Individuals—Special Tax Situations Quickfinder® Handbook

(2010 Tax Year)

Page Updates for the 2010 Tax Relief ActInstructions: This packet contains “marked up” changes to the pages in the Indi-viduals—Special Tax Situations Quickfinder® Handbook that were affected by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act), which was enacted after the handbook was published. To update your handbook, you can make the same changes in your handbook or print the revised page and paste over the original page.

Note: The pages included in this packet are “marked up” for the items described in the 2010 Tax Relief Act—Handbook Update Guide following this cover sheet.

Copyright 2011 Thomson Reuters Individuals—Special Tax Situations Quickfinder® Handbook—2010 Tax Relief Act Handbook Update Guide

Individuals—Special Tax Situations Quickfinder® Handbook2010 Tax Year

2010 Tax Relief Act—Handbook Update GuideHow to use this guide: This guide lists the topics discussed in the 2010 Handbook that were affected by the 2010 Tax Relief Act, which was enacted after the Handbook’s publication date. The changes listed here have been made for you by the Quickfinder editorial team in the Page Updates for the 2010 Tax Relief Act packet. To update your Handbook, you can make the same changes in your Handbook or print the revised page from the Page Updates for the 2010 Tax Relief Act packet and paste over the original page. For a complete summary of the 2010 Tax Relief Act (including provisions affecting 2011 and later years), go to the Tax Act—2010 Tax Relief Act section of the Updates section of Quickfinder.com.

Page Section or Table Title Change/Comment2-15 Energy Efficient Home Builders Credit The credit is extended for two years to apply to homes acquired in 2010 and 2011.3-2 Deceased Taxpayer—Tax Returns An estate tax exclusion of $5 million and a maximum estate tax rate of 35% apply

to decedents who died in 2010. Alternatively, the executor can elect to be exempt from estate tax, in which case, the basis of property acquired from the decedent is determined under the modified carryover basis rules. For decedents who die any time from 1/1/10–12/16/10, the deadline for filing Form 706 (and paying estate tax) is extended until no earlier than nine months after date of enactment (12/17/10). Also, footnote 3 only applies when the executor elects to be exempt from the estate tax.

4-12 Casualty Loss—Deduction Limit Rules for Personal-Use and Employee Property

The $500 per-casualty reduction amount and the suspension of the 10%-of-AGI reduction were not extended to 2010.

4-13 Determining the Deductible Loss The $500 per-casualty reduction amount and the suspension of the 10%-of-AGI reduction were not extended to 2010.

4-14 Federally Declared Disasters—Quick Summary of Special Tax Relief Provisions

The expired special relief provisions were not extended to federally declared disas-ters occurring in 2010.

4-14 Depreciation and Section 179 Deduction

The expired special relief provisions were not extended to federally declared disas-ters occurring in 2010.

4-15 Disaster Expenses The expired special relief provisions were not extended to federally declared disas-ters occurring in 2010.

4-15 Net Operating Losses The expired special relief provisions were not extended to federally declared disas-ters occurring in 2010.

6-26 Recovery Periods for Farm Property (2010)

The five-year recovery period for new farm machinery and equipment was not extended for assets placed in service in 2010.

6-26, 8-5 Bonus Depreciation For qualifying property placed in service in 2010, the special depreciation allowance rate is as follows:• Property acquired and placed in service 1/1/10–9/8/10: 50%.• Property acquired and placed in service 9/9/10–12/31/10: 100%.

6-33 Qualified Conservation Contribution The higher AGI limit (50%; 100% for qualified farmers and ranchers) is extended to 2010 and 2011.

7-13 Differential Wage Credit for Small Business Employer

The credit is extended for two years, through 2011.

8-5 Percentage Depletion Quick Facts The 100%-of-net-income limit that normally applies is suspended for 2010 and 2011 for marginal production properties.

9-2 Not Rented for Profit, Where to report The increase to the standard deduction for real property taxes paid (up to $500; $1,000 if MFJ) was not extended to 2010.

9-12 Qualified Restaurant Property The 15-year (39-year for ADS) recovery period for qualified restaurant property is extended to 2010 and 2011.

9-12 Qualified Leasehold Improvement Property

The 15-year (39-year for ADS) recovery period for qualified leasehold improvement property is extended to 2010 and 2011.

10-7 Qualified Retail Improvement Property The 15-year (39-year for ADS) recovery period for qualified retail improvement property is extended to 2010 and 2011.

Table continued on the next page

2010 Tax Relief Act—Handbook Update GuideHow to use this guide: This guide lists the topics discussed in the 2010 Handbook that were affected by the 2010 Tax Relief Act, which was enacted after the Handbook’s publication date. The changes listed here have been made for you by the Quickfinder editorial team in the Page Updates for the 2010 Tax Relief Act packet. To update your Handbook, you can make the same changes in your Handbook or print the revised page from the Page Updates for the 2010 Tax Relief Act packet and paste over the original page. For a complete summary of the 2010 Tax Relief Act (including provisions affecting 2011 and later years), go to the Tax Act—2010 Tax Relief Act section of the Updates section of Quickfinder.com.

Page Section or Table Title Change/Comment11-11 AMT and the Education Tax Credits The lifetime learning credit can offset both regular tax and AMT in 2010 and 2011.11-11, 11-16

Education Tax Incentives Comparison Chart (2010)

Deduction for tuition and fees is extended to 2010 and 2011.

12-23 Educator’s Expense Deduction The up-to-$250 educator’s expense deduction is extended to 2010 and 2011.

Notes

Copyright 2011 Thomson Reuters Individuals—Special Tax Situations Quickfinder® Handbook—2010 Tax Relief Act Handbook Update Guide

2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook 2-15Construction Contractors

Selected Other Key tax ruleS

Loss ContractsIf a construction contract is losing money, a contractor using the PCM may only recognize the actual loss in existence at year end for tax purposes [Reg. §1.460-4(b)(2)]. This differs from the financial accounting (GAAP) rule that requires recognizing 100% of the loss in the first year it becomes apparent that the contract will lose money.If the CCM is being used, a contractor recognizes a loss for tax purposes in the year of completion. [Reg. §1.460-4(d)(1)]

Terminated ContractsIf a long-term contract is terminated before completion and, as a result, the contractor retains ownership of the property subject to the contract, the contractor must reverse the transaction in the tax year the contract terminates. [Reg. §1.460-4(b)(7)]• To reverse the transaction, the contractor reports a loss

(or gain) equal to the cumulative allocable contract costs reported under the contract in all prior years less the cumulative gross receipts reported under the contract in all prior years.

• The contractor has an adjusted basis in the retained property equal to the cumulative contract costs reported under the contract in all prior tax years.

• If the contractor received any consideration from the customer with respect to the termination, the contractor must reduce the adjusted basis (but not below zero) by the FMV of the consider-ation. If this amount exceeds the adjusted basis of the retained property, the contractor recognizes income.

Mid-Contract Changes in ContractorRegulations address the tax effect of a change in contractor that occurs during the course of a contract accounted for using a long-term contract method. The regulations apply where a long-term contract accounted for by one contractor (old contractor) using a long-term contract method is transferred to another contractor (new contractor) who is responsible for reporting income from the same contract. The regulations divide the rules for mid-contract changes into two categories, constructive completion transactions and step-in-the-shoes transactions. See Regulation §1.460-4(k) for details, including many examples.

Energy Efficient Home Builders CreditU Caution: The energy efficient home builders credit expired at the end of 2009 but legislation is pending that would reinstate it. Practitioners should monitor legislative activity in this area.Contractors that built new energy efficient homes in the U.S. could claim a tax credit of $2,000 per dwelling unit for homes sold after 2005 and before 2010 (IRC §45L). To qualify, the unit must have been certified to have an-nual energy consumption for heating and cooling that was at least 50% less than comparable units and met certain other requirements. The credit could also apply to a substantial reconstruction and rehabilitation of an existing dwelling unit because that counted as new construction for this purpose. A manufactured home that met a 30% reduced energy consumption standard could generate a $1,000 credit. These credits only applied to homes sold by contractors for use as personal residences. The contractor’s tax basis in the home was reduced by the amount of the credit.

Payroll Tax Holiday for Hiring Unemployed WorkersA 6.2% payroll tax incentive is available for hiring certain un-employed workers during the period February 4, 2010 through December 31, 2010. The employer is entitled to an exemption for its share of the Social Security taxes on wages paid to qualified employees from March 19, 2010 through December 31, 2010. [IRC §3111(d)]

Domestic Production Activities Deduction (DPAD)For 2010, the DPAD is 9% of the lesser of:1) Qualified production activities income (QPAI) or 2) AGI (for individuals—taxable income for other entities)

determined without regard to the DPAD.The DPAD cannot exceed 50% of the wages paid and reported on Form W-2 by the business for the year. Only W-2 wages allocable to the eligible activity are counted. Taxpayers engaged in more than one activity will have to allocate wages between the activities, if all are not eligible activities.U Caution: The calculation of the DPAD is not optional. A taxpayer performing an eligible activity must calculate the DPAD, even if the result is zero.QPAI. To determine the net income that qualifies for the 9% de-duction, the taxpayer’s receipts must be divided into those from eligible activities (domestic production gross receipts, or DPGR) and non-DPGR. Then, the taxpayer’s expenses must be allocated between the two categories of income. The DPGR less allocable costs equals QPAI.N Observation: Although initially intended for manufacturers, the DPAD specifically applies to both construction performed within the United States and architectural and engineering services for U.S. construction projects. For more information on the DPAD, see Tab O in the Small Busi-ness Quickfinder® Handbook. For a detailed discussion of the con-struction contractor specific provisions of the DPAD, see Chapter 9, Construction Contractors, in PPC’s Specialized Industry Tax Guide.

Worker ClassificationIn the construction industry, there are significant controversies involving the treatment of workers as employees or indepen-dent contractors (ICs). Workers treated as ICs must be issued Form 1099s if the amount paid for the year exceeds $600. For those workers treated as employees, Form W-2s must be filed. The contractor will be liable for federal income tax withholding (FITW), social security and Medicare (FICA) taxes on employee wages, and state and federal unemployment (FUTA) taxes.However, the classification of workers as ICs or employees has other ramifications for the contractor. Employees generally must be covered by employer retirement plans and fringe benefit pro-grams, whereas ICs can establish their own retirement plans or fringe benefit programs. The contractor may also be subject to a number of federal and state employment statutes.Preventing an IRS reclassification of ICs as employees. Pre-venting a reclassification issue from arising is not easy. However, there are steps that can be taken to minimize the likelihood that a reclassification battle will be fought.• First and foremost, the contractor must file Form 1099s for all

payments to individuals that exceed $600 during the year. Continued on the next page

2012

3-2 2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook Decedents

Example: Eddie Jones died on March 21, 2011, before filing his 2010 tax return. His personal representative must file his 2010 return by April 18, 2011. His final tax return is his 2011 return (for the period 1/1/11–3/21/11) and is due April 16, 2012.

