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Irse File

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Irse File

Irse file 7. Irse file   Coverdell Education Savings Account (ESA) Table of Contents Introduction What Is a Coverdell ESAQualified Education Expenses ContributionsContribution Limits Additional Tax on Excess Contributions Rollovers and Other TransfersRollovers Changing the Designated Beneficiary Transfer Because of Divorce DistributionsTax-Free Distributions Taxable Distributions When Assets Must Be Distributed Introduction If your modified adjusted gross income (MAGI) is less than $110,000 ($220,000 if filing a joint return), you may be able to establish a Coverdell ESA to finance the qualified education expenses of a designated beneficiary. Irse file For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return. Irse file There is no limit on the number of separate Coverdell ESAs that can be established for a designated beneficiary. Irse file However, total contributions for the beneficiary in any year cannot be more than $2,000, no matter how many accounts have been established. Irse file See Contributions , later. Irse file This benefit applies not only to higher education expenses, but also to elementary and secondary education expenses. Irse file What is the tax benefit of the Coverdell ESA. Irse file   Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed. Irse file   If, for a year, distributions from an account are not more than a designated beneficiary's qualified education expenses at an eligible educational institution, the beneficiary will not owe tax on the distributions. Irse file See Tax-Free Distributions , later. Irse file    Table 7-1 summarizes the main features of the Coverdell ESA. Irse file Table 7-1. Irse file Coverdell ESA at a Glance Do not rely on this table alone. Irse file It provides only general highlights. Irse file See the text for definitions of terms in bold type and for more complete explanations. Irse file Question Answer What is a Coverdell ESA? A savings account that is set up to pay the qualified education expenses of a designated beneficiary. Irse file Where can it be established? It can be opened in the United States at any bank or other IRS-approved entity that offers Coverdell ESAs. Irse file Who can have a Coverdell ESA? Any beneficiary who is under age 18 or is a special needs beneficiary. Irse file Who can contribute to a Coverdell ESA? Generally, any individual (including the beneficiary) whose modified adjusted gross income for the year is less than $110,000 ($220,000 in the case of a joint return). Irse file Are distributions tax free? Yes, if the distributions are not more than the beneficiary's adjusted qualified education expenses for the year. Irse file What Is a Coverdell ESA A Coverdell ESA is a trust or custodial account created or organized in the United States only for the purpose of paying the qualified education expenses of the Designated beneficiary (defined later) of the account. Irse file When the account is established, the designated beneficiary must be under age 18 or a special needs beneficiary. Irse file To be treated as a Coverdell ESA, the account must be designated as a Coverdell ESA when it is created. Irse file The document creating and governing the account must be in writing and must satisfy the following requirements. Irse file The trustee or custodian must be a bank or an entity approved by the IRS. Irse file The document must provide that the trustee or custodian can only accept a contribution that meets all of the following conditions. Irse file The contribution is in cash. Irse file The contribution is made before the beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary. Irse file The contribution would not result in total contributions for the year (not including rollover contributions) being more than $2,000. Irse file Money in the account cannot be invested in life insurance contracts. Irse file Money in the account cannot be combined with other property except in a common trust fund or common investment fund. Irse file The balance in the account generally must be distributed within 30 days after the earlier of the following events. Irse file The beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary. Irse file The beneficiary's death. Irse file Qualified Education Expenses Generally, these are expenses required for the enrollment or attendance of the designated beneficiary at an eligible educational institution. Irse file For purposes of Coverdell ESAs, the expenses can be either qualified higher education expenses or qualified elementary and secondary education expenses. Irse file Designated beneficiary. Irse file   This is the individual named in the document creating the trust or custodial account to receive the benefit of the funds in the account. Irse file Contributions to a qualified tuition program (QTP). Irse file   A contribution to a QTP is a qualified education expense if the contribution is on behalf of the designated beneficiary of the Coverdell ESA. Irse file In the case of a change in beneficiary, this is a qualified expense only if the new beneficiary is a family member of that designated beneficiary. Irse file See chapter 8, Qualified Tuition Program . Irse file Eligible Educational Institution For purposes of Coverdell ESAs, an eligible educational institution can be either an eligible postsecondary school or an eligible elementary or secondary school. Irse file Eligible postsecondary school. Irse file   This is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U. Irse file S. Irse file Department of Education. Irse file It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. Irse file The educational institution should be able to tell you if it is an eligible educational institution. Irse file   Certain educational institutions located outside the United States also participate in the U. Irse file S. Irse file Department of Education's Federal Student Aid (FSA) programs. Irse file Eligible elementary or secondary school. Irse file   This is any public, private, or religious school that provides elementary or secondary education (kindergarten through grade 12), as determined under state law. Irse file Qualified Higher Education Expenses These are expenses related to enrollment or attendance at an eligible postsecondary school. Irse file As shown in the following list, to be qualified, some of the expenses must be required by the school and some must be incurred by students who are enrolled at least half-time. Irse file The following expenses must be required for enrollment or attendance of a designated beneficiary at an eligible postsecondary school. Irse file Tuition and fees. Irse file Books, supplies, and equipment. Irse file Expenses for special needs services needed by a special needs beneficiary must be incurred in connection with enrollment or attendance at an eligible postsecondary school. Irse file Expenses for room and board must be incurred by students who are enrolled at least half-time (defined below). Irse file The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts. Irse file The allowance for room and board, as determined by the school, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student. Irse file The actual amount charged if the student is residing in housing owned or operated by the school. Irse file Half-time student. Irse file   A student is enrolled “at least half-time” if he or she is enrolled for at least half the full-time academic work load for the course of study the student is pursuing, as determined under the standards of the school where the student is enrolled. Irse file Qualified Elementary and Secondary Education Expenses These are expenses related to enrollment or attendance at an eligible elementary or secondary school. Irse file As shown in the following list, to be qualified, some of the expenses must be required or provided by the school. Irse file There are special rules for computer-related expenses. Irse file The following expenses must be incurred by a designated beneficiary in connection with enrollment or attendance at an eligible elementary or secondary school. Irse file Tuition and fees. Irse file Books, supplies, and equipment. Irse file Academic tutoring. Irse file Special needs services for a special needs beneficiary. Irse file The following expenses must be required or provided by an eligible elementary or secondary school in connection with attendance or enrollment at the school. Irse file Room and board. Irse file Uniforms. Irse file Transportation. Irse file Supplementary items and services (including