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

FS-2013-7, June 2013 

The report released by Principal Deputy Commissioner Danny Werfel reflects a number of important findings, aggressive actions and next steps to help the IRS make improvements. Highlights of the three major areas covered in “Charting a Path Forward at the IRS: Initial Assessment and Plan of Action” include:

Accountability. This covers the steps being taken to ensure accountability for the mismanagement described in last month’s Treasury Inspector General for Tax Administration (TIGTA) report:

  • The report found significant management and judgment failures occurred, as outlined in the TIGTA report. These contributed to the inappropriate treatment of taxpayers applying for tax- exempt status. 

  • The IRS is identifying the individuals within the IRS who are responsible for the mismanagement identified in the TIGTA report, evaluating their role and determining the appropriate consequences for each individual.

  • We have installed new leadership at all five levels of the senior executive managerial chain that had responsibility over the activities identified in the TIGTA report.

  • The IRS is digging deeper into the facts to determine if there are instances of wrongdoing or inappropriate conduct beyond the mismanagement identified in the original TIGTA report.  By extending our review beyond the scope of the original audit, we are ensuring a more comprehensive understanding of the facts and circumstances that led to these events.

  • In addition, the IRS has empaneled an Accountability Review Board to provide recommendations within 60 days (and later as needed) on any additional personnel actions that should be taken.

Fixing the Problems with the Review of Applications for Tax-Exempt Status. This part covers several process improvements underway to ensure that taxpayers are treated appropriately and effectively in the review of applications for tax-exempt status:   

  • Suspended the use of any “be-on-the-lookout,” or BOLO, lists in the application process for tax-exempt status.

  • Started development of new guidance materials to allow IRS staff to operate without BOLO lists and under the reformed, more efficient process.

  • Initiated an end-to-end overhaul of the business processes by which applications for tax-exempt status are fulfilled.

  • Added technical and programmatic experts from across the IRS to assist the Exempt Organizations staff with the review of applications for tax- exempt status.

  • Created a new voluntary process to help certain taxpayers who have been in our priority application backlog for more than 120 days to gain fast-track approval to operate as a 501(c)(4) tax-exempt entity. This self-certification process allows them a streamlined path to tax-exempt status if they agree they will operate within limits and thresholds of political and social welfare activities. These groups have the option of obtaining an approval if they self-certify that less than 40 percent of their expenditures and volunteer time will go toward political campaign intervention activities and that at least 60 percent of their expenditures and volunteer time will go toward social welfare activities. 

  • Created a new “Advocacy Application Review Committee” to provide expertise from other parts of the IRS to review screening and determination decisions inside the Exempt Organizations area.

  • Started the process to create a new check-and-balance mechanism, where IRS criteria and screening procedures will be reviewed on a systemic basis and report any material risks of inappropriate criteria immediately to the IRS Commissioner, the IRS Oversight Board, and the relevant tax committees of Congress.

  • Worked with the Department of the Treasury regarding the need for greater clarity for certain terms relevant for 501(c)(4) tax-exempt organizations, with a commitment for inclusion in the next Treasury Priority Guidance Plan.

  • Continued to make substantial progress on all TIGTA recommendations from their May report on Exempt Organizations.

Review of IRS Operations and Risks. The report identifies a series of actions to ensure taxpayers that selection criteria across the IRS are appropriate and that taxpayers are aware of how they can seek assistance if they have concerns about the IRS. The report further outlines steps underway to ensure that critical program or operational risks within the IRS are identified early, raised to the right decision-makers and shared timely with key stakeholders:

  • Although there is no current evidence that selection criteria in other IRS business unit is inappropriate, the nature of the problems identified in the tax-exempt application process warrants a review of certain process controls within the IRS.  The IRS will initiate a comprehensive, agency-wide review of compliance selection criteria.  Results will be shared with the Department of the Treasury, the IRS Oversight Board, and the Chairpersons of the House Ways and Means Committee and the Senate Finance Committee.

