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Taxation of Long-term Care Insurance Proceeds
A qualified long-term care insurance contract is generally
treated as an accident and health insurance contract for income tax purposes.
Amounts received under a qualified long-term care insurance contract (other
than policyholder dividends or premium refunds) may be excludable from
income as amounts received for personal injury and sickness. The premiums
on long-term care insurance contracts and the expenses of qualified long-term
care are treated as medical expenses.
Example: Income exclusion for long-term care insurance
payments.
Joe is confined to a nursing home for 30 days in
2010. The nursing home charges $210 per day, for a total of $6,300. Joe's
long-term care insurance contract pays 80% of the amount charged by the
home after a 10-day waiting period, so the insurance company sends him
a check for $3,360 {[$6,300 - (10 x $210)] x 80%}. The $3,360 is excluded
from Joe's 2010 taxable income. Furthermore, Joe can deduct the $2,940
unreimbursed difference ($6,300 $3,360) as a medical expense, subject
to the adjusted gross income limitation.
Some long-term care insurance contracts pay a certain
amount per day, regardless of the actual long-term care costs. However,
the exclusion from taxable income is limited. For 2010, the excludable
amounts are $290 per day or $105,850 ($290 x 365) for the year. However,
long-term care insurance proceeds received on a per diem basis can be
excluded from income (even if they exceed the limits) if the taxpayer
has long-term care expenses in excess of the cap. For example, there would
be no income to the taxpayer if the policy paid $300 per day and the cost
of the long-term care facility was that amount or more. Otherwise, amounts
received in excess of the dollar cap are fully taxable. However the per
diem limitation does not apply if the taxpayer is terminally ill when
the insurance payments are received.
Tax Calendar
April 15- Besides being the last day to file (or extend) your
2009 personal return and pay any tax that is due, 2010 first quarter estimated
tax payments for individuals, trusts, and calendar-year corporations are
due today. So are 2009 returns for trusts and calendar-year estates, partnerships,
and LLCs, plus any final contribution you plan to make to an IRA or Education
Savings Account for 2009. SEP and Keogh contributions are also due today
if your return is not being extended.
-If you need to file a 2009
gift tax return, it also must be filed or extended by this date.
-If you paid cash wages
of $1,700 or more in 2009 to a household employee, you must file Schedule
H by this date. You may also have to report any federal unemployment tax
paid and any income tax you withheld for your household employees.
-Most employers must file Form 941 (Employer's Quarterly
Federal Tax Return) to report Medicare, social security, and income taxes
withheld in the first quarter of 2010. (If your tax liability is less
than $2,500, you can pay it in full with a timely filed return.) If you
deposited the tax for the quarter in full and on time, you have until
May 10 to file the return.
June I5- Second quarter estimated tax-payments for individuals,
trusts, and calendar year corporations are due today.
National Taxpayer Advocate
Reports to Congress
In her recent report to Congress, National Taxpayer
Advocate Nina Olson warned that increased demands on the IRS have eroded
the Service's ability to meet taxpayer service needs, and she expressed
concern that IRS collection practices have harmed financially struggling
taxpayers without producing significant revenue gains. She indicated the
IRS's declining ability to answer telephone calls and the current (automated)
tax lien filing procedures as the most serious problems facing taxpayers.
Olson noted that the IRS has set a target for FY 2010 of answering only
71 % of calls from taxpayers seeking to speak with a customer service
representative about account questions, down from 83% in FY 2007. "This
level of service is unacceptable," she noted.
Among other topics, the report questioned the IRS's"
pay refunds first, verify eligibility later" approach to return processing
and the wisdom of running social programs through the tax system. On a
positive note, Olson praised the IRS for successfully implementing significant
legislative changes designed to stimulate the economy in the midst of
the filing season.
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Medical
Deduction for Personal Care Products
A recent IRS information release contains some practical
guidance concerning the deduction of some personal care items as medical
expenses. Although the information release does not constitute an official
ruling, it does guide taxpayers concerning deductibility of certain items.
The release states that two of the factors indicating that an otherwise
personal expense is for medical care are the taxpayer's reason for buying
the item and whether a physician has recommended the item to treat a diagnosed
medical condition. The taxpayer also must establish that the item would
not have been bought but for the disease or illness. This information
release notes that treatments for acne, incontinence, arthritis,
Reduction of Seller-financed Debt
Many residential and commercial real estate owners have
experienced a reduction in property values during the recent economic
downturn. So much so that owners may want to renegotiate the original
purchase terms of seller-financed real estate deals. In this situation,
a special rule may apply when seller-financed (i.e., purchase money) debt
on the property purchased is reduced. This rule applies only if the creditor
is the original seller of the property, the debt arose from the debtor's
purchase of the property, and the purchaser (debtor) would recognize debt
discharge income except for this provision (i.e., the purchaser is not
bankrupt or insolvent and did not make a qualified real property debt
election).
