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Part 4. Examining Process

Chapter 19. Liability Determination

Section 15. Discretionary Programs (Cont. 1)

4.19.15  Discretionary Programs (Cont. 1)

4.19.15.24 
Charitable Contributions

4.19.15.24.1  (10-01-2003)
Qualifying Payments

  1. The following table provides examples of qualifying and non qualifying payments.

    Qualifying payments Non-qualifying payments
    Out of pocket expenses paid when serving as a volunteer for a qualified organization Bingo, raffles, lottery tickets, cookies, merchandise
    Expenses paid for a student living with you, if the student was placed by a qualified organization Membership dues or fees paid to country clubs or fraternal lodges
    Gifts that are to be used by the organization for its religious, charitable, educational, scientific or literary purposes Tuition and registration fees
    Gifts to be used for a public purpose The value of your time or services
    Automobile expenses incurred when doing charitable work Personal living expenses incurred while performing services for a qualified organization
    Cost and upkeep of uniforms required when doing charitable work Amounts paid for the benefit of a specific person
      The value of donated blood

4.19.15.24.2  (10-01-2003)
Qualifying Organizations

  1. Qualified organizations are listed in Publication 78 – Cumulative List of Organizations. If an organization is not listed in Publication 78 and is not a church or governmental agency, the taxpayer should be able to obtain a copy of the letter issued to the organization by the IRS granting it "qualifying organization " status.

  2. Qualifying and non-qualifying organizations can include, but are not limited to:

    Qualifying Organizations Non-qualifying Organizations
    Churches, synagogues and other religious organizations Civic leagues, sports clubs, labor unions, chambers of commerce
    Federal, state and local governments Most foreign organizations
    Nonprofit schools and hospitals, Groups that are run for personal profit, Public parks and recreation facilities Lobbying groups
    Salvation Army, Red Cross, Goodwill, Boy Scouts, Girl Scouts, etc. Individuals, political groups or specific candidates for public office.
    Volunteer fire departments  

4.19.15.24.3  (10-01-2003)
Types of Contributions

  1. Contributions can be in the form of cash or non-cash. Examples of the types of contributions are:

    Type of Contribution Example
    Cash Cash, check, money order, credit card, payroll deductions such as CFC, electronic funds transfers
    Non-cash Clothes, automobiles, household goods, artwork, stock, real estate

4.19.15.24.4  (01-01-2007)
Amount of Contribution Deduction

  1. In general a taxpayer can deduct the full amount of a cash contribution.

  2. If the taxpayer paid the qualified organization more than the fair market value of an item he received, such as merchandise or tickets to sporting events, the deduction is limited to the amount in excess of the fair market value.

  3. For non-cash contributions, the deduction is usually limited to the fair market value of the property on the date of the donation.

  4. For non-cash contributions of clothing and household goods donated after August 17, 2006, the items must be in good used condition or better. If the used clothing or furniture is not in good used condition or better, then a deduction may be allowed if the amount claimed for the item is more than $500 and the taxpayer includes with the return a qualified appraisal.

  5. For tax years beginning with the 2006 return, the taxpayer may make a qualified charitable distribution from a traditional or Roth IRA. The taxpayer must be age 70-1/2 at the time of the contribution and the maximum amount of the charitable distribution is $100,000. In general, the distribution is not deductible as a Schedule A charitable contribution. An exception applies if the taxpayer had non-deductible IRA contributions.

  6. If the amount claimed is a carry-over from a prior year, request verification for that amount and current year contributions. This does not constitute an audit of the prior year.

  7. For non-cash contributions of motor vehicles, including automobiles, boats, and airplanes made after 12/31/2004, the deduction in general is limited to the lesser of $500 or the fair market value of the vehicle. See the chart below.

    If ... And ... Then ...
    The taxpayer donates a motor vehicle and deducts more than $500 The qualified organization sells the vehicle The deduction is the smaller of

    1. the fair market value on the date of the contribution, or

    2. the gross proceeds from the sale of the vehicle by the organization. Form 1098-C will show the gross proceeds and must be attached to the return.

