Taxpayers can exclude from gross income a discharge (in whole or in part) of qualified principal residence indebtedness before January 1, 2013.  The exclusion applies where a taxpayer restructures their acquisition debt on a principal residence or loses their principal residence in a foreclosure.  The exclusion does not apply to a taxpayer in a Title 11 bankruptcy case; as the regular Title 11 bankruptcy exclusion takes precedence.  Insolvent taxpayers other than those in a Title 11 bankruptcy case can elect to use the insolvency exception instead of the qualified principal exception.   However, taxpayers choosing the insolvency election should be aware that the amount of discharge indebtedness income that is excludable from gross income by reason of insolvency is limited to the amount the debtor is insolvent immediately before the discharge transaction.  Therefore, the qualified principal residence exclusion may prove to be more advantageous as the insolvency limitation does not apply. 

The most important aspect of the qualified principal residence exclusion is that is applies only to that portion of qualified principal residence indebtedness that is considered acquisition indebtedness.   Acquisition indebtedness is debt used to buy, build, or substantially improve the taxpayer’s principal residence and must have been secured by that residence.  Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualifies for the exclusion.  However, proceeds of refinanced debt used for other purposes do not qualify for the exclusion and the exclusion amount is limited to the old mortgage principal, just before the refinancing.   In addition, there is a $2 million limit on the aggregate amount of debt that can be treated as qualified principal residence indebtedness.

Details on the completion of the tax forms and how to report on your tax return to follow…..

Let me start by encouraging you to put the IRS on your payment priority list.  Credit card companies present perhaps the only industry that will hit you with worse penalties and interest for late payment than the IRS.  We have seen plenty of companies and individuals come to us with overwhelming IRS debt which began as several years of small underpayments that have snowballed with interest and penalties.  And out of all your creditors, the IRS is the one that can reach into your bank accounts, garnish your wages, put liens on your assets and business, and make your life completely miserable.

You wan’t to avoid all that, but you can’t pay.  Now what?

If you think you can pay the balance within 120 days, send what you can with your return and then call 1-800-829-1040 to request to pay the balance in full within 120 days. This way you may be able to avoid penalties.  If you don’t want to call the number, you can go to irs.gov and click “I Need To…” in the upper right hand corner, then click “Set up a payment plan”.

If you can’t pay it within 120 days, you will need to do a payment plan.  Pay what you can, and file your return with Form 9465 attached to the front.  You can also apply online the same way you would if you could pay within 120 days.  The cost for a monthly installment agreement is $105 unless you do it through electronic payments, in which case it is $52.  Depending on your circumstances, you may be able to get a reduced charge for the monthly installment agreement.

If you have access to low interest financing, you may want to consider taking out a loan to pay off your balance due.  The IRS charges adjustable interest rates of about 5% per month, plus late payment penalties of up to 1% per month even if you are on a payment plan.  The IRS website suggests that even if you took out a loan with 13% annual interest to pay your tax debt, you may still  save money over a payment plan depending on your situation.

In a worse case scenario, you can file an Offer in Compromise.  Don’t be fooled by the TV ads, this is not a magic solution for people to relieve themselves of small IRS debts so that they can save thousands of dollars and go buy a boat.  The Offer in Compromise process is long and intrusive.  The IRS will calculate exactly how much you owe and what they think you can pay before the statute of limitations expires for each year.  If you have cash left over each month after paying the most basic necessities, assets that could be sold to cover old tax debts, or expenses that you could cut out of your family budget, your best bet is either going with a payment plan or getting a low interest loan and paying of the IRS balance.

One of the worst financial decision you could make is to ignore your IRS debt and hope they don’t notice.

If you mistakenly took a required payout from an IRA or a plan for 2009, the IRS is giving you a second chance to put the money back into your account. For 2009 the normal ban on rolling over required minimum payouts does not apply because for 2009 Congress suspended the rule requiring mandatory distributions from IRAs and defined contribution plans. Since many people may not have known about the suspension, they now have the option to roll the money back into the IRA or plan by Nov. 30 for mandatory payouts taken before Oct. 1, even those withdrawn or early in 2009. The 60-day rollover rule applies to such payouts taken after Sept. 30.

This relief is limited to one rollover for distributions made from and IRA, so if you took monthly payouts in 2009 from an IRA to meet the now suspended rule on minimum required distributions, you can only roll back one of the withdrawals.

