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Contributions to Trump accounts will be treated as completed gifts that are not future interests in property and the gift tax annual exclusion amount will apply under a safe harbor for certain donors making contributions to Trump accounts created under Code Sec. 530A.

Contributions to Trump accounts will be treated as completed gifts that are not future interests in property and the gift tax annual exclusion amount will apply under a safe harbor for certain donors making contributions to Trump accounts created under Code Sec. 530A.

Pursuant to the rules of Code Sec. 530A, distributions from Trump accounts are limited during the growth period, which is the period ending on January 1 of the year in which the account beneficiary attains age 18. During the growth period, annual contributions are limited to $5,000 per year, as adjusted for inflation after 2027. Gifts of future interests in property are not eligible for the annual gift tax exclusion and must be reported on a federal gift tax return.

The safe harbor applies for a particular year if the following requirements of section 4.02 are met:

• The taxpayer is an individual;
• The only taxable gifts made by the taxpayer during the calendar year are cash contributions to one or more Trump accounts, each made before the calendar year in which the account beneficiary attains age 18;
• The taxpayer's total gifts during the calendar year to each individual who is an account beneficiary, including contributions to that individual beneficiary's Trump account, do not exceed the Code Sec. 2503(b) annual exclusion;
• Such contributions to Trump accounts during the calendar year do not generate for that year either a gift or generation-skipping transfer (GST) tax liability after application of the taxpayer's remaining applicable credit amount against the gift tax or remaining GST exemption; and
• Disregarding the Trump account contributions described in section 4.02(2) of the revenue procedure, a gift tax return is not required to be filed, and no gift tax return is otherwise filed for that calendar year by or on behalf of the taxpayer for any other purposes.

If these requirements are satisfied, each Trump account contribution made by the taxpayer during the calendar year will be treated as a completed gift to the account beneficiary that is not a future interest in property and to which the annual exclusion applies for purposes of gift and GST tax reporting. As a result, taxpayers within the scope of the safe harbor will not be required to file a gift tax return reporting the such contributions.

Rev. Proc. 2026-25

IR 2026-80

The IRS has issued final regulations identifying certain Charitable Remainder Annuity Trust (CRAT) transactions and substantially similar transactions as listed transactions subject to the reportable transaction disclosure rules. The regulations require participants and material advisors to disclose these transactions to the IRS while clarifying that charitable organizations whose only interest is as charitable remaindermen are not treated as participants or parties to prohibited tax shelter transactions. The regulations are effective July 9, 2026.

The IRS has issued final regulations identifying certain Charitable Remainder Annuity Trust (CRAT) transactions and substantially similar transactions as listed transactions subject to the reportable transaction disclosure rules. The regulations require participants and material advisors to disclose these transactions to the IRS while clarifying that charitable organizations whose only interest is as charitable remaindermen are not treated as participants or parties to prohibited tax shelter transactions. The regulations are effective July 9, 2026.

Under Code Secs. 6011 and 6707A, the IRS may identify transactions with tax avoidance potential as listed transactions. The final regulations add Reg. §1.6011-15, identifying transactions in which appreciated property is contributed to a purported CRAT, sold by the trust, and the sale proceeds are used to purchase an annuity, with the beneficiary improperly treating the annuity payments under Code Sec. 72 instead of applying the distribution ordering rules of Code Sec. 664(b).

Although participants and material advisors remain subject to the applicable disclosure requirements, organizations described in Code Sec. 170(c) that merely receive the charitable remainder interest are excluded from participant status and are not treated as parties to prohibited tax shelter transactions under Code Sec. 4965 solely because of that interest. The IRS finalized the regulations without substantive changes from the proposed regulations issued in 2024.

T.D. 10051

IR 2026-82

A portion of litigation settlement proceeds consisting of attorney’s fees and costs was includible in the gross income of two individuals (taxpayers). Said portion was not deductible under Code Sec. 62(a)(20). The Fair Credit Reporting Act’s (FCRA) (P.L. 91-508) fee-shifting provisions were inapplicable in this case.

