Pennsylvania Trusts and Estates Blog

Congratulations to Doug Smith on the opening of the Central Pennsylvania Federal Tax Clinic (CPFTC). The clinic is located at 601 South Queen Street, Lancaster, PA 17608-0599. Get more information at www.pataxhelp.org or call Doug Smith at (717) 299-7388 X3911.

Enelly Betancourt, staff writer for the Lancaster Newspapers reports:

Low-income taxpayers can receive free legal assistance or advice at a new taxpayer clinic.

The new Community Action Program clinic helps taxpayers who have tax controversies with the Internal Revenue Service.

It also informs individuals who have a limited English proficiency about their rights and responsibilities under federal tax law.

The clinic, at CAP's 601 S. Queen St. headquarters, is open Monday through Friday from 9 a.m. to 5 p.m.

Appointments are required.

"We currently provide income-tax preparation services, but there is a tremendous need in the area of tax controversy assistance," Mark Esterbrook, CAP's chief executive officer, said.

The clinic's primary goal is to prevent additional hardship among the working poor by ensuring that low-income taxpayers always have a source of free legal assistance.

"We understand that this is the first clinic of its kind between Philadelphia and Pittsburgh," Brian Sweigart, CAP communications officer, said.

Named manager of the new CAP clinic is Douglas Smith. He is one of two lawyers nationwide named public service fellows by the American Bar Association's Section of Taxation. His two-year ABA fellowship covers his salary and benefits.

Smith previously was in private practice as a tax and estate planning attorney.

Also helping to fund the clinic will be an IRS Low Income Taxpayer Clinic grant, in an amount that's yet to be determined, Sweigart said.

For information or to request an appointment, call 299-7388, ext. 3911.

Many loans among family members are interest free. Be careful. If you loan money to a relative or friend, there may be income and/or gift tax consequences if there is no interest or if the interest is below the market rate.

For loans of $10,000 or less, you don't have to worry about any of this. Such a loan may carry little or no interest, and there are no income tax consequences or reporting requirements.

For loans of $10,001 to $100,000 (all loans between the borrower and lender are added together for this threshold), the forgone interest to be included in income by the lender and deducted by the borrower is limited to the amount of the borrower's net investment income for the year. If the borrower's net investment income is less than $1,000, it is deemed to be zero.

What does the borrower's net investment income have to do with it? One of the purposes of these rules is to prevent taxpayers from shifting income to kids or other family members who are in lower tax brackets. For example, Dad loans his 19 year old Son $100,000. Son invests it, receives interest, dividends, and capital gain income which Son reports on his own 1040 and pays no income tax. Then Son repays the $100,000 to Dad. The effect of this has been (1) Dad has made a gift to Son of the income and (2) the income has been taxed at lower brackets, in fact, at zero.

If, on the other hand, Dad lends Son $100,000 to buy a house, or to pay for college, and Son uses the loan proceeds for the intended purpose, then there has been no income-shifting. No income is being generated by the loaned funds. Interest will be imputed to this type of gift loan only to the extent that the son has investment income.

The IRS publishes applicable federal rates (AFRs) monthly. There are interest rates for short, mid, and long-term loans. Short-term rates are for demand loans and term loans of 3 years or less; mid-term is for 3-9 years; and long-term is over 9 years. For example, the short-term AFRs for January 2010 are short-term 0.57%, mid-term 2.45%, and long-term 4.11%.

For demand loans, the difference between the interest calculated using the stated rate and the applicable federal rate is generally treated as income to the lender and a gift from the lender to the borrower on December 31 of each year that the loan is outstanding. A demand loan is payable in full at any time on the lender's demand.

For term loans, a lender who makes a below market rate (BMR) loan is treated as having made a gift of the difference between the amount of the loan and the present value of all the scheduled payments, using the applicable federal rate on the date the loan is made. When making a term loan it is usually best to state an interest rate. The Lender may forgive interest payments as they come due. The forgiveness of the interest is a gift and the lender must, nevertheless, include the amount of the interest in income.

The Lender can forgive $13,000 of interest and principal payments using the annual gift tax exclusion. If the loan is from a married couple to a married couple, maybe Mom and Dad to Son and Daughter-in-law, up to $52,000 (4 x $13,000) in interest and principal payments could be forgiven each year with no gift tax consequences. Mom and Dad have interest income to report on their 1040. Son and Daughter-in-law are treated as having paid interest. If the loan was used by Son and Daughter-in-law to buy a home, and if the loan is secured by a mortgage on the home, the interest will be deductible for them as interest on their primary residence mortgage.

For any of these arrangements, make sure the terms are in writing. This accomplishes two things: (1) the terms of the arrangements are clear to the lender, the borrower, and other family members and (2) the loan documentation can stop the IRS from claiming that the transfer of cash was a gift. This is very important. Without written documentation that the transfer is a loan, the IRS can argue that there was no loan at all; it was just a gift. Plus, if the borrower can't make good on the loan, you would need to have this documentation in order to deduct it as a non-business bad debt.