    The deduction for the motor vehicle is more than $500 The vehicle is/was significantly used, or improved by the organization In general, the taxpayer can deduct the fair market value of the vehicle on the date of the contribution. Form 1098-C will show if the vehicle was significantly used or improved by the organization and must be attached to the return.
    The deduction for the motor vehicle is more than $500 The vehicle was given to a needy individual, or sold to a needy individual for a price much lower than the vehicle’s fair market value In general the taxpayer may deduct the fair market value of the vehicle on the date of the contribution Form 1098-C will show if the vehicle was transferred to a needy individual.

4.19.15.24.4.1  (01-15-2008)
Acceptable Documentation for Charitable Contributions

  1. The following table lists examples of acceptable documentation for charitable contributions.

    Type of Contribution Types of Documentation
    Cash contributions of less than $250 to a single organization, including regular contributions to a single organization – for example $10 a week to a church Cancelled checks, receipts, verification of electronic funds transfer, or a statement from qualified charity. The record must show the name of the organization, the date, and the amount of the contribution. See IRM 4.19.15.24.4.1.(6) through (9) below for additional information about verifying contributions if there is doubt regarding the authenticity of the statement provided.
    Cash contribution of $250 or more to a single organization For each such donation -the taxpayer must provide an acknowledgement/statement or receipt from the organization showing the date of the contribution, amount of the contribution, a description of any goods or services received, and an estimate of the value of the goods and services received, or if the goods and services provided are solely intangible religious benefits then a statement to that effect. The taxpayer must receive/obtain the statement from the organization the earlier of the filing of the return or the due date for the filing of the return (including extensions). See IRM 4.19.15.24.4.1.(6) through (9) below for additional information where there is doubt regarding the authenticity of statements for verifying contributions.
    Expenses incurred while working for a charitable organization Taxpayer's own records to prove the amount of the expense and the amount of reimbursement received, if any and a statement from the organization describing the dates and types of service provided, the value of any services or goods received by the taxpayer.
    Non-cash contribution less than $250 Receipt or statement showing the name and location of the organization, date of the donation and a description of the property, and a reliable written record from the taxpayer that includes the fair market value of the property at the time of the contribution, and any terms or conditions attached to the gift. There is no requirement that a receipt or statement be provided by the charitable organization.
    Non-cash contributions between $250 and $500 (inclusive) Taxpayer must provide a written statement from the organization. See IRM 4.19.15.24.4.1.(6) through (9) below.
    Non-cash gifts over $500 but not more than $5,000 Taxpayer must provide a written statement from the organization showing all the information required for non-cash gifts between $250, and $500. In addition, Form 8283, Section A must be completed and attached to the return.
    Non-cash gifts over $5,000 Same documentation as above for non-cash gifts under $5,000 except in lieu of Form 8283, Section A, Form 8283, Section B must be completed and attached to the return along with a required qualified written appraisal unless the non-cash gift is inventory, publicly traded stock or intellectual property. (See Publication 561).
    Contribution of property over $500,000 Taxpayer must attach appraisal to return unless contribution is inventory, publicly traded stock, or intellectual property. Form 8283 must also be completed and attached to the return. Everything required for property over $5,000 is also required here.
    Contribution of motor vehicle, including automobiles, boats and airplanes of more than $500 Taxpayer must attach Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, or other statement received from the charitable organization that reports the same information as the Form 1098-C. A qualified appraisal is also required if the taxpayer is entitled to deduct the fair market value and the deduction is $5,000 or more for motor vehicles.
    Clothing and household furniture not in good used condition or better (contributions made after 8-17-2006) The amount claimed must be more than $500 for a single item of clothing or household item and the return must include a qualified appraisal that substantiates valuation of more than $500.
    Easements in Registered Historic Districts A qualified appraisal, photographs of the entire exterior of the building and a description of all restrictions on the development of the building must be included with the return.


  2. See Exhibit 4.19.15-6, Form 886-A.

  3. Taxpayers can provide information via mail, fax or telephone.

  4. Contributions are deductible in the year they are made. Checks, receipts and other documentation provided by taxpayers should be dated for the tax year in question.

  5. Written statements from charitable organizations must be received by the taxpayer on or before the earlier of:

    • the date the return is filed for the year contribution was made is filed, or

    • the due date of the return, including extensions.

    Note:

    See Notice 2002–25 for special rules for contributions made after 09-10-2001 and before 01-01-2002.