extended day programs). Irse file The purchase of computer technology, equipment, or Internet access and related services is a qualified elementary and secondary education expense if it is to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in elementary or secondary school. Irse file (This does not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature. Irse file ) Contributions Any individual (including the designated beneficiary) can contribute to a Coverdell ESA if the individual's MAGI (defined later under Contribution Limits ) for the year is less than $110,000. Irse file For individuals filing joint returns, that amount is $220,000. Irse file Organizations, such as corporations and trusts, can also contribute to Coverdell ESAs. Irse file There is no requirement that an organization's income be below a certain level. Irse file Contributions must meet all of the following requirements. Irse file They must be in cash. Irse file They cannot be made after the beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary. Irse file They must be made by the due date of the contributor's tax return (not including extensions). Irse file Contributions can be made to one or several Coverdell ESAs for the same designated beneficiary provided that the total contributions are not more than the contribution limits (defined later) for a year. Irse file Contributions can be made, without penalty, to both a Coverdell ESA and a QTP in the same year for the same beneficiary. Irse file Table 7-2 summarizes many of the features of contributing to a Coverdell ESA. Irse file When contributions considered made. Irse file   Contributions made to a Coverdell ESA for the preceding tax year are considered to have been made on the last day of the preceding year. Irse file They must be made by the due date (not including extensions) for filing your return for the preceding year. Irse file   For example, if you make a contribution to a Coverdell ESA in February 2014, and you designate it as a contribution for 2013, you are considered to have made that contribution on December 31, 2013. Irse file Contribution Limits There are two yearly limits: One on the total amount that can be contributed for each designated beneficiary in any year, and One on the amount that any individual can contribute for any one designated beneficiary for a year. Irse file Limit for each designated beneficiary. Irse file   For 2013, the total of all contributions to all Coverdell ESAs set up for the benefit of any one designated beneficiary cannot be more than $2,000. Irse file This includes contributions (other than rollovers) to all the beneficiary's Coverdell ESAs from all sources. Irse file Rollovers are discussed under Rollovers and Other Transfers , later. Irse file Example. Irse file When Maria Luna was born in 2012, three separate Coverdell ESAs were set up for her, one by her parents, one by her grandfather, and one by her aunt. Irse file In 2013, the total of all contributions to Maria's three Coverdell ESAs cannot be more than $2,000. Irse file For example, if her grandfather contributed $2,000 to one of her Coverdell ESAs, no one else could contribute to any of her three accounts. Irse file Or, if her parents contributed $1,000 and her aunt $600, her grandfather or someone else could contribute no more than $400. Irse file These contributions could be put into any of Maria's Coverdell ESA accounts. Irse file Limit for each contributor. Irse file   Generally, you can contribute up to $2,000 for each designated beneficiary for 2013. Irse file This is the most you can contribute for the benefit of any one beneficiary for the year, regardless of the number of Coverdell ESAs set up for the beneficiary. Irse file Example. Irse file The facts are the same as in the previous example except that Maria Luna's older brother, Edgar, also has a Coverdell ESA. Irse file If their grandfather contributed $2,000 to Maria's Coverdell ESA in 2013, he could also contribute $2,000 to Edgar's Coverdell ESA. Irse file Reduced limit. Irse file   Your contribution limit may be reduced. Irse file If your MAGI (defined on this page) is between $95,000 and $110,000 (between $190,000 and $220,000 if filing a joint return), the $2,000 limit for each designated beneficiary is gradually reduced (see Figuring the limit , later). Irse file If your MAGI is $110,000 or more ($220,000 or more if filing a joint return), you cannot contribute to anyone's Coverdell ESA. Irse file Table 7-2. Irse file Coverdell ESA Contributions at a Glance Do not rely on this table alone. Irse file It provides only general highlights. Irse file See the text for more complete explanations. Irse file Question Answer Are contributions deductible? No. Irse file What is the annual contribution limit per designated beneficiary? $2,000 for each designated beneficiary. Irse file What if more than one Coverdell ESA has been opened for the same designated beneficiary? The annual contribution limit is $2,000 for each beneficiary, no matter how many Coverdell ESAs are set up for that beneficiary. Irse file What if more than one individual makes contributions for the same designated beneficiary? The annual contribution limit is $2,000 per beneficiary, no matter how many individuals contribute. Irse file Can contributions other than cash be made to a Coverdell ESA? No. Irse file When must contributions stop? No contributions can be made to a beneficiary's Coverdell ESA after he or she reaches age 18, unless the beneficiary is a special needs beneficiary. Irse file Modified adjusted gross income (MAGI). Irse file   For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return. Irse file MAGI when using Form 1040A. Irse file   If you file Form 1040A, your MAGI is the AGI on line 22 of that form. Irse file MAGI when using Form 1040. Irse file   If you file Form 1040, your MAGI is the AGI on line 38 of that form, modified by adding back any: Foreign earned income exclusion, Foreign housing exclusion, Foreign housing deduction, Exclusion of income by bona fide residents of American Samoa, and Exclusion of income by bona fide residents of Puerto Rico. Irse file MAGI when using Form 1040NR. Irse file   If you file Form 1040NR, your MAGI is the AGI on line 36 of that form. Irse file MAGI when using Form 1040NR-EZ. Irse file   If you file Form 1040NR-EZ, your MAGI is the AGI on line 10 of that form. Irse file   If you have any of these adjustments, you can use Worksheet 7-1. Irse file MAGI for a Coverdell ESA , later, to figure your MAGI for Form 1040. Irse file Worksheet 7-1. Irse file MAGI for a Coverdell ESA 1. Irse file Enter your adjusted gross income  (Form 1040, line 38)   1. Irse file   2. Irse file Enter your foreign earned income exclusion and/or housing exclusion (Form 2555, line 45, or Form 2555-EZ, line 18)   2. Irse file       3. Irse file Enter your foreign housing deduction (Form 2555, line 50)   3. Irse file         4. Irse file Enter the amount of income from Puerto Rico you are excluding   4. Irse file       5. Irse file Enter the amount of income from American Samoa you are excluding (Form 4563, line 15)   5. Irse file       6. Irse file Add lines 2, 3, 4, and 5   6. Irse file   7. Irse file Add lines 1 and 6. Irse file This is your  modified adjusted gross income   7. Irse file   Figuring the limit. Irse file    To figure the limit on the amount you can contribute for each designated beneficiary, multiply $2,000 by a fraction. Irse file The numerator (top number) is your MAGI minus $95,000 ($190,000 if filing a joint return). Irse file The denominator (bottom number) is $15,000 ($30,000 if filing a joint return). Irse file Subtract the result from $2,000. Irse file This is the amount you can contribute for each beneficiary. Irse file You can use Worksheet 7-2. Irse file Coverdell ESA Contribution Limit to figure the limit on contributions. Irse file    Worksheet 7-2. Irse file Coverdell ESA Contribution Limit 1. Irse file Maximum contribution   1. Irse file $2,000 2. Irse file Enter your modified adjusted gross income (MAGI) for purposes of figuring the contribution limit to a Coverdell ESA (see definition or Worksheet 7-1, earlier)   2. Irse file   3. Irse file Enter $190,000 if married filing jointly; $95,000 for all other filers   3. Irse file   4. Irse file Subtract line 3 from line 2. Irse file If zero or less, enter -0- on line 4, skip lines 5 through 7, and enter $2,000 on line 8   4. Irse file   5. Irse file Enter $30,000 if married filing jointly; $15,000 for all other filers   5. Irse file     Note. Irse file If the amount on line 4 is greater than or equal to the amount on line 5, stop