidential real property placed in service after 1986, prior depreciation is not recaptured as ordinary income unless a special depreciation allowance was claimed.

Unrecaptured Section 1250 GainUnrecaptured Section 1250 gain is the gain attributable to SL depreciation on Section 1250 property (most real property). This gain is treated as a capital gain subject to a maximum 25% rate. For rules on how to calculate the unrecaptured Section 1250 gain, see Tab 7.

Installment SalesAll ordinary income depreciation recapture must be recognized in the year of sale, even if no principal payments are received in that year[IRC§453(i)].NotethatunrecapturedSection1250gain(gainattributable to SL depreciation) is not automatically recognized in the year of sale. Instead, it is recognized as payments are received.See Installment Sales on Page 7-11.

lIke-kInD exchanges— DePrecIaTIOn rules

Depreciation of MACRS property acquired in a like-kind exchange or as a result of an involuntary conversion is determined as follows: [Reg.§1.168(i)-6]1) The exchanged basis of the replacement property is the basis in

the relinquished property after taking depreciation for the year of exchange (or if less, the basis of the replacement property under the like-kind exchange rules). No Section 179 deduction can be claimed on the exchanged basis.


a) Exchanged basis recovery period:i) If the replacement property has the same or a shorter

recovery period than the relinquished property, use the remaining recovery period of the relinquished property.

ii) If the replacement property has a longer recovery pe-riod than the relinquished property, use the remaining recovery period of the replacement property as if it had originally been placed in service in the same taxable year as the relinquished property.

b) Exchanged basis depreciation method:i) If the replacement property has the same or a more accel-

erated depreciation method than the relinquished property, use the depreciation method of the relinquished property.

ii) If the replacement property has a slower depreciation method than the relinquished property, use the depre-ciation method of the replacement property as if it had originally been placed in service in the same taxable year as the relinquished property.

2) Excess basis is any excess of the basis in the replacement property over the exchanged basis (this is normally boot paid). Determine the recovery period and depreciation method for the excess basis of the replacement property using the applicable recovery period and depreciation method for the property at the time of the exchange. Section 179 deduction can be claimed.

Electing out. Taxpayers may elect out of these depreciation rules for like-kind exchanges. Then, the exchanged basis and excess basis, if any, in the replacement property are treated as placed in service on the date acquired (or if later, the date the relinquished property was given up) and the adjusted depreciable basis of the relinquished property is treated as being disposed of by the taxpayer at the time of the exchange. The election must be made by the due date (including extensions) of the tax return for the year of replace-ment, and is made by reporting the depreciation for the replacement property (computed as described above) in Part III of the Form 4562. Also, attach a statement indicating “Election made under Section 1.168(i)-6(i)” for each property involved in the exchange. The elec-tion may be revoked only with the consent of the IRS.

cOMPuTer sOFTwareCost of purchased computer software:•Software included in the purchase price of a computer (not

separately stated) is added to the basis of the computer and depreciated over five years, or expensed under Section 179.

•Softwarereadilyavailableforpurchasebythegeneralpublicisdepreciable as intangible property over 36 months using the SL method beginning with the month the software is placed in service [IRC§167(f)(1)].Includedepreciationonline16ofForm4562,as “other depreciation.” Can also claim special depreciation if all other requirements met. For tax years beginning after 2002 and before 2013, off-the-shelf computer software is eligible for the Section 179 deduction.

•Purchasedsoftwarewithauseful lifeof lessthanoneyear isdeductible as a current expense.

Cost of developing computer software: (Rev. Proc. 2000-50)•Deductinaccordancewiththerulesforresearchandexperimen-

tal expenditures or•Capitalizeandamortizeratablyover60monthsfromthedate

development is completed or 36 months from the date the soft-ware is placed in service.

Leased or licensed software. Deduct as a rental expense.Software included in purchase price of a trade or business. Am-ortizeover15yearsbeginningwiththemonthacquired.(IRC§197)

leasehOlD IMPrOveMenTsGenerally, any improvement to depreciable property has the same recovery period and method as the improved property (but is treated as placed in service when the improvement is made). So an improvement to a commercial building [whether made by the lessor (landlord) or the lessee (tenant)] generally would be de-preciated straight-line over 39 years. But, see Qualified leasehold improvement property below for special rules.Lessee (tenant). Any remaining undepreciated basis is deductible by the lessee when the lease terminates.Lessor (landlord). The lessor can deduct the undepreciated basis of the improvement at the end of the lease term only if the actual improvement is irrevocably disposed of or abandoned by the lessor attheterminationofthelease.[IRC§168(i)(8)]

QualIFIeD real PrOPerTy

Qualified real property is any of the following:•Qualifiedleaseholdimprovementproperty.•Qualifiedrestaurantproperty.•Qualifiedretailimprovementproperty. Expired Provision Alert: Qualified real property placed in service in 2011 was assigned a 15-year recovery period (SL depreciation re-quired). It was also eligible for Section 179 expensing if placed in service in a tax year beginning in 2011. It’s possible that Congress will extend these provisions to 2012, but had not done so at the time of this publica-tion. See Expired Tax Provisions on Page 17-1 for more information. Qualified leasehold improvement property. Qualified leasehold improvement property is generally any improvement to an interior part of a building that is nonresidential real property if:1) The improvement was made pursuant to a lease by the ten-

ant, sub-tenant or the landlord to a part of the property to be occupied exclusively by the tenant (or sub-tenant).

2) The improvement is placed in service more than three years after the date the building was first placed in service (by any taxpayer).

3) The expenses are not for the enlargement of the building, any elevator or escalator, any structural components benefiting a common area or the internal structural framework of the building.

U Caution: Leases between related parties are not treated as leases for purposes of qualified leasehold improvement prop-erty[IRC§168(k)(3)].Relatedpartiesincludetaxpayersandtheirspouses, parents, grandparents, children, grandchildren and siblings. Taxpayers are also considered related to certain entities that they own (directly or indirectly) 80% or more.If a landlord transfers ownership of qualified leasehold improve-ment property, the improvement will not be qualified property to any subsequent owner. (Exceptions exist for transfers because of death, corporate merger, formations of business entities where the taxpayer retains significant control, like-kind exchanges and involuntaryconversions.)[IRC§168(e)(6)]Qualified restaurant property. This is any Section 1250 property that is a building or an improvement to a building if more than 50% of the building’s square footage is devoted to preparation of, and seating foron-premisesconsumptionof,preparedmeals.[IRC§168(e)(7)]Qualified retail improvement property. This is generally any im-provement to an interior portion of a building that is nonresidential realpropertyif:[IRC§168(e)(8)]1) Such portion is open to the general public and is used in the

retail business of selling tangible personal property to the general public and


2012 is

is2012

2014


— End of Tab 10 —

2) Such improvement is placed in service more than three years after the date the building was first placed in service.

3) The expenses are not for the enlargement of the building, any elevator or escalator, any structural components benefiting a common area or the internal structural framework of the building.

If an owner transfers ownership of qualified retail improvement property, the improvement will not be qualified retail improvement property to any subsequent owner. (Exceptions exist for transfers because of death, corporate merger, formations of business entities where the taxpayer retains significant control, like-kind exchanges and involuntary conversions.)

Qualified Real Property—Special Rules (2012)Qualified

Leasehold Improvement

Property

Qualified Restaurant

Property

Qualified Retail

Improvement Property

MACRS recovery period 15 15 15Eligible for special (bonus) depreciation? Yes No1 No1

Eligible for Section 179 deduction? Yes2 Yes2 Yes2

Must be placed in service more than three years after building placed in service? Yes No YesMust be made pursuant to a lease? Yes No No1 Expired Provision Alert: For 2011, the recovery period was 15 years (SL) and

property was eligible for Section 179 expensing (heating and air conditioning units were not eligible). See Expired Tax Provisions on Page 17-1.

2 Exception: If property also meets the definition of qualified leasehold improvements, it qualifies for special depreciation allowance.

cOrrecTIng DePrecIaTIOn errOrsFile Form 3115, Application for Change in Accounting Method, to report depreciation changes that qualify as accounting method changes. Changes that are not accounting method changes are reported on amended returns.Depreciation corrections made on From 3115.•Thetreatmentofanassetfromnondepreciabletodepreciable

or vice versa.•Changetothedepreciationmethod,recoveryperiodorconven-

tion of a MACRS asset.•Changing froman incorrect to the correct amount of special

(bonus) depreciation.•Changefromimproperlyexpensingtocapitalizinganasset.Depreciation corrections made on an amended return.•Correcting mathematical or posting errors.•Achangeinusefullife(non-MACRSassets).•Achangeinsalvagevalue(otherthantozero).•Achangeintheplaced-in-servicedate. Note: Generally, an accounting method is not established until the taxpayer uses it for two consecutive tax years. Thus, an account-ing method used on only one return would generally be corrected on an amended return. However, taxpayers can change a depre-ciation accounting method used on a single return either by filing an amended return or by filing a Form 3115. (Rev. Proc. 2011-14)

Automatic permission for changing depreciation accounting method. The IRS grants automatic consent to certain accounting method changes, including changing from an impermissible to permissible method of computing depreciation (which enables taxpayers who have claimed less than the allowable amount of depreciation to catch up to the allowable amount). Form 3115, Application for Change in Accounting Method, is filled out in dupli-cate. The original is attached to a timely filed tax return (including extensions) for the year of change. The copy is filed with the IRS in Ogden, UT, no later than the time when the tax return is filed. See Form 3115 instructions (revised March 2012) for mailing address. There is no user fee under this procedure.U Caution: Automatic permission is not given to change from expensing an item to capitalizing and depreciating it.A Section 481(a) adjustment is usually required when an account-ing method is changed to ensure that income or expense items are not omitted or duplicated. It is calculated on Form 3115. The 481(a) adjustment is then reported as income (or a deduction) on the tax return, starting in the year of change. A negative adjustment (depreciation in previous years was understated) is recognized in full that year. A positive adjustment (depreciation was overstated) is spread over four years. Exception: A positive adjustment less than $25,000 can be recognized in the year of change. Note: The Section 481(a) adjustment is computed for all prior tax years, not just those that are still open. (Rev. Proc. 2011-14)

Example: Brad purchased a rental duplex on January 1, 2009 for $250,000 (not including land). While preparing the 2012 return, the preparer discovers that no depreciation had been claimed for the duplex on the previous three returns. Straight-line depreciation over 27.5 years for the years 2009–2011 equals $26,894 ($9,091 per year with mid-month convention in 2009). A Form 3115 to change the accounting method is attached to Brad’s 2012 Form 1040. The negative Section 481(a) adjustment of $26,894 is reported on his Schedule E reporting income and deductions from the duplex. 2012 depreciation of $9,091 is claimed on Form 4562.

InTangIble asseTs— aMOrTIzaTIOn rules

Certain intangible assets can be amortized over 15 years begin-ning in the month they are acquired, even if there is no way to determine their useful life. 15-year amortization applies to the following intangible assets that are purchased by a taxpayer (not self-created):(IRC§197)•Goodwill.•Goingconcernvalue.•Workforceinplace.•Covenantnottocompeteenteredintoaspartofpurchasinga

business.•Copyrightsandpatents.•Franchise,trademark,tradenames.•Informationbasessuchasclientfiles,customerlistsanddirect

mail and telemarketing lists.•Contractswithcustomersorsuppliers(unlessthecontractshave

a fixed duration and are nonrenewable).•Computersoftwareacquiredinconnectionwiththepurchaseof

a business and not available to the general public.•Purchasedmortgage servicing rights (canbeamortizedover

108 months if they are not acquired in an acquisition of a trade orbusiness).[IRC§167(f)(3)]

1

2 Heating and air conditioning units are not eligible.


See the Business Vehicles—Quick Facts table on Page 11-1 for the limits that apply to vehicles placed in service during 2008–2012.Special use vehicles. These vehicles are not subject to the Sec-tion 280F depreciation limits. This category includes the following:1) An ambulance, hearse or combination ambu-

lance-hearse used in a trade or business.2) A vehicle used in the trade or business of

transporting persons or property for com-pensation or hire (for example, a taxicab).

3) Qualified non-personal use vehicles. See Qualified non-personal-use vehicles on Page 11-9.

2012 Deduction Limits for Vehicles Limit Vehicle Description Amount

Depreciation/ 179 Expense

Car—GVW (unloaded) up to 6,000 lbs.:• Vehicle qualifies for special depreciation.• Taxpayer elects out of special depreciation or

vehicle doesn’t qualify.

$ 11,1601

3,1601

Depreciation/ 179 Expense

Truck or van—GVWR (loaded) up to 6,000 lbs.:• Vehicle qualifies for special depreciation.• Taxpayer elects out of special depreciation or

vehicle doesn’t qualify.

$ 11,3601

3,3601

Section 179 Expense (Depreciation Limit Doesn’t Apply)

• Car—GVW (unloaded) over 6,000 lbs. but GVWR not over 14,000 lbs.

• Truck or van—GVWR (loaded) over 6,000 lbs. but not over 14,000 lbs.

$ 25,0002

Vehicles described in the row above that:• Are designed to seat more than nine passengers

behind the driver seat,• Have an open cargo area or covered box that is

at least six feet long and not readily accessible from the passenger compartment (for example, a pick-up with full-size cargo bed) or

• Have an integral enclosure fully enclosing the driver compartment and load carrying device, do not have seating behind the driver’s seat and have no body section protruding more than 30 inches ahead of the windshield.

$ 500,0003

Truck or van—GVWR (loaded) over 14,000 lbs. $ 500,0003

1 Section 280F limit. Applies to sum of depreciation and Section 179 expensing.2 Per vehicle Section 179 limit. Also subject to annual limit on Section 179 expensing.3 Annual Section 179 limit for all assets expensed. Expired Provision Alert: For

2011, the maximum Section 179 deduction was $500,000. See Dollar Limit on Section 179 Deduction on Page 10-10.

Section 179 Limit for Heavy VehiclesAny four-wheeled vehicle primarily designed to carry passengers over public streets, roads or highways that is not subject to the Section 280F depreciation limits and is rated at 14,000 pounds GVW or less is subject to a $25,000 limit on the Section 179 de-duction.[IRC§179(b)(5)]Thus, cars with an unloaded GVW over 6,000 pounds (over 6,000 loaded GVWR if a truck or van) and that are rated at no more than 14,000 pounds GVW are subject to the limit. For exceptions, see the 2012 Deduc-tion Limits for Vehicles table above. Note: Even though these vehicles are not subject to the 280F depreciation limits, they are still listed property.The $25,000 limit is per vehicle (not per taxpayer). It is not pro-rated for vehicles with less than 100% business use.Website: GVWs and GVWRs for many vehicles can be found at www. intellichoice.com and www.carsdirect.com/research. These

amounts can also usually be found on a label attached to the inside edge of the driver’s door.

Calculating Vehicle DepreciationStep 1: Determine the business/investment use percentage by dividing business/investment miles driven during the year by total miles driven. Step 2: Multiply the Section 280F limit for the year by the busi-ness/investment use percentage. This is the maximum amount that can be claimed as depreciation (including any Section 179 deduction) for the year.Step 3: Determine the Section 179 deduction. The Section 179 deduction can only be claimed in the year the auto is placed in service and only if qualified business use is more than 50%.Step 4: Determine the special depreciation allow-ance, if applicable.N Observation: The special depreciation allowance applies un-less the taxpayer elects out. See Special Depreciation Allowance on Page 10-8 for details.Step 5: Determine MACRS depreciation based on a five-year recovery period. If qualified business use is 50% or less, deprecia-tion must be calculated SL.Special rule if 100% special depreciation allowance claimed in prior year. The special depreciation rate was 100% for qualifying assets purchased and placed in service from September 9, 2010– December 31, 2011.Generally, when depreciation is limited under Section 280F, the disallowed amount (called unrecovered basis) cannot be deducted until after the end of the vehicle’s recovery period (subject to the Section280F limits then ineffect) [IRC§280F(a)(1)(B)].Underthat rule, claiming 100% special depreciation results in all of the vehicle’s basis (assuming 100% business use) in excess of the first year Section 280F limit becoming unrecovered basis, which cannot be depreciated until after the end of the vehicle’s recovery period. To mitigate this result, taxpayers who claim 100% special depreciation that is limited by Section 280F can elect a safe-harbor method for their unrecovered basis (Rev. Proc. 2011-26). Under the safe-harbor method, taxpayers compute depreciation after the first year by assuming special depreciation in the first year was 50% rather than 100%.The safe-harbor method is elected by applying it to deduct depre-ciation on a vehicle subject to the Section 280F limit for the first year after the placed-in-service year.

Example: In 2011, Matt purchased a new car for $20,000 that he used 100% for business. The car qualified for the 100% special depreciation allowance, but Matt’s 2011 depreciation was limited to $11,060 (the Section 280F limit). In 2012, Matt adopts the safe-harbor method. So, for 2012 and later, he is treated as if he claimed 50% special depreciation in 2011 for figuring his unrecovered basis and depreciation:Deemed 2011 depreciation [($20,000 × 50%) + ($10,000 × 20%)] ........................................................................$ 12,000Actual 2011 depreciation .................................................................< 11,060 >Unrecovered basis ...........................................................................$ 940The $940 unrecovered basis is recovered beginning in 2017, subject to the 280F limits in effect.For 2012, the car’s depreciation is $3,200 (32% × $10,000 unadjusted depreciable basis if 50% depreciation had been claimed in 2011). Because this amount is less than the 280F limit ($4,900) Matt deducts $3,200 in 2012.

Example continued on the next page


Variation: Assume the same facts except the car cost $18,400. For 2011, Matt’s 100% special depreciation allowance is limited to $11,060 (the Section 280F limit). Under the safe-harbor accounting method, he is deemed to have claimed 50% special depreciation for determining the car’s unrecovered basis and its remaining adjusted depreciable basis, as follows: Deemed 2011 depreciation [($18,400 × 50%) + ($9,200 × 20%)] ...$ 11,040 Actual 2011 depreciation .................................................................< 11,060> Unrecovered basis (cannot be less than zero) ................................$ 0 Because there is no unrecovered basis under the safe-harbor method, Matt cannot use the optional depreciation tables to compute depreciation on his car for years after the placed-in-service year. Instead, he must compute de-preciation using the 200% declining balance method (assuming the half-year convention applies) as follows: Beginning unadjusted basis .............................................................$ 18,400 2011 actual depreciation ..................................................................< 11,060>Adjusted basis at 12/31/11 ..............................................................$ 7,340200% declining balance rate ........................................................... 40% 2012 depreciation ............................................................................$ 2,936 Because this amount is less than the 280F depreciation limit ($4,900) Matt deducts $2,936 as depreciation for 2012.

Business Use 50% or LessPassenger automobiles (see Passenger auto on Page 11-2) used 50% or less for business purposes are not eligible for Section 179 ex-pense or special depreciation allowance and must be depreciated over five years using the SL method. The half-year or mid-quarter conventions still apply. See the Vehicle Depreciation—MACRS Percentages table on Page 11-5.Investment use. Investment use is not counted for determining whether a vehicle meets the more than 50% business-use test (to qualify for accelerated depreciation and Section 179 expensing). But, the combined business/investment percentage is used to compute the depreciable portion of the vehicle’s basis.

Example #1: An auto is used 40% in a trade or business and 25% for investment. Method: SL depreciation must be used based on 65% business/investment use.Example #2: An auto is used 80% in a trade or business and 10% for in-vestment. Method: Accelerated depreciation (200% DB) may be used and calculated based on 90% business/investment use.

Electing Straight-Line DepreciationEven if business use exceeds 50%, a taxpayer may elect to depre-ciate an auto under the five-year SL method instead of using 200% declining balance. Electing SL depreciation avoids the recapture of excess deductions if business use drops to 50% or less in a later year. The election is made by entering “SL” in column (g) of Part V, Form 4562. The election applies to all five-year class life property placed in service in the year the election is made.

MaxIMIzIng vehIcle secTIOn 179 exPense

The Section 179 deduction is available only if a vehicle is used more than 50% for business in the year it is purchased and placed in service. Any amount claimed reduces the basis for computing MACRS depreciation. The total of the Section 179 expense plus MACRS depreciation may not exceed the Section 280F limit. See limits (based on year placed in service) in the Business Vehicles—Quick Facts table on Page 11-1. See Section 179 Deduction on Page 10-9 for details.

@ Strategy: If a vehicle’s depreciation deduction (including any special depreciation allowance) equals (or exceeds) the Section 280F limit, it is better to make the Section 179 expensing election for other assets (since the full amount of the allowed deduction for the vehicle can be reached with depreciation deductions). But, for low-basis vehicles or vehicles subject to the mid-quarter convention and placed in service during the fourth quarter, a Section 179 deduction can be used to “fill up” the Section 280F limit.See the Section 280F Limit Applies When table on Page 11-1 to determine whether first-year depreciation exceeds the 280F limit.

Example #1: A used car is purchased on June 1, 2012, for $8,000 and is used 100% for business. MACRS depreciation (using the half-year convention) is $1,600 ($8,000 × 20%). Since this is below the 280F limit ($3,160), the taxpayer should elect to expense $1,560 of the auto under Section 179 to bring the total deduction allowed up to $3,160 for the year.Example #2: Assume the same facts as Example #1, except the vehicle costs $18,000. MACRS depreciation using the half-year convention is $3,600 ($18,000 × 20%), limited to a maximum deduction of $3,160. A Section 179 expense election for the vehicle would not do any good in this situation.

Use the following formula to calculate the Section 179 deduction needed to maximize the first-year deductions for an auto when 100% special depreciation is not claimed.

Optimal Section 179 Deduction for Vehicles1) Multiply auto’s basis by business-use percentage ............. 1) 2) Multiply the annual Section 280F depreciation limit by

the business-use percentage ............................................. 2) 3) Multiply line 1 by Factor A in table below ............................ 3) 4) Line 2 minus line 3. If zero or less, STOP.

No Section 179 deduction should be claimed .................... 4) 5) Divide the result in line 4 by Factor B in table below.

Result equals Section 179 deduction ................................. 5)

Convention

Factor

No Special Depreciation

50% Special

Depreciation Allowed

A B A BHalf year ................................ .20 .80 .60 .40MQ—1st quarter .................... .35 .65 .675 .325MQ—2nd quarter ................... .25 .75 .625 .375MQ—3rd quarter .................... .15 .85 .575 .425MQ—4th quarter .................... .05 .95 .525 .475

Example: A used auto purchased for $20,000 is placed in service on Decem-ber 10, 2012. The taxpayer is subject to the mid-quarter convention. The auto is used 80% for business. The optimal Section 179 deduction is calculated as follows:1) $20,000 × 80% = $16,0002) 3,160 × 80% = 2,5283) 16,000 × .05 = 8004) 2,528 – 800 = 1,7285) 1,728 ÷ .95 = 1,819

Proof: $ 1,819 Section 179 expense

+ 709 MACRS depreciation [($16,000 – 1,819) × 5%]

$2,528 ($3,160 Section 280F limit × 80% business use)


U Caution: An employee who trades in an auto used for business as an employee elects out of the depreciation rules for like-kind exchanges by completing Form 2106, Part II, Section D to report the auto’s depreciation. If the employee does not elect out of the general rules, depreciation for the auto acquired in the exchange is reported on Form 4562.

Example: Jim purchased a Honda in February 2009 for $20,000. The half-year convention applied. He used it 100% in his business. In November 2012, Jim exchanges, in a like-kind exchange, his Honda plus $14,000 cash for a new Mazda that will also be used solely in his business. The Mazda qualifies for special depreciation. Jim also claims a Section 179 deduction on the Mazda’s excess basis. The 2012 Section 280F limit for the Honda (if the trade hadn’t occurred) is $1,775. The 2012 280F limit for the Mazda is $11,160. The depreciation and basis calculations for 2012 are as follows:

Depreciation/ Section 179 Basis

Honda basis at December 31, 2011 ($20,000 cost – $2,960 – $4,800 – $2,850) ......................................... $ 9,390

Step 1: 2012 depreciation on Honda ($20,000 × 11.52% ÷ 2, limited to $1,775) ................... $ 1,152 < 1,152>Exchanged basis in Mazda .................................................................. 8,238

Step 2: Special depreciation on Mazda exchanged basis ($8,238 × 50%, limited to $11,160 – $1,152 = $10,008) ....................................................................... 4,119 < 4,119>

Step 3: Regular deprecation on Mazda exchanged basis (limited to $1,775 – $1,152 – $4,119 = $0)......... 0 < 0>Mazda exchanged basis at December 31, 2012 ................................. $ 4,119Mazda excess basis ........................................................................... $14,000

Step 4: Sec. 179 deduction (limited to $11,160 – $1,152 – $4,119 = $5,889) ........................... 5,889 < 5,889>

Step 5: Special depreciation on excess basis [50% × ($14,000 – $5,889), limited to $11,160 – $1,152 – $4,119 – $5,889 = $0] .................................... 0 < 0>

Step 6: Regular depreciation on Mazda excess basis [($14,000 – $5,889) × 20%, limited to $11,160 – $1,152 – $4,119 – $5,889 – $0 = $0] .......... 0 < 0>Mazda excess basis at December 31, 2012 ........................................ $ 8,111Total 2012 depreciation ............................................... $11,160Basis of Mazda at end of 2012 ($4,119 + $8,111) .............................. $12,230

sellIng a busIness auTOFor a 100% business-use auto, the basis for computing gain or loss is generally the original cost or other basis less the amount of depreciation allowed. If the standard mileage rate was used, basis is reduced by the depreciation component of the business standard mileage rate (see the Business Vehicles—Quick Facts table on Page 11-1). For an auto with both business and personal use, gain or loss must be figured as though two separate assets were sold. The business-use percentage is determined, then the selling price and basis are allocated between the business and personal portions. Total depreciation is subtracted from the busi-ness portion of the basis.When the business-use percentage varies from year to year, use the following formula to determine the business-use percentage for the year of sale.

