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Center for Agricultural Law & Taxation
Form 3115 Part 2
June 15, 2017
Center for Agricultural Law & Taxation
Objectives
• This webinar will cover the following:
• Preparation of the § 481(a) adjustment
• Missed depreciation deduction
• Deducted to much depreciation using the wrong convention
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Center for Agricultural Law & Taxation
Private Letter Ruling 201723010, 06/09/2017
• Form 3115 submitted with its request for extension of time will be considered as timely filed for stated year where taxpayer acted reasonably and in good faith and granting extension wouldn't prejudice govt.'s interests
• To obtain an extension of time to make a regulatory election that does not meet the requirements of § 301.9100-2 (automatic extensions) a taxpayer must satisfy the requirements set forth in § 301.9100-3
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Center for Agricultural Law & Taxation
Common Depreciation Errors
• Posting Errors
• Mathematical errors
• Use of the wrong recovery period or depreciation method
• Deducting as an ordinary expenses an expenditure that should have been capitalized or depreciated
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Center for Agricultural Law & Taxation
Quick Review
• Depreciation rules are fairly simple
• The year an asset is placed in service, a determination must be made concerning the depreciable life, method and convention
• All future depreciation should be consistent Based on that election
• Once it is determined that an impermissible method was elected and has been used for 2 or more consecutive years, a change of accounting method can be made with the Form 3115 to convert to a permissible method 5
Center for Agricultural Law & Taxation
Depreciation Change in the Method of Accounting• Changes in computing depreciation generally are
accounting-method changes, this includes:
• A change in depreciation method
• Recovery period or
• Convention
• Remember : a change due to posting or mathematical errors or changes in underlying facts are not accounting-method changes nor is the use of that method for just one year or an adjustment to the useful life
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Center for Agricultural Law & Taxation
Changes that Require Form 3115
• A change from a impermissibale accounting method to a permissible – 2 year rule
• Change in the treatment of a asset from non-depreciable to depreciable and the reverse
• A change from not claiming bonus depreciation to claiming bonus
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Center for Agricultural Law & Taxation
Clarify Some Issues
• No § 481(a) adjustment is required or permitted when an amended return is filed
• Automatic approval under Rev. Proc. 2011‐14 allows a taxpayer to recoup missed or understated allowable depreciation from open or closed years
• No user fees apply
• Form 3115 must be attached to a timely filed original return for the year of change
• An additional copy must be filed as described in the instructions
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Center for Agricultural Law & Taxation
The Amount of the Adjustment
• Represents the aggregate amount of net income or expense that would have been reported in the tax year before the year of change if the taxpayer had used the correct method
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Computing the § 481 Adjustment
• Compare the amounts reported in prior years
• The amounts that would have been reported if:
• The client has used the correct method, convention or life
• Decreased in income is taken in the year discovered
• Increase in income is spread over 4 years – ¼ of the adjustment is taken each year
• Exception: If the increase in taxable income is less than $50,000 the client can elect to include the entire adjustment in the year of change – the year the error discovered
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Center for Agricultural Law & Taxation
Election
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Center for Agricultural Law & Taxation
The 4 Year Spread Exceptions
• The §481(a) adjustment is taken into account in one tax year for a negative §481(a) adjustment and four tax years for a positive §481(a) adjustment
• However, Rev. Proc. 2015-13, there are a number of modifications to the §481(a) spread periods
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Election
• An applicant may elect a one-year § 481(a) adjustment period for a positive § 481(a) adjustment that is less than $50,000 (§ 7.03(3)(c) of Rev. Proc. 2015-13)
• An applicant may also elect a one-year § 481(a) adjustment period for all positive § 481(a) adjustments for the year of change if an eligible acquisition transaction occurs during the year of change or
• In the subsequent tax year on or before the due date for filing the applicant's federal tax return for the year of change
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Center for Agricultural Law & Taxation
The 4 Year Spread Exceptions
• The §481(a) spread period is shortened to two tax years (year of change and next tax year) for a positive §481(a) adjustment related to a change in method of accounting requested while a taxpayer is under IRS examination
• The §481(a) spread period will continue to be four tax years if the change is filed in a;
• Window period
• The current method is not before the director, or
• The change is filed on behalf of a new member of a consolidated group 14
Center for Agricultural Law & Taxation
The 4 Year Spread Exceptions
• The taxpayer may elect a one-year §481(a) spread period for a positive §481(a) adjustment in two limited circumstances
• First, a taxpayer may continue to elect a one-year §481(a) spread period for a positive §481(a) adjustment that is de minimis
• Rev. Proc. 2005-13 increases the de minimis amount for purposes of this election from $25,000 to $50,000
• Rev. Proc. 2015-13 creates a new election whereby a taxpayer may use a one-year §481(a) spread period if it engages in an `eligible acquisition transaction.'