  • The IRS has been very successful in mission execution across its very broad portfolio for many years, collecting 92 percent of government receipts of about $2.5 trillion in FY 2012.  At the same time, the Service is challenged by many of the same concerns affecting other large organizations, both public and private sector, including budgetary concerns, human capital concerns, and overall programmatic execution concerns. The report outlines initial areas where challenges exist and actions are needed to position the IRS to successfully fulfill its mission.

  • The report calls for establishing an Enterprise Risk Management Program to provide a common framework for capturing, reporting and addressing risk areas across the IRS.  This will improve timeliness in bringing information to the attention of the Commissioner and other IRS leaders as well as stakeholders to help prevent future instances of inappropriate treatment or mismanagement.

  • Initiate additional internal and external education and outreach about the role of the National Taxpayer Advocate, an independent voice inside the IRS, in assisting taxpayers in resolving problems with the IRS. 

  • Establish routine reporting on IRS operational risks with Congress and the IRS Oversight Board.

 

Page Last Reviewed or Updated: 19-Dec-2013

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Www onlinetaxes h&rblock com 2. Www onlinetaxes h&rblock com   Accounting Methods Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Accounting MethodsCash Method Accrual Method Farm Inventory Cash Versus Accrual Method Special Methods of Accounting Combination Method Changes in Methods of Accounting Introduction You must use an accounting method that clearly shows your income and expenses. Www onlinetaxes h&rblock com You must also figure your taxable income and file an income tax return for an annual accounting period called a tax year. Www onlinetaxes h&rblock com This chapter discusses accounting methods. Www onlinetaxes h&rblock com For information on accounting periods, see Publication 538, Accounting Periods and Methods, and the Instructions for Form 1128, Application To Adopt, Change, or Retain a Tax Year. Www onlinetaxes h&rblock com Topics - This chapter discusses: Cash method Accrual method Farm inventory Special methods of accounting Changes in methods of accounting Useful Items - You may want to see: Publication 538 Accounting Periods and Methods 535 Business Expenses Form (and Instructions) 1128 Application To Adopt, Change, or Retain a Tax Year 3115 Application for Change in Accounting Method See chapter 16 for information about getting publications and forms. Www onlinetaxes h&rblock com Accounting Methods An accounting method is a set of rules used to determine when and how your income and expenses are reported on your tax return. Www onlinetaxes h&rblock com Your accounting method includes not only your overall method of accounting, but also the accounting treatment you use for any material item. Www onlinetaxes h&rblock com A material item is one that affects the proper time for inclusion of income or allowance of a deduction. Www onlinetaxes h&rblock com An item considered material for financial statement purposes is generally also considered material for income tax purposes. Www onlinetaxes h&rblock com See Publication 538 for more information. Www onlinetaxes h&rblock com You generally choose an accounting method for your farm business when you file your first income tax return that includes a Schedule F (Form 1040), Profit or Loss From Farming. Www onlinetaxes h&rblock com If you later want to change your accounting method, you generally must get IRS approval. Www onlinetaxes h&rblock com How to obtain IRS approval is discussed later under Changes in Methods of Accounting . Www onlinetaxes h&rblock com Types of accounting methods. Www onlinetaxes h&rblock com   Generally, you can use any of the following accounting methods. Www onlinetaxes h&rblock com Each method is discussed in detail below. Www onlinetaxes h&rblock com Cash method. Www onlinetaxes h&rblock com Accrual method. Www onlinetaxes h&rblock com Special methods of accounting for certain items of income and expenses. Www onlinetaxes h&rblock com Combination (hybrid) method using elements of two or more of the above. Www onlinetaxes h&rblock com Business and other items. Www onlinetaxes h&rblock com   You can account for business and personal items using different accounting methods. Www onlinetaxes h&rblock com For example, you