Steve Hamilton is a Tampa native and a graduate of the University of South Florida and the University of Missouri. He now lives in northern Kentucky. A career CPA, Steve has extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.
Tuesday, December 24, 2019
Sunday, December 22, 2019
Year-End Retirement Tax Changes
On Friday December 20, 2019 the President signed two
spending bills, averting a government shutdown at midnight.
The reason we are talking about it is that there were
several tax provisions included in the bills. Many if not most are as dry as
sand, but there are a few that affect retirement accounts and are worth talking
about.
Increase the Age for Minimum Required
Distributions (MRDs)
We know that we are presently required to begin
distributions from our IRAs when we reach age 70 ½. The same requirement
applies to a 401(k), unless one continues working and is not an owner.
Interestingly, Roths have no MRDs until they are inherited.
In a favorable change, the minimum age for MRDs has
been increased to 72.
Repeal the Age Limitation for IRA
Contributions
Presently you can contribute to your 401(k) or Roth
past the age of 70 ½. You cannot, however, contribute to your IRA past age 70
½.
In another favorable change, you will now be allowed
to contribute to your IRA past age 70 ½.
COMMENT: Remember that
you generally need income on which you paid social security taxes (either
employee FICA or self-employment tax) in order to contribute to a retirement
account, including an IRA. In short, this change applies if you are working
past 70 ½.
New Exception to 10% Early Distribution
Penalty
Beginning in 2020 you will be allowed to withdraw up
to $5,000 from your 401(k) or IRA within one year after the birth or adoption
of a child without incurring the early distribution penalty.
BTW, the exception applies to each spouse, so a
married couple could withdraw up to $10,000 without penalty.
And the “within one year” language means you can
withdraw in 2020 for a child born in 2019.
Remember however that the distribution will still be
subject to regular income tax. The exception applies only to the penalty.
Limit the Ability to Stretch an IRA
Stretching begins with someone dying. That someone had
a retirement account, and the account was transferred to a younger beneficiary.
Take someone in their 80s who passes away with $2
million in an IRA. They have 4 grandkids, none older than age 24. The IRA is
divided into four parts, each going to one of the grandkids. The required
distribution on the IRAs used to be based on the life expectancy of someone in
their 80s; it is now based on someone in their 20s. That is the concept of
“stretching” an IRA.
Die after December 31, 2019 and the maximum stretch
(with some exceptions, such as for a surviving spouse) is now 10 years.
Folks, Congress had to “pay” for the other breaks
somehow. Here is the somehow.
Annuity Information and Options Expanded
When you get your 401(k) statement presently, it shows
your account balance. If the statement is snazzy, you might also get
performance information over a period of years.
In the future, your 401(k) statements will provide
“lifetime income disclosure requirements.”
Great. What does that mean?
It means that the statement will show how much money
you could get if you used all the money in the 401(k) account to buy an
annuity.
The IRS is being given some time to figure out what
the above means, and then employers will have an extra year before having to
provide the infinitely-better 401(k) statements to employees and participants.
By the way …
You will never guess this, but the law change also
makes it easier for employers to offer annuities inside their 401(k) plans.
Here is the shocked face:
In case you work for a small employer who does not
offer a retirement plan, you might want to mention the enhanced tax credit for
establishing a retirement plan.
The old credit was a flat $500. It got almost no
attention, as $500 just doesn’t move the needle.
The new credit is $250 per nonhighly-compensated employee,
up to $5,000.
At $5 grand, maybe it is now worth looking at.
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Sunday, December 15, 2019
Deducting State And Local Taxes On Your Individual Return
You
probably already know about the change in the tax law for deducting state and
local taxes on your personal return.
It
used to be that you could itemize and deduct your state and local income taxes,
as well as the real estate taxes on your house, without limitation. Mind you, other restrictions may have
kicked-in (such as the alternative minimum tax), but chances are you received some
tax benefit from the deduction.
Then
the Tax Cuts and Jobs Act put a $10,000 limit on the state income/local income/property
tax itemized deduction.
Say
for example that the taxes on your house are $5 grand and your state income taxes
are $8 grand. The total is $13 grand, but the most you can deduct is $10 grand.
The last $3 grand is wasted.