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Center for Agricultural Law & Taxation
Eligible Acquisition Transaction
• An eligible acquisition transaction for a controlled foreign corporation (CFC) or a corporation that is not an S corporation is defined as either
• (1) an acquisition of stock ownership in the taxpayer by another party that either results in the acquisition of control of the taxpayer or causes the taxpayer's tax year to end, or
• (2) an acquisition of assets in a transaction to which §381(a) applies
• In the case of all other taxpayers, an eligible acquisition transaction is an acquisition of an ownership interest in the taxpayer by another party that does not cause the taxpayer to cease to exist for federal income tax purposes (e.g., the sale or exchange of a partnership interest that does not cause a technical termination of the partnership under §708(b)(1)(B))
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Center for Agricultural Law & Taxation
Eligible Acquisition Transaction
• The eligible acquisition transaction election can be made if an eligible acquisition transaction occurs during the year of change or in the subsequent tax year on or before the due date (including extensions) for filing the taxpayer's federal income tax return for the year of change
• Once this election is made, it is irrevocable and will apply to all changes in method of accounting the taxpayer makes pursuant to Rev. Proc. 2015-13 for the year of change
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Out of Business
• A client who ceases to engage in business , the adjustment must be taken in the last tax year of business
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Where To Report the Adjustment
• Line 26 of Form 3115 is the adjustment
• Report on the same form where the original error occurred
• Generally Schedule C, E,F or Form 2106 for the purpose of a small business
• This applies to other entities as well but our focus of the seminar was for small taxpayers
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Center for Agricultural Law & Taxation
Repair Regulations – Rev. Proc. 2015-20
• Small business taxpayers were allowed to make certain accounting method changes under the tangible property (or “repair”) regulations without filing Form 3115
• The revenue procedure allowed small businesses to make certain accounting method changes on a cut-off basis, that is, with a § 481(a) adjustment that only takes into account amounts paid or incurred, and dispositions, in tax years after Jan. 1, 2014
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Center for Agricultural Law & Taxation
Repair Regulations – Rev. Proc. 2015-20• For the first tax year that begins on or after Jan. 1,
2014, small business taxpayers that choose to prospectively apply the tangible property regulations to amounts paid or incurred, and dispositions, in tax years beginning on or after Jan. 1, 2014, to make certain tangible property accounting method changes on their federal tax return without including a separate Form 3115 or separate statement
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Repair Regulations – Rev. Proc. 2015-20• Taxpayers with gross receipts under $10 million
(averaged over the prior three years) or assets under $10 million can elect to adopt the 2014 changes deducting or capitalizing repairs and property additions without filing Form 3115, Application for Change in Accounting Method
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Repair Regulations Checklist of Method Changes Covered by Rev. Proc. 2015-20 Form 3115 optional
Joe Kristan Developed the Next Chart
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What Was Given Up By Not Filing Form 3115?• Audit Protection
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Polling Question
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Failure to Claim Depreciation
Example 1 Jessica’s Sewing World
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Jessica’s Sewing World
• Jessica started a small business in 2014
• Jessica determined she could do her own return and filed returns for 2014, 2015 and comes to you in 2016 as she heard about a business deduction called “depreciation”
• In reviewing her return you realize that Jessica did not depreciate any of the assets purchased for the business and did not take any deduction for the assets on the filed tax returns
• The discovery was in the year 2016 and two years have past using this method of accounting
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Jessica’s Sewing World
• Jessica purchased no assets in 2016
• Jessica uses the cash method of accounting
• Jessica is not under examination
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Center for Agricultural Law & Taxation
Jessica’s Assets Purchased in 2014
• 3 sewing machines each cost $4,500 = $13,500 purchased January 11, 2014
• Office and display equipment cost $10,987 purchased January 30, 2014
• Cash register $6,980 purchased March 3, 2014
• Computer needed to correctly operate sewing machines with software cost $16,980 purchased January 11, 2014
