Individual taxation report: recent developments.

• Author: Auerbach, Art

This article covers recent developments affecting taxation of individuals, including the health care reform and other legislation, regulations, cases, and IRS guidance. The items are arranged in Code section order.

Sec. 25A: Hope and Lifetime Learning Credits

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The Government Accountability Office (GAO) has suggested that Congress grant the IRS the authority to use prior-year tax returns to verify a taxpayer's eligibility for the Hope credit. (1) In addition, the GAO has made the following recommendations to the IRS to reduce taxpayer confusion and increase compliance with the eligibility requirements for higher education benefits:

* Determine the feasibility of using current information reported on Form 1098-T, Tuition Statement, such as school location and taxpayer identification number or Social Security number, in the IRS's compliance programs; and

* Revise Form 1098-T to improve the usefulness of information on qualifying education expenses.

Sec. 32: Earned Income Credit

The Tax Court held that an individual who was incarcerated at a maximum security correctional facility was not entitled to an earned income credit. (2) Sec. 32(c)(2)(B)(iv) excludes wages earned while an individual is an inmate at a penal institution from the definition of earned income for purposes of the credit. In addition, the taxpayer was liable for the accuracy-related penalty. He did not have reasonable cause to believe that he was entitled to the credit and did not act in good faith within the meaning of Sec. 6664(c)(1) in claiming the credit.

Sec. 36: First-Time Homebuyer Credit

A series of letters issued by the IRS in April clarified various issues related to the first-time homebuyer credit. The Office of Chief Counsel advised that the Sec. 6111 general interest rules applicable to overpayments of tax apply to the first-time homebuyer credit. (3)

The Homebuyer Assistance and Improvement Act of 2010, (4) enacted July 2, extended the deadline to qualify for the first-time homebuyer credit from June 30, 2010, to September 30, 2010. Under Sec. 36 (before amendment), the credit was available only to qualifying homebuyers who bought a principal residence on or after April 9, 2008, and on or before April 30, 2010, or who entered into a written binding contract on or before April 30, 2010, to close on the purchase of a principal residence on or before June 30, 2010. Because of delays due to a number of reasons largely outside their control, many qualifying homebuyers who entered into binding contracts on or before April 30 were unable to close on their residences by the original June 30 deadline. The act extended the deadline for closing to September 30 (but it did not change the April 30, 2010, contract deadline).

Sec. 36B: Refundable Credit for Coverage Under a Qualified Health Plan

The Patient Protection and Affordable Care Act (5) (Patient Protection Act) provides for a refundable tax credit that eligible taxpayers can use to help cover the cost of premiums for health insurance purchased through a state health benefit exchange (which each state is required to establish under the act). Under new Sec. 36B, an eligible individual will enroll in a plan offered through an exchange and report his or her income to the exchange. Based on the information provided to the exchange and his or her income, the individual will receive a premium assistance credit. Treasury will pay the credit amount directly to the insurance plan in which the individual is enrolled. The individual will then pay to the plan in which he or she is enrolled the dollar difference between the premium tax credit amount and the total premium charged for the plan. Alternatively, eligible individuals can pay for the insurance out of pocket and then claim the credit on their tax returns.

Eligibility for the premium assistance credit is based on the individual's income for the tax year ending two years prior to the enrollment period. The premium assistance credit is available for individuals (single or joint filers) with household incomes between 100% and 400% of the federal poverty level (for the family size involved) who do not receive health insurance through an employer or a spouse's employer. The credit amount is determined by the secretary of Health and Human Services, based on the amount by which premiums exceed a threshold amount. The threshold rises from 2% of income for those at 100% of the federal poverty level for the family size involved to 9.5% of income for those at 400% of the federal poverty level for the family size involved.

The Health Care and Education Reconciliation Act of 2010 (6) (Reconciliation Act) provides for an inflation adjustment in the starting and ending percentages for years after 2014. The adjustment will be based on the rate of premium growth for the preceding calendar year over that year's rate of income growth.