  6. Valid Charitable Organization Statements – Statements from a charitable organization are only required to include:

    • The Name of the Organization

    • The Date of the Contribution

    • amount and date of cash contribution

    • description of non-cash contribution

    • statement that no goods or services were provided by the organization in return for the contribution, if that was the case

    • description and good faith estimate of the value of goods or services, if any, that the organization provided in return for the contribution

    • statement that good and services, if any, that the organization provided in return for the contribution consisted entirely of intangible religious benefits, if that was the case
      Unless you question the authenticity of the acknowledgement/statement, when above items are present, do not request any additional information from the organization (Official Letterhead, Signature, etc.). See item 8 below.

  7. There may be instances when you question the truthfulness of the statement submitted by the taxpayer. In those instances it is appropriate to request additional documentation to substantiate the contribution has been made. Some examples of circumstances in which to request additional information are when:

    • the amount of the contribution is excessive in comparison to reported income;

    • documents appear altered;

    • unreadable receipts and/or statement, or

    • the statement or receipts does not include date, amount or the name of the organization.

      Note:

      Some organizations support the concept of tithing, or giving 10% of one's income. A taxpayer's deduction of 10% of income, alone, is not a basis to question documentation without considering other factors.



      The workpapers must be documented to explain the reasons why additional documentation was requested and reasons when the statement appears questionable.

  8. If you question the authenticity of the acknowledge/statement:

    • Cash Contributions- verification should be requested, i.e. cancelled checks or bank records

    • Non-cash Contributions- verification can be requested from the organization to ascertain it provided the acknowledgement/statement submitted by the taxpayer.

  9. Most taxpayers make some cash, out of pocket contributions for which they have no receipts. If the taxpayer provides reliable written record that meets both conditions listed below, the statement then will meet the documentation requirements for contributions can be accepted.

    • record was prepared on or near the date the expense was incurred and

    • It includes the name of the organization, date and description of the contribution.

      Note:

      Beginning with tax year 2007 returns, a bank record, or a statement from the charitable organization showing the name of the organization, date of the contribution, and the amount, must substantiate cash contributions, regardless of the amount.

  10. If the taxpayer provides acceptable documentation for a portion of the deduction and provides a statement that the balance was made in cash, but does not include the information stated above, use your judgment in allowing the amount claimed, but see the note regarding cash contributions beginning with tax year 2007.

4.19.15.24.4.2  (01-01-2006)
Limitations on Contributions

  1. Taxpayers contribution deductions are limited to 50% of their adjusted gross income for the year in which they are claiming the deduction. If their deduction exceeds 50% of their AGI, they can carry the excess forward to the next five tax years until it has been deducted in full.

  2. Exceptions:

    • Taxpayers are limited to 20 % of AGI if the property contributed is capital gain property or for use of qualified organization.

    • A 30% limitation applies for gifts to Veteran’s organizations, fraternal societies and certain private non-operating foundations.

  3. If the taxpayer does carry a deduction forward to another tax year, he must consider the carried-forward amount in computing his deductible contribution for that year. Any unused contribution that has not been deducted by the fifth succeeding tax year is lost. If the carryover is disallowed for the current year and the examiner finds it has also been carried forward, the subsequent year should be opened if the carryover is substantial and the approval of the manager is obtained.

  4. Taxpayers should keep records, (such as copies of tax returns or worksheets) to verify any carryover deductions.

4.19.15.24.4.3  (10-01-2003)
Additional Research Material

  1. For additional information on allowable deductions you may refer to Publication 526, Charitable Contributions, for the tax year you are examining.

4.19.15.24.4.4  (04-17-2008)
Charitable Contribution Rules - Project Code 0391, Project Code 0392 and Project Code 0629

  1. Project Code 0391 is Charitable contributions carryover with no prior year Schedule A.

  2. Project Code 0392 is Charitable contributions carryover with prior year contributions of less than 50 percent of AGI.

  3. Project Code 0629 is Charitable contributions and identifies returns with a deduction for cash contributions. PC 0629 cases are automated for batch processing.

  4. The examination of these cases will begin with case selection from the Dependent Database (DDb). The selected returns will have broken one of the contribution business rules indicated above. DDb should also provide Schedule A, Line 17 amounts claimed on the taxpayer’s prior three tax returns. Each case will be established on AIMS in Source Code 06 with the appropriate Project Code.

