TAMRA - major provisions for individual taxpayers. (Technical and Miscellaneous Revenue Act of 1988)by Talwar, Askay K.
The Technical and Miscellaneous Revenue Act of 1988 (TAMRA) retroactively makes many long-awaited technical corrections to TRA 86 and RA 87, extends a number of otherwise expiring tax provisions and adds new substantive provisions such as the Taxpayer Bill of Rights. This article focuses on provisions that affect individual taxpayers.
Individual Tax Provisions
Income of Children Under 14
Prior to TRA 86, a child's income (earned or unearned) was taxed to the child at the child's marginal tax rate. TRA 86 introduced the so- called "Kiddie" tax provisions which taxed children under 14 on part of their unearned income at their parent's top marginal rate, unless the tax at the child's marginal rate would be higher.
TAMRA now allows parents to elect to include the unearned income of their children under 14 on their own returns. The election is available only if the gross income of the child is between $500 and $5,000 and consists only of interest and dividends. The election is not available if estimated tax payments have been made in the child's name or the child is subject to backup witholding. The advantage of this provision, effective for taxable years beginning after December 31, 1988, is that parents who make the election do not have to file separate returns for their children.
Series EE Savings Bonds
New Code Sec. 135 creates an exclusion from gross income for the interest income on certain U.S. Series EE savings bonds used for qualified educational expenses of the taxpayer, spouse of their dependents. This exclusion is available only to individuals who have purchased these bonds after attaining age 24 and are sole owners of the bonds or own such bonds jointly with their spouses.
If the aggregate redemption amount, i.E., principal plus interest, of all Series EE bonds redeemed by the taxpayer during the taxable year does not exceed the student's qualified educational expenses, all interest is excludable subject to a phaseout based on the taxpayer's adjusted gross income (AGI). If the redemption amount exceeds qualified educational expense, the amount of excludable interest is reduced on a pro-rata basis, i.e., the ratio of qualified educational expense to the sum of principal and interest on all Series EE bonds redeemed during the taxable year. The exclusion is subject to a phaseout as modified AGI for joint return rises from $60,000 to $90,000 and from $40,000 to $55,000 for single taxpayers and heads of household. Married taxpayers who file separate returns are not eligible for the exclusion.
This provision applies to taxable years beginning after December 31, 1989 for bonds issued after that date, but excludes tax-free roll-overs of Series E bonds to EE bonds.
The Standard Deduction for Elderly or Blind Dependents
Under Sec. 63(c)(5), the standard deduction for a taxpayer who may be claimed as a dependent on another taxpayer's return is limited to the greater of $500 or the taxpayer's earned income. Under TRA 86, the limit applied to the basic standard deduction as well as the additional standard deduction for elderly or blind taxpayers (an additional $600 per individual if married; $750 if unmarried). TAMRA retroactively (effective for the 1987 tax year) modifies the limitation so that it applied only to the basic standard deduction and not to the additional standard deduction allowed to elderly or blind individuals.
Accordingly, an elderly or blind individual who may be claimed as a dependent on another taxpayer's return may claim a basic standard deduction up to the greater of $500 or the amount of earned income, plus the additional standard deduction, e.g., $600 for a married taxpayer. Since this additional standard deduction is not limited by the amount of the dependent's income, it may be applied against any remaining income (earned or unearned) that has not been offset by the allowance of the basic standard deduction.
Dependency Exemption for Full-Time Students: Age Limitation
Previously, the gross income test ($1,950 in 1988) was waived if the taxpayer's dependent is a full time student. TAMRA provides that a taxpayer may not claim a dependency exemption for a dependent student who is 24 years old before the close of the calendar year, unless the dependent's gross income for the year is less than the exemption amount. If the parent cannot claim an exemption under this rule, the child may claim an exemption on his or her own return. This provision is effective after December 31, 1988.
Applicability of Percentage Reduction Rule to Meal Costs Deductible as Moving Expenses
TRA 86 generally limited the deduction for meals to 80% of costs, effective for tax years beginning after 1986. It provided that the 80% rule applied at the employer level where the employer reimbursed the employee for meals incurred in connection with job-connected moves deductible under Sec. 217.
TAMRA retroactively changes the rule by providing that the 80% rule applies at the employee level where the employer pays or reimburses the employee for meal deductible in connection with job related moves under Sec. 217. This change is effective for tax years beginning after 1986.