Total Business Miles All Years= Business-Use

PercentageTotal Miles Driven All Years

Example: Charlie purchased a car on July 1, 2008, for $15,000. He used the car 75% for business every year until he sold it for $3,000 on December 31, 2012. Business mileage was 16,000 in 2008, 15,500 in 2009, 12,000 in 2010, 12,500 in 2011 and 10,000 in 2012. The standard mileage rate was used.Total Basis Reduction: (See the Business Vehicles—Quick Facts table on Page 11-1 for the depreciation component of the standard mileage rate.)2008: 16,000 @ 21¢ = $3,360 2011: 12,500 @ 22¢ = $ 2,7502009: 15,500 @ 21¢ = 3,255 2012: 10,000 @ 23¢ = 2,3002010: 12,000 @ 23¢ = 2,760 Total depreciation ............ $14,425Business Basis:

$15,000 original cost × 75% ......................................................... $11,250Less depreciation ......................................................................... <14,425>Adjusted basis (cannot be negative) ............................................ $ –0–

Business Gain/Loss:$3,000 sale price × 75% ............................................................... $ 2,250Less adjusted basis ...................................................................... < –0–>Gain on sale ................................................................................. $ 2,250

Nondeductible Personal Loss:$3,000 sale price × 25% ............................................................... $ 750Less adjusted basis ($15,000 × 25%) .......................................... < 3,750>Loss (nondeductible) .................................................................... $<3,000>

alTernaTIve MOTOr vehIcle Tax creDIT

Form 8910

The only alternative motor vehicle credit available for vehicles placed in service after 2011 is the credit for qualified fuel cell motor vehicles. These are propelled by power derived from one or more cells that convert chemical energy directly into electricity. A list of qualified vehicles and the credit amount is available at www.irs.gov. Search for “qualified fuel cell vehicles.”

creDITs FOr Plug-In vehIcles

Plug-In Electric Drive Motor VehiclesTaxpayers can claim a credit for each new qualifying vehicle purchased for use or lease but not for resale. The portion of the credit attributable to the business-use percentage of the vehicle is treated as part of the taxpayer’s general business credit. The remainder is treated as a nonrefundable personal credit that can offsetbothregulartaxandAMT.(IRC§30D)Qualifying vehicles are new four-wheeled plug-in electric ve-hicles manufactured primarily for use on public streets, roads and highways that meet certain technical requirements. The credit amount ranges from $2,500 to $7,500. However, the following do not qualify:1) Vehicles manufactured primarily for off-road use (such as golf

carts).2) Vehicles weighing 14,000 pounds or more.3) Low-speed vehicles (four-wheeled vehicles that can obtain a

speed of 20 but not more than 25 miles per hour and a gross vehicle weight rating of less than 3,000 pounds).

Manufacturers’ certification. The IRS will acknowledge a manufacturer’s (or in the case of a foreign vehicle manufacturer, its domestic distributor’s) certifications that a vehicle meets the standards to qualify for the credit. Taxpayers may rely on such a


Example 1: Sherman regularly works in an office in the city where he lives. His employer sends him to a one-week training session at a different office in the same city. He travels directly from his home to the training location and returns each day. He can deduct the cost of his daily round- trip transportation between his home and the training location.Example 2: Walter’s principal place of business is in his home. He can deduct the cost of round-trip transportation between his home and his client’s or customer’s place of business.

Deducting Commuting Expense

Is this job temporary (one year or less)?

Commuting expenses between home and

another work location in the same trade or

business are deductible.Commuting

expenses are nondeductible.

Is this job outside the taxpayer’s

metropolitan area?

Does the taxpayer have one or more regular work locations away from home?

Commuting expenses are deductible.

Commuting expenses are nondeductible.

Commuting expenses to temporary job in the same trade

or business are deductible.

No Yes

No Yes

No

No Yes

Yes

Is Taxpayer’s Home the Principal Place of Business?

When Local Transportation Expenses Are DeductibleTaxpayer’s Home Is Not The Principal Place of Business

Page 14 of 55 of Publication 463 16:08 - 1-FEB-2006

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

deduct your travel expenses. These expensesare discussed in chapter 1.

If you travel more than 100 miles away fromhome in connection with your performance ofservices as a member of the reserves, you maybe able to deduct some of your reserve-relatedtravel costs as an adjustment to gross incomerather than as an itemized deduction. For moreinformation, see Armed Forces Reservists Trav-eling More Than 100 Miles From Home underSpecial Rules, in chapter 6.

Commuting expenses. You cannot deductthe costs of taking a bus, trolley, subway, or taxi,or of driving a car between your home and yourmain or regular place of work. These costs arepersonal commuting expenses. You cannot de-duct commuting expenses no matter how faryour home is from your regular place of work.You cannot deduct commuting expenses even ifyou work during the commuting trip.

Example. You had a telephone installed inyour car. You sometimes use that telephone tomake business calls while commuting to andfrom work. Sometimes business associates ridewith you to and from work, and you have abusiness discussion in the car. These activitiesdo not change the trip from personal to busi-ness. You cannot deduct your commuting ex-penses.

Parking fees. Fees you pay to park your carat your place of business are nondeductiblecommuting expenses. You can, however, de-duct business-related parking fees when visitinga customer or client.

Advertising display on car. Putting displaymaterial that advertises your business on yourcar does not change the use of your car frompersonal use to business use. If you use this carfor commuting or other personal uses, you stillcannot deduct your expenses for those uses.

Car pools. You cannot deduct the cost ofusing your car in a nonprofit car pool. Do notinclude payments you receive from the passen-gers in your income. These payments are con-sidered reimbursements of your expenses.However, if you operate a car pool for a profit,you must include payments from passengers in

Figure B. When Are Transportation Expenses Deductible?

�

� �

�

�

�

�

��

�

�

�

Temporarywork location

Home Regular ormain job

Alwaysdeductible

Alwaysdeductible

Second job

Never deductible

Never deductible

ona

dayoff from

regular or main

job

Deduc

tible

ifyo

uha

vea

regu

laror

main

job

atan

othe

r locat

ion Always deductible

Most employees and self-employed persons can use this chart.(Do not use this chart if your home is your principal place of business.See Office in the home.)

Home: The place where you reside. Transportation expenses between your home andyour main or regular place of work are personal commuting expenses.

Regular or main job: Your principal place of business. If you have more than one job,you must determine which one is your regular or main job. Consider the time youspend at each, the activity you have at each, and the income you earn at each.

Temporary work location: A place where your work assignment is realisticallyexpected to last (and does in fact last) one year or less. Unless you have a regularplace of business, you can only deduct your transportation expenses to a temporarywork location outside your metropolitan area.

Second job: If you regularly work at two or more places in one day, whether or notfor the same employer, you can deduct your transportation expenses of getting fromone workplace to another. You cannot deduct your transportation costs between yourhome and a second job on a day off from your main job.

your income. You can then deduct your caryou stay overnight, you are traveling away from Transportation expenses you have in goingexpenses (using the rules in this publication).home. You may have deductible travel ex- between home and a part-time job on a day off

penses as discussed in chapter 1. from your main job are commuting expenses. Hauling tools or instruments. HaulingYou cannot deduct them. tools or instruments in your car while commuting

No regular place of work. If you have no to and from work does not make your car ex-Armed Forces reservists. A meeting of anregular place of work but ordinarily work in the penses deductible. However, you can deductArmed Forces reserve unit is a second place ofmetropolitan area where you live, you can de- any additional costs you have for hauling tools orbusiness if the meeting is held on a day on whichduct daily transportation costs between home instruments (such as for renting a trailer you towyou work at your regular job. You can deduct theand a temporary work site outside that metropol- with your car).expense of getting from one workplace to theitan area.other as just discussed under Two places of Union members’ trips from a union hall. IfGenerally, a metropolitan area includes thework. you get your work assignments at a union hallarea within the city limits and the suburbs that

You usually cannot deduct the expense if the and then go to your place of work, the costs ofare considered part of that metropolitan area.reserve meeting is held on a day on which you getting from the union hall to your place of workYou cannot deduct daily transportation costsdo not work at your regular job. In this case, your are nondeductible commuting expenses. Al-between your home and temporary work sitestransportation generally is a nondeductible com- though you need the union to get your workwithin your metropolitan area. These are nonde-muting expense. However, you can deduct your assignments, you are employed where youductible commuting expenses.transportation expenses if the location of the work, not where the union hall is located.

Two places of work. If you work at two places meeting is temporary and you have one or moreOffice in the home. If you have an office inin one day, whether or not for the same em- regular places of work.your home that qualifies as a principal place ofployer, you can deduct the expense of getting If you ordinarily work in a particular metropol-business, you can deduct your daily transporta-from one workplace to the other. However, if for itan area but not at any specific location and thetion costs between your home and another worksome personal reason you do not go directly reserve meeting is held at a temporary locationlocation in the same trade or business. (Seefrom one location to the other, you cannot de- outside that metropolitan area, you can deductPublication 587, Business Use of Your Home,duct more than the amount it would have cost your transportation expenses.for information on determining if your home of-you to go directly from the first location to the If you travel away from home overnight tofice qualifies as a principal place of business.)second. attend a guard or reserve meeting, you can

Page 14 Chapter 4 Transportation

Hauling Tools or EquipmentIf a taxpayer incurs expenses for transporting job-related tools and materials above the ordinary nondeductible expenses of commut-ing, the additional expense may be deducted. For example, cost of renting a trailer that is towed by the taxpayer’s car.A deduction is available only for that portion of the cost of transporting the work materials in excess of the cost of commuting by that same mode of transportation without the work materials. It is immaterial that the employee would have used a less expensive mode of transportation if it were not for the necessity of carrying the tools.

certification (Notice 2009-89). A list of qualified vehicles and the credit amount is available at www.irs.gov. Search for “plug-in electric drive motor vehicles.”Phase-out based on vehicle sales. The credit phases out when the manufacturer has sold 200,000 qualifying vehicles after 2009 [IRC §30D(e)].Asofpublicationdate,nomanufacturerhad reached the threshold. Search for “plug-in electric drive motor vehicles” at www.irs.gov to check the status of manufacturer’s quarterly sales.

Low-Speed and 2- and 3-Wheeled Vehicles (Plug-In Electric Vehicles) Expired Provision Alert: For 2011, a credit was available for purchasing certain low-speed and 2- and 3-wheeled plug-in elec-tric vehicles [IRC §30(f)].It’spossiblethatCongresswillextendthis provision to 2012, but it had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for details.

ReportingThe credit for plug-in electric drive motor vehicles is claimed on Form 8936. The portion of the credit attributable to business/in-vestment use of the vehicle is part of the general business credit. The remainder is a personal nonrefundable credit that can offset regular tax and AMT.

cOMMuTIng exPensesIn general, the costs of commuting between a taxpayer’s home and work location are nondeductible personal expenses.

Deductible CommutingCommuting expenses are allowed in going between a taxpayer’s home and work location if: (Rev. Rul. 99-7)1) The expense is for going between the taxpayer’s

home and a temporary work location outside the metropolitan area where the taxpayer lives and normally works,

2) The taxpayer has one or more regular work locations away from home and the expenses are for going between home and a temporary work location in the same trade or business, regardless of distance or

3) The taxpayer’s home is the taxpayer’s principal place of busi-ness, and the expenses are for going between home and an-other work location in the same trade or business, regardless of whether the other work location is regular or temporary and regardless of the distance.

Temporary work location. A work location is considered tempo-rary if employment is expected to last and actually does last for one year or less. See the Temporary vs. Indefinite Assignment on Page 9-4.Principal place of business. To determine whether the home is the taxpayer’s principal place of business, consider:•Therelativeimportanceoftheactivitiesperformedateachplace

where he conducts business and•Theamountoftimespentateachplacewherebusinessiscon-

ducted.A home office qualifies as the principal place of business if the taxpayer: •Usesitexclusivelyandregularlyforadministrativeormanage-

ment activities of his trade or business.•Hasnootherfixedlocationwheresubstantialadministrativeor

management activities for the trade or business are conducted.

For 2012, is

§30D(g)].

The credit for 2- and 3-wheeled plug-in electric vehicles is claimed on Form 8834.


Tax Credits, AMT and Special Taxpayers

Tax Credits Summary (2012)For information on additional credits available to individuals, see Line-By-Line Quick Reference to 2012 Form 1040 on Page 4-1. See Tab O in the Small Business Quickfinder® Handbook for more information on the general business tax credits and energy tax credits for businesses.

Tax Credit IRC § For Credit Amount

IRS Pub

Tax Form

Refundability, Carryover

Allowed Against AMT?

QF Page

Additional Child

24 Taxpayers who don’t claim full $1,000 tax credit for each child and have (1) one or more qualifying children and over $3,000 of earned income or (2) three or more qualifying children.

Up to $1,000 per child. 972 8812 Partially refundable

Yes 12-6

Adoption Expense

23 Expenses incurred in the legal adoption of a child under age 18 or for the adoption of an incapacitated or special needs person (regardless of age). Credit is phased out for modified AGI between $189,710–$229,710.

$12,650 for a special needs child; up to $12,650 per child for all other adoptions.

17 8839 Nonrefundable; fwd 5 years

Yes 12-2

Alternative Motor Vehicle

30B Qualified fuel cell motor vehicle. Limit depends on model. 17 8910 Nonrefundable Yes 11-7

Child and Dependent Care

21 Care expenses for dependent(s) under age 13 or incapacitated that allow taxpayer to work or look for work.

20% to 35% of qualifying (limited) expenses depending on AGI level.

503 2441 Nonrefundable No1 12-3

Child 24 Taxpayers with qualifying children under age 17. Phase-out begins at modified AGI over $110,000 MFJ; $75,000 Single, HOH and QW; $55,000 MFS.

$1,000 per child. 972 1040 Generally nonrefundable

Yes 12-5

Earned Income

32 Working taxpayers with the following number of children:• None; AGI < $13,980 ($19,190 if MFJ). • One; AGI < $36,920 ($42,130 if MFJ).• Two; AGI < $41,952 ($47,162 if MFJ). • Three or more; AGI < $45,060 ($50,270 if MFJ).

Maximum credit:• $475 for no children.• $3,169 for one child.• $5,236 for two children.• $5,891 for three or more

children.

596 Sch. EIC

Refundable Yes 12-6

Education—American Opportunity

25A Up to four years of qualified higher education expenses. Credit is per student. Modified AGI phase-out: $80,000–$90,000 ($160,000–$180,000 for MFJ).

Up to $2,500 (100% of first $2,000; 25% of next $2,000).

970 8863 May be partially refundable (40%)

Yes 12-9

Education—Lifetime Learning

25A Postsecondary education and courses to acquire or improve job skills. Credit per return. Modified AGI phase-out: $52,000–$62,000 ($104,000–$124,000 for MFJ).

Up to $2,000 (20% of first $10,000).


Elderly or Disabled

22 Low-income taxpayers age 65 or older or permanently and totally disabled. Nontaxable Social Security (or equivalent) must be less than $7,500 MFJ if both spouses qualify.

Based on filing status, age and income. For MFJ also based on spouse’s age and income.

524 Sch. R

Nonrefundable No1 4-20

Federal Tax Paid on Fuels

34 Fuels used on a farm for farming purposes, for off-highway business use and other qualified uses.

Varies by type of fuel and use. 510 4136 Refundable Yes —

Foreign Tax 27 and

901(a)

Income taxes paid to a foreign country or U.S. possession on income that is also subject to U.S. federal income tax.

Amount of foreign tax up to U.S. tax multiplied by ratio of foreign/total taxable income.

514 1116 Nonrefundable; back 1 yr; fwd 10 years

Yes 12-10

Table continued on the next page

Tab 12 TopicsTax Credits Summary (2012) ................................ Page 12-1Adoption Credit or Benefit Exclusion ................... Page 12-2Child and Dependent Care Credit ......................... Page 12-3Child Tax Credit ..................................................... Page 12-5Earned Income Credit ........................................... Page 12-6Education Tax Credits ........................................... Page 12-8First-Time Homebuyer Credit ................................ Page 12-9Foreign Tax Credit ............................................... Page 12-10Health Coverage Tax Credit ................................ Page 12-10Residential Energy Tax Credits ........................... Page 12-10Retirement Saver’s Credit ................................... Page 12-11

Small Employer Health Insurance Credit ............ Page 12-12Alternative Minimum Tax (AMT) .......................... Page 12-12 Minimum Tax Credit ........................................... Page 12-13Household Employers ......................................... Page 12-15Ministers/Clergy .................................................. Page 12-16Military Personnel ............................................... Page 12-18Community Property ........................................... Page 12-19U.S. Taxpayers Working Abroad ......................... Page 12-20Non-U.S. Citizens ............................................... Page 12-21Oil and Gas Investors ......................................... Page 12-23EIC—Tips for Preparers ...................................... Page 12-25

Yes

Yes

Yes


aDOPTIOn creDIT Or beneFIT exclusIOn

Form 8839; See also IRC §23 and §137

Taxpayers adopting an eligible or special needs child may be able totakeanadoptionexpensetaxcredit(IRC§23)and/orexcludeemployer-providedadoptionbenefits from income (IRC§137).Both a credit and exclusion may be claimed for the same adoption; however, both cannot be claimed for the same expense. File Form 8839, Qualified Adoption Expenses, to claim the credit or exclusion.Credit rules. The credit can offset both regular tax and AMT. Expired Provision Alert: For 2011, the credit was refundable. Congress could extend this provision to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1.For 2012, the credit is nonrefundable. Any unused credit can be carried forward for five years.Married couples must file a joint return to take the adoption credit or exclusion. An individual is not considered married if legally separated under a decree of divorce or separate maintenance.Married and living apart. A married individual can take the credit or the exclusion on a separate return if the individual:•Livesapartfromhisspouseforthelastsixmonthsof

the tax year,•Providesthehomethatistheeligiblechild’shomefor

more than half the year and•Paysmorethanhalfthecostofkeepingupthathome

for the year.

Qualifying ChildA credit or exclusion can be claimed with respect to the expenses of adopting either an eligible child or a child with special needs.

Eligible child. A child who is either:•Underage18whenqualifiedadoptionexpensesincurredor•Physicallyormentallyincapableofcaringforhimself. Note: If the child turns 18 before the adoption is finalized, only expenses incurred before he turned 18 will be eligible for credit.Special needs child. A child who meets the following two require-ments:1) Child is a citizen or resident of the U.S. or a U.S. possession. 2) A state determines that the child cannot or should not be re-

turned to the parents’ home, and unless adoption assistance is provided to the adoptive parents, the child will probably not be adopted due to a specific factor or condition. Example of factors/conditions: Child’s ethnic background, age, membership in a minority or sibling group, medical condition, or physical, mental or emotional handicap.

Child’s Identifying Number (SSN, ITIN, ATIN)Form 8839 requires an identifying number for each eligible child. Use whichever of the following numbers is appropriate.1) Social Security number (SSN) if the child has one or if the

parents can obtain one in time to file a tax return. Apply for an SSN on Form SS-5.

2) Individual Taxpayer Identification Number (ITIN) if the child is a resident or nonresident alien and not eligible for a SSN. Apply foranITINonFormW-7(RevisedJanuary2012).

3) Adoption Taxpayer Identification Number (ATIN) if the child is a U.S. citizen or resident and the parents are unable to obtain the child’s existing SSN or apply for a new SSN until the adoption is final. An ATIN may be obtained by filing Form W-7A with the IRS along with a copy of legal placement papers. The ATIN will remain in effect for two years. An extension is available.

Note: An ATIN may be used to claim the child’s dependency exemption, the child care credit or the child tax credit; an ATIN may not be used to claim the EIC.

Personal Tax Credits Summary (2012) (Continued)

Tax Credit IRC § For Credit Amount IRS Pub

Tax Form

Refundability, Carryover

Allowed Against AMT?

QF Page

Health Coverage

35 Individuals eligible to receive trade adjustment allowance or who receive pension benefits from the PBGC.

80% of qualified health insurance cost.

502 8885 Refundable Yes 12-10

Minimum Tax 53 Credit allowed against regular tax for part of the alternative minimum tax (AMT) paid and attributable to deferral items (timing preferences and adjustments).

AMT attributable to deferral items.

17 8801 6251

Partially refundable; fwd indefinitely

Yes (refund-

able part)

12-13

Mortgage Interest

25 Part of interest expense paid by homebuyers issued a government mortgage credit certificate.

Based on interest paid and credit rate under certificate.

530 8396 Nonrefundable; fwd 3 years

No1 —

Personal Energy Property1

25C Homeowners who install certain energy saving improvements such as insulation, doors, windows, heat pumps, etc.

10% or 100% of cost depending on type; $500 aggregate lifetime limit.


Residential Energy Efficient Property

25D Following property installed on taxpayer’s personal residences (principal residence only for fuel cell): solar water heating, solar electric, fuel cells, small wind energy, geothermal heat pump.

30% of cost; $1,000/kW limit for fuel cells.

17 5695 Nonrefundable; fwd indefinitely

Yes 12-11

Retirement Saver’s

25B For individuals who make retirement plan contributions. Credit in addition to tax deduction. AGI ≤ $57,500 MFJ; $43,125 HOH; $28,750 Single, MFS, QW.

10% to 50% of contributions. Maximum: $2,000 MFJ, $1,000 other.

590 8880 Nonrefundable Yes 12-11

Small Employer Health Insurance

45R Certain employers who pay health insurance premiums for their employees.

Up to 35% of premiums paid (state average premium for small market, if less).

— 8941 Nonrefundable; back 1, fwd 20.

Yes 12-12

1 Expired Provisions Alert: For 2011, a credit was available for purchasing certain personal energy property. Also, for 2011, the credits noted could offset AMT. It’s possible that Congress will extend these provisions to 2012, but had not done so at the date of this publication. See Expired Tax Provisions on Page 17-1 for more information.

Yes

Yes


Dollar and AGI LimitationsCredit and exclusion limits:•The credit or exclusion is basedon theamount of

qualifying adoption expenses the taxpayer pays in connection with the adoption (except for the adoption of a special needs child, see below).

•For2012,thelimitis$12,650fortheadoptionofeacheligible child.

•Thelimitisacumulative,perchildlimitoveralltaxyears (not an annual limit).

•Limitappliesseparatelytothecreditandexclusion(eachcanbeup to $12,650 per child in 2012) if both are taken.

•Expensesofanunsuccessfuladoptionarecombinedwithex-penses of a later successful adoption for dollar limits.

Special needs child. The $12,650 credit or exclusion is allowed for the adoption of a special needs child even if the taxpayer does not have qualified adoption expenses.

Example: Mark and Peggy adopt a special needs child and the adoption is finalized in 2012. Their actual adoption expenses are $6,000. They are still allowed to claim the full $12,650 credit in 2012.

AGI limit. The credit and exclusion are phased out for taxpayers with a modified AGI between $189,710 and $229,710 (for 2012). The AGI phase-out is applied only in the year the adoption credit is generated, and is not applied in future years to reduce any credit carryovers.

Qualified Adoption ExpensesIncludes: Does not include:• Adoption fees.• Attorneys fees.• Court costs.• Travel expenses (including

meals and lodging) while away from home.

• Re-adoption expenses related to the adoption of a foreign child.

• Expenses paid under any state, local or federal program.

• Expenses that violate state law.• Cost of carrying out a surrogate parenting

arrangement.• Cost of adopting spouse’s child.• Expenses paid or reimbursed by employer,

another person or an organization.• Cost otherwise allowed as a deduction or credit.

When to Claim Adoption Credit or ExclusionDomestic Adoption Foreign Adoption1

Adoption CreditExpenses paid in a year… Claim credit in…

Before adoption is final Following year Year adoption is finalAdoption is final Year paid Year paidAfter adoption is final Year paid Year paid

Exclusion for Employer-Provided Adoption BenefitsBenefits received in a year… Claim exclusion in…

Before adoption is final Year received Year adoption is final2

Adoption is final Year received Year receivedAfter adoption is final Year received Year received1 For a foreign adoption, credit and/or exclusion is allowed only if adoption becomes

final.2 See Form 8839 instructions on how to report employer provided benefits in years

before the adoption is final.

When Is a Foreign Adoption Final?An adoption finalized outside the U.S. that is a convention adoption is considered final in the year that either (1) the foreign country enters a final decree of adoption or (2) the Secretary of State issues a Hague Adoption Certificate. If finalized in the U.S., the adoption is considered final in the year a state court issues a final adoption decree. (Rev. Proc. 2010-31)A convention adoption is the adoption of a non-U.S. citizen or resi-dent child who, in connection with the adoption has moved, or will move, from a country that is a party to the Hague Convention on Protection of Children and Cooperation in Respect of Intercountry Adoption, if the adoptive parent has filed an Application for Deter-mination of Suitability to Adopt a Child from a Convention Country (Form 1-800A or successor) with the Department of State. A list of countries that are parties to the Hague convention can be found at www.adoption.state.gov.See Rev. Proc. 2005-31 for when a foreign adoption that is not a convention adoption is final.

Substantiation RequirementsSee the instructions for Form 8839 for records that should be kept or attached to the return.

chIlD anD DePenDenT care creDITForm 2441; see also IRC §21 and IRS Pub. 503

Taxpayers can claim a nonrefundable credit for a percentage of their dependent care expenses that enable them to work. The credit offsets regular tax, but not AMT. Expired Provision Alert: For 2011, the credit can offset AMT (as well as regular tax). It’s possible Congress will extend this pro-vision to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.Maximum qualifying expenses for the child and dependent care credit is $3,000 for taxpayers with one qualifying individual and $6,000 for taxpayers with two or more qualifying individuals. Expenses paid for child and dependent care may also qualify for tax benefits under the taxpayer’s employer-provided pre-tax de-pendent care benefit (DCB) plan. See Dependent Care Benefits on Page 12-5. Note: Employees may receive up to $5,000 ($2,500 if MFS) tax-free benefits under a dependent care benefit (DCB) plan. Tax-free benefits under an employer DCB plan reduce the maximum qualifying expenses for the credit. See Employer benefits reduce credit on Page 12-5.

and


Credit RateThe credit percentage ranges from 20% to 35% with a maximum credit of 20% of qualified expenses for taxpayers with adjusted gross income over $43,000.

Child Care Credit Rate TableAdjusted Gross Income

DecimalAdjusted Gross Income

DecimalOver: Not Over: Over: Not Over:$ 0 – $15,000 0.35 $29,000 – $31,000 0.2715,000 – 17,000 0.34 31,000 – 33,000 0.2617,000 – 19,000 0.33 33,000 – 35,000 0.2519,000 – 21,000 0.32 35,000 – 37,000 0.2421,000 – 23,000 0.31 37,000 – 39,000 0.2323,000 – 25,000 0.30 39,000 – 41,000 0.2225,000 – 27,000 0.29 41,000 – 43,000 0.2127,000 – 29,000 0.28 43,000 – No Limit 0.20

Multiply decimal amount by qualifying expenses, not to exceed: • $3,000 for one qualifying individual or• $6,000 for two or more qualifying individuals.See Expenses Limited to Earned Income of Taxpayer or Spouse in the next column.