4.19.15.24.4.4.1  (04-17-2008)
Initial Contact

  1. The following table shows the Initial Contact Letter to send to the taxpayer.

    Project Code Issue Letter Amount to Disallow
    PC 0391
    PC 0392     		Letter 566/ Form 886-A with applicable explanation Schedule A, Line 17 — Carryover from prior year
    PC 0629 Initial Contact Letter 566 / Form 886-A Documents Request  

4.19.15.24.4.4.2  (04-17-2008)
No Response Cases

  1. Take the following action if the taxpayer has not replied to the most recent letter by the normal purge date.

    Latest Letter issued Action
    Letter 566 Issue Letter 525 with Form 4549 / Form 4549-EZ .
    Letter 525 or Letter 692 , and the Form 4549 / Form 4549-EZ reflects a deficiency Follow normal procedures to have Statutory notice issued based on the adjustments shown on Form 4549 / Form 4549-EZ .

4.19.15.24.4.4.3  (12-12-2008)
Processing Taxpayer Replies to Letter 566

  1. The following describes the processing of taxpayer replies to Letter 566 for Project Codes 0391, 0392 and 0629 cases:

    If And Then
    The taxpayer responds to Letter 566 You are able to verify that the taxpayer is entitled to all or part of the amount as a contribution deduction. Issue Letter 525 with a Form 4549 / Form 4549-EZ and an appropriate explanation to the taxpayer. Follow normal procedure for mail out and suspense.
    The taxpayer responds to Letter 566 You are unable to verify that the taxpayer is entitled to any part of the amount claimed as a contribution deduction. Issue Letter 525 with the Form 4549 / Form 4549-EZ and an appropriate explanation to the taxpayer. Follow normal Letter 525 procedures for mail out and suspense.
    The taxpayer replies to Letter 566 with information he is entitled to an additional deduction for contributions You are able to verify that he is entitled to an additional deduction. Issue Letter 525 with a Form 4549 / Form 4549-EZ and an appropriate explanation to the taxpayer. Follow normal Letter 525 procedures for mail out and suspense.

4.19.15.24.4.4.4  (04-17-2008)
Closing Actions

  1. Take the necessary action to close the case based on the chart below.

    If the Taxpayer Then
    Signs the Form 4549 / Form 4549-EZ , reflecting a deficiency or overpayment Follow normal procedures for Closed Agreed cases.
    Does not reply to Letter 525 or Letter 692 and Form 4549 / Form 4549-EZ reflects an overpayment Follow normal procedure for Disposal Code 08 closings.
    Does not reply to the 90 Day letter Follow normal procedures for defaulting cases.
    Verifies that the contribution is allowable as a carryover deduction Follow normal procedures for No— Change cases.
    Files a Form 1040X removing the contribution deduction and AM assesses the additional tax. Close the case using Disposal Code 08. In Field 35 of Form 5344 shown the entire amount of the assessment.

4.19.15.25  (12-12-2008)
Casualty and Theft Losses

  1. The examiner must keep in mind the following:

    • If the taxpayer’s property was covered by insurance and the taxpayer fails to file a timely claim for reimbursement, the taxpayer cannot take a deduction.

    • The taxpayer may deduct non-business casualty or theft losses only to the extent that:

      The amount of each separate casualty or theft loss exceeds $100 and
      The total amount of all losses during the year exceeds 10% of the adjusted gross income.

    • The Katrina Emergency Tax Relief Act of 2005 (KETRA) and the Gulf Opportunity Zone Act of 2005 (GOZA) suspended the $100 and 10% of adjusted gross income limitations on casualty or theft losses of personal-use property to the extent that the losses arose in the:

      Hurricane Katrina disaster area on or after 8/25/05 and were attributable to Hurricane Katrina.
      Hurricane Rita disaster area on or after 9/23/05 and were attributable to Hurricane Rita.
      Hurricane Wilma disaster area on or after 10/23/05 and were attributable to Hurricane Wilma.

    Note:

    Simple disappearance of money or property (lost or mislaid) is not a theft.

  2. In order to deduct a casualty loss, the taxpayer must be able to show all of the following:

    1. The type of casualty (car accident, fire storm, etc.) and when it occurred.

    2. That the loss was a direct result of the casualty.

    3. That the taxpayer was the owner of the property, or if it was leased property that the taxpayer was contractually liable to the owner for the damage.