Who Should File the ReturnEstate representative. If the decedent named an executor or a court appoints a personal representative or other estate admin-istrator, that person must file for the decedent. A joint return can be filed for a decedent and a surviving spouse if the spouse has not remarried by the end of the tax year and the surviving spouse and estate representative both agree to file jointly. If the surviving spouse remarried before the end of the tax year, the decedent’s filing status is MFS.Surviving spouse. If there is no court-appointed representative by the deadline for the return, the spouse can file a joint return with the decedent as long as he did not remarry before the end of the tax year [Reg. §1.6013-1(d)(3) and (4)]. A spouse can file a joint return even if he expects that an estate representative will be appointed. If the surviving spouse is the appointed representative, he files for the decedent as representative and not as surviving spouse. Note: If a personal representative is later appointed, that person may disaffirm the joint return by filing a separate return for the decedent within one year of the due date (including extensions) of the spouse’s (joint) return. [Reg. §1.6013-1(d)(5)]Person in charge of decedent’s property. If there is no court-appointed representative and no surviving spouse, a “person in charge of the decedent’s property” must file the returns. This person may be anyone in actual or constructive possession of decedent’s property; generally, one of the heirs is chosen informally by the others to act in this capacity. Filing by a person in charge of the decedent’s property should only be done for estates which will not require probate. If the return shows a refund, the “person” must verify on Form 1310 that a court has not and will not appoint a representative. The IRS uses the term personal representative

Deceased Taxpayer—Tax ReturnsTax

ReturnIRS

FormDue Date1 Return required if:

Final Income Tax Return

1040 April 15 of the year following death2 • The decedent’s gross income from January 1 through the date of death exceeds the filing floor for the decedent’s filing status and age determined on the date of death or

• The decedent meets any other filing requirements for individuals (such as having SE income).• A return can be filed to claim a refund or refundable credit.

Income Tax Returns for Preceding

Years

1040 April 15 of the year of death2 The decedent dies after the end of the year but before filing, and the decedent met any of the filing requirements for individuals. Original or amended returns for back years must also be filed if the decedent would have been required to file them. Amended returns may be filed to claim refunds.

Fiduciary Income Tax

Return

1041 15th day of the fourth month following the close of the tax year

• Estate had gross income of $600 or more in the tax year or• Estate has a nonresident alien beneficiary.A return can be filed to pass deductions to beneficiaries in the estate’s final year. Notes: • Gross income includes proceeds from the sale of decedent’s home or other capital asset if paid to the

probate estate.• If decedent was the grantor of a revocable trust, Form 1041 may be required to report trust income.

Estate Tax Return3

706 Nine months after the date of death.4 The decedent’s gross estate at death, plus taxable lifetime gifts, exceeds the applicable exclusion amount ($1 million for 2011). [IRC §6018(a)] Note: Gross estate includes amounts qualifying for the charitable and marital deductions.

Gift Tax Return

709 Earlier of:• April 15 of the year following gift or• Form 706 due date

• The decedent made a taxable gift in the year of death.• The decedent made a taxable gift in the year preceding death and died before filing.• Returns for back years must be filed if the decedent failed to file a required return.

1 Original return due date. Return may be extended. 2 For calendar-year taxpayers. The due date is the same date the decedent’s return would have been due had death not occurred.3 Estates of decedents dying in 2010 are not required to file Form 706 since the estate tax was repealed for 2010. However, such estates may be required to file an

information return (which the IRS had not released at the time of this publication) to allocate the allowable basis increase under the modified carryover basis rules. (See Basis of Inherited Property in Tab 15 of the 1040 Quickfinder® Handbook for more information on these rules.)

throughout its publications and instructions to refer to both ap-pointed representatives and persons in charge of the decedent’s property; under state law, personal representative generally refers only to someone actually appointed by a court.

Determining Whether to File MFJA final individual income tax return (Form 1040) must be filed for the year of a dece-dent’s death. If the surviving spouse does not remarry during the year, the spouse may file a joint return with the decedent for the year of death, though they are not required to do so [IRC §6013(a)(3)]. The joint return will include income and deductions for the decedent prior to the date of death and the surviving spouse’s income and deductions for the entire year. If the surviving spouse remarries before the close of the tax year that includes the date of death, a separate return must be prepared for the decedent. [Reg. §1.6013-1(d)(2)]

Advantages and Disadvantages of Filing a Joint ReturnAdvantages• Ability to use one spouse’s excess deductions against the income of the other

spouse (for example, excess charitable contributions of a decedent who died before generating the income needed to offset the donations).

• Possible increase in the IRA contribution limit (because of the spousal IRA rules).• Ability to use decedent’s net operating loss (NOL), capital loss, and passive

activity loss carryovers to offset income of the surviving spouse.

Disadvantages• The decedent’s estate and the surviving spouse are jointly and severally

liable for any tax, interest and penalties due on the joint return [IRC §6013(d)(3)]. When the surviving spouse is not the sole beneficiary of the estate, the personal representative may not be willing to expose the estate to potential unknown liabilities (for example, tax on the surviving spouse’s unreported income). This risk may be avoided because of the Section 6013(e) innocent spouse rules; however, it is not entirely clear that the rules apply in the case of the personal representative and the estate, nor will every situation meet the criteria for such relief. [Reg. §1.6013-5(a)]

• Possible scale-back of deductions that are subject to AGI limits (for example, medical expenses) if joint AGI is higher than separate AGI.

($5 million for 2010 and 2011)

if the executor elects to be exempt from estate tax.

4 No earlier than nine months after 12/17/10 for decedent who died anytime from 1/1/10–12/16/10.

4-12 2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook Disaster Victims

Example: Velma bought a new chair four years ago for $300. In April, a fire destroyed the chair. She estimates that it would cost $500 to replace it. If she had sold the chair before the fire, she estimates that she could have received only $100 for it because it was four years old. The chair was not insured. Velma’s loss is $100, the FMV of the chair before the fire. It is not $500, the replacement cost.

Residential Real PropertyIn determining the amount of a casualty loss from damage to personal-use residential property, trees and other landscaping are considered part of the entire residential property, and are not valued separately or assigned a separate basis, even if purchased separately [Reg. §1.165-7(b)(2)(ii)]. In calculating the amount of the loss, damaged and de-stroyed trees and other landscaping may adversely affect the FMV of the entire property by reducing the curb or overall appeal of the property.One way to determine the decrease in FMV is to compare an appraisal of the entire property, including trees and other landscaping, before the damage caused by the casualty to an appraisal of the entire property after the damage

caused by the casualty, including damage to trees and other landscaping. Valuation of the damage to a tree by an arborist does not determine the decrease in FMV of the entire property. (Rev. Rul. 68-29)

Alternatively, the cost of cleaning up and restoring the residential property, including trees and other landscap-ing, to its condition before the casualty may be used as evidence of the decrease in FMV, if the clean-up, repairs and restoration are actually done, are not excessive, are necessary to bring the property back to its condition before the casualty, take care of the damage only and do not cause the property to be worth more than before the casualty [Reg. §1.165-7(a)(2)(ii); Pub. 547]. For example, if these requirements are satisfied, the cost of removing destroyed or damaged trees (minus any sal-vage received), pruning and other measures taken to preserve damaged trees, and replanting necessary to restore the property to its approximate value before the casualty may be acceptable as evidence of the decrease in fair market value caused by the casualty. Taxpayers may not include the cost of purchasing any capital asset, such as a compact loader or tractor, or the value of the time they spend cleaning up their own property in the cost of cleaning up and restoring their property.

Casualty Loss—Deduction Limit Rules for Personal-Use and Employee Property$100/$500 Rule* 10% Rule* 2% Rule—Employee Property

General Application Reduce each casualty loss by $100 when figuring the deduction. Apply this rule to personal-use property after determining the amount of the loss. For 2009, this amount was increased to $500. Note: At the time of publication, Congress was considering legislation that would extend this increased amount to 2010.

Reduce the total casualty loss by 10% of taxpayer’s adjusted gross income. Apply this rule to personal-use property after reducing each loss by $100 (the $100 rule).Exception: 10% rule does not apply in federally declared disaster areas.

Apply this rule to property used in performing services as an employee after determining the amount of the loss and adding it to the taxpayer’s job expenses and other miscellaneous itemized deductions. Reduce the total deductions, including the casualty loss, by 2% of taxpayer’s adjusted gross income.

Single Event Apply this rule only once, even if many pieces of property are affected.

Apply this rule only once, even if many pieces of property are affected.

Apply this rule only once, even if many pieces of property are affected.

More Than One Event Apply to the loss from each event. Apply to the total of all your losses from all events during the tax year.

Apply to the total of all your losses from all events during the tax year.

More Than One Person— With loss from the same event (other than a married couple filing jointly)

Apply separately to each person. Apply separately to each person. Apply separately to each person.

Married Couple— With loss from the same event

Filing joint return

Apply as if spouses were one person. Apply as if spouses were one person.

Apply as if spouses were one person.

Filing separate return

Apply separately to each spouse. Apply separately to each spouse. Apply separately to each spouse.

More Than One Owner (other than a married couple filing jointly)

Apply separately to each owner of jointly owned property.

Apply separately to each owner of jointly owned property.

Apply separately to each owner of jointly owned property.

* The $100/$500 and 10% rules do not apply if the loss arose in the (1) Hurricane Katrina disaster area after August 24, 2005, the Hurricane Rita disaster area after September 22, 2005, or the Hurricane Wilma disaster area after October 22, 2005, and the loss was caused by the Hurricane, (2) the Kansas disaster area after May 3, 2007, and the loss was caused by the storms and tornadoes or (3) the Midwestern disaster area from May 5, 2008, through July 31, 2008.

if disaster occured before 2010.

2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook 4-13Disaster Victims

Example #1: Susan lost a large tree in her backyard due to a severe storm, but sustained no other property damage. An arborist valued the damage to the tree at $2,500. Susan spent $600 to remove the tree and grind the stump and she received $500 from her insurance company for debris removal. The value of the damage to the tree determined by the arborist does not qualify as a measure of the casualty loss because it does not reflect the decrease in the FMV of the property as a whole, including the residence, land and improve-ments. Susan can obtain an appraisal of the entire property to determine any decrease in value resulting from the loss the tree. Alternatively, Susan can use costs incurred to clean up and remove the tree as a measure of the decrease in the property’s FMV as long as the costs are not excessive, are necessary to bring the property back to its condition before the casualty, take care of the damage only and do not cause the property to be worth more than before the casualty. Susan would then subtract the amount reimbursed by insurance. Under this alternative, Susan has a casualty loss of $100.Example #2: Brian had a large tree that fell during a storm and crushed a shed. Among many trees on the property, it was the only tree that was damaged. The loss of this tree does not affect the FMV of the entire property. Homeowners’ insurance reimbursed Brian for the costs of repairing the shed and removing the tree. Since insurance paid for all repair costs to bring the property back to its pre-casualty condition and value, Brian has no casualty loss.

Business or Income-Producing PropertyIf business or income-producing property, such as rental property, is completely destroyed, the decrease in FMV is not considered. Instead the loss is computed as follows:

Adjusted basis in the property– Any salvage value– Any insurance or other reimbursement received or

expected to be received

Amount of casualty loss

Inventory. There are two ways to deduct a casualty loss of inven-tory, including items held for sale to customers:1) Deduct the loss through the increase in the cost of goods sold

by properly reporting opening and closing inventories. Do not claim this loss again as a casualty loss. If the loss is claimed through the increase in the COGS, include any insurance or other reimbursement received for the loss in gross income.

2) Deduct the loss separately. If deducted separately, eliminate the affected inventory items from the COGS by making a downward adjustment to opening inventory or purchases. Reduce the loss by the reimbursement received. Do not include the reimburse-ment in gross income. If reimbursement is not received by the end of the year, a loss cannot be claimed to the extent there is a reasonable prospect of recovery.