Eligibility Tests1) The care must be for one or more qualifying persons who are

identified on Form 2441. See Qualifying Individual below.2) The taxpayer (and spouse, if married) must have earned in-

come during the year (but see Exception for student or disabled spouse in the next column).

3) Expenses must be paid so taxpayer (and spouse) can work or look for work. Expenses must be pro-rated if the work test is met for only part of the year.

4) Expenses are not eligible if paid to the tax-payer’s spouse, the parent of the taxpayer’s under-age 13 qualifying child, a person the taxpayer can claim as a dependent, or the taxpayer’s child who is under age 19 at the end of the year.

5) If married, taxpayers must generally file a joint return (but see Considered unmarried on Page 4-8).

6) The taxpayer must identify the care provider on Form 2441.

Qualifying IndividualFor this credit, a qualifying individual includes:1) The taxpayer’s qualifying child (see Qualifying Child on Page

4-9) under age 13 whom the taxpayer can claim as a dependent (but see Children of Divorced or Separated Parents on Page 4-12 for rules in those situations).

2) The taxpayer’s dependent who is physically or mentally in-capable of caring for himself and who has the same principal place of abode as the taxpayer for over half the tax year. See Dependents on Page 4-9 for who qualifies as a taxpayer’s dependent.

Exception: A person who would have been the taxpayer’s dependent except that: (a) his gross income was $3,800 or more, (b) he filed a joint return or (c) the taxpayer (or spouse if filing jointly) could be claimed as a dependent on someone else’sreturnistreatedasadependentforthistest.[IRC§21(b)(1)(B)]

3) The taxpayer’s spouse who is physically or mentally incapable of caring for himself and who has the same principal place of abode as the taxpayer for over half the tax year.

Note: It is possible for an individual to qualify for only part of the year. For example, if a child turned 13 on September 20, 2012, count expenses incurred through September 19, 2012, even if they are paid after that date (as long as they are paid by year-end).

Qualifying ExpensesDependent care center. The cost of care provided outside the home generally qualifies if the care is for (1) a qualifying child (under age 13) or (2) another qualifying individual who regularly spends at least eight hours each day in the taxpayer’s household. The care center must comply with all applicable state and local laws and regulations.Household services. Qualifying expenses include expenses for household services for the care of a qualifying individual. Costs of a maid, housekeeper, babysitter or cook ordinarily qualify if they are at least partly for the well-being and protection of a qualify-ing individual. The qualifying expense includes costs incurred to provide meals and lodging for the in-home provider.Household employee. Wages paid for household services may require the taxpayer to pay the employer’s portion and to withhold the employee’s portion of Social Security and Medicare taxes, and to pay federal unemployment tax and similar state taxes. Employ-ment taxes paid on household employee wages for qualifying child and dependent care expenses qualify for the credit. See Household Employers on Page 12-15 and IRS Publication 926.School costs. Expenses for a child in nursery school, pre-school or similar program for children below the level of kindergarten qualify because the educational benefits are incidental to the child care costs. If the costs of schooling are separable from the cost of the child’s care, only the cost of care is used in figuring the credit. Costs to attend kindergarten or a higher grade do not qualify. However, expenses for before- or after-school care of a child in kindergarten or a higher grade may be for the care of a qualifying individual. [IRSPub.503;Reg.§1.21-1(d)(5)]Camp. The cost of sending a child to an overnight camp is not a work-related expense. The cost of a day camp is a qualified ex-pense, even if it specializes in a particular activity, like soccer. But, the cost of summer school and tutoring programs do not qualify. Also, a day camp that provides care to more than six individuals and receives fees or grants (even if a non-profit organization) must comply with all applicable state and local laws and regulations for expenses to qualify.Special school expenses. Special school expenses may qualify for either a child and dependent care credit or a medical deduction. If only part of the expenses are used to get the maximum child care credit, the unused expenses can be used for the medical deduction.

Expenses Limited to Earned Income of Taxpayer or SpouseEligible expenses are limited to the earned income of either the taxpayer or spouse, whichever is less. Earned income includes nontaxable combat pay, if elected (by including the pay on the earned income line on Form 2441).Exception for student or disabled spouse. If one spouse is a full-time student or disabled, earned income is deemed to be at least (1) $250 per month with one qualifying individual or (2) $500 per month with two or more qualifying individuals. Note: The exception is only available for one spouse. If in the same month both spouses are full-time students or disabled, only one spouse is deemed to have earned income of $250 (or $500) for that month.Taxpayers taking online courses are considered students for this test if the organization offering the course has traditional classroom instruction in addition to online courses. If only online course are offered, the taxpayer is not considered a student.

Allowable Expenses—Year-End TimingGenerally, the credit must be based on payments made in the year services are provided.Prepaid expenses. If expenses are paid in the year before ser-vice is provided, the prepaid expenses qualify for the credit in the following year.


Qualifying child defined. For the EIC, a taxpayer’s qualifying child is defined under Qualifying Child on Page 4-9, with the following exceptions and additional requirements:1) The support test does not apply.2) The residency test is satisfied only if the child had the same

principal place of abode in the U.S. as the taxpayer for over half the year (the U.S. residence requirement is deemed to be met for Armed Forces personnel who are stationed on extended active duty outside the U.S.).

3) The rules under Children of Divorced or Separated Parents on Page 4-12 do not apply (see the Release of Exemption to Noncustodial Parent table on Page 4-12).

4) The child was unmarried at year-end (unless the taxpayer could claim a dependency exemption for the child, or could have claimed the exemption if not for the rules discussed under Children of Divorced or Separated Parents on Page 4-12).

5) The child’s name, age and Social Security number are reported on the taxpayer’s return or in such other fashion as the IRS may prescribe.

Earned Income DefinedTo qualify for the EIC, a taxpayer must have earned income, which is generally limited to the amount included in taxable income.Earned income includes:•Wages,salaries,tipsandothertaxableemployeepay.•Netearnings fromselfemployment, reducedby the

deductible portion of the SE tax.•Unionstrikebenefits.•Disabilitybenefitsreceivedbeforeminimumretire-

ment age to the extent included in taxable wages on Form 1040, line 7. (Pub. 596; CCA 199916041)

•Grossincomereceivedasastatutoryemployee.•Nontaxablecombatpay,ifthetaxpayerelectstotreat

it as earned income for EIC purposes. (Elect by reporting all pay on line 64b of Form 1040.)

Earned income does not include:•TaxablescholarshiporfellowshipgrantsnotreportedonFormW-2.•Amountspaidtoaninmateinapenalinstitutionforwork.•Pensionsor annuities, includingamounts receivedasapen-

sion or annuity from a nonqualified deferred compensation or nongovernmental Section 457 plan.

•Communitypropertyincomethatistreatedasbelongingtothetaxpayer, but that is earned by the taxpayer’s spouse. This rule applies to taxpayers who are married, but qualify to file as HOH under rules for married taxpayers living apart and who live in a state that has community property laws and to registered do-mestic partners living in California, Nevada or Washington and same-sex spouses in California. Earned income includes the entire amount earned by the taxpayer, even if part of it is treated as belonging to another taxpayer under community property laws.

•Nontaxableworkfare payments, which are cash paymentsreceived from a state or local agency that administers public assistance programs funded under the federal Temporary As-sistance for Needy Families (TANF) program in return for certain work activities.

•Nontaxablemilitarypay(butataxpayercanelecttotreatnontax-able combat pay as earned income—see Earned income includes above).

Ministers and church employees. See Earned Income Credit (EIC) on Page 12-17 for information about the EIC for ministers and other church employees.

Investment IncomeTaxpayers generally will not qualify for the EIC if investment income exceeds $3,200 in 2012.Investment income includes:•Taxableinterestanddividends.•Tax-exemptinterest.•Netincomefromnonbusinessrentsandroyalties.•Capitalgainnetincome[theamountonline13ofForm1040,

minus any gain on Form 4797, line 7 (line 9 of Form 4797 if lines 8 and 9 are used)].

•Netpassiveactivitiesincome.

Enforcement ProvisionsNoncustodial parent. The IRS may deny the EIC to a noncustodial parent based on data received from the Federal Case Registry of Child Support Orders.Fraud. Taxpayers who fraudulently claim the EIC cannot take the credit for the next 10 years.Reckless or intentional disregard of rules. Taxpayers who improperly claim the EIC with a reckless or intentional disregard of the rules cannot take the credit for the next two years.Denial/reinstatement. Taxpayers whose EIC was reduced or disallowed for any year after 1996 (for any reason other than a math or clerical error) must file Form 8862, Information to Claim Earned Income Credit After Disallowance, to reinstate their eligi-bility in future years.Due diligence for tax preparers. A $500 penalty (per failure) is imposed on any preparer who fails to meet due diligence require-mentswithrespecttotheEIC.[IRC§6695(g)]Reg.§1.6695-2containsproceduresthatpreparersmustfollowtoprotect themselves from the penalty. A preparer must:1) Complete and attach Form 8867, Paid Preparer’s Earned In-

come Credit Checklist (or similar form that provides the same information), to the taxpayer’s return.

2) Complete the EIC Worksheet in the Form 1040 instructions (or similar worksheet that provides the same information). See Earned Income Credit (EIC) Worksheet (2012) on Page 3-8.

3) Keep a record of how, when and from whom the information used to prepare the Form 8867 and EIC worksheet was ob-tained.

4) Keep copies of any documents that the client provides (includ-ing Social Security cards and birth certificates) that are used to determine eligibility for or amount of the EIC.

5) Make reasonable inquiries if the information furnished to, or known by, the preparer appears to be incorrect, inconsistent or incomplete.

6) Retain the above information for three years from the latest of:a) The due date of the tax return (not in-

cluding extensions). b) The date the return was filed (if the

preparer signed the return and filed it electronically).

c) The date the return was presented to the taxpayer for sig-nature (if the preparer signed the return and did not file it electronically).

d) The date preparer submitted the EIC part of the return to the preparer who signed the return (if preparer prepared the EIC portion of the return but another preparer signed the return).


eDucaTIOn Tax creDITsForm 8863; see also IRC §25A and IRS Pub. 970

For 2012, the following education credits are available:•Americanopportunitycredit.•Lifetimelearningcredit(LLC).The American opportunity credit can offset regular tax and AMT. The LLC can offset regular tax, but not AMT. Expired Provision Alert: For 2011, the LLC could offset AMT (in addition to regular tax). It’s possible Congress will extend this provision to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information. Note: See the Education Tax Incentives Comparison Chart (2012) on Page 13-5 for more education-related tax breaks.

Who Claims the Credit?The education credits are available for qualified tuition and/or related expenses of the taxpayer, the taxpayer’s spouse or a dependent of the taxpayer claimed on the taxpayer’s return. They are not available to married taxpayers who file as MFS.Dependent claimed on another person’s re-turn. If a parent claims a child as a dependent, only that parent may claim the education credit for the child. If the parent is eligible to, but does not claim the student as a dependent, onlythestudentcanclaimtheeducationcredit.[Reg.§1.25A-1(f)] Note: This does not change the basic rule that a child cannot claim a personal exemption for himself if the parent is eligible to, butchoosesnotto,claimthechildasadependent.[IRC§151(d)(2)]Qualifying expenses paid by a student are considered to have been paid by the parent if the student is claimed as a dependent on the parent’staxreturn[Reg.§1.25A-5].Likewise,ifthestudentisnotclaimed as a dependent, qualifying expenses paid by parent can be claimed by the child. See Third-party payments below.

Example #1: In 2012, Ferdinand pays qualified tuition for his son to attend college during 2012. Ferdinand claims his son as a dependent on his tax return. Assuming he meets other requirements, Ferdinand is allowed an education credit on his tax return regardless of who paid the qualifying expenses. His son cannot claim the credit.Example #2: Assume the same facts as Example #1, but Ferdinand chooses not to claim his son as a dependent on his tax return (even though eligible to do so). If Ferdinand’s son meets other requirements, he may claim the education credit on his return. The result would be the same regardless of whether Ferdinand or his son paid the qualified expenses. (FSA 200236001)

@ Strategy: It may be advantageous for parents who do not qualify for the education credit for their child’s expenses due to the AGI limitation to not claim the child as a dependent, so the child (student) can claim the education credit on his return. In that situation, no one claims the dependency exemption.Third-party payments. If a third party (anyone other than the taxpayer, his spouse or a claimed dependent) pays a student’s qualified expenses directly to an eligible institution, the student is treated as receiving the payment from the third party and, in turn, paying the qualified expenses. If the student is not claimed as a dependent on another person’s return, the student claims the education credit (if otherwise eligible). If the student is claimed as a dependent on another person’s return, the expenses treated as paid by the student are treated as paid by the person claiming the dependency exemption, and that person claims the education credit.[Reg.§1.25A-5(b)]

Qualified ExpensesExpenses qualify in the tax year paid. Payments must be for an academic period (such as quarter, semester or trimester) that begins either in the same tax year or in the first three months of the following tax year. For institutions that use credit hours or clock hours and not academic periods, each payment period may be treated as an academic period. Amounts reported on Form 1098-T (either as received or as billed) by the educational institution may differ from the amount actually paid. Only amounts the taxpayer paid or was deemed to pay qualify for the credits.An eligible institution is any accredited college, university, vocation-al school or other accredited post-secondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education (DOE), including certain institutions located outside the U.S. that participate in the DOE programs. An institution should be able to state whether it is eligible. There’s also a list at www.fafsa.ed.gov. Click on “School Code Search.”

Qualified Education Expenses (2012)American

OpportunityLifetime Learning

Tuition and fees Yes Yes1

Course-related books, supplies and equipment Yes2 Yes3

Room and board No No1 Includes courses taken to acquire or improve job skills.2 Must be required for enrollment or attendance at an eligible educational institution.3 Must be paid to an eligible institution as a condition of enrollment or attendance.

Qualified expenses do not include:•Expensesforhobbycoursesthatinvolvesports,gamesorhob-

bies, or any noncredit course unless it is part of the student’s degree program. Exception: These expenses will qualify for the lifetime learning credit if taken to acquire or improve job skills.

•Personalexpensessuchasroomandboard,insurance,medi-cal expense and transportation. Bundled fees that include both qualified expenses and personal expenses must be allocated by the institution.

Reimbursements. Credit may not be claimed for expenses that are covered by a tuition reimburse-ment that is excludable from income (such as a business-related course reimbursed by an employer). If the reimbursement is taxable, the credit is allowed.Payments with borrowed funds. The credits can be claimed for qualified tuition and related expenses paid with the proceeds of a loan. The expenses are used to figure the credit for the year in which the expenses are paid, not the year in which the loan is repaid.[Reg.§1.25A-5(e)(3)]Adjustments to qualified education expenses. Qualified edu-cation expenses must be reduced by the amount of any tax-free educational assistance received, including:•Tax-freepartsofscholarshipsandfellowships,•Pellgrants,•Employer-providededucationalassistance,•Veterans’educationalassistanceand•Anyothernontaxablepayments(otherthangiftsorinheritances)

received as educational assistance. Note: Total qualified education expenses must be reduced by amounts reported in box 5 (Scholarships or grants) of Form 1098-T, Tuition Statement, if the reported amounts are from tax-free educa-tional assistance. However, do not reduce the qualified education expenses by any scholarship or fellowship reported as income on the student’s tax return because it was used to pay nonqualified expenses (such as room and board).

Both credits


Phase-Outs for Higher Income TaxpayersThe education credits are subject to phase-out based on a tax-payer’s modified AGI.

Modified AGI Phase-Out Ranges (2012)American Opportunity Lifetime Learning

MFJ $160,000–180,000 $104,000–124,000Single, HOH, QW 80,000– 90,000 52,000– 62,000MFS Do Not Qualify Do Not QualifyModified AGI is AGI increased by the exclusions for foreign earned income, foreign housing costs and income from certain U.S. possessions and Puerto Rico.

American Opportunity CreditCredit amount. The maximum credit is $2,500 per student (100% of the first $2,000 of eligible expenses and 25% of the next $2,000 of expenses). The credit offsets both regular tax and AMT.40% of the credit is refundable. Caution: The credit is not refund-able if the taxpayer is a child (1) under age 18 [or age 18 (or a full-time student age 19–23) and whose earned income is less than or equal to half of his support], (2) who has at least one living parent and (3) does not file a joint return. N Observation: Generally, an American opportunity credit claimed on a college student’s return will not be refundable if the student is under age 24. Note: The credit is per student per year. A family may have more than one eligible student in a year.Degree requirement. Student must be enrolled in a program that leads to a degree, certificate or other recognized educational credential.Work load. Student must take at least one-half of the normal full-time work load for the student’s course of study for at least one academic period beginning during the tax year.No felony drug conviction. Student must be free of any felony conviction for possessing or distributing a controlled substance.First four years of education. To qualify for the credit, the student, as of the beginning of the tax year, must not have completed the first four years of post-secondary education at an eligible educa-tional institution. The credit can only be claimed for four tax years for any one student. The institution determines whether or not the student has completed the first four years of education as of the beginning of the tax year.

Lifetime Learning CreditCredit amount. The lifetime learning credit is a nonrefundable tax credit of 20% of up to $10,000 of qualified tuition and fees paid dur-ing the tax year. Maximum credit is $2,000. Note: The credit is per taxpayer, not per student. Thus, a family’s maximum credit is the same regardless of the number of students in the family. No workload requirement. Allowed regardless of the number of courses taken.Nondegree courses eligible. Available for undergraduate, graduate, professional degree students and students acquiring or improving their job skills.

Example: Pam, a professional photographer, enrolls in an advanced photog-raphy course at a local college. The course is not part of a degree program, but Pam enrolls to improve her job skills. The expense qualifies for the lifetime learning credit.

Unlimited number of years. There is no limit on the number of years for which the credit can be claimed for each student.

Coordination of Credits and ExclusionsEducation credits. A taxpayer may not claim both an American opportunity credit and a lifetime learning credit for the same student in the same year.æ Practice Tip: Families with more than one student during the year can choose to take the credits on a per-student, per-year basis. For example, the American opportunity credit can be claimed for one student and the lifetime learning credit claimed for another in the same year.Education savings account (ESA)/qualified tuition program (QTP). A taxpayer can claim an American opportunity credit or lifetime learning credit in the same year that the taxpayer excludes an ESA or QTP distribution from income as long as the same expenses are not used for both benefits. Qualified education ex-penses (QEE) are reduced in the following order:1) Amounts excluded from income such as

scholarships and employer-provided edu-cation assistance.

2) Amounts used to claim education credits.Thus, if an education credit is claimed, QEE are first allocated to the credit, and any remaining QEE go toward computing the taxable amount of the distribution from an ESA or QTP.If a student receives distributions from both an ESA and a QTP that are more than the QEE, the expenses must be allocated between the distributions.Tuition and fees deduction. A taxpayer may not claim the tuition and fees deduction if an education credit is claimed for the same student in the sameyear [IRC§222(c)(2)(A)].SeeTuition and Fees Deduction on Page 13-4.Savings bond interest exclusion. The amount of education expenses used to compute an education credit reduces the amount used in computing the interest exclusion on U.S. savings bonds[IRC§135(d)(2)].SeeSavings Bond Interest Exclusion on Page 13-3.

FIrsT-TIMe hOMebuyer creDITForm 5405; See also IRC §36

The first-time homebuyer credit is not available for homes pur-chased in 2012. However, taxpayers who claimed the credit, which was available for homes purchased during 2008–2011, may have to repay (recapture) their credits. æ Practice Tip: The IRS has a tool to help taxpayers find the original amount of their credit, annual repayment amounts (if ap-plicable), total amount paid and the total balance left to be paid. This information can be accessed at www.irs.gov (search for “first-time homebuyer credit lookup”).

Repayment of CreditThe rules for repaying or recapturing the credit differ depending on when the home was purchased. Generally, the rules for homes purchased in 2009–2011 are more favorable than those for homes purchased in 2008.Home purchased in 2009–2011. The credit does not have to be repaid unless the taxpayer sells or otherwise stops using the home as a principal residence within 36 months beginning on the date of purchase. Then, the credit is repaid in the year of sale. If the home is sold to an unrelated person, the repayment is limited to the gain on the sale.


Home purchased in 2008. The credit must be repaid in 15 equal annual installments (without interest) beginning with the second tax year after the year the credit is claimed. The repayment amount is included as an additional tax on the taxpayer’s return for that year.•Ifthehomeissoldbeforethe15-yearperiodends,anyremaining

credit is repaid in the year of sale. Repayment is limited to the gain from the sale (unless sold to a related person), determined by reducing the home’s basis by the credit not already repaid.

•Repayment isn’t accelerated if the residence is involuntarilyconverted and the taxpayer acquires a new principal residence within two years.

•Repaymentends if the taxpayerdies, sononeis due in the year of death or any future years. If a joint return was filed when the credit was claimed, the surviving spouse would only have to repay his half of the remaining credit. (IR 2008-106)

•Repayment isn’t required if the home is transferredbetweenspouses or former spouses incident to a divorce. For years end-ing after the transfer, the transferee spouse is responsible for remaining repayment.

•Therepaymentcan’tbeoffsetbythetaxpayer’snonrefundablepersonal credits.

Reporting credit repayment. A repayment is computed on Form 5405 and carried to Form 1040 if: (1) the home was disposed of or ceased to be a principal residence in 2012 or (2) the home was purchased in 2010, destroyed or sold through condemnation in 2010, and has not been replaced within two years of the event. In all other situations (for example, credit repayment in installments for a home purchased in 2008), repayment is reported directly on Form 1040.

FOreIgn Tax creDITForm 1116; see also IRC §901 and IRS Pubs. 514 and 901

Taxpayers may choose to either claim a foreign tax credit or a tax deduction on Schedule A (Form 1040) for taxes paid to a foreign government or U.S. possession on income that is also subject to U.S. income tax. Taxpayers cannot claim both the credit and the deduction on the same foreign tax. But, a Schedule A deduction is allowed for certain taxes that do not qualify for the foreign tax credit.Foreign taxes that do not qualify for the credit include:•Taxesattributabletoexcludedincome(suchasforeignearned

income).•Taxesattributabletoforeigncountriesdesignatedby

the Secretary of State as countries (1) involved with international terrorism, (2) that have no diplomatic relations with the U.S. or (3) whose governments are not recognized by the U.S. See Pub. 514 for a list of these countries.

•Taxesthatwouldberefundedifthetaxpayermadea claim.

•Taxesthatarereturnedtothetaxpayerasasubsidy.•Withholdingtaxpaidonforeign-sourcedividendsifstockfrom

the foreign corporation has not been held at least 16 days.Foreign tax credit limit. Generally, the foreign tax credit is limited to U.S. tax multiplied by the ratio of foreign taxable income over total taxable income (before personal exemptions). The limit is calculated on Form 1116 and requires separating foreign-source income into specified categories. Note: The foreign tax credit limit does not apply to taxpayers who elect to claim the foreign tax credit without filing Form 1116.

Election not to file Form 1116. Taxpayers can claim the foreign tax credit on line 47 of Form 1040 without filing Form 1116 if:1) Total foreign taxes paid or accrued during the year do not

exceed$300($600MFJ).2) All foreign income is passive income (such as dividends, inter-

est, annuities and rents or royalties not from an active trade or business) and is reported on Form 1099-DIV, 1099-INT, Schedule K-1 or other similar statement.

3) For dividend income, the shares were held for at least 16 days.4) The taxpayer is not filing Form 4563 or excluding income from

sources within Puerto Rico.5) All foreign taxes were legally owed, not eligible for a refund

and paid to countries that are recognized by the U.S. and do not support terrorism.

Excess foreign taxes cannot be carried to or from a tax year to which the election applies (but carryovers to and from other years are unaffected). Note: If this election is made, the AMT foreign tax credit is the same as the credit for regular tax.Simplified AMT foreign tax credit. Generally, the AMT foreign tax credit (AMTFTC) is calculated by refiguring the foreign tax credit limit considering only income and deductions allowed for AMT. Tax-payers may elect a simplified AMTFTC limit, which uses the ratio of foreign regular taxable income over total AMT taxable income. The election must be made for the first tax year the taxpayer claims an AMTFTC. Once made, the election applies to all later tax years and may be revoked only with IRS consent.

healTh cOverage Tax creDITForm 8885; see also IRC §35 and IRS Pub. 502

The health coverage tax credit provides a refundable credit for certain individuals who receive pension benefits from the Pen-sion Benefit Guaranty Corporation (PBGC) or who are eligible to receive a trade adjustment allowance. Eligible individuals can claim a credit equal to 72.5% of the amount paid in 2012 for qualifying health insurance for the taxpayer and qualifying family members.

resIDenTIal energy Tax creDITsForm 5695; see also IRC §25C and §25D and IRS Pub. 17

Personal Energy Property Expired Provision Alert: For 2011, a personal (nonbusi-ness) energy property credit is available. It’s possible Congress will extend this provision to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.Taxpayers can claim a credit for certain home improvements placed in service in 2011(IRC§25C).Thecreditcanoffsetregulartaxand AMT.Allowable credit:•For2011, the credit is equal to 10% of the cost of qualified energy-

efficient improvements plus 100% of the cost of residential energy property expenditures.

•Thecreditislimitedto(1)$50foreachadvancemainaircirculat-ing fan; (2) $150 for each natural gas, propane or oil furnace or hot water boiler and (3) $300 for each item of: (a) electric heat pump water heaters, (b) electric heat pumps, (c) biomass fuel stoves, (d) high-efficiency central air conditioners or (e) natural gas, propane or oil water heaters.

20122012


•The total amount of credit that canbe claimed in2011 com-bined is $500 ($200 for exterior windows and skylights). This amount is reduced (but not below zero) for any credits claimed in 2006–2010.

Qualifying property. The property must be installed on or in the taxpayer’s principal residence that is located in the U.S. (new construction, vacation and rental homes don’t qualify). The im-provement must be new (not used) property.Qualifying property must meet technical requirements related to energy savings. Taxpayers are not required to determine whether these requirements are met. Instead, they can rely on a manufac-turer’s certification statement (that the property meets the technical requirements) to claim the credit. (Notice 2009-53)Property used partly for business. If the home is used partly for business (for example, a home office), any qualified expenditure must be allocated between nonbusiness and business use if the improvement is used more than 20% for business. If allocation is required, only the portion of the expenditure allocated to nonbusi-ness use qualifies for the credit.

