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Taxact 2011 Returning User

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Taxact 2011 Returning User

Taxact 2011 returning user 2. Taxact 2011 returning user   Tax Shelters and Other Reportable Transactions Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Abusive Tax SheltersRules To Curb Abusive Tax Shelters Investor Reporting Penalties Whether To Invest Introduction Investments that yield tax benefits are sometimes called “tax shelters. Taxact 2011 returning user ” In some cases, Congress has concluded that the loss of revenue is an acceptable side effect of special tax provisions designed to encourage taxpayers to make certain types of investments. Taxact 2011 returning user In many cases, however, losses from tax shelters produce little or no benefit to society, or the tax benefits are exaggerated beyond those intended. Taxact 2011 returning user Those cases are called “abusive tax shelters. Taxact 2011 returning user ” An investment that is considered a tax shelter is subject to restrictions, including the requirement that it be disclosed, as discussed later. Taxact 2011 returning user Topics - This chapter discusses: Abusive Tax Shelters , Rules To Curb Abusive Tax Shelters , Investor Reporting , Penalties , and Whether To Invest . Taxact 2011 returning user Useful Items - You may want to see: Publication 538 Accounting Periods and Methods 556 Examination of Returns, Appeal Rights, and Claims for Refund 561 Determining the Value of Donated Property 925 Passive Activity and At-Risk Rules Form (and Instructions) 8275 Disclosure Statement 8275-R Regulation Disclosure Statement 8283 Noncash Charitable Contributions 8886 Reportable Transaction Disclosure Statement See chapter 5, How To Get Tax Help , for information about getting these publications and forms. Taxact 2011 returning user Abusive Tax Shelters Abusive tax shelters are marketing schemes involving artificial transactions with little or no economic reality. Taxact 2011 returning user They often make use of unrealistic allocations, inflated appraisals, losses in connection with nonrecourse loans, mismatching of income and deductions, financing techniques that do not conform to standard commercial business practices, or mischaracterization of the substance of the transaction. Taxact 2011 returning user Despite appearances to the contrary, the taxpayer generally risks little. Taxact 2011 returning user Abusive tax shelters commonly involve package deals designed from the start to generate losses, deductions, or credits that will be far more than present or future investment. Taxact 2011 returning user Or, they may promise investors from the start that future inflated appraisals will enable them, for example, to reap charitable contribution deductions based on those appraisals. Taxact 2011 returning user (But see the appraisal requirements discussed under Rules To Curb Abusive Tax Shelters , later. Taxact 2011 returning user ) They are commonly marketed in terms of the ratio of tax deductions allegedly available to each dollar invested. Taxact 2011 returning user This ratio (or “write-off”) is frequently said to be several times greater than one-to-one. Taxact 2011 returning user Because there are many abusive tax shelters, it is not possible to list all the factors you should consider in determining whether an offering is an abusive tax shelter. Taxact 2011 returning user However, you should ask the following questions, which might provide a clue to the abusive nature of the plan. Taxact 2011 returning user Do the tax benefits far outweigh the economic benefits? Is this a transaction you would seriously consider, apart from the tax benefits, if you hoped to make a profit? Do shelter assets really exist and, if so, are they insured for less than their purchase price? Is there a nontax justification for the way profits and losses are allocated to partners? Do the facts and supporting documents make economic sense? In that connection, are there sales and resales of the tax shelter property at ever increasing prices? Does the investment plan involve a gimmick, device, or sham to hide the economic reality of the transaction? Does the promoter offer to backdate documents after the close of the year? Are you instructed to backdate checks covering your investment? Is your debt a real debt or are you assured by the promoter that you will never have to pay it? Does this transaction involve laundering United States source income through foreign corporations incorporated in a tax haven and owned by United States shareholders? Rules To Curb Abusive Tax Shelters Congress has enacted a series of income tax laws designed to halt the growth of abusive tax shelters. Taxact 2011 returning user These provisions include the following. Taxact 2011 returning user Disclosure of reportable transactions. Taxact 2011 returning user   You must disclose information for each reportable transaction in which you participate. Taxact 2011 returning user See Reportable Transaction Disclosure Statement , later. Taxact 2011 returning user   Material advisors with respect to any reportable transaction must disclose information about the transaction on Form 8918, Material Advisor Disclosure Statement. Taxact 2011 returning user To determine whether you are a material advisor to a transaction, see the Instructions for Form 8918. Taxact 2011 returning user   Material advisors will receive a reportable transaction number for the disclosed reportable transaction. Taxact 2011 returning user They must provide this number to all persons to whom they acted as a material advisor. Taxact 2011 returning user They must provide the number at the time the transaction is entered into. Taxact 2011 returning user If they do not have the number at that time, they must provide it within 60 days from the date the number is mailed to them. Taxact 2011 returning user For information on penalties for failure to disclose and failure to maintain lists, see Internal Revenue Code sections 6707, 6707A, and 6708. Taxact 2011 returning user Requirement to maintain list. Taxact 2011 returning user   Material advisors must maintain a list of persons to whom they provide material aid, assistance, or advice on any reportable transaction. Taxact 2011 returning user The list must be available for inspection by the IRS, and the information required to be included on the list generally must be kept for 7 years. Taxact 2011 returning user See Regulations section 301. Taxact 2011 returning user 6112-1 for more information (including what information is required to be included on the list). Taxact 2011 returning user Confidentiality privilege. Taxact 2011 returning user   The confidentiality privilege between you and a federally authorized tax practitioner does not apply to written communications made after October 21, 2004, regarding the promotion of your direct or indirect participation in any tax shelter. Taxact 2011 returning user Appraisal requirement for donated property. Taxact 2011 returning user   If you claim a deduction of more than $5,000 for an item or group of similar items of donated property, you generally must get a qualified appraisal from a qualified appraiser and complete and attach section B of Form 8283 to your return. Taxact 2011 returning user If you claim a deduction of more than $500,000 for the donated property, you generally must attach the qualified appraisal to your return. Taxact 2011 returning user If you file electronically, see Form 8453, U. Taxact 2011 returning user S. Taxact 2011 returning user Individual Income Tax Transmittal for an IRS e-file Return, and its instructions. Taxact 2011 returning user For more information about appraisals, including exceptions, see Publication 561. Taxact 2011 returning user Passive activity loss and credit limits. Taxact 2011 returning user   The passive activity loss and credit rules limit the amount of losses and credits that can be claimed from passive activities and limit the amount that can offset nonpassive income, such as certain portfolio income from investments. Taxact 2011 returning user For more detailed information about determining and reporting income, losses, and credits from passive activities, see Publication 925. Taxact 2011 returning user Interest on penalties. Taxact 2011 returning user   If you are assessed an accuracy-related or civil fraud penalty (as discussed under Penalties , later), interest will be imposed on the amount of the penalty from the due date of the return (including any extensions) to the date you pay the penalty. Taxact 2011 returning user Accounting method restriction. Taxact 2011 returning user   Tax shelters generally cannot use the cash method of accounting. Taxact 2011 returning user Uniform capitalization rules. Taxact 2011 returning user   The uniform capitalization rules generally apply to producing property or acquiring it for resale. Taxact 2011 returning user Under those rules, the direct cost and part of the indirect cost of the property must be capitalized or included in inventory. Taxact 2011 returning user For more information, see Publication 538. Taxact 2011 returning user Denial of deduction for interest on an underpayment due to a reportable transaction. Taxact 2011 returning user   You cannot deduct any interest you paid or accrued on any part of an underpayment of tax due to an understatement arising from a reportable transaction (discussed later) if the relevant facts affecting the tax treatment of the item are not adequately disclosed. Taxact 2011 returning user This rule applies to reportable transactions entered into in tax years beginning after October 22, 2004. Taxact 2011 returning user Authority for Disallowance of Tax Benefits The IRS has published guidance concluding that the claimed tax benefits of various abusive tax shelters should be disallowed. Taxact 2011 returning user The guidance is the conclusion of the IRS on how the law is applied to a particular set of facts. Taxact 2011 returning user Guidance is published in the Internal Revenue Bulletin for taxpayers' information and also for use by IRS officials. Taxact 2011 returning user So, if your return is examined and an abusive tax shelter is identified and challenged, published guidance dealing with that type of shelter, which disallows certain claimed tax shelter benefits, could serve as the basis for the examining official's challenge of the tax benefits you claimed. Taxact 2011 returning user In such a case, the examiner will not compromise even if you or your representative believes you have authority for the positions taken on your tax return. Taxact 2011 returning user The courts have generally been unsympathetic to taxpayers involved in abusive tax shelter schemes and have ruled in favor of the IRS in the majority of the cases in which these shelters have been challenged. Taxact 2011 returning user Investor Reporting You may be