A portion of litigation settlement proceeds consisting of attorney’s fees and costs was includible in the gross income of two individuals (taxpayers). Said portion was not deductible under Code Sec. 62(a)(20). The Fair Credit Reporting Act’s (FCRA) (P.L. 91-508) fee-shifting provisions were inapplicable in this case.

Background

The taxpayers sued multiple credit reporting agencies under FCRA provisions. They eventually settled with each agency. In all relevant Forms 1099–MISC the settlement amounts were reflected without the attorney’s fees and costs.

Civil Rights Interpretation for FCRA Claims Denied

The taxpayers’ FCRA claims of unlawful discrimination did not fall under Code Sec. 62(e)(18)(i). Said claims were based on fair and accurate credit reporting and not consumer privacy. Particularly, the taxpayers’ concerns did not fall under “highly sensitive” and “intimate personal information” categories.

J.W. Eiler, 167 T.C. No. 3, Dec. 62,865

The IRS has reminded taxpayers that major life events can affect tax filing requirements, eligibility for tax benefits and the amount of tax withheld from paychecks. The agency explained that changes such as marriage, the birth or adoption of a child, divorce or the death of a loved one may require updates to tax information and a review of filing status.

The IRS has reminded taxpayers that major life events can affect tax filing requirements, eligibility for tax benefits and the amount of tax withheld from paychecks. The agency explained that changes such as marriage, the birth or adoption of a child, divorce or the death of a loved one may require updates to tax information and a review of filing status. A name change following marriage should be reported to the Social Security Administration so the updated name matches Social Security records. An address change should be reported to the IRS by filing Form 8822, Change of Address, and employers, financial institutions and the U.S. Postal Service should also be notified. Marriage may also require submission of a new Form W-4, Employee's Withholding Certificate, to ensure the correct amount of tax is withheld.

Additionally, the IRS noted that the birth or adoption of a child may make a taxpayer eligible for valuable tax benefits, including the Child Tax Credit, Adoption Credit and Child and Dependent Care Credit, if applicable requirements are satisfied. Divorce or the death of a spouse may also affect filing status, tax withholding and eligibility for certain tax benefits. The IRS encouraged prompt updates to tax records, careful evaluation of changes affecting tax obligations and use of available IRS resources to better understand the tax consequences of major life events. Early action can help avoid filing issues, support accurate tax reporting, maximize available tax benefits and improve preparation for the next tax filing season.

IRS Tax Tip 2026-55

The Internal Revenue Service received and processed less returns during 2026, according to the Treasury Inspector General for Tax Administration.

The Internal Revenue Service received and processed less returns during 2026, according to the Treasury Inspector General for Tax Administration.

In a recently released report, TIGTA stated that from March 1, 2025, through February 28, 2026, the IRS received 51.5 million tax returns, down from 52. 4 million in the previous year, though it did see a significant drop in paper returns received from 1.2 million in 2025 to 618,000 in 2026. Of the returns received in 2026, the agency processed 50.9 million returns, down from 51.8 million.

From the beginning of the 2026 tax filing season to the end of February 2026, TIGTA reported that the inventory backlog in key tax return processing programs increased from 1.9 million to 2.4 million. Additionally, nearly 75 percent of the amended return inventory is over-aged during the 2026 tax filing season.

“Generally, inventories increase during the filing season as the IRS balances efforts to answer phone calls and reduce inventories,” TIGTA stated in the report. “However, with the reduction in staff, increases in key inventories could become a concern.”

The number of refunds dipped to 36.5 million from 36.9 million, although there was a $360 increase in the average refund from $3,382 in 2025 to $3,742.

