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January 14, 2013
Posted by Sanger & Manes, LLP

I'm Selling Real Estate in 2013 (Let's Say in the Palm Springs Area), Help Me Understand the New 3.8% Surtax on the Sale (Part 2)...

Nothing brings a new law home like some examples, let's take a look:


1.) A single individual with a salary of $210,000, which exceeds the $200,000 threshold, could be subject to the 3.8% tax IF he also has "net investment income."

2.) A married couple with a combined income of $275,000, which exceeds the $250,000 threshold, could be subject to the 3.8% tax IF they also have "net investment income."

3.) A married couple have an Adjusted Gross Income (AGI) of $175,000, less than the $250,000 threshold, but have a "net investment income" of $100,000. Their Modified Adjusted Gross Income (MAGI) (MAGI = Adjusted Gross Income + "net investment income") is $275,000 ($175,000 + $100,000), exceeding the $250,000 threshold, making them subject to the tax.

4.) A married couple have an AGI of $240,000. Their total "net investment income" is $6,000, $2,000 of interest and $4,000 of dividends. The 3.8% tax would not apply even though they have "net investment income" as their MAGI 0f $246,000 ($240,000 + $6,000) is below the $250,000 threshold. But if they have the same interest and dividends plus a $10,000 capital gain, their MAGI would be $256,000. The excess of MAGI over the applicable threshold amount of $250,000 would be $6,000 ($256,000 - $250,000) and their "net investment income" is now $16,000 ($2,000 of interest, $4,000 of dividends and $10,000 of capital gains). Since $6,000 is less than $16,000, and the tax is calculated on the lesser, the 3.8% tax would be applied to the $6,000 and the tax would be $228 ((3.8% x $6,000).

5.) A married couple, purchased their primary residence 20 years ago for $100,000 and have lived in it since that time. Today, it is worth $700,000. If they sold it their profit would be $600,000. The first $500,000 of profit for a married couple selling their primary residence and meeting the ownership and occupancy tests would be tax-free, because of the couples federal home sales profit tax exemption of $500,000. The remaining $100,000 profit ($600,000-$500,000 exemption) would be "net investment income." The question would then be are they subject to the new 3.8% tax? That depends.
If their AGI was $175,000, the $100,000 "net investment income" capital gain profit would then be added to their AGI for a MAGI of $275,000 ($175,000 + $100,000). If the MAGI totaled less than $250,000, the new tax would not apply although they would still have to pay the capital gains tax on $100,000 profit. In this example, as the MAGI is $25,000 greater than the $250,000 threshold ($275,000 - $250,000), the new tax would apply. The new 3.8% tax applies to the lesser of the "net investment income," in this case $100,000, or the $25,000 that their MAGI exceeds $250,000 for a couple filing a joint return. As $25,000 is less than $100,000, the additional tax would be $950 (3.8% of $25,000).

6.) A married couple sold their principal residence for $525,000. They originally purchased it for $325,000. Their gain is $200,000, but they satisfy the ownership and occupancy requirements for the $500,000 couples federal home sales profit tax exemption of $500,000) and after applying the exclusion they have no capital gain and there "net investment income" is zero. Even though they have $300,000 of AGI, they are not subject to the new 3.8% tax as they have no "net investment income."

7.) A married couple inherited stocks and bonds that they liquidated. The sale
of these assets generated a capital gain of $120,000. Their AGI is $140,000 and their MAGI is $260,000 ($120,000 + $140,000). The excess of MAGI of $260,000 over threshold $250,000 is $10,000 ($260,000 - $250,000). The new 3.8% tax applies to the lesser of the "net investment income," in this case $120,000, or the $10,000 that their MAGI exceeds $250,000 for a couple filing a joint return. As $10,000 is less than $120,000, the additional tax would be $380 ($10,000 x 0.038).

8.) A married couple have total investment income from bonds, CD's, dividends, and capital gains of $145,000. Their AGI is $190,000 and their MAGI is $335,000 ($145,000 + $190,000). Their excess MAGI over the threshold of $250,000 is $85,000 ($335,000 - $250,000). The new 3.8% tax applies to the lesser of the "net investment income," in this case $145,000, or the $85,000 that their MAGI exceeds $250,000 for a couple filing a joint return. As $85,000 is less than $145,000, the additional tax would be $3,230 ($85,000 x 0.038).

9.) A married couple own a vacation home they purchased for $275,000. They have never rented it to others. They sell it for $335,000 and their second home sale capital gain is $60,000 ($335,000 - $275,000). The home sale profit exemption does not apply to second homes. In the year of the sale their AGI is $225,000 and their MAGI is $285,000 ($225,000 + $60,000). Their excess MAGI over the threshold of $250,000 is $35,000 ($285,000 - $250,000). The new 3.8% tax applies to the lesser of the "net investment income," in this case $60,000, or the $35,000 that their MAGI exceeds $250,000 for a couple filing a joint return. As $35,000 is less than $60,000, the additional tax would be $1,330 ($35,000 x 0.038).

January 8, 2013
Posted by Sanger & Manes, LLP

I'm Selling Real Estate in 2013 (Let's Say in the Palm Springs Area), Help Me Understand the New 3.8% Surtax on the Sale (Part 1)...

Beginning January 1, 2013, a new 3.8% unearned Medicare income tax will be levied under IRS Section 1411(a)(1) on some "net investment income." This tax is designed to raise an estimated $210 billion to help fund Medicare and health care reform. The tax will apply to the lesser of "net investment income" or the dollar excess of "Modified Adjusted Gross Income over the applicable threshold amount". The 3.8% tax applies in addition to any other taxes that otherwise would apply to the associated income.

It is not true, as some frightening emails have suggested, that the new tax is a sales tax on the total sale price, nor is it true that it will affect all home sales or even most home sales. It is not true, as the emails have reported, that it would cost an additional $3,800 (3.8% x $100,000) in taxes to sell a $100,000 home.

What is Net Investment Income?

The first test for determining the amount of income subject to the 3.8% tax is determining the "net investment income," which includes income from capital gains (less capital losses), rentals (less expenses), dividends, annuities, and royalties. It also includes income derived from a passive activity such as real estate investing and from income derived from a net gain attributable to the sale of property including a home. Income associated with a normal business in which the individual materially participates is not subject to the tax. Also, distributions from a retirement plan are not subject to the tax.