There is a good chance that the credit will be extended by Congress, but nothing is finalized at this point.  There is an even better chance that Congress will clarify the credit and make it so that you don’t have to complete the sale by November 30th, just sign the contract.

If you are a member of the armed forces and missed this credit due to extended overseas deployment, you have until the end of 2010 to take the credit.  Also, the provision requiring you to repay the credit if you sell the house within three years does not apply if an overseas deployment forces you to sell.

In most cases, the WOTC comes to 40% of the employee’s qualified wages for the first year of employment if they work at least 400 hours that year.  If they work at least 120 hours, but less than 400 hours, the credit is 25%.  The credit is limited to the first $6,000 of income, although there are exceptions that I will note later in this memo.  The wages subject to the credit cannot be claimed as a deduction on your tax return.

In order to qualify for the WOTC, you must fill out Form 8850 for the IRS (which has a portion for the employer and employee to fill out) and file for certification with your local agencies.  For Florida, the Form 8850 and Florida Form ETA-9061 must be completed and mailed to the Agency for Workforce Innovation in Tallahassee no later than 28 days after the employee’s start date.

Examples of WOTC Scenarios:

You hire Mr. Smith for $10 an hour.  Mr. Smith is an ex-felon and works for you for 700 hours this year, or 17 and a half weeks.  At the end of the year, you have paid him $7,000 in gross income.  The work opportunity credit comes to $2,400 (first $6,000 in wages x 40%).

Instead, you hire Mr. Smith for $10 an hour and he works 300 hours, or 7 and half weeks.  At the end of the year, you have paid him $3,000 in gross wages.  The total credit is $750 ($3,000 x 25% since he worked more than 120 hours, but less than 400).

Exceptions:

For qualified veterans, the wage limit is $12,000.  This means that your potential credit could be as much as $4,800.

For summer youth employees, the credit is 40% of wages paid during any 90 day period between May 1 and September 15 up to a maximum of $3,000 per employee.

Wages do not include amounts paid under federally funded on-the-job training programs, Social Security work supplement payments under section 482(e) of the Social Security Act, or wages paid to employees filling strike replacement positions.

Drawbacks:

Except in the case of a C-Corporation, the WOTC is taken on the personal income tax return of the owners of the company.  In other words, even if you hire someone to work for the first half of the year, you won’t be able to apply the credit until the following year when you file your corporate and personal income tax returns.

You must reduce your deduction for wages by the total amount of the credit.  If you pay someone $20,000 for the year and take the maximum credit of $2,400 (40% x the first $6,000 in wages), then on your company’s tax return you can only deduct $17,600 in wages for that individual.  If you are the single owner of an S Corp and in the top tax bracket, that would reduce your effective tax savings by $840 ($2,400 x 35% tax bracket).

The WOTC is taken on Form 3800 of your personal return as a general business tax credit, but it is not refundable.  In other words, if your total tax liability after other credits and deductions comes to zero for the year, you cannot take the WOTC for that year.  You can carry it forward up to twenty years or carry it back to the previous year.

As real estate values increased between 2004 and 2006 some individuals took the opportunity to diversify and invest in residential real estate by purchasing rental properties.  Now, some of those individuals are faced with the prospect of foreclosure as property values have declined and the economy has slowed.

When a lender takes property either through foreclosure or deed in lieu of foreclosure in satisfaction of recourse debt the transaction is treated as a sale with proceeds equal to the lesser of fair market value at the time of foreclosure or the amount of secured debt.  This provision leads to debt discharge income if the amount of debt exceeds fair market value.

Individuals faced with foreclosure should consider spending $150 to have an appraisal completed at the time of foreclosure to validate the fair market value and potentially reduce debt discharge income.  It should be noted that debt discharge income only occurs once the lender discharges all or part of any deficiency (excess of debt over fair market value).  Please note that this discussion is limited to solvent taxpayers whereby debt does not constitute real property business debt.   If you are facing foreclosure, we recommend you contact us so we can properly plan for any tax consequences that may arise as result of debt discharge income.

Fortunately, the IRS offers guidance in Publication 517 on complicated issues such as payroll taxes and housing allowances.  Unfortunately, this publication is written in IRS speak which can be more difficult to translate than Greek.  Consider us your concordance.

The following are the top ten questions we are asked by the churches we work with, and some simple, plain English answers.