Determining the Deductible LossAfter the amount of the casualty or theft loss is determined, the next step is determining how much of the loss can be deducted.Personal-use property—$100/$500 and 10% rules. For personal casualties, the loss (after deducting insurance proceeds or other reimbursements) from each separate theft or casualty must first be reduced by $100 ($500 in 2009) [IRC §165(h)(1)]. For example, if a taxpayer suffers one loss from a fire and another from a flood, the $100/$500 rule applies twice—once for the loss from each casualty. After applying the $100/$500 rule, the taxpayer’s personal casualty losses for the year are only deductible to the extent they exceed 10% of the taxpayer’s AGI [IRC §165(h)(2)]. The 10% rule does not apply in federally declared disaster areas.U Caution: At the time of publication, Congress was considering legislation that would extend the increased $500 amount to 2010.

Example: In 2007, Sam bought a personal-use SUV for $30,000. In 2010, the SUV was badly damaged in an accident. Immediately before the ac-cident the SUV’s FMV was $19,000. Immediately after the accident, the FMV was $5,000. Sam filed an insurance claim and received $10,000 from the insurance company. The amount of the casualty loss deduction in 2010 before the application of the 10% of AGI limit is $3,500 which is calculated as follows: Value of property immediately before casualty ............................... $ 19,000 Less: Value of property immediately after casualty ........................ < 5,000>Value of property actually destroyed .............................................. $ 14,000 Loss to be taken into account for purposes of Section 165(a): Lesser of amount of property actually destroyed ($14,000) or adjusted basis of property ($30,000) .................................... $ 14,000Less: Insurance received ................................................................ < 10,000> Subtotal .......................................................................................... $ 4,000 Less: $100 limitation ....................................................................... < 100>Deduction allowable before application of the 10% of adjusted gross income limit ...................................................... $ 3,900

Employee business-use property—2% rule. Losses to property used in performing services as an employee are added to other job expenses and miscellaneous itemized deductions on Schedule A (Form 1040) and are reduced by 2% of the taxpayer’s AGI.Business property. Casualty losses on business property (other than employee property) and income-producing property are not subject to an AGI or dollar limit. Part-personal, part-business use property. When property is used partly for personal purposes and partly for business or income-producing purposes, the casualty loss deduction must be computed separately for each portion. The $100/$500 rule and the 10% rule apply only to the casualty loss on the personal-use portion of the property.

Example: Same facts as in the preceding example except Sam uses the SUV 60% of the time for work, which qualifies as an employee unreimbursed business expense. Therefore, the $4,000 casualty loss must be allocated between personal and business use and the limitations for each applied, as follows:

Loss Amount Applicable LimitsPersonal-use (40%) $1,600 $100 and 10% of AGIEmployee business-use (60%)

$2,400 2% of AGI (after combining with other miscellaneous itemized deductions)

Deductible Losses Exceeding Income If casualty or theft losses along with other deductions cause a taxpayer’s deductions to exceed his income for that year, the tax-payer may have a net operating loss (NOL). Deductible personal casualty losses are fully allowed in determining a taxpayer’s NOL. Thus, the limitation on certain other non-business deductions in calculating an individual’s NOL does not apply to personal casualty loss deductions. [IRC §172(d)(4)(C)]

Federally declared diSaSterSTaxpayers affected by a federally declared disaster are eligible for special tax relief provisions. See the table Federally Declared Disasters—Quick Summary of Special Tax Relief Provisions on Page 4-14 for an overview.

4-14 2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook Disaster Victims

Federally Declared Disasters—Quick Summary of Special Tax Relief ProvisionsItem Special relief

Casualty loss deduction • 10%-of-AGI limit waived.*•Can elect to claim in year before year of the

disaster.Depreciation—50% bonus*

50% special (bonus) depreciation is allowed on qualified disaster assistance property (see Depreciation and Section 179 Deduction in the next column) for the year it’s placed in service. Such property is not subject to the AMT adjustment for its entire recovery period.

Disaster expenses* Certain disaster-related expenses paid in connection with a trade or business or business-related property are deductible, even though they are normally capitalized.

Disaster relief payments Payments are nontaxable.Involuntary conversions of business or income-producing property

Any tangible replacement property acquired for use in any business is treated as similar or related in service or use to the destroyed property.

Involuntary conversions of principal residence

•Replacement period is four years rather than two years.

• Special rules for avoiding gain on receipt of insurance proceeds.

Net operating loss (NOL) carryback*

NOL attributable to disaster loss may be carried back five years and fully deductible against AMT income.

Section 179 expense* Deduction limit is increased by lesser of (a) $100,000 or (b) cost of qualifying section 179 disaster assistance property. Threshold for phaseout is increased by lesser of (a) $600,000 or (b) cost of qualifying section 179 disaster assistance property.

Standard deduction* Nonitemizers can increase their standard deduction by the amount of their disaster loss deduction (net disaster loss).

Tax deadlines Deadlines for filing and paying taxes and making IRS contributions are often postponed.

* For disasters declared after 2007 and occurring before 2010. At the time of publication, Congress was considering legislation that would extend this rule to federally declared disasters occurring in 2010. Tax preparers should monitor the situation.

Federally Declared DisasterA federally declared disaster is a disaster that oc-curred in an area directed by the President to be eligible for federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act [IRC §165(i)(3)]. A disaster area is the area determined to warrant such assistance. See the 2010 Federally Declared Disaster Areas table on Page 4-20 for a list of the 2010 federally declared disasters. [An ongo-ing list of disaster areas is available on the Federal Emergency Management Agency (FEMA) website at www.fema.gov.]

Casualty Loss—Choice of Year to ClaimA casualty loss attributable to a federally declared disaster can be claimed in the year the disaster occurred or in the year preceding the loss on a timely return or amended return (Form 1040X) [IRC §165(i)]. This may increase the tax savings from the loss and may entitle the taxpayer to a refund earlier than if he waited to file the loss year’s return. If a taxpayer owns multiple properties that are damaged by a federally declared disaster, the taxpayer cannot elect to claim a casualty loss on one property in the prior year and a casualty loss on another property in the current year. Taxpayers must report all losses from a federally declared disaster together,

either in the year of the disaster or in the prior year. [§1.165-11(d)]æ Practice Tip: Determining the most beneficial year in which to claim the loss requires a careful evaluation of the taxpayer’s entire tax picture for both years, including filing status, amount of income and other deductions, and the applicable tax rates. For example, claiming the loss in the higher income year may not be the most advantageous approach.Election statement. To claim the disaster loss on the year preceding the loss, an election state-ment (such as the following sample election) must be attached to the tax return for that year. The statement, must include specific information about the time, place (city or town, county and state) and nature of the disaster that caused the loss. Indicate that the loss is being claimed in the year preceding the disaster. Also, information about the disaster should be noted on the top of page 1 of the return (for example, “Hurricane XYZ”).

Election to Deduct Disaster Loss in PreviousTax Year Under Reg. §1.165-11

The taxpayer hereby elects under IRC Sec. 165(i) to deduct the casualty loss occurring on [date] in the tax year ended [tax year end] , which is the year prior to the year of loss. The location of the property that was damaged or destroyed by the disaster is [city or town, county and state] . The disaster loss amount is $ [amount] .

An election to claim the casualty loss in the preceding year must be made by the later of the following dates:• The due date (without extensions) for filing the tax return for the

tax year in which the disaster actually occurred. • The due date (with extensions) for filing the return for the preced-

ing tax year.

Example: In 2010, Felix incurred a casualty loss related to a federally declared disaster. He has until April 18, 2011, to amend his 2009 return and make the election to claim the loss on the preceding year return.

Casualty Loss—Waiver of 10%-of-AGI LimitThe 10%-of-AGI limit on personal casualty losses is waived for net disaster losses [IRC §165(h)]. A net disaster loss is equal to:a) Personal casualty losses attributable to a federally declared

disaster occurring before 2010, and occurring in a disaster area, minus

b) Personal casualty gains. Note: The waiver only applies to disasters declared after 2007 and occurring before 2010. However, proposed legislation may extend the provision to disasters occurring in 2010.

Depreciation and Section 179 DeductionTwo special cost recovery rules apply to business property placed in service after 2007 for disasters declared after 2007 and occurring before 2010. Proposed legislation may extend this benefit to disasters occurring in 2010.50% special depreciation. The following rules apply to qualified disaster assistance property: [IRC §168(n)]• 50% special (bonus) depreciation deduction is allowed for the

tax year the property is placed in service.• The adjusted basis of the property is reduced by the amount of

that deduction before computing the amount otherwise allowable as a depreciation deduction for the tax year and any later tax year.

• The property is not subject to the AMT adjustment for its entire recovery period.

2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook 4-15Disaster Victims

Qualified disaster assistance property is property used in an active trade or business that is either: 1) MACRS property with a recovery period of 20 years or less,

computer software, water utility property or qualified leasehold improvement property or

2) Nonresidential real property or residential rental propertyIn addition, substantially all of the property’s use must be in a federally declared disaster area, the new property must replace or rehabilitate property that was damaged or destroyed and its first use in the disaster area must begin with the taxpayer. Section 179 deduction. The Section 179 deduction limit is in-creased by the lesser of (a) $100,000 or (b) the cost of qualified Section 179 disaster assistance property placed in service during the tax year. The qualifying property threshold (when deduction begins to phase-out) is increased by the lesser of: (a) $600,000 or (b) the cost of qualified Section 179 disaster assistance property. Qualified Section 179 disaster assistance property is Section 179 property which is qualified disaster assistance property (see above). [IRC §179(e)]

Disaster ExpensesA taxpayer may elect to deduct qualified disaster expenses, which are expenditures related to a feder-ally declared disaster and that are: (IRC §198A)1) Paid or incurred in connection with a trade or business or with

business-related property;2) For any of the following reasons:

• Abatement or control of hazardous substances that were released;

• Removal of debris from, or the demolition of structures on, damaged or destroyed business-related real property or

• Repair of damaged business-related property and 3) Otherwise chargeable to capital account. Note: This election is not available for disasters occurring after 2009. However, at the time of publication, Congress was considering legislation that would extend the provision to disasters occurring in 2010. Tax preparers should watch for developments.

Disaster Relief PaymentsSee Disaster Relief Payments on Page 4-17 for informa-tion on payments that can be excluded from income.

Involuntary Conversion of Principal ResidenceIf the taxpayer’s home is destroyed by a casualty that is part of a federally declared disaster, special rules make it easier to avoid gain on insurance payments (see Deferral of gain under the invol-untary conversion rules on Page 4-17). The involuntary conversion timing rules are expanded to allow a four-year period to purchase the replacement property instead of the usual two-year period.

Net Operating LossesFor 2008 and 2009, qualified disaster losses can be carried back five years and are deductible against 100% of AMT income. Pending legislation may extend this provision to 2010 disasters. A qualified disaster loss is the lesser of: 1) The sum of (a) the casualty losses attributable to a federally

declared disaster and (b) the deduction for qualified disaster expenses (or what would be allowable if not otherwise treated as an expense) or

2) The NOL for the tax year. [IRC §172(b)]

If the taxpayer elects not to apply the five-year car-ryback, the loss is carried back two years. An election can be made to carry the losses forward instead.