here. Irse file You are not allowed to contribute to a Coverdell ESA for 2013. Irse file       6. Irse file Divide line 4 by line 5 and enter the result as a decimal (rounded to at least 3 places)   6. Irse file . Irse file 7. Irse file Multiply line 1 by line 6   7. Irse file   8. Irse file Subtract line 7 from line 1   8. Irse file   Note: The total Coverdell ESA contributions from all sources for the designated beneficiary during the tax year may not exceed $2,000. Irse file Example. Irse file Paul, who is single, had a MAGI of $96,500 for 2013. Irse file Paul can contribute up to $1,800 in 2013 for each beneficiary, as shown in the illustrated Worksheet 7-2, Coverdell ESA Contribution Limit–Illustrated. Irse file Worksheet 7-2. Irse file Coverdell ESA Contribution Limit—Illustrated 1. Irse file Maximum contribution   1. Irse file $2,000 2. Irse file Enter your modified adjusted gross  income (MAGI) for purposes of figuring the contribution limit to a Coverdell ESA (see definition or Worksheet 7-1, earlier)   2. Irse file 96,500 3. Irse file Enter $190,000 if married filing jointly; $95,000 for all other filers   3. Irse file 95,000 4. Irse file Subtract line 3 from line 2. Irse file If zero or less, enter -0- on line 4, skip lines 5 through 7, and enter $2,000 on line 8   4. Irse file 1,500 5. Irse file Enter $30,000 if married filing jointly; $15,000 for all other filers   5. Irse file 15,000   Note. Irse file If the amount on line 4 is greater than or equal to the amount on line 5,  stop here. Irse file You are not allowed to  contribute to a Coverdell ESA for 2013. Irse file       6. Irse file Divide line 4 by line 5 and enter the result as a decimal (rounded to at least 3 places)   6. Irse file . Irse file 100 7. Irse file Multiply line 1 by line 6   7. Irse file 200 8. Irse file Subtract line 7 from line 1   8. Irse file 1,800 Note: The total Coverdell ESA contributions from all sources for the designated beneficiary during the tax year may not exceed $2,000. Irse file Additional Tax on Excess Contributions The beneficiary must pay a 6% excise tax each year on excess contributions that are in a Coverdell ESA at the end of the year. Irse file Excess contributions are the total of the following two amounts. Irse file Contributions to any designated beneficiary's Coverdell ESA for the year that are more than $2,000 (or, if less, the total of each contributor's limit for the year, as discussed earlier). Irse file Excess contributions for the preceding year, reduced by the total of the following two amounts: Distributions (other than those rolled over as discussed later) during the year, and The contribution limit for the current year minus the amount contributed for the current year. Irse file Exceptions. Irse file   The excise tax does not apply if excess contributions made during 2013 (and any earnings on them) are distributed before the first day of the sixth month of the following tax year (June 1, 2014, for a calendar year taxpayer). Irse file   However, you must include the distributed earnings in gross income for the year in which the excess contribution was made. Irse file You should receive Form 1099-Q, Payments From Qualified Education Programs, from each institution from which excess contributions were distributed. Irse file Box 2 of that form will show the amount of earnings on your excess contributions. Irse file Code “2” or “3” entered in the blank box below boxes 5 and 6 indicate the year in which the earnings are taxable. Irse file See Instructions for Recipient on the back of copy B of your Form 1099-Q. Irse file Enter the amount of earnings on line 21 of Form 1040 (or Form 1040NR) for the applicable tax year. Irse file For more information, see Taxable Distributions , later. Irse file   The excise tax does not apply to any rollover contribution. Irse file Note. Irse file Contributions made in one year for the preceding tax year are considered to have been made on the last day of the preceding year. Irse file Example. Irse file In 2012, Greta's parents and grandparents contributed a total of $2,300 to Greta's Coverdell ESA— an excess contribution of $300. Irse file Because Greta did not withdraw the excess before June 1, 2013, she had to pay an additional tax of $18 (6% × $300) when she filed her 2012 tax return. Irse file In 2013, excess contributions of $500 were made to Greta's account, however, she withdrew $250 from that account to use for qualified education expenses. Irse file Using the steps shown earlier under Additional Tax on Excess Contributions , Greta figures the excess contribution in her account at the end of 2013 as follows. Irse file (1)   $500 excess contributions made in 2013     + (2)   $300 excess contributions in ESA at end of 2012     − (2a)   $250 distribution during 2013         $550 excess at end of 2013   × 6%=$33           If Greta limits 2014 contributions to $1,450 ($2,000 maximum allowed − $550 excess contributions from 2013), she will not owe any additional tax in 2014 for excess contributions. Irse file Figuring and reporting the additional tax. Irse file   You figure this excise tax in Part V of Form 5329. Irse file Report the additional tax on Form 1040, line 58 (or Form 1040NR, line 56). Irse file Rollovers and Other Transfers Assets can be rolled over from one Coverdell ESA to another or the designated beneficiary can be changed. Irse file The beneficiary's interest can be transferred to a spouse or former spouse because of divorce. Irse file Rollovers Any amount distributed from a Coverdell ESA is not taxable if it is rolled over to another Coverdell ESA for the benefit of the same beneficiary or a member of the beneficiary's family (including the beneficiary's spouse) who is under age 30. Irse file This age limitation does not apply if the new beneficiary is a special needs beneficiary. Irse file An amount is rolled over if it is paid to another Coverdell ESA within 60 days after the date of the distribution. Irse file Do not report qualifying rollovers (those that meet the above criteria) anywhere on Form 1040 or 1040NR. Irse file These are not taxable distributions. Irse file Members of the beneficiary's family. Irse file   For these purposes, the beneficiary's family includes the beneficiary's spouse and the following other relatives of the beneficiary. Irse file Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them. Irse file Brother, sister, stepbrother, or stepsister. Irse file Father or mother or ancestor of either. Irse file Stepfather or stepmother. Irse file Son or daughter of a brother or sister. Irse file Brother or sister of father or mother. Irse file Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. Irse file The spouse of any individual listed above. Irse file First cousin. Irse file Example. Irse file When Aaron graduated from college last year he had $5,000 left in his Coverdell ESA. Irse file He wanted to give this money to his younger sister, who was still in high school. Irse file In order to avoid paying tax on the distribution of the amount remaining in his account, Aaron contributed the same amount to his sister's Coverdell ESA within 60 days of the distribution. Irse file Only one rollover per Coverdell ESA is allowed during the 12-month period ending on the date of the payment or distribution. Irse file This rule does not apply to the rollover of a military death gratuity or payment from Servicemembers' Group Life Insurance (SGLI). Irse file Military death gratuity. Irse file   If you received a military death gratuity or a payment from Servicemembers' Group Life Insurance (SGLI), you may roll over all or part of the amount received to one or more Coverdell ESAs for the benefit of members of the beneficiary's family (see Members of the beneficiary's family , earlier). Irse file Such payments are made to an eligible survivor upon the death of a member of the armed forces. Irse file The contribution to a Coverdell ESA from survivor benefits received cannot be made later than 1 year after the date on which you receive the gratuity or SGLI payment. Irse file   This rollover contribution is not subject to (but is in addition to) the contribution limits discussed earlier under Contribution Limits . Irse file The amount you roll over cannot exceed the total survivor benefits you received, reduced by contributions from these benefits to a Roth IRA or other Coverdell ESAs. Irse file   The amount contributed from the survivor benefits is treated as part of your basis (cost) in the Coverdell ESA, and will not be taxed when distributed. Irse file See Distributions , later. Irse file The limit of one rollover per Coverdell ESA during