Also, TAMRA provides that meal reimbursements are excludible from wages for employment tax purposes (both income and social security tax) if it is reasonable to believe that a deduction is allowable as a moving expense under Sec. 217 as determined without the 80% limit. This rule is also effective for tax years beginning after 1986.
Exceptions to Deduction Limitations for Meal and
A taxpayer generally may not claim a deduction for a meal unless the taxpayer or a representative is present. Exceptions to this rule are enumerated at Sec. 274(k)(2). TAMRA gives the Treasury regulatory authority to provide additional exceptions retroactively. Examples contained in the Committee Reports include meal expenses of the taxpayer's spouse and children incurred in connection with job-related moves, and away-from-home meal expenses of a job applicant.
Denial of Deduction for Certain Residential Telephone Service
TAMRA provides that not deduction is allowed to an individual taxpayer for any charge required to be paid by the taxpayer to obtain local telephone service for the first telephone line in a taxpayer's residence, whether or not it is the taxpayer's principal residence. The rule applies only with respect to the first telephone line, even if the taxpayer claims to use that line solely for business purposes. This provision is effective for taxable years beginning after December 31, 1988.
Home Office Deduction Rules
TAMRA clarifies that when a deduction for business use of a dwelling is carried forward to a succeeding taxable year by reason of the business income limitation in Sec. 280A(c)(5), such deduction shall continue to be allowable only up to the amount of income from the business in which it arose, whether or not the dwelling unit is used as a residence during such taxable year. This clarifying amendment to Sec. 280A(c)(5) is effective as if included in TRA 86.
In Rev. Rul. 86-63, 1986-1 CB 6, the IRS ruled that if a taxpayer makes a contribution to an educational institution where athletic games are regularly sold out in advance and in return receives the right to buy tickets to those games, he or she cannot take a charitable contribution deduction for the amount contributed.
TAMRA provides that, retroactive to tax years beginning after December 31, 1983, 80% of the cost of the right to obtain preferred seating at athletic events of a college or university is so deductible. No amount paid for the purchase of tickets, whether paid separately or as part of a lump-sum payment which includes the right to purchase tickets, is deductible as charitable contribution. the statute of limitations for closed years is waived for years affected by this provision if the taxpayer files a refund claim before November 10, 1989.
The Personal and Investment Interest Provisions
Pre-August 17, 1988 Refinancing
TAMRA provides that interest on indebtedness secured by a qualified residence and incurred after August 16, 1986 to refinance grandfathered indebtedness (for example, to obtain a lower interest rate) will be treated as qualified residence interest if certain requirements are met.
Indebtedness secured by the qualified residence and incurred after August 16, 1986 to refinance pre-August 17, 1986 grandfathered indebtedness qualifies under this rule to the extent that the principal amount of the refinancing does not exceed the principal amount of the refinancing does grandfathered indebtedness immediately before the refinancing. The refinancing exception will cease to apply, however, after the expiration of the period of the pre-August 17, 1986 indebtedness was scheduled to be repaid at the end of 1992, interest on any refinancing of that debt, to the extent not otherwise deductible, will not be deductible after 1992. Where the pre-August 17, 1986 debt was not amortized over its term (e.g., a "balloon" note), interest on any otherwise qualified refinancing of that debt will be deductible for the term of the first refinancing of the pre-August 17, 1986 indebtedness, but not for more than 30 years after that refinancing. A refinancing of indebtedness originally incurred after August 16, 1986 to refinance pre-August 17, 1986 grandfathered indebtedness (e.g., a second refinancing of such pre-August 17, 1986 debt) can also qualify under this rule, subject to these requirements.
Thus, under the provision, the current balance (taking into account all amortization of principal) of the debt secured by the taxpayer's residence and incurred on or before August 16, 1986, that was grandfathered under the Reform Act, can be refinanced.
These rules apply to taxable years beginning in 1987. RA 87 amended the rules relating to the deductibility of qualified residence interest for taxable years beginning after December 31, 1987. Thus, a similar rule applies for 1988 and later years as a result of RA 87.
Interest on debt secured by a qualified residence may be treated as deductible qualified residence interest. TAMRA clarifies the definition of a qualified residence. Under the new law, a residence is a qualified residence even if the taxpayer does not use it at least 14 days a year or 10% of the time it is rented--whichever is greater--provided that the residence is not rented at all during the year. This provision applies to interest incurred after 1986.