Postponed Tax DeadlinesThe IRS may postpone certain tax deadlines for up to one year for taxpayers who are affected by a federally declared disaster (whether or not those taxpayers are claiming casualty losses) (IRC §7508A). Types of deadlines that may be postponed are:• Time for filing income, excise and employment tax returns;• Time for paying income, excise and employment taxes and• Time for making contributions to a traditional IRA or a Roth IRA.If a tax deadline is postponed, the IRS will publicize it in the af-fected area and publish it in an Internal Revenue Bulletin (IRB). Go to www.irs.gov for more information.

additiOnal tax relieF FOr certain diSaSter VictimS

In addition to the special tax provisions that apply to federally declared disasters, Congress has also enacted tax legislation providing taxpayers affected by selected disasters additional tax relief. These are often enhancements to the provisions allowed to all federally declared disaster victims but many are unique to this group of disaster victims.For 2010, special tax relief is allowed to victims of the following disasters:• Midwestern storms, tornadoes and flooding in 2008.• Kansas storms and tornadoes in 2007.• Hurricanes Katrina, Rita and Wilma.See the tables summarizing the special tax relief avail-able to these disaster victims beginning on Page 4-21.

Midwestern Storms, Tornadoes and Flooding Victims The Heartland Disaster Tax Relief Act of 2008 provided special relief to victims of Midwestern storms, tornadoes and flooding that was modeled after the tax relief provided to victims of Hurricanes Katrina, Wilma and Rita. Midwestern disaster area. The Midwestern disaster area is an area: 1) With respect to which the President declared a disaster on or

after May 20, 2008, and before August 1, 2008 by reason of severe storms, tornadoes or flooding occurring in any of the following states:• Arkansas • Kansas • Nebraska• Illinois • Michigan • Wisconsin• Indiana • Minnesota• Iowa • Missouri

2) Determined to warrant individual or individual and public as-sistance from the federal government. Note: The table Midwestern Disaster Area Victims—Special Tax Relief table on Page 4-21 describes the various special tax relief provisions. Of those provisions, certain ones are not restricted by item 2 above; instead, they are available not only to taxpayers in counties eligible for individual or individual and public assistance from the federal government (as stated in item 2 above), but also those in counties eligible for public only assistance. These provisions are:• The relaxed rules for qualified retirement plan distributions, re-

contributions to qualified retirement plans due to withdrawals for Continued on the next page

6-26 2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook Farmers and Ranchers

Recovery Periods for Farm Property (2010)Recovery Period (Yrs.)

Asset Description MACRS ADSAgricultural structures (single purpose) 10 15Cattle (dairy or breeding) 5 7Cotton ginning assets 7 12Drainage facilities 15 20Farm buildings (other than single purpose structures) 20 25Farm machinery and equipment (new) 7* 10Farm machinery and equipment (used) 7 10Fences (agricultural) 7 10Goats and sheep (breeding) 5 5Grain bins 7 10Hogs (breeding) 3 3Horses (age when placed in service):• Breeding and working (12 years or less). 7 10• Breeding and working (more than 12 years). 3 10• Racing horses (more than two years). 3 12Horticultural structures (single purpose) 10 15Tractor units (over-the-road) 3 4Trees or vines bearing fruits or nuts 10 20Truck (heavy duty, unloaded weight 13,000 lbs. or more) 5 6Truck (weight less than 13,000 lbs.) 5 5Water wells 15 20* This was reduced to five years for 2009. At the time of publication, Congress

was considering legislation that would extend the five-year life to 2010. Tax preparers should monitor the situation.

Section 179 Deduction for Farm PropertyFor 2010, the Section 179 deduction limit is $500,000 (see Tab 10 in the 1040 Quickfinder® Handbook for more details).Qualifying farm property includes:• Tangible personal property (tangible property other than real

property) such as machinery and equipment, milk tanks, auto-matic feeders, barn cleaners and office equipment.

• Livestock (horses, cattle, hogs, sheep, goats and mink and other fur-bearing animals).

• Single-purpose agricultural and horticultural structures.Single-purpose agricultural structure. Building or enclosure specifically designed, constructed and used for: housing, raising and feeding a particular type of livestock (including poultry but not horses), their produce and the equipment necessary for feeding and caring. Special-purpose structures qualify if used to:• Breed chickens or hogs,• Produce milk from dairy cattle or• Produce feeder cattle or pigs, broiler chickens or eggs.Single-purpose horticultural structure:1) A greenhouse specifically designed, constructed and used for

the commercial production of plants or2) A structure specifically designed, constructed and used for

commercial mushroom production.Property that qualifies as a single-purpose agricultural or horticultural structure includes:• Greenhouse.• Hay storage/cattle feeding facility.• Integrated hog raising facility.• Milk parlor.• Poultry house.

Bonus DepreciationAn additional 50% allowance for bonus depreciation is available for assets meeting the following requirements:1) MACRS recovery period of 20 years or less,2) New assets (not used) and3) Purchased and placed in service in 2010.

Vehicles Exempt from Depreciation LimitsDepreciation limits apply only to luxury autos that fall under the definition of a passenger automobile, defined as a four-wheeled vehicle designed for street use with an un-loaded gross vehicle weight rating of 6,000 pounds or less [IRC §280F(d)(5)]. Unloaded gross vehicle weight means the curb weight of the vehicle fully equipped for service without passengers or cargo.• Few, if any, cars fall outside the passenger automobile definition,

but a truck or van falls under the definition only if the gross vehicle weight is 6,000 pounds or less.

• Gross vehicle weight for a truck or van is the manufacturer’s specified maximum weight rating for a loaded vehicle.

• Trucks and vans include sport utility vehicles and minivans, if they are built on a truck chassis and have an enclosed body.

Section 179 deduction. Another implication of escaping the passenger automobile definition is that a Section 179 expensing deduction may be claimed on the vehicle exceeding the 6,000 pound definition. However, a truck, van or sport utility vehicle with a gross vehicle weight rating of 14,000 lbs. or less is subject to a Section 179 maximum amount of $25,000.• There is an important exception for pickup trucks with at least

a 6-foot interior length cargo area box. These pickup trucks are eligible for a Section 179 deduction of up to $500,000 for 2010.

• The Section 179 write-off can be a significant advantage, even for vehicles purchased late in the year. However, if business usage is 50% or less, the deduction is unavailable.

Vehicle Expense SubstantiationTaxpayers must be able to prove the following items to claim a deduction for vehicle expenses: [Temp. Reg. §1.274-5T(b)(6)]1) The amount of each separate expense.2) The mileage for each business use of the vehicle.3) The date of the expense or use.4) The business reason for the expense or use.Farm vehicle exception. If an owned or leased vehicle is used during most of a normal business day directly in the business of farming, in lieu of substantiating its use, the taxpayer may deter-mine any deduction or credit for the vehicle as if the business use were 75% plus the percentage, if any, attributable to an amount included in an employee’s gross income. A taxpayer who satisfies the substantiation requirements by using the 75% rule cannot use a different method in subsequent years. The converse is also true. [Temp. Reg. §1.274-6T(b)]

lOSSeS OF certain FarmerS limitedFor tax years beginning after 2009, individual taxpayers that re-ceive any direct or counter-cyclical payment under Title I of the Food, Conservation and Energy Act of 2008, any payment elected to be received in lieu of such payment or any CCC loan, are lim-ited in terms of the deductibility of a Schedule F farming loss [IRC §461(j)(1)]. Applicable subsidy payments for this provision do not include CRP payments. The definition of a farming business for

(100% if acquired and placed in service 9/9/10–12/31/10)

2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook 6-33Farmers and Ranchers

The DPAD cannot exceed 50% of the wages paid and reported on Form W-2 by the business for the year. Only W-2 wages allocable to the eligible activity are counted. Taxpayers engaged in more than one activity must allocate wages between the activities, if all are not eligible activities.U Caution: The calculation of the DPAD is not optional. A taxpayer performing an eligible activity must calculate the DPAD, even if the result is zero.QPAI. To determine the net income that qualifies for the 9% de-duction, the taxpayer’s receipts must be divided into those from eligible activities (domestic production gross receipts, or DPGR) and non-DPGR. Then, the taxpayer’s expenses (including cost of goods sold) must be allocated between the two categories of income. The DPGR less allocable costs equals QPAI.U Caution: While most U.S. farming activities generate DPGR, income from custom farming—if the farmer does not have the benefits and burden of ownership of the property—is not DPGR.The following discussion of the DPAD focuses on aspects that are unique to agriculture. For more information on the DPAD, see Tab O in the Small Business Quickfinder® Handbook.Farm activities. Qualifying production includes manufacturing, producing, growing and extracting (MPGE) activities. • Growing includes cultivating soil, raising livestock, fishing and

mining minerals.• Eligible activities also include storage, han-

dling or other processing activities (other than transportation activities) within the U. S. related to the sale, exchange or other disposi-tion of agricultural products. [Reg. §1.199-3(e)(1)]

• The taxpayer must have the benefits and burdens of ownership of the property during the period the MPGE activity occurs, in order for the gross receipts to qualify for the DPAD.

• Proceeds from business interruption insurance, government subsidies and government payments not to produce are gross receipts for the DPAD, to the extent they are substitutes for gross receipts that would qualify. [Reg. §1.199-3(i)(1)(iii)]

A special de minimis rule lets a taxpayer consider all of his farm gross receipts as qualifying DPGR if the nonqualifying portion is less than 5% of total gross receipts. [Reg. §1.199-1(d)(3)] Wage limitation. Wages for the 50% limitation may be calculated under any one of three methods (see Rev. Proc. 2006-47). Essen-tially, the business wages of the taxpayer must be those subject to FICA and properly reported on a Form W-2. Many Schedule F proprietors, who would otherwise qualify for the DPAD, will lack wages and not be able to claim the deduction. In these cases, there may be services provided by family members that could be compensated, to overcome the wage limitation. However, the extra FICA costs to formalize these previously uncompensated services must be compared to the income tax savings from the DPAD.Small business simplified allocation method. A taxpayer must allocate business expenses to qualifying DPGR to calculate QPAI on which the 9% computation is made.• The general method, available to all taxpayers, is known as the

Section 861 method. This is a detailed cost accounting approach using the regulations that govern foreign activity allocations. Because this is a detailed item-by-item allocation, it offers no special opportunity for farmers and ranchers.

• The regulations provide two simplified methods of allocating expenses to qualifying and nonqualifying DPGR. Of these two methods, the small business simplified overall method [Reg. §1.199-4(f)] is available to all farming businesses not required to use the accrual method of accounting. Under this method, total

Net Operating Loss (NOL) CarrybacksIn general, an NOL is carried back to the two prior tax years. However, the Code provides a special five-year carryback period for farming losses. [IRC §172(b)(1)(G)]The amount available for the special five-year farm carryback is the smaller of the NOL if only items attributable to a farming business are taken into account or the regular NOL for the year. A farming business is a trade or business involving the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity. This definition includes the businesses of operating a nursery or sod farm, the raising or harvesting of trees bearing fruit, nuts, or other crops, or ornamental trees. The raising, shearing, feeding, caring for, training and management of animals is also a farming business.If a farmer entitled to a five-year NOL carryback elects to decline the privilege, the normal NOL carryback rules apply [IRC §172(i)(3)]. In some cases, a farmer might wish to decline all carryback periods, in order to carry the NOL to future tax years.

Debt CancellationFull or partial cancellation of a debt is gen-erally considered income for tax purposes. See Debt Cancellation on Page 1-18 for ex-ceptions and Tab 6 in the 1040 Quickfinder® Handbook regarding a special exclusion for qualified farm indebtedness.