After 2018, the inflation adjustment will be based on the rate of premium growth for the preceding calendar year over that year's consumer price index growth, but only if the aggregate amount of premium assistance tax credits and cost-sharing reductions (under Section 1402 of the Patient Protection Act) for the preceding calendar year exceeds an amount equal to 0.504% of the gross domestic product for the preceding calendar year.

The premium assistance credit will be available for years ending after December 31, 2013.

Sec. 36C: Adoption Expenses

The health care reform legislation (7) made changes to the adoption credit and the exclusion for adoption assistance programs (and redesignated the adoption expenses Code section, formerly Sec. 23, as Sec. 36C). The maximum adoption credit for 2010 increased to $13,170 per eligible child from $12,170 for both nonspecial-needs adoptions and special-needs adoptions. The credit is also made refundable. Both the new dollar limit and the phaseout of the credit are adjusted for inflation in tax years beginning after December 31, 2010. The Economic Growth and Tax Relief Reconciliation Act of 2001 (8) (EGTRRA) sunset for the adoption credit is delayed for one year, becoming effective for tax years beginning after December 31, 2011.

The maximum exclusion for adoption assistance programs for 2010 is increased to $13,170 per eligible child from $12,170 for both nonspecial-needs adoptions and special-needs adoptions. Both the new dollar limit and the income limitation of the employer-provided adoption assistance exclusion are adjusted for inflation in tax years beginning after December 31, 2010. The EGTRRA sunset for the exclusion is delayed for one year, becoming effective for tax years beginning after December 31, 2011.

The provisions generally are effective for tax years beginning after December 31, 2009.

Sec. 45R: Employee Health Insurance Expenses of Small Employers

The Patient Protection Act provides tax credits for small businesses and individuals designed to increase levels of health insurance coverage as part of the Sec. 38 general business credit. Small businesses--defined as businesses with 25 or fewer employees and average annual wages of less than $50,000--are eligible for a credit of up to 50% of nonelective contributions the business makes on behalf of its employees for insurance premiums (new Sec. 45R). Tax-exempt organizations would get a 35% credit against payroll taxes.

Employers with 10 or fewer employees and average wages of less than $25,000 will get 100% of the credit; for other eligible employers, the credit will be reduced based on the number of employees over 10 and the excess of the employees' average wages over $25,000. The $25,000 average annual wages figure will be indexed for inflation after 2013.

This credit is available for tax years beginning after December 31, 2009, and is phased in from 2010 through 2013. During the phase-in years, the maximum credit is 35% of the employer's eligible premium expense (25% for tax-exempt employers). After 2013, the credit will be available for a maximum of two consecutive years, beginning with the first year the employer offers a qualified plan through a state insurance exchange (Sec. 45R(e)(2)).

Small businesses claiming the credit will include it as part of the general business credit on their tax returns and attach new Form 8941, Credit for Small Employer Health Insurance Premiums. Tax-exempt small employers, who do not normally file income tax returns, will attach Form 8941 to their Form 990-T, Exempt Organization Business Income Tax Return, which will be revised for the 2011 filing season to enable eligible tax-exempt organizations to claim the credit.

Sec. 56: Adjustments in Computing AMT

Beginning after 2012 (after 2016 for taxpayers over 65), the medical expense deduction will be subject to 10% of the AGI floor (increased from 7.5%). This will eliminate the alternative minimum tax (AMT) adjustment for medical deductions because the floor for deductibility of medical expenses will be the same for both regular tax and AMT purposes.

Sec. 61: Gross Income Defined

General welfare exclusion: A private letter ruling involved whether funds received by individuals from a county for various programs--including a job training one and one available to county employees--were excludible under the general welfare exclusion to Sec. 61. (9) The IRS ruled that the payments were excludible but emphasized that the general welfare exclusion applies only where the government payments are made out of a welfare fund based on the recipients' identified need; they are not excludible when made as compensation for services.

Another, heavily redacted, ruling involved a state program established to help address some economic condition. (10) Grants were given to help mostly low-income individuals purchase some type of property (not specified in the letter ruling, but likely a dwelling because it was to be occupied within a few days after purchase). The grant-giving entity argued that the grants were not gross income to...