What is the Modified Adjusted Gross Income over the applicable threshold amount?

The second test for determining the amount of income subject to the 3.8% tax is the dollar amount of Modified Adjusted Gross Income (MAGI) greater than the applicable threshold amount. For an individual filer the applicable threshold amount is $200,000 and for a married couple filing jointly the threshold is $250,000. Modified Adjusted Gross Income (MAGI) = Adjusted Gross Income + "net investment income." Home sale profits are capital gains and are considered to be investment income.

What About Code Section 121, Which Permits an Individual to Exempt $250,000 in Capital Gains from the Sale of a Primary Residence?

If certain ownership and occupancy requirements are met, capital gains from the sale of a primary residence less than $250,000 for an individual and less than $500,000 for a couple filing a joint return are currently exempt and will continue to be exempt from taxation. The vast majority of home sellers will not be subject to the new 3.8% tax. In July 2012, the median sales price for existing homes was $181,500. Homes that sold for more than $500,000 accounted for only 11% of home sales. To qualify for the home sale profit exemption, the sale home must be a primary residence which the seller owns and has lived in for two-of-the-last-five years prior to the sale. Husbands and wives can each claim a $250,000 exemption on a joint tax return if both spouses meet the two-of-the-last-five year occupancy test, although only one spouse need meet the ownership test. Two co-owners not married to each other who meet the ownership and occupancy tests can each claim up to $250,000 tax-free home sale profits. Those homeowners who cannot meet the full ownership and occupancy requirements for capital gain exclusion may qualify for a partial exclusion equal to the fraction of the time that the ownership and occupancy requirement are met.

Note, the home sale profit exemption does not apply to second homes or to property owned solely for investment purposes. In those cases, the usual ordinary income or capital gains rules apply.

Are Canadians or Other Non-US CItizens Subject to the New 3.8% Tax?
Canadians, or other foreign nationals owning a second home in the U.S. would not qualify for the exemption, but nor are they subject to the new 3.8% tax.

What About Estates and Trusts?

The new 3.8% tax will also apply to estates and trusts. For estates and trusts, the tax is equal to the lesser of the estate's or trust's undistributed net investment income, or the excess of the estate's or trust's Adjusted Gross Income (AGI) over the dollar amount at which the highest tax bracket begins for such taxable year.


We'll run through some examples, in Part 2....

July 23, 2012
Posted by Sanger & Manes, LLP

Dual US (and Foreign Country) Citizens Who Don't Owe Tax in The US, It's Easy to Get Compliant with IRS Now. For the Other US Citizens With Foreign Accounts and Who do Owe US Tax, You Need to Consider the 2012 FBAR Amnesty Program

IR-2012-65 allows Dual Citizens who Don't Owe Tax in the US a Pain-Free Way to Become Compliant

First of all, which dual citizens don't owe tax in the US? As a general matter, a dual citizen who have been living in a foreign country and been paying that country's tax (as appropriate) probably does not owe much tax in the US (if any). The US taxes its citizen's income no matter where they earn it anywhere in the world. But the US also works in cooperation with almost every country in the world (except for countries such as Cuba, Iran and Yemen...i.e., countries we have no relations with). If you are an American citizen living in France (you might also be a French citizen), and you have been paying your appropriate French tax for the money you earn in France, odds are you will not owe tax in the US. Why is this so? Most foreign countries have higher tax rates than the US. So as long as the income is of a type which we recognize (such as wages for services, or gains for stock sales, or rental income, or dividends, etc), the US will credit income earned in France by the dual French/US citizen. Thus, after the credit, the US citizen probably owes $0 US tax or very little US tax, on the amounts he earns in France. And the same goes for that US citizens with most every other country.

Now let's not confuse the issue of whether the dual citizen owes any US tax with the obligation of the dual citizen to: (a) file US tax returns; and (b) file FBARs annually if they have bank accounts outside the US with over $10,000 at any point in the calendar year. Those obligations generally exist whether the person owes US tax or not. But for those people the new guidance is terrific. Those individuals must complet their past-due tax returns (at least 3 years) and delinquent FBARs (at least 6 years), and they'll probably have no penalty to get compliant provided you don't owe significant US Tax. A great deal.

Now if you haven't been paying the appropriate tax in France (or whatever foreign country), and you probably haven't been paying the appropriate tax in the US if you haven't been completing your tax returns here, then (provided you have bank accounts in the foreign country over $10,000) you need to go through the 2012 FBAR amnesty program (review our prior posts for a description of the OVDP).

Let's point out some important factors of the new amnesty program.

More Notes about the 2012 FBAR Amnesty Program

The 2012 FBAR amnesty program is currently underway. There is no deadline for the program. The program could be pulled by the IRS at any time, or the IRS could raise the current amnesty FBAR penalty (27.5% of the highest (aggregate) overseas balance in the highest year with a bank account abroad) at any time. Again, for those going through the amnesty program, you really have strongly consider taking the 27.5% penalty if you did not check the box on the Schedule B of the Form 1040 (asking the taxpayer to check the box if he or she had any foreign bank accounts). For those who don't go into the amnesty and eventually get caught, the penalties can be enormous. They can wipe you out, no question. Also, in really egregious circumstances, jail is a possibility. And, as we understand it, foreign countries (like Switzerland) are feeling little option but to turn over bank account records to the US government (either presently, or soon).

The IRS clearly draws a distinction between those taxpayers who come in voluntarily, and those who are caught. If you are a US citizen or resident and have overseas bank accounts and you owe tax in the US on those amounts (maybe because you haven't paid the appropriate tax in the foreign country at issue), you probably should consider the 2012 amnesty program soon.

July 16, 2012
Posted by Sanger & Manes, LLP

US Citizens and Residents of the Coachella Valley, Have You Failed to Report Your Foreign Bank Accounts? IRS Offers a 2012 Amnesty Program (and Now has Released Detailed Information About the 2012 Amnesty Program), But its Tricky (Part III)

So a few months ago on this blog we informed you that the IRS offered a new FBAR amnesty program (now the 3rd program it's offered), but that it only had released the broad stokes of the program (see our entry from February 16, 2012, for our last discussion of this topic). Since then, the IRS has established new procedures for dual citizens who have foreign bank accounts but who have paying the appropriate tax on the amounts in the those accounts in the foreign country at issue. Taxpayers with this situation can resolve it rather easily without having to go through a formal amnesty program (see our post from July 5, 2012, discussing this new option). However, that program won't be available for everyone, and for the rest there is now the 2012 Overseas Voluntary Disclosure Program (the "OVDP"). On June 26, 2012, the IRS issued a set of Frequently Asked Questions and Answers (this is new guidance to assist taxpayers under the 2012 OVDP).