Qualified Conservation Contribution A qualified conservation contribution is a contribution of a qualified real property interest to a qualified organization to be used only for conservation purposes. For definitions of the preceding italicized terms, see Pub. 526, Charitable Contributions. A landowner who grants a conservation easement is eligible for a charitable contribu-tion deduction. The allowable deduction is generally the amount by which FMV of the property drops as a result of the easement. To qualify, easement rights must be granted in perpetuity and must be granted to a qualified organization such as a governmental unit or local land trust. Farmers and ranchers. Qualified conservation contributions made by a qualified farmer or rancher in 2006–2009 are deductible up to 100% of the excess of the taxpayer’s contribution base (AGI) over the amount of all other allowable contributions. (At the time of publication, Congress was considering legislation that would extend this provision to 2010. Tax preparers should monitor the situation.)Qualified farmer or rancher: A taxpayer (including certain farming corporations) whose gross income from farming is greater than one-half of the gross income for the taxpayer for the year. Gross income from farming for this purpose is the typical definition of income from raising agricultural or horticultural commodities, including livestock, but it also extends to the planting, raising or cutting of trees.For a qualified conservation contribution of agricultural property, the property interest must include a restriction that the property remains generally available for agricultural or livestock production. Although no requirement exists that this production actually occur, the property must remain available for it.

Domestic Production Activities Deduction (DPAD)For 2010, the DPAD is 9% of the lesser of:1) Qualified production activities income (QPAI) or 2) AGI with certain modifications (for individuals—taxable income

for other entities) determined without regard to the DPAD. Continued on the next page

2011

2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook 7-13Military Members

Nontaxable combat pay election. Members can elect to have their nontaxable combat pay included in earned income for the EIC by including the nontaxable combat pay on line 64b of Form 1040. If the election is made, all nontaxable combat pay received must be included in earned income. Taxpayers filing a joint return in which both spouses received nontaxable combat pay can each make their own election. The amount of nontaxable combat pay should be shown on Form W-2 in box 12 with code Q. Electing to include nontaxable combat pay in earned income may increase or decrease the EIC.æ Practice Tip: Calculate the credit with and without the nontax-able combat pay before making the election. Whether the election increases or decreases the EIC depends on total earned income, filing status and number of qualifying children.

Example #1: George and Janice are married and will file a joint return. They have one qualifying child. George was in the Army and earned $11,000 ($5,000 taxable wages + $6,000 nontaxable combat pay). Janice worked part of the year and earned $2,000. Their taxable earned income and AGI are both $7,000. George and Janice qualify for the earned income credit.Without adding the nontaxable combat pay to their earned income, their credit is $2,389. If the nontaxable combat pay is added to their earned income, their credit is $3,050. Because making the election will increase their EIC, they elect to add the nontaxable combat pay to their earned income for the EIC.Example #2: The facts are the same as in Example #1 except George had nontaxable combat pay of $20,000. When George’s nontaxable combat pay is added to their earned income, their credit is $2,161. Because the credit they can get by not adding the nontaxable combat pay to their earned income is $2,389, they decide not to make the election.

Child Tax Credit and Additional Child Tax CreditTaxpayers with one or more qualifying children may be able to claim a child tax credit of up to $1,000 per qualifying child. The child tax credit is generally a nonrefundable credit that is limited to regular tax liability plus alternative minimum tax (AMT) liability. The additional child tax credit allows a portion of the child tax credit to be refundable for certain taxpayers.Military service exception to the residency test. To be eligible for the child tax credit, a qualifying child must have lived with the taxpayer for more than one-half of the year. Temporary absences for military service count as time lived at home.Earned income. For the additional child tax credit, taxable earned income is generally defined the same as for the EIC [in Section 32(c)(2)]. Nontaxable combat pay excluded from gross income under Section 112 is included in earned income for calculating the additional child tax credit. [IRC §24(d)(1)]

Differential Wage Credit for Small Business EmployerU Caution: Proposed legislation may extend this credit to dif-ferential wages paid in 2010. Practitioners should be alert for future activity in this area.An eligible small business (employing less than 50 employees with a written plan providing for differential payments (see Military Dif-ferential Pay on Page 7-8) may claim a credit equal to 20% of up to $20,000 of differential wages paid to each qualifying employee during the tax year (IRC §45P). The credit is available for payments made after June 17, 2008 and before 2010. The employer’s salary deduction must be decreased by an amount equal to the credit.The credit is claimed on Form 8932, Credit for Employer Differ-ential Wage Payments. The credit is also reported on Form 3800, General Business Credit.

First-Time Homebuyer CreditMembers serving outside the U. S. have an extra year to purchase a principal residence and still qualify for the credit. See Tab 12 in the 1040 Quickfinder® Handbook for details on the credit.Generally, the credit must be recaptured if the taxpayer disposes of the residence, or the residence ceases to be the taxpayer’s principal residence, during the 36-month period beginning on the date of purchase. However, special rules apply to members of the armed forces. If a member disposes of or ceases to use a principal residence after December 31, 2008, in connection with government orders (received by the taxpayer or spouse) for qualified official extended duty service, he will be exempt from the recapture provi-sion for a residence purchased before January 1, 2009.

Making Work Pay CreditEligible taxpayers may claim a credit up to $400 ($800 for joint returns). For purposes of calculating the credit, earned income in-cludes nontaxable combat pay regardless of whether the taxpayer elects to treat the combat pay as earned income for the EIC [IRC §36A(d)(2)]. The credit is reported on Schedule M, Making Work Pay and Government Retiree Credits. Nontaxable combat pay is included in earned income on Schedule M, line 1a and also shown separately on line 1b.

tax FOrgiVeneSS OF military decedent’S tax liability

Tax liability can be forgiven, or if already paid, refunded, if a mem-ber dies: (IRC §692)• While in active service in a combat zone,• From wounds, disease or other injury received in a combat zone

or• From wounds or injury incurred in a terrorist or military action.Tax for the year of death and possibly for earlier years can be forgiven. In addition, any unpaid tax liability at the date of death may be forgiven (does not have to be paid).If a member dies, a surviving spouse or personal representative handles duties such as filing any tax returns and claims for re-fund of withheld or estimated tax. A personal representative can be an executor, administrator or anyone who is in charge of the decedent’s assets.Joint returns. Only the decedent’s part of the joint income tax liability is eligible for the refund or tax forgiveness. To determine the decedent’s part, the person filing the claim must: [Reg. §1.692-1(b)]1) Figure the income tax for which the decedent

would have been liable if a separate return had been filed,

2) Figure the income tax for which the spouse would have been liable if a separate return had been filed and

3) Multiply the joint tax liability by a fraction. The numerator of the fraction is the amount in 1, above. The denominator of the fraction is the total of 1 and 2. This is the decedent’s tax liability that is eligible for the refund or tax forgiveness.

Residents of community property states. If the decedent’s legal residence was in a community property state and the spouse reported half the military pay on a separate return, the spouse can get a refund of taxes paid on his share of the pay for the years involved. The forgiveness of unpaid tax on the military pay also would apply to the half owed by the spouse for the years involved.

2012

2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook 8-5Oil and Gas Investors

provided the other Section 179 conditions are met. Claiming a Sec-tion 179 deduction for L&WE can greatly simplify recordkeeping and accelerate deductions.An additional 50% special (bonus) depreciation allowance is avail-able for assets meeting the following requirements:1) MACRS recovery period of 20 years or less,2) New assets (not used) and3) Purchased and placed in service before 2011.

 Law Change Alert: The special (bonus) depreciation allow-ance has been extended for 2010.Depletion. A working interest owner is entitled to a deduction for the greater of cost depletion (IRC §612) or allowable percentage depletion (sometimes called statutory depletion—IRC §613A). Cost depletion is based on the LHC of the property and is calculated using the mineral reserves (obtained from engineering reports) and the number of units sold for the year [Reg. §1.611-2(a)]. For cash-basis taxpayers, the “number of units sold” means units for which payment was actually received within the tax year. Cost depletion is similar to depreciation determined on a units-of-production method.

Cost Depletion CalculationUnrecovered depletable costs

× Units Sold = Cost

DepletionEstimated recoverable reserves (in units) at beginning of year** Usually obtained from engineering reports.

æ Practice Tip: For cost depletion purposes, natural gas produc-tion is converted into equivalent barrels of oil using a ratio of 6,000 cubic feet (6 MCF) of gas to one barrel of oil. [IRC §613A(c)(4)]

Percentage Depletion Quick FactsBased On A percentage of gross receipts from the property.Rate Generally 15% for oil and gas properties. The rate for marginal

production properties (see Net Income Limitation below) is increased if the average crude oil price falls below $20. Given present oil prices, no rate increase is anticipated in the foreseeable future.

Who Qualifies?

Independent producers (generally working interest owners who are not retailers or refiners) with <1,000 barrels average daily production from all wells. Royalty owners are also eligible.

Net Income Limitation

Percentage depletion is limited to the net income from each property before any depletion or Section 199 domestic producer deductions. Report income and expenses by property in a supporting schedule to Schedule C—the Sample Oil and Gas Depletion Schedule on Page 8-11 can be used for this. Note: For pre-2008 tax years and for tax years beginning in 2009, the net income limitation did not apply to marginal production properties, which include stripper well property (property with average daily production divided by the number of wells on the property of 15 barrels or less) or domestic property whose production is substantially all “heavy oil” [IRC §613A(c)(6)(D) and (H)]. Although the provision to exclude marginal production properties has expired, it could be reinstated in future years. Practitioners should be alert to further developments in this area.

65% Limitation

A taxpayer’s total percentage depletion from all oil and gas properties cannot exceed 65% of taxable income, computed before percentage depletion, NOL and capital loss carryback and Section 199 deductions [IRC §613A(d)]. Deductions denied by this limitation are carried to succeeding tax years. See Example #2 in the next column.

Not Limited to Basis

Cost depletion stops when LHC is fully depleted. Percentage depletion continues (even after LHC is depleted) because it is based on a percentage of gross income from the property.

Example #1: Hal West invested in oil and gas properties for the first time on March 15, 2010. He owns a working interest in three producing wells that were all drilled during 2010 after Hal acquired an interest in the properties. In addition, Hal invested in two additional drilling projects that were determined to be dry holes and abandoned before the end of the year.At year-end, Hal received a separate Form 1099-MISC for each of the three pro-ducing properties. In the 1099-MISC box labeled “Nonemployee Compensation,” the well operators listed the gross payments (before deducting severance tax) made to him for each well. Hal saved all the stubs (run tickets) from the revenue checks he received. The run tickets indicate gross revenue, severance tax ex-pense and barrels (oil) or MCF (thousand cubic feet—gas) produced by the well.The following table shows Hal’s share of the oil and gas operations. Page 1 of Hal’s completed Schedule C and his Sample Oil and Gas Depletion Schedule are shown on Page 8-11.

WellsDuke 1 Duke 2 Nick 1 Mars 1 Mars 2 Totals

Dry Hole? No No No Yes Yes N/AHal’s share:Revenue $18,500 $ 4,600 $13,207 – – $36,307Deductions:Prod. Tax1 1,203 267 790 – – 2,260LHC2 $ 1,700 $ 850 2,550IDC 9,000 8,500 9,200 12,900 9,100 48,700LOE3 2,200 3,000 1,800 – – 7,000Section 1794 1,500 1,500 1,200 – – 4,200Depletion5 2,775 100 217 – – 3,092

Net Income 1,822 <8,767> 0 <14,600> <9,950> <31,495>Capitalized:LHC 1,000 1,000 750 2,750

1 Production (severance) tax.2 Deducted on dry holes; capitalized on producing properties. See the Practice Tip

below.3 Lease operating expense.4 Computed on L&WE—see Sample Oil and Gas Depletion Schedule on Page 8-11.5 Separately computed for each producing property as the greater of cost or

percentage depletion—see Sample Oil and Gas Depletion Schedule on Page 8-11.