required to file a reportable transaction disclosure statement. Taxact 2011 returning user Reportable Transaction Disclosure Statement Use Form 8886 to disclose information for each reportable transaction (discussed later) in which you participated. Taxact 2011 returning user Generally, you must attach Form 8886 to your return for each tax year in which you participated in the transaction. Taxact 2011 returning user Under certain circumstances, a transaction must be disclosed within 90 days of the transaction being identified as a listed transaction or a transaction of interest (discussed later). Taxact 2011 returning user In addition, for the first year Form 8886 is attached to your return, you must send a copy of the form to: Internal Revenue Service OTSA Mail Stop 4915 1973 North Rulon White Blvd. Taxact 2011 returning user  Ogden, UT 84404 If you file your return electronically, the copy sent to OTSA must show exactly the same information, word for word, provided with the electronically filed return and it must be provided on the official IRS Form 8886 or an exact copy of the form. Taxact 2011 returning user If you use a computer-generated or substitute Form 8886, it must be an exact copy of the official IRS form. Taxact 2011 returning user If you fail to file Form 8886 as required or fail to include any required information on the form, you may have to pay a penalty. Taxact 2011 returning user See Penalty for failure to disclose a reportable transaction , later under Penalties. Taxact 2011 returning user The following discussion briefly describes reportable transactions. Taxact 2011 returning user For more details, see the Instructions for Form 8886. Taxact 2011 returning user Reportable transaction. Taxact 2011 returning user   A reportable transaction is any of the following. Taxact 2011 returning user A listed transaction. Taxact 2011 returning user A confidential transaction. Taxact 2011 returning user A transaction with contractual protection. Taxact 2011 returning user A loss transaction. Taxact 2011 returning user A transaction of interest entered into after November 1, 2006. Taxact 2011 returning user Note. Taxact 2011 returning user Transactions with a brief asset holding period were removed from the definition of reportable transaction for transactions entered into after August 2, 2007. Taxact 2011 returning user Listed transaction. Taxact 2011 returning user   A listed transaction is the same as, or substantially similar to, one of the types of transactions the IRS has determined to be a tax-avoidance transaction. Taxact 2011 returning user These transactions have been identified in notices, regulations, and other published guidance issued by the IRS. Taxact 2011 returning user For a list of existing guidance, see Notice 2009-59 in Internal Revenue Bulletin 2009-31, available at www. Taxact 2011 returning user irs. Taxact 2011 returning user gov/irb/2009-31_IRB/ar07. Taxact 2011 returning user html. Taxact 2011 returning user Confidential transaction. Taxact 2011 returning user   A confidential transaction is offered to you under conditions of confidentiality and for which you have paid an advisor a minimum fee. Taxact 2011 returning user A transaction is offered under conditions of confidentiality if the advisor who is paid the fee places a limit on your disclosure of the tax treatment or tax structure of the transaction and the limit protects the confidentiality of the advisor's tax strategies. Taxact 2011 returning user The transaction is treated as confidential even if the conditions of confidentiality are not legally binding on you. Taxact 2011 returning user Transaction with contractual protection. Taxact 2011 returning user   Generally, a transaction with contractual protection is one in which you or a related party has the right to a full or partial refund of fees if all or part of the intended tax consequences of the transaction are not sustained, or a transaction for which the fees are contingent on your realizing the tax benefits from the transaction. Taxact 2011 returning user For information on exceptions, see Revenue Procedure 2007-20 in Internal Revenue Bulletin 2007-7, available at www. Taxact 2011 returning user irs. Taxact 2011 returning user gov/irb/2007-07_IRB/ar15. Taxact 2011 returning user html. Taxact 2011 returning user Loss transaction. Taxact 2011 returning user   For individuals, a loss transaction is one that results in a deductible loss if the gross amount of the loss is at least $2 million in a single tax year or $4 million in any combination of tax years. Taxact 2011 returning user A loss from a foreign currency transaction under Internal Revenue Code section 988 is a loss transaction if the gross amount of the loss is at least $50,000 in a single tax year, whether or not the loss flows through from an S corporation or partnership. Taxact 2011 returning user   Certain losses (such as losses from casualties, thefts, and condemnations) are excepted from this category and do not have to be reported on Form 8886. Taxact 2011 returning user For information on other exceptions, see Revenue Procedure 2004-66 in Internal Revenue Bulletin 2004-50, as modified and superseded by Revenue Procedure 2013-11, (or future published guidance) available at www. Taxact 2011 returning user irs. Taxact 2011 returning user gov/irb/2004-50_IRB/ar11. Taxact 2011 returning user html. Taxact 2011 returning user Transaction of interest. Taxact 2011 returning user   A transaction of interest is a transaction entered into after November 1, 2006, that is the same as, or substantially similar to, one of the types of transactions that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest. Taxact 2011 returning user The IRS has identified the following transactions of interest. Taxact 2011 returning user “Toggling” grantor trusts as described in Notice 2007-73, 2007-36 I. Taxact 2011 returning user R. Taxact 2011 returning user B. Taxact 2011 returning user 545, available at www. Taxact 2011 returning user irs. Taxact 2011 returning user gov/irb/2007-36_IRB/ar20. Taxact 2011 returning user html. Taxact 2011 returning user Certain transactions involving contributions of a successor member interest in a limited liability company as described in Notice 2007-72, 2007-36 I. Taxact 2011 returning user R. Taxact 2011 returning user B. Taxact 2011 returning user 544, available at www. Taxact 2011 returning user irs. Taxact 2011 returning user gov/irb/2007-36_IRB/ar19. Taxact 2011 returning user html. Taxact 2011 returning user Certain transactions involving the sale or other disposition of all interests in a charitable remainder trust and claiming little or no taxable gain as described in Notice 2008-99, 2008-47 I. Taxact 2011 returning user R. Taxact 2011 returning user B. Taxact 2011 returning user 1194, available at www. Taxact 2011 returning user irs. Taxact 2011 returning user gov/irb/2008-47_IRB/ar11. Taxact 2011 returning user html. Taxact 2011 returning user Certain transactions involving a U. Taxact 2011 returning user S. Taxact 2011 returning user taxpayer owning controlled foreign corporations (CFCs) that hold stock of a lower-tier CFC through a domestic partnership to avoid reporting income as described in Notice 2009-7, 2009-3 I. Taxact 2011 returning user R. Taxact 2011 returning user B. Taxact 2011 returning user 312, available at www. Taxact 2011 returning user irs. Taxact 2011 returning user gov/irb/2009-03_IRB/ar10. Taxact 2011 returning user html. Taxact 2011 returning user   For updates to this list, go to www. Taxact 2011 returning user irs. Taxact 2011 returning user gov/Businesses/Corporations/Abusive-Tax-Shelters-and-Transactions. Taxact 2011 returning user Penalties Investing in an abusive tax shelter may lead to substantial expenses. Taxact 2011 returning user First, the promoter generally charges a substantial fee. Taxact 2011 returning user If your return is examined by the IRS and a tax deficiency is determined, you will be faced with payment of more tax, interest on the underpayment, possibly a 20%, 30%, or even 40% accuracy-related penalty, or a 75% civil fraud penalty. Taxact 2011 returning user You may also be subject to the penalty for failure to pay tax. Taxact 2011 returning user These penalties are explained in the following paragraphs. Taxact 2011 returning user Accuracy-related penalties. Taxact 2011 returning user   An accuracy-related penalty of 20% can be imposed for underpayments of tax due to: Negligence or disregard of rules or regulations, Substantial understatement of tax, Substantial valuation misstatement (increased to 40% for gross valuation misstatement), Transaction lacking economic substance (increased to 40% for undisclosed transaction lacking economic substance), or Undisclosed foreign financial asset understatement (40% in all cases). Taxact 2011 returning user Except for a transaction lacking economic substance, this penalty will not be imposed if you can show you had reasonable cause for any understatement of tax and that you acted in good faith. Taxact 2011 returning user Your failure to disclose a reportable transaction is a strong indication that you failed to act in good faith. Taxact 2011 returning user   If you are charged an accuracy-related penalty, interest will be imposed on the amount of the penalty from the due date of the return (including extensions) to the date you pay the penalty. Taxact 2011 returning user   The 20% penalties do not apply to any underpayment attributable to a reportable transaction understatement subject to an accuracy-related penalty (discussed later). Taxact 2011 returning user Negligence or disregard of rules or regulations. Taxact 2011 returning user   The penalty for negligence or disregard of rules or regulations is imposed only on the part of the underpayment due to negligence or disregard of rules or regulations. Taxact 2011 returning user The penalty will not be charged if you can show you had reasonable cause for understating your tax and that you acted in good faith. Taxact 2011 returning user    Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code. Taxact 2011 returning user It also includes any failure to keep adequate books and records. Taxact 2011 returning user A return position that has a reasonable basis is not negligence. Taxact 2011 returning user   Disregard includes any careless, reckless, or intentional disregard of rules or regulations. Taxact 2011 returning user   The penalty for disregard of rules and regulations can be avoided if all the following are true. Taxact 2011 returning user You keep adequate books and records. Taxact 2011 returning user You have a reasonable basis for your position on the tax issue. Taxact 2011 returning user You make an adequate disclosure of your position. Taxact 2011 returning user Use Form 8275 to make your disclosure and attach it to your return. Taxact 2011 returning user To disclose a position contrary to a