Residential Energy Efficient PropertyTaxpayers can claim a tax credit for residential energy efficient propertyplacedinservicein2012.(IRC§25D)The credit is equal to 30% of the cost of the following property:•Solarenergysystems(waterheatingandelectricity).•Fuelcells.•Smallwindenergysystems.•Geothermalheatpumps.There is no limit on the credit amount except in the case of fuel cells, where the credit limit is $1,000 per kW of capacity. The credit is claimed on Form 5695 and is allowed against regular tax and AMT.Other rules:•Thecredit(otherthanforfuelcells) isrestrictedtoequipment

for the taxpayer’s personal residence, which must be in the U.S. The credit for fuel cell property is only available for a principal residence.

•Nocreditisallowedforequipmentusedtoheatswimmingpoolsor hot tubs.

•Thecost includes laborcostsproperlyallocable to theonsitepreparation, assembly or original installation of the property and for piping or wiring to interconnect such property to the home.

•The taxpayer’sbasis in the credit property is reducedby theamount of the credit.

•Taxpayerscanrelyonmanufacturer’sstatementthatpropertyqualifies for the credit. (Notice 2009-41)

•Creditisavailablefornewconstructionaswellasimprovementsto existing homes.

reTIreMenT saver’s creDITForm 8880; see also IRC §25B and IRS Pub. 590

Qualified individuals are allowed a nonrefundable credit of up to $1,000($2,000MFJ)foreligiblecontributionstoanIRAortoanemployer-sponsored retirement plan. The credit can offset both regular tax and AMT.The amount of the credit is the eligible contribution multiplied by the credit rate, based on filing status and AGI.

Retirement Saver’s Credit Phase-Out (2012)Credit Rate

Adjusted Gross Income1

MFJ HOH Single, MFS, QW50% $ 0 – 34,500 $ 0 – 25,875 $ 0 – 17,250

20% 34,501 – 37,500 25,876 – 28,125 17,251 – 18,750

10% 37,501 – 57,500 28,126 – 43,125 18,751 – 28,750

0% 57,501 and over 43,126 and over 28,751 and over1 AGI must be increased by any exclusion or deduction for foreign earned income,

foreign housing cost, income for residents of American Samoa and income from Puerto Rico.

The credit is in addition to any deduction or exclusion that otherwise applies with respect to the contribution.Qualified individuals must:1) Be at least age 18 by the end of the year, 2) Not be a dependent claimed on another person’s return and3) Not be a full-time student.Eligible contributions. Limited to $2,000 per year for each indi-vidual. Eligible contributions include the sum of:1) Contributions (other than rollover contributions) to traditional

or Roth IRAs.2) Contributions to tax-exempt employee-funded pension plans

under Section 501(c)(18)(D).3) Elective deferrals to 401(k) plans, 403(b) annuities, nonquali-

fied deferred-compensation plans maintained by state or local governments (457 plans), SIMPLE plans and SARSEPs.

4) Voluntary after-tax employee contributions to any qualified retirement plan, annuity plan or IRA.

Reduction of eligible contributions. For 2012, eli-gible contributions are reduced by the total amount ofdistributionsthetaxpayer(andspouse,ifMFJ)received fromJanuary 1, 2010 through theduedate (including extensions) of the 2012 return from:1) Traditional or Roth IRAs,2) 401(k), 403(b), governmental 457, 501(c)(18),

SEP or SIMPLE plans and3) Qualified retirement plans.The reduction does not include:•Distributionsnottaxableastheresultofarolloveroratrustee-

to-trustee transfer.•DistributionsrelatedtoaRothIRAconversion.•Loansfromaqualifiedemployerplantreatedasadistribution.•Distributionsofexcesscontributionsordeferrals(and income

allocable to such contributions or deferrals).•Distributionsofcontributionsmadeduringataxyearandreturned

(with any income allocable to such contributions) on or before the due date (including extensions) for that tax year.

•Distributionsofdividendspaidonstockheldbyanemployeestock-ownership plan under Section 404(k).

•Distributionsfromamilitaryretirementplan.

2011

2012


sMall eMPlOyer healTh Insurance creDIT

Form 8941; See also IRC §45R

Qualified small employers (including sole proprietors) can claim a nonrefundable credit for health insurance premiums they pay for their employees. The credit is part of the general business credit and offsets regular tax and AMT.The credit is up to 35% of the lesser of:1) The employer’s contribution to a qualified health insur-

ance arrangement for employees for the year or2) The amount that would have been contributed if the

total premium for each employee equaled the aver-age premium for the small group market in which the employer offered health insurance coverage. These amounts are available in the Form 8941 instructions.

Example: Mark, who lives and runs his business in Connecticut, paid 80% of the premiums for family coverage for his six FTE employees in 2012. His employees pay the remaining 20%. Assume the 2012 average premium for family coverage for the small group market for employers in Connecticut is $14,096. The premiums considered for the credit are the lesser of 80% of the total actual premiums paid or $67,661 [80% × ($14,096 × 6)].

Credit reduces deduction for health insurance. The employer’s deduction for employee health plans is reduced by the small em-ployer health insurance credit.

Qualified Small EmployerA qualified small employer is generally one that:•Employs fewer than25 full-timeequivalent (FTE) employees

during its tax year. •Paysaverageannualwageslessthan$50,000.•Payspremiumsforitsemployeesunderaqualifiedhealthinsur-

ance arrangement.FTE employees are determined by dividing the total hours worked by all employees (up to 2,080 per employee) by 2,080 (rounded down to the next lowest whole number). Count hours worked by seasonal workers only if they work more than 120 days during the tax year.Average annual wages are computed by dividing total Medicare wages paid by the number of FTE employees, rounded down to the nearest $1,000.Qualified health insurance arrangement is an arrangement under which an employer pays premiums for each employee en-rolled in health insurance coverage offered by the employer. The contribution must be an amount equal to a uniform percentage (at least 50%) of the premium cost of the qualified health plan. For employers offering one plan and whose health insurer uses composite billing, the uniformity requirement is met if the employer either (1) pays the same percentage (not less than 50%) or (2) pays the same dollar amount (not less than 50% of the self-only premium) for each employee. See Notice 2010-82 for details and how the requirement is met in other situations.

Example #1: Max offers one health plan to his employees. The employee’s cost is $5,000 per year for self-only coverage and $10,000 per year for family coverage. Max can meet the uniformity requirement by paying at least 50% of each employee’s cost ($2,500 for self-only and $5,000 for family) or by paying at least $2,500 (50% of self-only coverage) per employee, regardless of which coverage was elected.

Only premiums paid to a health insurance issuer, such as an in-surance company or HMO, for health care coverage count for the credit. A church welfare benefit plan subject to state insurance law enforcement also qualifies (Notice 2010-82). In addition to major medical coverage, premiums for more limited coverage, such as the following, are counted: (Notice 2010-44)•Limitedscopedentalorvision.•Long-termcare,nursinghomecare,homehealthcare,commu-

nity-based care or any combination thereof.•Coverageonlyforaspecifieddiseaseorillness•Hospitalindemnityorotherfixedindemnityinsurance.•Medicaresupplementalhealthinsurance.U Caution: Self-employed individuals (general partners and sole proprietors), >2% S corporation shareholders and >5% owners of other businesses, as well as their spouses, children, grandchildren, siblings, parents, grandparents, aunts, uncles, nieces, nephews and in-laws are not treated as employees for these definitions. So, their wages and hours worked are not counted in determining the number of FTE employees and average annual wages, and premiums paid for their health insurance coverage don’t qualify for the credit. Also, a member of the individual’s household who is not related but qualifies as a dependent is not an employee.

Credit Phase-Out The amount of the credit is reduced in the following situations:1) More than 10 FTE employees. The reduction is the otherwise

applicable credit multiplied by the number of FTE employees in excess of 10, and divided by 15.

2) Average annual wages exceed $25,000. The reduction is the otherwise applicable credit multiplied by the amount by which average annual wages exceed $25,000 and divided by $25,000.

For an employer with more than 10 FTEs and average annual wages exceeding $25,000, the credit is reduced (not below zero) by the sum of the two reductions.

Example: For 2012, James, a qualified employer, had 12 FTE employees and paid them average annual wages of $30,000. He paid $96,000 in health care premiums for those employees. The premiums paid were less than the average premium for the small group market in James’s state. James’s credit is calculated as follows:Credit amount before any reduction ........ 35% × 96,000 ..................... $ 33,600Reduction for number of FTE employees > 10 ....................................... 33,600 × 2/15 ..................... < 4,480>Reduction for average annual wages > $25,000 ..................................... 33,600 × 5,000/25,000 ....... < 6,720>Total 2012 tax credit ............................................................................ $ 22,400

alTernaTIve MInIMuM Tax (aMT)Form 6251; see also IRC §55–59

The AMT is calculated using a different set of tax rules than those used for regular tax. Under the AMT rules, some deductions taken for regular tax are not allowed (or are limited). Also, certain income and expenses are recognized under different rules for AMT.If the AMT calculation results in a higher tax than regular income tax, the difference is added to regular income tax on Form 1040. In effect, the taxpayer is liable for either the AMT or regular income tax, whichever is higher.IRS resource. The AMT Assistant—a tool based on the AMT work-sheet in the Form 1040 instructions—is designed to help taxpayers determine if they are subject to the AMT. It can be accessed by typing “AMT Assistant” in the search box at www.irs.gov.


Alternative Minimum Taxable Income (AMTI)The starting point for the AMTI calculation is AGI for taxpayers who do not claim itemized deductions, or AGI minus itemized deduc-tions for taxpayers claiming itemized deductions. To that amount, taxpayers must add or subtract certain adjust-ments and preferences. See AMT for Individuals—Adjustments and Preferences on Page 12-14.•Adjustmentsareincomeorexpenseitemscomputeddifferently

for AMT and regular tax. They can increase or decrease AMTI.•PreferencesareitemsthatcanonlyincreaseAMTI.Both the standard deduction and the deduction for personal exemp-tions are preferences that are not deductible for AMT. However, they are not reported on Form 6251, because the starting point for computing AMTI on that form is income before the standard deduction and deduction for personal exemptions.@ Strategy: Taxpayers who claim the standard deduction for regular tax cannot itemize for AMT. Since the standard deduction is not deducted for AMT, taxpayers who are subject to AMT might save tax by itemizing deductions for regular tax (assuming those deductions are deductible for AMT), even if less than the standard deduction. However, consider any state income tax effect, since many states require taxpayers to use the same method (standard or itemized deductions) for state as they use for federal tax. Elect itemized deductions rather than the standard deduction by filing Schedule A and checking the box on line 30.AMT NOL. Any NOL deducted to arrive at AGI is added back to AMTI, which is then reduced by the alternative tax NOL deduc-tion (ATNOLD). The ATNOLD is generally limited to 90% of AMTI (figured without regard to the ATNOLD and any Section 199 do-mestic producer deduction). The instructions for Form 6251 line 11 explain these computations.Married-filing-separate filers. MFS filers with AMTI above the upper limit of the exemption phase-out range must add to AMTI the lesser of: (1) 25% of the excess of AMTI over that amount or (2) their AMT exemption amount. This amount is added to the total reported on Form 6251, line 28.

AMT ExemptionAn exemption is subtracted from AMTI to determine the amount subject to tax. Expired Provision Alert: For 2011, the AMT exemption amounts were temporarily increased. It’s likely Congress will in-crease the exemption amounts for 2012 as well, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.

AMT Exemption Amounts (2012)AMT exemption:MFJ or QW ....................................................................................... $ 78,750Single or HOH .................................................................................. 50,600MFS .................................................................................................. 39,375Exemption reduced by 25% of AMTI over:MFJ or QW ....................................................................................... $ 150,000 Single or HOH .................................................................................. 112,500 MFS .................................................................................................. 75,000Exemption eliminated at AMTI of:MFJ or QW ....................................................................................... $ 465,000Single or HOH .................................................................................. 314,900MFS .................................................................................................. 232,5001 When 2012 amounts are available, an update will be posed at www.quickfinder.

com.

Child subject to kiddie tax. A child’s exemption amount is the lesser of the exemption for a single taxpayer or the child’s earned income plus $6,950 (for 2012).

AMT Tax Rates/ComputationTaxpayers who reported capital gain distributions directly on line 13 of Form 1040, who reported qualified dividends on line 9b of Form 1040, or who had a gain on both lines 15 and 16 of Schedule D (refigured for the AMT) calculate tax in Part III, Tax Computation Using Maximum Capital Gains Rates, of Form 6251. Tax rates for capital gains are the same as for regular tax and are applied in the same order (0%, 15%, 25% and 28%). Qualified dividends are also taxed at the same rates for both AMT and regular tax.All others use AMT tax rates of:•26%onamountsuptoandincluding$175,000($87,500MFS).•28%onamountsabove$175,000($87,500MFS).Tentative minimum tax (TMT). Once the appropriate tax rate has been applied to AMTI, the amount is reduced by the AMT foreign tax credit to arrive at TMT. See Simplified AMT foreign tax credit on Page 12-10.Alternative minimum tax is the excess of TMT over an adjusted regular income tax.

Tentative minimum tax (TMT)– Regular income tax + Tax on lump-sum distributions+ Foreign tax credit for regular tax= AMT. Report on line 45 of Form 1040.

MInIMuM Tax creDITForm 8801; see also IRC §53

The minimum tax credit (MTC) is available if the taxpayer paid AMT generated by deferral items in a prior year.AMT adjustments and preferences fall into two categories:1) Deferral items. Items that do not cause a

permanent difference in taxable income over time (depreciation, etc.).

2) Exclusion items. Items that cause a per-manent difference in taxable income (are never considered for AMT).

See AMT for Individuals—Adjustments and Preferences on Page 12-14.Generally, the MTC can only be used to the extent that regular tax exceeds the tentative minimum tax. If the taxpayer stays in an AMT situation, or is close to paying AMT (regular tax is only slightly greater than the tentative minimum tax), the MTC might never be used or provide only minimal benefit.

Portion of MTC May Be RefundableA portion of the MTC may qualify as an “AMT refundable credit,” which means that taxpayers benefit from the credit regardless of their tax liability.AMT refundable credit. For 2012, the AMT refundable credit is com-putedonForm8801,PartIV,andequalsthegreaterof:[IRC§53(e)]1) 50% of the long-term unused MTC or2) The prior year AMT refundable credit.


AMT for Individuals—Adjustments and PreferencesItem Regular Income Tax

(Form 1040)Alternative Minimum Tax

(Form 6251) Type1

Standard Deduction Can be deducted instead of itemized deductions. Not deducted. Note: No entry made on Form 6251 since form starts with income before standard deduction.

Exclusion

Deduction for Personal Exemptions

Deduct the number of exemptions claimed multiplied by a set amount (adjusted annually). Deduction partially phased out at higher income levels.

Not deducted. Note: No entry made on Form 6251 since form starts with income before deduction for personal exemptions.

Exclusion

Home Mortgage Interest

Qualified residence interest (QRI) to acquire or improve a principal and one second home (including certain boats and motor homes) and interest on a home equity loan of up to $100,000 are deductible.

Qualified housing interest, which is QRI (except interest on a second home that is a boat or motor home) and interest on a home equity loan, but only to the extent used to acquire or improve the residence, are deductible. If an eligible mortgage is refinanced, interest on any portion of the refinancing that exceeds the balance of the refinanced mortgage is not deductible.

Exclusion

Depletion Depletion deduction limited by taxable income. Cost depletion limited to basis.

Deduction limit must be refigured using allowable AMT income and deductions. Cost depletion limited to basis refigured under AMT rules.

Exclusion

Depreciation After 1986

Choice between general depreciation system (GDS) and alternative depreciation system (ADS).

Asset placed in service before 1999: If MACRS 200% DB used for regular tax, refigure for AMT using MACRS 150% DB over ADS recovery period. Otherwise, use regular tax method and ADS recovery period.Asset placed in service after 1998: If MACRS 200% DB used for regular tax, refigure for AMT using MACRS 150% DB over GDS recovery period. Property is not adjusted for AMT if special depreciation claimed.

Deferral

Disposition of Property

Gain or loss computed based on regular tax basis.

Gain or loss from the sale of property recalculated for AMT if property’s basis different for AMT than for regular tax. Adjustments such as depreciation, research and development and incentive stock options may cause basis differences.

Deferral

Exercise of Incentive Stock Options

Exercise of an incentive stock option (ISO) is generally not a taxable event.

Difference between amount paid and fair market value (FMV) must be added to AMTI unless the stock is sold before year-end (in the same year).

Deferral

Intangible Drilling Costs (IDC)

Deductible currently or elect to write off over 60 months.

If 60-month write-off is not elected, “excess IDC” in excess of 65% of net income from well is added back for AMT. Excess IDC = productive well IDC less 120-month SL or cost depletion method recovery. Limited application to independent producers.

Deferral

Interest From Private Activity

Bonds

Exempt from income tax. Allocable interest expense not deductible.

If issued after August 7, 1986, income must be included for AMT purposes. Income may be reduced by allocable expenses that were not deductible for regular tax. Does not apply to interest from bonds issued in 2009 and 2010.

Exclusion

Investment Interest Expense

Interest relating to tax-exempt income is not deductible. Other investment interest limited to net investment income (reported on Form 4952).

Use a separate Form 4952 to calculate investment income under AMT rules. Interest used to carry tax-exempt private activity bonds is deductible, subject to limits.

Exclusion

Long-Term Contracts

Certain taxpayers can use completed contract method.

Generally must use percentage of completion method. There are certain exceptions for home construction.

Deferral

Medical and Dental Expenses

Amounts over 7.5% of AGI are deductible. Amounts over 10% of AGI are deductible. Add back 2.5% of AGI or actual amount deducted on Schedule A, whichever is less.

Exclusion

Miscellaneous Deductions

Amount that exceeds 2% of AGI is deductible on Schedule A.

Not allowed. Add back any amount deducted on Schedule A. Exclusion

Deductions Limited By Income

Certain deductions such as Section 179, business use of home expenses, SE health insurance deduction, Keogh, SEP, SIMPLE and IRA contributions are limited to earned income (or taxable income from a trade or business) computed for regular tax.

Deductions must be recalculated for AMT based on income limitations that take into account all AMT adjustments and preferences. Enter the difference between amount calculated for regular tax and the amount allowed for AMT. Also, taxable IRA distributions may have to be recomputed, if prior deductions were different for regular tax and AMT. Note: Deductions limited by AGI (or modified AGI) for regular tax do not have to be recomputed.

Must Be Allocated

Passive Activities Loss limited to passive income. Calculate on Form 8582, Passive Activity Loss Limitations.

Use a separate Form 8582 to calculate passive gains or losses taking into account all AMT adjustments and preferences that apply.

Deferral

Qualified Small Business Stock

50% capital gain exclusion is allowed for Section 1202 stock sold in 2012.

7% of excluded gain on 2012 sales is added back to AMT. Exclusion

Tax Refund Add to income if previously deducted (under the tax-benefit rules).

Tax refunds (including property tax refunds) are not included in income for AMT purposes. Enter negative amount on Form 6251.

Exclusion

Taxes State and local income taxes or state and local general sales tax, real estate tax, etc., are deductible.

Not allowed. Add back any taxes deducted on Schedule A. Exclusion

1 Only deferral items can generate a minimum tax credit. See Minimum Tax Credit on Page 12-13.


Residency start date. Under the first-year choice, the residency starting date for 2012 is the first day of the earliest 31-day period that meets both conditions used to qualify for the choice. Note: Taxpayers need not be married to make this election.To make this choice, attach a statement to Form 1040 that includes the taxpayer’s name and address and specifies:1) The taxpayer is making the first-year choice.2) The taxpayer was not a resident in 2011.3) The taxpayer is a resident under the substantial presence test

in 2013.4) The number of days of presence in the U.S. during 2013.5) The date or dates of the 31-day period of presence and the

period of continuous presence in the U.S. during 2012.6) The date or dates of absence from the U.S. during 2012 treated

as days of presence.

Example: Alberto, a citizen of Argentina, arrives in the United States under an H-1 (work) visa on November 1, 2012. Generally, he is considered a nonresident alien for 2012 and files Form 1040NR. However, if he meets the substantial presence test during 2013, he can elect to be treated as a U.S. resident for part of 2012. If he makes this election, his residency start date is November 1, 2012. He is considered a nonresident alien before November 1, 2012, and a resident alien beginning on November 1, 2012.

Choosing Resident Alien Status for the Entire YearA dual-status alien can choose be treated as a U.S. resident for the entire year if all of the following apply. The taxpayer (1) is a nonresident alien at the beginning of the year, (2) is a resident alien or U.S. citizen at the end of the year and (3) is married to a U.S. citizen or resident alien at the end of the year. Additionally, the taxpayer’s spouse must join in making the choice.This includes situations in which spouses are nonresident aliens at the beginning of the tax year and are resident aliens at the end of the tax year. Note: Taxpayers who are single at the end of the year cannot make this choice.Under this choice, these rules apply:1) Both spouses are treated as U.S. residents for

the entire year for income tax purposes.2) Both spouses are taxed on worldwide income.3) Taxpayer and spouse must file a joint return

for the year of the choice.4) Neither spouse can make this choice for any

later tax year, even if separated, divorced or remarried.

5) The special instructions and restrictions for dual-status taxpay-ers do not apply.

Note: A similar choice is available if, at the end of the tax year, one spouse is a nonresident alien and the other spouse is a U.S. citizen or resident. See Treating Nonresident Spouse as a Resident in the next column.Making the choice. Attach a statement signed by both spouses to the joint Form 1040 that includes the following:1) A declaration that both spouses qualify to make the choice and

that both choose to be treated as U.S. residents for the entire tax year.

2) The name, address and taxpayer identification number (SSN or ITIN) of each spouse.

Example: Assume that Alberto, in the previous example, is married to Ma-ria, also a citizen of Argentina, who arrives in the U.S. with her husband on November 1, 2012. If each of them makes the first-year choice to be treated as resident aliens as of November 1, 2012, they can now also elect to be treated as U.S. residents for the entire year. Now, Alberto and Maria are not subject to the restrictions that apply to dual-status taxpayers. They can claim the standard deduction and will use the more advantageous MFJ tax rates.

Treating Nonresident Spouse as ResidentIf, at the end of a tax year, a nonresident alien is married to a citizen or resident alien, the nonresident spouse may choose to be treated as a U.S. resident. This includes situations in which one spouse is a nonresident alien at the beginning of the tax year, but a resident alien at the end of the year, and the other spouse is a nonresident alien at the end of the year. A joint return must be filed for that tax year with worldwide income reported.To make the choice, attach a statement signed by both spouses to the joint Form 1040 that includes the following:1) A declaration that one spouse was a nonresident alien and

the other spouse a U.S. citizen or resident alien on the last day of the tax year, and that both choose to be treated as U.S. residents for the entire tax year.

2) The name, address and taxpayer identification number (SSN or ITIN) of each spouse.

Tax Identification Number for AliensAliens who are required to have an individual taxpayer identification number (ITIN), but are not eligible to obtain a Social Security num-ber, must file Form W-7, Application for IRS Individual Taxpayer Identification Number.Taxpayers who are applying for an ITIN to file a tax return must attach an original, completed return to Form W-7 to get the ITIN. After Form W-7 has been processed, the IRS will assign an ITIN to the return and process the return as if it were filed at the address listed in the tax return instructions. Exception: See the Form W-7 instructions for exceptions to the requirement that a tax return be attached.Aliens need an ITIN to (1) file a tax return to report U.S.-source income or obtain a refund, (2) file an elective joint return with a U.S. citizen or resident spouse or (3) allow a U.S. citizen or resident to claim them as a dependent (resident of Canada or Mexico).

OIl anD gas InvesTOrsIRC §613A; see also IRS Pub. 535

Royalty InterestIncome. Payments to an owner of a royalty interest in oil and gas are reported by the payor on Form 1099-MISC, box 2 (without any reduction for severance taxes). The royalty-owner reports this gross income amount on Schedule E, Part I, using a separate column for each royalty property. Expenses. The royalty owner’s payments are reduced by sever-ance (production) taxes, which are withheld by the payor. Form 1099-MISC may also report the severance taxes. If not, look to the production run detail (run tickets), attached as a stub on each royalty check or sent along with the check, for production taxes. Severance taxes are deducted on line 16 of Schedule E, along with any allocable real estate taxes. While oil and gas royalty owners typically do not incur other expenses, any such expenses that are incurred are deducted on the appropriate lines of Sched-ule E, Part I.


is placed in service at the well site. The operator of the well (usu-ally not the working interest owner) determines the character of expenditures as either IDC or capitalizable L&WE. See MACRS Recovery Periods (2012) on Page 10-2 for oil and gas asset re-covery periods. Section 179 Deduction on Page 10-9 also applies.Domestic producer deduction. A working interest owner qualifies to claim the Section 199 domestic producer deduction (if property is in the U.S.). See Tab 6.

DepletionWorking interest and royalty interest owners are entitled to a deduction for the greater of cost depletion(IRC§612)orallowablepercentagedepletion (sometimes called statutory deple-tion—IRC§613A).Cost depletion is basedon the property’s LHC and is calculated using the mineral reserves (obtained from engineering reports) and the numberofunitssold for theyear [Reg.§1.611-2(a)].Forcash-basis taxpayers, the “number of units sold” means units for which payment was actually received within the tax year.

Cost Depletion Calculation

Unrecovered depletable costs

× Units sold = Cost

depletionEstimated recoverable reserves (in units) at the

beginning of year1

1 Usually obtained from engineering reports.

æ Practice Tip: For cost depletion, natural gas production is converted into equivalent barrels of oil using a ratio of 6,000 cubic feettoonebarrel(orsixMCFequalsonebarrel).[IRC§613A(c)(4)]

Percentage Depletion Quick FactsAmount A percentage of gross receipts from the property. Gross

receipts do not include lease bonuses, advance royalties or other amounts payable without regard to production from the property.

Rate Generally 15% for oil and gas properties.

Who Qualifies?

Independent producers (generally working interest owners who are not retailers or refiners) with <1,000 barrels of daily production. Royalty owners are also eligible.