1. Do ordained members of the Clergy have FICA taxes withheld from their paychecks?

Before we answer this, we need to define some terms.  Federal Tax Withholding (FTW) is the money taken out of your paycheck for Income Taxes.  Yes, even a minister of a tax exempt church still has to pay Income Taxes.

FICA stands for Federal Insurance Contribution Act.  That really isn’t important.  What’s important is that FICA is your Social Security and Medicare taxes.  In a normal job, half of this tax (6.2% for Social Security, 1.45% for Medicare) is withheld from your paycheck, the other half is paid by your employer.  If you are an ordained member of the Clergy, you do not pay FICA taxes.

However, if you have not specifically filed to be exempt from the Social Security program, you will pay Self Employment Taxes (SECA) on your personal Income Tax return on April 15th.  This tax comes to 15.3%, so we recommend making additional quarterly estimated tax payments or withholding extra from your paycheck to avoid a hefty tax bill at the end of the year.

2. What is the difference between FICA and SECA?

You might be asking yourself at this point, is there a difference between FICA and SECA taxes?  If not, just skip this section

FICA and SECA taxes end up coming to the same percentage.  The only difference is that with FICA taxes the employer pays half and gets a deduction for it (not really helpful for your tax exempt church) and the other half is withheld from your paycheck.  For SECA taxes the employee pays the whole amount on their personal tax return, but the employee get’s to take a deduction for half.  This makes better use of the tax deduction, but sticks the employee with the whole tax bill.

3. What about my non-ordained church employees?

Unless you file specifically for them to be excluded from FICA withholding, then they are treated like employees of any other business.  They will have FTW and FICA withheld from their paychecks.

If your church is religiously opposed to paying FICA taxes, then you can file Form 8274 to exclude your employees from having it withheld from their check.  This doesn’t get them out of paying these taxes, it just means they have to pay them in the form of Self Employment taxes on their own personal Income Tax return instead.

4. So then what is the advantage of electing out of the Social Security program?

For non-ordained Church employees…nothing.  They still have to pay the tax whether it is withheld from their paycheck and the church pays the employer portion, or they pay both portions themselves through Self Employment taxes.  And before you think about ordaining your secretary, treasurer, cleaning person, and maintenance staff, their duties do not qualify as ministerial duties so it won’t work.

For Clergy, if you opt out of the Social Security program then you don’t have to pay Self Employment Taxes on your earnings.  That will save you 15.3% in taxes, which certainly isn’t a bad deal.  The downside is that you will not be eligible to collect Social Security or Medicare.  You will need to start saving now to make sure you can take care of your family when you retire.

5. Do I have to have Federal Withholding taken out of my paycheck?

Don’t be confused.  Whether you have Federal Withholding (not to be confused with FICA or SECA) taken out of your paycheck or pay your taxes through quarterly installments, you are responsible for paying your income taxes each year.  I think having income taxes withheld from your paycheck is easier and saves you from quarterly sticker shock, but as an ordained member of the clergy you don’t have to do it this way.  If you are disciplined and can make sure you have enough saved up each quarter to make your estimated tax payments, it is always nice to be able to earn interest on that money as long as possible.

6. How does the housing allowance for clergy work?

The Church can pay you to rent a house, pay you the fair rental value of your home, or provide a home for you without increasing your income taxes.  However, you will pay Self Employment Taxes on these amounts if you are not exempt! Let me provide some examples:

Let’s say Rev. Smith lives in a parsonage provided by the church.  The church doesn’t charge him any amount for the parsonage and pays his utility bills.  For Income Tax purposes, these amounts are completely exempt.  However, if he is not exempt from FICA or SECA, he will have to include the fair rental value of the parsonage and the amount paid for utilities as Self Employment income.

Now, let’s say Rev. Smith moves to a smaller church that does not have a parsonage.  The church can rent a house for him and pay his utility bills and even furnish the place for him without increasing his income tax.  However, just like with the parsonage, the amount that is paid for his rental, utilities, and furnishings becomes self employment income to him if he is not exempt.

Finally, let’s assume that after a few years Rev. Smith has established himself and decides to buy a house.  The church can now pay him the fair rental value of his furnished home plus utilities without increasing his Income Taxes.  But once again, this amount is subject to Self Employment Taxes if he is not exempt.

