Fed Tax: AMT Relief
California CPA magazine: March/April 2008
By Stuart R. Josephs, CPA
The 2007 Tax Increase Prevention Act (P.L. 110-166) was signed into law Dec. 26, 2007 and provides the following alternative minimum tax exemptions for 2007 only:
• $66,250 for married individuals filing jointly and surviving spouses;
• $44,350 for single individuals, including heads of households; and
• $33,125 for married individuals filing separately.
The Act did not change the AMT exemption phase-out rules.
This new law also allows taxpayers to use most nonrefundable personal credits to offset their AMT liability for 2007 only.
2007 Mortgage Forgiveness Debt Relief Act
New Exclusion for Discharges of Certain Mortgages: This Act (P.L. 110-142), signed into law Dec. 20, 2007, applies to debt discharged after 2006 and before 2010. It generally allows taxpayers to exclude from gross income discharges of up to $2 million ($1 million for married individuals filing separately) of debt that is secured by the taxpayer’s principal residence and was incurred in the acquisition, construction or substantial improvement of that residence. This type of debt is called qualified principal residence indebtedness (QPRI).Refinancing of such debt is eligible for this treatment to the extent that the refinancing amount does not exceed the amount of the refinanced debt.
The residence’s basis is reduced by the excluded income, but not below zero.
If any loan is completely or partially discharged and only part of the loan is QPRI, this exclusion applies only to so much of the amount discharged as exceeds the amount of the loan (determined immediately before the discharge), which is not QPRI.
This exclusion does not apply to the discharge of a loan if the discharge is on account of services performed for the lender or any other factor not directly related to a decline in the residence’s value or to the taxpayer’s financial condition.
The exclusion also does not apply to taxpayers in a Title 11 bankruptcy case.
The existing law’s exclusion for debt discharges of insolvent taxpayers, who are not in a Title 11 bankruptcy case, will not apply to a taxpayer eligible for this new mortgage forgiveness exclusion unless the taxpayer elects to apply the insolvency exclusion instead of the new exclusion.
Treatment of Mortgage Insurance Premiums as Interest: The 2006 Tax Relief and Health Care Act (P.L. 109-432) temporarily allowed taxpayers to treat qualified mortgage insurance as qualified residence interest, which is an itemized deduction. To be deductible, these premiums must be paid or accrued for qualified mortgage insurance obtained in connection with QPRI.
Qualified mortgage insurance is mortgage insurance provided by the Veterans Administration (VA), the Federal Housing Administration (FHA) or the rural Housing Administration (RHA) and private mortgage insurance [as defined by Section 2 of the 1998 Homeowners Protection Act (12 U.S.C. 4901), as in effect on Dec. 20, 2006].
Any amounts paid by the taxpayer for qualified mortgage insurance that is properly allocable to any mortgage, the payment of which extends to periods that are after the close of the tax year in which that amount is paid, are chargeable to a capital account and must be treated as paid in those periods to which they are allocated. However, no deduction is allowed for the unamortized premiums if the mortgage is satisfied before the end of its term. These two rules do not apply to premiums paid for qualified mortgage insurance provided by the VA or the RHA.
The amount of mortgage insurance premiums otherwise treated as qualified residence interest is reduced (but not below zero) by 10 percent of such amount for each $1,000 ($500 for married filing separately), or fraction thereof, that the taxpayer’s adjusted gross income for the tax year exceeds $100,000 ($50,000 for married filing separately).
Under the old law, this treatment did not apply to mortgage insurance contracts issued before 2007 or to premiums paid or accrued after 2007 or properly allocable to periods after 2007.
The new law extends this treatment for three years. Hence, it continues to apply if the mortgage insurance contract is issued after 2006 and the premiums are paid or accrued before 2011 and are not properly allocable to periods after 2011.
IRS Notice 2008-15, released Jan. 8, 2008, contains guidance and transitional relief for individual taxpayers and reporting entities regarding the allocation of prepaid qualified mortgage insurance premiums to determine the amount deductible for 2007.
Residence Exclusion Liberalized for Surviving Spouse: Under the old law, the maximum $500,000 gain exclusion was available only if a husband and wife filed a joint return for the year in which their principal residence was sold. A final joint return can be filed only for the year in which one of the spouses dies. Therefore, if a principal residence was sold after the year in which a spouse died, the surviving spouse’s maximum exclusion was only $250,000.
Under the new law, for sales and exchanges after 2007, surviving single spouses can qualify for the maximum $500,000 exclusion if the sale (or exchange) occurs not later than two years after their spouse’s death and the requirements for the $500,000 exclusion under IRC Sec. 121(b)(2)(A) were met immediately before the spouse’s death.
Increased Penalties: For partnership returns required to be filed after Dec. 20, 2007, the penalty for failure to file is increased from five to 12 months and the per partner penalty is increased from $50 to $85.
For S corp returns required to be filed after Dec. 20, 2007, a new monthly penalty applies for failure to timely file an S corp return or failure to provide the information required to be shown on the return. This penalty, assessed against the S corp, is $85 times the number of S corp shareholders during any part of the tax year for which the return was required, for each month (or fraction thereof) during which the failure persists, up to 12 months.
2007 Technical Corrections Act
This Act (P.L. 110-172), signed into law Dec. 29, 2007, contains more than 25 changes to nine major tax laws enacted since 1998. All these changes are retroactively effective as if included in the original legislation that enacted the provision which the 2007 Act has corrected. Many of those changes are clerical and technical corrections of obvious drafting errors. However, there also are some substantive changes, which are summarized as follows:• Liberalized definition of AMT refundable credit to more effectively use long-term unused credits under the AMT.
• Relaxation of the Sec. 470 sale-in, sale-out rules in certain legitimate real estate and venture capital partnerships.
• Revised regular tax and AMT computations when individual taxpayers exclude foreign earned income and/or foreign housing costs.
• Revised rules regarding basis adjustment to stock of S corp donating property to charity.
• Donee’s use of donated personal property must be substantially related to the purpose or function that was the basis for the donee’s tax-exemption to avoid reduction or recapture of the donor’s income tax charitable deduction.
• Repeal of limits on estate and gift tax charitable deductions for series of fractional donations of tangible personal property.
• Clarifications regarding application of the special elective deferral limit to designated Roth contributions and that elective deferrals designated as Roth contributions are subject to Social Security and Medicare taxes.
• Modification of the active business definition under Sec. 355 (regarding spin-offs, split-offs and split-ups) in connection with the separate affiliated group rule.
• Clarifying the treatment for a loss on a position identified in certain off-setting situations.
• Look-through rule clarified for related controlled foreign corporations.
• Revised rules regarding substantial and gross valuation misstatements attributable to incorrect appraisals.
Estate and Trust Deductions
The Supreme Court unanimously affirmed the Second Circuit Court of Appeals decision and rejected the contrary rationale of the Sixth Court by holding that investment advisory fees paid by a trust are deductible only to the extent that they exceed 2 percent of the trust’s adjusted gross income pursuant to Sec. 67(a).Stuart R. Josephs, CPA has a San Diego-based Tax Assistance Practice (TAP) specializing in assisting practitioners in resolving their clients’ tax questions and problems. Josephs, chair of the Federal Subcommittee of CalCPA’s Committee on Taxation, can be reached at (619) 469-6999 or stuartrjosephs@yahoo.com.