TIGTA also reported that the IRS did not meet its hiring goals for the 2026 tax filing season. The agency had been approved to hire 1,900 employees for submission processing (these workers process original and amended returns and resolve tax return errors) but only onboarded 800 individuals. Likewise, it was approved to hire 3,500 account management employees (handlers of taxpayer contacts through telephone and mail and process adjustments) but brought 2,300 on board.

Submission processing management said it would be onboarding new hires throughout the tax season, while account management leadership had no plans to hire new employees and would only be onboarding those who previously received offers but had delays in the hiring process.

In a positive from the 2026 season, TIGTA reported that the new and modified “e-file business rules associated with the child tax Credit, state and local tax deduction, and adoption credit are working as intended.”

Taxpayer Assistance Centers offered incorrect tax guidance during nearly half of unannounced visits by Treasury Inspector General for Tax Administration staff.

Taxpayer Assistance Centers offered incorrect tax guidance during nearly half of unannounced visits by Treasury Inspector General for Tax Administration staff.

According to a recent TIGTA report, during the 2025 tax filing season, the Treasury watchdog made 91 unannounced visits to TACs nationwide at various time (regular and extended hours), at the 61 visits where TIGTA staff did receive assistance, “TAC employees did not provide the correct tax law guidance during 28 of those visits (46 percent).”

TAC employees were presented with questions across one of the three areas – injured spouse, selling your main home, and American Opportunity Tax Credit. The report notes that for questions related to tax law topics, “TAC employees must use the Interactive Tax Law Assistant ITLA) tool to respond to taxpayers. The ITLA tool asks a series of questions, then generates accurate and complete responses based on the taxpayer’s situation. The tool is designed for TAC employees and is intended to improve operational performance in the areas of quality, efficiency, customers satisfaction, and employee satisfaction.”

TIGTA noted that during the 2025 filing season, “managers counseled several TAC employees for not using the ITLA tool during taxpayer interactions. During our site visits, we also observed that TAC employees did not always the ITLA tool to answer our tax law questions.”

Additionally, of those 91 visits, TIGTA “did not receive full assistance during 30 of our 91 visits due to incomplete or inaccurate responses to tax law questions, denial of entry by security or unexpected TAC closures.”

A taxpayer's expenses incurred due to travel outside of the United States for business activities are deductible, but under a stricter set of rules than domestic travel. Foreign travel expenses may be subject to special allocation rules if a taxpayer engages in personal activities while traveling on business. Expenses subject to allocation include travel fares, meals, lodging, and other expenses incident to travel.  

Allocation expenses

Frequently, international business trips have a personal aspect. A taxpayer who travels outside of the United States for both business and pleasure may deduct no part of his or her travel expenses (airfare, cabs, hotel, meals, etc.) if the trip is not primarily related to business. However, business expenses incurred while at the destination are deductible even though the travel expenses are not.

If the trip is primarily related to business, then that portion of travel properly allocated to the business portion may be deducted. Proper allocation is based on the amount of time spent on each activity. "Primary purpose" is a purpose of more than 50 percent. Foreign travel for purposes of allocation is travel outside the 50 states and the District of Columbia.

The general "primary purpose" rule on foreign business travel, fortunately, has two huge exceptions, one for anyone who travels a week or less and the other for most employees on business trips under an expenses allowance arrangement.

The allocation rules do not apply to taxpayers:

• who do not have substantial control over the business trip;
• whose travel outside the United States is a week or less in duration; 
• who establish that a personal vacation was not a major factor in deciding to take the trip; and
• whose personal activities conducted during the trip are less than 25 percent of the total travel time.

Taxpayers who travel under reimbursement or other expense allowance arrangements are not considered to have substantial control over the business trip unless they are the managing executive of the employer or a party related to, or more than 10 percent owner of the employer.

Conventions

Business conventions come under a separate rule. A taxpayer cannot deduct travel expenses for attending a convention, seminar or similar business meeting held outside the "North American area" unless specific criteria are satisfied. The "North American area" includes not only the US, Canada, and Mexico but also Costa Rica, Honduras and many islands in the Atlantic, Caribbean, and the Pacific.