regulation, use Form 8275-R. Taxact 2011 returning user Use Form 8886 to disclose a reportable transaction (discussed earlier). Taxact 2011 returning user Substantial understatement of tax. Taxact 2011 returning user   An understatement is considered to be substantial if it is more than the greater of: 10% of the tax required to be shown on the return, or $5,000. Taxact 2011 returning user An “understatement” is the amount of tax required to be shown on your return for a tax year minus the amount of tax shown on the return, reduced by any rebates. Taxact 2011 returning user The term “rebate” generally means a decrease in the tax shown on your original return as the result of your filing an amended return or claim for refund. Taxact 2011 returning user   For items other than tax shelters, you can file Form 8275 or Form 8275-R to disclose items that could cause a substantial understatement of income tax. Taxact 2011 returning user In that way, you can avoid the substantial understatement penalty if you have a reasonable basis for your position on the tax issue. Taxact 2011 returning user Disclosure of the tax shelter item on a tax return does not reduce the amount of the understatement. Taxact 2011 returning user   Also, the understatement penalty will not be imposed if you can show there was reasonable cause for the underpayment caused by the understatement and that you acted in good faith. Taxact 2011 returning user An important factor in establishing reasonable cause and good faith will be the extent of your effort to determine your proper tax liability under the law. Taxact 2011 returning user Substantial valuation misstatement. Taxact 2011 returning user   In general, you are liable for a 20% penalty for a substantial valuation misstatement if all the following are true. Taxact 2011 returning user The value or adjusted basis of any property claimed on the return is 150% or more of the correct amount. Taxact 2011 returning user You underpaid your tax by more than $5,000 because of the misstatement. Taxact 2011 returning user You cannot establish that you had reasonable cause for the underpayment and that you acted in good faith. Taxact 2011 returning user   You may be assessed a penalty of 40% for a gross valuation misstatement. Taxact 2011 returning user If you misstate the value or the adjusted basis of property by 200% or more of the amount determined to be correct, you will be assessed a penalty of 40%, instead of 20%, of the amount you underpaid because of the gross valuation misstatement. Taxact 2011 returning user The penalty rate is also 40% if the property's correct value or adjusted basis is zero. Taxact 2011 returning user Transaction lacking economic substance. Taxact 2011 returning user   The economic substance doctrine only applies to an individual that entered into a transaction in connection with a trade or business or an activity engaged in for the production of income. Taxact 2011 returning user For transactions entered into after March 30, 2010, a transaction has economic substance for you as an individual taxpayer only if: The transaction changes your economic position in a meaningful way (apart from federal income tax effects), or You have a substantial purpose (apart from federal income tax effects) for entering into the transaction. Taxact 2011 returning user   For purposes of determining whether economic substance exists, a transaction's profit potential will only be taken into account if the present value of the reasonably expected pre-tax profit from the transaction is substantial compared to the present value of the expected net tax benefits that would be allowed if the transaction were respected. Taxact 2011 returning user   If any part of your underpayment is due to any disallowance of claimed tax benefits by reason of a transaction lacking economic substance or failing to meet the requirements of any similar rule of law, that part of your underpayment will be subject to the 20% accuracy-related penalty even if you had a reasonable cause and acted in good faith concerning that part. Taxact 2011 returning user   Additionally, the penalty increases to 40% if you do not adequately disclose on your return or in a statement attached to your return the relevant facts affecting the tax treatment of a transaction that lacks economic substance. Taxact 2011 returning user Relevant facts include any facts affecting the tax treatment of the transaction. Taxact 2011 returning user    Any excessive amount of an erroneous claim for an income tax refund or credit (other than a refund or credit related to the earned income credit) that results from a transaction found to be lacking economic substance will not be treated as having a reasonable basis and could be subject to a 20% penalty. Taxact 2011 returning user Undisclosed foreign financial asset understatement. Taxact 2011 returning user   For tax years beginning after March 18, 2010, you may be liable for a 40% penalty for an understatement of your tax liability due to an undisclosed foreign financial asset. Taxact 2011 returning user An undisclosed foreign financial asset is any asset for which an information return, required to be provided under Internal Revenue Code section 6038, 6038B, 6038D, 6046A, or 6048 for any taxable year, is not provided. Taxact 2011 returning user The penalty applies to any part of an underpayment related to the following undisclosed foreign financial assets. Taxact 2011 returning user Any foreign business you control, reportable on Form 5471, Information Return of U. Taxact 2011 returning user S. Taxact 2011 returning user Persons With Respect To Certain Foreign Corporations, or Form 8865, Return of U. Taxact 2011 returning user S. Taxact 2011 returning user Persons With Respect to Certain Foreign Partnerships. Taxact 2011 returning user Certain transfers of property to a foreign corporation or partnership, reportable on Form 926, Return by a U. Taxact 2011 returning user S. Taxact 2011 returning user Transferor of Property to a Foreign Corporation, or certain distributions to a foreign person, reportable on Form 8865. Taxact 2011 returning user Your ownership interest in certain foreign financial assets, temporarily reportable on Form 8275 or 8275-R. Taxact 2011 returning user    Instead of, or in addition to, Form 8275 or 8275-R, you may have to file Form 8938, Statement of Specified Foreign Financial Assets, with your tax return. Taxact 2011 returning user See the Instructions for Form 8938 for details. Taxact 2011 returning user    Your acquisition, disposition, or substantial change in ownership interest in a foreign partnership, reportable on Form 8865. Taxact 2011 returning user Creation or transfer of money or property to certain foreign trusts, reportable on Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxact 2011 returning user Penalty for incorrect appraisals. Taxact 2011 returning user   The person who prepares an appraisal of the value of property may have to pay a penalty if: He or she knows, or reasonably should have known, that the appraisal would be used in connection with a return or claim for refund; and The claimed value of the property on a return or claim for refund based on that appraisal results in a substantial valuation misstatement or a gross valuation misstatement as discussed earlier. Taxact 2011 returning user For details on the penalty amount and exceptions, see Publication 561. Taxact 2011 returning user Penalty for failure to disclose a reportable transaction. Taxact 2011 returning user   If you fail to include any required information regarding a reportable transaction (discussed earlier) on a return or statement, you may have to pay a penalty of 75% of the decrease in tax shown on your return as a result of such transaction (or that would have resulted if the transaction were respected for federal tax purposes). Taxact 2011 returning user For an individual, the minimum penalty is $5,000 and the maximum is $10,000 (or $100,000 for a listed transaction). Taxact 2011 returning user This penalty is in addition to any other penalty that may be imposed. Taxact 2011 returning user   The IRS may rescind or abate the penalty for failing to disclose a reportable transaction under certain limited circumstances but cannot rescind the penalty for failing to disclose a listed transaction. Taxact 2011 returning user For information on rescission, see Revenue Procedure 2007-21 in Internal Revenue Bulletin 2007-9 available at www. Taxact 2011 returning user irs. Taxact 2011 returning user gov/irb/2007-09_IRB/ar12. Taxact 2011 returning user html. Taxact 2011 returning user Accuracy-related penalty for a reportable transaction understatement. Taxact 2011 returning user   If you have a reportable transaction understatement, you may have to pay a penalty equal to 20% of the amount of that understatement. Taxact 2011 returning user This applies to any item due to a listed transaction or other reportable transaction with a significant purpose of avoiding or evading federal income tax. Taxact 2011 returning user The penalty is 30% rather than 20% for the part of any reportable transaction understatement if the transaction was not properly disclosed. Taxact 2011 returning user You may not have to pay the 20% penalty if you meet the strengthened reasonable cause and good faith exception. Taxact 2011 returning user The reasonable cause and good faith exception does not apply to any part of a reportable transaction understatement attributable to one or more transactions that lack economic substance. Taxact 2011 returning user   This penalty does not apply to the part of an understatement on which the fraud penalty, gross valuation misstatement penalty, or penalty for nondisclosure of noneconomic substance transactions is imposed. Taxact 2011 returning user Civil fraud penalty. Taxact 2011 returning user   If any underpayment of tax on your return is due to fraud, a penalty of 75% of the underpayment will be added to your tax. Taxact 2011 returning user Joint return. Taxact 2011 returning user   The fraud penalty on a joint return applies to a spouse only if some part of the underpayment is due to the fraud of that spouse. Taxact 2011 returning user Failure to pay tax. Taxact 2011 returning user   If a deficiency is assessed and is not paid within 10 days of the demand for payment, an investor can be penalized with up to a 25% addition to tax if the failure to pay continues. Taxact 2011 returning user Whether To Invest In light of the adverse tax consequences and the substantial amount of penalties and interest that will result if the claimed tax benefits are disallowed, you should consider tax shelter investments carefully and seek competent legal and financial advice. Taxact 2011 returning user Prev  Up  Next   Home   More Online Publications
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Questions and Answers on the Individual Shared Responsibility Provision