Background

Again, recall US tax citizens or residents must file a "FBAR" (a "Report of Foreign Bank and Financial Accounts") annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States. The term financial account includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. The FBAR is filed on a US Treasury Form TD F 90-22.1, by June 30 of the year after the US citizen or resident had a non-US account.


So What Are Broad Strokes of the 2012 OVDP?

Largely, we've already discussed basics of the 2012 OVDP in our prior posts, since the amnesty program remains very similar to the 2011 amnesty program. Taxpayers going through program will have to make a very important decision.

Option One- No Questions Asked. The taxpayer chooses pay a one-time penalty of 27.5% of the highest aggregate overseas account(s) balance in the highest year. So if the aggregate overseas account balance in the highest year (of all the years when the individual did not file a FBAR) was $2,000,000 (and by the way, when we say highest aggregate overseas account balance we are including the value of overseas assets- such as a house- plus the value of overseas accounts), the taxpayer is volunteering to pay a penalty to the IRS of $550,000 (27.5% x $2,000,000), plus the unpaid income tax (if any), plus penalties for failure to file or pay income tax (if any). That stings, no question.

Option Two- Roll the Dice for a Lesser Penalty. The taxpayer asks for a lower penalty than the 27.5% general amnesty penalty (which required a payment of at least $550,000 for a $2,000,000 overseas aggregate account balance above). But this is a gamble with big stakes. If the IRS agrees that the taxpayer is entitled to a lesser penalty based on the facts of the case, then great. But if the IRS doesn't agree, the taxpayer can lose big. In fact, if upon review the IRS believes that the taxpayer's failure to file a FBAR was "willful", they can take EVERYTHING in the foreign accounts (maybe more). The taxpayer cannot elect option two and roll the dice if the facts of his case have even the whiff of a willful failure not to file FBARs. So what factors suggest to the IRS a taxpayer willfully failed to file a FBAR???

How Do I Know if the IRS will Consider My Failure to File FBARS a Willful Failure, so That I Better Take the 27.5% No Questions Asked Penalty?

So this is really where the rubber meets the road on the 2012 OVDP FBAR amnesty. I need to know whether my case is too risky to ask for the opt-out, and just accept the 27.5% one-time penalty. I must accept the 27.5% penalty if there is a decent chance the IRS will deem my failure to file FBARs as willful. What is a willful failure to file? While there are no concrete answers to this, here are some factors (which come both from the 2012 OVDP Q&A guidance and from our own discussions with the IRS):

1) If the taxpayer has large, unreported taxable gains attributable to the overseas account(s), this is a negative factor (e.g., you got a Swiss account which you haven't filed a FBAR for and you trade stocks in the account and had some major gains and a lot of tax due in the US from these gains...you should probably take the 27.5% amnesty deal...see Q&A 51.2 of the new ODVP guidance).

2) You failed to check the box on Part III of the Schedule B of the Form 1040 that states you had foreign bank accounts. It's one thing not to file FBAR's annually, but it's another thing to fail to state on your personal income tax return that you had any foreign bank accounts. That is not a good factor for someone looking for the opt-out deal.

3) You failed to pay the appropriate tax in the foreign country at issue. It looks better if while failing to file FBARs and paying tax in the US, you were at least tax compliant in the foreign country at issue. Note that if you paid the correct tax overseas, it's quite possible (due to the tax credit system) that you have $0 US tax owed. If you paid the correct tax to the foreign country at issue, that's a very positive factor.

Make a Calm, Objective Decision on Whether to "Opt-Out"

In our experience, there is natural inclination for clients not to want to accept the 27.5% (of the highest aggregate foreign account balance(s) in the highest year) penalty. This is understandable. But again, you need to calmly and objectively assess your case before you make the critical decision of whether to opt-out of the no questions asked 27.5% penalty. The stakes are huge (you could lose the entire value of these accounts if you're wrong). If you haven't declared your overseas bank accounts yet, and you are increasingly worried about the IRS and the Department of Justice discovering them, we strongly recommend you give us or a competent tax attorney a call to review your case.

We'll talk about how long the new FBAR 2012 Amnesty Program is expected to last, and other features of the program, in our next post.

July 5, 2012
Posted by Sanger & Manes, LLP

IRS Makes It Dramatically Easier (and less costly) For US Citizens Living In Another Country to Catch up on Past-Due Tax Returns and FBARs

On June 26, 2012, the IRS announced a new initiative to help US citizens living in another country (very likely dual citizens) catch up with their unfiled US tax returns and FBARs.

Background

In our law office in Palm Springs, we regularly see clients who may be Americans by birth, but who live in (and are also probably a citizen of) another country (usually Canada). While the dual American/Canadian may enjoy visiting Indian Wells three months a year, she really lives in Vancouver. But since she was born in Seattle, she has a social security number, she is a US citizen, and (whether she wants one or not) she has an obligation to file a US tax return every year (even though maybe she's never filed one in her life). Plus, since she has bank accounts outside the US in Canada with more than $10,000 in them, she has an annual FBAR filing requirement as well.

Before the Recent Announcement, This Was a Big Problem for the Dual Citizen Living Abroad

Dual citizens living (permanently) in a country other than the US did not know what to do. Was our Seattle-born dual US/Canadian citizen living permanently in Vancouver supposed to file 25 years of back taxes? Wouldn't that lead to possibly thousands of dollars in back taxes and interest and penalties to the IRS? And as for the delinquent FBARs, isn't the failure to file penalty for an FBAR $10,000 per each year going as far back as the FBAR program has been in existence (it started in 2003)? Our Vancouver resident might think it would be nice to get straight with the IRS because she doesn't like the specter of unpaid income tax and past due FBARs hanging over her head, but it's certainly not worth the $300,000 in back taxes and interest and FBAR penalties she will have to pay for coming clean.