a 12-month period does not apply to a military death gratuity or SGLI payment. Irse file Changing the Designated Beneficiary The designated beneficiary can be changed. Irse file See Members of the beneficiary's family , earlier. Irse file There are no tax consequences if, at the time of the change, the new beneficiary is under age 30 or is a special needs beneficiary. Irse file Example. Irse file Assume the same situation for Aaron as in the last example (see Rollovers , earlier). Irse file Instead of closing his Coverdell ESA and paying the distribution into his sister's Coverdell ESA, Aaron could have instructed the trustee of his account to simply change the name of the beneficiary on his account to that of his sister. Irse file Transfer Because of Divorce If a spouse or former spouse receives a Coverdell ESA under a divorce or separation instrument, it is not a taxable transfer. Irse file After the transfer, the spouse or former spouse treats the Coverdell ESA as his or her own. Irse file Example. Irse file In their divorce settlement, Peg received her ex-husband's Coverdell ESA. Irse file In this process, the account was transferred into her name. Irse file Peg now treats the funds in this Coverdell ESA as if she were the original owner. Irse file Distributions The designated beneficiary of a Coverdell ESA can take a distribution at any time. Irse file Whether the distributions are tax free depends, in part, on whether the distributions are equal to or less than the amount of Adjusted qualified education expenses (defined later) that the beneficiary has in the same tax year. Irse file See Table 7-3, Coverdell ESA Distributions at a Glance, for highlights. Irse file Table 7-3. Irse file Coverdell ESA Distributions at a Glance Do not rely on this table alone. Irse file It provides only general highlights. Irse file See the text for definitions of terms in bold type and for more complete explanations. Irse file Question Answer Is a distribution from a Coverdell ESA to pay for a designated beneficiary's qualified education expenses tax free? Generally, yes, to the extent the amount of the distribution is not more than the designated beneficiary's adjusted qualified education expenses. Irse file After the designated beneficiary completes his or her education at an eligible educational institution, can amounts remaining in the Coverdell ESA be distributed? Yes. Irse file Amounts must be distributed when the designated beneficiary reaches age 30, unless he or she is a special needs beneficiary. Irse file Also, certain transfers to members of the beneficiary's family are permitted. Irse file Does the designated beneficiary need to be enrolled for a minimum number of courses to take a tax-free distribution? No. Irse file Adjusted qualified education expenses. Irse file   To determine if total distributions for the year are more than the amount of qualified education expenses, reduce total qualified education expenses by any tax-free educational assistance. Irse file Tax-free educational assistance includes: The tax-free part of scholarships and fellowships (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Pell grants (see Pell Grants and Other Title IV Need-Based Education Grants in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), and Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. Irse file The amount you get by subtracting tax-free educational assistance from your total qualified education expenses is your adjusted qualified education expenses. Irse file Tax-Free Distributions Generally, distributions are tax free if they are not more than the beneficiary's adjusted qualified education expenses for the year. Irse file Do not report tax-free distributions (including qualifying rollovers) on your tax return. Irse file Taxable Distributions A portion of the distributions is generally taxable to the beneficiary if the total distributions are more than the beneficiary's adjusted qualified education expenses for the year. Irse file Excess distribution. Irse file   This is the part of the total distribution that is more than the beneficiary's adjusted qualified education expenses for the year. Irse file Earnings and basis. Irse file   You will receive a Form 1099-Q for each of the Coverdell ESAs from which money was distributed in 2013. Irse file The amount of your gross distribution will be shown in box 1. Irse file For 2013, instead of dividing the gross distribution between your earnings (box 2) and your basis (already-taxed amount) (box 3), the payer or trustee may report the fair market value (account balance) of the Coverdell ESA as of December 31, 2013. Irse file This will be shown in the blank box below boxes 5 and 6. Irse file   The amount contributed from survivor benefits (see Military death gratuity , earlier) is treated as part of your basis and will not be taxed when distributed. Irse file Figuring the Taxable Portion of a Distribution The taxable portion is the amount of the excess distribution that represents earnings that have accumulated tax free in the account. Irse file Figure the taxable portion for 2013 as shown in the following steps. Irse file Multiply the total amount distributed by a fraction. Irse file The numerator is the basis (contributions not previously distributed) at the end of 2012 plus total contributions for 2013 and the denominator is the value (balance) of the account at the end of 2013 plus the amount distributed during 2013. Irse file Subtract the amount figured in (1) from the total amount distributed during 2013. Irse file The result is the amount of earnings included in the distribution(s). Irse file Multiply the amount of earnings figured in (2) by a fraction. Irse file The numerator is the adjusted qualified education expenses paid during 2013 and the denominator is the total amount distributed during 2013. Irse file Subtract the amount figured in (3) from the amount figured in (2). Irse file The result is the amount the beneficiary must include in income. Irse file The taxable amount must be reported on Form 1040 or Form 1040NR, line 21. Irse file Example. Irse file You received an $850 distribution from your Coverdell ESA, to which $1,500 had been contributed before 2013. Irse file There were no contributions in 2013. Irse file This is your first distribution from the account, so your basis in the account on December 31, 2012, was $1,500. Irse file The value (balance) of your account on December 31, 2013, was $950. Irse file You had $700 of adjusted qualified education expenses (AQEE) for the year. Irse file Using the steps in Figuring the Taxable Portion of a Distribution , earlier, figure the taxable portion of your distribution as follows. Irse file   1. Irse file $850 (distribution) × $1,500 basis + $0 contributions  $950 value + $850 distribution       =$708 (basis portion of distribution)     2. Irse file $850 (distribution)−$708 (basis portion of distribution)     =$142 (earnings included in distribution)   3. Irse file $142 (earnings) × $700 AQEE  $850 distribution           =$117 (tax-free earnings)     4. Irse file $142 (earnings)−$117 (tax-free earnings)=$25 (taxable earnings)                 You must include $25 in income as distributed earnings not used for qualified education expenses. Irse file Report this amount on Form 1040, line 21, listing the type and amount of income on the dotted line. Irse file Worksheet 7-3, Coverdell ESA–Taxable Distributions and Basis , at the end of this chapter, can help you figure your adjusted qualified education expenses, how much of your distribution must be included in income, and the remaining basis in your Coverdell ESA(s). Irse file Coordination With American Opportunity and Lifetime Learning Credits The American opportunity or lifetime learning credit can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used for both benefits. Irse file This means the beneficiary must reduce qualified higher education expenses by tax-free educational assistance, and then further reduce them by any expenses taken into account in determining an American opportunity or lifetime learning credit. Irse file Example. Irse file Derek Green had $5,800 of qualified higher education expenses for 2013, his first year in college. Irse file He paid his college expenses from the following sources. Irse file     Partial tuition scholarship (tax free) $1,500     Coverdell ESA distribution 1,000     Gift from parents 2,100     Earnings from part-time job 1,200           Of his $5,800 of qualified higher education expenses, $4,000 was tuition and related expenses that also qualified for an American opportunity credit. Irse file Derek's