Basic Information

1. What is the individual shared responsibility provision?

Under the Affordable Care Act, the federal government, state governments, insurers, employers and individuals are given shared responsibility to reform and improve the availability, quality and affordability of health insurance coverage in the United States. Starting in 2014, the individual shared responsibility provision calls for each individual to have minimum essential health coverage (known as minimum essential coverage) for each month, qualify for an exemption, or make a payment when filing his or her federal income tax return.

2. Who is subject to the individual shared responsibility provision?

The provision applies to individuals of all ages, including children. The adult or married couple who can claim a child or another individual as a dependent for federal income tax purposes is responsible for making the payment if the dependent does not have coverage or an exemption.

3. When does the individual shared responsibility provision go into effect?

The provision goes into effect on Jan. 1, 2014. It applies to each month in the calendar year. 

4.  Is transition relief available in certain circumstances?

Yes. Notice 2013-42, published on June 26, 2013, provides transition relief from the shared responsibility payment for individuals who are eligible to enroll in eligible employer-sponsored health plans with a plan year other than a calendar year (non-calendar year plans) if the plan year begins in 2013 and ends in 2014 (2013-2014 plan year). The transition relief applies to an employee, or an individual having a relationship to the employee. The transition relief begins in January 2014 and continues through the month in which the 2013-2014 plan year ends.

In addition, Notice 2014-10, published on Jan. 23, 2014, provides transition relief for individuals covered under certain limited-benefit government-sponsored programs. Coverage under these programs is not minimum essential coverage unless it is designated as such by the Department of Health and Human Services. Under Notice 2014-10, individuals who have coverage under these government-sponsored programs will not be held liable for the shared responsibility payment for months in 2014 when they have that coverage. The specific government-sponsored programs are optional family planning coverage of family services under title XIX of the Social Security Act, optional coverage of tuberculosis-related services under title XIX of the Social Security Act, coverage of pregnancy-related services under title XIX of the Social Security Act, coverage limited to treatment of emergency medical conditions (in accordance with section 1611(b)(12)(A) of title 8 of the United States Code) under title XIX of the Social Security Act, coverage for medically needy individuals under title XIX of the Social Security Act, coverage authorized under section 1115(a)(2) of the Social Security Act, limited-benefit TRICARE coverage of space available care provided under chapter 55 of title 10 of the United States Code and limited-benefit TRICARE coverage of line of duty care under chapter 55 of title 10 of the United States Code.  

5. What counts as minimum essential coverage?

Minimum essential coverage includes the following:

  • Employer-sponsored coverage, including self-insured plans, COBRA coverage and retiree coverage
  • Coverage purchased in the individual market, including a qualified health plan offered by the Health Insurance Marketplace 
  • Medicare Part A coverage and Medicare Advantage plans
  • Most Medicaid coverage
  • Children's Health Insurance Program (CHIP) coverage
  • Certain types of veterans health coverage administered by the Veterans Administration
  • Most types of TRICARE coverage under chapter 55 of title 10 of the United States Code
  • Coverage provided to Peace Corps volunteers
  • Coverage under the Nonappropriated Fund Health Benefit Program
  • Refugee Medical Assistance supported by the Administration for Children and Families
  • Self-funded health coverage offered to students by universities for plan or policy years that begin on or before Dec. 31, 2014 (for later plan or policy years, sponsors of these programs may apply to HHS to be recognized as minimum essential coverage)
  • State high risk pools for plan or policy years that begin on or before Dec. 31, 2014 (for later plan or policy years, sponsors of these program may apply to HHS to be recognized as minimum essential coverage)
  • Other coverage recognized by the Secretary of HHS as minimum essential coverage

Minimum essential coverage does not include coverage providing only limited benefits, such as the following:

  • Coverage consisting solely of excepted benefits, such as:
    • Stand-alone vision care or dental care
    • Workers' compensation
    • Accident or disability policies
  • Medicaid providing only family planning services
  • Medicaid providing only tuberculosis-related services
  • Medicaid providing only coverage limited to treatment of emergency medical conditions
  •  Pregnancy-related Medicaid coverage*
  • Medicaid coverage for the medically needy*
  • Section 1115 Medicaid demonstration projects*
  • Space available TRICARE coverage provided under chapter 55 of title 10 of the United States Code for individuals who are not eligible for TRICARE coverage for health care services from private sector providers*
  • Line of duty TRICARE coverage provided under chapter 55 of title 10 of the United States Code*

* These categories of coverage are generally not minimum essential coverage. However, to the extent that certain programs within these categories provide comprehensive coverage, the Secretary of HHS may recognize these programs as minimum essential coverage in the future. The IRS in Notice 2014-10 announced relief from the shared responsibility payment for months in 2014 in which individuals are covered under any of these programs to the extent that they are not minimum essential coverage. Information will be made available later about how the income tax return will take account of coverage under one of these programs. 

6. What are the statutory exemptions from the requirement to obtain minimum essential coverage?

  1. Religious conscience. You are a member of a religious sect that is recognized as conscientiously opposed to accepting any insurance benefits. The Social Security Administration administers the process for recognizing these sects according to the criteria in the law.
  2. Health care sharing ministry. You are a member of a recognized health care sharing ministry.
  3. Indian tribes. You are (1) a member of a federally recognized Indian tribe or (2) an individual eligible for services through an Indian care provider.
  4. Income below the income tax return filing requirement. Your income is below the minimum threshold for filing a tax return. The requirement to file a federal tax return depends on your filing status, age and types and amounts of income. To find out if you are required to file a federal tax return, use the IRS Interactive Tax Assistant (ITA).
  5. Short coverage gap. You went without coverage for less than three consecutive months during the year. For more information, see question 22.
  6. Hardship. You have suffered a hardship that makes you unable to obtain coverage, as defined in final regulations issued by the Department of Health and Human Services. See question 21 for more information on claiming hardship exemptions..
  7. Affordability. You can’t afford coverage because the minimum amount you must pay for the premiums is more than eight percent of your household income.
  8. Incarceration. You are in a jail, prison, or similar penal institution or correctional facility after the disposition of charges against you.
  9. Not lawfully present. You are not a U.S. citizen, a U.S. national or an alien lawfully present in the U.S.

7. What do I need to do if I want to be sure I have minimum essential coverage or an exemption for 2014?

The vast majority of coverage that people have today counts as minimum essential coverage. For those who do not have coverage, who anticipate discontinuing the coverage they have currently, or who want to explore whether more affordable options are available, the Health Insurance Marketplace is open in every state and the District of Columbia. The Marketplace helps individuals compare available coverage options, assess their eligibility for financial assistance and find minimum essential coverage that fits their budget.

For those seeking an exemption from the individual responsibility provision, the Marketplace is able to provide certificates of exemption for many of the exemption categories. HHS has issued final regulations on how the Health Insurance Marketplace grants these exemptions. Individuals will also be able to claim certain exemptions for 2014 when they file their federal income tax returns in 2015. Individuals who are not required to file a federal income tax return because their gross income falls below the return filing threshold do not need to take any further action to secure an exemption. See question 21 for further information on how to claim an exemption.

For more information about the Marketplace, visit the Health Insurance Marketplace website. For more information about financial assistance, see our Questions and Answers on the premium tax credit.

8. Is more detailed information available about the individual shared responsibility provision?

Yes. The Treasury Department and the IRS have issued final regulations on the new individual shared responsibility provision, and the IRS has created an individual shared responsibility page. In addition, the Treasury Department and the IRS have issued proposed regulations, which provide guidance on additional issues that were identified in the preamble to the final regulations. Additional information on exemptions and minimum essential coverage is available in final regulations issued by the Department of Health and Human Services and in a Shared Responsibility Provision Question and Answer issued by the Centers for Medicare & Medicaid Services

Who is Affected?

9. Are children subject to the individual shared responsibility provision?

Yes. Each child must have minimum essential coverage or qualify for an exemption for each month in the calendar year. Otherwise, the adult or married couple who can claim the child as a dependent for federal income tax purposes will generally owe a shared responsibility payment for the child..

10. Are senior citizens subject to the individual shared responsibility provision?

Yes. Senior citizens must have minimum essential coverage or qualify for an exemption for each month in a calendar year. Both Medicare Part A and Medicare Part C (also known as Medicare Advantage) qualify as minimum essential coverage.  

11. Are all individuals living in the United States subject to the individual shared responsibility provision?

All U.S. citizens living in the United States are subject to the individual shared responsibility provision as are all permanent residents and all foreign nationals who are in the United States long enough during a calendar year to qualify as resident aliens for tax purposes. Foreign nationals who live in the United States for a short enough period that they do not become resident aliens for federal income tax purposes are not subject to the individual shared responsibility payment even though they may have to file a U.S. income tax return. The IRS has more information available on when a foreign national becomes a resident alien for federal income tax purposes.