    4. The amount of any insurance reimbursement.

  3. In order to deduct a theft loss, the taxpayer must be able to show all of the following:

    1. When the property was discovered missing.

    2. The property was stolen.

    3. The property belonged to the taxpayer.

    4. Whether a claim for reimbursement exists for which there is a reasonable expectation of recover.

  4. The following situations can result in casualty losses:

    • Car accidents

    • Earthquakes.

    • Floods.

    • Fires.

    • Government-ordered demolition or relocation of a home that is unsafe to use because of a disaster.

    • Hurricanes.

    • Mine cave-ins.

    • Shipwrecks.

    • Sonic booms.

    • Storms.

    • Tornadoes.

    • Vandalism.

    • Volcanic eruptions.

  5. Considerations when taxpayer qualifies for a Disaster Area Loss:

    1. A Presidentially Declared Disaster is a disaster that occurred in an area designated by the President to be eligible for federal assistance under the Robert T. Stafford Disaster Relief and Emergency Assistance Act. This includes a major disaster or an emergency declaration under the Act. If the casualty loss is from a disaster that occurred in a Presidentially Declared Disaster Area, the taxpayer can choose to deduct that loss on his current year return or by amending the return in the prior year. Ensure the taxpayer is not claiming the same expenses for both years.

    2. The taxpayer must reduce his casualty loss by funds received under any disaster provision and by any insurance reimbursement.

    3. Refer to IRM 25.16.1.7.3, Assistance Provided to Disaster Victims.

4.19.15.26  (01-01-2006)
Employee Business Expense (EBE) Cases

  1. These are cases with Form 2106 expenses included in Schedule A Miscellaneous Deductions and where miscellaneous deductions do not appear consistent with the taxpayer’s occupation or income. Because the Form 2106 and many lines on the 1040 Schedule A are not transcribed, you may see a combination of employee business expenses and miscellaneous expenses.

  2. Returns will be requested for this issue.

    1. Returns will be reviewed to determine if expenses appear in line with the occupation on the Form 2106.

    2. Returns will be classified for other issues.

  3. Initial Contact Letter 566 (SG/CG) (ICL) and explanation of the substantiation required to support the employee business expense will be issued to the taxpayer.

    1. Use the approved questionnaire/explanation on Form 886-A . ( See Exhibit 4.19.15-7. See Exhibit 4.19.15-8.)

    2. Also request any entries that are missing on the Form 2106.

    3. Request any receipts or records specific to the amounts on the Form 2106 in question.

  4. Follow normal suspense time frames. If there is no response to the ICL, issue a Report disallowing the entire employee business expense amount.

4.19.15.26.1  (01-01-2006)
Evaluating EBE Taxpayer Responses

  1. All responses need to be evaluated using judgment considering what is known about the occupation.

  2. The reimbursement policy of the employer is the starting point for all EBE audits and MUST be secured.

  3. Taxpayers may claim the government per diem rate for the M & IE portion of travel expenses, provided they have supported the travel. However, receipts are required for the lodging portion of these expenses and the government per diem rates cannot be used as a substitute.

  4. An expenditure for entertainment, to the extent it is lavish or extravagant, shall not be allowable as a deduction.

  5. Documentary evidence is required for:

    1. Any expense for lodging while traveling away from home, and

    2. Any other expenditure of $75 or more.

  6. IRC 274(d) provides that no deduction shall be allowed for entertainment, gifts, listed property or travel unless the taxpayer substantiates the following elements of the expenditures:

    1. Amount of each expenditure.

    2. Time or date of the travel, entertainment, or gift.

    3. Place of the travel or entertainment; description of the gift.

    4. Business purpose for each expenditure.

    5. Business relationship to the taxpayer of each person entertained, using an entertainment facility, or receiving a gift.

  7. Many expenses not listed in (5) above can be summarized, or aggregated. See Publication 463 Travel, Entertainment, Gift, and Car Expenses, Section 5 Record Keeping for a table that shows the substantiation requirement for specific expenses.

  8. Travel expenses are deductible when taxpayers are temporarily away from their tax home. However, an indefinite assignment to another location is a change in tax home, thus travel expenses are not deductible.