This
is probably not problem if you live in Nevada, Texas or Florida, but it is
likely a big problem if you live in California, New York, New Jersey or
Connecticut.
There
have been efforts in the House of Representatives to address this matter. One
bill would temporarily raise the cap to $20,000 for married taxpayers before
repealing the cap altogether for two years, for example.
The
tax dollars involved are staggering. Even raising the top federal to 39.6%
(where it was before the tax law change) to offset some of the bill’s cost still
reduces federal tax receipts by over $500 billion over the next decade.
There
are also political issues: The Urban-Brookings Tax Policy Center ranked the 435
Congressional districts on the percentage of households claiming the SALT (that
is, state and local tax) deduction in 2016. Nineteen of the top 20 districts
are controlled by Democrats. You can pretty much guess how this will split down
party lines.
Then
the you have the class issues: approximately two-thirds of the benefit from
repealing the SALT cap would go to households with annual incomes over
$200,000. Granted, these are the people who pay the taxes to begin with, but the
point nonetheless makes for a tough sell.
And
irrespective of what the House does, the Senate has already said they will not
consider any such bill.
Let’s
go over what wiggle room remains in this area. For purposes of our discussion,
let’s separate state and local property taxes from state and local income taxes.
Property
Taxes
The
important thing to remember about the $10,000 limitation is that it addresses your
personal taxes, such as your primary residence, your vacation home, property taxes
on your car and so on.
Distinguish
that from business-related property taxes.
If
you are self-employed, have rental real estate, a farm or so on, those property
taxes are considered related to that business activity. So what? That means they
attach to that activity and are included wherever that activity is reported on
your tax return. Rental real estate, for example, is reported on Schedule E.
The real estate taxes are reported with the rental activity on Schedule E, not as
itemized deductions on Schedule A. The $10,000 cap applies only to the taxes reported
as itemized deductions on your Schedule A.
Let
me immediately cut off a planning “idea.” Forget having the business/rental/farm
pay the taxes on your residence. This will not work. Why? Because those taxes
do not belong to the business/rental/farm, and merely paying them from the business/rental/farm
bank account does not make them a business/rental/farm expense.
State
and Local Income Taxes
State
and local income taxes do not follow the property tax rule. Let’s say you have
a rental in Connecticut. You pay income taxes to Connecticut. Reasoning from
the property tax rule, you anticipate that the Connecticut income taxes would
be reported along with the real estate taxes when you report the rental activity
on your Schedule E.
You
would be wrong.
Why?
Whereas
the income taxes are imposed on a Connecticut activity, they are assessed on
you as an individual. Connecticut does not see that rental activity as an “tax
entity” separate from you. No, it sees you. With that as context, state and local
income tax on activities reported on your individual tax return are assessed on
you personally. This makes them personal income taxes, and personal income
taxes are deducted as itemized deductions on Schedule A.
It
gets more complicated when the income is reported on a Schedule K-1 from a “passthrough”
entity. The classic passthrough entities include a partnership, LLC or S
corporation. The point of the passthrough is that the entity (generally) does
not pay tax itself. Rather, it “passes through” its income to its owners, who
include those numbers with their personal income on their individual income tax
returns.
What
do you think: are state and local income taxes paid by the passthrough entity
personal taxes to you (meaning itemized deductions) or do they attach to the
activity and reported with the activity (meaning not itemized deductions)?
Unfortunately,
we are back (in most cases) to the general rule: the taxes are assessed on you,
making the taxes personal and therefore deductible only as an itemized
deduction.
This
creates a most unfavorable difference between a corporation that pays its own
tax (referred to as a “C” corporation) and one that passes through its income
to its shareholders (referred to as an “S” corporation).
The
C corporation will be able to deduct its state and local income taxes until the
cows come home, but the S corporation will be limited to $10,000 per
shareholder.
Depending
on the size of the numbers, that might be sufficient grounds to revoke an S corporation
election and instead file and pay taxes as a C corporation.
Is
it fair? As we have noted before on this blog, what does fair have to do with
it?
We
ran into a comparable situation a few years ago with an S corporation client.
It had three shareholders, and their individual state and local tax deduction
was routinely disallowed by the alternative minimum tax. This meant that there was zero tax benefit to
any state and local taxes paid, and the company varied between being routinely
profitable and routinely very profitable. The SALT tax deduction was a big
deal.