Transfer of Residence Incident to Divorce
For taxable years beginning in 1987, TAMRA provides that in certain circumstances involving a transfer of a qualified residence between spouses incident to a divorce or legal separation, the basis limitation on debt, interest on which may be deductible, may be increased by the amount of secured indebtedness incurred by a spouse in connection with the acquisition of the other spouse's interest in the residence. The amount of such debt may not, however, exceed the fair market value of the interest in the residence being acquired.
The Phase-In Rule and the Investment Interest Carryover
Effective for tax years beginning after 1986, TAMRA provides that the current year's investment interest disallowed during any taxable year in the phase-in period shall not exceed the sum off:
1. The amount that would be disallowed if (a) the net investment income were increased by the ceiling amount--generally $10,000, (b) the reduction of net investment income by passive losses allowed under the passive loss phase-in rule did not apply, and (c) an interest in any activity that is not treated as passive and in which the taxpayer does not materially participate and is not treated as held for investment; and
2. The applicable percentage for such year (e.g., 35% in 1987) of the amount which would be disallowed, under the fully phased-in investment interest limitation, over the amount determined under (1) above.
It also provides that, if the taxpayer so elects, the amount disallowed as investment interest under prior law, which would have been treated as investment interest paid or accrued in the taxpayer's first taxable year beginning after 1986, to the extent attributable to a passive activity, shall be treated as a deduction allocable to such passive activity, for purposes of applying Sec. 469 and not as a deduction for investment interest. The passive loss phase-in rules shall not apply to such amount. The election is to be made on a one- time basis and is to apply to all pre-1987 investment interest of the taxpayer attributable to passive activities.
The Passive Loss Rules
The $25,000 Active Participation Rule for Real Estate
TAMRA retroactively clarifies the active participation requirement for the allowance of up to $25,000 of losses from certain rental real estate activities. It provides that the active participation requirement applies both in the year the loss arose and in the year the loss allowed under the $25,000 rule.
Limited Partnership Interest
TRA 86 provided that any limited partnership interest in an activity automatically was considered a passive interest. TAMRA gives Treasury the authority to provide exceptions by regulations. Thus, Treasury has the authority for Temp. Reg. Sec. 1.469-5T(e), which provides that the rule does not apply to general partners or to limited partners who satisfy the 500-hour test, or either of the prior years of participation tests.
The Phase-In and Pre-Enactment Interests
The 1987 Form 8582, Passive Activity Loss Limitation, as designed by the Service, applied the $25,000 allowance for active real estate investments first to pre-10/23/86 investments and then to post-10/22/86 investments. Although there was no statutory authority for choosing this method, the result was an effective reduction in the amount eligible for the phase-in allowance for pre-10/23/86 investments.
TAMRA effectively validates the position taken on the 1987 tax form. It provides that the general loss disallowance rule of Sec.469(a) does not apply to the applicable percentage (for example, 65% in 1987) of the passive activity loss (or credit) attributable to pre-enactment interests.
For this purpose, the portion of the passive activity loss (or credit) attributable to pre-enactment interests is the lesser of:
1. The amount of the passive activity loss (or credit) which would be disallowed without regard to the phase-in rules; or
2. The amount of the passive activity loss (or credit) which would be disallowed by taking into account only pre-enactment interests and by disregarding both the phase-in rules and the carryover of disallowed loss rules.
For example, assume that in 1987 an individual with a full $25,000 exemption available had a $15,000 loss from pre-enactment rental activities in which the individual actively participated, and no pther income or loss from passive activities. The individual is entitled to deduct $25,000 under the rental real estate rule of Sec. 469(i) but is not entitled to a further deduction under the phase-in rules of Sec. 469(m). This is because the amount of the passive activity loss attributable to pre-enactment interests is the lesser of:
1. the amount dissallowed without regard to the phase-in rules (i.e.,$5,000); or
2. the amount which would be disallowed if only pre-enactment interests were taken into account (i.e., zero, since none of the $15,000 loss attributable to pre-enactment interests would be disallowed if only those interests were taken into account).
Rental Use of Dwelling
Sec. 280A(c)(5) limits the deduction that can be claimed if a taxpayer rents out a dwelling unit but also uses it personally for certain specified periods. TRA-86 provided that these taxpayers were subject to the passive loss limitations in addition to the Sec. 280(A)(c)(5) limits.
TAMRA modifies the old rules by eliminating the partial overlap of the deduction limits of Sec. 280A(c)(5) and by the passive loss rules, thus simplifying the application of these rules.