  9. Travel expenses for conventions, seminars, and similar meetings are deductible under IRC 162 if the taxpayer’s attendance benefits or advances his trade or business. No deduction is allowable if a taxpayer is attending for social, political, or other purposes not related to his trade or business.

  10. IRC 274(c)(1) states foreign travel must first be deductible under IRC 162 or IRC 212. The travel must be ordinary and necessary in the pursuit of a trade or business, or for the production of income. If the expense meets those requirements, then the business portion of the travel is deductible.

  11. Travel outside of the United States generally must be allocated between business and personal. IRC 274(c)(2) provides two exceptions to the rule that travel expenses be allocated between business and personal. No allocation is made if foreign travel does not exceed one week, or if less than 25% of the trip is personal, then travel to and from the business destination is allowed in full.

  12. Any issues beyond the expertise of the examiner assigned the case should be referred to the lead examiner to secure the appropriate technical guidance.

  13. It is not necessary to fully allow or disallow any expenses. Expenses can be partially allowed when revising the report. Special care should be taken to explain these revisions to the taxpayer.

  14. Additional Items to consider. Consider the following points when working EBE cases.

    Employee Business Expense Auditing Techniques
    When examining employee business expenses, you must consider whether the employer has a reimbursement plan.
    You must be able to determine if the plan is accountable or non-accountable. When examining expenses you believe are under an unaccountable plan, you may encounter nondeductible expenses that were reimbursed.
    Always request a written statement of the reimbursement plan from the employer. The written statement can be an excerpt from the employee handbook or a statement prepared for the purpose of the examination.
    If the statement is prepared for the purpose of examination, be sure the author has sufficient knowledge of the employee plan.
    If the statement presented from the employer is vague, discuss with your manager or lead the possibility of making a third party contact.
    Be logical in organizing the examination. It may be better to structure the examination of these expenses into categories i.e. travel, entertainment, listed property, gifts, than by time periods (all of May’s expenses or July’s expenses). Examining by topic will allow you to see inconsistencies in the taxpayer’s records. It will also allow you to determine the credibility of the taxpayer’s record keeping.
    Look for recurring names for entertainment and meals, as well as recurring locations for travel. Recurring names may indicate a family member or a friend.
    Be mindful of travel dates. Are the dates during holiday periods? If travel dates are during holiday seasons, this may indicate personal expenses.
    Does the taxpayer use a travel agent on some occasions and not at other times? If he uses a travel agent regularly, this may be a source of documentation. A travel agent may or may not be used by his company. Does he use more than one travel agent? Most companies use one travel agent; if there are two or more, there may be some personal expenses intermingled with valid business travel.
    Hotel receipts will often show how many people stayed in a room. If friends or family were staying with the taxpayer while they were away from home, you must determine if there was a business purpose for their stay and what, if any, additional charges were incurred.
    Airline tickets and travel agency statements will show departure dates and who actually traveled. Compare the dates of the business meetings with the actual length of the trip. You could discover that the taxpayer extended his/her stay for a personal vacation. Request a detailed itinerary.
    For employees on "accountable" plans, evaluate any reimbursement records. In most cases, the expenses reimbursed by the employer should be accepted up to the amount of reimbursement on face value since it is assumed that they were incurred for a business purpose. Special attention should be paid when they exceed the reimbursement policy. This may also be used to establish the business portion of the use of an automobile where the employee is taking an actual expense deduction vs. a mileage deduction.
    Be alert for altered documents. Look for erasures of dates, times, places or amounts. Look for possible consecutive numbered receipts, especially for high entertainment costs.

4.19.15.26.2  (01-01-2006)
Additional Information

  1. Additional EBE information and materials should be referenced when working EBE cases. These include:

    • Publication 463 – Travel, Entertainment, Gift, and Car Expenses.

    • Training courses available: Training Doc 6712–502 Basic Income Tax Law for Correspondence Examination – Module D, Standard and Itemized Deductions (Lesson 7).

    • Publication 529 – Miscellaneous Expenses.

    • Publication 17 – Your Federal Income Tax.

    • Treas. Reg. § 1.274-5T(c)(6)(i)(B).

4.19.15.27  (10-01-2002)
Miscellaneous Deductions

  1. The examiner should have the taxpayer send in the following documentation:

    • Copies of cancelled checks and paid bills of the expenses claimed.