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Center for Agricultural Law & Taxation
Assets and Depreciation
Asset Life Convention Basis DepreciationClaimed
Corrected Depreciation
S. Machine 1 7 HY $4,500 0 $1,745
S. Machine 2 7 HY $4,500 0 $1,745
S. Machine 3 7 HY $4,500 0 $1,745
Cash Register 7 HY $6,980 0 $2,706
Computer 5 HY $16,980 0 $8,830
Display Equip 7 HY $5,000 0 $1,935
Office Furniture 7 HY $5,987 0 $2,322
$48,447 $21,02831
Center for Agricultural Law & Taxation
Pub 946 Table A-1 page 71
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Table of Class Lives and Recovery Periods
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See Attached Statement #1
See Statement #2
See Statement # 3
Center for Agricultural Law & Taxation
Form 3115 – Part III
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Center for Agricultural Law & Taxation
Assets and Depreciation
Asset Life Convention Basis DepreciationClaimed
Corrected Depreciation
S. Machine 1 7 HY $4,500 0 $1,745
S. Machine 2 7 HY $4,500 0 $1,745
S. Machine 3 7 HY $4,500 0 $1,745
Cash Register 7 HY $6,980 0 $2,706
Computer 5 HY $16,980 0 $8,830
Display Equip 7 HY $5,000 0 $1,935
Office Furniture 7 HY $5,987 0 $2,322
$48,447 $21,02840
Center for Agricultural Law & Taxation
§ 481(a) Adjustment
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Center for Agricultural Law & Taxation
Line 27
• Remember this line applies to “Positive” adjustments so in this case the answer would be no
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Form 3115 Schedule E
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Form 3115 Schedule E
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Form 3115 Schedule E
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Adjustment on the Tax Return
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Schedule C Part V
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Schedule C Part II
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What Needs to Be Included in the Statement?• Taxpayer’s name and EIN or SSN as applicable
• An explanation of the items being changed and the reason for the change
• The years the depreciation was incorrect
• Explanation of how the items were depreciated or treated in the past
• Statement needed to support the proposed change
• Business description of business requesting the change
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Center for Agricultural Law & Taxation
What Needs to Be Included in the Statement?• Method of accounting
• If other businesses are owned a description of the businesses accounted for separately
• Authority for the change – Required by § 168
• Was first year special depreciation allowance claimed in any of the years? If not, explain why
• Will the property be in a single, multiple, general …. asset account?
• The applicable code section
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Center for Agricultural Law & Taxation
What Needs to Be Included in the Statement?• The depreciation method
• The applicable convention
• The applicable class life
• Is the taxpayer required to report the entire adjustment in the current year because the property was disposed of?
• Is the taxpayer electing to report the entire adjustment in the current year under the de-minimisrule?
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Bonus Depreciation
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Bonus Depreciation
• Do Not forget about Bonus Depreciation in this problem
• We have kept it simple for demonstration purposes
• Jessica did not attach a statement to the return electing out of bonus
• No statement – therefore it was as if she elected bonus for her assets and therefore the assets we used in our example would have to be reduced by the bonus depreciation allowed or allowable
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Center for Agricultural Law & Taxation
Bonus Depreciation Election RulesChart from Parker Pro Library
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Bonus Depreciation
• The taxpayer can elect, for any class of property, not to deduct any special depreciation allowances for all property in such class placed in service during the tax year
• To make an election, attach a statement to the return indicating what election is made and the class of property for which the election applies
• The election must be made separately by each person owning qualified property
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Center for Agricultural Law & Taxation
Bonus Depreciation
• Generally, the election must be made on a timely filed tax return (including extensions) for the year in which the property was placed in service
• Once the taxpayer elects not to deduct a special depreciation allowance for a class of property, they cannot revoke the election without IRS consent
• A request to revoke the election is a request for a letter ruling
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Center for Agricultural Law & Taxation
Bonus Depreciation
• If you timely filed the return without making an election, the taxpayer can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions)