Net Income Limit

Percentage depletion is limited to the net income from each property before any depletion or Section 199 domestic producer deductions. Report income and expenses by property in a supporting schedule.Expired Provision Alert: For 2011, the net income limit did not apply to “marginal production,” which is domestic production from a stripper well property or from a property primarily producing heavy oil [IRC §613A(c)(6)]. It’s possible that Congress will extend this provision to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.

65% Limit

A taxpayer’s total percentage depletion from all oil and gas properties cannot exceed 65% of taxable income, computed before percentage depletion, NOL and capital loss carryback and Section 199 deductions [IRC §613A(d)]. Deductions denied by this limitation are carried to succeeding tax years.

Not Limited to Basis

Cost depletion stops when LHC is fully depleted. Percentage depletion continues (even after LHC is depleted) because it is based on a percentage of gross income from the property.

Working InterestThe owner of a working interest in an oil and gas property bears all costs involved in finding oil or gas and, if exploration is successful, the expenses incurred in lifting the minerals from the reservoir.N Observation: A working interest in oil and gas property is not subject to the passive activity loss limits, if the taxpayer holds the working interest directly or through an entity that does not limit the taxpayer's liability [IRCSec.469(c)(3)].Anentity limits thetaxpayer'sliabilityifitis:•Alimitedpartnershipinwhichthetaxpayerisnota

general partner, •AnScorporationor•Anentitythatlimits(underapplicablestate

law) potential liability to a determinable fixed amount (such as an LLC).

Regardless of passive or nonpassive status, working interest income generally is subject to self-employment tax when held directly or in a general partnership or joint venture arrangement. (Rev. Rul. 58-166)Prepaid drilling costs. During the drilling stage of the well, working interest owners may receive monthly invoices from the operator for their share of expenses. Often, however, they prepay their share of the total estimated expenses in a lump sum before the well is drilled. A cash-basis taxpayer cannot deduct the prepayment until actual expenses have been incurred by the drilling contractor. [Keller, 53 AFTR 2d 86-663 (8th Cir., 1984)] Note: Any amounts paid for lease and well equipment (L&WE) or leasehold cost (LHC), whether prepaid or otherwise, must be capitalized and recovered through depreciation (L&WE) or deple-tion (LHC).Intangible drilling cost (IDC). IDC is any cost incurred that in itself has no salvage value and is incident to and necessary for the drilling of wells and the preparation of wells for the production of oil and gas. These costs include wages, fuel, repairs, hauling andsupplies.[Reg.§1.612-4(a)]•InthefirstyearIDCisincurred,thetaxpayermayelecttocurrentlydeductIDC[IRC§263(c)].Iftheelectionismade,thetaxpayergenerally must deduct IDC in all subsequent years as it is paid or incurred for all properties. However, he can still make an annual election under Section 59(e) to capitalize and amortize some or all of the IDC incurred that year over 60 months.

•If theSection263(c) expensingelection is notmade, IDC iscapitalized and recovered through depletion (or depreciation if the cost was associated with transporting or installing physical property).

Dry holes. A taxpayer who does not elect to expense IDC may still elect to expense IDC on nonproductive wells (dry holes). The deduction is allowable only in the year the wells are completed asdryholes[Reg.§1.612-4(b)(4)].Evenwhensomecostsareincurred in one year and the outcome of the well is known by the time that year’s tax return is filed, the costs may not be deducted until the year the well is completed.æ Practice Tip: For a taxpayer to deduct LHC on dry holes, there must be an identifiable event or point (plugging and abandoning) when the property becomes worthless. Taxpayers do not auto-matically abandon a lease if a well is dry; therefore, tax preparers should verify with clients that they intend to abandon or not renew the lease before writing off the LHC.Depreciation. A working interest owner’s share of L&WE costs is normally capitalized and depreciated. Often, the majority of an owner’s depreciable costs are incurred when a well is determined to be a producing property and pumping and storage equipment


payments must be reasonable in relation to the services rendered. Maintain records showing services performed and wages paid. (Rev. Rul. 72-23; Jenkins, TC Memo 1988-292)

Example #1: Phil is in the 35% tax bracket and owns rental property. Phil pays his 17-year-old son $5,000 during the year to help manage and maintain the property. The deduction for wages reduces Phil’s tax by $1,750 ($5,000 × 35%). Since Phil’s son has no other income, his standard deduction reduces his taxable income to zero.Example #2: Marty and Trish are married, operate a business as a partner-ship, and are in the 35% tax bracket. They hire their 17-year-old daughter, Abby, to perform services for the partnership, and pay her $15,500 in wages. Abby defers $10,000 into the partnership’s SIMPLE IRA plan. The SIMPLE deduction combined with the standard deduction reduces Abby’s taxable income to zero. The deduction for wages reduces the parents’ income tax by $5,425 ($15,500 × 35%).

Parent-Child Employment—Payroll TaxesIncome Tax W/H

Required?FICA FUTA

Child employed by parent (unincorporated business) Yes Exempt if

under age 18Exempt if

under age 21Child employed by parent-owned corporation Yes Taxable Taxable

Child employed by parent for domestic work No Exempt if

under age 21Exempt if

under age 21Note: FICA and FUTA exemptions for a child apply only for sole proprietorships (including single-member LLCs) and partnerships where the only partners are the child’s parents. FUTA exemptions for parents and spouses apply only to sole proprietorships.

FaMIly lOansA loan to a family member to finance a first home, start a new business or pay personal expenses should be made in a busi-nesslike manner.The lender should have an enforceable note that shows: (1) fixed loan amount, (2) definite payment date, (3) stated rate of interest and (4) collateral or security, if applicable.Interest on loans between related parties. As a lender, it is best to charge the family member interest at the market rate. On loans between related parties, the IRS establishes minimum interest rates (called the applicable federal rates, or AFRs) that change monthly (see Imputed Interest on Below Market Loans on Page 5-24). A taxable gift occurs if the difference between the interest charged and the interest that would be charged using the AFR com-bined with other gifts to the borrower exceeds $13,000 (for 2012).Interest paid by the borrower is:•Deductible if the loan is for business, investments or is a quali-

fied home mortgage (subject to investment interest expense and mortgage interest expense limits).

•Not deductible if the loan is for personal purposes or used to pay personal expenses, including qualified education expenses (see Restrictions on Page 13-4).

Advantages to a lender of a bona fide loan:•Maydeductabad-debtlossifloanisnotrepaid.(SeeNon-

business Bad Debt on Page 7-10.)•Principalnotsubjecttogifttaxrules.Gift loans safe from tax consequences:•Loans$10,000orlessthatarenotusedfor

buying income-producing assets (for example, stocks).[IRC§7872(c)(2)]

•Loans$100,000or lesswhere theborrower’snet investmentincomedoesnotexceed$1,000.[IRC§7872(d)(1)]

Example: Chester makes an interest-free loan to his daughter, Sally, to start a business, forgoing $3,500 in interest each year (based on AFR). The IRS treats the forgone interest as a $3,500 gift. There are no gift tax consequences in 2012 since the forgone interest plus Chester’s other gifts to Sally total less than $13,000. No income tax is owed on the forgone interest if Sally has $1,000 or less of net investment income. However, if her net investment income is $2,500 (more than $1,000), Chester must include $2,500 as income (the lesser of her net investment income or the $3,500 of forgone interest).

cusTODIal accOunTs

Uniform Gifts to Minors Act (UGMA) Uniform Transfers to Minors Act (UTMA)Generally, minors are not legally allowed to own money or prop-erty. For this reason, each state has a uniform gifts to minors or uniform transfers to minors act, which is used to facilitate owner-ship of assets by children. A custodial account created under a state’s UGMA or UTMA is similar to a trust, except terms are set in statute instead of requiring a separate trust document. Most banks, brokers and other financial institutions will set up UGMA or UTMA accounts for minor beneficiaries.Under a state’s UGMA or UTMA, legal title to money or property is held in a custodial account. The custodian, often a parent, has a fiduciary responsibility to manage the account in a prudent manner for benefit of the child. When the child reaches the age of majority (usually 18 or 21, depending on the state) control of the account transfers to the child. Some states allow the custodian to retain control over UTMA accounts until the child reaches age 25.Income tax. A UGMA or UTMA account is set up using the child’s Social Security number and income is taxed to the child. Exception: Income used by the parent to pay for support of the minor child is taxable to the parent if the parent has a legal obligation to make such payments. (Rev. Ruls. 59-357 and 56-484)Gift and estate tax. A gift in trust generally does not qualify for the $13,000 (for 2012) annual gift exclusion because the gift repre-sents a future interest. However, gifts made to UGMA and UTMA accounts are considered gifts of present interest and therefore qualify for the annual gift exclusion.

savIngs bOnDs InTeresT exclusIOnForm 8815; See also IRC §135 and IRS Pub. 970

All or part of the interest earned on Series EE bonds issued after December 31, 1989 or on Series I bonds, is excluded from income for certain taxpayers if the bonds are used for qualified educational expenses.(IRC§135)

Requirements•Bondownermustbeatleast24yearsold

before bond’s issue date.•Interestistax-freeiftheamountofbondsredeemed(principal

plus interest) is less than qualified educational expenses in year of redemption. If redemption amount is more than expenses, the excludable amount is based on the ratio of expenses to redemp-tion amount.

•Qualifiededucationalexpensesaretuitionandfeesforthebondowner or his dependent or spouse at a qualifying educational institution (college, university or vocational education school). Room, board and books do not qualify. Qualified expenses include contributions to a qualified tuition program (QTP) or an education savings account (ESA).



•Qualifiedexpensesdonotincludethosepaidwithtax-freeschol-arships, tax-free withdrawals from ESAs and QTPs, nontaxable veterans’ educational assistance benefits, tax-free employer-provided educational assistance and any expenses used in computing education credits.

•Exclusionnotavailabletomarriedtaxpayersfilingseparately.•Exclusionphasesoutfor2012whenmodifiedAGIisbetween$72,850–$87,850($109,250–$139,250MFJorQW).ModifiedAGI is AGI (before the savings bond interest exclusion) increased by: (1) foreign earned income and housing exclusion, (2) foreign housing deduction, (3) exclusion for income from certain U.S. possessions and Puerto Rico, (4) exclusion for employer adop-tion benefits, (5) student loan interest deduction, (6) domestic production activities deduction and (7) tuition and fees deduction.

The AGI phase-out applies to the year the bonds are redeemed and interest is excluded from income. It does not matter what the bond owner’s AGI is in any other tax year.

sTuDenT lOan InTeresT DeDucTIOnSee also IRC §221 and IRS Pub. 970

Taxpayers can deduct up to $2,500 of interest paid on qualified education loans for college or vocational school expenses as an adjustmenttoincome(above-the-line)(IRC§221).Thedeductionis available on qualifying loans for the benefit of the taxpayer or the taxpayer’s spouse or dependent at the time that the debt was incurred.For 2012, the deduction is phased out when modified AGI is between$60,000and$75,000 ($125,000and$155,000MFJ).Modified AGI is AGI (before the student loan interest deduction) increased by: (1) foreign earned income or housing, (2) foreign housing deduction, (3) income from certain U.S. possessions or Puerto Rico, (4) domestic production activities deduction and (5) tuition and fees deduction.

Qualified LoansQualified education loans are loans taken out solely to pay quali-fied education expenses, including tuition, fees, room and board, books, equipment and transportation for an eligible student to attend an eligible educational institution.Coordination with other education benefits. Qualified education expenses must be reduced by amounts paid with nontaxable edu-cation benefits received, such as employer-provided educational assistance, nontaxable distributions from an ESA or QTP, savings bond interest education exclusion or veterans’ educational benefits.Eligible educational institutions include colleges, vocational schools and other post-secondary institutions that are eligible to participate in Department of Education student aid programs.Eligible student. Students must take at least one half the normal full-time load in a degree, certificate or other qualified program at an eligible institution.

Restrictions1) Not available to taxpayers who are claimed as dependents

(listed on line 6c of Form 1040) on another taxpayer’s return.2) Not available to married taxpayers filing separately.3) The taxpayer must be legally obligated to repay the loan and

actually pay the interest during the tax year to deduct the inter-est.

4) Interest on a loan from a related person does not qualify. Re-lated persons include: siblings, spouses, ancestors (parents, grandparents, etc.) and lineal descendants, as well as certain corporations, partnerships, trusts and exempt organizations.

5) Loans from a qualified employer plan [for example, 401(k) plan] do not qualify.

N Observation: Because of restrictions 1 and 3, a student loan interest deduction often will not be allowed when the student takes out the loan and his parents claim a dependency deduction for the student/child. Reason: If the parents are not legally obligated to repay, they cannot deduct any interest they pay. Alternatively, if the student pays interest on the loan, he cannot deduct the interest if his parents claim a dependency exemption deduction for him. But, even if a dependency exemption deduction is claimed by the parents for the student/child, it may make sense for the student/child to take out the loan when payments will not be due until after graduation, at which point the child will likely no longer be claimed as a dependent and can therefore, deduct the interest on his return. If parents make payments on the student/child’s loan after the child graduates and treat the payments as gifts to the child, the child is eligible to deduct the interest on his tax return.

TuITIOn anD Fees DeDucTIOnForm 8917; See also IRC §222 and IRS Pub. 970

Expired Provision Alert: The tuition and fees deduction expired at the end of 2011. It’s possible Congress will extend the provision to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.Taxpayers are allowed to claim an above-the-line tuition and fees deduction for qualified higher education expenses paid. The deduc-tion is limited based on the taxpayer’s modified AGI.The deduction is not allowed for MFS filers or for any taxpayer who qualifies as a dependent (whether or not claimed) on another taxpayer’s return.

Tuition and Fees Deduction LimitDeduction

Limit1

If Modified AGI is:Single, HOH, QW MFJ

$ 4,000 $ 0 – $ 65,000 $ 0 – $130,0002,000 65,001 – 80,000 130,001 – 160,000

0 Over $ 80,000 Over $160,0001 Deduction equals qualified higher education expenses, if less.Note: There is no AGI phase-out range. Thus married taxpayers with $4,000 of qualifying educational expenses and modified AGI of $130,000 or less would be entitled to deduct the full $4,000.

Modified AGI is AGI before the tuition and fees deduction, in-creased by: (1) foreign earned income and housing exclusion, (2) foreign housing deduction, (3) exclusion for income from certain U.S. possessions and Puerto Rico and (4) domestic production activities deduction.


Educ

atio

n Ta

x Inc

entiv

es C

ompa

rison

Cha

rt (2

012)

Amer

ican

Op

portu

nity

Cre

dit

Life

time

Lear

ning

Cre

dit

IRA

W

ithdr

awals

Savin

gs B

ond

Inte

rest

Exc

lusio

nSt

uden

t Loa

n

Inte

rest

Ded

uctio

n

Tuiti

on an

d Fe

es

Dedu

ctio

nCa

utio

n: E

xpire

d1

Quali

fied

Tuiti

on

Prog

ram

(QTP

) (5

29 P

lan)

Educ

atio

n Sa

vings

Ac

coun

t (ES

A)

IRC

§25

A25

A72

(t)13

522

122

252

953

0

QF P

age

12-9

12-9

14-1

13-3

13-4

13-4

13-6

13-7

Tax B

enef

itTa

x cre

dit—

40

% re

funda

ble;2

60%

nonr

efund

able.

Tax c

redit

—no

nrefu

ndab

le.10

% ea

rly w

ithdr

awal

pena

lty is

waiv

ed.

Tax-f

ree i

ntere

st.Ab

ove-

the-lin

e tax

de

ducti

on.

Abov

e-the

-line t

ax

dedu

ction

.Ta

x-fre

e ear

nings

(sa

vings

plan

) or t

ax-

free e

duca

tion c

redit

s (p

repa

id pla

n).

Tax-f

ree e

arnin

gs.

2012

Ann

ual L

imits

Cred

it up t

o $2,5

00 pe

r stu

dent

(100

% of

first

$2,00

0 of e

xpen

ses

and 2

5% of

next

$2,00

0).

Cred

it up t

o $2,0

00 pe

r re

turn (

20%

of up

to

$10,0

00 of

expe

nses

).

Amou

nt of

quali

fying

ex

pens

es.

Amou

nt of

quali

fying

ex

pens

es.

Dedu

ction

of up

to

$2,50

0 of in

teres

t paid

on

educ

ation

loan

.

Dedu

ction

of up

to

$4,00

0 of q

ualify

ing

expe

nses

paid.

Nond

educ

tible

contr

ibutio

ns lim

ited

to am

ount

nece

ssar

y to

cove

r qua

lified

ex

pens

es.

$2,00

0 non

dedu

ctible

co

ntribu

tion p

er ch

ild

unde

r age

18 or

any

age i

f spe

cial-n

eeds

ch

ild.

Quali

fied

Ed

ucat

ion

Ex

pens

es (Q

EE)3

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment.

4

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment.

5

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment;

4 room

and

boar

d if a

t leas

t half

-tim

e atte

ndan

ce.

Tuitio

n and

fees

; co

ntribu

tions

to Q

TPs

and E

SAs.

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment;

room

and

boar

d, tra

nspo

rtatio

n, oth

er ne

cess

ary

expe

nses

.

Tuitio

n and

fees

; bo

ok, s

uppli

es an

d eq

uipme

nt.5

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment;

4 room

and

boar

d if a

t leas

t half

-tim

e atte

ndan

ce.

Tuitio

n and

fees

; bo

oks,

supp

lies a

nd

equip

ment;

4 room

an

d boa

rd if

at lea

st ha

lf-tim

e atte

ndan

ce;

paym

ents

to QT

P.6

QEE

Must

Be F

orTa

xpay

er, sp

ouse

or

depe

nden

t.Ta

xpay

er, sp

ouse

or

depe

nden

t.Ta

xpay

er, sp

ouse

, chil

d or

gran

dchil

d.Ta

xpay

er, sp

ouse

or

depe

nden

t.Ta

xpay

er, sp

ouse

or

depe

nden

t.Ta

xpay

er, sp

ouse

or

depe

nden

t.Ac

coun

t ben

eficia

ry.Ac

coun

t ben

eficia

ry.

Quali

fyin

g Ed

ucat

ion

First

four y

ears

of un

derg

radu

ate.

Unde

rgra

duate

and

grad

uate.

Unde

rgra

duate

and

grad

uate.

Unde

rgra

duate

and

grad

uate.

Unde

rgra

duate

and

grad

uate.

Unde

rgra

duate

and

grad

uate.

Unde

rgra

duate

and

grad

uate.

K–12

, und

ergr

adua

te an

d gra

duate

.

Othe

r Rul

es an

d Re

quire

men

tsMu

st be

enro

lled

at lea

st ha

lf-tim

e in

a deg

ree p

rogr

am;

pare

nts ca

n shif

t cre

dit

to stu

dent

by no

t cla

iming

stud

ent a

s a

depe

nden

t.

Avail

able

for un

limite

d nu

mber

of ye

ars f

or

both

degr

ee an

d no

n-de

gree

prog

rams

; pa

rents

can s

hift c

redit

to

stude

nt by

not

claim

ing st

uden

t as a

de

pend

ent.

Pena

lty w

aived

on IR

A dis

tributi

ons u

p to t

he

amou

nt of

quali

fied

expe

nses

for t

he ye

ar.

Appli

es on

ly to

quali

fied S

eries

EE

bond

s iss

ued a

fter

1989

or S

eries

I bon

ds;

bond

owne

r mus

t be

at lea

st 24

year

s old

when

bond

issu

ed.

Loan

mus

t be i

ncur

red

solel

y to p

ay qu

alifie

d ed

ucati

on ex

pens

es

of stu

dent

enro

lled

at lea

st ha

lf-tim

e in

a deg

ree p

rogr

am.

Paye

r mus

t be l

egall

y ob

ligate

d to r

epay

debt.

Not a

llowe

d if

educ

ation

expe

nses

ar

e ded

ucted

unde

r an

other

prov

ision

or

educ

ation

cred

it is

claim

ed.

Acco

unt o

wner

can

chan

ge be

nefic

iary

or re

claim

fund

s; ca

n ele

ct to

spre

ad gi

ft ove

r fiv

e yea

rs; so

me st

ates

allow

dedu

ction

to

resid

ents;

bene

ficiar

y ca

n be a

nyon

e.

Contr

ibutio

ns m

ust b

e ma

de by

the o

rigina

l re

turn d

ue da

te; m

ay

also c

ontrib

ute to

QTP

; ma

ndato

ry dis

tributi

ons

at ag

e 30;

bene

ficiar

y ca

n be a

nyon

e.

2012

Mod

ified

AGI

Ph

ase-

Out

Not a

llowe

d if M

AGI

exce

eds:7

MFJ ..

........

........

........

..$ 1

60,00

0–18

0,000

$ 104

,000–

124,0

00N/

A$ 1

09,25

0–13

9,250

$ 125

,000–

155,0

00$ 1

60,00

0N/

A$ 1

90,00

0–22

0,000

Sing

le, H

OH, Q

W8 ...

..80

,000–

90,0

0052

,000–

62,0

0072

,850–

87,8

5060

,000–

75,0

0080

,000

95,00

0–11

0,000

MFS .

........

........

........

..Do

Not

Quali

fyDo

Not

Quali

fyDo

Not

Quali

fyDo

Not

Quali

fyDo

Not

Quali

fy95

,000–

110,0

001 E

xpire

d Pr

ovisi

on A

lert:

The t

uition

and f

ees d

educ

tion

expir

ed at

the e

nd of

2011

. It’s

poss

ible

Cong

ress

will

exten

d the

prov

ision

to 20

12, b

ut ha

d not

done

so at

the t

ime o

f this

publi

catio

n. Se

e Ex

pired

Tax P

rovis

ions o

n Pag

e 17

-1 fo

r mor

e info

rmati

on.

2 Cau

tion:

Not

refun

dable

for c

ertai

n chil

dren

unde

r age

24. S

ee A

mer

ican

Oppo

rtunit

y Cre

dit on

Pag

e 12-

9.3 Q

ualify

ing ed

ucati

onal

expe

nses

mus

t be r

educ

ed by

any t

ax-fr

ee sc

holar

ships

and g

rants

. The

same

educ

ation

al ex

pens

es ca

nnot

be us

ed fo

r figu

ring m

ore t

han o

ne be

nefit.

4 Mus

t be r

equir

ed fo

r enr

ollme

nt or

atten

danc

e at a

n elig

ible e

duca

tiona

l insti

tution

.5 M

ust b

e paid

to th

e elig

ible e

duca

tiona

l insti

tution

as a

cond

ition o

f the s

tuden

t’s en

rollm

ent o

r atte

ndan

ce at

the i

nstitu

tion.

6 See

Qua

lified

elem

enta

ry a

nd se

cond

ary e

xpen

ses (

K–12

th g

rade

) on P

age 1

3-7 f

or ad

dition

al QE

E for

K–1

2 stud

ents.

7 No A

GI ph

ase-

out r

ange

. Up t

o $4,0

00 is

dedu

ctible

if MA

GI do

es no

t exc

eed $

65,00

0 ($1

30,00

0 for

MFJ

). Up

to $2

,000 i

s ded

uctib

le if M

AGI d

oes n

ot ex

ceed

$80,0

00 ($

160,0

00 fo

r MFJ

).8 F

or sa

vings

bond

inter

est e

xclus

ion, Q

W is

subje

ct to

the sa

me ph

ase-

out r

ange

as M

FJ.


Qualified Higher Education Expenses•Tuitionand fees required for theenrollmentorattendanceat

an eligible educational institution for the taxpayer, spouse or a dependent. Charges and fees associated with books, supplies and equipment are qualified expenses if the amount must be paid to the eligible educational institution as a condition of the enrollmentorattendanceofthestudent.[Reg.§1.25A-2(d)(2)]

•Expensesqualify in the tax year paid.Paymentmust be foreducation that begins either in the same tax year or in the first three months of the following tax year.

•Aneligible institution isanyaccreditedcollege,university,vo-cational school or other accredited post-secondary education institution. Note: Students should receive Form 1098-T, Tuition State-ment, from each educational institution they attended during the year that shows either the payments the institution received (box 1) or the amount it billed (box 2) for tuition and fees. However , the amount in boxes 1 and 2 of Form 1098-T might be different than what the taxpayer actually paid. When figuring the deduction, use only the amounts paid in 2012 for qualified education expenses.Nonqualified expenses include: insurance, medical expenses, room and board, transportation or similar personal, living or family expenses.Adjustments to qualified expenses. Qualified expenses must be reduced by the amount paid with tax-free educational assistance such as scholarships, Pell grants, employer-provided assistance, veterans’ educational assistance and any other nontaxable pay-ment (other than gifts, bequests or inheritances) received for education expenses. Qualified expenses must also be reduced by the expenses considered to figure:•U.S.savingsbondinterestexcludedunderCodeSection135.•Tax-freedistributionsfromanESAorQTP.

Coordination With Other Education BenefitsFor each eligible student, the taxpayer can claim either the tuition and fees deduction or an education credit, but not both. The tuition and fees deduction is not allowed (for a particular student) if the education expenses are deducted under any other provision of the law.

QualIFIeD TuITIOn PrOgraMsSee also IRC §529 and IRS Pub. 970

A qualified tuition program (QTP) allows a taxpayer to make contributions to an account or program to be used to pay qualified higher education costs. (QTPs are sometimes called Section 529 plans.) Two types of plans are available:1) Prepaid programs. Contributions are used to purchase

tuition credits for a designated beneficiary (student).2) Savings account plans. Contributions are made to

an account established to pay for the qualified higher education expenses of a beneficiary (student).

Contributions1) The contributor is not subject to any AGI limitations.2) The amount that can be contributed to a QTP is limited to the

amount necessary to provide for qualified expenses of the beneficiary (as determined by the plan).

3) The contribution is considered a completed gift; it is excluded from the contributor’s estate.

4) Contributors can elect to take contributions larger than the annual gift exclusion into account ratably over five years. For

example, an individual can contribute $65,000 to a QTP in 2012 without gift tax consequences provided no other gifts are made to the account beneficiary in 2012. For years 2013–2016, the $13,000 ($65,000 ÷ 5) gift allocated to that year is taken into account for the annual gift tax exclusion in effect for those years.

æ Practice Tip: The election is made on Form 709 by checking the box on Schedule A and attaching an explanation statement.

5) Contributions to a QTP are not deductible.