parents claimed a $2,500 American opportunity credit (based on $4,000 expenses) on their tax return. Irse file Before Derek can determine the taxable portion of his Coverdell ESA distribution, he must reduce his total qualified higher education expenses. Irse file     Total qualified higher education expenses $5,800     Minus: Tax-free educational assistance −1,500     Minus: Expenses taken into account in  figuring American opportunity credit − 4,000     Equals: Adjusted qualified higher education  expenses (AQHEE) $ 300           Since the adjusted qualified higher education expenses ($300) are less than the Coverdell ESA distribution ($1,000), part of the distribution will be taxable. Irse file The balance in Derek's account was $1,800 on December 31, 2013. Irse file Prior to 2013, $2,100 had been contributed to this account. Irse file Contributions for 2013 totaled $400. Irse file Using the four steps outlined earlier, Derek figures the taxable portion of his distribution as shown below. Irse file   1. Irse file $1,000 (distribution) × $2,100 basis + $400 contributions  $1,800 value + $1,000 distribution           =$893 (basis portion of distribution)     2. Irse file $1,000 (distribution)−$893 (basis portion of distribution)     = $107 (earnings included in distribution)   3. Irse file $107 (earnings) × $300 AQHEE  $1,000 distribution       =$32 (tax-free earnings)     4. Irse file $107 (earnings)−$32 (tax-free earnings)=$75 (taxable earnings)                 Derek must include $75 in income (Form 1040, line 21). Irse file This is the amount of distributed earnings not used for adjusted qualified higher education expenses. Irse file Coordination With Qualified Tuition Program (QTP) Distributions If a designated beneficiary receives distributions from both a Coverdell ESA and a QTP in the same year, and the total distribution is more than the beneficiary's adjusted qualified higher education expenses, those expenses must be allocated between the distribution from the Coverdell ESA and the distribution from the QTP before figuring how much of each distribution is taxable. Irse file The following two examples illustrate possible allocations. Irse file Example 1. Irse file In 2013, Beatrice graduated from high school and began her first semester of college. Irse file That year, she had $1,000 of qualified elementary and secondary education expenses (QESEE) for high school and $3,000 of qualified higher education expenses (QHEE) for college. Irse file To pay these expenses, Beatrice withdrew $800 from her Coverdell ESA and $4,200 from her QTP. Irse file No one claimed Beatrice as a dependent, nor was she eligible for an education credit. Irse file She did not receive any tax-free educational assistance in 2013. Irse file Beatrice must allocate her total qualified education expenses between the two distributions. Irse file Beatrice knows that tax-free treatment will be available if she applies her $800 Coverdell ESA distribution toward her $1,000 of qualified education expenses for high school. Irse file The qualified expenses are greater than the distribution, making the $800 Coverdell ESA distribution tax free. Irse file Next, Beatrice matches her $4,200 QTP distribution to her $3,000 of QHEE, and finds she has an excess QTP distribution of $1,200 ($4,200 QTP − $3,000 QHEE). Irse file She cannot use the extra $200 of high school expenses (from (1) above) against the QTP distribution because those expenses do not qualify a QTP for tax-free treatment. Irse file Finally, Beatrice figures the taxable and tax-free portions of her QTP distribution based on her $3,000 of QHEE. Irse file (See Figuring the Taxable Portion of a Distribution in chapter 8, Qualified Tuition Program for more information. Irse file ) Example 2. Irse file Assume the same facts as in Example 1 , except that Beatrice withdrew $1,800 from her Coverdell ESA and $3,200 from her QTP. Irse file In this case, she allocates her qualified education expenses as follows. Irse file Using the same reasoning as in Example 1, Beatrice matches $1,000 of her Coverdell ESA distribution to her $1,000 of QESEE—she has $800 of her distribution remaining. Irse file Because higher education expenses can also qualify a Coverdell ESA distribution for tax-free treatment, Beatrice allocates her $3,000 of QHEE between the remaining $800 Coverdell ESA and the $3,200 QTP distributions ($4,000 total). Irse file   $3,000 QHEE × $800 ESA distribution  $4,000 total distribution = $600 QHEE (ESA)     $3,000 QHEE × $3,200 QTP distribution  $4,000 total distribution = $2,400 QHEE (QTP)   Beatrice then figures the taxable part of her: Coverdell ESA distribution based on qualified education expenses of $1,600 ($1,000 QESEE + $600 QHEE). Irse file See Figuring the Taxable Portion of a Distribution , earlier, in this chapter. Irse file   QTP distribution based on her $2,400 of QHEE (see Figuring the Taxable Portion of a Distribution in chapter 8, Qualified Tuition Program). Irse file The above examples show two types of allocation between distributions from a Coverdell ESA and a QTP. Irse file However, you do not have to allocate your expenses in the same way. Irse file You can use any reasonable method. Irse file Losses on Coverdell ESA Investments If you have a loss on your investment in a Coverdell ESA, you may be able to deduct the loss on your income tax return. Irse file You can deduct the loss only when all amounts from that account have been distributed and the total distributions are less than your unrecovered basis. Irse file Your basis is the total amount of contributions to that Coverdell ESA. Irse file You claim the loss as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23 (Schedule A (Form 1040NR), line 9), subject to the 2%-of-adjusted-gross-income limit. Irse file If you have distributions from more than one Coverdell ESA account during a year, you must combine the information (amount of distribution, basis, etc. Irse file ) from all such accounts in order to determine your taxable earnings for the year. Irse file By doing this, the loss from one ESA account reduces the distributed earnings (if any) from any other ESA account. Irse file For examples of the calculation, see Losses on QTP Investments in chapter 8, Qualified Tuition Program. Irse file Additional Tax on Taxable Distributions Generally, if you receive a taxable distribution, you also must pay a 10% additional tax on the amount included in income. Irse file Exceptions. Irse file   The 10% additional tax does not apply to distributions: Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary. Irse file Made because the designated beneficiary is disabled. Irse file A person is considered to be disabled if he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition. Irse file A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration. Irse file Included in income because the designated beneficiary received: A tax-free scholarship or fellowship (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), or Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. Irse file Made on account of the attendance of the designated beneficiary at a U. Irse file S. Irse file military academy (such as the USMA at West Point). Irse file This exception applies only to the extent that the amount of the distribution does not exceed the costs of advanced education (as defined in section 2005(d)(3) of title 10 of the U. Irse file S. Irse file Code) attributable to such attendance. Irse file Included in income only because the qualified education expenses were taken into account in determining the American opportunity or lifetime learning credit (see Coordination With American Opportunity and Lifetime Learning Credits , earlier). Irse file Made before June 1, 2014, of an excess 2013 contribution (and any earnings on it). Irse file The distributed earnings must be included in gross income for the year in which the excess contribution was made. Irse file Exception (3) applies only to the extent the distribution is not more than the scholarship, allowance, or payment. Irse file Figuring the additional tax. Irse file    Use Part II of Form 5329, to figure any additional tax. Irse file Report the amount on Form 1040, line 58, or Form 1040NR, line 56. Irse file When Assets Must Be Distributed Any assets remaining in a Coverdell ESA must be distributed when either one of the following two events occurs. Irse file The designated beneficiary reaches age 30. Irse file In this case, the remaining assets must be distributed within 30 days after the beneficiary reaches age 30. Irse file However, this rule does not apply if the