IRS New Procedure Offers Significant Relief For Dual Citizens Living in a Foreign Country Who Have Not Filed US Tax Returns or FBARs in Years

Under the new procedure, taxpayers will be required to file delinquent tax returns for the past three years and file delinquent FBARs for the past six years. All submissions will be reviewed, but for those taxpayers presenting low compliance risk, the review will be expedited and the IRS will not assert penalties or pursue follow-up actions. How do we know if a taxpayer has a "low risk" case where there may be no penalties imposed? Absent unique factors, if the submitted returns show less than $1,500 in tax due in each of the reviewed years, they will be treated as low risk.

So the Dual Citizen Who Hasn't Done a US Tax Return in 20 Years Can Do the 3 Most Recent Tax Returns, and 6 Most Recent Past Due FBARs, and Maybe Have No Penalties and Now Have a Clean IRS History?

The answer is yes! And it's easier than you might think. If our Vancouver resident, born in Seattle (and with a vacation home in Indian Wells) has been paying proper taxes in Canada all these years, due to the tax cooperation between the US and Canada (and the tax credit system), she very possibly owes $0 in past due US taxes for the reviewed years (easily below the $1,500 per year threshold). And the same goes if she was born in New York City and now lives in France (or almost any other country). No failure to file income tax return penalty, and no $10,000 per year failure to file FBAR penalty!!! This is great news for the dual citizen living abroad who just wants to clean their US tax record.

See IR-2012-64 for more details, or call our office.

May 14, 2012
Posted by Sanger & Manes, LLP

How Do I Sell My House, Buy Another, and Not Pay Tax?...Let's See Some Examples:

Let's do some basic (and not so basic) 1031 examples. Again, before we start, remember that in addition to a rising real estate market (no sure thing the last few years, although in the Palm Springs area we might finally be turning the corner), in order to qualify for 1031 you need property either: held for (a) investment or (b) productive use in a trade or business.
Also remember vacation homes are unlikely to qualify as either: held for (a) investment or (b) productive use in a trade or business, unless the owner or the owner's family uses the vacation house not more than 14 days a year. A property used as rental property will qualify for Section 1031 because the IRS deems rental properties as held for productive use in a trade or business.

Basic 1031 Examples

Here's a basic example (1): Tom purchases a Palm Desert house in 2001 for $500k. Tom sells it in 2006 for $1,000,000. Shortly thereafter in 2006, Tom purchases an Indian Wells home for $1,000.000. In 2012, Tom sells the Indian Wells home for $1,250,000. Assuming the Section 1031 requirements met, Tom's taxable income in 2006 is $0, and Tom's taxable income in 2012 is $750,000.

When the taxpayer receives cash in the transaction, the taxpayer must recognize gain (at least to the extent of the cash received).

Basic example (2):
Tom exchanges real estate held for investment (i.e., the general rule is he or his family uses it not more than 2 weeks a year), which he purchased in 2000 for $500,000 which now (in 2012) has a fair market value of $800,000, for other real estate (to be held for productive use in a trade or business) worth $600,000, and $200,000 in cash. The gain from the transaction is $300,000 (Tom bought a property for $500,000 and is now exchanging it for a new property worth $600,000 plus $200,000 in cash), but the $300,000 gain is only recognized to the extent of the cash received: $200,000. Tom must recognize $200,000 in 2012 when he engages in the exchange.

And let's do one more example (with a little more complexity, including two assets transferred (only one of which qualifies under 1031)), plus the question of what is the basis in the new property:

Basic example (3): In 2007, Tom transfers real estate he used exclusively as a rental property which he purchased in 2002 for $1,000,000 in exchange for other real estate (to be held as rental property) which has a fair market value of $900,000, an automobile which has a fair market value of $200,000, and $150,000 in cash. Tom realizes a gain of $250,000 (bought property in 2002 for $1,000,000 and sold it in 2007 for property plus a car plus cash all worth $1,250,000). Tom must recognize (ie pay tax on) the entire $250,000 gain because he received items other than another real property (the car plus the cash) worth a total of $350,000. The basis of the new rental property received in exchange is the basis of the transferred real estate ($1,000,000) decreased by the amount of money received ($150,000) and increased in the amount of gain that was recognized ($250,000), which results in a basis for the property received of $1,100,000. This basis of $1,100,000 is allocated between the automobile and the real estate received by Tom. The basis of the automobile must remain its fair market value at the date of the exchange- $200,000, with the basis of the real estate received being the remainder: $900,000. So at the end of the transaction, the basis in new property is only $900,000 ($100,000 less than the basis in the old property).

April 14, 2012
Posted by Sanger & Manes, LLP

How Do I Sell My House, Buy Another, and Not Pay Tax?

We're taking a break from speaking about the FBAR amnesty program (we will return to this topic shortly), but were going to continue to parallel (for now) our Canadian Snowbird Blog. So the topic at hand is how do I sell my house (we're assuming the house has gone up in value), buy a new house, and not pay tax? Let's assume, for the sake of discussion, that I sell a La Quinta home which has appreciated in value by $500,000 since I bought the house in 1997.

Question #1- Can I sell the house in La Quinta (for $500k more than he bought it for) and buy the Palm Desert replacement property without paying any US tax?
The general answer is yes. Internal Revenue Code Section 1031allows me to exchange, tax free, US real property for other US real property, if several requirements are met.

Question #2- What are the general requirements for a Section 1031 exchange?
In order for me the taxpayer to exchange real property for other real property, and not pay tax:
A) The Property must be exchanged for "like-kind" property. "Like-kind" simply means that real property must be exchanged for real property. But Section 1031 also mandates both the relinquished property and the replacement property must be held for productive use in a trade or business or for investment. Thus, I cannot exchange into or out of my own personal residence, because that is not deemed held for productive use in a trade or business or for investment. Vacation homes may qualify if they are rented out to unrelated persons, or held primarily for investment rather than personal use. For example, in the 2007 case of Moore v. CIR, the Tax Court held that an exchange of vacation homes did not qualify for nonrecognition under ยง 1031(a)(1) because neither home was held for investment: "the mere hope or expectation that property may be sold at a gain cannot establish an investment intent if the taxpayer uses the property as a residence." Subsequent to the Moore case, the IRS issued Rev. Proc. 2008-16, which provides vacation properties may qualify for a 1031 if:
(a) The dwelling unit is owned by the taxpayer for at least 24 months immediately before the exchange; and
(b) Within the qualifying use period, in each of the two 12-month periods immediately preceding the exchange,
(i) The taxpayer rents the dwelling unit to another person or persons at a fair rental for 14 days or more, and
(ii) The period of the taxpayer's personal use of the dwelling unit does not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented at a fair rental.
In addition, the replacement property must meet the same requirements for the two years after the exchange (i.e., must be rented out and not used too much for personal use). So if I have a vacation home for (primarily) personal use, I will have a difficult time taking advantage of Section1031 tax free exchange treatment.
B) It's not as simple as selling my property one day (let's assume for a gain), and buying a replacement property down the road, and not paying tax on the gain. First, the replacement property must be identified not later than 45 days after the sale of the first property. What does it mean to indentify a property? You identify a property in writing, giving the writing to an independent party (a qualified intermediary). Second, the replacement property must be received not later than 180 days after the sale.
We'll pick it up here in our next post, reviewing some examples of how the tax treatment works....