can figure your business income under an accrual method, even if you use the cash method to figure personal items. Www onlinetaxes h&rblock com Two or more businesses. Www onlinetaxes h&rblock com   If you operate two or more separate and distinct businesses, you can use a different accounting method for each business. Www onlinetaxes h&rblock com Generally, no business is separate and distinct unless a complete and separate set of books and records is maintained for each business. Www onlinetaxes h&rblock com Cash Method Most farmers use the cash method because they find it easier to keep records using the cash method. Www onlinetaxes h&rblock com However, certain farm corporations and partnerships and all tax shelters must use an accrual method of accounting. Www onlinetaxes h&rblock com See Accrual Method Required , later. Www onlinetaxes h&rblock com Income Under the cash method, include in your gross income all items of income you actually or constructively received during the tax year. Www onlinetaxes h&rblock com Items of income include money received as well as property or services received. Www onlinetaxes h&rblock com If you receive property or services, you must include the fair market value (FMV) of the property or services in income. Www onlinetaxes h&rblock com See chapter 3 for information on how to report farm income on your income tax return. Www onlinetaxes h&rblock com Constructive receipt. Www onlinetaxes h&rblock com   Income is constructively received when an amount is credited to your account or made available to you without restriction. Www onlinetaxes h&rblock com You do not need to have possession of the income for it to be treated as income for the tax year. Www onlinetaxes h&rblock com If you authorize someone to be your agent and receive income for you, you are considered to have received the income when your agent receives it. Www onlinetaxes h&rblock com Income is not constructively received if your receipt of the income is subject to substantial restrictions or limitations. Www onlinetaxes h&rblock com Direct payments and counter-cyclical payments. Www onlinetaxes h&rblock com   If you received direct payments or counter-cyclical payments under Subtitle A or C of the Farm Security and Rural Investment Act of 2002, you will not be considered to have constructively received a payment merely because you had the option to receive it in the year before it is required to be paid. Www onlinetaxes h&rblock com Delaying receipt of income. Www onlinetaxes h&rblock com   You cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. Www onlinetaxes h&rblock com You must report the income in the year the money or property is received or made available to you without restriction. Www onlinetaxes h&rblock com Example. Www onlinetaxes h&rblock com Frances Jones, a farmer, was entitled to receive a $10,000 payment on a grain contract in December 2013. Www onlinetaxes h&rblock com She was told in December that her payment was available. Www onlinetaxes h&rblock com She requested not to be paid until January 2014. Www onlinetaxes h&rblock com However, she must still include this payment in her 2013 income because it was made available to her in 2013. Www onlinetaxes h&rblock com Debts paid by another person or canceled. Www onlinetaxes h&rblock com   If your debts are paid by another person or are canceled by your creditors, you may have to report part or all of this debt relief as income. Www onlinetaxes h&rblock com If you receive income in this way, you constructively receive the income when the debt is canceled or paid. Www onlinetaxes h&rblock com See Cancellation of Debt in chapter 3. Www onlinetaxes h&rblock com Deferred payment contract. Www onlinetaxes h&rblock com   If you sell an item under a deferred payment contract that calls for payment in a future year, there is no constructive receipt in the year of sale. Www onlinetaxes h&rblock com However, if the sales contract states that you have the right to the proceeds of the sale from the buyer at any time after delivery of the item, then you must include the sales price in income in the year of the sale, regardless of when you actually receive payment. Www onlinetaxes h&rblock com Example. Www onlinetaxes h&rblock com You are a farmer who uses the cash method and a calendar tax year. Www onlinetaxes h&rblock com You sell grain in December 2013 under a bona fide arm's-length contract that calls for payment in 2014. Www onlinetaxes h&rblock com You include the proceeds from the sale