beneficiary is a special needs beneficiary. Irse file The designated beneficiary dies before reaching age 30. Irse file In this case, the remaining assets must generally be distributed within 30 days after the date of death. Irse file Exception for Transfer to Surviving Spouse or Family Member If a Coverdell ESA is transferred to a surviving spouse or other family member as the result of the death of the designated beneficiary, the Coverdell ESA retains its status. Irse file (“Family member” was defined earlier under Rollovers . Irse file ) This means the spouse or other family member can treat the Coverdell ESA as his or her own and does not need to withdraw the assets until he or she reaches age 30. Irse file This age limitation does not apply if the new beneficiary is a special needs beneficiary. Irse file There are no tax consequences as a result of the transfer. Irse file How To Figure the Taxable Earnings When a total distribution is made because the designated beneficiary either reached age 30 or died, the earnings that accumulated tax free in the account must be included in taxable income. Irse file You determine these earnings as shown in the following two steps. Irse file Multiply the amount distributed by a fraction. Irse file The numerator is the basis (contributions not previously distributed) at the end of 2012 plus total contributions for 2013 and the denominator is the balance in the account at the end of 2013 plus the amount distributed during 2013. Irse file Subtract the amount figured in (1) from the total amount distributed during 2013. Irse file The result is the amount of earnings included in the distribution. Irse file For an example, see steps (1) and (2) of the Example under Figuring the Taxable Portion of a Distribution, earlier. Irse file The beneficiary or other person receiving the distribution must report this amount on Form 1040, line 21, or Form 1040NR, line 21, listing the type and amount of income on the dotted line. Irse file Worksheet 7-3 Instructions. Irse file Coverdell ESA—Taxable Distributions and Basis Line G. Irse file Enter the total distributions received from all Coverdell ESAs during 2013. Irse file Do not include amounts rolled over to another ESA within 60 days (only one rollover is allowed during any 12-month period). Irse file Also, do not include excess contributions that were distributed with the related earnings (or less any loss) before the first day of the sixth month of the tax year following the year for which the contributions were made. Irse file Line 2. Irse file Your basis (amount already taxed) in this Coverdell ESA as of December 31, 2012, is the total of:   •All contributions to this Coverdell ESA before 2013 •Minus the tax-free portion of any distributions from this Coverdell ESA before 2013. Irse file   If your last distribution from this Coverdell ESA was before 2013, you must start with the basis in your account as of the end of the last year in which you took a distribution. Irse file For years before 2002, you can find that amount on the last line of the worksheet in the Instructions for Form 8606, Nondeductible IRAs, that you completed for that year. Irse file For years after 2001, you can find that amount by using the ending basis from the worksheet in Publication 970 for that year. Irse file You can determine your basis in this Coverdell ESA as of December 31, 2012, by adding to the basis as of the end of that year any contributions made to that account after the year of the distribution and before 2013. Irse file Line 4. Irse file Enter the total distributions received from this Coverdell ESA in 2013. Irse file Do not include amounts rolled over to another Coverdell ESA within 60 days (only one rollover is allowed during any 12-month period). Irse file   Also, do not include excess contributions that were distributed with the related earnings (or less any loss) before the first day of the sixth month of the tax year following the year of the contributions. Irse file Line 7. Irse file Enter the total value of this Coverdell ESA as of December 31, 2013, plus any outstanding rollovers contributed to the account after 2012, but before the end of the 60-day rollover period. Irse file A statement should be sent to you by January 31, 2014, for this Coverdell ESA showing the value on December 31, 2013. Irse file   A rollover is a tax-free withdrawal from one Coverdell ESA that is contributed to another Coverdell ESA. Irse file An outstanding rollover is any amount withdrawn within 60 days before the end of 2013 (November 2 through December 31) that was rolled over after December 31, 2013, but within the 60-day rollover period. Irse file Worksheet 7-3. Irse file Coverdell ESA—Taxable Distributions and Basis How to complete this worksheet. Irse file • • • Complete Part I, lines A through H, on only one worksheet. Irse file  Complete a separate Part II, lines 1 through 15, for each of your Coverdell ESAs. Irse file  Complete Part III, the Summary (line 16), on only one worksheet. Irse file Part I. Irse file Qualified Education Expenses (Complete for total expenses)       A. Irse file Enter your total qualified education expenses for 2013   A. Irse file   B. Irse file Enter those qualified education expenses paid for with tax-free educational assistance (for example, tax-free scholarships, veterans' educational benefits, Pell grants, employer-provided educational assistance)   B. Irse file         C. Irse file Enter those qualified higher education expenses deducted on Schedule C or C-EZ (Form 1040). Irse file Schedule F (Form 1040), or as a miscellaneous itemized deduction on Schedule A (Form 1040 or 1040NR)   C. Irse file         D. Irse file Enter those qualified higher education expenses on which  an American opportunity or lifetime learning credit was based   D. Irse file         E. Irse file Add lines B, C, and D   D. Irse file   F. Irse file Subtract line E from line A. Irse file This is your adjusted qualified education expense for 2013   E. Irse file   G. Irse file Enter your total distributions from all Coverdell ESAs during 2013. Irse file Do not include rollovers  or the return of excess contributions (see instructions)   F. Irse file   H. Irse file Divide line F by line G. Irse file Enter the result as a decimal (rounded to at least 3 places). Irse file If the  result is 1. Irse file 000 or more, enter 1. Irse file 000   G. Irse file . Irse file Part II. Irse file Taxable Distributions and Basis (Complete separately for each account) 1. Irse file Enter the amount contributed to this Coverdell ESA for 2013, including contributions made for 2013 from January 1, 2014, through April 15, 2014. Irse file Do not include rollovers or the return of excess contributions   1. Irse file   2. Irse file Enter your basis in this Coverdell ESA as of December 31, 2012 (see instructions)   2. Irse file   3. Irse file Add lines 1 and 2   3. Irse file   4. Irse file Enter the total distributions from this Coverdell ESA during 2013. Irse file Do not include rollovers  or the return of excess contributions (see instructions)   4. Irse file   5. Irse file Multiply line 4 by line H. Irse file This is the amount of adjusted qualified  education expense attributable to this Coverdell ESA   5. Irse file         6. Irse file Subtract line 5 from line 4   6. Irse file         7. Irse file Enter the total value of this Coverdell ESA as of December 31, 2013,  plus any outstanding rollovers (see instructions)   7. Irse file         8. Irse file Add lines 4 and 7   8. Irse file         9. Irse file Divide line 3 by line 8. Irse file Enter the result as a decimal (rounded to  at least 3 places). Irse file If the result is 1. Irse file 000 or more, enter 1. Irse file 000   9. Irse file . Irse file       10. Irse file Multiply line 4 by line 9. Irse file This is the amount of basis allocated to your  distributions, and is tax free   10. Irse file     Note. Irse file If line 6 is zero, skip lines 11 through 13, enter -0- on line 14, and go to line 15. Irse file       11. Irse file Subtract line 10 from line 4   11. Irse file   12. Irse file Divide line 5 by line 4. Irse file Enter the result as a decimal (rounded to  at least 3 places). Irse file If the result is 1. Irse file 000 or more, enter 1. Irse file 000   12. Irse file . Irse file       13. Irse file Multiply line 11 by line 12. Irse file This is the amount of qualified education  expenses allocated to your distributions, and is tax free   13. Irse file   14. Irse file Subtract line 13 from line 11. Irse file This is the portion of the distributions from this  Coverdell ESA in 2013 that you must include in income   14. Irse file   15. Irse file Subtract line 10 from line 3. Irse file This is your basis in this Coverdell ESA as of December 31, 2013   15. Irse file   Part III. Irse file Summary (Complete only once)       16. Irse file Taxable amount. Irse file Add together all amounts on line 14 for all your Coverdell ESAs. Irse file Enter here  and include on Form 1040, line 21, or Form 1040NR, line 21, listing the type and amount of income on the dotted line   16. Irse file   Prev  Up  Next   Home   More Online Publications
