Every year, Congress and the Internal Revenue Service help us justify a tax preparer's worth to clients by throwing a few new curves into the tax return preparation process. The 2005 tax return filing season is no exception.This year Congress even threw a few curves at the IRS and commercial tax software creators by passing year-end tax legislation with an impact on 2005 returns after the IRS had already done much of the work on its tax forms for the filing season. Here are some items to watch out for as you work through the 2005 return filing season.
At first blush, this looks like great news for tax return preparers. The new six-month automatic extension eliminates the separate two-month extension from August 15 to October 15 and the need to create all of those creative extension letters during the height of summer, coming up with reasons that the IRS will accept and grant an extension.
On the other hand, it will tend to focus the work of return preparers around just two dates rather than three, creating even more stress on time available during those two periods. Interest on payment shortfalls, of course, continues to accrue from the original due date of the return until payment is made.
Uniform definition of child
The new uniform definition of a child for purposes of the dependency exemption, the child tax credit, the dependent care credit, the earned income tax credit and head-of-household filing status was supposed to simplify our lives by creating a common definition of a qualifying child across all five of these provisions, and giving to all of the provisions the broadest definition available.
Still, the many changes have brought some confusion and potential adverse results. Some head-of-household filers who had relied on the support test for head-of-household filing status may now find that they no longer qualify under the relationship test.
Also, Congress has now back-tracked from statutory language that appeared to permit the assignment of an exemption to the non-custodial parent in a divorce decree. A technical correction included in the Gulf Opportunity Zone Tax Act of 2005 clarifies that the exemption can only be transferred to the non-custodial parent through a signed Form 8332 or similar statement.
The domestic manufacturing deduction will create plenty of headaches this year for business taxpayers and their preparers trying to figure out what activities qualify and how to make the necessary allocations.
It can also create issues for many individual filers. For pass-through entities, the deduction is determined at the shareholder or partner level. It is not by accident that the new deduction appears as Line 35 of the 2005 Form 1040, rather than on Schedule C. Many individual taxpayers who thought of themselves as fairly passive investors in a pass-through entity will now have to wrestle with calculating their share of the deduction.
State tax refunds
We have long had to keep track of whether or not the taxpayer itemized deductions or took the standard deduction to determine whether or not to include the state tax refund as an item of income on the tax return. The introduction of the choice of the sales tax deduction in 2004 has created some new issues to address with respect to handling the tax refund in 2005.
It will no longer be enough to determine whether the taxpayer itemized or not, and whether the refund is less than the difference between the itemized deductions and the standard deduction. The tax preparer will now have to determine whether, if the taxpayer itemized, the deduction was claimed for income taxes or for sales taxes in 2004. And if the deduction was claimed for income taxes, the inquiry should go on to include whether the refund exceeds the difference between the state income tax claimed and the sales tax deduction that could have been taken.
This is good news for taxpayers, but it might require the preparer to go back to 2004 and calculate what the sales tax deduction might have been. If it was fairly clear in 2004 that the taxpayer would be better off with the income tax deduction, there may be no calculations of a sales tax deduction in the taxpayer's 2004 file.
The new rules for charitable contributions of cars, boats and airplanes took effect in 2005. Rather than making their own determination of fair market value, taxpayers will now generally be required to deduct the price obtained by the charity on the sale of the vehicle and reported to the taxpayer. In a recent clarification, the charity is also required to include on that form any benefits received by the taxpayer from the charity in exchange for the donation, which must in turn be subtracted from the claimed deduction.
If a taxpayer has made significant charitable contributions for the 2005 year that exceed the normal 50 percent of adjusted gross income limit on charitable contribution deductions, the tax return preparer will have to look at the extent to which those contributions were made on or after Aug. 28, 2005, to see if they qualify for the waiver of the 50 percent limit included in the Katrina Emergency Tax Relief Act. The contributions by an individual need not be hurricane-related to qualify for the waiver.
If taxpayers made charitable contributions for tsunami relief in January 2005, the tax preparer will also have to determine whether or not the taxpayer claimed a deduction for those contributions in 2004 or whether those contributions are eligible for a 2005 deduction.
Hurricane relief, rebuilding
The Katrina Emergency Tax Relief Act of 2005 and the Gulf Opportunity Zone Act of 2005 introduced several new tax breaks into the code focused on hurricane relief and rebuilding. Many of these are focused on residents and businesses in the disaster areas.
A few, however, can apply outside of the disaster area. These include the new exemption for providing housing to displaced persons, a work opportunity tax credit for hiring workers who arrived from the Katrina disaster area, and a more generous mileage rate for Katrina-related charity work.
Business mileage rate
The IRS, in an effort to be taxpayer-friendly, took cognizance of the spike in gas prices during 2005 and took the unusual step of adjusting the standard business mileage rate mid-year. For miles driven on or after Sept. 1, 2005, the rate increased to 48.5 cents per mile from 40.5 cents per mile. This generosity on the part of the IRS will require preparers to get a separate total for business miles for each of the periods.
Schedule D instructions
The IRS revised instructions to Schedule D for 2005 in a way that appeared to require each transaction to be separately listed on Schedule D or D-1, rather than only being separately stated in an attached broker statement. The IRS has tried to assure taxpayers that they did not intend such a drastic change, but it is clear that the IRS wants any attached statement, including a broker statement, to include information substantially similar to that required on Schedule D and D-1.
Free filing program
Some vendors participating in the IRS's free e-filing program did not put any income limits on taxpayers utilizing their free filing option for 2004. In an effort to better direct the program toward the people that it was designed to help, the IRS has put a maximum $50,000 adjusted gross income limit on participation in the program this year, although many of the vendors have lower income limits for their free filing offerings.
The IRS is also requiring better disclosure of any fees and costs associated with refund anticipation loans offered to free filers and any costs for filing the related state tax return.
The IRS issued Information Release 2006-014 on Jan. 17, 2006, stating that it had been forced by legislative changes to revise several tax forms that had already been issued for the 2005 filing season and that they would not be available for e-filing until the end of January. The IRS also cautioned taxpayers and preparers that returns utilizing these forms could not be e-filed in the interim.
While revised paper forms were available quickly through IRS Web site downloads, the availability of these forms for e-file use was delayed. They should, however, be available now. Among the dozen forms affected are: Form 8606, Nondeductible IRAs; Form 8863, Education Credits (Hope and Lifetime Learning Credits); and Form 3800, General Business Credit. Paper filers should also make sure that they are using the latest version of the forms.
Tax return preparers will want to make sure that they are on top of these changes and that any software used for the 2005 filing season has been updated to accommodate last-minute changes. Advising clients of these developments and their ramifications will also remind taxpayers of the value that tax return preparation assistance can offer.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH, a Wolters Kluwer business.
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