Undocumented loans can become particularly contentious when the lender dies. Documentation establishes whether the loan is to be repaid to the estate or was a lifetime gift. Many times, a family lender, especially to children or grandchildren, does not expect a loan to be repaid after the lender's death. If this is so, it is necessary for the lender to state in his or her will that the balance of principal and accrued interest on the loan is forgiven. Otherwise, the loan will have to be repaid, or will be a set-off against the borrower's distributive share of the estate. Simple documentation can avoid this set-up for a sibling fight and the expense and time that usually ensues.

Starting January 1, 2010 there are many tax changes to deal with. Many tax breaks are phased out. The changes below are the current state of the law. It is always possibly for Congress to act to extend or replace disappearing provisions. The House passed a bill that extended many of these provisions, but the Senate was unable to schedule a vote on it. The Senate has been tied in knots over the health care bill.

Roth IRA Conversions

Starting in 2010 the income cap for converting a traditonal IRA to a Roth IRA is eliminated. Now anyone can do a Roth conversion. If the conversion is done in 2010, taxpayers can spread the income tax attributable to it over two years: 2011 and 2012. Note that while the income cap is removed for purposes of qualifying for the conversion of a traditional IRA to a Roth IRA, there remains an income cap on regular contributions to a Roth IRA. The income phase-out begins at $167,000 for joint filers.

New Vehicle Sales Tax

Individuals will no longer be able to take an itemized deduction or increase the standard deduction for the sales tax on the purchase of a new motor vehicle. Vehicles had to be purchased after February 16, 2009 and before January 1, 2010 to qualify for the deduction.

No More Sales Tax Deduction

The choice to deduct state sales tax payments instead of deducting state and local income taxes is gone. This provision was very important for taxpayers in states like Florida where there is no income tax.

No Phase-outs for Personal Exemptions and Itemized Deductions

In 2010 there will be no phase out of deductions and exemptions for higher income taxpayers. This will greatly benefit high earners.

Teachers' Deduction

The $250 deduction for teachers who buy classroom supplies with their own money is eliminated.

Tuition and Fees

The $4,000 deduction for college tuition and fees expires after 2009. This deduction was permitted "above the line", meaning it could be taken even if the taxpayers didn't itemize.

Contribution to Charity from IRAs

IRA owners older than 70½ who make contributions from their IRAs directly to charity will no longer be able to exclude these withdrawals from income.

No More Property Tax Deduction

Non-itemizers will no longer be able to deduct up to $1000 in property taxes paid. This provision had been a help to home-owners who had no mortgage so that there was no interest deduction to help make itemization worthwhile.

Alternative Minimum Tax Exemptions Reduced

The Alterative Minimum Tax exemption levels fall back to $45,000 for married filing jointly and $33,750 for singles an heads of household. (In 2009 the exemption was $70,950 for married filing jointly and 46,700 for singles and heads of household.) Some commentators say that as many as 1 in 5 taxpayers will be subject to the AMT in 2010.

No Exclusion for Unemployment

The first $2400 of unemployment benefits will no longer be tax-free.

Energy Credit Reduced

The 30% tax credit for the cost of energy-saving home improvements is reduced to 19% and is capped at $500.

Section 179 Expensing

The maximum amount of equipment that can be expensed (instead of depreciated) is reduced to $135,000 to $250,000. Businesses can no longer claim 50% bonus depreciation on assets placed in service in 2010.

Income Tax on Dividends

For taxpayers in brackets higher than 15%, qualified dividends are taxed at a maximum rate of 15% through December 31, 2010. For taxpayers in the 10% and 15% brackets, qualified dividends are taxed at 0% through December 31, 2010. The provisions sunsets on December 31, 2010, and dividend taxation reverts to former 2002 rates.

Mileage Reimbursement

The mileage rates effective January 1, 2010 are 50 cents for business, 16½ cents for medical and 14 cents for charitable purposes.

Home Buyers Credit

If you used the Home Buyers Credit in 2008, you must start paying it back in 2010. The qualification period for first-time home buyers to purchase a home and qualify for the credit continues through May 1, 2010.

Contributions to Retirement Accounts

Remember you have until April 15, 2010 to contribute to a traditional or a Roth IRA. If you have Keogh or SEP and you get a filing extension for your 2009 return until October 5, 2010, you have until that date to make contributions.

No Estate Tax

The federal estate tax is repealed for individuals who die in 2010.

Wild Cards

If the Senate and House eventually hammer out a health care bill that becomes law, there are various provisions in the current legislation on how to pay for it. The House bill includes a 5.4% surtax on high earners and would curtail flexible spending accounts. The Senate bill includes a 40% surtax on high-end employer-sponsored health plans - that provide health coverage valued at more than $8,500 for individuals and $23,000 for families (they call them "Cadillac plans") and increases the Medicare payroll tax. Hold onto your wallet.