in your 2014 gross income since that is the year payment is received. Www onlinetaxes h&rblock com However, if the contract states that you have the right to the proceeds from the buyer at any time after the grain is delivered, you must include the sales price in your 2013 income, regardless of when you actually receive payment. Www onlinetaxes h&rblock com Repayment of income. Www onlinetaxes h&rblock com   If you include an amount in income and in a later year you have to repay all or part of it, then you can usually deduct the repayment in the year repaid. Www onlinetaxes h&rblock com If the repayment is more than $3,000, a special rule applies. Www onlinetaxes h&rblock com For details, see Repayments in chapter 11 of Publication 535, Business Expenses. Www onlinetaxes h&rblock com Expenses Under the cash method, generally you deduct expenses in the tax year you pay them. Www onlinetaxes h&rblock com This includes business expenses for which you contest liability. Www onlinetaxes h&rblock com However, you may not be able to deduct an expense paid in advance or you may be required to capitalize certain costs, as explained under Uniform Capitalization Rules in chapter 6. Www onlinetaxes h&rblock com See chapter 4 for information on how to deduct farm business expenses on your income tax return. Www onlinetaxes h&rblock com Prepayment. Www onlinetaxes h&rblock com   Generally, you cannot deduct expenses paid in advance. Www onlinetaxes h&rblock com This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. Www onlinetaxes h&rblock com Example. Www onlinetaxes h&rblock com On November 1, 2013, you signed and paid $3,600 for a 3-year (36-month) insurance contract for equipment. Www onlinetaxes h&rblock com In 2013, you are allowed to deduct only $200 (2/36 x $3,600) of the cost of the policy that is attributable to 2013. Www onlinetaxes h&rblock com In 2014, you'll be able to deduct $1,200 (12/36 x $3,600); in 2015, you'll be able to deduct $1,200 (12/36 x $3,600); and in 2016 you'll be able to deduct the remaining balance of $1,000. Www onlinetaxes h&rblock com An exception applies if the expense qualifies for the 12-month rule. Www onlinetaxes h&rblock com See Publication 538 for more information and examples. Www onlinetaxes h&rblock com See chapter 4 for special rules for prepaid farm supplies and prepaid livestock feed. Www onlinetaxes h&rblock com Accrual Method Under an accrual method of accounting, you generally report income in the year earned and deduct or capitalize expenses in the year incurred. Www onlinetaxes h&rblock com The purpose of an accrual method of accounting is to correctly match income and expenses. Www onlinetaxes h&rblock com Certain businesses engaged in farming must use an accrual method of accounting for its farm business and for sales and purchases of inventory items. Www onlinetaxes h&rblock com See Accrual Method Required and Farm Inventory , later. Www onlinetaxes h&rblock com Income Generally, you include an amount in income for the tax year in which all events that fix your right to receive the income have occurred, and you can determine the amount with reasonable accuracy. Www onlinetaxes h&rblock com Under this rule, include an amount in income on the earliest of the following dates. Www onlinetaxes h&rblock com When you receive payment. Www onlinetaxes h&rblock com When the income amount is due to you. Www onlinetaxes h&rblock com When you earn the income. Www onlinetaxes h&rblock com When title passes. Www onlinetaxes h&rblock com If you use an accrual method of accounting, complete Part III of Schedule F (Form 1040) to report your income. Www onlinetaxes h&rblock com Inventory. Www onlinetaxes h&rblock com   If you keep an inventory, generally you must use an accrual method of accounting to determine your gross income. Www onlinetaxes h&rblock com An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. Www onlinetaxes h&rblock com See Publication 538 for more information. Www onlinetaxes h&rblock com Also see Farm Inventory , later, for more information on items that must be included in inventory by farmers and inventory valuation methods for farmers. Www onlinetaxes h&rblock com Expenses Under an accrual method of accounting, you generally deduct or capitalize a business expense when both of the following apply. Www onlinetaxes h&rblock com The all-events test has been met. Www onlinetaxes h&rblock com This test is met when: All events have occurred that fix the fact that you have a liability, and The amount of