12. Are US citizens living abroad subject to the individual shared responsibility provision?

Yes. However, U.S. citizens who are not physically present in the United States for at least 330 full days within a 12-month period are treated as having minimum essential coverage for that 12-month period. In addition, U.S. citizens who are bona fide residents of a foreign country (or countries) for an entire taxable year are treated as having minimum essential coverage for that year. In general, these are individuals who qualify for a foreign earned income exclusion under section 911 of the Internal Revenue Code. Individuals may qualify for this rule even if they cannot use the exclusion for all of their foreign earned income because, for example, they are employees of the United States. Individuals that qualify for this rule need take no further action to comply with the individual shared responsibility provision during the months when they qualify. See Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, for further information on the foreign earned income exclusion.  

U.S. citizens who meet neither the physical presence nor residency requirements will need to maintain minimum essential coverage, qualify for an exemption or make a shared responsibility payment for each month of the year. For this purpose, minimum essential coverage includes a group health plan provided by an overseas employer. One exemption that may be particularly relevant to U.S. citizens living abroad for a small part of a year is the exemption for a short coverage gap. This exemption provides that no shared responsibility payment will be due for a once-per-year gap in coverage that lasts less than three months.  

13. Are residents of the territories subject to the individual shared responsibility provision?

All bona fide residents of the United States territories are treated by law as having minimum essential coverage. They are not required to take any action to comply with the individual shared responsibility provision.

Minimum Essential Coverage

14. If I receive my coverage from my spouse’s employer, will I have minimum essential coverage?

Yes. Employer-sponsored coverage is generally minimum essential coverage. (See question 5 for information on specialized types of coverage that are not minimum essential coverage.) If an employee enrolls in employer-sponsored coverage that provides minimum value for himself and his family, the employee and all of the covered family members have minimum essential coverage.

15. Do my spouse and dependent children have to be covered under the same policy or plan that covers me?

No. You, your spouse and your dependent children do not have to be covered under the same policy or plan. However, you, your spouse and each dependent child for whom you may claim a personal exemption on your federal income tax return must have minimum essential coverage or qualify for an exemption, or you will owe a shared responsibility payment when you file a return.

16. My employer tells me that our company’s health plan is “grandfathered.” Does my employer’s plan provide minimum essential coverage?

Yes. Grandfathered group health plans provide minimum essential coverage.

17. I am a retiree, and I am too young to be eligible for Medicare. I receive my health coverage through a retiree plan made available by my former employer. Is the retiree plan minimum essential coverage?

Yes. Retiree health plans are generally minimum essential coverage.

18. I work for a local government that provides me with health coverage. Is my coverage minimum essential coverage?

Yes. Employer-sponsored coverage is minimum essential coverage regardless of whether the employer is a governmental, nonprofit or for-profit entity.

19. Do I have to be covered for an entire calendar month to avoid the shared responsibility payment liability for not having minimum essential coverage for that month?

No. You will be treated as having minimum essential coverage for a month as long as you have coverage for at least one day during that month.

20. If I change health coverage during the year and end up with a gap when I am not covered, will I owe a payment?

Individuals are treated as having minimum essential coverage for a calendar month if they have coverage for at least one day during that month. Additionally, as long as the gap in coverage is less than three months, you may qualify for an exemption and not owe a payment. See question 22 for more information on the exemption for a short coverage gap.

Exemptions

21. If I think I qualify for an exemption, how do I obtain it?

It depends upon the exemption for which you qualify.

  • The religious conscience exemption and most hardship exemptions are available only by going to the Health Insurance Marketplace and applying for an exemption certificate. Information on obtaining these exemptions is available in final rules issued by the Department of Health and Human Services.
  • The exemptions for members of federally recognized Indian tribes, members of health care sharing ministries and individuals who are incarcerated are available either by going to a Marketplace or Exchange and applying for an exemption certificate or by claiming the exemption as part of filing a federal income tax return.
  • The exemptions for lack of affordable coverage, a short coverage gap, certain hardships, household income below the filing threshold and individuals who are not lawfully present in the United States may be claimed only as part of filing a federal income tax return.

22. What qualifies as a short coverage gap?

In general, a gap in coverage that lasts less than three months qualifies as a short coverage gap. If an individual has more than one short coverage gap during a year, the short coverage gap exemption only applies to the first gap.

23. If my income is so low that I am not required to file a federal income tax return, do I need to do anything special to claim an exemption from the individual shared responsibility provision?

No. If you are not required to file a federal income tax return for a year because your gross income is below your return filing threshold, you are automatically exempt from the shared responsibility provision for that year and do not need to take any further action to secure an exemption. If you are not required to file a tax return for a year but file one anyway, you will be able to claim the exemption on your tax return.

24. If I am exempt from the shared responsibility payment, can I still be eligible for the premium tax credit?

In many cases, yes, but it depends upon the exemption. If you are exempt because you are incarcerated or because you are not lawfully present in the United States, you are not eligible to enroll in a qualified health plan through the Marketplace and therefore cannot claim a premium tax credit. However, individuals with other types of exemptions may obtain coverage through the Marketplace and claim a premium tax credit if they otherwise qualify for the credit.

Reporting Coverage or Exemptions or Making Payments

25. Will I have to do something on my federal income tax return to show that I had coverage or an exemption?

The individual shared responsibility provision goes into effect in 2014. You will not have to account for coverage or exemptions or to make any payments until you file your 2014 federal income tax return in 2015. Information will be made available later about how the income tax return will take account of coverage and exemptions. Insurers will be required to provide everyone that they cover each year with information that will help them demonstrate they had coverage beginning with the 2015 tax year.

26. What happens if I do not have minimum essential coverage or an exemption, and I cannot afford to make the shared responsibility payment when filing my tax return?

The IRS routinely works with taxpayers who owe amounts they cannot afford to pay. The law prohibits the IRS from using liens or levies to collect any individual shared responsibility payment. However, if you owe a shared responsibility payment, the IRS may offset that liability against any tax refund that may be due to you.