February 16, 2012
Posted by Sanger & Manes, LLP

US Tax Residents- Have You Failed to Report Your Foreign Bank Accounts? IRS Offers a 2012 Amnesty Program, But It's Tricky (Part II)

We're speaking about US citizens or residents (and US tax residents can be citizens of any country who happen to stay in the US too long in a given year, this could be citizens from any country outside of the US who may visit Palm Springs, or Rancho Mirage or Palm Desert long enough for a given year that they are deemed a US tax resident; we are also speaking of citizens of foreign countries who are US green card holders). US citizens and residents must declare to the Department of Treasury their foreign bank accounts (provided they have over $10,000 in aggregate foreign bank accounts/ assets...not a high bar). They must file these information returns (called "FBARs") by June 30 of each year. Many US citizens and tax residents (particularly those who are current or former citizens of another country) are unaware of the FBAR requirement, which was enacted in 2003. That is why the IRS amnesty programs can be so valuable. In 2012, the IRS is again offering a FBAR amnesty program. This is the third such amnesty program. There is no guarantee there will be a fourth.

Structure of the IRS Amnesty Program
Although the IRS has yet to provide (much) specific guidance on the 2012 amnesty program, it will almost certainly follow the framework provided in the 2011 program. So it makes sense to review generally the 2011 program (the "OVDI Program"). Taxpayers who made voluntary disclosures under the 2011 OVDI Program could expect the following penalties/payments:

Path One- the No Questions Asked Path requires the taxpayer to pay 27.5% (for the 2012 program...under the 2011 OVDI Program it was only 25%) of the highest aggregate overseas account balance in the highest year. So if the aggregate overseas account balance in the highest year (when the individual did not file a FBAR) was $2,000,000 (and by the way, when we say highest aggregate overseas account balance we are including the value of overseas assets- such as a house- plus the value of overseas accounts), the individual is volunteering to pay a penalty to the IRS of $550,000 (27.5% x $2,000,000), plus the unpaid income tax (if any), plus penalties for failure to file or pay income tax (if any). So, under Path One, the easy/no risk path, the individual with undeclared overseas accounts (and assets) of $2,000,000 must pay a penalty of $550,000 at an absolute minimum...THIS IS A STIFF AMNESTY PENATLY!!!

Path Two- Opt Out of the 27.5% No Questions Asked Penalty, and Ask the IRS for a Lesser Penalty Path Ahh, this sounds better. Let's ask for a lower penalty than the 27.5% general amnesty penalty (which required a payment of at least $550,000 for a $2,000,000 overseas aggregate account balance above). But here's the catch: you can ask the IRS for a lesser penalty, and they might agree (and the individual might end up owing almost nothing to the IRS)...on the other hand, under Path Two, if the IRS doesn't agree, they can take every penny of your overseas aggregate account balances!!! Quite a gamble under Path Two.

More on the Path Two, and the decision making process which an individual must undertake when deciding between Path One and Two (or not taking part in the amnesty program at all)...in Part III of this series coming up.

February 6, 2012
Posted by Sanger & Manes, LLP

US Tax Residents- Have You Failed to Report Your Foreign Bank Accounts? IRS Offers a 2012 Amnesty Program, But It's Tricky (Part I)

In January, the Internal Revenue Service reopened the offshore voluntary disclosure program to help people hiding offshore accounts get current with their taxes. Although details of the 2012 program were not immediately available, the parameters will likely be very similar to the 2011 Offshore Voluntary Disclosure Initiative ("OVDI"). While 2011 OVDI Program seemed straight-forward, it turned out it was anything but straight-forward.

US Citizens or Tax Residents Must File a FBAR Annually

US tax citizens or residents must file a "FBAR" (a "Report of Foreign Bank and Financial Accounts") annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States. The term financial account is broadly defined and includes any bank, securities derivatives, or other financial instrument accounts. It also includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. The FBAR is filed on a US Treasury Form TD F 90-22.1. The FBAR is filed with the US Department of Treasury by June 30 of the year after the US citizen or resident had a non-US account. The FBAR requirement has been in existence since 2003.

2012 Program Will Likely Be Similar to the 2011 Program

Although the IRS has yet to provide details, it's a fairly safe assumption that the 2012 will look very similar to the 2011 OVDI Program. So, for taxpayers who went through the 2011 OVDI Program, what were the penalties?

Non-Willful Failure to File a FBAR

The general penalty for a "non-willful" failure to file a FBAR for a given year is $10,000 per year.

Willful Failure to File a FBAR
A willful failure to file a FBAR is far more significant. In the case of a willful failure to file a FBAR, the penalty can be as high as 50% of the aggregate balance of the overseas account(s) per year. This is steep. Let's look at this example published last year by the IRS in their 2011 Offshore Voluntary Disclosure Initiative Frequently Asked Questions and Answers (Q&A 8):

We start with an account balance in 2002 or $1,000,000

Year Interest Income Account Balance
2003 $50,000 $1,050,000
2004 $50,000 $1,100,000
2005 $50,000 $1,150,000
2006 $50,000 $1,200,000
2007 $50,000 $1,250,000
2008 $50,000 $1,300,000
2009 $50,000 $1,350,000
2010 $50,000 $1,400,000

If the taxpayers didn't come forward, when the IRS discovered their offshore activities, and the IRS deemed the failure to file "willful", they would face up to $4,543,000 in tax, accuracy-related penalty, and FBAR penalty. The taxpayers would also be liable for interest and possibly additional penalties, and an examination could lead to criminal prosecution.