the liability can be determined with reasonable accuracy. Www onlinetaxes h&rblock com Economic performance has occurred. Www onlinetaxes h&rblock com Economic performance. Www onlinetaxes h&rblock com   Generally, you cannot deduct or capitalize a business expense until economic performance occurs. Www onlinetaxes h&rblock com If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or as the property is used. Www onlinetaxes h&rblock com If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Www onlinetaxes h&rblock com Example. Www onlinetaxes h&rblock com Jane, who is a farmer, uses a calendar tax year and an accrual method of accounting. Www onlinetaxes h&rblock com She entered into a contract with ABC Farm Consulting in 2012. Www onlinetaxes h&rblock com The contract stated that Jane pay ABC Farm Consulting $2,000 in December 2012. Www onlinetaxes h&rblock com It further stipulates that ABC Farm Consulting will develop a plan for integrating her farm with a larger farm operation based in a neighboring state by March 1, 2013. Www onlinetaxes h&rblock com Jane paid ABC Farm Consulting $2,000 in December 2012. Www onlinetaxes h&rblock com Integration of operations according to the plan began in May 2013 and they completed the integration in December 2013. Www onlinetaxes h&rblock com Economic performance for Jane's liability in the contract occurs as the services are provided. Www onlinetaxes h&rblock com Jane incurs the $2,000 cost in 2013. Www onlinetaxes h&rblock com An exception to the economic performance rule allows certain recurring items to be treated as incurred during a tax year even though economic performance has not occurred. Www onlinetaxes h&rblock com For more information, see Economic Performance in Publication 538. Www onlinetaxes h&rblock com Special rule for related persons. Www onlinetaxes h&rblock com   Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. Www onlinetaxes h&rblock com Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible. Www onlinetaxes h&rblock com For more information, see Internal Revenue Code section 267. Www onlinetaxes h&rblock com Accrual Method Required Generally, the following businesses, if engaged in farming, must use an accrual method of accounting. Www onlinetaxes h&rblock com A corporation (other than a family corporation) that had gross receipts of more than $1,000,000 for any tax year beginning after 1975. Www onlinetaxes h&rblock com A family corporation that had gross receipts of more than $25,000,000 for any tax year beginning after 1985. Www onlinetaxes h&rblock com A partnership with a corporation as a partner, if that corporation meets the requirements of (1) or (2) above. Www onlinetaxes h&rblock com A tax shelter. Www onlinetaxes h&rblock com Note. Www onlinetaxes h&rblock com Items (1), (2), and (3) above do not apply to an S corporation or a business operating a nursery or sod farm, or the raising or harvesting of trees (other than fruit and nut trees). Www onlinetaxes h&rblock com Family corporation. Www onlinetaxes h&rblock com   A family corporation is generally a corporation that meets one of the following ownership requirements. Www onlinetaxes h&rblock com Members of the same family own at least 50% of the total combined voting power of all classes of stock entitled to vote and at least 50% of the total shares of all other classes of stock of the corporation. Www onlinetaxes h&rblock com Members of two families have owned, directly or indirectly, since October 4, 1976, at least 65% of the total combined voting power of all classes of voting stock and at least 65% of the total shares of all other classes of the corporation's stock. Www onlinetaxes h&rblock com Members of three families have owned, directly or indirectly, since October 4, 1976, at least 50% of the total combined voting power of all classes of voting stock and at least 50% of the total shares of all other classes of the corporation's stock. Www onlinetaxes h&rblock com For more information on family corporations, see Internal Revenue Code section 447. Www onlinetaxes h&rblock com Tax shelter. Www onlinetaxes h&rblock com   A tax shelter is a partnership, noncorporate enterprise, or S corporation that meets either of the following tests. Www onlinetaxes h&rblock com Its principal purpose is the avoidance or evasion of federal income tax. Www onlinetaxes h&rblock com It is a farming syndicate. Www onlinetaxes h&rblock com A farming syndicate is an entity that meets either of the following tests. Www onlinetaxes h&rblock