æ Practice Tip: For a taxpayer to deduct LHC on dry holes, the normal Section 165 requirements (for deducting losses) must be met. In other words, there must be an identifiable event or point (plugging and abandoning) when the property becomes worthless. Taxpayers do not automatically abandon a lease if a well is dry; therefore, the practitioner should verify with the client that he intends to abandon or not renew the lease before writing off the LHC.

Example #2: Assume the same facts as in Example #1. In addition to his oil and gas operations, Hal’s other income is $70,000 in wages and $500 of interest income. His allowable itemized deductions total $21,358. He is married and has three children. Hal has no NOL carrybacks or Section 199 deduc-tion. Hal’s overall limit for deducting percentage depletion (65% limitation) is calculated as follows for 2010:

Wages ...................................................................... $ 70,000Interest income ........................................................... 500Schedule C from Example #1 (see Page 8-11) ...................... <31,495>Itemized deductions ...................................................... <21,358>Exemptions (5 × $3,650) ................................................ <18,250>Taxable income before 65% limitation calculation .................. <603>Add back percentage (but not cost) depletion tentatively allowed (see Sample Oil and Gas Depletion Schedule on Page 8-11) .... 2,992Adjusted taxable income ................................................ 2,389Percentage limitation..................................................... × 65%Percentage depletion limit .............................................. $ 1,553

Example continued on the next page

100% if acquired and placed in service 9/9/10–12/31/10

through 2012.

–2011,

does

9-2 2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook Real Estate Owners

mine whether the property conveyed is held primarily for sale in the ordinary course of business, and therefore is dealer property.• Schedule E is filed for a rental real estate activity that is not

subject to self-employment tax.• Schedule C is used to report rental activity as income or loss from

a trade or business if the rental houses are owned as inventory by a dealer.

• Schedule C is used to report rental activity of a qualified joint venture held by a husband and wife who elect to forgo partner-ship reporting under Section 761(f). Check the box on Line 1 of Schedule C. See Tab 6 of the 1040 Quickfinder® Handbook for more information on qualified joint ventures.

Not Rented For ProfitWhen property is not rented to make a profit, deductions for rental expenses are allowed only up to the amount of rental income. Any excess rental expense cannot carry forward to the next year. For more information about the rules for an activity not engaged in for profit, see Chapter 1 of Publication 535. See also the Rivera case discussed on Page 9-5.Where to report. Not-for-profit rental income is reported on Form 1040, line 21. Mortgage interest (if the use of the property is a main home or second home), real estate taxes and casualty losses are reported on the appropriate lines of Schedule A (Form 1040) if the taxpayer itemizes deductions. If the taxpayer does not itemize deductions, property taxes of up to $500 ($1,000 if MFJ) may be added to the basic standard deduction in 2009 [IRC §63(c)(1)]. Pending legislation may extend this benefit to 2010.Other rental expenses are claimed, subject to the rules explained in Chapter 1 of Publication 535, as miscellaneous itemized deductions on line 23 of Schedule A (Form 1040). The taxpayer can deduct these expenses only if they, together with certain other miscellaneous itemized deductions, total more than 2% of adjusted gross income. Postponing decision. If rental income is more than rental ex-penses for at least three years out of a period of five consecutive years, it is presumed the taxpayer is renting the property to make a profit. Taxpayers may choose to postpone the decision of whether the rental is for profit by filing Form 5213.

rental incOme and expenSe

Rental Income Gross income includes all amounts received as rent. Rental income is any payment received for the use or occupation of property. When to report. When to report rental income depends on whether the taxpayer is on the cash basis method or the accrual basis method. If the taxpayer is on the cash basis method, report rental income for the year the taxpayer actually or constructively receives it, regardless of when it was earned. Income is constructively received when it is made available. Examples include being credited to a bank account or receiving a check, even if the check is not yet deposited. An accrual basis method taxpayer generally reports income when it is earned, rather than when it is received. Expenses are deducted when they are incurred, rather than when they are paid.For more information about constructive receipt of income and accrual methods of accounting, see Pub. 538, Accounting Periods and Methods. Advance rent. Advance rent is any amount received before the period it covers and is included in income in the year received regardless of the period covered or the method of accounting used. [Reg. §1.61-8(b)]

Security deposits. A security deposit is not included in income when received if the taxpayer plans to return it to the tenant at the end of the lease [Indianapolis Power & Light Company, 65 AFTR 2d 90-394, (5 S.Ct. 1990)]. However, if part or all of the security deposit is kept during any year because the tenant does not live up to the terms of the lease; include the amount kept in income in that year. Note: If an amount called a security deposit is to be used as a final payment of rent, it is advance rent and therefore included in income when received. Payment for canceling a lease. If the tenant pays an amount to cancel a lease, the amount received is rent. Include the payment in income in the year it is received regardless of the taxpayer’s method of accounting. [Reg. §1.61-8(b)]Expenses paid by tenant. If the tenant pays any of the landlord’s expenses, the payments are rental income and must be included in income [Reg. §1.61-8(c)]. The expense can be deducted if it is a deductible rental expense.

Example # 1: Mike is the tenant and pays the water and sewage bill for Jimmy’s rental property and deducts it from the normal rent payment. Under the terms of the lease, Mike does not have to pay this bill. Jimmy will include the utility bill paid by Mike and any amount received as a rent payment in his rental income. Jimmy can deduct the utility payment made by Mike as a rental expense.Example # 2: While Jimmy is out of town, the furnace in Mike’s rental property stops working. Mike, the tenant pays for the necessary repairs and deducts the repair bill from the rent payment. Jimmy will include the repair bill paid by Mike and any amount received as a rent payment in his rental income. Jimmy can deduct the repair payment made by Mike as a rental expense.

Property or services. If the taxpayer receives property or services, instead of money, as rent, the fair market value of the property or services is included in rental income. If the services are provided at an agreed upon or specified price, that price is the fair market value unless there is evidence to the contrary.

Example: Jackie is Jill’s tenant. Jackie is a painter. Jackie offers to paint Jill’s rental property instead of paying two months’ rent. Jill accepts her offer.Jill includes in rental income the amount Jackie would have paid for two months’ rent. Jill can deduct that same amount as a rental expense for paint-ing her property.

Lease with option to buy. If the rental agreement gives the tenant the right to buy the rental property, the payment that is received under the agreement is generally rental income. If the tenant ex-ercises the right to buy the property, the payments received for the period after the date of sale are considered part of the selling price. Rental of property also used as a home. If the taxpayer’s rent property is also used as their home and they rent it fewer than 15 days during the tax year, do not include the rent received in income and do not deduct rental expenses [IRC §280A(g)]. However, the taxpayer can deduct on Schedule A (Form 1040) the interest, taxes and casualty and theft losses that are allowed for nonrental property. See Mixed-Use Property/Vacation Home discussed on Page 9-4. Part interest. If a part interest in rental property is owned, the taxpayer must report the proportionate amount of the rental income from the property.

Rental Expenses Law Change Alert: Beginning with payments made after 2010, IRS reporting requirements for rental expenses are expanded by the Small Business Jobs Act of 2010. For 2011, landlords must report payments of $600 or more per year to a service provider

9-12 2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook Restaurant Owners

Cash Reporting RequirementsAny business receiving more than $10,000 in cash in any one trans-action (or two or more related transactions) must file Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, within 15 days of the cash transaction [IRC §6050I(a)]. For these purposes, transactions are related if they are conducted within a 24-hour period, or if the business knows or has reason to know that each transaction is one in a series of related transactions. Cash includes U.S. coin and currency and foreign currency [IRC §6050I(d)]. Cashier’s checks, bank drafts, traveler’s checks and money orders having a face value of not more than $10,000 must be reported where meeting a designated reporting transaction test or received in a transaction in which the business knows the cash is being used in an attempt to avoid the reporting of the transaction. Designated reporting transactions include the retail sale of con-sumer durables, collectibles or travel and entertainment activities [Reg. §1.6050I-1(c)]. While it is unlikely that a restaurant will receive more than $10,000 in cash for a single transaction, the possibility that a patron may try to avoid the reporting requirements, coupled with the fact that a cash payment for entertainment is a designated reporting event, increases the likelihood that a restaurant may have to file Form 8300 at some point in time.

Example: Krooked has his daughter’s wedding reception at the Indigestion Restaurant at a cost of $11,000. He pays for the reception with cash (U.S. currency). Since the reception occurs in Indigestion’s trade or business and the payment involves cash in excess of $10,000, Form 8300 must be filed for this transaction. Variation: Now assume that Krooked pays for the reception with two $5,500 cashier checks from First Usury Bank and tells the Indigestion manager that he is doing so to avoid the Form 8300 filing requirement. Even though the checks individually are $10,000 or less, the restaurant knows that the transac-tion is structured to avoid the Form 8300 reporting requirements. Accordingly, Indigestion still must file a Form 8300 reporting the transaction.

depreciatiOn and amOrtizatiOnRestaurants are subject to the normal depreciation rules, includ-ing Section 179 expense and the special depreciation allowance. However, there are special rules for qualified restaurant property and leasehold improvements. Law Change Alert: Under the 2010 Small Business Jobs Act, assuming all other requirements are met, qualified real property (which includes qualified leasehold improvement property, quali-fied restaurant property and qualified retail improvement property) placed in service in tax years beginning in 2010 and 2011 are eligible for Section 179 expensing. See Qualified real property in the next column.

Qualified Restaurant PropertyQualified restaurant property placed in service in 2010 has a 39-year recovery period. Such property placed in service after October 22, 2004, and before January 1, 2010, is eligible for a 15-year recovery period.Qualified restaurant property is any Section 1250 (for example, depreciable realty) property that is a building or an improvement to a building if more than 50% of the building’s square footage is devoted to the preparation of, and seating for, on-premises con-sumption of prepared meals. [IRC §168(e)(7)] Note: Qualified restaurant property placed in service after October 22, 2004 and before January 1, 2009, only included building improvements placed in service more than three years after the building was first placed in service. For 2009 and 2010, buildings are also included and the three-year requirement is no longer applicable.

Qualified restaurant property is not eligible for additional 50% special (bonus) depreciation allowance. [IRC §168(e)(7)(B)]

Qualified Leasehold Improvement PropertyQualified leasehold property placed in service in 2010 has a 39-year recovery period. Such property placed in service after October 22, 2004, and before January 1, 2010, was depreciated over a 15-year period. Law Change Alert: The 2010 Small Business Jobs Act provides that qualified leasehold improvement property placed in service in 2010 is eligible for 50% special (bonus) depreciation.Qualified leasehold improvement property is a leasehold improvement that is: 1) Made to an interior portion of a nonresidential

building;2) Made pursuant to a lease by either the lessee,

sublessee or the lessor to property that is to be occupied exclusively by the lessee or sublessee and

3) Placed in service more than three years after the date the building was first placed in service.

An improvement made by the lessor is qualified leasehold improve-ment property only if the improvement is held by that person. How-ever, there are certain events that do not cause qualified leasehold improvements made by the lessor to lose their status (for example, death, Section 1031 exchanges, etc.). [See IRC §168(e)(6)(B).] Note: Both qualified restaurant property and qualified lease-hold improvement property must be depreciated on the straight-line method.