7. What if the church decides to reimburse me more than the fair rental value of my home?

You only get the exemption for the fair rental value of your furnished home plus utilities.  If that is $30,000 a year and the church gives you a housing allowance of $35,000, that additional $5,000 becomes taxable for Income Taxes as well as Self Employment Taxes.

8. In the end, what will the forms I take to my tax preparer look like?

As a minister, you will probably receive a W-2 Form from the church for your ministerial services.  This will show your wages in box 1 and any Federal Withholding in box 2.  Box 14 will show your housing and utilities allowances.

You may also receive 1099 Forms for extra services you perform such as weddings, funerals and honorariums for special speaking engagements.  These amounts will be reported as business income on Schedule C allowing you to deduct any related expenses against these amounts.  Yes, this is subject to Income Taxes, and yes, unless you are exempt this is subject to Self Employment Taxes as well.

9. What about unreimbursed expenses and business expenses?

This gets a little complicated, and I recommend contacting your tax adviser/preparer when it comes time for preparation.  Very simply put, the IRS doesn’t let you take deductions against non-taxable income.  Where this becomes an issue for you as an ordained member of the clergy is that your housing allowance is non-taxable income.

Basically, you can only deduct a percentage of your expenses based on what percentage of your total income (wages, honorariums, housing allowance, etc.) is subject to Income Taxes.  The result is a set of complicated worksheets that only the IRS could come up with.  On the other hand, even though your housing allowance is not subject to Income Taxes, you can still deduct 100% of your mortgage interest and property taxes on Schedule A.

10. What about Health Insurance and Retirement?

Whether you opt out of Social Security and Medicare or not, you might be wondering how the IRS treats your income for retirement plans and health insurance plans.

For Retirement Plan purposes, you have some flexibility as far as what plan you can set up.  If you receive wages from the church based on a specific, regular ministry that you provide for the church, then you are most likely considered an employee even though your wages are subject to Self Employment taxes.  This allows the church to set up an employee retirement plan and have you participate.

On the other hand, if you receive money for irregular services such as marriages, baptisms, and funerals, this is considered self employment income and you may be eligible to set up a SEP or SIMPLE plan for yourself.  I recommend consulting with your tax adviser or financial adviser to determine your specific circumstances.

You may be eligible for favorable treatment of your health insurance costs if you are determined to be self-employed.  If you perform services aside from your normal ministerial duties and are not eligible to participate in a health plan subsidized by yours or your spouses employer, than you can take your health insurance costs as a non-itemized deduction on page one of your Income Tax return up to the amount of your net self employment income.

We hope this guide has proven useful.  As with any tax question, please consult your tax adviser for additional information for your specific situation.

EFTPS is a simple, hassle free way to make your payroll tax deposits online.  However, you should start planning now for the switch over if you are a Bank of America business customer.  It can take up to fifteen days from the day you apply to get your PIN and online password for EFTPS in the mail.

You can apply for your EFTPS PIN by clicking here.

The problem with a Roth IRA is that higher income individuals and people filing separately.  In 2010 that will change.  The law preventing Married Filing Separate filers from contributing to a Roth IRA will expire on January 1, 2010.

For wealthy individuals there is a trick to it.  The income limitations for direct Roth IRA contributions will still be in place, making it so that joint filers with adjust gross income over $176,000 and single filers with AGI over $120,000 cannot make contributions directly to a Roth IRA.  However, the rule making it so that people with AGI of $100,000 or more can’t role a traditional IRA over to a Roth will be gone as of January 1, 2010.

The result is that you will be able to make non-deductible contributions to a traditional IRA and then roll them over into a Roth IRA no matter what your income level is.  You will only pay taxes on any earnings between your original contribution and the rollover.

If your AGI will be over the limit for 2009, you can still get a headstart this year by opening a traditional IRA now and making non-deductible contributions for 2009.

However, a district court has recently decided that you can lose that bankruptcy exemption if you misuse your IRA.  Although creditors cannot typically grab IRA funds, that rule does not apply if engages in a prohibited transactions with the account. In this case, the owner of a self-directed IRA borrowed money from it and used the account to pay off a mortgage on property that he wanted. His self-dealing with the account nullified the bankruptcy exemption (Willis, D. C., Fla.).

The IRS did not come after this individual for back taxes on the account after discovering the prohibited transactions.  In fact, the IRS has typically been lenient when it comes to IRA mistakes, especially if they are unintentional.  Don’t expect your creditors to be as nice.