com Interests in the activity have been offered for sale in an offering required to be registered with a federal or state agency with the authority to regulate the offering of securities for sale. Www onlinetaxes h&rblock com More than 35% of the losses during the tax year are allocable to limited partners or limited entrepreneurs. Www onlinetaxes h&rblock com   A “limited partner” is one whose personal liability for partnership debts is limited to the money or other property the partner contributed or is required to contribute to the partnership. Www onlinetaxes h&rblock com   A “limited entrepreneur” is one who has an interest in an enterprise other than as a limited partner and does not actively participate in the management of the enterprise. Www onlinetaxes h&rblock com Farm Inventory If you are required to keep an inventory, you should keep a complete record of your inventory as part of your farm records. Www onlinetaxes h&rblock com This record should show the actual count or measurement of the inventory. Www onlinetaxes h&rblock com It should also show all factors that enter into its valuation, including quality and weight, if applicable. Www onlinetaxes h&rblock com Hatchery business. Www onlinetaxes h&rblock com   If you are in the hatchery business, and use an accrual method of accounting, you must include in inventory eggs in the process of incubation. Www onlinetaxes h&rblock com Products held for sale. Www onlinetaxes h&rblock com   All harvested and purchased farm products held for sale or for feed or seed, such as grain, hay, silage, concentrates, cotton, tobacco, etc. Www onlinetaxes h&rblock com , must be included in inventory. Www onlinetaxes h&rblock com Supplies. Www onlinetaxes h&rblock com   Supplies acquired for sale or that become a physical part of items held for sale must be included in inventory. Www onlinetaxes h&rblock com Deduct the cost of supplies in the year used or consumed in operations. Www onlinetaxes h&rblock com Do not include incidental supplies in inventory as these are deductible in the year of purchase. Www onlinetaxes h&rblock com Livestock. Www onlinetaxes h&rblock com   Livestock held primarily for sale must be included in inventory. Www onlinetaxes h&rblock com Livestock held for draft, breeding, or dairy purposes can either be depreciated or included in inventory. Www onlinetaxes h&rblock com See also Unit-livestock-price method , later. Www onlinetaxes h&rblock com If you are in the business of breeding and raising chinchillas, mink, foxes, or other fur-bearing animals, these animals are livestock for inventory purposes. Www onlinetaxes h&rblock com Growing crops. Www onlinetaxes h&rblock com   Generally, growing crops are not required to be included in inventory. Www onlinetaxes h&rblock com However, if the crop has a preproductive period of more than 2 years, you may have to capitalize (or include in inventory) costs associated with the crop. Www onlinetaxes h&rblock com See Uniform capitalization rules below. Www onlinetaxes h&rblock com Also see Uniform Capitalization Rules in  chapter 6. Www onlinetaxes h&rblock com Items to include in inventory. Www onlinetaxes h&rblock com   Your inventory should include all items held for sale, or for use as feed, seed, etc. Www onlinetaxes h&rblock com , whether raised or purchased, that are unsold at the end of the year. Www onlinetaxes h&rblock com Uniform capitalization rules. Www onlinetaxes h&rblock com   The following applies if you are required to use an accrual method of accounting. Www onlinetaxes h&rblock com The uniform capitalization rules apply to all costs of raising a plant, even if the preproductive period of raising a plant is 2 years or less. Www onlinetaxes h&rblock com The costs of animals are subject to the uniform capitalization rules. Www onlinetaxes h&rblock com Inventory valuation methods. Www onlinetaxes h&rblock com   The following methods, described below, are those generally available for valuing inventory. Www onlinetaxes h&rblock com The method you use must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. Www onlinetaxes h&rblock com Cost. Www onlinetaxes h&rblock com Lower of cost or market. Www onlinetaxes h&rblock com Farm-price method. Www onlinetaxes h&rblock com Unit-livestock-price method. Www onlinetaxes h&rblock com Cost and lower of cost or market methods. Www onlinetaxes h&rblock com   See Publication 538 for information on these valuation methods. Www onlinetaxes h&rblock com If you value your livestock inventory