If you are unsure of how to allocate your business travel expenses and need additional information, please give our office a call. We would be glad to help.

With the subprime mortgage mess wreaking havoc across the country, many homeowners who over-extended themselves with creative financing arrangements and exotic loan terms are now faced with some grim tax realities. Not only are they confronted with the overwhelming possibility of losing their homes either voluntarily through selling at a loss or involuntarily through foreclosure, but they must accept certain tax consequences for which they are totally unprepared.

Many homeowners - whether in connection with their principal residence or a vacation property - may not anticipate that foreclosure and a home sale that produces a loss can trigger significant and unexpected income tax liabilities, especially when the sale does not produce enough gain to pay off outstanding mortgage debt.

Selling at a loss

Homeowners may be unpleasantly surprised to learn that they can not write-off losses incurred from the sale of their home. When a homeowner is forced to sell their personal residence for less than the price they paid, the loss incurred on the sale is considered to be a non-deductible personal expense for federal income tax purposes. What's more, if the homeowner eventually buys another home that is sold down the road at a taxable profit, previous losses cannot be used to offset that gain.

Faced with such a situation, the technique of renting out the home, rather than selling it, might help some homeowner buy time until better times. If renting eventually stops making financial sense, the homeowner who sells at a loss might then succeed in establishing a deductible business loss from the business of renting property. However, only losses incurred after the property is converted may be deducted.

Debt forgiveness

Homeowners who sell their property when their mortgage debt exceeds the net sale price of the home (a so-called "short sale") may find that they owe taxes to the IRS. For example, assume you paid $500,000 for a home that you sell for a net sale price of $400,000, but you have a mortgage of $550,000 on the property. For tax purposes, you have incurred a $100,000 loss on the sale because the sale price is lower than your tax basis in the property ($400,000 sale price - $500,000 basis = $100,000 loss). Moreover, you still owe $150,000 to your mortgage lender since a mortgage note is a personal liability in addition to being an encumbrance on the house itself. If the lender refuses to discharge the remaining debt, you'll have to pay off the loan and there is no tax break or write-off for doing so.

On the other hand, if the mortgage lender forgives part or all of the remaining $150,000 debt, the amount discharged is considered taxable income. With few exceptions, discharged debt of all types is treated as income, taxable at ordinary rates just like a salary. It is irrelevant to the IRS that no tangible income was actually received on the sale of the home or forgiveness of debt by the lender. You will owe taxes on the amount of mortgage debt that the lender discharges. What's more, there is no offset from your $100,000 loss on the sale of the property; nor is this income covered by the $250,000 exclusion on taxable gain on the sale of a principal residence ($500,000 for joint filers).

A lender who discharges any part or all of a homeowner's debt must report the forgiven debt on Form 1099-C (Cancellation of Debt) to you and to the IRS. You must report the amount of discharged debt as income on your tax return in the year the mortgage debt is forgiven.

Foreclosure

Foreclosure also produces tax consequences that may be wholly unanticipated by the homeowner. Taxable gains and income from mortgage debt forgiveness also occur in foreclosure. Tax liability upon foreclosure depends on whether you have a nonrecourse or recourse loan. A recourse loan permits the lender to sue the borrower for any outstanding debt. When a foreclosure occurs on the property of a homeowner with a nonrecourse loan, however, the lender is only entitled to collect the amount that the home is sold for, and the borrower has no further liability.

Example. Your tax basis in your home is $400,000. You have a recourse loan and your mortgage debt totals $350,000. But at the time of foreclosure the fair market value of your home has decreased to $325,000. However, the lender forgives the remaining unpaid mortgage debt of $25,000 (usually because the lender sees that the former homeowner has little assets left, the remaining debt would be hard to collect, and an immediate write off gives the lender an immediate tax deduction). Tax law treats you as having received ordinary income from the cancellation of the debt in the amount of $25,000.