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Irse file 2. Irse file   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. Irse file ” 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. Irse file In many cases, however, losses from tax shelters produce little or no benefit to society, or the tax benefits are exaggerated beyond those intended. Irse file Those cases are called “abusive tax shelters. Irse file ” An investment that is considered a tax shelter is subject to restrictions, including the requirement that it be disclosed, as discussed later. Irse file Topics - This chapter discusses: Abusive Tax Shelters , Rules To Curb Abusive Tax Shelters , Investor Reporting , Penalties , and Whether To Invest . Irse file 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. Irse file Abusive Tax Shelters Abusive tax shelters are marketing schemes involving artificial transactions with little or no economic reality. Irse file 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. Irse file Despite appearances to the contrary, the taxpayer generally risks little. Irse file 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. Irse file 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. Irse file (But see the appraisal requirements discussed under Rules To Curb Abusive Tax Shelters , later. Irse file ) They are commonly marketed in terms of the ratio of tax deductions allegedly available to each dollar invested. Irse file This ratio (or “write-off”) is frequently said to be several times greater than one-to-one. Irse file 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. Irse file However, you should ask the following questions, which might provide a clue to the abusive nature of the plan. Irse file 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. Irse file These provisions include the following. Irse file Disclosure of reportable transactions. Irse file   You must disclose information for each reportable transaction in which you participate. Irse file See Reportable Transaction Disclosure Statement , later. Irse file   Material advisors with respect to any reportable transaction must disclose information about the transaction on Form 8918, Material Advisor Disclosure Statement. Irse file To determine whether you are a material advisor to a transaction, see the Instructions for Form 8918. Irse file   Material advisors will receive a reportable transaction number for the disclosed reportable transaction. Irse file They must provide this number to all persons to whom they acted as a material advisor. Irse file They must provide the number at the time the transaction is entered into. Irse file 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. Irse file For information on penalties for failure to disclose and failure to maintain lists, see Internal Revenue Code sections 6707, 6707A, and 6708. Irse file Requirement to maintain list. Irse file   Material advisors must maintain a list of persons to whom they provide material aid, assistance, or advice on any reportable transaction. Irse file 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. Irse file See Regulations section 301. Irse file 6112-1 for more information (including what information is required to be included on the list). Irse file Confidentiality privilege. Irse file   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. Irse file Appraisal requirement for donated property. Irse file   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. Irse file If you claim a deduction of more than $500,000 for the donated property, you generally must attach the qualified appraisal to your return. Irse file If you file electronically, see Form 8453, U. Irse file S. Irse file Individual Income Tax Transmittal for an IRS e-file Return, and its instructions. Irse file For more information about appraisals, including exceptions, see Publication 561. Irse file Passive activity loss and credit limits. Irse file   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. Irse file For more detailed information about determining and reporting income, losses, and credits from passive activities, see Publication 925. Irse file Interest on penalties. Irse file   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. Irse file Accounting method restriction. Irse file   Tax shelters generally cannot use the cash method of accounting. Irse file Uniform capitalization rules. Irse file   The uniform capitalization rules generally apply to producing property or acquiring it for resale. Irse file Under those rules, the direct cost and part of the indirect cost of the property must be capitalized or included in inventory. Irse file For more information, see Publication 538. Irse file Denial of deduction for interest on an underpayment due to a reportable transaction. Irse file   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. Irse file This rule applies to reportable transactions entered into in tax years beginning after October 22, 2004. Irse file 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. Irse file The guidance is the conclusion of the IRS on how the law is applied to a particular set of facts. Irse file Guidance is published in the Internal Revenue Bulletin for taxpayers' information and also for use by IRS officials. Irse file 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. Irse file 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. Irse file 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. Irse file Investor Reporting You may be required to file a reportable transaction disclosure statement. Irse file Reportable Transaction Disclosure Statement Use Form 8886 to disclose information for each reportable transaction (discussed later) in which you participated. Irse file Generally, you must attach Form 8886 to your return for each tax year in which you participated in the transaction. Irse file 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). Irse file 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. Irse file  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. Irse file If you use a computer-generated or substitute Form 8886, it must be an exact copy of the official IRS form. Irse file 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. Irse file See Penalty for failure to disclose a reportable transaction , later under Penalties. Irse file The following discussion briefly describes reportable transactions. Irse file For more details, see the Instructions for Form 8886. Irse file Reportable transaction. Irse file   A reportable transaction is any of the following. Irse file A listed transaction. Irse file A confidential transaction. Irse file A transaction with contractual protection. Irse file A loss transaction. Irse file A transaction of interest entered into after November 1, 2006. Irse file Note. Irse file Transactions with a brief asset holding period were removed from the definition of reportable transaction for transactions entered into after August 2, 2007. Irse file Listed transaction. Irse file   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. Irse file These transactions have been identified in notices, regulations, and other published guidance issued by the IRS. Irse file For a list of existing guidance, see Notice 2009-59 in Internal Revenue Bulletin 2009-31, available at www. Irse file irs. Irse file gov/irb/2009-31_IRB/ar07. Irse file html. Irse file Confidential transaction. Irse file   A confidential transaction is offered to you under conditions of confidentiality and for which you have paid an advisor a minimum fee. Irse file 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. Irse file The transaction is treated as confidential even if the conditions of confidentiality are not legally binding on you. Irse file Transaction with contractual protection. Irse file   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. Irse file For information on exceptions, see Revenue Procedure 2007-20 in Internal Revenue Bulletin 2007-7, available at www. Irse file irs. Irse file gov/irb/2007-07_IRB/ar15. Irse file html. Irse file Loss transaction. Irse file   