at cost or the lower of cost or market, you do not need IRS approval to change to the unit-livestock-price method. Www onlinetaxes h&rblock com However, if you value your livestock inventory using the farm-price method, then you must obtain permission from the IRS to change to the unit-livestock-price method. Www onlinetaxes h&rblock com Farm-price method. Www onlinetaxes h&rblock com   Under this method, each item, whether raised or purchased, is valued at its market price less the direct cost of disposition. Www onlinetaxes h&rblock com Market price is the current price at the nearest market in the quantities you usually sell. Www onlinetaxes h&rblock com Cost of disposition includes broker's commissions, freight, hauling to market, and other marketing costs. Www onlinetaxes h&rblock com If you use this method, you must use it for your entire inventory, except that livestock can be inventoried under the unit-livestock-price method. Www onlinetaxes h&rblock com Unit-livestock-price method. Www onlinetaxes h&rblock com   This method recognizes the difficulty of establishing the exact costs of producing and raising each animal. Www onlinetaxes h&rblock com You group or classify livestock according to type and age and use a standard unit price for each animal within a class or group. Www onlinetaxes h&rblock com The unit price you assign should reasonably approximate the normal costs incurred in producing the animals in such classes. Www onlinetaxes h&rblock com Unit prices and classifications are subject to approval by the IRS on examination of your return. Www onlinetaxes h&rblock com You must annually reevaluate your unit livestock prices and adjust the prices upward or downward to reflect increases or decreases in the costs of raising livestock. Www onlinetaxes h&rblock com IRS approval is not required for these adjustments. Www onlinetaxes h&rblock com Any other changes in unit prices or classifications do require IRS approval. Www onlinetaxes h&rblock com   If you use this method, include all raised livestock in inventory, regardless of whether they are held for sale or for draft, breeding, sport, or dairy purposes. Www onlinetaxes h&rblock com This method accounts only for the increase in cost of raising an animal to maturity. Www onlinetaxes h&rblock com It does not provide for any decrease in the animal's market value after it reaches maturity. Www onlinetaxes h&rblock com Also, if you raise cattle, you are not required to inventory hay you grow to feed your herd. Www onlinetaxes h&rblock com   Do not include sold or lost animals in the year-end inventory. Www onlinetaxes h&rblock com If your records do not show which animals were sold or lost, treat the first animals acquired as sold or lost. Www onlinetaxes h&rblock com The animals on hand at the end of the year are considered those most recently acquired. Www onlinetaxes h&rblock com   You must include in inventory all livestock purchased primarily for sale. Www onlinetaxes h&rblock com You can choose either to include in inventory or depreciate livestock purchased for draft, breeding, sport or dairy purposes. Www onlinetaxes h&rblock com However, you must be consistent from year to year, regardless of the method you have chosen. Www onlinetaxes h&rblock com You cannot change your method without obtaining approval from the IRS. Www onlinetaxes h&rblock com   You must include in inventory animals purchased after maturity or capitalize them at their purchase price. Www onlinetaxes h&rblock com If the animals are not mature at purchase, increase the cost at the end of each tax year according to the established unit price. Www onlinetaxes h&rblock com However, in the year of purchase, do not increase the cost of any animal purchased during the last 6 months of the year. Www onlinetaxes h&rblock com This “no increase” rule does not apply to tax shelters which must make an adjustment for any animal purchased during the year. Www onlinetaxes h&rblock com It also does not apply to taxpayers that must make an adjustment to reasonably reflect the particular period in the year in which animals are purchased, if necessary to avoid significant distortions in income. Www onlinetaxes h&rblock com Uniform capitalization rules. Www onlinetaxes h&rblock com   A farmer can determine costs required to be allocated under the uniform capitalization rules by using the farm-price or unit-livestock-price inventory method. Www onlinetaxes h&rblock com This applies to any plant or animal, even if the farmer does not hold