The civil liabilities outside the 2011 Offshore Voluntary Disclosure Initiative potentially include:

FBAR penalties totaling up to $4,375,000 for willful failures to file complete and correct FBARs (2004 - $550,000, 2005 - $575,000, 2006 - $600,000, 2007 - $625,000, 2008 - $650,000, and 2009 - $675,000, and 2010 - $700,000),

So, if the IRS deemed the failure to file a FBAR was willful in this case, the IRS could impose a penalty of $4,543,000, even though the taxpayer's account was only as high as $1,400,000 (i.e., the penalty is 3 times higher than the highest overseas aggregate account value)!!!

We discuss what constitutes a willful failure to file, and what the 2012 amnesty program offers taxpayers, in future posts. But the key take-away for US citizen/residents with foreign bank accounts is: you better participate in the 2012 amnesty program, because the possible penalties for not filing FBARs are huge.

February 3, 2012
Posted by Sanger & Manes, LLP

Canadian Snowbirds in Palm Springs Who are US Tax Residents- Have You Failed to Report Your Canadian Bank Accounts? IRS Offers a 2012 Amnesty Program, But It's Tricky (Part I)

In January, the Internal Revenue Service reopened the offshore voluntary disclosure program to help people hiding offshore accounts get current with their taxes. Although details of the 2012 program were not immediately available, the parameters will likely be very similar to the 2011 Offshore Voluntary Disclosure Initiative ("OVDI"). While 2011 OVDI Program seemed straight-forward, it turned out it was anything but straight-forward.

Canadian Snowbirds Who Are US Citizens or Tax Residents Must File a FBAR Annually

US tax citizens or residents (i.e., Canadians who are in the US a little too much in a given year) must file a "FBAR" (a "Report of Foreign Bank and Financial Accounts") annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States. The term financial account is broadly defined and includes any bank, securities derivatives, or other financial instrument accounts. It also includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. Canadian snowbirds will likely have no shortage of these back in Canada. The FBAR is filed on a US Treasury Form TD F 90-22.1. The FBAR is filed with the US Department of Treasury by June 30 of the year after the US citizen or resident had a non-US account. The FBAR requirement has been in existence since 2003.

2012 Program Will Likely Be Similar to the 2011 Program

Although the IRS has yet to provide details, it's a fairly safe assumption that the 2012 will look very similar to the 2011 OVDI Program. So, for taxpayers who went through the 2011 OVDI Program, what were the penalties?

Non-Willful Failure to File a FBAR

The general penalty for a "non-willful" failure to file a FBAR for a given year is $10,000 per year.

Willful Failure to File a FBAR
A willful failure to file a FBAR is far more significant. In the case of a willful failure to file a FBAR, the penalty can be as high as 50% of the aggregate balance of the overseas account(s) per year. This is steep. Let's look at this example published last year by the IRS in their 2011 Offshore Voluntary Disclosure Initiative Frequently Asked Questions and Answers (Q&A 8):

We start with an account balance in 2002 or $1,000,000

Year Interest Income Account Balance
2003 $50,000 $1,050,000
2004 $50,000 $1,100,000
2005 $50,000 $1,150,000
2006 $50,000 $1,200,000
2007 $50,000 $1,250,000
2008 $50,000 $1,300,000
2009 $50,000 $1,350,000
2010 $50,000 $1,400,000

If the taxpayers didn't come forward, when the IRS discovered their offshore activities, and the IRS deemed the failure to file "willful", they would face up to $4,543,000 in tax, accuracy-related penalty, and FBAR penalty. The taxpayers would also be liable for interest and possibly additional penalties, and an examination could lead to criminal prosecution.

The civil liabilities outside the 2011 Offshore Voluntary Disclosure Initiative potentially include:

FBAR penalties totaling up to $4,375,000 for willful failures to file complete and correct FBARs (2004 - $550,000, 2005 - $575,000, 2006 - $600,000, 2007 - $625,000, 2008 - $650,000, and 2009 - $675,000, and 2010 - $700,000),

So, if the IRS deemed the failure to file a FBAR was willful in this case, the IRS could impose a penalty of $4,543,000, even though the taxpayer's account was only as high as $1,400,000 (i.e., the penalty is 3 times higher than the highest overseas aggregate account value)!!!

We discuss what constitutes a willful failure to file, and what the 2012 amnesty program offers taxpayers, in future posts. But the key take-away for US citizen/residents with foreign bank accounts is: you better participate in the 2012 amnesty program, because the possible penalties for not filing FBARs are huge.

December 28, 2011
Posted by Sanger & Manes, LLP

California Taxpayers: Failed to File a Gift Tax Return for a Property Transfer to a NonSpouse Relative From 2005-2010? The State of California is About to Tell the IRS All About It

A district court has now granted the IRS permission to issue a summons to the State of California Board of Equalization, as part of a gift tax enforcement initiative to detect transfers of real property between nonspouse relatives that weren't reported on gift tax returns. California now joins Connecticut, Florida, Hawaii, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia, Washington, and Wisconsin, as states where the state governments must turn over records about property transfers to the IRS. If you transferred property to nonspouse relatives and did not complete the appropriate gift tax return, the State of California may be on the verge of telling the IRS all about you.

Gift Tax Background
Intra-family transfers of property are extremely common. Remember that in 2011, decedents can exclude up to $5 million of their estate before having to pay estate tax on the remainder. Likewise, in 2011 individuals can "gift" up to $5 million and not pay a tax on the gift amount (the Internal Revenue Code therefore "unifies" the estate tax and the gift tax.) However, any individual who makes gifts to any one donee during a calendar year above the $13,000 annual exclusion must file a gift tax return (an IRS Form 709). A return must be filed even if no tax is payable (due to the $5 million lifetime exclusion).

When the IRS issues a Summons to the State of California, what Information can it Gather about You?
With a summons served upon the state of California, the IRS can uncover transfers of real property to nonspouse family members. How? Property transfers in California generally constitute a "change in ownership" so that the county assessor may reassess a property for property tax purposes. Absent a change in ownership, the state may only increase a California property owner's taxes by 2% per year. In order to claim an exclusion from the change in ownership reassessment rule, California taxpayers must file Forms BOE-58-AH (Claim for Reassessment Exclusion for Transfer Between Parent and Child) or BOE-58-G (Claim for Reassessment Exclusion for Transfer Between Grandparent and Grandchild). These forms are filed with the local county assessor's office. California property owners are generally very diligent about completing these forms, because they do not want their property reassessed for fear of considerably higher property taxes. The state of California maintains a statewide database of the information garnered from these forms. And now the IRS has access to the Forms BOE-58-AH and BOE-58-G filed by California transferors of property (to relatives) seeking to avoid a reassessment of the property.