Page Last Reviewed or Updated: 25-Mar-2014

The Taxact 2011 Returning User

Taxact 2011 returning user 4. Taxact 2011 returning user   Interest Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Allocation of InterestOrder of funds spent. Taxact 2011 returning user Payments from checking accounts. Taxact 2011 returning user Amounts paid within 30 days. Taxact 2011 returning user Optional method for determining date of reallocation. Taxact 2011 returning user Interest on a segregated account. Taxact 2011 returning user How to report. Taxact 2011 returning user Interest You Can DeductStatement. Taxact 2011 returning user Expenses paid to obtain a mortgage. Taxact 2011 returning user Prepayment penalty. Taxact 2011 returning user De minimis OID. Taxact 2011 returning user Constant-yield method. Taxact 2011 returning user Loan or mortgage ends. Taxact 2011 returning user Interest You Cannot DeductPenalties. Taxact 2011 returning user Who is a key person? Exceptions for pre-June 1997 contracts. Taxact 2011 returning user Interest allocated to unborrowed policy cash value. Taxact 2011 returning user Capitalization of Interest When To Deduct InterestPrepaid interest. Taxact 2011 returning user Discounted loan. Taxact 2011 returning user Refunds of interest. Taxact 2011 returning user Prepaid interest. Taxact 2011 returning user Discounted loan. Taxact 2011 returning user Tax deficiency. Taxact 2011 returning user Related person. Taxact 2011 returning user Below-Market LoansLimit on forgone interest for gift loans of $100,000 or less. Taxact 2011 returning user Introduction This chapter discusses the tax treatment of business interest expense. Taxact 2011 returning user Business interest expense is an amount charged for the use of money you borrowed for business activities. Taxact 2011 returning user Topics - This chapter discusses: Allocation of interest Interest you can deduct Interest you cannot deduct Capitalization of interest When to deduct interest Below-market loans Useful Items - You may want to see: Publication 537 Installment Sales 550 Investment Income and Expenses 936 Home Mortgage Interest Deduction Form (and Instructions) Sch A (Form 1040) Itemized Deductions Sch E (Form 1040) Supplemental Income and Loss Sch K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc. Taxact 2011 returning user Sch K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. Taxact 2011 returning user 1098 Mortgage Interest Statement 3115 Application for Change in Accounting Method 4952 Investment Interest Expense Deduction 8582 Passive Activity Loss Limitations See chapter 12 for information about getting publications and forms. Taxact 2011 returning user Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. Taxact 2011 returning user If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds. Taxact 2011 returning user Allocate your interest expense to the following categories. Taxact 2011 returning user Nonpassive trade or business activity interest Passive trade or business activity interest Investment interest Portfolio interest Personal interest In general, you allocate interest on a loan the same way you allocate the loan proceeds. Taxact 2011 returning user You allocate loan proceeds by tracing disbursements to specific uses. Taxact 2011 returning user The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds. Taxact 2011 returning user Secured loan. Taxact 2011 returning user   The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. Taxact 2011 returning user Example. Taxact 2011 returning user You secure a loan with property used in your business. Taxact 2011 returning user You use the loan proceeds to buy an automobile for personal use. Taxact 2011 returning user You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. Taxact 2011 returning user    If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. Taxact 2011 returning user The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. Taxact 2011 returning user For more information, see Publication 936. Taxact 2011 returning user Allocation period. Taxact 2011 returning user   The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates. Taxact 2011 returning user The date the loan is repaid. Taxact 2011 returning user The date the loan is reallocated to another use. Taxact 2011 returning user Proceeds not disbursed to borrower. Taxact 2011 returning user   Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your use of the funds. Taxact 2011 returning user This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt. Taxact 2011 returning user Proceeds deposited in borrower's account. Taxact 2011 returning user   Treat loan proceeds deposited in an account as property held for investment. Taxact 2011 returning user It does not matter whether the account pays interest. Taxact 2011 returning user Any interest you pay on the loan is investment interest expense. Taxact 2011 returning user If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. Taxact 2011 returning user Example. Taxact 2011 returning user Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. Taxact 2011 returning user No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. Taxact 2011 returning user On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. Taxact 2011 returning user On September 4, Celina uses an additional $40,000 from the account for personal purposes. Taxact 2011 returning user Under the interest allocation rules, the entire $100,000 loan is treated as property held for investment for the period from January 4 through April 1. Taxact 2011 returning user From April 2 through September 3, Celina must treat $20,000 of the loan as used in the passive activity and $80,000 of the loan as property held for investment. Taxact 2011 returning user From September 4 through December 31, she must treat $40,000 of the loan as used for personal purposes, $20,000 as used in the passive activity, and $40,000 as property held for investment. Taxact 2011 returning user Order of funds spent. Taxact 2011 returning user   Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts. Taxact 2011 returning user Any unborrowed amounts held in the same account. Taxact 2011 returning user Any amounts deposited after these loan proceeds. Taxact 2011 returning user Example. Taxact 2011 returning user On January 9, Olena opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. Taxact 2011 returning user The following table shows the transactions in her account during the tax year. Taxact 2011 returning user Date Transaction January 9 $500 proceeds of Loan A and $1,000 unborrowed funds deposited January 14 $500 proceeds of Loan B  deposited February 19 $800 used for personal purposes February 27 $700 used for passive activity June 19 $1,000 proceeds of Loan C  deposited November 20 $800 used for an investment December 18 $600 used for personal purposes Olena treats the $800 used for personal purposes as made from the $500 proceeds of Loan A and $300 of the proceeds of Loan B. Taxact 2011 returning user She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. Taxact 2011 returning user She treats the $800 used for an investment as made entirely from the proceeds of Loan C. Taxact 2011 returning user She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds. Taxact 2011 returning user For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment. Taxact 2011 returning user Payments from checking accounts. Taxact 2011 returning user   Generally, you treat a payment from a checking or similar account as made at the time the check is written if you mail or deliver it to the payee within a reasonable period after you write it. Taxact 2011 returning user You can treat checks written on the same day as written in any order. Taxact 2011 returning user Amounts paid within 30 days. Taxact 2011 returning user   If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. Taxact 2011 returning user This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. Taxact 2011 returning user   If the loan proceeds are deposited in an account, you can apply this rule even if the rules stated earlier under Order of funds spent would otherwise require you to treat the proceeds as used for other purposes. Taxact 2011 returning user If you apply this rule to any payments, disregard those payments (and the proceeds from which they are made) when applying the rules stated under Order of funds spent. Taxact 2011 returning user   If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. Taxact 2011 returning user Example. Taxact 2011 returning user Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. Taxact 2011 returning user Giovanni deposits $1,500 in an account on August 18 and on August 28 writes a check on the account for a passive activity expense. Taxact 2011 returning user Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. Taxact 2011 returning user Regardless of these other transactions, Giovanni can treat $1,000 of the deposit he made on August 18 as being paid on August 4 from the loan proceeds. Taxact 2011 returning user In addition, Giovanni can treat the passive activity expense he paid on August 28 as made from the $1,000 loan proceeds treated as deposited in the account. Taxact 2011 returning user Optional method for determining date of reallocation. Taxact 2011 returning user   You can use the following method to determine the date loan proceeds are reallocated to another use. Taxact 2011 returning user You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates. Taxact 2011 returning user The first day of that month. Taxact 2011 returning user The date the loan proceeds are deposited in the account. Taxact 2011 returning user However, you can use this optional method only if you treat all payments from the account during the same calendar month in the same way. Taxact 2011 returning user Interest on a segregated account. Taxact 2011 returning user   If you have an account that contains only loan proceeds and interest earned on the account, you can treat any payment from that account as being made first from the interest. Taxact 2011 returning user When the interest earned is used up, any remaining payments are from loan proceeds. Taxact 2011 returning user Example. Taxact 2011 returning user You borrowed $20,000 and used the proceeds of this loan to open a new savings account. Taxact 2011 returning user When the account had earned interest of $867, you withdrew $20,000 for personal purposes. Taxact 2011 returning user You can treat the withdrawal as coming first from the interest earned on the account, $867, and then from the loan proceeds, $19,133 ($20,000 − $867). Taxact 2011 returning user All the interest charged on the loan from the time it was deposited in the account until the time of the withdrawal is investment interest expense. Taxact 2011 returning user The interest charged on the part of the proceeds used for personal purposes ($19,133) from the time you withdrew it until you either repay it or reallocate it to another use is personal interest expense. Taxact 2011 returning user The interest charged on the loan proceeds you left in the account ($867) continues to be investment interest expense until you either repay it or reallocate it to another use. Taxact 2011 returning user Loan repayment. Taxact 2011 returning user   When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order. Taxact 2011 returning user Personal use. Taxact 2011 returning user Investments and passive activities (other than those included in (3)). Taxact 2011 returning user Passive activities in connection with a rental real estate activity in which you actively participate. Taxact 2011 returning user Former passive activities. Taxact 2011 returning user Trade or business use and expenses for certain low-income housing projects. Taxact 2011 returning user Line of credit (continuous borrowings). Taxact 2011 returning user   The following rules apply if you have a line of credit or similar arrangement. Taxact 2011 returning user Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan. Taxact 2011 returning user Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different loans. Taxact 2011 returning user Treat these loans as repaid in the order shown on the loan agreement. Taxact 2011 returning user Loan refinancing. Taxact 2011 returning user   Allocate the replacement loan to the same uses to which the repaid loan was allocated. Taxact 2011 returning user Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan. Taxact 2011 returning user Debt-financed distribution. Taxact 2011 returning user   A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. Taxact 2011 returning user The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds. Taxact 2011 returning user How to report. Taxact 2011 returning user   If the proceeds were used in a nonpassive trade or business activity, report the interest on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership or S corporation in column (a) and the amount in column (h). Taxact 2011 returning user If the proceeds were used in a passive activity, follow the Instructions for Form 8582, Passive Activity Loss Limitations, to determine the amount of interest expense that can be reported on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership in column (a) and the amount in column (f). Taxact 2011 returning user If the proceeds were used in an investment activity, enter the interest on Form 4952. Taxact 2011 returning user If the proceeds are used for personal purposes, the interest is generally not deductible. Taxact 2011 returning user Interest You Can Deduct You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your