Taxpayer Penalized for Wasting Court’s Time

Taxpayer, a self-employed hearing aid specialist, claimed he had no taxable income and made no estimated tax payments on his 2006 and 2007 tax returns. Through third-party information returns and a bank account analysis, the IRS determined he had unreported business receipts of $209,331 for 2006 and $279,600 for 2007. The IRS found his tax returns to be invalid and prepared substitute returns with notices of deficiency. The taxpayer argued he was not subject to tax because he was not involved in a trade or business. Finding him liable for the deficiencies, the Tax Court’s Judge Marvel said, “without exception, petitioner has raised only frivolous and groundless arguments.” In addition to the tax deficiency, penalties of $30,000 were assessed for wasting the time and resources of the Court. John Lewis Hill , TC Memo 2013-264 (Tax Ct.)

Taxpayers, a married couple, were disallowed the qualified mortgage interest deduction for the interest they paid on a loan from the wife’s mother. After purchasing a house, the couple later signed a document described as a “mortgage note” promising to pay the wife’s mother monthly interest payments plus the full principal amount of $427,333. The Tax Court held that the interest was not deductible because the loan was not recorded and did not meet the requirements to be secured debt. However, the couple was not liable for the 20% accuracy-related penalty because they acted with reasonable cause and made a good-faith effort to properly determine their tax liability. Christopher DeFrancis , TC Summ. Op. 2013-88 (Tax Ct.)

Year-end tax planning could be especially productive this year because timely action could nail down a host of tax breaks that won’t be around next year unless Congress acts to extend them, which, at the present time, looks doubtful. These include, for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line deduction for qualified higher education expenses; and tax-free distributions by those age 70-1/2 or older from IRAs for charitable purposes. For businesses, tax breaks that are available through the end of this year but won’t be around next year unless Congress acts include: 50% bonus first year depreciation for most new machinery, equipment and software; an extraordinarily high $500,000 expensing limitation; the research tax credit; and the 15-year writeoff for qualified leasehold improvements, qualified restaurant buildings and improvements and qualified retail improvements.

High-income-earners have other factors to keep in mind when mapping out year-end plans. For the first time, they have to take into account the 3.8% tax surtax on unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax that applies to individuals receiving wages with respect to employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).

The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and net investment income (NII) for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than unearned income, and others will need to consider ways to minimize both NII and other types of MAGI.

The Social Security Administration announced the wage base for computing Social Security tax for 2014 will increase to $117,000 from the 2013 wage base of $113,700. This means that, for 2014, the maximum OASDI portion of the FICA tax an employee will pay is $7,254 ($117,000 x 6.2%), and employers will match the employee’s contribution. There is no wage base on the Medicare portion of the tax, so both employers and employees will pay Medicare tax on all wages at a rate 1.45%. Employees with wages greater than $200,000 will pay an additional Medicare tax of 0.9%. It is estimated that of the 165 million workers that will pay Social Security taxes in 2014, about 10 million will pay higher taxes because of the increased wage base.