California tells the IRS of the Property Transfer, now the IRS is Looking for The Transferor's Form 709
The rest is relatively simple. The state of California allows the IRS to review the Forms BOE-58-AH and BOE-58-G, and the IRS simply follows up by seeing whether that individual completed a Form 709 (and paid gift taxes, if appropriate). IRS survey results concluded that at least 50% and up to 90% of individuals who transferred property to nonspouse family members failed to file a Form 709.

California residents- if you transferred property since 2005 to a nonspouse family member, and you should have filed a Form 709 and didn't (and didn't pay the appropriate gift tax, if any), go file it now. Because there is a very good chance the IRS is going to find this out anyway, and the penalties of their discovering your lack of compliance will be much worse if you have not already rectified the situation.

December 23, 2011
Posted by Sanger & Manes, LLP

Tax Court: Professional Gamblers Can Deduct More on Their Tax Return Than Recreational Gamblers

Visitors to the Coachella Valley often spend some time at our local casinos: such as the SPA Casino in Palm Springs or the Agua Caliente Casino in Rancho Mirage. When the gambler has a single win of at least $1,200, the casino is required by law to issue the big winner a W-2G, which notifies the IRS of the win (great, thanks a lot casino). The Internal Revenue Code does allow a taxpayer to deduct gambling losses from gambling winnings (but not below zero) on an annual basis, but as we've discussed before, proving gambling losses can be difficult. After all, unlike the big win, the casino never notifies the IRS when the gambler has a big loss. The IRS has traditionally accepted a daily log or journal kept by the taxpayer detailing the gambling activity of the day as proof of gambling losses, but how realistic is keeping a daily journal? In our high-tech modern era, the best evidence a taxpayer can use to show the IRS that he or she was, in fact, a big loser (and not a big winner) is the casino issued "players card". The card allows the casino to electronically track the individual's gambling winnings and losses. This serves as excellent evidence when proving gambling losses to the IRS. So gamblers, always get and use the casino issued player's card, because the day might easily come when you need to prove your gambling losses to the IRS.

Special Rules For Deductions of "Professional Gamblers"

As discussed above, the Internal Revenue Code permits individuals to deduct gambling losses to the extent of gambling winnings (but not below zero). But here we're talking about gambling loses (i.e., wagering losses). What about expenses incurred in gambling? Can an individual who gambles for a living deduct gambling expenses just like a regular business expense (the rest of us seem to be able to deduct our business expenses)? If so, does the amount of gambling winnings have any bearing on the amount of expenses the professional gambler may deduct?

The US Tax Court addressed theses issues in the recent case of Mayo v. Commissioner, 136 TC 81 (2011). In that case, the taxpayer in question was in the business of "gambling on horse races"(i.e., a professional gambler). Although a facts and circumstances test, a professional gambler is generally one who gambles for profit, and not for recreation. The taxpayer in the case had substantial losses from the gambling on races, but the taxpayer also had significant expenses associated with the gambling activity. Such "business" expenses included meals, telephone costs, horse racing periodicals and admission fees into the horse racing grounds. If the taxpayer were allowed to deduct his total gambling losses and expenses, the total deduction would, in fact, exceed his total gambling winnings on the year.

The Tax Court held that these amounts may be deducted by the professional gambler. So gamblers with heavy losses and expenses are far better off classifying themselves as professional gamblers than recreational gamblers. This categorization permits the individual to deduct gambling losses (up to the amount of gambling winnings, as with any gambler), and expenses associated with gambling (below the gambling winnings threshold...fantastic!).

September 30, 2011
Posted by Sanger & Manes, LLP

IRS Announces New Amnesty Program For Employers Who Have Improperly Classified Employees as Independent Contractors

In Announcement 2011-64, the IRS developed a new program to permit employer/ taxpayers to voluntarily reclassify workers as employees for employment tax purposes. And the penalty for compliance: a mere 10% of the employment tax liability that would have been due for the last year (plus the promise to the classify the individuals as employees going forward)!

Recall the importance of how an employer classifies its workers. Subject to a base limit, the compensation of every employee is subject to FICA taxes (commonly called social security taxes). Further, IRC Section 3102(a) requires employers to withhold FICA taxes from an employee's pay. If the employer fails to withhold the tax, it is still liable for payment of the tax. In addition, the employer must also pay a matching FICA tax equal to the employee portion of the tax. Lastly, a federal unemployment tax (FUTA ) is assessed on employers on all "wages" paid in a calendar quarter, although frequently employers never actually pay federal unemployment taxes due to credits they receive for payment of state unemployment taxes. An independent contractor (or self-employed person), on the other hand, pays for his or her own social security in the form of self-employment taxes (SECA). A self-employed person pays an amount equal to the employee portion plus the employer portion of employment taxes.

Who's an employee and who's an independent contractor? It comes down to a review of factors, including:

(1) the degree of control exercised by the principal;
(2) which party invests in the work facilities used by the worker;
(3) the opportunity of the individual for profit or loss;
(4) whether the principal can discharge the individual;
(5) whether the work is part of the principal's regular business;
(6) the permanency of the relationship;
(7) whether the worker is paid by the job or by the time;
(8) the relationship the parties believed they were creating; and
(9) the provision of employee benefits.

To be eligible for the program, called the Voluntary Classification Settlement Program ("VCSP"), an employer must: (1) consistently have treated the workers in the past as nonemployees; (2) have filed all required Forms 1099 for the workers for the previous three years; and (3) not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers. No interest or penalties will be due (there will be the 10% employment tax liability for the previous year), and the employers will not be audited on payroll taxes related to these workers for prior years. Participating employers will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes. The IRS retains discretion whether to accept a taxpayer's application under the VCSP. Taxpayers whose application has been accepted will enter into a closing agreement with the IRS.

July 13, 2011
Posted by Sanger & Manes, LLP

Tax Court Says Downturn in the Economy is an Acceptable Reason For Penalty Abatement on Failure to Deposit Employment Taxes? No Kidding.