Alternatively, if you had a nonrecourse loan in the amount of $350,000 and your home sold at auction for $325,000, you would have no further liability to the lender since it cannot pursue you for the lost $25,000. Therefore, since your mortgage lender cannot legally pursue you for the remaining $25,000, there will be no debt for them to discharge. Such nonrecourse loans, however, are very rare in personal, non-business settings.

Moreover, if property is foreclosed and sold at auction for more than the home's tax basis, the sale produces taxable gain. In this case, however, the gain from a foreclosure sale of an individual's principal residence may be excluded to the extent of up to $250,000 ($500,000 for married homeowners filing jointly), depending on the length of homeownership. No exclusion, however, is given on vacation property that is not a principal residence.

Future relief for homeowners?

In mid-April, Reps. Robert E. Andrews (D-New Jersey) and Ron Lewis (R-Kentucky), introduced the Mortgage Cancellation Relief Act of 2007 (H.R. 1876), a bill that would assist many homeowners affected by the loss of their home through foreclosure or short sale. The legislation would exempt discharged debt on primary home mortgages from treatment as income subject to income taxation. Currently, the bill is before the House Ways and Means Committee.

If you would like more information on the tax consequences of foreclosure or the potential implications of taking a loss on the sale of your home or vacation property, please call our office and we can discuss your options for minimizing your tax liabilities.

These days, both individuals and businesses buy goods, services, even food on-line. Credit card payments and other bills are paid over the internet, from the comfort of one's home or office and without any trip to the mailbox or post office.

Now, what is probably your biggest "bill" can be paid on-line: your federal income taxes.

There are three online federal tax payment options available for both businesses and individuals: electronic funds withdrawal, credit card payments and the Electronic Federal Tax Payment System. If you are not doing so already, you should certainly consider the convenience -and safety-- of paying your tax bill online.  While all the options are now "mainstream" and have been used for at least several years, safe and convenient, each has its own benefits as well as possible drawbacks. The pros and cons of each payment option should be weighed in light of your needs and preferences.

Electronic Funds Withdrawal

Electronic funds withdrawal (or EFW) is available only to taxpayers who e-file their returns. EFW is available whether you e-file on your own, or with the help of a tax professional or software such as TurboTax. E-filing and e-paying through EFW eliminates the need to send in associated paper forms.

Through EFW, you schedule when a tax payment is to be directly withdrawn from your bank account. The EFW option allows you to e-file early and, at the same time, schedule a tax payment in the future. The ability to schedule payment for a specific day is an important feature since you decide when the payment is taken out of your account. You can even schedule a payment right up to your particular filing deadline.

The following are some of the tax liabilities you can pay with EFW:

• Individual income tax returns (Form 1040)
• Trust and estate income tax returns (Form 1041)
• Partnership income tax returns (Forms 1065 and 1065-B)
• Corporation income tax returns for Schedule K-1 (Forms 1120, 1120S, and 1120POL)
• Estimated tax for individuals (Form 1040)
• Unemployment taxes (Form 940)
• Quarterly employment taxes (Form 941)
• Employers annual federal tax return (Form 944)
• Private foundation returns (Form 990-PF)
• Heavy highway vehicle use returns (Form 2290)
• Quarterly federal excise tax returns (Form 720)

For a return filed after the filing deadline, the payment is effective on the filing date. However, electronic funds withdrawals can not be initiated after the tax return or Form 1040 is filed with the IRS. Moreover, a scheduled payment can be canceled up until two days before the payment.