Section 179 ExpenseRestaurants may elect to currently deduct some or all of the cost of qualifying property that would otherwise be subject to depreciation. The Section 179 deduction is limited to a maximum annual amount ($500,000 for 2010 and 2011). The deduction is also limited by taxable income and is scaled back when the taxpayer places more than a certain amount ($2,000,000 for 2010 and 2011) of Section 179 property in service during the tax year.See Tab 10 of the 1040 Quickfinder® Handbook and Tab 5 of the Depreciation Quickfinder® Handbook for additional information on qualifying property and limits for the Section 179 deduction.Qualified real property. Qualified leasehold im-provement property, qualified restaurant property and qualified retail improvement property placed in service in tax years beginning in 2010 and 2011 are eligible for Section 179 expensing. Heating and air conditioning units are not eligible.The Section 179 election for these types of property is limited to $250,000 per year. Any Section 179 deduction for qualified real property that is unused due to the taxable income limit cannot be carried to a year beginning after 2011. Any carryforward remaining at the end of the tax year beginning in 2011 is treated as placed in service in that 2011 tax year. [IRC §179(f)]

Amortizing IntangiblesA significant portion of the restaurant industry is comprised of franchised restaurants. The acquisition of a franchise is governed by Section 197 and therefore the cost of a franchise is amortized ratably over 15 years. The 15-year amortization period applies regardless of the actual useful life of the Section 197 intangible. Franchise renewals must also be amortized over 15 years. For purposes of Section 197, a franchise is defined as the right to distribute, sell or provide goods, services or facilities within a specified area.

15

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15

2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook 10-7Retailers

æ Practice Tip: In its Audit Technique Guide for Cost Segre-gation, the IRS lists assets assigned a five-year recovery period because they are used in the retail business (Class 57.0 assets per Rev. Proc. 87-56). Many of these assets are part of or attached to a building and thus may be incorrectly depreciated over 39 years.

Qualified Retail Improvement PropertyFor 2010 and 2011, qualified retail improvement property is eligible for Section 179 expense. The Section 179 election for this type of property is limited to $250,000 per year. Any such Section 179 deduction unused by the end of 2011 is not carried forward, but treated as an asset placed in service in the 2011 tax year.Generally, building improvements are depreciated over 39 years. However, qualified retail improvement property placed in service in 2009 qualified for 15-year, straight-line depreciation [IRC §168(e)(3)(E)(ix)]. Qualified retail improvement property is any improvement to an interior portion of a build-ing that is nonresidential real property if: (a) that portion is open to the general public and is used in the retail trade or business of selling tangible personal property to the general public, and (b) that improvement is placed in service more than three years after the date the building was first placed in service [IRC §168(e)(8)(A)]. Qualified retail improvement property is not eligible for additional first-year 50% bonus depreciation, and the following improvements are not included: (a) the enlargement of the building, (b) any eleva-tor or escalator, (c) any structural component benefitting a common area or (d) the internal structural framework of the building. [IRC §168(e)(8)(C)]U Caution: The 15-year recovery period for qualified retail im-provement property expired at the end of 2009; however, Congress has proposed legislation reinstating the provision. Practitioners should continue to monitor this area for further developments.

Gas Stations and Convenience StoresBuildings and land improvements used primarily in the marketing of petroleum and petroleum products are classified as 15-year property under Rev. Proc. 87-56 (Asset Class 57.1). So, traditional gasoline service station buildings (that is, no convenience store attached) and related land improvements, including billboards and car washes, qualify as 15-year property.

Underground storage tanks, fuel dispensing pumps and other automobile service equipment are typically considered personal property and assigned a five-year recovery period under Rev. Proc. 87-56 (Asset Class 57.0).N Observation: A service station building that is movable personal property is property used in the retail business and assigned a five-year recovery (Asset Class 57.0). Gener-ally, only smaller structures (such as kiosks) will qualify. The critical factors are whether the structure is easily movable and constructed in a manner that reflects anticipation of the structure having to be moved. Even if there is no plan to move a modular structure, it is still assigned a five-year recovery period. Retail motor fuels outlet. Depreciable real property that is a re-tail motor fuels outlet is 15-year property [IRC §168(e)(3)(E)(iii)]. However, a retail motor fuels outlet is not eligible for the Section 179 deduction since it is Section 1250 property. Note: A building used for a business activity (such as a restaurant or convenience store) in addition to selling gas (or other petroleum-related products) doesn’t qualify as an asset used primarily in the marketing of petroleum and petroleum products (asset class 57.1). Thus, it must be depreciated over 39 years unless it can qualify as a retail motor fuels outlet. (Rev. Proc. 88-22)Real property is a retail motor fuels outlet if it is used to a substantial extent in the retail marketing of petroleum (or petroleum products) and meets any one of the following three tests:• It is 1,400 square feet or less.• 50% or more of the gross revenues generated from

the property are derived from petroleum sales.• 50% or more of the floor space in the property is

devoted to petroleum marketing activity.For purposes of determining whether a building qualifies as a retail motor fuels outlet, gross revenue includes all excise and sales taxes.A retail motor fuels outlet qualifies as 15-year property regardless of whether the owner is also the operator. However, the owner has to include the gross revenue of all businesses operated in the outlet building for the 50% test. (Rev. Rul. 97-29)

Assets Used in a Retail Business—Five Year Recovery Period (Continued)Per IRS Cost Segregation Audit Techniques Guide

Asset Description

Retail furniture Includes furniture unique to retail stores and distinguishable from office furniture. For example, a high stool in a cosmetic department, a shoe department footstool, a hair salon barber chair, or a bench outside a dressing room.

Ripening rooms Special enclosed equipment boxes used to ripen produce by circulating special gases. The rooms are large boxes with special doors and large airplane-type propellers, which circulate the gases used to ripen the produce. The boxes are housed within a distribution center warehouse. These specialized facilities are considered to be part of the retail distribution equipment because they have a special retail purpose and can not be used for any other purpose. The boxes are not a part of the building structure.

Security systems Electronic article surveillance systems including electronic gates, surveillance cameras, recorders, monitors and related equipment, the primary purpose of which is to minimize merchandise shrinkage due to theft. Also includes teller-style pass-through windows, security booths, and bulletproof enclosures generally located in the cash office and customer service areas.

Signs Interior and exterior signs used for display or theme identity. For example, interior signs to identify departments or exterior signs to display trade names or trade symbols. For pylon signs, includes only sign face.

Sound systems Equipment and apparatus, including wiring, used to provide amplified sound or music. For example, public address by way of paging a customer or background music. Excludes applications linked to fire protection and alarm systems.

Wall coverings Strippable wallpaper that causes no damage to the underlying wall or wall surface.

Walls—interior partitions

Interior walls for merchandise display where the partition can be (1) readily removed and remain in substantially the same condition after removal as before or (2) moved and reused, stored or sold in their entirety.

Window treatments Window treatments such as drapes, curtains, louver, blinds, post construction tinting and interior decorative theme décor which are readily removable.

2010

2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook 11-11Students—Higher Education

Other AOTC requirements:• Degree requirement. Student must be enrolled in a program that

leads to a degree, certificate or other recognized educational credential.

• Work load. Student must take at least half of the normal full-time work load for the student’s course of study for at least one academic period beginning during the tax year.

• No felony drug conviction. Student must be free of any felony conviction for possessing or distributing a controlled substance.

• Modified AGI phase-outs [IRC Sec. 25A(i)(4)]. The AOTC phases out for modified AGI between $160,000 and $180,000 for married joint filers and $80,000 to $90,000 for other qualified taxpayers.

Lifetime Learning CreditThe lifetime learning credit is a nonrefundable tax credit of 20% of up to $10,000 of qualified tuition and fees paid during the tax year. Maximum credit is $2,000.Other lifetime learning credit requirements:• Credit not workload-based. Allowed regardless of the number of

courses taken.• Both degree and nondegree courses eligible. Available for under-

graduate, graduate, professional degree students and students acquiring or improving their job skills.

• Unlimited number of years. There is no limit on the number of years for which the credit can be claimed for each student.

• Per return per year. The credit does not vary based on the number of students in a family.

• Modified AGI phase-outs (Rev. Proc. 2009-50). For 2010, the lifetime learning credit phases out for modi-fied AGI between $100,000 and $120,000 for married joint filers and $50,000 to $60,000 for other qualified taxpayers.

Example: Pam, a professional photographer, enrolls in an advanced photog-raphy course at a local college. The course is not part of a degree program, but Pam enrolls to improve her job skills. The expense qualifies for the lifetime learning credit (provided Pam does not claim a business expense for it).

AMT and the Education Tax CreditsFor 2010, the AOTC is allowed to offset AMT, but the lifetime learning credit will not be allowed against AMT (unless Congress decides to change the law). In 2011, neither credit is currently scheduled to offset AMT.

Coordination of Credits and ExclusionsEducation credits. A taxpayer may not claim both an AOTC and a lifetime learning credit for the same student in the same year.Education savings account (ESA) and qualified tuition pro-gram (QTP). A taxpayer can claim the AOTC or lifetime learning credit in the same year that the taxpayer excludes an ESA or QTP distribution from income as long as the same expenses are not used for both benefits. Qualified education expenses (QEE) are reduced in the following order:1) Amounts excluded from income such as scholarships and

employer-provided education assistance then2) Amounts used to claim education credits such as the AOTC

and lifetime learning credits.Thus, if an education credit is claimed, QEE are first allocated to the credit, and any remaining QEE go toward computing the tax-able amount of the distribution.If a student receives distributions from both an ESA and a qualified tuition program that are more than the remaining expenses, the expenses must be allocated between the distributions.Tuition and fees deduction. Should the above-the-line deduction for qualified tuition and feed be extended beyond 2009 (currently

expired at end of 2009), a taxpayer may not claim the deduction if the AOTC or lifetime learning credit is claimed for the same student in the same year [IRC §222(c)(2)(A)]. The taxpayer may claim either the credit or the deduction, whichever is more advantageous. Education savings bond program. The amount of education expenses used to compute the AOTC or lifetime learning credit reduces the amount used in computing the exclusion of interest on Series EE or Series I U.S. savings bonds. [IRC §135(d)(2)]Educational assistance program. Qualified education expenses are reduced by any tax-free educational assistance received.

Form 1098-TTo help compute the education credits, taxpayers should receive Form 1098-T from the educational institution by January 31 of the following year. An institution may choose to report either payments received (box 1), or amounts billed (box 2), for qualified education expenses. In addition, Form 1098-T should provide other informa-tion for that institution, such as adjustments made for prior years, the amount of scholarships or grants, reimbursements or refunds and whether the student was enrolled at least half-time or was a graduate student. The eligible educational institution may ask for a completed Form W-9S, Request for Student’s or Borrower’s Taxpayer Identifica-tion Number and Certification, or similar statement to obtain the student’s name, address and taxpayer identification number.

Comparing the Education Credits (2010)American Opportunity Tax Credit Lifetime Learning Credit

Up to $2,500 credit per eligible student. Up to $2,000 credit per return.Available for the first four years of post-secondary education.

Available for all years of postsecondary education and for courses to acquire or improve job skills.

Available only for four years per eligible student.

Available for an unlimited number of years.

Student must be pursuing an undergraduate degree or other recognized education credential.

Student does not need to be pursuing a degree or other recognized education credential.

Student must be enrolled at least half time for at least one academic period beginning during the year.

Available for one or more courses.

No felony drug conviction on student’s record.

Felony drug conviction rule does not apply.