On July 5, 2011, in the case of Custom Stairs & Trim, LTD., v. Commissioner (TC Memo 2011-155), the US Tax Court addressed the issue of what circumstances constitute "reasonable cause" for the purpose of abating a penalty for an employer's failure to deposit employment taxes in a timely manner. Does a downturn in the economy constitute reasonable cause? Some may find the result surprising.

Background
Federal law requires employers to withhold taxes from its employees' paychecks. Each time the employee pays wages, it must withhold - or take out of its employees' paychecks - certain amounts for federal income tax, social security tax, and Medicare tax (these taxes are termed "employment taxes"). Further, an employer must file a quarterly Form 941 reporting the wages it paid to its employees for the previous quarter. The IRS Form 941 includes totals for: (a) the number of employees and total pay for the period being reported; (b) amounts withheld from the pay of employees for the period; (c) taxable Social Security and Medicare wages for the period; and (d) calculation of total Social Security and Medicare wages. The form requires a calculation of the total taxes and the total deposits (from the employer to the government) made during the period. Beginning January 1, 2011, an employer deposits all depository taxes (such as the employment tax) electronically by electronic funds transfers.

IRC Section 6656 imposes penalties on late deposits of the employment tax (of 2 to 15% on the amount of tax, depending on the lateness of the deposit). Under IRC Section 6656(a) and Rev Proc. 2001-58, however, the IRS may abate the penalty if it determines there exists "reasonable cause" to do so.

Does a Downturn in the Economy Constitute "Reasonable Cause"?
In Custom Stairs & Trim, LTD., v. Commissioner, the employer failed to make certain employment tax deposits. As a consequence, the IRS imposed a penalty under IRC Section 6656- Failure to Make Deposit of Taxes. The issue before the US Tax Court was whether the company's failure to make the deposit of taxes was attributable to reasonable cause, so that the penalties should be abated. As a reason for failing to make the deposit for the 2nd quarter of 2008, the company cited the effects of the economic recession. It noted it had been forced during this time to lay off employees, eliminate vacations and reduce employee benefits. The company stated it simply did not have enough money to deposit the taxes for that quarter and meet its other crucial operating expenses. The company did deposit taxes during that time it owed for a previous quarter for which it was in arrears. The IRS responded, in turn, that it never constitutes reasonable cause (for the purposes of abating penalties) to pay other creditors before the IRS.

In its decision, the Tax Court noted that in the 2nd, 3rd, 7th and 9th circuits (the 9th circuit is California's circuit) the courts have opined that financial hardship, under certain circumstances, can constitute reasonable cause. The Tax Court stated reasonable cause will be found if the taxpayer "exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship." In determining whether the taxpayer exercised ordinary business care and prudence, "consideration will be given to all the facts and circumstances of the taxpayer's financial situation, including the amount and nature of the taxpayer's expenditures in light of the income. Primary factors in determining whether a taxpayer exercised ordinary business care are: (1) the taxpayer's favoring other creditors over the Government, (2) a history of failing to make deposits, (3) the taxpayer's financial decisions, and (4) the taxpayer's willingness to decrease expenses and personnel."

Because the company did actually make deposits during the 2008 quarter (albeit, for amounts due from prior periods, and not the actual amounts due for the 2nd quarter of 2008) the Tax Court reasoned the company was not paying other obligations instead of its obligation to the IRS. That fact coupled with the economic downturn (including proof that the company cut benefits and payroll and was attempting to sell some of its real property) satisfied the Tax Court, which ruled that the company exercised ordinary business care, and that the IRS must abate the company's penalties for failure to deposit the employment taxes for the second quarter of 2008.

Include your author as one of the surprised.

July 7, 2011
Posted by Sanger & Manes, LLP

Tax Court Decision Offers a Refresher on Definition of Chronically Ill Individual for Deducting Long-Term Care Expenses

On July 7, 2011, the US Tax Court, in Estate of Lillian Baral (137 T.C. No. 1), the Tax Court offered a good refresher on the fundamentals of deducting long-term medical costs for those who qualify as "chronically ill".

The opinion walks through a series of particular and critical definitions for this process.

The general rule of deductibility, provided under IRC Section 213, is that certain expenses paid during the taxable year for the medical care of the taxpayer or a dependent that are not compensated for by insurance or otherwise may be deducted to the extent that the expenses exceed 7.5 percent of the taxpayer's adjusted gross income.

"Medical Care", under IRC Section 213, includes amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, and amounts paid for qualified long-term care services.

"Qualified long-term care services", under IRC 7702B, means necessary diagnostic, preventative, therapeutic, curing, treating, mitigating, and rehabilitative services and maintenance or personal care services required by a chronically ill individual and provided pursuant to a plan of care prescribed by a licensed health care practitioner.

A "chronically ill individual" means any individual who has been certified by a licensed health care practitioner as meeting one of three tests: (1) being unable to perform at least two of six specified activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for a period of at least 90 days due to a loss of functional capacity ("the ADL level of disability"); (2) having a level of disability similar to the ADL level of disability as determined under regulations prescribed by the Secretary in consultation with the Secretary of Health and Human Services ("the similar level of disability"); or (iii) requiring substantial supervision to protect the individual from threats to health and safety due to severe cognitive impairment ("cognitive impairment").

Finally "licensed health care practitioner" is a physician, registered professional nurse, licensed social worker, or other individual who meets requirements that may be prescribed by IRS

In this particular case, while the doctor specified in his evaluation that the patient required assistance for daily living, he did not specify which activities (amongst the categories of eating, toileting, transferring, bathing, dressing, and continence) the patient could not accomplish on her own. The Tax Court did, however, refer to a doctor's report which stated that the patient suffered from dementia, and therefore would not take her medication regularly without supervision. Therefore, the patient qualified under the 3rd test of chronically ill individual, as she required substantial supervision to protect herself from threats to her health and safety due to severe cognitive impairment. As such, the amounts paid to the caregivers were deductible by the patient as amounts paid for qualified long-term care services under IRC Section 213.

One important final note, under IRC Section 7702B, an individual who otherwise qualifies as chronically ill will not qualify unless during the preceding 12 month period the licensed health care practitioner certifies the individual meets the requirements. In Estate of Lillian Baral, although the court refers to the doctor's notes from 3 years ago regarding the patient's not properly taking her medication, the court does note that in the last 12 months the doctor's evaluation states that the patient required supervision because of her memory deficit and therefore needed supervision for her health and safety. Hence, the 12 month certification requirement was satisfied.