    • A complete explanation for the purpose of the expense.

    • See Exhibit 4.19.15-6, Form 886-A.

  2. The table below is an all-inclusive list of deductions not subject to the 2% AGI limitation, but is not all inclusive for unallowable or items subject to the 2% AGI limitation.

    Subject to 2% AGI Limitation Not subject to 2% Unallowable
    Unreimbursed employee expenses (Line 21) Deductible unreimbursed employee expenses that are

    • Paid or incurred during the tax year.

    • For the purpose of carrying on a trade or business.

    • Ordinary and necessary.

    		 List of Deductions:

    • Amortizable premium on taxable bonds.

    • Casualty and theft losses from income producing property.

    • Federal estate tax on income in respect of a decedent.

    • Gambling losses up to the amount of gambling winnings.

    		 List of non-deductible expenses are:

    • Brokers commissions to buy investment property or to sell securities

    • Burial or funeral expenses

    • Campaign expenses

    • Capital expenses

    • Check writing fees

    • Club dues

    • Commuting expenses. If the taxpayer hauls tools, instruments, or other items in an auto to and from work, the taxpayer can deduct only the additional cost of hauling the items (such as the rent for a trailer to carry the items).

    Examples are:

    • Business bad debt of an employee

    • Education that is work related if 1) it maintains or improves skills required in the taxpayer’s present work, 2) is required by the employer or the law to keep current salary, status or job, and the requirement serves a business purpose of the employer, and 3) the education does not qualify the taxpayer for a new trade or business. (Only for the taxpayer and not for dependents).

    • Legal fees related to job

    • Licenses and regulatory fees.

    • Malpractice insurance premiums.

    • Medical examinations required by employer

    • Occupational taxes

    • Passport for a business trip

    • Related to the job periodicals and other printed reading material.

    • Work related travel, transportation, entertainment.

    • Business liability Insurance.

    • Damages for Breach of Employment Contracts.

    • Depreciation on Computers or Cellular phones if for the convenience of employer and required as a condition of employment.

    • Dues to Chamber of Commerce and Professional Societies.

    • Educator Expenses over limit

    • Job Search Expenses

    • Repayment of Income Aid Payment

    • Research Expenses of a College Professor

    • Tools used in your work

    • Union Dues and Expenses.

    • Work clothes and Uniforms.

    • Impairment-related work expenses of persons with disabilities.

    • Loss from other activities from Schedule K-1

    • Repayments of more than $3,000 under a claim of right.

    • Unrecovered investment in an annuity.

    • Fees and licenses such as car or marriage licenses and dog tags.

    • Fines or penalties.

    • Health Spa expenses.

    • Hobby Losses – if no income from the hobby activity

    • Homeowners insurance premiums

    • Home repairs, insurance, and rent.

    • Home security system.

    • Illegal bribes and kickbacks.

    • Investment related seminars.

    • Life insurance premiums.

    • Lobbying Expenses

    • Losses from the sale of your home, furniture, personal car, expenses of sale of your home.

    • Lost or mislaid items.

    • Lunches with coworkers

    • Meals while working late.

    • Personal disability insurance premiums.

    • Personal legal expenses.

    • Personal, living or family expenses.

    • Political contributions.

    • Professional accreditation fees.

    • Professional reputation.

    • Relief fund contributions.

    • Residential telephone service

    • Stockholders meetings

    • Tax-exempt income expenses

    • Education expenses of a dependent.

    • Value of loss of wages.

    • Adoption expenses, but see Adoption Credit.

    • Personal accounts.

    • Travel expenses for another individual

    • Voluntary unemployment benefit contributions.

    • Cost of a wristwatch.
    Tax preparation fees (Line 22)
    Other expenses (Line 23). You can deduct certain other expenses as miscellaneous itemized deductions subject to the 2% limitation for expenses to produce or collect income that must be included in your gross income, expenses to manage conserve or maintain property for producing such income or to determine taxability. These expenses must be reasonable and closely related for these purposes.

    Note:

    Examples are:

    • Appraisal Fees.

    • Clerical help and office rent.

    • Depreciation on Home Computer

    • Excess deductions of an estate.

    • Collection fees.

    • Hobby expenses if hobby income.