If these conditions are satisfied, the purchaser reduces
the basis in the property acquired with the seller-financed debt and does
not recognize debt discharge income (see the example below). This treatment
is not elective; it is mandatory if the three requirements listed in the
previous paragraph are met.
Example: Reduction of seller-financed residential mortgage.
Stella bought her residence from Fran in 2006 for $135,000.
Fran financed the transaction by taking-back a $125,000 recourse mortgage
from Stella in addition to receiving a $10,000 cash down payment. Fran's
basis in the property at the time of sale was $75,000. Fran uses the installment
method to recognize her profit on the sale over the period of time she
receives payments from Stella. Stella made her payments to Fran until
early 2010. She then threatened to abandon the property unless Fran reduced
the remaining mortgage debt because the property had substantially decreased
in value.
Fran agreed to reduce the remaining balance of Stella's
mortgage from $121,000 to $100,000, and Stella agreed to make payments
to Fran under a revised loan amortization schedule. Stella was solvent
at the time of the debt reduction.
Stella must reduce her basis in the home by $21,000
to reflect the reduction in the purchase money debt owed to Fran. Stella
does not recognize any debt discharge income because the debt arose from
the purchase of the property, the original seller of the property held
the obligation that was reduced, and Stella was solvent at the time.
So, there is no immediate tax impact on Stella resulting
from the renegotiated transaction.
Regulatory guidance indicates
that both parties must reflect any adjustment to seller-financed debt
for tax basis purposes, so Fran must also make an adjustment to reflect
the new terms. She has been recognizing her profit over time, as payments
are received, using the installment method. In this case, there are no
immediate tax ramifications on Fran. But she must recompute, and in this
case lower, the profit percentage of each payment to reflect the $21,000
($121,000-$100,000) seller-financed mortgage reduction. Accordingly,
the tax impact will occur over the term of the loan as Fran receives payments
from Stella.
As with most business transactions, it is a good policy
to review the tax and legal aspects prior to closing. So, please call
us to discuss any business tax planning or compliance issue.
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Deducting Interest on S Corporation Stock Debt
Maximizing deductible interest expense is generally
a good tax planning strategy for most taxpayers. One category of interest
expense that can be deductible is interest paid on debt to finance the
purchase of S corporation stock. Specifically, interest on shareholder
level debt used to purchase S corporation stock from another shareholder
(i.e. the corporation does not receive the cash) can qualify as deductible
business interest if certain conditions are satisfied. In contrast,
interest expense on debt used to finance the purchase of stock in a C
corporation is considered investment interest because the debt proceeds
are used to acquire property (C corporation stock) that generates investment
income (dividends) to the shareholder.
Interest expense on debt incurred to purchase stock
in an S corporation may be treated as deductible business interest when
certain conditions are met. As a result of applying debt allocation procedures,
the shareholder's debt will be attributed to the S corporation's trade
or business, passive activities, or investment activities. The shareholder's
interest expense will then be subject to the specific rules applicable
to each category. (See the following example.)
Example: Acquisition of S corporation stock from another
shareholder.
Using borrowed money, Linda acquired 5% of the outstanding
stock in Essco, Inc., an S corporation, from Leon for $25,000. Linda incurred
$3,000 of interest expense on the loan. The corporation manufactures hydraulic
hose assemblies and owns manufacturing equipment with a fair market value
(FMV) of $200,000. Linda materially participates in the business and there
have been no debt-financed distributions.
Accordingly,
Linda could allocate her $25,000 debt to the S corporation's manufacturing
equipment. As a result, Linda's $3,000 interest expense is treated as
a business interest expense.
Note that debt proceeds must be reallocated among the
S corporation's assets as either the assets or the use of the assets changes.
So, the allocation could change from year to year.
Please contact us if you have questions related to the
deductibility of interest or any other tax planning or compliance issue.
The
Tax and Business Alert is designed to provide accurate information regarding
the subject matter covered. However, before completing any significant
transactions based on the information contained herein, please contact
us for advice on how the information applies in your specific situation.
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