trade or business. Taxact 2011 returning user Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. Taxact 2011 returning user It does not matter what type of property secures the loan. Taxact 2011 returning user You can deduct interest on a debt only if you meet all the following requirements. Taxact 2011 returning user You are legally liable for that debt. Taxact 2011 returning user Both you and the lender intend that the debt be repaid. Taxact 2011 returning user You and the lender have a true debtor-creditor relationship. Taxact 2011 returning user Partial liability. Taxact 2011 returning user   If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued. Taxact 2011 returning user Example. Taxact 2011 returning user You and your brother borrow money. Taxact 2011 returning user You are liable for 50% of the note. Taxact 2011 returning user You use your half of the loan in your business, and you make one-half of the loan payments. Taxact 2011 returning user You can deduct your half of the total interest payments as a business deduction. Taxact 2011 returning user Mortgage. Taxact 2011 returning user   Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. Taxact 2011 returning user However, rather than deducting the interest currently, you may have to add it to the cost basis of the property as explained later under Capitalization of Interest. Taxact 2011 returning user Statement. Taxact 2011 returning user   If you paid $600 or more of mortgage interest (including certain points) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement. Taxact 2011 returning user You will receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that person's trade or business. Taxact 2011 returning user A governmental unit is a person for purposes of furnishing the statement. Taxact 2011 returning user   If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form 1098. Taxact 2011 returning user You cannot deduct this amount. Taxact 2011 returning user For information on how to report this refund, see Refunds of interest, later in this chapter. Taxact 2011 returning user Expenses paid to obtain a mortgage. Taxact 2011 returning user   Certain expenses you pay to obtain a mortgage cannot be deducted as interest. Taxact 2011 returning user These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. Taxact 2011 returning user If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage. Taxact 2011 returning user Prepayment penalty. Taxact 2011 returning user   If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest. Taxact 2011 returning user Interest on employment tax deficiency. Taxact 2011 returning user   Interest charged on employment taxes assessed on your business is deductible. Taxact 2011 returning user Original issue discount (OID). Taxact 2011 returning user   OID is a form of interest. Taxact 2011 returning user A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. Taxact 2011 returning user The OID is the difference between the stated redemption price at maturity and the issue price of the loan. Taxact 2011 returning user   A loan's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on it other than qualified stated interest. Taxact 2011 returning user Qualified stated interest is stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a single fixed rate. Taxact 2011 returning user You generally deduct OID over the term of the loan. Taxact 2011 returning user Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis. Taxact 2011 returning user De minimis OID. Taxact 2011 returning user   The OID is de minimis if it is less than one-fourth of 1% (. Taxact 2011 returning user 0025) of the stated redemption price of the loan at maturity multiplied by the number of full years from the date of original issue to maturity (the term of the loan). Taxact 2011 returning user   If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year. Taxact 2011 returning user On a constant-yield basis over the term of the loan. Taxact 2011 returning user On a straight-line basis over the term of the loan. Taxact 2011 returning user In proportion to stated interest payments. Taxact 2011 returning user In its entirety at maturity of the loan. Taxact 2011 returning user You make this choice by deducting the OID in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. Taxact 2011 returning user Example. Taxact 2011 returning user On January 1, 2013, you took out a $100,000 discounted loan and received $98,500 in proceeds. Taxact 2011 returning user The loan will mature on January 1, 2023 (a 10-year term), and the $100,000 principal is payable on that date. Taxact 2011 returning user Interest of $10,000 is payable on January 1 of each year, beginning January 1, 2014. Taxact 2011 returning user The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × . Taxact 2011 returning user 0025 × 10). Taxact 2011 returning user You choose to deduct the OID on a straight-line basis over the term of the loan. Taxact 2011 returning user Beginning in 2013, you can deduct $150 each year for 10 years. Taxact 2011 returning user Constant-yield method. Taxact 2011 returning user   If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. Taxact 2011 returning user You figure your deduction for the first year using the following steps. Taxact 2011 returning user Determine the issue price of the loan. Taxact 2011 returning user Generally, this equals the proceeds of the loan. Taxact 2011 returning user If you paid points on the loan (as discussed later), the issue price generally is the difference between the proceeds and the points. Taxact 2011 returning user Multiply the result in (1) by the yield to maturity. Taxact 2011 returning user Subtract any qualified stated interest payments from the result in (2). Taxact 2011 returning user This is the OID you can deduct in the first year. Taxact 2011 returning user   To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price in step (1). Taxact 2011 returning user To get the adjusted issue price, add to the issue price any OID previously deducted. Taxact 2011 returning user Then follow steps (2) and (3) above. Taxact 2011 returning user   The yield to maturity is generally shown in the literature you receive from your lender. Taxact 2011 returning user If you do not have this information, consult your lender or tax advisor. Taxact 2011 returning user In general, the yield to maturity is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. Taxact 2011 returning user Example. Taxact 2011 returning user The facts are the same as in the previous example, except that you deduct the OID on a constant yield basis over the term of the loan. Taxact 2011 returning user The yield to maturity on your loan is 10. Taxact 2011 returning user 2467%, compounded annually. Taxact 2011 returning user For 2013, you can deduct $93 [($98,500 × . Taxact 2011 returning user 102467) − $10,000]. Taxact 2011 returning user For 2014, you can deduct $103 [($98,593 × . Taxact 2011 returning user 102467) − $10,000]. Taxact 2011 returning user Loan or mortgage ends. Taxact 2011 returning user   If your loan or mortgage ends, you may be able to deduct any remaining OID in the tax year in which the loan or mortgage ends. Taxact 2011 returning user A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. Taxact 2011 returning user If you refinance with the original lender, you generally cannot deduct the remaining OID in the year in which the refinancing occurs, but you may be able to deduct it over the term of the new mortgage or loan. Taxact 2011 returning user See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct, later. Taxact 2011 returning user Points. Taxact 2011 returning user   The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. Taxact 2011 returning user These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. Taxact 2011 returning user If any of these charges (points) are solely for the use of money, they are interest. Taxact 2011 returning user   Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. Taxact 2011 returning user However, you can choose to fully deduct points in the year paid if you meet certain tests. Taxact 2011 returning user For exceptions to the general rule, see Publication 936. Taxact 2011 returning user The points reduce the issue price of the loan and result in original issue discount (OID), deductible as explained in the preceding discussion. Taxact 2011 returning user Partial payments on a nontax debt. Taxact 2011 returning user   If you make partial payments on a debt (other than a debt owed the IRS), the payments are applied, in general, first to interest and any remainder to principal. Taxact 2011 returning user You can deduct only the interest. Taxact 2011 returning user This rule does not apply when it can be inferred that the borrower and lender understood that a different allocation of the payments would be made. Taxact 2011 returning user Installment purchase. Taxact 2011 returning user   If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. Taxact 2011 returning user If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under the contract may be recharacterized as interest (unstated interest). Taxact 2011 returning user The amount recharacterized as interest reduces your basis in the property and increases your interest expense. Taxact 2011 returning user For more information on installment sales and unstated interest, see Publication 537. Taxact 2011 returning user Interest You Cannot Deduct Certain interest payments cannot be deducted. Taxact 2011 returning user In addition, certain other expenses that may seem to be interest but are not, cannot be deducted as interest. Taxact 2011 returning user You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest. Taxact 2011 returning user Interest paid with funds borrowed from original lender. Taxact 2011 returning user   If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original lender through a second loan, an advance, or any other arrangement similar to a loan. Taxact 2011 returning user You can deduct the interest expense once you start making payments on the new loan. Taxact 2011 returning user   When you make a payment on the new loan, you first apply the payment to interest and then to the principal. Taxact 2011 returning user All amounts you apply to the interest on the first loan are deductible, along with any interest you pay on the second loan, subject to any limits that apply. Taxact 2011 returning user Capitalized interest. Taxact 2011 returning user   You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. Taxact 2011 returning user See Capitalization of Interest, later. Taxact 2011 returning user In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest accrued on the property), you cannot deduct the interest. Taxact 2011 returning user Add this interest to the basis of the property. Taxact 2011 returning user Commitment fees or standby charges. Taxact 2011 returning user   Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not deductible as interest payments. Taxact 2011 returning user You may be able to deduct them as business expenses. Taxact 2011 returning user   If the funds are for inventory or certain property used in your business, the fees are indirect costs and you generally must capitalize them under the uniform capitalization rules. Taxact 2011 returning user See Capitalization of Interest, later. Taxact 2011 returning user Interest on income tax. Taxact 2011 returning user   Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business. Taxact 2011 returning user Treat this interest as a business deduction only in figuring a net operating loss deduction. Taxact 2011 returning user Penalties. Taxact 2011 returning user   Penalties on underpaid deficiencies and underpaid estimated tax are not interest. Taxact 2011 returning user You cannot deduct them. Taxact 2011 returning user Generally, you cannot deduct any fines or penalties. Taxact 2011 returning user Interest on loans with respect to life insurance policies. Taxact 2011 returning user   You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person. Taxact 2011 returning user   If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. Taxact 2011 returning user However, the deduction for any month cannot be more than the interest figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as Moody's Corporate Bond Yield Average-Monthly Average Corporates) (Moody's rate) for that month. Taxact 2011 returning user Who is a key person?   