• Write “Filed pursuant to section 301.9100-2” on the amended return
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But, 2014 Late Legislation Revived Bonus• Reminder –
• Bonus depreciation differs in some important ways from Section 179:
• It is not subject to an annual dollar limit
• It may only be utilized for new, not used, property
• The property need not be used over 50% of the time for business, unless it is “listed property” such as automobiles, computers, and certain other personal property, and
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Center for Agricultural Law & Taxation
Bonus Depreciation
• Often, the same asset will qualify for § 179 expensing and bonus depreciation
• The taxpayer makes a choice of the method to use or can combine the methods
• The order in the combined method become important
• 1. §179
• 2. bonus
• 3. Regular depreciation
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Center for Agricultural Law & Taxation
Bonus Depreciation
• On December 19, 2014, President Obama signed into law the Tax Increase Prevention Act of 2014 (TIPA), which extended 50% bonus depreciation for property placed in service in 2014
• Rev. Proc. 2015-48 provides guidance for claiming or not claiming 50 percent bonus depreciation for such property – issued in August of 2015
• Bonus was set to expire at the end of 2014
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The Use of the Wrong Convention/Life
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James the Rental Genius
• James owns property purchased in 2012 on various dates
• 1/ 2/2012 Single Family Dwelling $ 62,000 excludes land
• 4/15/2012 Single Family Dwelling $48,000 excludes land
• 08/24/2012 Duplex $102,000 excludes land
• James’s prepared the 2012 – 2015 returns using the Non - Residential Real property, Mid-Month Convention Straight Line 39 years as at the time the tax return was filed the property was available for rent but not yet rented
• James never changed the method in future years
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Center for Agricultural Law & Taxation
James the Rental Genius
• James comes into your practice asking for tax preparation assistance
• Brings all work papers and prior year returns
• James uses a cash method of accounting
• No audit is currently being conducted on James tax return
• James purchased no new assets in 2016
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Table A-7a – Method Used
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Table A-6 Method that Should Have Benn Used
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Depreciation Schedule as 39 Year Property – James Depreciation ScheduleDate Asset 2012 2013 2014 2015 Total
01/02/2012 SFD 1525.822.461
1589.682.564
1589.682.564
1589.682.564
6294.86
05/15/2012 SFD 770.401.605
1230.722.564
1230.722.564
1230.722.564
4462.56
08/24/2012 Duplex 982.26.963
2615.282.564
2615.282.564
2615.282.564
8828.10
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Depreciation Schedule as 27.5 Year Property –You Preparer a Correct Schedule
Date Asset 2012 2013 2014 2015
01/02/2012$62,000
SFD 2160.073.485
2254.323.636
2254.323.636
2254.323.636
05/15/2012$48,000
SFD 1091.042.273
1745.283.636
1745.283.636
1745.283.636
08/24/2012$102,000
Duplex 1391.281.364
3708.723.636
3708.723.636
3708.723.636
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Spreadsheet for Corrected DepreciationDate Placed in Service
Asset Life Basis Depreciation Claimed Under 39 years
Corrected Depreciation27.5 years
Difference
01/02/2012 SFD 39 $62,000 6294.86 8923.03 -2628.17
05/15/2012 SFD 39 $48,000 4462.56 6326.88 -1864.32
08/24/2012 Duplex 39 $102,000 8828.10 12517.44 -3689.34
Total 19585.52 27767.35 -8181.83
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481(a) Adjustment
• Negative $8,181.83
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James 2016 Schedule E
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Income Section of Schedule E
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Statements
• DCN 7
• The taxpayer is changing the convention of three items previously classified as non-residential rental property to residential rental property (Line 14 a)
• The taxpayers overall method of accounting is cash (Line 14 d)
• The taxpayer has claimed less than the amount of depreciation allowed with regard to the three assets (Line 14a)
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Question 14 b and c
Year Placed in Service
Description Corrected Asset Class
14bCurrent Method
14cCorrected Method
1/2012 Rental House
§ 1250 MACRS 39 SL
MACRS 27.5 SL
5/2012 Rental House
§ 1250 MACRS 39 SL
MACRS 27.5 SL
8/2012 Rental House
§ 1250 MACRS 39 SL
MACRS 27.5 SL
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Form 3115 15a
• The taxpayers owns and operates three rental property, 2 single family dwellings and 1 duplex
• This is the only trade or business the taxpayers operate and the taxpayer is allowed to group all rental property within the same entity as one unit
• The business Activity Code is 531100
