Individual taxation: digest of recent developments.

• Author: Cook, Ellen D.

This article covers recent significant developments affecting taxation of individuals, including legislative changes, cases, regulations, and other IRS guidance. The items are arranged in Code section order.

The Treasury Inspector General for Tax Administration (TIGTA) semiannual report to Congress for the period October 2008-March 2009 includes a recommendation that legislation is needed to clarify whether refundable tax credits, such as the additional child tax credit, may be paid to filers without valid Social Security numbers. (1) Currently, an individual taxpayer identification number (ITIN) is available to any resident or nonresident alien who is unable to obtain an SSN but has a tax return filing requirement. Each year the IRS approves billions of dollars in tax credits claimed by ITIN filers without adequate verification of eligibility. In tax year 2007, for example, more than 1.2 million (66%) ITIN filers received additional child tax credits of $1.8 billion. The TIGTA report says payment of federal funds to ITIN filers is inconsistent with federal law and policy.

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Specifically, TIGTA recommends that the IRS develop processes to:

* Identify individuals who are improperly using ITINs for work purposes and develop outreach efforts with the Social Security Administration to address the improper use;

* Limit the automatic population feature for ITIN tax returns;

* Ensure that accurate tax information is put into the IRS systems from both paper and electronically filed ITIN tax returns; and

* Ensure that the requirements for the child tax credit and the additional child tax credit are met on ITIN returns claiming the credits.

Further, in cases in which the credits may not be paid, TIGTA recommends that the IRS be given math error authority to disallow associated claims for credits. The IRS management agrees with the recommendation.

The IRS management agreed to continue to work with software companies to limit the auto-populate feature and also agreed to work with Treasury's Office of Tax Policy to consider legislation to limit claims for the additional child tax credit to taxpayers with an SSN. However, the IRS disagreed with the other recommendations, although the report says TIGTA does not believe that the IRS management provided adequate justification for the disagreement.

Sec. 24: Child Tax Credit

A bankruptcy court has held that a non-refundable child tax credit is not exempt property under state law in Colorado. (2) It disallowed a couple's claimed exemption for that amount and ordered the couple to turn over the pre-petition portion of their 2008 income tax refund to the bankruptcy estate.

Sec. 25: Interest on Home Mortgages

The Government Accountability Office (GAO), in a July 2009 report, made seven recommendations to the IRS regarding home mortgages: (3)

* Revise the National Research Program's case selection system so a tax return's mortgage interest deduction is not automatically excluded as an examination issue if it matches information reported on Form 1098, Mortgage Interest Statement;

* Revise Form 1098 to require third parties to provide information on mortgage balances, the address of a home securing a mortgage, and an indicator of whether the mortgage is for a current-year refinancing;

* Investigate whether using information from private sources would be productive in detecting mortgage interest non-compliance, especially for home equity debt;

* Revise the wording on Schedule A, Itemized Deductions, to clearly state that the mortgage interest deduction is subject to limitations;

* Conduct a test to evaluate whether mortgage interest deduction-related outreach programs to taxpayers and tax return preparers could be a cost-effective way to reduce noncompliance. Outreach might include sending correspondence covering key rules and common mistakes or promoting seminars on common types of misreporting;

* Set a date to complete the Chief Counsel determination on whether the acquisition debt limit is $1 million or $1.1 million when used in combination with the home equity debt limit; and

* Revise examiner training materials by adding examples cited as common problems by auditors and paid tax return preparers, such as those involving multiple homes or home-based businesses. After the Chief Counsel's final determination on the acquisition limit, revise examiner training and the worksheet in guidance to reflect the project's outcome.

The GAO received written comments from the IRS on July 23, 2009. The IRS agreed with five of the recommendations and agreed to study the other two.

The IRS acknowledged that without information about taxpayers' mortgage debts, it cannot easily detect taxpayer noncompliance with the mortgage interest deduction limits. It also said that the absence of information about noncompliance prevents it from efficiently deciding how to select cases for review and noted that the complexity of the rules causes problems for some taxpayers.

Regarding the recommendation to revise Form 1098 to include more information on taxpayer mortgages, the IRS agreed to study the issue, saying it does not have enough data to support revisions at this time. Because the IRS acknowledged in its comments that it does not have information about taxpayers' mortgage debts to easily detect noncompliance, the GAO believes that the recommended revisions to Form 1098 would be cost-effective ways to provide the IRS with additional useful information to help it detect noncompliance.

Concerning the recommendation to conduct a test to evaluate whether mortgage interest deduction-related outreach programs could be a cost-effective way to reduce noncompliance, the IRS said it would study the feasibility of such a test. It also addressed the question of whether the acquisition debt limit is $1 million or $1.1 million in chief counsel advice released in October, discussed in the coverage of Sec. 163 on p. 183.

Sec. 32: Earned Income Credit

The TIGTA semiannual report to Congress includes a recommendation that the IRS conduct a study to identify alternative processes that will expand its ability to effectively and efficiently identify and adjust erroneous earned income tax credit claims. (4)

TIGTA also recommended that the IRS work with the Assistant Secretary of the Treasury for Tax Policy to obtain the authority necessary to implement alternative processes to adjust erroneous earned income tax credit claims. The IRS management agreed with the recommendations and has planned appropriate corrective actions.

Sec. 36: First-Time Homebuyer's Credit

The Worker, Homeownership, and Business Assistance Act of 2009, (5) signed into law on November 6, 2009, extended the first-time homebuyer's credit, which had been set to expire on November 30, 2009. The act provides that taxpayers who enter into a binding contract before May 1, 2010, to close on the purchase of a principal residence before July 1, 2010, are eligible for the $8,000 credit.

Income limitations to qualify for the credit were increased so that the credit phases out for individual taxpayers with modified adjusted gross income between $125,000 and $145,000 ($225,000 and $245,000 for joint filers) for the year of purchase. Further, taxpayers may elect to treat the purchase of a principal residence in 2009 or before the new deadline in 2010 as made on December 31 of the calendar year preceding the purchase. Finally, no credit is allowed for taxpayers under age 18 on the date of the purchase or for the purchase of any residence costing more than $800,000.

The law expands the credit to include "long-time residents of the same principal residence" for purchases made after November 6, 2009, the effective date of the new provisions. That is, taxpayers who have owned and used the same residence as their principal residence for any five-year consecutive period during the previous eight-year period ending with the date on which the new residence is purchased are eligible for a $6,500 credit. The new phaseouts and age/cost limitations also apply.

Military families are provided some relief; the credit recapture rules are waived for members of the U.S. uniformed services (Army, Navy, Air Force, Marines, Coast Guard, and commissioned corps of the U.S. Public Health Service and...