We
contacted Georgia, as the client had sizeable jobs in Georgia, and we asked
whether they could – for Georgia purposes – file as a C corporation even though
they filed their federal return as an S corporation. Georgia was taken aback,
as we were the first or among the first to present them with this issue.
Why
did we do this?
Because
a C corporation pays its own tax, meaning that the Georgia taxes could be
deducted on the federal S corporation return. We could sidestep that nasty itemized
deduction issue, at least with Georgia.
Might
the IRS have challenged our treatment of the Georgia taxes?
Sure,
they can challenge anything. It was our professional opinion, however, that we
had a very strong argument. Who knows: maybe CTG would even appear in the tax
literature and seminar circuit. While flattering,
this would have been a bad result for us, as the client would not have appreciated
visible tax controversy. We would have won the battle and lost the war.
However,
the technique is out there and other states are paying attention, given the new
$10,000 itemized deduction limitation. Connecticut, for example, has recently
allowed its passthroughs to use a variation of the technique we used with Georgia.
I
suspect many more states will wind up doing the same.
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Sunday, December 8, 2019
New Tax On Colleges
I read that Harvard estimates that a change from the
Tax Cut and Jobs Act will cost approximately $38 million.
Harvard is referring to the “endowment tax” on
colleges and universities.
Have you heard about this?
Let us set up the issue by discussing the taxation of
private foundations.
The “best” type of charity (at least tax-wise) is the
501(c)(3). These are the March of Dimes and United Ways, and they are
publicly-supported by a broad group of interested donors. In general, this
means a large number of individually modest donations. Mind you, there can be
an outsized donation (or several), but there are mathematical tests to restrict
a limited number of donors from providing a disproportionate amount of the charity’s
support.
Then we get to private foundations. In general, this
means that a limited number of donors provide a disproportionate amount of
support. Say that CTG comes into big bucks and sets up the CTG Family
Foundation. There is little question that one donor provided a lopsided amount of
donations: that donor would be me. In its classic version, I would be
the only one funding the CTG Family Foundation.
There can be issues when a foundation and a person are
essentially alter egos, and the Code provides serious penalties should that someone
forget the difference. Foundations have enhanced information reporting
requirements, and they also pay a 2% income tax on their net investment income.
The 2% tax is supposedly to pay for the increased IRS attention given
foundations compared to publicly-supported charities.
The Tax Cut and Jobs Act created a new tax – the 1.4% tax on endowment income – and it targets an unexpected group: colleges and universities that
enroll at least 500 tuition-paying students and have endowment assets of at
least $500,000 per student.
Let me think this through. I went to graduate school
at the University of Missouri at Columbia. Its student body is approximately
30,000. UMC would need an endowment of at least $15 billion to come within reach
of this tax.
I have two immediate thoughts:
(1) Tax practitioners commonly refer to the 2% tax
on foundations as inconsequential, because … well, it is. My fee might be more
than the tax; and
(2) I am having a difficult time getting worked up
over somebody who has $15 billion in the bank.
The endowment tax is designed to hit a minimal number
of colleges and universities – probably less than 50 in total. It is expected
to provide approximately $200 million in new taxes annually, not an
insignificant sum but not budget-balancing either. As a consequence, there has
been speculation as to its provenance and purpose.
With this Congress has again introduced brain-numbing complexity
to the tax Code. For example, the tax is supposed to exclude endowment funds
used to carry-on the school’s tax-exempt purpose. Folks, it does not take 30-plus years of tax
practice to argue that everything a school does furthers its tax-exempt
purpose, meaning there is nothing left to tax. Clearly that is not the intent
of the law, and tax practitioners are breathlessly awaiting the IRS to provide
near-Torahic definitions of terms in this area.
The criticism of the tax has already begun. Here is
Harvard referring to its $40 billion endowment:
“We remain opposed to this damaging and unprecedented tax that will not only reduce resources available to colleges and universities to promote excellence in teaching and to sustain innovative research…”
Breathe deeply there, Winchester. Explain again why
any school with $40 billion in investments even charges tuition.
Which brings us to Berea College in central Kentucky,
south of Lexington. The school has an endowment of approximately $700,000 per student,
so it meets the first requirement of the tax. The initial draft of the tax bill
would have pulled Berea into its dragnet, but there was bipartisan agreement
that the second requirement refer to “tuition-paying” students.