or treat the plant or animal as inventory property. Www onlinetaxes h&rblock com Cash Versus Accrual Method The following examples compare the cash and accrual methods of accounting. Www onlinetaxes h&rblock com Example 1. Www onlinetaxes h&rblock com You are a farmer who uses an accrual method of accounting. Www onlinetaxes h&rblock com You keep your books on the calendar year basis. Www onlinetaxes h&rblock com You sell grain in December 2013 but you are not paid until January 2014. Www onlinetaxes h&rblock com Because the accrual method was used and 2013 was the tax year in which the grain was sold, you must both include the sales proceeds and deduct the costs incurred in producing the grain on your 2013 tax return. Www onlinetaxes h&rblock com Example 2. Www onlinetaxes h&rblock com Assume the same facts as in Example 1 except that you use the cash method and there was no constructive receipt of the sales proceeds in 2013. Www onlinetaxes h&rblock com Under this method, you include the sales proceeds in income for 2014, the year you receive payment. Www onlinetaxes h&rblock com Deduct the costs of producing the grain in the year you pay for them. Www onlinetaxes h&rblock com Special Methods of Accounting There are special methods of accounting for certain items of income and expense. Www onlinetaxes h&rblock com Crop method. Www onlinetaxes h&rblock com   If you do not harvest and dispose of your crop in the same tax year that you plant it, you can, with IRS approval, use the crop method of accounting. Www onlinetaxes h&rblock com You cannot use the crop method for any tax return, including your first tax return, unless you receive approval from the IRS. Www onlinetaxes h&rblock com Under this method, you deduct the entire cost of producing the crop, including the expense of seed or young plants, in the year you realize income from the crop. Www onlinetaxes h&rblock com    See chapter 4 for details on deducting the costs of operating a farm. Www onlinetaxes h&rblock com Also see Regulations section 1. Www onlinetaxes h&rblock com 162-12. Www onlinetaxes h&rblock com Other special methods. Www onlinetaxes h&rblock com   Other special methods of accounting apply to the following items. Www onlinetaxes h&rblock com Amortization, see chapter 7. Www onlinetaxes h&rblock com Casualties, see chapter 11. Www onlinetaxes h&rblock com Condemnations, see chapter 11. Www onlinetaxes h&rblock com Depletion, see chapter 7. Www onlinetaxes h&rblock com Depreciation, see chapter 7. Www onlinetaxes h&rblock com Farm business expenses, see chapter 4. Www onlinetaxes h&rblock com Farm income, see chapter 3. Www onlinetaxes h&rblock com Installment sales, see chapter 10. Www onlinetaxes h&rblock com Soil and water conservation expenses, see chapter 5. Www onlinetaxes h&rblock com Thefts, see chapter 11. Www onlinetaxes h&rblock com Combination Method Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly shows your income and expenses and you use it consistently. Www onlinetaxes h&rblock com However, the following restrictions apply. Www onlinetaxes h&rblock com If you use the cash method for figuring your income, you must use the cash method for reporting your expenses. Www onlinetaxes h&rblock com If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. Www onlinetaxes h&rblock com Changes in Methods of Accounting A change in your method of accounting includes a change in: Your overall method, such as from the cash method to an accrual method, and Your treatment of any material item, such as a change in your method of valuing inventory (for example, a change from the farm-price method to the unit-livestock-price method, discussed earlier). Www onlinetaxes h&rblock com Generally, once you have set up your accounting method, you must receive approval from the IRS before you can change to another method of accounting. Www onlinetaxes h&rblock com You may also have to pay a fee. Www onlinetaxes h&rblock com To obtain approval, you must generally file Form 3115. Www onlinetaxes h&rblock com There are instances when you can obtain automatic consent to change certain methods of accounting. Www onlinetaxes h&rblock com See the List of Automatic Accounting Method Changes located in the Instructions for Form 3115. Www onlinetaxes h&rblock com For more information on changes in methods of accounting, see Form 3115 and the Instructions for Form 3115. Www onlinetaxes h&rblock com Also see Publication 538. Www onlinetaxes h&rblock com Prev  Up  Next   Home   More Online Publications