EFW does not allow you to make payments greater than the balance you owe on your return. Therefore, you can't pay any penalty or interest due through EFW and would need to choose another option for these types of payments. While a payment can be cancelled up to two business days before the scheduled payment date, once your e-filed return is accepted by the IRS, your scheduled payment date cannot be changed. Thus, if you need to change the date of the payment, you have to cancel the original payment transaction and chose another payment method. Importantly, if your financial institution can't process your payment, such as if there are insufficient funds, you are responsible for making the payment, including potential penalties and interest. Finally, while EFW is a free service provided by the Treasury, your financial institution most likely charges a "convenience fee."

Credit Card Payments

Do you have your card ready? The Treasury Department is now accepting American Express, Discover, MasterCard, and VISA.

Both businesses and individual taxpayers can make tax payments with a credit card, whether they file a paper return or e-file. A credit card payment can be made by phone, when e-filing with tax software or a professional tax preparer, or with an on-line service provider authorized by the IRS. Some tax software developers offer integrated e-file and e-pay options for taxpayers who e-file their return and want to use a credit card to pay a balance due.

However, there is a convenience fee charged by service providers. While fees vary by service provider, they are typically based on the amount of your tax payment or a flat fee per transaction. For example, you owe $2,500 in taxes and your service provider charges a 2.49% convenience fee. The total fee to the service provider will be $62.25. Generally, the minimum convenience fee is $1.00 and they can rise to as much as 3.93% of your payment.

The following are some tax payments that can be made with a credit card:

• Individual income tax returns (Form 1040)
• Estimated income taxes for individuals (Form 1040-ES)
• Unemployment taxes (Form 940)
• Quarterly employment taxes (Form 941)
• Employers annual federal tax returns (Form 944)
• Corporate income tax returns (Form 1120)
• S-corporation returns (Form 1120S)
• Extension for corporate returns (Form 7004)
• Income tax returns for private foundations (Form 990-PF)

However, as is the case is with the EFW option, if a service provider fails to forward your payment to the Treasury, you are responsible for the missed payment, including potential penalties and interest.

Electronic Federal Tax Payment System

EFTPS is a system that allows individuals and businesses to pay all their federal taxes electronically, including income, employment, estimated, and excise taxes. EFTPS is available to both individuals and businesses and, once enrolled, taxpayers can use the system to pay their taxes 24 hours a day, seven days a week, year round. Businesses can schedule payments 120 days in advance while individuals can schedule payments 365 days in advance. With EFTPS, you indicate the date on which funds are to be moved from your account to pay your taxes. You can also change or cancel a payment up to 2 business days in advance of the scheduled payment date.

EFTPS is an ideal payment option for taxpayers who make monthly installment agreement payments or quarterly 1040ES estimated payments. Businesses should also consider using EFTPS to make payments that their third-party provider is not making for them.

EFTPS is a free tax payment system provided by the Treasury Department that allows you to make all your tax payments on-line or by phone. You must enroll in EFTPS, however, but the process is simple.

We would be happy to discuss these payment options and which may best suit your individual or business needs. Please call our office learn more about your on-line federal tax payment options.

Fringe benefits have not only become an important component of employee compensation, they also have a large financial impact on an employer's business. Fringe benefits are non-compensation benefits provided by an employer to employees. Unless they fall within one of the specific categories of tax-exempt fringe benefits, however, are taxable to employees.

Qualified employee discounts are among several categories of fringe benefits that are non-taxable to the employee under Code Sec. 132 and also deductible by the employer as an ordinary and necessary business expense. If you want to give employee discounts, this is the type you should consider first.

Qualified employee discounts

For an employee discount to be excludable from an employee's income and deductible by the employer, it must constitute a qualified employee discount. A qualified employee discount is an employee discount provided on qualified property or services. If the benefits are not qualified, they are taxable to the employee.

Qualified employee discounts are those that are provided on products or services sold in the ordinary course of the employer's line of business. For instance, employee discounts on items sold only at an employee store are not excludable from gross income because they are not offered for sale to non-employee customers in the ordinary course of the employer's line of business.

An employer may exclude the value of an employee discount provided to an employee from his or her wages, up to the following limits:

• For a discount on services, 20% of the price the employer charges non-employee customers for the service.

