Barbara Weltman, Esq.
The idea of trying to challenge the Internal Revenue Service
is more likely to create visions of defeat and punishment than
triumph and reward. But some taxpayers do take on the IRS and win
-- through a ruling by either the IRS or the Tax Court -- providing
hope and possible tax savings for all of us.
Notable recent taxpayer victories and the lessons they provide...
TAX DEDUCTION FOR AN ADVANCED DEGREE
Lori Singleton-Clarke, a nurse in Bryantown, Maryland, who managed
110 nurses and technicians in a long-term-care facility, deducted
nearly $15,000 in one year for online courses to obtain a Master of
Business Administration (MBA). She pursued the degree to become
more effective in her duties and because she felt that she was at a
professional disadvantage working with more highly educated
doctors. She took the courses online for convenience, eventually
obtaining her MBA from the University of Phoenix. The IRS rejected
the deduction, and Singleton-Clarke challenged that rejection in
Tax Court, arguing her case at a one-hour trial without the help of
a lawyer.
IRS position: The cost of an MBA
isn’t deductible for a nurse, because an MBA is focused on a
different type of trade or business (not nursing). Only the cost of
education that maintains or improves a current job or profession is
deductible. In fact, after receiving her degree, Singleton-Clarke
obtained a new supervisory position at the facility where she had
been working.
Tax Court ruling: Earning an MBA
doesn’t automatically mean that you are in a new business. It is a
general course of study that does not necessarily lead to a new
profession. (
Case: Lori Singleton-Clarke, TC Summary
Opinion 2009-182.)
Lesson: When claiming a deduction
for higher education, specify whether it is a general degree, such
as an MBA, or a degree directly related to the profession that you
already are in, such as a master’s degree or doctorate in education
earned by a teacher. This is different from a degree in law,
medicine or other profession that leads to special licensing or
certification, which counts as a new trade or business and is not
deductible.
Note: If a deduction cannot be
claimed, it still may be possible to claim a lifetime learning
credit. This tax credit is for 20% of tuition and fees up to $2,000
per tax year and applies to all higher learning.
QUALIFIED WITHDRAWALS FROM AN IRA
Richard Glen Venet, a 48-year-old Michigan resident, was laid off
from his job after 22 years and couldn’t find a new job for four
years. Because he had mounting credit card debts and he was falling
behind on his mortgage, he withdrew $110,691 from his IRA to avoid
foreclosure on his home. He set aside $22,138 of that amount to
cover taxes on the withdrawal but did not pay any early
distribution penalty -- even though he was under age 59½ -- because
the deduction was the result of a financial hardship. He used about
$80,000 to pay off mortgage and credit card debt and put the rest
in his bank account, which he drew on to help pay for his
daughter’s college education.
IRS position: Venet is liable for
the early withdrawal penalty on the entire amount because he failed
to show that any exception to the 10% penalty for a distribution
before age 59½ applied.
Tax Court ruling: Part of the money
that was withdrawn from the IRA is not subject to an early
withdrawal penalty, because there is an exemption for withdrawals
used to pay higher education costs for a taxpayer or taxpayer’s
spouse or dependent. Unfortunately, there is no exemption from the
penalty for "hardship" withdrawals from an IRA, regardless of
financial need. In this case, $9,300 used to pay for the daughter’s
room and board at college was exempt from the penalty -- but not
the rest of the withdrawal. (
Case: Richard Venet, TC
Memo 2009-268.)
Lesson: Even though a taxpayer can
lose on one issue, he/she can win on another for a partial victory.
In addition to education, there is an exemption for paying health
insurance premiums when a person is unemployed or paying
unreimbursed medical expenses exceeding 7.5% of adjusted gross
income.
CASH FROM GIVING UP LIFE INSURANCE
If you have a life insurance policy that you no longer need or want
-- for example, you bought it to protect your family but your
children are grown and self-sufficient -- you may be able to pocket
some money by selling the policy to a third party or surrendering
the policy to the insurer. Many taxpayers believe that they
shouldn’t be taxed when surrendering a life insurance policy. And
they have been proved right -- in some cases.
IRS ruling: Some or all of the funds
received when a life insurance policy is sold or surrendered may be
tax-free. Whether part of the money you receive is treated as
highly taxed ordinary income, a capital gain, or neither depends on
the premiums that you have paid, the type of policy you own and
whether you sell or surrender the policy.
If you...
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Surrender a whole-life
policy, money received from the insurance company up to
the amount of the premiums you have paid over the years is not
taxed. Money that you receive in excess of the total premiums you
have paid is taxed as ordinary income. (Cash surrender value is
determined by the policy contract.)
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Sell a whole-life
policy, your taxable gain is the amount that you have
received on the sale in excess of the total premiums you have paid
over the years, which may be greater than your gain in a surrender.
Part of any such gain on the sale is ordinary income, but part is a
capital gain -- capital gains are taxed at no more than 15% (0% for
those in the 10% and 15% tax brackets). The portion of the gain
that would have been ordinary income if the policy had been
surrendered instead of sold continues to be ordinary income -- any
gain in excess of that is a capital gain.
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Sell a term
policy, all of the gain is a capital gain because there
is no cash surrender value in the case of a term policy, which pays
a stated death benefit but does not provide anything to the
policyholder or to the beneficiary of the policy beyond this
benefit. (Ruling: IRS Revenue Ruling 2009-13.)
Lesson: You may be able to turn a
nonproductive asset -- a life insurance policy -- into some cash
with favorable tax treatment. But before you sell or surrender a
policy, it is wise to talk with an estate-planning adviser to
determine the tax consequences. You also can learn more about the
possible consequences online at the Web sites of the Insurance
Information Institute (
www.iii.org)
and the National Association of Insurance Commissioners
(
www.naic.org).
HOME BUYER TAX CREDIT
If you’re buying a home, you may not be able to go it alone -- you
may need co-owners or someone who can guarantee the mortgage. But
these parties may not be eligible for a first-time home buyer tax
credit or a repeat home buyer tax credit. How does this impact the
ability of home buyers to claim a tax credit of up to
$8,000?
Example: A father who owned a home
wanted to help his daughter purchase her first home by guaranteeing
her mortgage. Would she still qualify for the first-time home buyer
tax credit?
IRS rulings: Having a co-owner or
guarantor won’t prevent an eligible buyer from claiming the tax
credit. (To determine who is an eligible buyer, go to
www.FederalHousingTaxCredit.com/glance.php.)
How the rulings apply...
Guarantors. If a lender requires that a buyer
have someone guarantee to pay the loan if the main borrower
defaults, the buyer can claim the credit even if the person
guaranteeing the mortgage would not qualify for the credit.
(
Ruling: IRS Chief Counsel Letter, INFO
2009-0101.)
Co-owners. If two people who aren’t married
buy a home together, the fact that one is not eligible doesn’t
deprive the other buyer of the credit. The eligible buyer can claim
the full credit for the home. If both buyers qualify, then the
credit must be shared between them. (
Ruling: IRS
Notice 2009-12.)
Lesson: To help you swing the purchase, you can use
the help of a co-owner or mortgage guarantor -- even if that person
wouldn’t qualify for the credit.
Note: If you are looking to qualify
for the tax credit, you need to have closed on the sale by April
30, 2010 (or June 30, 2010, if you were in contract by the end of
April).