So what?
Berea College does not charge tuition.
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Tuesday, November 26, 2019
The Gig Economy
Say that I retire. Perhaps my wife wins the lottery or
marries well.
I get bored. Perhaps I would like a little
running-around money. Maybe I flat-out need extra money.
I find a website that connects experienced tax
practitioners to people needing tax services. There might be specializations available:
as a practitioner I might accept corporate or passthrough work, for example, but
not individual tax returns. I could work as much or as little as I want. I
might work Friday and Saturday afternoons, for example, but not accept work on
weekdays. I could turn down or fire clients. I could take time off without fear
of dismissal.
There would have to be rules, of course. Life is a collection
of rules. I might have to provide my state license to substantiate my
credentials. I might have to post an E&O policy. It seems reasonable to expect
the website to impose standards, such as for professional conduct, client communications,
timeliness of service and so on
How would I get paid?
I am thinking that I would bill through the website.
An advantage is that the website can devote more resources than I care to
provide, making the arrangement a win-win-win for all parties involved. The
website would collect from the client and then electronically deposit to my
bank account.
Here is my question: is the website my employer?
Don’t scoff. We are talking the gig economy.
The issue has gained notoriety as states – New Jersey
and California come to mind – have gone after companies like Uber and Lyft.
From these states’ perspective, the issue is simple: if there is more than a de
minimis interdependence between the service recipient and provider, then there
must be an employment relationship between the two. Employment of course means
FICA withholding, income tax withholding, unemployment insurance, disability
insurance (in some cases), workers compensation and so on.
Let us be honest: employment status is Christmas day
for some states. They would deem your garden statue an employee if they could
wring a dollar out of you by doing so.
New Jersey recently hit Uber with a tax bill for $650
million, for example.
The employee-independent contractor issue is a BIG
deal.
What in the world is the difference between an
employee and an independent contractor?
People have been working on this question for a long
time. The IRS has posited that employment means control – of the employer over
the employee – and also that control travels on a spectrum. As one moves to the
one end of the spectrum, it becomes increasingly likely that an employer-employee
relationship exists.
The IRS looks at three broad categories:
(1) Behavioral control
(2) Financial control
(3) Relationship of the parties
The IRS then looks at factors (sometimes called the 20
factors) through the lens of the above categories.
·
Can the service recipient tell you what,
where, when and how to do something?
·
Is the service recipient the only
recipient of the provider’s services?
·
Is the service relationship continuing?
Answer yes to those three factors and you sound a lot
like an employee.
Problem is the easy issues exist only in a classroom
or at seminar. In the real world, it is much more likely that you will find a
mix of yes and no. In that event, how may “yes” answers will mean employee
status? How many “no” answers will indicate contractor status?
Answer: no one knows.
Some states have taken a different approach, using
what is called an “ABC” test. There was a significant case (Dynamex) in
California. It interpreted the ABC test as follows:
(1) The service provider is free from the
direction and control of the service recipient in connection with the
performance of the work.
(2) The service provider performs work outside the
usual course of the service recipient’s business.
(3) The service provider is customarily engaged in
the independent performance of the services provided.
I get the first one, but I point out that it is rarely
all or nothing. If we here at CTG Command bring on a contractor CPA – say for
the busy season or to collaborate on a tax area near the periphery of our
experience – we would still have expectations. For example,
·
our office hours are XXX
·
reviewer turnaround times to tax preparers
are XXX
·
responses to client calls are to occur
with XXX hours or less
·
responses to me are to occur within X
hours or less
·
drop-dead due dates are XXX
How many of these can we have before we fail the A in
the ABC test?
Let’s look at B.
We are a CPA firm. Odds are we are interested in
experienced CPAs. It is quite unlikely that we will have need of a master
plumber or stonemason.
Have we automatically failed the B in the ABC test?
And what does C even mean?
I am a 30+ year tax CPA. I am a specialist and have
been for many years. I would say that I am “customarily engaged” in tax
practice. Do I have “independent performance,” however?
If I interpret this test to mean that I have more than
one client, it somewhat makes sense, although there are still issues. For
example, upon semi-retirement, I would like to be “of counsel” to a CPA firm. I
have no intention of working every day, or of being there endless hours during
the busy season. No, what I am thinking is that the firm would call me for
specialized work – more complex tax issues, perhaps some tax representation. It
would provide a mental challenge but not become a burden to me.