• For a discount on merchandise or other property, the employer's gross profit percentage times the price the employer charges non-employee customers for the property.

For example, if an employer's business sells a product for $100 and its cost is $75, the gross profit margin is $25. Therefore, to be tax-free to the employee, the discount cannot exceed $25. If an employer charges customers $100 for a certain service, the employee's tax-free discount for the same service cannot exceed $20 (i.e. 20 percent of the value of the service). Any excess discount will be treated as taxable income to the employee.

Qualified employee discounts can be provided through a direct reduction in the price of property or services as well through a cash rebate system. However, the discounts cannot be provided on real estate or investment property, such as stocks and bonds.

Non-discrimination

Qualified employee discounts must be available to employees on a nondiscriminatory basis, which requires that the benefits be available on substantially the same terms to all employees or to each member of a reasonable classification of employees that does not discriminate in favor of highly compensation employees. An employer engaged in more than one line of business must treat each line of business separately in applying the discrimination test. If an employer's plan fails the test, only your employees who are not highly compensated may exclude the value of the benefit from income.

Business expense deduction

An employer can deduct the actual cost of providing fringe benefits to employees as an ordinary and necessary business expense, whether or not the benefits are taxable to the employees. Employers can deduct the cost of providing qualified employee discounts as either compensation for services rendered or as a tax deductible business expense under Code Sec. 162.

As with other business expenses incurred by an employer for which tax deductions are sought, expenses paid or incurred in carrying on a trade or business are deductible only if they are ordinary and necessary. Ordinary and necessary expenses must be reasonable in amount to be deductible.

Because a qualified employee discount is a type of fringe benefit (albeit tax exempt), and fringe benefits are a form of employee compensation under Code Sec. 61, a qualified employee discount will meet the business expense requirements of Code Sec. 162, providing for deduction by an employer. Thus, employers can deduct the cost of qualified employee discounts and not pay any employment taxes on them.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

Reasonable compensation is generally defined as the amount that would ordinarily be paid for like services by like enterprises under like circumstances. This broad definition is supplemented, for purposes of determining whether compensation is deductible as an ordinary and necessary expense, by a number of more specific factors expressed in varying forms by the IRS, the Tax Court and the Circuit Courts of Appeal, and generally relating to the type and extent of services provided, the financial concerns of the company, and the nature of the relationship between the employee and the employer.

Why IRS Is Interested

A chief concern behind the IRS's keen interest in what a company calls "compensation" is the possibility that what is being labeled compensation is in fact a constructive dividend. If employees with ownership interests are being paid excessive amounts by the company, the IRS may challenge compensation deductions on the grounds that what is being called deductible compensation is, in fact, a nondeductible dividend.

Another area of concern for the IRS is the payment of personal expenses of an employee that are disguised as businesses expenses. There, the business is trying to obtain a business expense deduction without the offsetting tax paid by the employee in recognizing income. In such cases, a business and its owners can end up with a triple loss after an IRS audit: taxable income to the individual, no deduction to the business and a tax penalty due from both parties.

Factors Examined

The factors most often examined by the IRS in deciding whether payments are reasonable compensation for services or are, instead, disguised dividend payments, include:

1. The salary history of the individual employee
2. Compensation paid by comparable employers to comparable employees
3. The salary history of other employees of the company
4. Special employee expertise or efforts
5. Year-end payments
6. Independent inactive investor analysis
7. Deferred compensation plan contributions
8. Independence of the board of directors
9. Viewpoint of a hypothetical investor contemplating purchase of the company as to whether such potential investor would be willing to pay the compensation.

Failure to pass the reasonable compensation test will result in the company's loss of all or part of its deduction. Analysis and examination of a company's compensation deductions in light of the relevant listed factors can provide the company with the assurance that the compensation it pays will be treated as reasonable -- and may in the process prevent the loss of its deductions.