Distributions1) Distributions of earnings from QTPs are

excluded from income if used for qualified higher education expenses (no tax return re-porting requirements in that case). If distributions are more than the beneficiary’s qualified expenses, the earnings portion of the excess is included in the beneficiary’s income (reported on line 21 of Form 1040).

2) The earnings portion of distributions not used for qualified higher education expenses also is subject to a 10% penalty (computed on Form 5329).

3) Taxpayers should receive Form 1099-Q, Payments from Quali-fied Education Programs (Under Sections 529 and 530), from the QTP showing earnings and basis related to a QTP distribution.

The 10% penalty does not apply:•Whenthedistributionisduetothebeneficiary’sdeathordisability.•Whenthedistribution is included in incomebecausetheben-

eficiary received a tax-free scholarship, veteran’s educational assistance or employer-paid educational assistance.

•WhenthebeneficiaryattendsaU.S.MilitaryAcademy.(SeeIRSPub. 970.)

•Whenthedistributionisincludedinincomebecausethequali-fied education expenses were reduced by the amount of those expenses used in determining an education credit.

Qualified higher education expenses include:•Tuition,fees,books,suppliesandequipmentrequiredforattend-

ing an eligible school.•Reasonablecostsofroomandboardforthosewhoareatleast

half-time students in a degree program.•Expensesofaspecial-needsbeneficiarywithaphysical,mental

or emotional condition that requires additional time to complete his education.

Example: In 2012, Sally incurred $6,700 of qualified education expenses, which were paid from the following sources:

Partial tuition scholarship (tax-free) ..................................................... $3,100QTP distribution ................................................................................... 3,700

To compute the taxable portion of her QTP distribution, Sally must reduce her total qualified education expenses by any tax-free educational assistance.

Total qualified education expenses ...................................................... $6,700Tax-free educational assistance ......................................................... <3,100>Adjusted qualified education expenses (AQEE) .................................. $3,600

Since the remaining expenses ($3,600) are less than the QTP distribution, part of the earnings will be taxable. Sally’s Form 1099-Q shows that $1,200 of the QTP distribution is earnings so she computes the taxable part of the distributed earnings as follows:

$1,200 ×$3,600 AQEE

= $1,168 (tax-free earnings)$3,700 distribution

$1,200 – $1,168 = $32 (taxable earnings)Sally must include $32 in income on Form 1040, line 21; however, the amount is not subject to the 10% penalty since it’s taxable because of her receiving a tax-free scholarship. (Form 5329 must be filed with the return, but it will show that no 10% penalty is due.)


Box 4. The amount of federal income tax withheld on the distri-bution. If an amount (other than zero) is shown, report on return and attach Copy B of Form 1099-R to the return.Box 5. Generally, the employee’s investment in the contract (after-tax contributions) re-covered tax-free this year, the portion that is basis in a designated Roth account, the part of premiums paid on commercial annuities or insurance contracts recovered tax-free or the nontaxable part of a charitable gift annuity. If the amount shown is the basis in a designated Roth account, the year the taxpayer first made contributions to that account may be entered in box 11.Box 6. The amount of net unrealized appreciation in employer securities distributed from the qualified plan. (See Distributions of employer stock on Page 14-11.)Box 7. A distribution code to indicate the type of distribution and whether there are any known exceptions to the early distribution tax. (See Reporting Penalty Taxes on Page 14-15.) If the distribu-tion is from a traditional IRA, SEP IRA or SIMPLE IRA, the “IRA/SEP/SIMPLE” box will be checked.

Form 1099-R, Box 7 Distribution Codes1 ►Early distribution, no known exception (in most cases, under age 591/2).

2 ►Early distribution, exception applies (under age 591/2).

3 ►Disability.

4 ►Death.

5 ►Prohibited transaction. (Account is no longer an IRA.)

6 ►Section 1035 exchange (a tax-free exchange of life insurance, annuity, qualified long-term care insurance or endowment contracts).

7 ►Normal distribution.

8 ►Excess contributions plus earnings/excess deferrals (and/or earnings) taxable in 2012.

9 ►Cost of current life insurance protection.

A ►May be eligible for 10-year tax option (see Form 4972).

B ►Designated Roth account distribution.

E ►Distributions under Employee Plans Compliance Resolution System (EPCRS).

F ►Charitable gift annuity.

G ►Direct rollover of a distribution (other than a designated Roth account distribution) to a qualified plan, a Section 403(b) plan, a governmental Section 457(b) plan or an IRA.

H ►Direct rollover of a designated Roth account distribution to a Roth IRA.

J ►Early distribution from a Roth IRA, no known exception (in most cases, under age 591/2).

L ►Loans treated as distributions.

N ►Recharacterized IRA contribution made for 2012 and recharacterized in 2012.

P ►Excess contributions plus earnings/excess deferrals taxable in 2011.

Q ►Qualified distribution from a Roth IRA.

R ►Recharacterized IRA contribution made for 2011 and recharacterized in 2012.

S ►Early distribution from a SIMPLE IRA in first two years, no known exception (under age 591/2).

T ►Roth IRA distribution, exception applies.

U ►Dividend distribution from ESOP under Section 404(k) (not eligible for rollover).

W ►Changes or payments for purchasing long-term care insurance contracts under combined arrangements.

Box 8. The current actuarial value of an annuity contract (that is part of a lump-sum distribution). This amount should not be included in boxes 1 and 2a.Box 9a. The percentage received by the person whose name ap-pears on the Form 1099-R (for a total distribution made to more than one person).

Box 9b. Optional reporting of the employee’s total contributions or designated Roth contributions, not including amounts recovered tax-free in prior years. Box 10. The amount of the distribution allocable to an in-plan Roth rollover made within the five-year period beginning with the first day of the year in which the rollover was made. (See In-plan Roth rollover on Page 14-11.)Box 11. Shows the first year a contribution was made to the des-ignated Roth account reported on the Form 1099-R.Boxes 12-17. State and local tax information provided for the recipient’s convenience.

Qualified Charitable Distributions (QCDs) Expired Provision Alert: The ability to make QCDs expired at the end of 2011. It’s possible Congress will extend the provision to 2012, but had not done so at the time of this publication. See Expired Tax Provisions on Page 17-1 for more information.Taxpayers who have reached age 701/2 can make a distribution of up $100,000 directly (by the trustee) from their IRA to a charitable organization.[IRC§408(d)(8)]•Forjointfilers,eachspousecanmakeaQCDofupto$100,000.•AQCDisnontaxable.•QCDsare limited to theamountofdistribution thatotherwise

would have been taxable.•NocharitabledeductionisallowedforanyQCD.•QCDcountstowardataxpayer’srequiredminimumdistribution.A QCD is reported on line 15a and -0- is shown in box 15b (unless part of the distribution was not a QCD so the taxable portion is shown on line 15b). Enter “QCD” next to line 15b.

Hardship DistributionsEmployees generally cannot withdraw funds from a 401(k) or 403(b) plan until they leave the company or reach normal retire-ment age. However, employees may qualify to withdraw elective contributions before then if there is an immediate and heavy financialneed.[Reg.§1.401(k)-1(d)(3)]Expenses that satisfy the financial need requirement:•Medicalexpenses,includingexpensesnotyetincurred.•Purchaseofprincipalresidence.•Tuitionforpost-secondaryeducation(onefullyear’spaymentfor

the employee, spouse, children or dependents).•To prevent eviction or to halt amortgage foreclosure on the

taxpayer’s principal residence.•Amountstocoveranticipatedfederalandstate incometaxes,

plus early withdrawal penalties due to the hardship distribution.•Costofburialorfuneralexpensesfortheemployee,parent,child

or other dependent.•Certainexpensesrelating to the repairofdamage to theem-

ployee’s principal residence that qualify for the casualty loss deduction without regard to whether loss exceeds 10% of AGI.

A plan that permits hardship distributions may include distributions for medical, tuition and funeral expenses for a primary beneficiary under the plan (even if not a spouse, child or dependent of the employee) (Notice 2007-7). In addition, a hardship of the employee’s spouse or dependent is deemed to constitute a hardship of the employee. Note: Section 457 plans may also allow hardship distributions but only if the participant or beneficiary has an unforeseeable emergency, which is similar to the immediate and financial need requirementdescribedabove.SeeReg.§1.457-6(c)fordetails.Tax treatment. There are no income tax or penalty exceptions specifically for hardship withdrawals. Thus, they are taxable and subject to a 10% penalty, unless a penalty exception applies. See the Exceptions to 10% Early Withdrawal Penalty Before Age 591/2 on Page 14-3 for exceptions to the 10% penalty.

QCDsmadeinJanuary2013canbetreatedasmadeonDecember 31, 2012. Also, IRA distributions received in Decem-ber 2012 and donated before February 2013 can be treated as QCDs. See Form 1040 instructions for more information.


reQuIreD MInIMuM DIsTrIbuTIOnsSee also Reg. §1.401(a)(9)-0 through -9,

Reg. §1.408-8 and IRS Pub. 590

Annual required minimum distributions (RMDs) from traditional IRAs, SIMPLE IRAs and SEP IRAs must begin starting for the year the taxpayer reaches age 701/2. Taxpayers can delay receipt of the first distribution until as late as the required beginning date, which is April 1 of the year following the year they turn 701/2. Thereafter, the RMD for each year must be made by December 31. If the first distribution is delayed until April 1 of the following year, the second distribution must be made by December 31 of that year.RMDs from qualified employer plans generally must begin for the year the individual reaches age 701/2 but can be delayed until the year the individual retires from the employer if he continues to work past age 701/2. However, this RMD exception doesn’t apply to par-ticipants who are more-than-5% owners of the business sponsoring thequalifiedplan.[IRC§401(a)(9)(C)andReg.§1.408-8,Q&A-2] Note: The RMD rules do not apply to Roth IRAs. Distributions from Roth IRAs are required only after the death of the participant.

RMD Calculation—Lifetime DistributionsThe RMD for each calendar year is the account balance on De-cember 31 of the preceding year divided by the distribution period from the Uniform Lifetime Table in the next column, for the owner’s age at the end of the distribution year.

Example: Carter and Ann each have an IRA valued at $90,000 on Decem-ber 31, 2012. Carter was born on September 5, 1942. Ann was born on March 5, 1943. Both reach age 701/2 in 2013. Carter will be 71 at the end of 2013; Ann will be 70. Their minimum distributions for 2013 are:

Carter ..............Ann .................

$90,000 ÷ 26.5 = $3,396$90,000 ÷ 27.4 = $3,285

Note: Since they turned age 701/2 in 2013, the distributions for 2013 can be delayed until as late as April 1, 2014 (the required beginning date).

Exception: An account owner whose sole beneficiary at all times during the year is a spouse who is more than 10 years younger canusethedistributionperiodfromtheJointLifeandLastSurvivorExpectancy Table in IRS Publication 590 (Table II of Appendix C) to compute the RMD, which will be less than the amount computed using the Uniform Lifetime Table. Marital status is determined on January1ofthedistributionyear.Theaccountownerdoesnotfail to have a spouse as beneficiary because of death or divorce later in the year unless the account owner changes beneficiaries before the end of the year (or before the spouse’s death). [Reg. §1.401(a)(9)-5,Q&A-4(b)]Account balance rules:•IfarolloverfromaretirementplanorIRAispendingonDecember

31 (distribution was made but the funds did not reach the receiv-ing IRA), increase the account balance of the receiving plan by the rollover amount.

•SeeReg.§1.401(a)(9)-5,Q&A-3, foraccountbalanceadjust-ments for qualified plans.

Excess Accumulation Penalty (Form 5329)An excess accumulation is any amount of an RMD that is not timely distributed. Any excess accumulation in a tax year is subject to a 50% penalty.æ Practice Tip: The IRS can waive the 50% penalty if the individual can establish that the shortfall was due to reasonable errorandstepsarebeingtakentoremedyit(Reg.§54.4974-2,Q&A-7). To request a waiver, file Form 5329, completing lines 50,

51 and 52. On line 52, enter “RC” and the amount of shortfall the taxpayer wants waived in parenthesis on the dotted line, reducing the amount otherwise entered on line 52 by this amount. Attach a letter of explanation to establish that the cause was a reasonable error and that steps are being taken to remedy the shortfall. The penalty will only have to be paid if the waiver is denied.

Uniform Lifetime Table (Table III of Appendix C in IRS Pub. 590)

Age Distribution Period



70....................27.4 86....................14.1 101................. 5.971....................26.5 87....................13.4 102................. 5.572....................25.6 88....................12.7 103................. 5.273....................24.7 89....................12.0 104................. 4.974....................23.8 90....................11.4 105................. 4.575....................22.9 91....................10.8 106................. 4.276....................22.0 92....................10.2 107................. 3.977....................21.2 93.................... 9.6 108................. 3.778....................20.3 94.................... 9.1 109................. 3.479....................19.5 95.................... 8.6 110 ................. 3.180....................18.7 96.................... 8.1 111 ................. 2.981....................17.9 97.................... 7.6 112 ................. 2.682....................17.1 98.................... 7.1 113 ................. 2.483....................16.3 99.................... 6.7 114 ................. 2.184....................15.5 100.................. 6.3 115+ ............... 1.985....................14.8Use this table for:• Unmarried owners.• Married owners, unless spouse is (1) the sole beneficiary and (2) more than

10 years younger than the owner. In that case, use Table II (Joint Life and Last Survivor Expectancy) in Pub. 590, Appendix C.

Other RulesMultiple distributions allowed. The annual RMD can be taken in more than one payment as long as the total distributions for the year are at least as much as the required amount. Multiple IRAs. A taxpayer with more than one traditional IRA must determine a separate RMD for each IRA. However, the total amount can be taken from anyoneormoreoftheIRAs.[Reg.§1.408-8,Q&A-9]Distributions total more than RMD. If, in any year, the taxpayer receives more than that year’s RMD, he cannot apply the excess against the RMD required for the next or any future tax year [Reg. §1.401(a)(9)-5,Q&A-2].(Exception: Any amount distributed in the year the taxpayer turns age 701/2 counts toward the amount that must be distributed by April 1 of the following year.)

luMP-suM DIsTrIbuTIOnsA taxpayer has three choices when a lump-sum distribution is received from a retirement plan.1) Defer tax by rolling it over to an eligible retirement plan. See

Rollovers and Transfers on Page 14-9.2) Keep the money and pay tax on it. If the taxpayer elects to

pay the tax, the lump-sum distribution may qualify for 10-year averaging.

Note: Ten-year averaging is available to individuals born beforeJanuary2,1936(andbeneficiariesofsuchindividuals).See instructions for Form 4972 for qualifications to use 10-year averaging.

3) Transfer to a Roth IRA. Although tax must be paid on the distri-bution, future earnings in the Roth IRA are potentially tax-free. See Roth IRA Conversions on Page 14-7.


Social Security and Medicare Highlights2013 2012 2011

Cost-of-living (COLA)adjustment 1.70% 3.60% 0.00%Maximum earnings and still receive full benefits:Under full retirement age (FRA) at year-end ..................................... $ 15,120 $ 14,640 $ 14,160Year FRA reached1 ......................... 40,080 38,880 37,680Month FRA reached and later ......... No Limit No Limit No Limit

Maximum earnings subject to:Social Security tax .......................... $ 113,700 $ 110,100 $ 106,800Medicare tax .................................. No Limit No Limit No Limit

Tax RatesEmployee:Social Security ................................ 6.20% 4.20% 4.20%Medicare ......................................... 1.452 1.45 1.45

Employer:Social Security ................................ 6.20% 6.20% 6.20%Medicare ......................................... 1.45 1.45 1.45

Self-Employed:Social Security ................................ 12.40% 10.40% 10.40%Medicare ......................................... 2.902 2.90 2.90

Earnings needed to earn one quarter of coverage $ 1,160 $ 1,130 $ 1,120Medicare:Part A monthly premium3 ................ $ 441.00 $ 451.00 $ 450.00Part B monthly premium4 ................ 104.90 99.90 96.40Hospital deductible ......................... 1,184.00 1,156.00 1,132.00Medical deductible .......................... 147.00 140.00 162.00

1 Limit applies only to months before attaining FRA. See Earnings May Reduce Benefits on Page 14-25.

2 Plus additional 0.9% on earned income exceeding $200,000 ($250,000 combined earned income if MFJ).

3 Applies if less than 40 quarters of covered employment. Lower premium if 30–39 quarters of covered employment.

4 Beneficiaries with higher incomes pay a higher premium. See Medicare Part B Premiums on Page 14-27.

5 2013 amounts not available at publication date. See Medicare Premiums on Page 17-1.

cOnTacTIng The sOcIal securITy aDMInIsTraTIOn (ssa)

Online. The following services are available at www.ssa.gov: •Applyforbenefits.•ApplyforhelpwithMedicareprescriptiondrugcosts.•RequestaSocialSecuritystatement(orreplacement).•EstimateMedicarebenefits.•EstimateSocial Security retirement, disability or

survivors benefits.•GetSocialSecurityformsandpublications.•FindthenearestSocialSecurityoffice.•Changeaddressortelephonenumber.•GetSocialSecuritystatement.Phone. In addition to the above, the automated telephone services are available by calling 1-800-772-1213 (TTY 1-800-325-0778):If the automated services are insufficient, Social Security representa-tives are available between 7 a.m. and 7 p.m. Monday through Friday.

Social Security StatementThe Social Security statement is available at www.ssa.gov. To ac-cess the statement, individuals must create a My Social Security account. The statement includes estimates of the individual’s retire-ment and disability benefits, lifetime earnings according to Social Security’s records, the estimated Social Security and Medicare taxes the individual has paid, information about qualifying and signing up for Medicare and things to consider for those age 55 and older who are thinking of retiring.

Estimating Social Security BenefitsAn estimate of Social Security benefits can be found on the Social Security Statement or online at www.ssa.gov/estimator. There are calcula-tors that estimate potential benefit amounts using assumptions about retirement dates and different levels of future earnings. The calculators show re-tirement benefits as well as disability and survivor benefit amounts.

sOcIal securITy beneFITs1) Retirement. Monthly benefits paid to retired workers as early

as age 62.2) Family. Monthly benefits paid to spouse, children (including

dependent adults who have been disabled since childhood), and some ex-spouses of retired and disabled workers.

3) Survivor. Monthly benefits paid to the widow(er), children (including dependent adults who have been disabled since childhood), some ex-spouses and dependent parents of a deceased worker.

4) Disability. Monthly benefits paid to workers under age 65 with a qualifying disability.

5) Medicare. Hospital and medical insurance coverage generally available at age 65. See Medicare on Page 14-27.

Tax on Social Security BenefitsA portion of Social Security benefits is taxed if income above a “base amount” (based on filing status) is received in addition to Social Securitybenefits(IRC§86).FormSSA-1099isreceivedeachJanu-ary showing the amount of benefits received in the previous year. See the Social Security Benefits Worksheet (2012) on Page 3-12.

Social Security

Social Security TopicsSocial Security and Medicare Highlights............. Page 14-21Contacting the Social Security

Administration (SSA) ........................................ Page 14-21Social Security Benefits ...................................... Page 14-21Social Security Quick Chart—Retirement

Benefits (2013) ................................................. Page 14-22Social Security Quick Chart—Family, Survivor

and Disability Benefits (2013) ........................... Page 14-23Retirement Benefits ............................................ Page 14-25Family and Survivor Benefits .............................. Page 14-26Disability Benefits................................................ Page 14-26Medicare ............................................................. Page 14-27Medigap Insurance ............................................. Page 14-29Medicaid.............................................................. Page 14-30Supplemental Security Income ........................... Page 14-30

Continued on Page 14-24


Socia

l Sec

urity

Qui

ck C

hart—

Retir

emen

t Ben

efits

(201

3)Ea

rly R

etire

men

t(P

erm

anen

tly R

educ

ed B

enef

its)

Full R

etire

men

t (F

ull B

enef

its)

Delay

ed R

etire

men

t (P

erm

anen

tly In

crea

sed

Bene

fits)

Elig

ibilit

y for

Be

nefit

sW

orke

rs ar

e elig

ible f

or ea

rly re

tireme

nt be

nefits

at ag

e 62.

Note

: If r

etire

ment

is dis

abilit

y-rela

ted, a

pply

for di

sabil

ity be

nefits

, whic

h gen

erall

y eq

ual fu

ll reti

reme

nt be

nefits

.

Full r

etire

ment

age (

FRA)

(see

below

) is w

hen a

wor

ker c

an

retire

and c

ollec

t full r

etire

ment

bene

fits.

Delay

ed re

tireme

nt is

avail

able

for a

worke

r ove

r the

FRA

. At a

ge 70

, wor

kers

autom

atica

lly re

ceive

bene

fits.

Age a

nd B

enef

it

Paym

ents

Rece

iving

bene

fits be

fore F

RA pe

rman

ently

redu

ces m

onthl

y ben

efits

base

d on

numb

er of

mon

ths be

nefits

rece

ived b

efore

FRA

. Spo

usal

bene

fits ba

sed o

n the

wo

rker’s

cove

rage

are a

lso re

duce

d.

FRA

depe

nds o

n the

year

the w

orke

r was

born

.De

laying

bene

fits pa

st FR

A inc

reas

es

bene

fits as

follo

ws:

% o

f Ful

l Ben

efits

if W

orke

rRe

ceive

s Ben

efits

at A

ge 62

Wor

ker B

orn

Full

Retir

emen

t Ag

eW

orke

r Bor

n

Incr

ease

in

Bene

fits E

ach

Ye

ar A

fter F

RAW

orke

r Bor

nW

orke

rSp

ouse

19

43–1

954.

......

......

......

.....6

6 yrs,

0 mo

nths

1931

–193

2 ...

......

......

.....

5.0 %

1943

–195

4 .....

........

........

........

........

........

........

75.00

% ..

......

......

......

....7

0.00%

195

5 ...

......

......

......

.....6

6 yrs,

2 mo

nths

1933

–193

4 ...

......

......

.....

5.5

1

955 .

........

........

........

........

........

........

....74

.17 .

......

......

......

......

.69.1

7

1

956

......

......

......

......

..66 y

rs, 4

month

s

19

35–1

936

......

......

......

..6.0

195

6 .....

........

........

........

........

........

........

73.33

....

......

......

......

....6

8.33

195

7 ...

......

......

......

.....6

6 yrs,

6 mo

nths

1937

–193

8 ...

......

......

.....

6.5

1

957 .

........

........

........

........

........

........

....72

.50 .

......

......

......

......

.67.5

0

1

958

......

......

......

......

..66 y

rs, 8

month

s

19

39–1

940

......

......

......

..7.0

195

8 .....

........

........

........

........

........

........

71.67

....

......

......

......

....6

6.67

195

9 ...

......

......

......

....6

6 yrs,

10 m

onths

1941

–194

2 ...

......

......

.....

7.5

1

959 .

........

........

........

........

........

........

....70

.83 .

......

......

......

......

.65.8

3

A

fter 1

959

......

......

......

......

..67 y

rs, 0

month

s

A

fter 1

942

......

......

......

..8.0

Afte

r 195

9 ....

........

........

........

........

........

........

70.00

....

......

......

......

....6

5.00

Earn

ings

Lim

it/Be

nefit

s Re

duct

ion

Year

s befo

re in

dividu

al re

ache

s full

retire

ment

age,

bene

fits ar

e red

uced

by $1

for

each

$2 ea

rned

over

$15,1

20.

• In

year

FRA

is re

ache

d (mo

nths u

p to F

RA on

ly) be

nefits

are r

educ

ed by

$1 fo

r eac

h $3 e

arne

d abo

ve $4

0,080

. •

Month

FRA

reac

hed a

nd la

ter, th

ere i

s no l

imit o

n ear

nings

.

Socia

l Sec

urity

Cre

dits

Ne

eded

for C

over

age

Note

: The

same

numb

er of

cre

dits i

s req

uired

rega

rdles

s of

retire

ment

date.

Wor

kers

can e

arn u

p to f

our c

redit

s per

year.

Fo

r 201

3, a c

redit

is ea

rned

for e

ach $

1,160

of

earn

ings.

So, w

orke

rs ea

rning

at le

ast $

4,640

in

2013

earn

four

cred

its.

Gene

ral R

ule

Spe

cial-R

ule—

Certa

in N

onpr

ofit

Empl

oyee

sW

orke

r Bor

nCr

edits

Nee

ded

Age o

n 1/1

/84Cr

edits

Nee

ded

19

29 or

later

.....

......

......

......

......

......

..40

60 o

r ove

r .....

......

......

......

......

......

...6

192

8 ...

......

......

......

......

......

......

...39

5

9 ....

......

......

......

......

......

......

...8

192

7 ...

......

......

......

......

......

......

...38

5

8 ....

......

......

......

......

......

......

..12

192

5 ...

......

......

......

......

......

......

...37

5

7 ....

......

......

......

......

......

......

..16

192

6 ...

......

......

......

......

......

......

...36

55 o

r 56 .

......

......

......

......

......

......

..20

192

4 ...

......

......

......

......

......

......

...35

Medi

care

Qui

ck C

hart

(201

3)Pa

rtDe

scrip

tion

Prem

ium

sDe

duct

ible/

Coin

sura

nce

AHo

spita

l Insu

ranc

e. Co

vers

inpati

ent h

ospit

al ca

re, c

are i

n a

skille

d nur

sing f

acilit

y foll

owing

a ho

spita

l stay

, hos

pice a

nd

home

healt

h car

e and

bloo

d.

None

if 40

or m

ore q

uarte

rs of

Medic

are c

over

age.

• $24

3/mo i

f 30–

39 qu

arter

s of M

edica

re co

vera

ge.

• $44

1/mo f

or ot

her e

ligibl

e ind

ividu

als.

Hosp

ital s

tay:

• $1

,184 f

or da

ys 1–

60.

• $2

96/da

y for

days

61–9

0.•

$592

/day f

or da

ys 91

–150

.•

All c

osts

beyo

nd 15

0 day

s.

Skille

d nu

rsing

facil

ity:

$148

/day f

or da

ys 21

–100

.

BMe

dical

Insur

ance

. Cov

ers d

octor

s’ se

rvice

s and

othe

r med

ical

servi

ces a

nd su

pplie

s.$1

04.90

–335

.70/m

o., de

pend

ing on

inco

me.