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. Irse file 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. Irse file   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. Irse file 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. Irse file irs. Irse file gov/irb/2004-50_IRB/ar11. Irse file html. Irse file Transaction of interest. Irse file   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. Irse file The IRS has identified the following transactions of interest. Irse file “Toggling” grantor trusts as described in Notice 2007-73, 2007-36 I. Irse file R. Irse file B. Irse file 545, available at www. Irse file irs. Irse file gov/irb/2007-36_IRB/ar20. Irse file html. Irse file Certain transactions involving contributions of a successor member interest in a limited liability company as described in Notice 2007-72, 2007-36 I. Irse file R. Irse file B. Irse file 544, available at www. Irse file irs. Irse file gov/irb/2007-36_IRB/ar19. Irse file html. Irse file 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. Irse file R. Irse file B. Irse file 1194, available at www. Irse file irs. Irse file gov/irb/2008-47_IRB/ar11. Irse file html. Irse file Certain transactions involving a U. Irse file S. Irse file 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. Irse file R. Irse file B. Irse file 312, available at www. Irse file irs. Irse file gov/irb/2009-03_IRB/ar10. Irse file html. Irse file   For updates to this list, go to www. Irse file irs. Irse file gov/Businesses/Corporations/Abusive-Tax-Shelters-and-Transactions. Irse file Penalties Investing in an abusive tax shelter may lead to substantial expenses. Irse file First, the promoter generally charges a substantial fee. Irse file 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. Irse file You may also be subject to the penalty for failure to pay tax. Irse file These penalties are explained in the following paragraphs. Irse file Accuracy-related penalties. Irse file   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). Irse file 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. Irse file Your failure to disclose a reportable transaction is a strong indication that you failed to act in good faith. Irse file   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. Irse file   The 20% penalties do not apply to any underpayment attributable to a reportable transaction understatement subject to an accuracy-related penalty (discussed later). Irse file Negligence or disregard of rules or regulations. Irse file   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. Irse file 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. Irse file    Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code. Irse file It also includes any failure to keep adequate books and records. Irse file A return position that has a reasonable basis is not negligence. Irse file   Disregard includes any careless, reckless, or intentional disregard of rules or regulations. Irse file   The penalty for disregard of rules and regulations can be avoided if all the following are true. Irse file You keep adequate books and records. Irse file You have a reasonable basis for your position on the tax issue. Irse file You make an adequate disclosure of your position. Irse file Use Form 8275 to make your disclosure and attach it to your return. Irse file To disclose a position contrary to a regulation, use Form 8275-R. Irse file Use Form 8886 to disclose a reportable transaction (discussed earlier). Irse file Substantial understatement of tax. Irse file   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. Irse file 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. Irse file 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. Irse file   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. Irse file In that way, you can avoid the substantial understatement penalty if you have a reasonable basis for your position on the tax issue. Irse file Disclosure of the tax shelter item on a tax return does not reduce the amount of the understatement. Irse file   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. Irse file 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. Irse file Substantial valuation misstatement. Irse file   In general, you are liable for a 20% penalty for a substantial valuation misstatement if all the following are true. Irse file The value or adjusted basis of any property claimed on the return is 150% or more of the correct amount. Irse file You underpaid your tax by more than $5,000 because of the misstatement. Irse file You cannot establish that you had reasonable cause for the underpayment and that you acted in good faith. Irse file   You may be assessed a penalty of 40% for a gross valuation misstatement. Irse file 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. Irse file The penalty rate is also 40% if the property's correct value or adjusted basis is zero. Irse file Transaction lacking economic substance. Irse file   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. Irse file 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. Irse file   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. Irse file   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. Irse file   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. Irse file Relevant facts include any facts affecting the tax treatment of the transaction. Irse file    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. Irse file Undisclosed foreign financial asset understatement. Irse file   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. Irse file 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. Irse file The penalty applies to any part of an underpayment related to the following undisclosed foreign financial assets. Irse file Any foreign business you control, reportable on Form 5471, Information Return of U. Irse file S. Irse file Persons With Respect To Certain Foreign Corporations, or Form 8865, Return of U. Irse file S. Irse file Persons With Respect to Certain Foreign Partnerships. Irse file Certain transfers of property to a foreign corporation or partnership, reportable on Form 926, Return by a U. Irse file S. Irse file Transferor of Property to a Foreign Corporation, or certain distributions to a foreign person, reportable on Form 8865. Irse file Your ownership interest in certain foreign financial assets, temporarily reportable on Form 8275 or 8275-R. Irse file    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. Irse file See the Instructions for Form 8938 for details. Irse file    Your acquisition, disposition, or substantial change in ownership interest in a foreign partnership, reportable on Form 8865. Irse file 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. Irse file Penalty for incorrect appraisals. Irse file   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. Irse file For details on the penalty amount and exceptions, see Publication 561. Irse file Penalty for failure to disclose a reportable transaction. Irse file   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). Irse file For an individual, the minimum penalty is $5,000 and the maximum is $10,000 (or $100,000 for a listed transaction). Irse file This penalty is in addition to any other penalty that may be imposed. Irse file   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. Irse file For information on rescission, see Revenue Procedure 2007-21 in Internal Revenue Bulletin 2007-9 available at www. Irse file irs. Irse file gov/irb/2007-09_IRB/ar12. Irse file html. Irse file Accuracy-related penalty for a reportable transaction understatement. Irse file   If you have a reportable transaction understatement, you may have to pay a penalty equal to 20% of the amount of that understatement. Irse file 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. Irse file The penalty is 30% rather than 20% for the part of any reportable transaction understatement if the transaction was not properly disclosed. Irse file You may not have to pay the 20% penalty if you meet the strengthened reasonable cause and good faith exception. Irse file 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. Irse file   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. Irse file Civil fraud penalty. Irse file   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. Irse file Joint return. Irse file   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. Irse file Failure to pay tax. Irse file   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. Irse file 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. Irse file Prev  Up  Next   Home   More Online Publications