Would I do this for more than one firm?
Doubt it. I point to that “burden” thing.
Have I failed the C test?
I am still thinking through the issues involved in
this area.
Including non-tax issues.
If I take an Uber and the driver gets into an accident
– injuring me – do I have legal recourse to Uber? Seems to me that I should. Is
this question affected by the employee-contractor issue? If it is, should it
be?
This prompts me to think that the law is inadequate
for a gig economy.
There is, for example, always some degree of control
between the parties, if for no other reason than expectation is a variant of
control. Not wanting to lose the gig is – at least to me – an incident of
control to the service recipient. Talk to a CPA firm partner with an outsized
client about expectation and control.
Why cannot CTG Command gig an experienced tax
professional – say for a specific engagement or issue - without the presumption
that we hired an employee? I can reasonably assure you that I will not be an employee
when I go “of counsel.” You can forget my attending those Monday morning staff
meetings.
Am I “independently performing” if I have but one
client? What if it is a really good client? What if I don’t want a second
client?
Problem is, we know there are toxic players out there who
will abuse any wiggle room you give them. Still, that is no excuse for bad tax
law. Not every person who works – let’s face it – is an employee. The gig
economy has simply amplified that fact.
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Sunday, November 17, 2019
New Life Expectancy Tables For Your Retirement Account
On November 7, 2019 the
IRS issued Proposed Regulations revising life expectancy tables used to calculate
minimum required distributions from retirement plans, such as IRAs.
That strikes me as a good
thing. The tables have not been revised since 2002.
There are three tables
that one might use, depending upon one’s situation. Let’s go over them:
The Uniform Lifetime Table
This
is the old reliable and the one most of us are likely to use.
Joint Life and Last Survivor Expectancy Table
This
is more specialized. This table is for a married couple where the age
difference between the spouses is greater than 10 years.
The Single Life Expectancy Table
Do
not be confused: this table has nothing to do with someone being single. This
is the table for inherited retirement accounts.
Let’s take a look at a
five-year period for the Uniform Lifetime Table:
Age
|
Old
|
New
|
Difference
|
71
|
26.5
|
28.2
|
1.7
|
72
|
25.6
|
27.3
|
1.7
|
73
|
24.7
|
26.4
|
1.7
|
74
|
23.8
|
25.5
|
1.7
|
75
|
22.9
|
24.6
|
1.7
|
If you had a million
dollars in the account, the difference in your required minimum distribution at
age 71 would be $2,275.
It is not overwhelming,
but let’s remember that the difference is for every remaining year of one’s
life.
As an aside, I recently
came across an interesting statistic. Did you know that 4 out of 5 Americans
receiving retirement distributions are taking more than the minimum amount? For
those – the vast majority of recipients – this revision to the life expectancy
tables will have no impact.
Let’s spend a moment
talking about the third table - the Single Life Expectancy Table. You may know
this topic as a “stretch” IRA.
A stretch IRA is not a
unique or different kind of IRA. All it means is that the owner died, and the
account has passed to a beneficiary. Since minimum distributions are based on
life expectancy, this raises an interesting question: whose life expectancy?
COMMENT: There is a difference on whether a spouse or a non-spouse inherits. It also matters whether the decedent reached age 70 ½ or not. It is a thicket of rules and exceptions. For the following discussion, let us presume a non-spouse inherits and the decedent was over age 70 ½.
An easy way to solve this
issue would be to continue the same life expectancy table as the original owner
of the account. The problem here is that – if the beneficiary is young enough –
one would run out of table.
So let’s reset the table.
We will use the beneficiary’s life expectancy.
And there you have the
Single Life Expectancy Table.
As well as the
opportunity for a stretch. How? By using someone much younger than the
deceased. Grandkids, for example.
Say that a 35-year old
inherits an account. What is the difference between the old and new life
expectancy tables?
Old 48.5
New 50.5
Hey, it’s better than
nothing and – again – it repeats every year.