• De

ducti

ble: $

147

• Co

insur

ance

: 20%

of M

edica

re-a

ppro

ved a

moun

t. El

igib

ility

Wor

kers

are n

ot eli

gible

for M

edica

re un

til the

y are

age 6

5, ar

e disa

bled o

r hav

e per

mane

nt kid

ney f

ailur

e. Re

ceivi

ng S

ocial

Sec

urity

bene

fits be

fore F

RA do

es no

t cha

nge w

hen i

ndivi

duals

beco

me

eligib

le for

Med

icare

.1 2

013 a

moun

ts no

t ava

ilable

at pu

blica

tion d

ate. S

ee M

edica

re P

rem

iums o

n Pag

e 17-

2.


MeDIcarewww.medicare.gov

Medicare is a national health insurance program for:•Personsage65andolder.•Certaindisabledpersons.•Personofanyagewithpermanentkidneyfailure.Medicare is four programs:•Part A: Hospital Insurance. For most Medicare beneficia-

ries, there is no premium for Medicare Part A. Individuals who are ineligible for free Part A can still enroll, but must pay a premium. See the Medicare Part A Premiums (2013) table in the next column.

•Part B: Medical Insurance. See the Medicare Part B Premiums (2013) table below.

•Part C: Combined Part A and Part B. Private insurance companies approved by Medicare provide this combined coverage through Medicare Advantage Plans like HMOs and PPOs.

•Part D: Prescription Drug Coverage. Optional coverage—see Medicare Drug Plans (Part D) on Page 14-29. Note: See 2013 Medicare Benefits table on Page 14-28 for a listing of covered services.Medicare does not cover most dental care, dentures, routine foot care and hearing aids. Eyeglasses are only covered if corrective lenses are needed after a cataract operation. Other exclusions apply.Medicare premium assistance. If a Medicare recipient has limited income and assets, programs are available to help pay medical costs. State rules vary. Contact the applicable state medical as-sistance (Medicaid) office. Contact information for each state is available at www.medicare.gov. Search for “helpful contacts.”1) Qualified Medicare Beneficiary (QMB) Program. Pays Medicare

premiums, deductibles and coinsurance for certain elderly and disabled persons entitled to Medicare Part A.

2) Specified Low-Income Medicare Beneficiary (SLMB) Program. Pays the medical insurance (Part B) premium for persons with incomes up to 20% over the national poverty level.

3) Qualifying Individual (QI) Program. Pays the Part B premiums only.4) Qualified Disabled & Working Individuals (QDWI) Program.

Pays Part A premiums only.Higher Part B premiums for higher income individuals. Certain Medicare Part B enrollees pay a higher Part B premium based on their income.

Medicare Part B Premiums (2013)Annual Income1 Monthly

PremiumSingle, HOH, QW MFJ MFS≤ $85,000 ≤ $170,000 ≤ $85,000 $104.90

$85,001–107,000 $170,001–214,000 N/A 146.90$107,001–160,000 $214,001–320,000 N/A 209.80$160,001–214,000 $320,001–428,000 $85,001–129,000 272.70

> $214,000 > $428,000 > $129,000 335.701 2011 AGI plus tax-exempt interest and exclusions for U.S. savings bond interest

and foreign earned income and housing.2 2013 amounts not available at publication date. See Medicare Premiums on

Page 17-2.

Applying for Medicare BenefitsAnyone not receiving Social Security retirement, disability or railroad retirement benefits should contact Social Security three months before turning age 65. See Contacting the Social Security Administration (SSA) on Page 14-21.

Individuals who must contact Social Security for Medicare:•Disabledwidow(er)age50to65whohasnotappliedfordisability

benefits because he is getting another kind of Social Security benefit. •Governmentemployeedisabledbeforeage65.•Individual,orhisspouseordependentchild,

with permanent kidney failure.•IndividualwhohadMedicarePartBinthe

past, but dropped coverage.•Individualwho turned downMedicare

Part B when he became entitled for Medicare Part A.U Caution: The sign-up period for Medicare Part B lasts seven months. It begins three months before the 65th birthday, includes the birthday month, and ends three months after the month that includes the 65th birthday. If not enrolled during initial enrollment, another op-portunityisgiveneachyearfromJanuary1throughMarch31,withcoveragebeginningthefollowingJuly.AnyonenotenrollinginMedi-care Part B when eligible pays a penalty to enroll later. The penalty is an increase in premium of 10% for each year eligible and not enrolled.

Eligibility for Hospital Insurance (Part A)Age 65 and older. A person is eligible for Medicare Part A if he:1) Is receiving Social Security or railroad retirement benefits,2) Is not receiving Social Security or railroad retirement benefits,

but has worked long enough to be eligible for them,3) Is entitled to Social Security benefits based on his spouse’s

(or divorced spouse’s) work record, and that spouse is at least age 65 (the spouse does not have to apply for benefits in order for the person to be eligible based on the spouse’s work) or

4) Has worked long enough in federal, state or local government to be insured for Medicare.

Under age 65. A person is eligible for Medicare Part A if he:•HasbeenentitledtoSocialSecuritydisabilitybenefitsforatleast

24 months,•Hasreceivedadisabilitypension fromthe railroadretirement

board and meets certain conditions or•HasLouGehrig’sdisease.Family members:1) Under certain conditions, a spouse, divorced spouse, widow(er)

and dependent parent may be eligible for hospital insurance at age 65.

2) Disabled widow(er) under age 65, disabled divorced widow(er) under age 65 and disabled children may be eligible, usually after a 24-month qualifying period.

Permanent kidney failure. People with end-stage renal disease are eligible for Medicare Part A at any age if they receive mainte-nance dialysis or a kidney transplant and:•AreinsuredoraregettingmonthlybenefitsunderSocialSecurity

or the railroad retirement system or•HaveworkedlongenoughingovernmentforMedicareinsurance. Notes:

– A spouse or child with this condition may be eligible for cover-age based on another’s work record.

– There may be a three-month waiting period after dialysis treatments begin for coverage to commence.

Medicare Part A Premiums (2013)1

Quarters of Covered Employment Monthly Premium30–39.......................................................................................... $243Less than 30 ............................................................................... $441

1 Applies only if ineligible for premium-free Part A. Part A is generally free when individual (or spouse) has at least 40 quarters of coverage.

2 2013 amounts not available at publication date. See Medicare Premiums on Page 17-2.

Continued on Page 14-29


2013 Medicare Benefits (Not All-Inclusive)

Hospital Insurance (Medicare Part A)—2013 Benefits per Benefit PeriodService Benefit Medicare Pays Recipient Pays 1

Hospitalization. Semi-private room and board, drugs as part of inpatient treatment, general nursing and other hospital services and supplies.

First 60 days All but $1,184 $1,18461st – 90th day All but $296 per day $296 per day

91st – 150th day 3 All but $592 per day $592 per dayBeyond 150 days Nothing All costs

Skilled nursing facility care (following a hospital stay). Semi-private room and board, skilled nursing and rehabilitative services, and other services and supplies.4

First 20 days 100% of approved amount Nothing21st – 100th day All but $148 per day Up to $148 per dayBeyond 100 days Nothing All costs

Home health services. Medically-necessary part-time or intermittent skilled nursing care and/or physical therapy, speech-language pathology services and/or services for people with a continuing need for occupational therapy. The patient must be homebound.

As long as medically necessary. 100% of approved amount; 80% of approved amount for durable medical equipment.

Nothing for services; 20% of approved amount for durable medical equipment.

Hospice care. Pain relief, symptom management and support services for the terminally ill. Inpatient respite care (up to five days per stay) so usual caregiver can rest.

For as long as doctor certifies need.

Amounts over $5 for outpatient drugs; 95% of Medicare-approved amount for inpatient respite care.

Up to $5 for outpatient drugs and 5% of approved amount for inpatient respite care.

Medical Insurance (Medicare Part B)—2013 Benefits per Calendar YearService Benefit Medicare Pays5 Recipient Pays 1, 5

Medical expenses. Doctors’ services, inpatient and outpatient medical and surgical services and supplies, physical and speech therapy, durable medical equipment and other services.

Unlimited if medically necessary. 80% of approved amount. 20% of approved amount and limited charges above approved amount.

Clinical laboratory services. Blood tests, urinalysis, diagnostic x-ray tests, some screening tests and more.

Unlimited if medically necessary. Generally, 100% of approved amount.

Nothing for services.

Home health care. Medically-necessary part-time or intermittent skilled nursing care and/or physical therapy, speech-language pathology services and/or services for people with a continuing need for occupational therapy. The patient must be homebound.

Unlimited if medically necessary. 100% of approved amount; 80% of approved amount for durable medical equipment.

Nothing for services; 20% of approved amount for durable medical equipment.

Outpatient hospital treatment. Services for the diagnosis or treatment of illness or injury.

Unlimited if medically necessary. 80% of approved amount. 20% of approved amount, plus co-pay for other than doctor’s services.

Outpatient mental health care Unlimited if medically necessary. 65% of approved amount. 35% of approved amount.

Ambulatory surgical services Unlimited if medically necessary. Generally, 80% of approved amount. 20% of approved amount.

Preventative services. Certain services, including flu and pneumonia vaccines, mammograms, pap smears and pelvic exams.

Unlimited if medically necessary. Generally, 100% of approved amount.

Nothing. May have to pay 20% of the charge for a doctor’s visit.

1 Either the recipient or the recipient’s insurance company is responsible for paying the amounts listed in the “Recipient Pays” column.2 2013 amounts not available at publication date. See Medicare Premiums on Page 17-2.3 Sixty reserve days may be used only once in a lifetime.4 Must be after a three-day minimum medically-necessary inpatient hospital stay.5 Must meet the Part B deductible before Medicare pays. For 2012, the Part B deductible was $140. The 2013 Part B deductible was not available at the time of this

publication. See Medicare Premiums on Page 17-2.2013 is $147.


Financial Planning starts on Page 15-14.

Estate Planning

Federal Estate and Gift Tax RatesFor gifts made and estates of decedents dying in 2010–2012

—Quick Tax Method—Taxable Amount

$ 0 – $ 10,000 × 18% minus $ 0 = Tax1

10,001 – 20,000 × 20% minus 200 = Tax1

20,001 – 40,000 × 22% minus 600 = Tax1

40,001 – 60,000 × 24% minus 1,400 = Tax1

60,001 – 80,000 × 26% minus 2,600 = Tax1

80,001 – 100,000 × 28% minus 4,200 = Tax1

100,001 – 150,000 × 30% minus 6,200 = Tax1

150,001 – 250,000 × 32% minus 9,200 = Tax1

250,001 – 500,000 × 34% minus 14,200 = Tax1

500,001 and over × 35% minus 19,200 = Tax1

1 Subtract the applicable credit from this amount. See the Estate and Gift Tax Credit/Exclusion table in the next column.

Caution: This table is for calculating the federal estate or gift tax, not an estate’s income tax. See the front cover of the Small Business Quickfinder® Handbook for an estate’s income tax rates.

Related InformationSmall Business Quickfinder® Handbook:•Estate Inventory Worksheet and Worksheet to Reconcile Income

Reported on Final Form 1040 and Form 1041—Tab A•Fiduciary Tax Returns—Tab G•Estate and Gift Tax Returns—Tab HTax Planning for Individuals Quickfinder® Handbook:•Estate and Gift Tax—Tab 15IRS Pub. 559, Survivors, Executors and Administrators.

Estate and Gift Tax Credit/ExclusionEstate Tax

For Transfers Made in: Credit Exclusion1998 $ 202,050 $ 625,0001999 211,300 650,000

2000–2001 220,550 675,0002002–2003 345,800 1,000,0002004–2005 555,800 1,500,0002006–2008 780,800 2,000,000

2009 1,455,800 3,500,0002010 1,730,8001 5,000,0001

2011 1,730,8002 5,000,0002

2012 1,772,8002 5,120,0002

2013 2,045,8002 5,250,0002

Gift TaxFor Transfers Made in: Credit Exclusion

1998 $ 202,050 $ 625,0001999 211,300 650,000

2000–2001 220,550 675,0002002–2009 345,800 1,000,000

2010 330,800 1,000,0002011 1,730,8002 5,000,0002

2012 1,772,8002 5,120,0002

2013 2,045,8002 5,250,0002

1 Executor could have elected that the estate not be subject to estate tax. See Death in 2010 and Executor Elected Out of Estate Tax on Page 15-5.

2 Plus the amount, if any, of deceased spousal unused exclusion (credit) amount.3 If Congress doesn’t act, scheduled to return to this amount.

Income Tax on InheritanceInheritance:– These rules apply to property passing from a decedent, including assets that pass through probate, as well as assets inherited directly by joint tenants, pay-on-death

designees and beneficiaries. Beneficiaries of taxable items generally report taxable income when they receive the income.– These rules may not apply to an asset if the decedent completed a gift of the asset before death.

Taxable Not Taxable• Annuities (except decedent’s investment in the contract).• Investment income paid after death.• Payments from employer—wages, salaries, bonuses, commissions, back pay,

vacation pay, sick pay.• Contracts for deed and other installment sales (gross profit percentage).• U.S. savings bond interest accrued through date of death unless decedent

included interest in income ratably or elected to include all accrued income in final return.

• Traditional IRAs (except nondeductible contributions), deferred compensation, qualified pension plans, profit-sharing plans, Keoghs.

• Accounts receivable.

• Life insurance proceeds.• Cash, bank accounts, CDs.• Stocks, bonds, mutual funds.1

• House, cabin, other real estate.1

• Cars, vehicles, household goods, jewelry, other personal property.1

• Roth IRA held more than five tax years (based on period held by both decedent and beneficiary).

• Payment from a probate estate of a sum of money or other property specifically described in a will.

1 Value on date of death generally is not taxable because basis steps up or down to FMV as of that date; however, see Basis of Inherited Property on Page 15-5 for special rules that apply to property inherited from decedents who died in 2010.

Tab 15 Estate Planning TopicsQuick Facts on Estate Planning ............................ Page 15-2Filing Income Tax Returns for Decedent

(Form 1040) ........................................................ Page 15-2Estate Distributions and Schedule K-1

(Form 1041) ........................................................ Page 15-4Probate ................................................................. Page 15-5Basis of Inherited Property.................................... Page 15-5Co-Ownership ....................................................... Page 15-6Wills ...................................................................... Page 15-7Planning for Illness/Disability ................................ Page 15-8Estate and Gift Tax ................................................ Page 15-8Gifts and Gift Tax Returns ................................... Page 15-10Charitable Gifts and Bequests ............................ Page 15-10Life Insurance ..................................................... Page 15-11Trusts .................................................................. Page 15-12


QuIck FacTs On esTaTe PlannIng

Basic Steps in Estate Planning 1) Make a complete and accurate inventory of all assets and

their values. 2) Determine the form of ownership of each asset; understand

its effect on the transfer of property at death. 3) Verify beneficiary designations on life insurance policies and

retirement accounts. 4) Estimate the size of the estate to determine

whether estate tax planning is needed. 5) Decide whether certain family members

or assets need special protection (minor children, those with special needs, family business).

6) Select beneficiaries and determine what provisions should be made for each.

7) Determine how financial and health care decisions will be made in the case of illness or disability.

8) Determine how health care will be funded. 9) Estimate the cost of alternative estate planning methods that

will meet the goals.10) Select and implement the estate plan.11) Laws and family circumstances change. Review plan regularly.

Special ConsiderationsIndividuals or couples with minor children. Individuals with mi-nor children should designate a guardian to care for their children. Even individuals with trust-based estate plans should have wills designating guardians for their minor children.Anyone with minor heirs or beneficiaries. If a minor is given property by will or as the direct beneficiary of an insurance policy or other asset, the minor receives the property upon reaching adulthood, usually age 18. Most people do not want large sums of money placed unconditionally in the hands of 18-year-olds. A trust can be included in a will to postpone the receipt of an inheritance. Anyone leaving a sizable amount to a minor child should consider this alternative. Many states have statutory custodial arrangements to delay receipt of specific assets until age 21.Married couples with estates over their combined estate tax exclusions. With proper planning, married spouses can each fully utilize their own estate tax exclusion, allowing more property to pass to heirs free from estate tax. For example, assume the estate tax exclusion is $5 million so when combined, a married couple’s estate tax exclusions total $10 million. However, couples whose estates are not equal or whose wills leave all or most property to the surviving spouse may miss the opportunity to fully use the estate tax exclusion of the first spouse to die. See Bypass trust on Page 15-13 for estate planning that helps married couples maximize the use of their estate tax exclusion amounts. See the Estate and Gift Tax Credit/Exclusion table on Page 15-1 for the estate tax exclusion amounts. Note: For 2011 and 2012 only, married couples can take ad-vantage of the deceased spouse’s unused exclusion amount (an executor can elect to transfer this to the surviving spouse). How-ever, this opportunity is currently available only in 2011 and 2012 (that is, the surviving spouse must use this additional exclusion either for lifetime gifts or at death). Tax preparers should monitor legislation for an extension of this favorable provision.Family businesses and farms. Specialized estate planning is essential for taxpayers who own businesses they hope to transfer to their heirs as going-concerns. The valuation of family-owned business interests is generally a contentious issue between the heirs and the IRS. Planning prior to death may help lower the estate tax value of the business interests or allow part of the business to be transferred before death at an estate tax savings.

Estate tax breaks are also available if family business interests are a significant part of a decedent’s estate. Qualifying real property can be valued based on its actual use rather than its highest and bestuse(IRC§2032A).Estatetaxcanbedeferredforfiveyearsand paid over 10 annual installments at low interest rates (IRC §6166).SeeTabHoftheSmall Business Quickfinder® Handbook.

FIlIng IncOMe Tax reTurns FOr DeceDenT (FOrM 1040)

Who Should File ReturnEstate representative. If a court appoints a personal representa-tive or other estate administrator, that person must file all required returns for the decedent. Form 56 may be used to notify the IRS of the fiduciary relationship. A joint return can be filed for a decedent and surviving spouse if the spouse has not remarried at the end of the tax year and the surviving spouse and estate representative both agree to file jointly. If the surviving spouse remarried before the end of the tax year, the decedent’s filing status is MFS.Surviving spouse. If there is no court-appointed representative by the deadline for the return, the spouse can file a joint return with the decedent as long as he did not remarry before the end of the tax year. A spouse can file a joint return even if he expects that an estate representative will be appointed. The representative, once appointed, may revoke the election to file jointly. If the surviving spouse is the appointed representative, he files for the decedent as representative and not as surviving spouse.Person in charge of decedent’s property. If there is no court-appointed representative and no surviving spouse, a “person in charge of the decedent’s property” must file the tax returns. This person may be anyone in actual or constructive possession of de-cedent’s property; generally, one of the heirs is chosen informally by the others to act in this capacity. Filing by a person in charge of the decedent’s property should only be done for estates that will not require probate. If the return shows a refund, the person must verify on Form 1310 that a court has not and will not appoint a representative. The IRS uses the term personal representative throughout its publications and instructions to refer to both appointed representatives and persons in charge of the decedent’s property.

Itemized DeductionsMost rules for a decedent’s deductions are the same as those for other individuals. Deductions are allowed if they were paid prior to the dece-dent’s death and would have been deductible by the decedent as of the date of death (accrued before death for accrual method taxpayers).Exceptions: •Medicalcostspaidfromthedecedent’sestatewithinoneyearof

the day following death can be deducted either on Schedule A of the decedent’s Form 1040 or on the estate tax return (Form 706) [IRC§213(c)].Ifmedicalcostsaredeductedonthedecedent’sForm 1040, they are deducted in the year incurred, either on the decedent’s final Form 1040 or by amending the Form 1040 from a prior year, and are subject to the 7.5%-of-AGI limit. If the expenses are claimed on Form 1040 or 1040X, attach a state-ment in duplicate listing the expenses, stating, “These amounts have not been claimed as deductions on Form 706. The estate waives the right to claim these amounts at any time as estate tax deductions.” The waiver is irrevocable. The statement is required even if the estate is not required to file Form 706. A taxpayer who paid medical expenses for a deceased spouse or dependent can deduct them in the year paid without attaching an election statement. Expenses are deductible if the decedent was the taxpayer’s spouse or dependent either at the time the medical service was provided or the expense was paid.

After 2010,


Federal estate and gift taxes are integrated. One set of rates is applied to the cumulative transfers made by a taxpayer during life and at death. The tax is imposed on the person transferring property rather than on the recipients, although the IRS can collect a decedent’s unpaid tax from those receiving property.A gift tax return (Form 709) must be filed if a taxpayer makes any taxable gifts in the calendar year. Taxable gifts are generally amounts over $13,000 (for 2012) given to someone other than a spouse or charity. Although tax is calculated on the return, no tax is due until the taxpayer exhausts the $5.12 million (for 2012) gift tax exclusion. See Exclusions below for a discussion of the estate and gift tax exclusion and credit.Each year that a gift tax return is filed, gifts made in all prior years must be reported on the return. Gift tax is calculated on the cu-mulative total. The tax due is the difference between the tax on the cumulative total and the tax on gifts made in prior years, less any remaining allowable credit.Annual gift tax exclusion. A taxpayer can give $13,000 (for 2012) per person to any number of recipients in a calendar year without paying federal estate and gift tax. Gifts that qualify for this annual exclusion are never taxed—no gift tax is owed when the gift is made, and the gift is not added back to the taxable estate at death. If a gift is over $13,000 (for 2012), only the excess is a taxable gift. The annual exclusion is indexed for inflation and will change again when cost of living adjustments reach the next $1,000 multiple.To qualify for the annual exclusion, a gift must be a present in-terest—the recipient must have all immediate rights to the use, possession, enjoyment and income of the property. The annual exclusion does not apply to a future interest—the recipient’s rights to benefit from the property begin at some future date. Most gifts to trusts do not qualify for the exclusion because they are gifts of future interests. Exceptions include gifts to a minor’s trust and gifts to a trust that includes a Crummey Power (see Crummey Power in Trust Document on Page 15-13).Gifts from married couples. See Returns for married couples on Page 15-10 for special rules that apply to gifts made by married couples.Qualified transfers—tuition and medical care. Direct payment of medical expenses or tuition for another personisnotagiftforgifttaxpurposes[IRC§2503(e)].Payment must be made to the school or medical provider and not to the beneficiary. Qualified transfers are not reported on Form 709. Payments for books, supplies, dormitory fees and board do not qualify. Tuition for part-time students qualifies. Medical payments can cover any type of expense deductible for income tax purposes, including payment of insurance premiums. The beneficiary of a qualified transfer does not need to be related to the taxpayer. In addition, an annual ex-clusion gift can be made to the beneficiary of a qualified transfer.Political transfers. A transfer to a political organization as defined in Section 527(e)(1) for use by the organization is not a taxable gift and does not need to be reported on a gift tax return. [IRC §2501(a)(4)]

ExclusionsEvery taxpayer is allowed an exclusion from gift and estate tax before the tax is imposed.For 2012, the estate and gift tax exclusion is a unified amount of $5.12 million. Any of the exclusion amount used for lifetime gifts reduces the amount remaining for estate tax purposes. Note: For 2004–2010, different exclusion amounts applied for estate tax and gift tax purposes. The gift tax exclusion was $1 million during those years but, any gift tax exclusion used against lifetime gifts reduced the estate tax exclusion available at death.

Portability of unused exclusion between spouses. Any appli-cable estate and gift tax exclusion amount that remains unused as of the death of a spouse who dies in 2011 or 2012 (the “deceased spousal unused exclusion amount”), generally is available for use by the surviving spouse, as an addition to the surviving spouse’s applicableexclusionamount[IRC§2010(c)(4)].Toaddtheamountto the surviving spouse’s exclusion, a timely filed (including exten-sions) estate tax return of the predeceased spouse must be filed, regardless of whether the estate of the predeceased spouse is otherwise required to file an estate tax return. (Notice 2011-82)If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by the surviving spouse is limited to the lesser of $5.12 million (for death in 2012, $5 million for death in 2011) or the unused exclusion of the last deceased spouse. Note: A surviving spouse may use the additional exclusion amount for taxable transfers made during life or at death.

Example: Alfred dies in 2012, with a $3 million estate that passes to his chil-dren. Alfred had never made any taxable gifts so his estate pays no estate tax (because his estate is less than his $5.12 million exclusion).The executor of Alfred’s estate elects to permit Alfred’s wife, Joyce, to use Alfred’s deceased spousal unused exclusion amount of $2.12 million ($5.12 million – $3 million) by filing a timely and complete Form 706.As of Alfred’s death, Joyce has made no taxable gifts. Thereafter, Joyce’s ap-plicable exclusion amount is $7.24 million (her $5.12 million basic exclusion amount plus $2.12 million deceased spousal unused exclusion amount from Alfred), which she may use for lifetime gifts or for transfers at death.

U Caution: The portability provision for a deceased spouse’s unused exclusion expires after 2012 so it won’t benefit surviving spouses after 2012 unless legislation extends the provision beyond 2012. See Estate and Gift Tax Credit/Exclusion on Page 15-1.