A key person is an officer or 20% owner. Taxact 2011 returning user However, the number of individuals you can treat as key persons is limited to the greater of the following. Taxact 2011 returning user Five individuals. Taxact 2011 returning user The lesser of 5% of the total officers and employees of the company or 20 individuals. Taxact 2011 returning user Exceptions for pre-June 1997 contracts. Taxact 2011 returning user   You can generally deduct the interest if the contract was issued before June 9, 1997, and the covered individual is someone other than an employee, officer, or someone financially interested in your business. Taxact 2011 returning user If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract. Taxact 2011 returning user Interest allocated to unborrowed policy cash value. Taxact 2011 returning user   Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. Taxact 2011 returning user This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. Taxact 2011 returning user For more information, see section 264(f) of the Internal Revenue Code. Taxact 2011 returning user Capitalization of Interest Under the uniform capitalization rules, you generally must capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property. Taxact 2011 returning user The property must be produced by you for use in your trade or business or for sale to customers. Taxact 2011 returning user You cannot capitalize interest related to property that you acquire in any other manner. Taxact 2011 returning user Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. Taxact 2011 returning user Designated property is any of the following. Taxact 2011 returning user Real property. Taxact 2011 returning user Tangible personal property with a class life of 20 years or more. Taxact 2011 returning user Tangible personal property with an estimated production period of more than 2 years. Taxact 2011 returning user Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million. Taxact 2011 returning user Property you produce. Taxact 2011 returning user   You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Taxact 2011 returning user Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property. Taxact 2011 returning user Carrying charges. Taxact 2011 returning user   Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. Taxact 2011 returning user You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. Taxact 2011 returning user For more information, see chapter 7. Taxact 2011 returning user Capitalized interest. Taxact 2011 returning user   Treat capitalized interest as a cost of the property produced. Taxact 2011 returning user You recover your interest when you sell or use the property. Taxact 2011 returning user If the property is inventory, recover capitalized interest through cost of goods sold. Taxact 2011 returning user If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method. Taxact 2011 returning user Partnerships and S corporations. Taxact 2011 returning user   The interest capitalization rules are applied first at the partnership or S corporation level. Taxact 2011 returning user The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction costs. Taxact 2011 returning user   If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production costs of the partnership or S corporation. Taxact 2011 returning user You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. Taxact 2011 returning user To properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule K-1 you receive from the partnership or S corporation. Taxact 2011 returning user Additional information. Taxact 2011 returning user   The procedures for applying the uniform capitalization rules are beyond the scope of this publication. Taxact 2011 returning user For more information, see sections 1. Taxact 2011 returning user 263A-8 through 1. Taxact 2011 returning user 263A-15 of the regulations and Notice 88-99. Taxact 2011 returning user Notice 88-99 is in Cumulative Bulletin 1988-2. Taxact 2011 returning user When To Deduct Interest If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows. Taxact 2011 returning user Cash method. Taxact 2011 returning user   Under the cash method, you can generally deduct only the interest you actually paid during the tax year. Taxact 2011 returning user You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment. Taxact 2011 returning user Prepaid interest. Taxact 2011 returning user   You generally cannot deduct any interest paid before the year it is due. Taxact 2011 returning user Interest paid in advance can be deducted only in the tax year in which it is due. Taxact 2011 returning user Discounted loan. Taxact 2011 returning user   If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. Taxact 2011 returning user For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier. Taxact 2011 returning user Refunds of interest. Taxact 2011 returning user   If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. Taxact 2011 returning user If you receive the refund in a later tax year, include the refund in your income to the extent the deduction for the interest reduced your tax. Taxact 2011 returning user Accrual method. Taxact 2011 returning user   Under an accrual method, you can deduct only interest that has accrued during the tax year. Taxact 2011 returning user Prepaid interest. Taxact 2011 returning user   See Prepaid interest, earlier. Taxact 2011 returning user Discounted loan. Taxact 2011 returning user   See Discounted loan, earlier. Taxact 2011 returning user Tax deficiency. Taxact 2011 returning user   If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. Taxact 2011 returning user If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you. Taxact 2011 returning user   However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid. Taxact 2011 returning user Related person. Taxact 2011 returning user   If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. Taxact 2011 returning user The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. Taxact 2011 returning user See section 267 of the Internal Revenue Code for more information. Taxact 2011 returning user Below-Market Loans If you receive a below-market gift or demand loan and use the proceeds in your trade or business, you may be able to deduct the forgone interest. Taxact 2011 returning user See Treatment of gift and demand loans, later, in this discussion. Taxact 2011 returning user A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. Taxact 2011 returning user A gift or demand loan that is a below-market loan generally is considered an arm's-length transaction in which you, the borrower, are considered as having received both the following. Taxact 2011 returning user A loan in exchange for a note that requires the payment of interest at the applicable federal rate. Taxact 2011 returning user An additional payment in an amount equal to the forgone interest. Taxact 2011 returning user The additional payment is treated as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction. Taxact 2011 returning user Forgone interest. Taxact 2011 returning user   For any period, forgone interest is The interest that would be payable for that period if interest accrued on the loan at the applicable federal rate and was payable annually on December 31, minus Any interest actually payable on the loan for the period. Taxact 2011 returning user Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. Taxact 2011 returning user Internal Revenue Bulletins are available on the IRS web site at www. Taxact 2011 returning user irs. Taxact 2011 returning user gov/irb. Taxact 2011 returning user You can also contact an IRS office to get these rates. Taxact 2011 returning user Loans subject to the rules. Taxact 2011 returning user   The rules for below-market loans apply to the following. Taxact 2011 returning user Gift loans (below-market loans where the forgone interest is in the nature of a gift). Taxact 2011 returning user Compensation-related loans (below-market loans between an employer and an employee or between an independent contractor and a person for whom the contractor provides services). Taxact 2011 returning user Corporation-shareholder loans. Taxact 2011 returning user Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement). Taxact 2011 returning user Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985). Taxact 2011 returning user   Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's demand) outstanding after June 6, 1984, and to term loans (loans that are not demand loans) made after that date. Taxact 2011 returning user Treatment of gift and demand loans. Taxact 2011 returning user   If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc. Taxact 2011 returning user ) equal to the forgone interest on the loan. Taxact 2011 returning user You are then treated as transferring this amount back to the lender as interest. Taxact 2011 returning user These transfers are considered to occur annually, generally on December 31. Taxact 2011 returning user If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. Taxact 2011 returning user The lender must report it as interest income. Taxact 2011 returning user Limit on forgone interest for gift loans of $100,000 or less. Taxact 2011 returning user   For gift loans between individuals, forgone interest treated as transferred back to the lender is limited to the borrower's net investment income for the year. Taxact 2011 returning user This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. Taxact 2011 returning user If the borrower's net investment income is $1,000 or less, it is treated as zero. Taxact 2011 returning user This limit does not apply to a loan if the avoidance of any federal tax is one of the main purposes of the interest arrangement. Taxact 2011 returning user Treatment of term loans. Taxact 2011 returning user   If you receive a below-market term loan other than a gift or demand loan, you are treated as receiving an additional cash payment (as a dividend, etc. Taxact 2011 returning user ) on the date the loan is made. Taxact 2011 returning user This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. Taxact 2011 returning user The same amount is treated as original issue discount on the loan. Taxact 2011 returning user See Original issue discount (OID) under Interest You Can Deduct, earlier. Taxact 2011 returning user Exceptions for loans of $10,000 or less. Taxact 2011 returning user   The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower and lender is $10,000 or less. Taxact 2011 returning user This exception applies only to the following. Taxact 2011 returning user Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets. Taxact 2011 returning user Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement. Taxact 2011 returning user This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. Taxact 2011 returning user Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less. Taxact 2011 returning user Exceptions for loans without significant tax effect. Taxact 2011 returning user   The following loans are specifically exempted from the rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender. Taxact 2011 returning user Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's customary business practices. Taxact 2011 returning user Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public. Taxact 2011 returning user Certain employee-relocation loans. Taxact 2011 returning user Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U. Taxact 2011 returning user S. Taxact 2011 returning user trade or business and not exempt from U. Taxact 2011 returning user S. Taxact 2011 returning user tax under an income tax treaty. Taxact 2011 returning user Any other loan if the taxpayer can show that the interest arrangement has no significant effect on the federal tax liability of the lender or the borrower. Taxact 2011 returning user Whether an interest arrangement has a significant effect on the federal tax liability of the lender or the borrower will be determined by all the facts and circumstances. Taxact 2011 returning user Consider all the following factors. Taxact 2011 returning user Whether items of income and deduction generated by the loan offset each other. Taxact 2011 returning user The amount of the items. Taxact 2011 returning user The cost of complying with the below-market loan provisions if they were to apply. Taxact 2011 returning user Any reasons, other than taxes, for structuring the transaction as a below-market loan. Taxact 2011 returning user Exception for loans to qualified continuing care facilities. Taxact 2011 returning user   The below-market interest rules do not apply to a loan owed by a qualified continuing care facility under a continuing care contract if the lender or lender's spouse is age 62 or older by the end of the calendar year. Taxact 2011 returning user A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below. Taxact 2011 returning user Designed to provide services under continuing care contracts (defined below). Taxact 2011 returning user Includes an independent living unit, and either an assisted living or nursing facility, or both. Taxact 2011 returning user Substantially all of the independent living unit residents are covered by continuing care contracts. Taxact 2011 returning user A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions. Taxact 2011 returning user The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives. Taxact 2011 returning user The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individual's spouse in an: independent living unit (which has additional available facilities outside the unit for the provision of meals and other personal care), and assisted living or nursing facility available in the continuing care facility. Taxact 2011 returning user The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care facility, as required for the health of the individual or the individual's spouse. Taxact 2011 returning user For more information, see section 7872(h) of the Internal Revenue Code. Taxact 2011 returning user Sale or exchange of property. Taxact 2011 returning user   Different rules generally apply to a loan connected with the sale or exchange of property. Taxact 2011 returning user If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. Taxact 2011 returning user However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. Taxact 2011 returning user See Unstated Interest and Original Issue Discount (OID) in Publication 537. Taxact 2011 returning user More information. Taxact 2011 returning user   For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1. Taxact 2011 returning user 7872-5 of the regulations. Taxact 2011 returning user Prev  Up  Next   Home   More Online Publications