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Form 3115 Line 16a
• Attach a full explanation of the legal basis supporting the proposed method for the item being changed
• Include a detailed and complete description of the facts that explains how the law specifically applies to the applicant’s situation and that demonstrates that the applicant is authorized to use the proposed method
• Include all authority (statutes, regulations, published rulings, court cases, etc.) supporting the proposed method - Depreciation or amortization (Code §§167, 168, or 197)
• Include either a discussion of the contrary authorities or a statement that no contrary authority exists
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Form 3115 Lines 17-19
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Form 3115 Part III
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Form 3115 Schedule E
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Other Sections that Are Common with Automatic Procedures
• The use of the cash and disbursements method of accounting by certain small taxpayers;
• Trade or business expenses (§162)
• Depreciation or amortization (§167, 168, or 197)
• Capital expenditures (§ 263)
• Uniform capitalization including UNICAP changes by producers of real or tangible personal property - Rev. Proc. 2002-19
• Methods of accounting (§ 446)
• Obligations issued at discount (§ 454)
• Prepaid subscription income (§ 455)
• Taxable year of deduction (§ 461)
• Inventories (§ 471)
• Last-in, first-out (LIFO) inventories (§ 472)
Center for Agricultural Law & Taxation
Technical Explanations
• Structure the explanation similar to a protest to engage every question successfully – break it down into manageable parts
• Issue
• Facts
• Law and Analysis
• Fact Patterns
• KISS – Keep it simple centered on the issue
• IRS Publication 538, Accounting Periods and Methods – review as needed
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Use What You Already Have – Don’t Reinvent the Wheel
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http://www.lisaihm.com/Worksheets.html
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The Scoop – Upcoming Dates
• June 21
• July 5
• July 19
• August16
• August 30
• September 13
• October 4
• October 18
• November 1
• Held at 8:00 am and 12:00 pm Central time84
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Up Coming Webinarshttp://www.calt.iastate.edu/calendar-node-field-seminar-date/month
• My Client Dies, What’s Next?, June 20
• The Fundamentals of Trusts - June 22
• Payment of Wages with Commodities and Gifting Grain - June 27
• Handling Tax Returns for Religious Groups – Amish and Mennonite
• June 29
• Net Operating Loss Basics July 6 and 7th
• Form 1099 Preparation July 13
• Farm Assets and Stepped Up Basis at the Death of the Farmer July 24
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Farm Assets and Stepped Up Basis at the Death of the Farmer – Just Placed on the CALT Website
• Review of assets that qualify for stepped-up basis
• An overview of valuation methods and depreciation issues related to the assets
• Is there a difference between a farmer who materially participates and who is a non-material participating farmer
• How is ownership basis affected?
• Reporting for the decedent, estate and beneficiary guidance
• The discussion will focus on the tax professional and the issues they face with specific situations
• July 24, 2017 - Noon to 2 PM - 2 hours of CPE
• http://www.calt.iastate.edu/seminar/2017-07-24/webinar-farm-assets-and-stepped-basis-death-farmer
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Upcoming Seminars – Mark Your Calendar – Final Dates
• S Corporation – July 20-21, 2017, Live and Webinar
• September 21, 2017 Ag Law Seminar, Live and Webinar
• September 22, 2017 Farm and Estate Tax Review, Live and Webinar
• Retirement and Social Security Issues(Webinar) = October 10-11, 2017
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The Schedule is Finalized for the 44th Annual Federal Income Tax Schools
• November 2-3, 2017 – Maquoketa, Iowa – Centerstone Inn and Suites
• November 6-7, 2017 – Le Mars, Iowa – Le Mars Convention Center
• November 8-9, 2017 – Atlantic, Iowa – Cass County Community Center
• November 9-10, 2017 – Mason City, Iowa – North Iowa Area Community College
• November 16-17, 2017 – Ottumwa, Iowa – Indian Hills Community College
• November 20-21, 2017 – Waterloo, Iowa – Hawkeye Community College
• December 11-12, 2017 – Ames, Iowa and Live Webinar – Quality Inn and Suites
Center for Agricultural Law & Taxation
The CALT Staff
William EdwardsInterim Director for the Beginning Farmer CenterInterim Director for the Center for Agricultural Law and [email protected] Heady518 Farm House LnAmes. Iowa 50011
Kristine A. Tidgren
Assistant Director
E-mail: [email protected]
Phone: (515) 294-6365
Fax: (515) 294-0700
Center for Agricultural Law & Taxation
The CALT Staff
Kristy S. MaitreTax SpecialistE-mail: [email protected]: (515) 296-3810Fax: (515) 294-0700
Tiffany L. Kayser
Program Administrator
E-mail: [email protected]
Phone: (515) 294-5217
Fax: (515) 294-0700