Note: In the case of publicly held corporations, a separate $1 million dollar per person cap is also placed on deductible compensation paid to the CEO and each of the four other highest-paid officers identified for SEC purposes. (Certain types of compensation, including performance-based compensation approved by outside directors, are not included in the $1 million limitation.)

The S Corp Enigma

The opposite side of the reasonable compensation coin is present in the case of some S corporations. By characterizing compensation payments as dividends, the owners of these corporations seek to reduce employment taxes due on amounts paid to them by their companies. In these cases, the IRS attempts to recharacterize dividends as salary if the amounts were, in fact, paid to the shareholders for services rendered to the corporation.

Caution. In the course of performing the compensation-dividend analysis, watch out for contingent compensation arrangements and for compensation that is proportional to stock ownership. While not always indicators that payments are distributions of dividends instead of compensation for services, their presence does suggest the possibility. Compensation plans should not be keyed to ownership interests. Contingent and incentive arrangements are also scrutinized by the IRS. The courts have frequently ruled that a shareholder has a built-in interest in seeing that the company is successful and rewarding him for increasing the value of his own property is inappropriate. Similar to the reasonable compensation test, however, this rule is not hard and fast. Accordingly, the rules followed in each jurisdiction will control there.

Conclusions

Determining whether a shareholder-employee's compensation is reasonable depends upon many variables, such as the contributions that employee makes to your business, the compensation levels within your industry, and whether an independent investor in your company would accept the employee's compensation as reasonable.

Please call our office for a more customized analysis of how your particular compensation package fits into the various rules and guidelines. Further examination of your practices not only may help your business better sustain its compensation deductions; it may also help you take advantage of other compensation arrangements and opportunities.

There are tax benefits for which you may be eligible if you are paying education expenses for yourself or an immediate member of your family. In the rush to claim one of two education tax credits or the higher-education expense deduction, IRS statistics indicate that a more modest yet still significant tax break is often being overlooked: the higher education student-loan interest deduction.

The student loan interest deduction for 2006 was the smaller of $2,500 or the amount of interest paid. The deduction amount may be gradually reduced or eliminated based on your filing status and modified adjusted gross income (MAGI).

Form 1098-E

Form 1098-E will help you calculate your student loan interest deduction. An institution that received interest payments of $600 or more during a calendar year on one or more qualified student loans must send Form 1098-E to each borrower.

Modified adjusted gross income

For 2007, the $2,500 maximum deduction for interest paid on qualified education loans begins to phase out ratably for taxpayers with modified adjusted gross income in excess of $55,000 ($110,000 for joint returns), and is completely phased out for taxpayers with modified adjusted gross income of $70,000 or more ($140,000 or more for joint returns).

Reduced deduction

If your credit must be reduced because of your MAGI, you must calculate your reduced deduction. To calculate your reduced amount, multiply your interest deduction (before the reduction) by a fraction. The numerator is your MAGI minus $55,000 ($110,000 for joint return filers). The denominator is $15,000 ($30,000 for joint return filers). Subtract the result from your deduction (before the reduction). This result is the amount you can deduct.

Example A. During 2007 Ed pays $800 interest on a qualified student loan. Ed's 2007 MAGI is $130,000 and he files a joint return. $800 X ($130,000-$110,000 / $30,000) =$533. Ed must reduce his deduction by $533. His reduced student loan interest deduction is $267 ($800 - $533).

Example B. During 2007 Bea, who is single, pays $2,750 interest on a qualified student loan. Bea's maximum deduction for 2007 is $2,500. However, Bea must further limit her maximum deduction since her MAGI is $60,000. Her required reduction is $2,500 x ($60,000 - $55,000 / $15,000) or $833.33 Her reduced student loan interest deduction is $2,500 - $833.33 or $1,666.67.

If you are unsure of your eligibility for the student loan interest deduction, please give our office a call and we will be happy to assist you.