Marital DeductionMost transfers to a spouse qualify for the marital deduction and pass to the spouse tax-free. Gifts that fully qualify for the deduction do not need to be reported on a gift tax return (unless they qualified because of a QTIP election as discussed below). Transfers to a surviving spouse at death must be reported on Form 706 but are generally fully deductible on the estate tax return.Exceptions:•Noncitizen. Generally, gifts to a noncitizen spouse do not qualify

for the marital deduction. Such gifts qualify for an annual exclu-sion of $139,000 (for 2012) if the gifts that exceed $13,000 (for 2012) would qualify for the marital deduction if given to a citizen spouse.[IRC§2523(i)]

•Certain Terminable Interests. A terminable interest is one that ends at death or on the occurrence of some other specified event (life estates, annuities, income interest in a trust, etc.). Generally, a gift of a terminable interest does not qualify for the marital de-duction if the donor also gave an interest in the property to a third person who will possess or enjoy the property after the spouse’s interestends[IRC§2523(b)(1),§2056(b)(1)].Thispreventsonespouse from using the other as a conduit to pass a tax-free gift to another beneficiary. Interests that terminate entirely without passing to a third person are generally deductible (tenancies by the entirety, joint tenancies exclusively between spouses, and joint and survivor annuities). If the surviving spouse is given certain rights, such as the right to income for life, and an election is made, certain terminable interests also qualify for the marital deduction. Such interests are included in the surviving spouse’s gross estate even though the disposition of the property is deter-mined by the original donor/decedent. See Qualified terminable interest property (QTIP) trust on Page 15-13 for more information. See Section 2523(e) and (f) and Section 2056(b).

after 2010


Charitable DeductionThere is an unlimited charitable deduction for the value of property transferred during life or at death for most charitable and public purposes. Gifts and bequests to lodges, amateur sports organiza-tions, veterans groups and tribal governments may not qualify for the deduction. Unlike the income tax deduction, most gifts to foreign charities qualify for the estate and gift tax charitable deduction.Partial interests. A transfer of property for both charitable and noncharitable purposes must meet specific IRS requirements to be deductible. See Charitable Gifts and Bequests in the next column.

gIFTs anD gIFT Tax reTurnsSee Estate and Gift Tax on Page 15-8 and Tab H

of the Small Business Quickfinder® Handbook

GiftsMost transfers of property or property interests without adequate consideration are subject to gift tax. Gifts can include transfers of cash or property, payments made to third parties on behalf of an-other, interest-free loans, below-market sales, irrevocable transfers to trusts and creation of certain joint tenancies. A transfer is only subject to gift tax when the gift is complete—when the donor no longer has the power to change its disposition. Gifts are taxed in the calendar year made and valued on the date they are completed.Year-end gifts made by check. A gift made by check to a non-charitable beneficiary is complete on the date the check is cashed or deposited in the recipient’s bank if: (1) the donor intended to make a gift, (2) the delivery was unconditional, (3) the check was deposited or cashed within a reasonable time of issuance, (4) the donor’s bank did not reject the check when presented and (5) the donor was alive when the donor’s bank paid it. (Rev. Rul. 96-56)

Gift Tax ReturnsA gift tax return is not required for:•GiftstoaspousewhoisaU.S.citizen:

– No gift was a terminable interest.•GiftstoaspousewhoisnotaU.S.citizen:

– Spouse received $139,000 (for 2012) or less.– No gift was a future interest.– No gift was a terminable interest.

•Giftstocharities,unlessForm709mustbefiledtoreportnon-charitable gifts or gift to charity was a partial interest in property.

•Giftstoanyoneelse:– No individual recipient received more than $13,000 (for 2012). æ Practice Tip: If the gift is discounted (such as a discount-

ed interest in a FLP), consider filing to adequately disclose that gift and start the statute of limitations.

– No gift was a future interest.Definitions:•Terminable Interest. One that will end at some time in the future

(life estates, income interests in trust, etc.).•Future Interest. One that delays the income or enjoyment of the

gift until some time in the future (remainder interest following a life estate, remainder interest in a trust, etc.).

Returns for married couples. Spouses have separate annual exclusions and generally must file separate gift tax returns. There is an exception when one spouse is only filing to consent to split-ting gifts given by the other (and total gifts to each donee did not exceed $26,000 in 2012).If a gift in excess of $13,000 (for 2012) is made by one spouse, the couple can use both annual exclusions by filing gift tax returns electing to split gifts. If spouses give community or joint property, the gift is considered to be given half by each—it is not a split gift.

If each combined gift is under $26,000 (for 2012), neither spouse needs to file a gift tax return because each has given a gift under the annual exclusion. Gift-splitting is only necessary when a gift in excess of $13,000 (for 2012) is made from assets belonging to only one spouse.

Basis of Gift PropertyThe basis of a gift property is the donor’s adjusted basis (plus any gift tax paid on the appreciation of the property to the time of the gift).Property with value less than basis. If the giver’s basis is greater than the FMV at the time of the gift, the basis for determining a lossislimitedtoFMVatthetimeofthegift[IRC§1015(a)].Own-ers of such assets should consider selling the assets and gifting the proceeds.

Gifts—Taxpayers With Small Estates•Theannualexclusionandothergifttaxdeductionsareirrelevant

for taxpayers who can safely anticipate remaining below the lifetime gift tax exclusion—a gift in excess of the annual exclu-sion is unlikely to cause a tax liability. The only consequence of such a gift is the requirement that a gift tax return be filed. See the Estate and Gift Tax Credit/Exclusion table on Page 15-1 for the lifetime gift tax exclusion amounts.

•Ifappreciatedpropertyisgifted,therecipienttakesthegiver’sbasis. On the other hand, most inherited property receives a stepped-up basis equal to FMV at the decedent’s death (but see Death in 2010 and Executor Elected Out of Estate Tax on Page 15-5 for rules that may apply to property inherited from a person who died in 2010). Thus, a gift can cause recipients to pay income tax on capital gains that they would not otherwise pay if they inherited the property.

•Creatingajointtenancycanbeagiftthatmustbereportedonagift tax return. See Joint Tenancy Gifts on Page 15-6.

Gifts—Taxpayers With Taxable EstatesTransferring property during life rather than waiting until death can create tax savings in some situations:•Giftsarevaluedatthetimetheyaregiven,ratherthanatdeath.

Making a gift removes future income and appreciation from the estate. Conversely, if an asset is expected to depreciate, it should not be gifted since its tax value is the value at the time of the gift.

•Gifttaxpaidbythedonorisremovedfromtheestateandnevertaxed, provided the donor does not die within three years of making thegift[IRC§2035(b)].Estatetaxispaidonadecedent’sentiretaxable estate, including the portion used to pay the estate tax. @ Strategy: If an ill spouse gives property, the healthy spouse

can pay the gift tax. If the healthy spouse lives three years, the gift tax will not be included in either estate. (Letter Rul. 9214027)

charITable gIFTs anD beQuesTsMost transfers for charitable and public purposes are fully deduct-ible on gift tax returns as well as on the estate tax return.

Transfers at Death vs. Lifetime GiftsAlthough gifts made to charity at a taxpayer’s death can be de-ducted on the estate tax return, the value of the donated property is generally not allowed as an income tax deduction. Most lifetime gifts, on the other hand, are deductible in full on the gift tax return and also allowed as income tax deductions.Taxpayers who have decided to include charitable gifts in their estate plans can often increase the value of their after-tax estates


Trust TaxationMost trusts file tax returns for each calendar year in which they have taxable income (Form 1041). Taxable income distributed to benefi-ciaries is reported to them on Schedule K-1. The trust pays tax on income retained in the trust. If a grantor retains sufficient control of trust assets, however, income on those assets is taxed to the grantor rather than the trust or beneficiaries. See Tab G of the Small Business Quickfinder® Handbook for more information on fiduciary tax returns.

Revocable Living TrustsRevocable living trusts are commonly used to avoid probate and to allow a trustee to manage the grantor’s assets during incapacity. Typically the grantor is the sole beneficiary as well as the trustee. A co-trustee is named to take over when the grantor becomes incapacitated. The trust agreement contains provisions for dis-tributing the trust assets after the grantor’s death, substituting for a will. The trust is “revocable” because the grantor can change terms and remove assets freely. A married couple can create a joint revocable living trust.Fully revocable trusts are grantor trusts for tax purposes. See Grant-or Trusts in Tab G of the Small Business Quickfinder® Handbook.Revocable trust at death. A revocable trust generally becomes irrevocable at the death of the last grantor. The trust is treated as a grantor trust only through the date of death. The trustee usually must file Form 1041 for the remainder of the year if the trust has taxable income. The trustee and estate representative can elect to report the trust income on the estate’s Form 1041 rather than filingaseparateformforthetrust.(IRC§645andReg.§1.645-1)

Planning for Married CouplesBecause each spouse has a separate estate tax exclusion amount, a married couple can shield the combined amount from federal estate tax. But shielding this combined amount is not automatic—steps must be taken to ensure that both credits can be used.Assume a couple owns all their assets jointly. When the first spouse dies, everything passes to the surviving spouse. The couple pays no estate tax when the first spouse dies because all assets passing from the decedent to the surviving spouse qualify for the estate tax marital deduction. The survivor, however, now owns all the couple’s assets. At the death of the survivor, all the assets will be taxable in his estate. Only the estate tax exclusion of the survivor will be available.Generally, in order to make use of the estate tax exclusion of the first spouse to die, some property must pass to someone other than the surviving spouse, either directly or in trust. Amounts inherited by someone other than the surviving spouse will be included in the first spouse’s taxable estate and will make use of the first spouse’s credit.See Exclusions at Page 15-9 for a limited opportunity for an ex-ecutor to elect to transfer a decedent’s unused exclusion amount to the surviving spouse. This favorable provision would allow the use of both spouses’ exclusions by the surviving spouse. but this is currently only available in 2011 and 2012.

Example: Fay and Mel have two assets—a house valued at $2 million and a brokerage account valued at $10 million. They own both assets jointly. Fay dies in 2011 when the estate tax exclusion is $5 million. Fay’s estate must file an estate tax return reporting one-half the value of the home and brokerage account. Since Mel inherits Fay’s half of both assets as surviving joint tenant, the entire estate qualifies for the marital deduction.Although Fay’s estate pays no tax, unless her executor elects to transfer her unused exclusion to Mel, her applicable credit is wasted since there is no tax to offset. Mel dies in 2012 when the estate tax exclusion is $5.12 million. Mel owned the home and brokerage account in full at the time of his death.

Example continued in the next column

Assuming the election to transfer Fay’s unused exclusion amount is not made, the entire value of both assets is taxed to Mel’s estate.

Fay MelTotal gross estate ........................................ $ 6,000,000 $ 12,000,000Less marital deduction ................................. < 6,000,000> < 0>Taxable estate ............................................. $ 0 $ 12,000,000Tax ............................................................... $ 0 $ 4,180,800Applicable credit amount ............................. < 1,730,800> < 1,772,800>Balance due ................................................. $ 0 $ 2,408,000Variation: Now assume that Fay’s executor elects to transfer her unused exclusion amount to Mel. Therefore, her $5 million exclusion is available for Mel. At Mel’s death, all the couple’s assets are included in his estate. But, because Mel can also use Fay’s exclusion, the couple’s estate tax is reduced by $1,750,000 ($2,408,000 – $658,000).

Fay MelTotal gross estate ........................................ $ 6,000,000 $ 12,000,000Less marital deduction ................................. < 6,000,000> < 0>Taxable estate ............................................. $ 0 $ 12,000,000Tax ............................................................... $ 0 $ 4,180,800Applicable credit amount ............................. $ 0 < 3,522,800>1

Balance due ................................................. $ 0 $ 658,0001 $5,000,000 (Fay’s exclusion) + $5,120,000 (Mel’s exclusion) × 35% – $19,200.

Steps in marital estate planning:1) Divide assets so that each spouse separately owns enough

assets to make use of his or her applicable credit.2) Use a will or beneficiary designations to pass some or all of the

separately owned assets to someone other than the surviving spouse.

3) Utilize portability of unused exclusion amount between spouses (if available).

Bypass trust. Many people are uncomfortable with the idea of leaving property to their children if they have a living spouse. The most common solution is a bypass trust. It keeps the assets available for the surviving spouse until death while accomplishing the estate tax savings described in the example above. Property passing to the bypass trust does not qualify for the marital deduc-tion and thus uses the applicable credit of the first spouse to die.Typically, bypass trusts are established by will. Each will includes provisions creating a trust if the testator is survived by a spouse. Assets in the amount of the testator’s available estate tax exclusion pass to the trust. The remaining assets are given to the surviving spouse either outright or in a qualified terminable interest property (QTIP) trust. The surviving spouse usually receives income from the bypass trust for life and a limited right to principal. At the death of the surviving spouse, the assets remaining in the bypass trust pass to the beneficiaries named in the will of the first spouse to die.Qualified terminable interest property (QTIP) trust. Assets are placed in trust at the death of the first spouse. The surviving spouse receives all income from the trust for life. At the surviving spouse’s death, assets pass to beneficiaries selected by the first spouse. The trust assets are taxable to the estate of the surviving spouse rather than to the estate of the first spouse. This technique is often chosen to ensure that the surviving spouse receives adequate income during life, yet the children of the marriage (or children of a former marriage) ultimately receive the remaining assets.

Crummey Power in Trust DocumentA Crummey power (named after the taxpayer in the court case in which it was first tested) qualifies gifts made to a trust for the $13,000 (for 2012) annual gift tax exclusion. See Annual gift tax exclusion on Page 15-9.The Crummey power gives the beneficiaries the right, for a limited time each year, to withdraw their shares of the money from the trust. If the beneficiaries do not exercise their right to withdraw the money, it stays in the trust, yet qualifies for the gift tax exclusion.

an


basIcs OF FInancIal PlannIng

Components of Financial PlanningFinancial planning is much more than choosing investments. In fact, it consists of the following aspects of an individual’s financial life:•Cashmanagementandbudgeting.•Riskmanagementandinsurance.•Educationplanning.•Retirementandfinancialindependenceplan-

ning.•Estateplanning.•Investmentplanningandassetallocation.•Integratingtaxandfinancialplanning.

Financial Planning ProcessFinancial planning can best be described as a process through which the following steps are taken:1) Identify and prioritize goals.2) Gather information (that is, facts, feelings, risk tolerance).3) Analyze information.4) Propose recommendations and/or alternatives.5) Take action.6) Review and monitor process as economy and needs change.

Common Mistakes Individuals Make•Nottakingactionontheplantheyhavemade.•Nothavingenoughcashreservesorsourcesofliquidfundsin

case of emergency. Most planners recommend an emergency fund (three to six months of pay) for unexpected financial set-backs. (Loss of job, natural disaster, major medical crisis, etc.)

•Notestablishingandfollowingabudget.

•Notpayingthemselves(saving)first.•Notlivingwithintheirmeans.•Having taxable investment incomealongwith

nondeductible consumer debt interest. Remedy: Pay off consumer debt with taxable income-producing assets.

•Havinglargeamountofconsumerdebt.Remedy: Replace consumer debt with a home equity loan.

•Makingextrapaymentstopayoffahomemortgagemorequickly,even as homeowners continue to carry more costly credit card debt.

•Failuretoparticipateormaximizeparticipationinretirementplanssuch as 401(k), 403(b), IRA, SIMPLE, SEP or qualified plans.

•Not periodically reviewing the coverage and deductible onhomeowner and auto insurance and changing the amounts if appropriate.

•Notcarryingatleast$1millionofpersonalumbrellainsuranceifindividual owns substantial assets.

•Nothavingawill.•Nottakingadvantageoftaxbreaks.

InvesTMenT PlannIng

Basics of Astute Investing1) Diversification/asset allocation.2) Limit risk according to stage of life and personal tolerance.3) Coordinate investments with taxability now and at retirement.4) If an investment sounds too good to be true, it probably is.

Prerequisites to Investing•Emergencyfund.Threetosixmonthsofpaytomeetemergen-

cies and to support the family during a financial setback.•Stableemployment.•Adequateinsurancecoveringdeath,disability,medical,etc.•Financialplanforshort-rangeandlong-rangegoals.Setinvest-

ment objectives considering time and risk tolerance.

DiversificationDiversification works on the principle that different asset catego-ries follow different cycles. When one is up, another is down. This strategy tends to smooth out market fluctuations and reduce risk. For example, a portfolio with a mix of growth stocks, value stocks, international stocks, corporate bonds, government bonds, cash investments, etc., normally provides a higher long-term return with less risk than one fully invested in any one of these categories.In determining appropriate allocation percentages, there are dif-ferent ways to look at the asset categories, some of which are:•Expected returns. Determine the range of possible

returns for each asset class and the portfolio as a whole, developing an economic forecast and related assumptions to build the asset allocation plan or relying on assumptions developed by third-party consultants (for example, investment consulting and brokerage firms).

•Correlation. Statistical information on how one asset class tends to behave relative to another.

•Model portfolios. Use a model portfolio allocation as a guideline in developing a recommended portfolio.

•Rule of thumb. A conservative rule of thumb is that the percent-age of stock holdings should be 100 minus age, and bond and cash holdings should be the percentage represented by age. Of course, this is only a rough guideline, and an individual’s personal profile should drive the asset allocation.

Financial Planning

Tab 15 Financial Planning Topics

Basics of Financial Planning ............................... Page 15-14Investment Planning ........................................... Page 15-14Mutual Funds ...................................................... Page 15-17Tax Saving Techniques ....................................... Page 15-18Home Mortgages ................................................ Page 15-19Retirement Planning ........................................... Page 15-20How Long Savings Will Last ............................... Page 15-21Figure Future Value of Assets at Retirement ...... Page 15-21Monthly Investments to Reach Financial

Goals ................................................................ Page 15-22Will Projected Pensions and Assets Provide

for Future Retirement?—A Quick Check Method.............................................................. Page 15-22

Future Value Tables ............................................ Page 15-23Present Value Tables .......................................... Page 15-24Tax-Free Investments ......................................... Page 15-24Insurance Planning ............................................. Page 15-25Life Insurance ..................................................... Page 15-25Types of Life Insurance Policies ......................... Page 15-26Annuities ............................................................. Page 15-28Disability Insurance ............................................. Page 15-29Long-Term Care Insurance ................................. Page 15-30



Tax Provisions That Expired on December 31, 2011Not Available in 2012 (Unless Extended by Legislation)

Note: This table summarizes significant tax provisions that affect individuals that expired on December 31, 2011. It’s possible that Congress will extend some or all of them to 2012, but had not done so at the date of this publication. Quickfinder will post an update at www.quickfinder.com if any of these provisions are extended to 2012.

Description IRC § QF Page

Provision in Effect for 2012 Provision in Effect for 2011 2011 Law Extended to 2012?1

Tax CreditsAdoption— Increased Credit Limit and Refundability

23 12-2 The maximum credit is $12,650; the credit is not refundable.

Maximum credit was $13,360; the credit was refundable.

No

Alternative Fuel Vehicle Refueling Property

30C(g)(2) O-82 Credit not available (other than for hy-drogen refueling property) after 2011.

A tax credit was available for certain alternative fuel vehicle refueling property.

Yes

Energy Efficient Homes

45L O-102 None. Credit not available after 2011. Builders of energy-efficient homes were allowed a $2,000 credit per qualifying home.

Yes3

First-Time Homebuyer

36(h)(3) 12-9 None. Credit not available after 4/30/11 (6/30/11 if taxpayer had a writ-ten binding contract before 5/1/11).

A credit was available to first-time homebuyers who were on qualified official extended duty outside the U.S.

No

Indian Employment

45A O-92 None. Credit not available after 2011. A tax credit was available to employ-ers who made qualifying payments to certain Indian tribe members.

Yes

Military Wage Differential

45P O-92 None. Credit not available after 2011. A credit was available for wages paid to activated military reservists.

Yes

New Markets 45D O-92 None. Credit not available after 2011. A credit was available for investment in community development entities.

Yes

Personal Energy Property

25C 12-10 None. Credit not available after 2011. A credit was available for making certain energy-efficient improvements to a taxpayer’s home.

Yes

Plug-In Electric Vehicles— Low-Speed and 2- and 3-Wheeled Vehicles

30(f) 11-8 None. Credit not available after 2011. Note: The Section 30D credit for plug-in electric drive motor vehicles is still available.

A credit was available for purchas-ing certain low-speed and 2- or 3-wheeled plug-in electric vehicles.

Yes3

Plug-In Vehicle Conversion

30B(i)(4) O-82 None. Credit not available after 2011. A credit was available for converting a vehicle to a plug-in electric drive motor vehicle.

No

Research and Development

41 O-92 None. Credit not available after 2011. A credit was available for increasing research activities.

Yes

Work Opportunity 51 O-92 For employees hired in 2012, the credit is only available for wages paid to qualified veterans.

A credit was available for wages paid to employees in several targeted groups.

Yes3

1 Use this column to indicate whether a provision is extended to 2012 or not. 2 Reference is to the 2012 Small Business Quickfinder® Handbook.

Notes

3 With modifications.


Tax Provisions That Expired on December 31, 2011 (Continued)Not Available in 2012 (Unless Extended by Legislation)




Business Property—Depreciation and Section 179Qualified Real Property Assigned a 15-Year Recovery Period

168(e)(3) 10-13 No special provisions for qualified leasehold improvements, qualified restaurant property and qualified retail improvement property placed in ser-vice in 2012. These are nonresidential real property with a 39-year (40 for ADS) recovery period.

Qualified leasehold improvements, qualified restaurant property and qualified retail improvements placed in service in 2011 were assigned a 15-year recovery period (39 years for ADS).

Yes

Qualified Real Property Eligible for Section 179

179(f) 10-10 Qualified leasehold improvements, qualified restaurant property and qualified retail improvements placed in service in a tax year beginning in 2012 are not eligible for Section 179 expensing.

Qualified leasehold improvements, qualified restaurant property and qualified retail improvements placed in service in a tax year beginning in 2011 were eligible for Section 179 expensing.

Yes

Section 179— Expensing Limit

179(b) 10-10 Expensing limit and qualifying property threshold are $139,000 and $560,000, respectively, for tax years beginning in 2012.

Expensing limit and qualifying property threshold were $500,000 and $2,000,000, respectively, for tax years beginning in 2011.

Yes

Special Depreciation Allowance

168(k)(5) 10-8 For qualified property placed in ser-vice in 2012, the special depreciation rate is 50% (100% for certain long-production property and noncommer-cial aircraft).

The special depreciation allowance equaled 100% of the adjusted basis of qualified property placed in service in 2011.

No

Individual Deductions and ExclusionsAdoption Assistance— Increased Exclusion Amount

137 12-2 Up to $12,650 of employer-provided adoption assistance is excludible.

Up to $13,360 of employer-provided assistance was excludible.

No

Educator’s Expenses

62(a)(2) 9-7 None. Provision not available after 2011.

Grade K-12 educators could deduct up to $250 of out-of-pocket expenses to arrive at AGI.

Yes

Fringe Benefits 132(f) 4-3 The exclusion for employer-provided mass transit benefits (transportation in a commuter highway vehicle and any transit pass) is $125 per month.

The exclusion for employer-provided mass transit benefits was $240 per month.

Yes

Mortgage Insurance Premiums

163(h)(3) 5-11 None. Provision not available after 2011.

Certain taxpayers could deduct mortgage insurance premiums as qualified residence interest.

Yes

Qualified Small Business Stock (QSBS)— Increased Exclusion

1202(a) — QSBS acquired in 2012 qualifies for 50% (60% if an empowerment zone business) gain exclusion (if five-year holding period met). A percentage of the excluded sale is an alternative minimum tax (AMT) preference item.

QSBS acquired between 9/28/10 and 12/31/11 qualifies for 100% gain exclusion (if five-year holding period met). Also, the excluded sale is not an AMT preference item.

Yes

State and Local Sales Tax

164(b)(5) 5-5 None. Provision not available after 2011.

Taxpayers could deduct state and local sales tax instead of state and local income taxes.

Yes

Tuition and Fees 222(e) 13-4 None. Provision not available after 2011.

Individuals with modified AGI below certain levels could deduct up to $4,000 of qualified higher education expenses to arrive at AGI.

Yes








IRAs and Health Savings AccountsHSAs—Rollovers from FSAs and HRAs

106(e) 4-17 None. Provision not available after 2011.

Taxpayers could transfer amounts from a flexible spending or health reimbursement arrangement into an HSA tax-free.

No

IRAs—Qualified Charitable Distributions

408(d)(8) 14-13 None. Provision not available after 2011.

Individuals age 701/2 or older could transfer up to $100,000 tax-free from their IRAs to a charitable organiza-tion. This qualified charitable distri-bution counted toward the required minimum distribution.

Yes

Alternative Minimum Tax (AMT)Credits that Offset AMT

26(a)(2) 12-1 The following nonrefundable personal credits cannot offset AMT:•Childanddependentcare.•Elderlyordisabled.•Lifetimelearning.•Mortgageinterest.

All nonrefundable personal credits could offset both regular tax and AMT.

Yes

Exemption Amount

55(d)(1) 12-13 The AMT exemption amounts are:•$45,000forMFJ.•$33,750forSingleandHOH.•$22,500forMFS.

The AMT exemption amounts were:•$74,450forMFJ.•$48,450forSingleandHOH.•$37,225forMFS.

Yes3

Charitable ContributionsFood Inventory 170(e)(3) — Special provision for contributions of

food inventory not available after 2011 for taxpayers other than C corpora-tions. Deduction amount for contrib-uted inventory is generally equal to taxpayer’s basis.

Taxpayers in a trade or business could take an above-basis deduction for donations of apparently whole-some food inventory.

Yes

Qualified Conservation Contributions

170(b) 5-13 Qualified conservation contributions are subject to the 30%-of-AGI limit and are carried forward for five years.

Qualified conservation contributions were subject to the 50%-of-AGI limit (100% for farmers and ranchers) and can be carried forward for 15 years.

Yes

S Corporations—Basis Reduction for Property Donations

1367(a) — S corporation shareholders reduce their stock basis by the pro rata share of any charitable deduction claimed for a donation of S corporation prop-erty.

S corporation shareholders reduced their stock basis by the pro rata share of the corporation’s adjusted basis in any property donated by the corpora-tion to charity.

Yes



Notes

3 With modifications.






Other Business (Including Sole Proprietor) ProvisionsDomestic Producers (Section 199) Deduction— Puerto Rican Activities

199(d)(8) 6-22 None. Provision not available for tax years beginning after 2011.

Income attributable to production activities in Puerto Rico was treated as domestic production income.

Yes

Environmental Remediation Costs

198 — None. Provision not available after 2011.

Taxpayers could elect to expense qualified environmental remediation costs, which otherwise would be capitalized.

No

FUTA Tax— Surtax Imposed

3301(1) — None. Provision expired on 6/30/11. 0.2% surtax was added to the FUTA tax.

No

Percentage Depletion— Suspension of Net Income Limit

613A(c) 12-24 The 100% of net income limit applies to percentage depletion for oil and gas from marginal wells for tax years beginning in 2012.

The 100% of net income limit on per-centage depletion for oil and gas from marginal wells was suspended for tax years beginning in 2011.

No

S Corporations— Reduced Recognition Period for Built-In Gains Tax

1374(d) — The built-in gains tax applies during the first 10 years following a conver-sion from a C corporation to an S corporation. A C corporation that elects to be taxed as an S corpora-tion is taxed at the highest corporate rate on all gains that were built-in at the time of the election if the gains are recognized during the recognition period.

The recognition period was reduced from the corporation’s first 10 years as an S corporation to its first five years.

Yes


—End of Tab 17—

Notes

Quickfinder - Thomson Reuters · Quickfinder ® 1040 Quickfinder® Handbook (2012 Tax Year) Updates...

Documents

Transcript of Quickfinder - Thomson Reuters · Quickfinder ® 1040 Quickfinder® Handbook (2012 Tax Year) Updates...