Example—Claiming Both Education Credits on ReturnCarter and Ann Wiggins are married and file a joint tax return. For 2010, they claim exemptions for their two de-pendent children and their modified AGI is $98,000. Their itemized deductions consist of $42,000 mortgage interest and charitable contributions. Their tax, before credits, is $5,373. Their son, Stanley, will receive his graduate (post-four year) degree in psychology from the State College in May 2011. Their daughter, Claire, enrolled full-time at that State College in August 2009 to begin working on her bachelor’s degree in physical education. In July 2010, the Wiggins paid $2,200 in tuition costs for each child for the Fall 2010 semester. In December 2010, they also paid $2,600 of tuition for each child for the Spring 2011 semester that begins in January. Carter and Ann, their children and the college meet all of the requirements for the education credits.• Because Stanley is obtaining his graduate (master’s) degree and

is beyond the first four years of his postsecondary education, his expenses do not qualify for the AOTC. But, amounts paid for his expenses in 2010 for academic periods beginning in 2010 and the first three months of 2011 qualify for the lifetime learning credit.

Continued on the next page

For 2010, the AOTC and lifetime learning credits can offset AMT.

tuition and fees

11-16 2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook Students—Higher Education

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te an

d gr

adua

te lev

els.

All u

nder

grad

uate

and

grad

uate

levels

.El

emen

tary,

seco

ndar

y, un

derg

radu

ate an

d gr

adua

te lev

els.

Othe

r Rul

es an

d Re

quire

men

tsMu

st be

enro

lled

at lea

st ha

lf-tim

e in

a deg

ree p

rogr

am;

pare

nts ca

n shif

t cre

dit

to stu

dent

by no

t cla

iming

stud

ent a

s a

depe

nden

t.

Avail

able

for un

limite

d nu

mber

of ye

ars f

or

both

degr

ee an

d no

n-de

gree

prog

rams

; pa

rents

can s

hift c

redit

to

stude

nt by

not

claim

ing st

uden

t as a

de

pend

ent.

Pena

lty w

aived

on

distrib

ution

s up t

o the

am

ount

of qu

alifie

d ex

pens

es fo

r the

ye

ar.

Appli

es on

ly to

quali

fied S

eries

EE

bond

s iss

ued a

fter

1989

or S

eries

I bon

ds;

bond

owne

r mus

t be

at lea

st 24

year

s old

when

bond

issu

ed.

Must

be en

rolle

d at

least

half-t

ime i

n a

degr

ee pr

ogra

m; lo

an

must

be in

curre

d so

lely t

o pay

quali

fied

educ

ation

expe

nses

.

Not a

llowe

d if e

duca

tion

expe

nses

are d

educ

ted

unde

r ano

ther p

rovis

ion

or ed

ucati

on cr

edit i

s cla

imed

.

Acco

unt o

wner

can

chan

ge be

nefic

iary

or re

claim

fund

s; ca

n ele

ct to

spre

ad gi

ft ov

er fiv

e yea

rs; so

me

states

allow

dedu

ction

to

resid

ents;

bene

ficiar

y ca

n be a

nyon

e.

Contr

ibutio

ns m

ust b

e ma

de by

the o

rigina

l re

turn d

ue da

te; m

ay

also c

ontrib

ute to

QTP

; ma

ndato

ry dis

tributi

ons a

t ag

e 30;

bene

ficiar

y can

be

anyo

ne.

2010

Mod

ified

AGI

Ph

ase-

Out

Not a

llowe

d if M

AGI

exce

eds:4

MFJ ..

........

........

........

...$

160,0

00 –

180,0

00$

100,0

00 –

120,0

00N/

A$

105,1

00 –

135,1

00$

120,0

00 –

150,0

00$

160,0

00N/

A$

190,0

00 –

220,0

00Si

ngle,

HOH

, QW

6 ......

8

0,000

– 9

0,000

5

0,000

– 6

0,000

7

0,100

– 8

5,100

6

0,000

– 7

5,000

8

0,000

9

5,000

– 11

0,000

MFS .

........

........

........

...Do

Not

Quali

fyDo

Not

Quali

fyDo

Not

Quali

fyDo

Not

Quali

fyDo

Not

Quali

fy

95,0

00 –

110,0

001 N

ot re

funda

ble fo

r cer

tain c

hildr

en un

der a

ge 24

. See

Am

erica

n Op

portu

nity T

ax C

redit

(Pre

vious

ly Kn

own

as th

e Ho

pe C

redit

) on P

age 1

1-10

.2 C

ourse

mate

rials

includ

e boo

ks, s

uppli

es, a

nd eq

uipme

nt ne

eded

for a

cour

se of

stud

y whe

ther o

r not

the m

ateria

ls ar

e pur

chas

ed fr

om th

e edu

catio

nal in

stitut

ion as

a co

nditio

n of e

nroll

ment.

3 Qua

lifying

educ

ation

al ex

pens

es m

ust b

e red

uced

by an

y tax

-free

scho

larsh

ips an

d gra

nts. T

he sa

me ed

ucati

onal

expe

nses

cann

ot be

used

for f

igurin

g mor

e tha

n one

bene

fit.4 N

o AGI

phas

e-ou

t ran

ge. U

p to $

4,000

is de

ducti

ble if

MAGI

does

not e

xcee

d $65

,000 (

$130

,000 f

or M

FJ).

Up to

$2,00

0 is d

educ

tible

if MAG

I doe

s not

exce

ed $8

0,000

($16

0,000

for M

FJ).

5 Mus

t be p

aid to

the e

ligibl

e edu

catio

nal in

stitut

ion as

a co

nditio

n of th

e stud

ents

enro

llmen

t or a

ttend

ance

at th

e ins

titutio

n.6 M

ust b

e req

uired

for e

nroll

ment

or at

tenda

nce a

t an e

ligibl

e edu

catio

nal in

stitut

ion.

7 For

savin

gs bo

nd in

teres

t exc

lusion

, QW

is su

bject

to the

same

phas

e-ou

t ran

ge as

MFJ

.8 E

xpire

d afte

r 200

9; mo

nitor

tax l

egisl

ation

for p

ossib

le ex

tensio

n to 2

010.

2010 Tax Year | Individuals—Special Tax Situations Quickfinder® Handbook 12-23Other Taxpayers

real eState agentS

Statutory NonemployeeA statutory nonemployee is a worker who by definition in the Code is treated as an independent contractor for tax purposes regardless of the actual payer-worker relationship. (See Tab 10 for information on statutory employees.) Thus, a business employing a statutory nonemployee does not withhold federal income tax or Social Security and Medicare (FICA) taxes nor does it pay federal unemployment (FUTA) taxes with respect to the worker.Qualified real estate agents are one of two categories of statu-tory nonemployees (the other being direct sellers—see Tab 3) [IRC §3508(a)]. Qualified real estate agents are treated as self-employed for all federal tax purposes, including income and employment taxes. Qualified real estate agent. To be a qualified agent, the individual must:1) Hold a valid current real estate license.2) Be paid substantially (at least 90%) by com-

missions on sales or other services performed as a real estate agent in connection with the sale of an interest in real property.

3) Have a written agreement with the payer stating the agent will not be treated as an employee for federal tax purposes. [Prop. Reg. §31.3508-1(b)]

Services performed as a real estate agent in connection with the sale of an interest in real property include the advertising or show-ing of real property, the acquisition of a lease to real property and the recruitment, training or supervision of other real estate persons. Such services also include appraisal activities in connection with a sale. However, property management activities are not considered services performed as a real estate agent.

Example: Sally Black works as a real estate agent for Realty Associates. Sally works daily and has a stipulated number of office hours each week during which she must be available in the office to handle incoming calls or customers. Sally is a licensed agent paid strictly on a commission basis. Her written contract with Realty Associates states she is not an employee. Is Sally an employee of Realty Associates or an independent contractor?Under each federal payroll tax statute, there are two statutory nonemployee occupations: qualified real estate agents and direct sellers. Here, Sally meets the requirements for a qualified real estate agent. Accordingly, Sally is an independent contractor, not an employee, of Realty Associates for federal income tax withholding (FITW), FICA and FUTA purposes. Realty Associates treats Sally’s compensation as contract labor.

1040 ReportingSchedule C. Since they are treated as independent contractors, qualified real estate agents report their income and deductions on Schedule C of Form 1040. (Pub. 334)Schedule SE. Since they are treated as self-employed for all purposes, qualified real estate agents are also liable for self-employment taxes. Therefore, their net income from Schedule C is carried to Schedule SE.

teacherS

Educator's Expense Deduction Law Change Alert: The educator’s expense deduction ended in 2009. However, proposed legislation would revive this deduction. Tax preparers should watch for further developments. The following discussion applies to 2009, but will be helpful if the deduction is reinstated for 2010.

For 2009, an eligible educator is allowed an above-the-line deduc-tion of up to $250 for classroom expenses paid during the tax year [IRC §62(a)(2)(D)]. Taxpayers who are both eligible educators and filing a joint return are each eligible for the $250 deduction, for a total of $500 on the return. However, neither spouse can deduct more than $250 of his own expenses.Eligible expenses include:• Books.• Supplies (other than nonathletic supplies for

courses of instruction in health or physical educa-tion).

• Computer equipment (including related software and services).

• Other equipment and supplementary materials used by the educator in the classroom.

These expenses must be ordinary and necessary employee busi-ness expenses. An ordinary expense is one that is common and ac-cepted in the educational field. A necessary expense is one that is helpful and appropriate for the profession of being an educator. An expense does not have to be required to be considered necessary.Eligible expenses must be reduced by the following amounts:• Excludable U.S. series EE and I savings bond interest from Form

8815. • Nontaxable qualified tuition program earnings. • Nontaxable earnings from Coverdell education savings accounts. • Any reimbursements received for these expenses that were not

reported in box 1 of the educator’s Form W-2. An eligible educator is:• Teacher, instructor, counselor, principal or aide and• Who worked in a K–12 school (as determined under state law)

for at least 900 hours during a school year. [IRC §62(d)(1)(A)]N Observation: The school year is used in determining if an individual meets the 900-hour requirement for defining an eligible educator, whereas the deduction is for expenses paid during the tax year. Because a school year spans two tax years, an individual who qualifies as an eligible educator for either the 2008–2009 or 2009–2010 school year is eligible for the deduction for the 2009 tax year. Form 1040 reporting. The educator’s expense deduction is claimed on line 23 of Form 1040. Itemizing deductions is not necessary to claim it.If the ordinary and necessary educator expenses are over $250, the excess is deductible on Schedule A as a miscellaneous itemized deduction subject to the 2%-of-AGI floor. Complete Form 2106 for unreimbursed employee business expenses.

Example: Seth, age 25 and single, is a seventh-grade history teacher. Dur-ing 2009, he incurs $300 for supplemental classroom materials and supplies that are not reimbursed by his employer. Seth deducts $250 on line 23 of his 2009 Form 1040. If Seth's marginal federal rate is 15%, this saves $38; if his marginal federal rate is 25%, the savings are $63.The remaining $50 is deductible on Schedule A as a miscellaneous itemized deduction (subject to the 2%-of-AGI floor).

Personal Educational ExpensesIt’s not uncommon for teachers to incur education expenses related to their job. Education expenses can be claimed, subject to certain limits and requirements, as either:• Educator’s expense deduction (see preceding discussion).• Education credit.• Tuition and fees deduction.

Continued on the next page

2010

or 2010–2011 2010

2010

2010