There is an odd thing
about using this table, if you have ever worked with a stretch IRA. For a
regular IRA – e.g., you taking distributions from your own IRA – you look at the
table to get a factor for your age in the distribution year. You then divide
that factor into the December 31 IRA balance for the year preceding the
distribution year to arrive at the required minimum amount.
Point is: you look at the
table every year.
The stretch does not do
that.
You look at the table one
time. Say you inherit at age 34. Your
required minimum distribution begins the following year (I am making an assumption
here, but let’s roll with it), when you are age 35. The factor is 48.5. When
you are age 36, you subtract one from the factor (48.5 – 1.0 = 47.5) and use
that new number for purposes of the calculation. The following year you again
subtract one (47.5 – 1.0 = 46.5), and so on.
Under the Proposed
Regulation you are to refer to the (new) Single Life Expectancy Table for that
first year, take the new factor and then subtract as many “ones” as necessary to
get to the beneficiary’s current age. It is confusing, methinks.
There are public comment
procedures for Proposed Regulations, so there is a possibility the IRS will change
something before the Regulations go final. Final will be year 2021.
So for 2020 we will use
the existing tables, and for 2021 we will be using the new tables.
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Sunday, November 10, 2019
Repaying The Health Care Subsidy
Twice in a
couple of weeks I have heard:
“They should check on the Exchange.”
The Exchange
refers to the health insurance marketplace.
In both cases
we were discussing someone who is between jobs.
The idea, of
course, is to get the subsidy … as someone is unemployed and can use it.
There might also
be a tax trap here.
When you
apply for Obamacare, you provide an estimate of your income for the coverage
year. The answer is intuitive if you are applying for 2020 (as we are not in
2020 yet), but it could also happen if you go in during the coverage year. Say
you are laid-off in July. You know your income through July, and you are guessing
what it might be for the rest of the year.
So what?
There is a
big what.
Receive a
subsidy and you have to pay it back – every penny of it – if your income
exceeds 400% of the poverty line for your state.
Accountants refer
to this as a “cliff.” Get to that last dollar of income and your marginal tax
rate goes stratospheric.
Four times
the poverty rate for a single person in Kentucky is approximately $50 grand. Have your income come in at $50 grand and a dollar
and you have to repay the entire subsidy.
It can hurt.
How much latitude
does a tax preparer have?
Not much. I
suppose if we are close we might talk about making a deductible IRA
contribution, or selling stock at a loss, or ….
There may be
more latitude if one is self-employed. Perhaps one could double-down on the
depreciation, or recount the inventory, or ….
Massoud and
Ziba Fanaieyan got themselves into this predicament.
The Fanaieyans
lived in California. He was retired and owned several rental properties. She
worked as a hairstylist.
They
received over $15,000 in subsidies for their 2015 tax year.
Four times
the California poverty line was $97,000.
They reported
adjusted gross income of $100,767.
And there
was (what I consider) a fatal preparation mistake. They failed to include Form
8962, which is the tax form that reconciles the subsidy received to the subsidy
to which one was actually entitled based on income reported on the tax return.
The IRS sent
a letter asking for the Form 8962.
The Fanaieyans
realized their mistake.
Folks, for
the most part tax planning is not a retroactive exercise. Their hands were
tied.
Except ….
Mr. Fanaieyan
remembered that book he was writing. All right, it was his sister’s book, but
he was involved too. He had paid some expenses in 2012 and 2013. Oh, and he had
advanced his sister $1,500 in 2015.
He had given
up the dream of publishing in 2015. Surely, he could now write-off those
expenses. No point carrying them any longer. The dream was gone.
They amended
their 2015 tax return for a book publishing loss.
The IRS
looked at them like they had three eyes each.
To Court
they went.
There were technical
issues that we will not dive into. For example, as a cash-basis taxpayer, didn’t
they have to deduct those expenses back in 2012 and 2013? And was it really a
business, or did they have a (dreaded) hobby loss? Was it even a loss, or were
they making a gift to his sister?
The Court
bounced the deduction. They had several grounds to do so, and so they did.
The Fanaieyans
had income over four times the poverty level.
They had to
repay the advance subsidies.
I cannot
help but wonder how this would have turned out if they had claimed the same
loss on their originally-filed return AND included a properly-completed Form
8962.
Failing to
include the 8962 meant that someone was going to look at the file.
Amending the
return also meant that someone was going to look at the file.
Too many
looks.
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