TAMRA, effective for taxable years beginning after 1986, treats as income from a passive activity gain that is recognized from the disposition of a passive activity. Thus, income from passive activities includes post-1986 gain from the pre-1987 installment sale of an activity that would have been treated as a passive activity had the passive loss rules then been in effect. Thus, more income is subject to the passive loss rules.
The Alternative Minimum Tax (AMT) Provisions
Married Filling Separately
To remove an incentive for separate filing by married individuals, TAMRA provides that the maximum exemption phase-out for married individuals filing separately will be the same as for married taxpayers filing jointly.
It thus provides that the Alternative Minimum Taxable Income (AMTI) of married individuals filing separately is increased by the lesser of: 1. 25% of AMTI over $155,000; or 2. $20,000.
This provision is effective for taxable years ending after November 10, 1988.
TAMRA retroactively provides that personal exemptions are not allowed for AMT purposes. Thus, taxpayers who did not add back the personal exemption on 1987 tax returns can expect to be billed by the IRS.
AMT on Minor's Income
New Code Sec. 59(j) provides rules for computing the AMT on the net unearned income of minor children. Generally, effective for years beginning after December 31, 1988, the child's AMT will be the incremental amount of AMT that would have been imposed on the parents, had the child's income been included in the parent's return.
Incentive Stock Options
TAMRA provides that a disqualifying disposition of incentive stock option stock in a year subsequent to its exercise will not eliminate the AMT adjustment from the year of exercise.
The spread on stock acquired from the exercise of an option where the holder of the stock is subject to a lapse restriction will be an adjustment only when the restriction lapses. The taxpayer can, however, make an election to the contrary. This provision is effective for exercises after December 31, 1987.
Sale of Residence
The following changes were made by TAMRA: . To quality for the $125,000 exclusion, taxpayers over must have lived in the residence for at least three out of five years before the sale. Under TAMTA, for taxpayers who become physically or mentally incapable of self care, periods during which they own the residence and live in a qualified facility, such as nursing home, count towards the three out five year rule. They must, however, live in the residence of an aggregate period of one year during the five year period. This provision is effective for sales after 9/30/88. . Unlike under prior law, gain from the sale of a principal residence may be deferred when one spouse dies after the sale of the old residence and before the new residence is purchased. This provision is effective for sales and exchanges after 12/31/84 for tax years beginning after 12/31/84.
Wash Sales and Stock Options
The Tax Court, in David E. Gantor, 91 TC 47, found that the wash sales rules did not cover stock option transactions. TAMRA reverses this result by providing that the wash sales rules cover options or contracts to buy and sell stocks or securities entered into after November 10, 1988.
Incentive Stock Options
TAMRA provides that after 1986, options which first become exercisable in any calendar year will not be treated as incentive stock options to the extent that the fair market value of the underlying stock exceeds $100,000. For purposes of determining which options qualify, options are accounted for in the order granted.
Extension of Expiring Provisions
Briefly, these provisions are as follows: . Employer provided educational assistance. The exclusion of $5,250 has been extended through 1988. The exclusion does not generally apply for graduate level courses. . Low income housing credit. The eligibility rules have been liberalized but the December 31, 1989 expiration date remains unchanged. . Research tax credit. This 20% credit has been extended for one year through December 31, 1989. The amount expensed or capitalized must be reduced by 50% of the credit amount, effective for tax years beginning in 1989. . Targeted jobs credit. TAMRA makes certain modifications, and extends the credit through December 31, 1989. . Employer provided group legal services. This exclusion, which expired December 31, 1987, was extended through December 31, 1988. It is limited to an annual premium value of $70. . Mutual fund shareholder expenses. Mutual funds can continue to report net dividend income through 1989 with no separate reporting of investment expenses. Thus, shareholder expenses will not be treated as miscellaneous itemized deductions subject to the 2% of adjusted gross income floor, through December 31, 1989.
Aside from the provisions discussed in this article, TAMRA deals with tax accounting, capital recovery, pensions and employee benefits, IRAs and 401(k) plans, partnerships, estate and gift taxation, corporate taxation and the Taxpayer's Bill of Rights. Practitioners need to become familiar with voluminous and complex tax legislation if they are to continue to properly serve their clients.
The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.
©2009 The New York State Society of CPAs. Legal Notices
Visit the new cpajournal.com.