    • Indirect deductions from pass-through entities

    • Investment fees and expenses.

    • Legal expenses

    • Repayments of income

    • Repayments of Social Security benefits

    • Safe Deposit Box rent

    • Service charges on Dividend reinvestment plans

    • Trustee administrative fees for IRA

4.19.15.28  (01-01-2006)
Return Preparer Referrals

  1. See LEM 4.19.1 – 4.19.15.28.

4.19.15.28.1  (01-01-2006)
Role of the Exam RPP Coordinator

  1. The Exam RPP Coordinator at each site will be the liaison between Campus Exam and the W&I HQ and elevate any issues for resolution.

  2. RPP primary role is to provide technical assistance to Correspondence Exam in working these cases.

  3. See LEM 4.19.1 – 4.19.15.28.1.

4.19.15.28.2  (01-01-2006)
Referral Process for RPP Returns

  1. See LEM 4.19.1 – 4.19.15.28.2.

  2. Cases will be opened on AIMS by W&I HQ and controlled under Project Code 0133, Source Code 70. Any scheme that is related to EITC will be controlled under Special Project Code 0132. The AIMS Assignee Code (AAC) will reflect the respective PBC for each site and an Employee Group Code (EGC) of 5000.

  3. See LEM 4.19.1 – 4.19.15.28.2.

  4. CI will not usually control these cases with a Z freeze.

4.19.15.28.3  (01-01-2006)
Controlling RPP Returns

  1. See LEM 4.19.1 – 4.19.15.28.3.

4.19.15.28.4  (01-01-2006)
Procedures for Working RPP Cases

  1. Normal Exam procedures will apply to working these cases. See LEM 4.19.1 – 4.19.15.28.4.

  2. Manager or RPP Coordinator must approve any short closing — DC 20, 32, or 33.

  3. Letter 566-B will be used to initiate the audit process for non-EITC cases. For EITC cases use Letter 566 as the initial contact letter (ICL). The letter will be prepared by checking off the appropriate boxes for the issues being examined. Form 886-A with proper paragraphs and Form 4549/ 4549-EZ will be included, as well as the proper enclosures.

  4. Follow normal deficiency processing from this point, allowing the normal time frames for purging and issuance of the Statutory Notice of Deficiency.

  5. See LEM 4.19.1 – 4.19.15.28.4.

  6. Examiners will ensure that procedures are followed for calculation of the interest suspension period as defined in IRC 6404(g). Please refer to IRM 4.19.13.5.1, RRA 98 Section 3305 Suspension of Interest – 18 Month Rule, for additional information.

4.19.15.28.5  (12-12-2008)
Examining the Schedule A on Preparer Referrals

  1. See LEM 4.19.1 – 4.19.15.28.5 for guidance on the issue of not disallowing Schedule A in its entirety.

  2. The examiners are required to familiarize themselves with 4.19.15.23. This IRM section will provide information related to the allowable and unallowable deductions on the Schedule A.

  3. Fraud penalties will not be considered on these cases by Campus Exam. The examiner will consider any other penalties as applicable as in the normal course of any examination, such as negligence penalty or substantial underpayment penalty, if warranted. If any indication of fraud is discovered in either the substantiation submitted or in the return itself, this should be brought to the attention of the RPP Coordinator/manager/HQ analyst. The following is a list of some examples of possible fraud. However, the examiner will need to be familiar with all other indicators:

    1. Altered photocopies of paid bills.

    2. Any discrepancy in the bank coding of the cancelled check (should coincide with amount claimed as paid).

    3. Any alteration of submitted documentation.

    4. Information received via a telephone call from a taxpayer being examined.

    5. Refer to IRM 25.1 and 4.19.15 for identifying badges of fraud.

  4. See LEM 4.19.1 – 4.19.15.28.5.

4.19.15.28.6  (10-01-2003)
Examining the Schedule C on Preparer Referrals

  1. Refer to LEM 4.19.1.5.3.1.

4.19.15.29  (12-12-2008)
Correspondence Exam Tip Program

  1. Cases worked in the Tip Program are initiated based on information received from Area Offices. Revenue Agents (RAs) and or Revenue Officer Examiners (ROEs) gather data from the employers of tipped employees and use this information to determine each employee’s correct tip income. If the employee did not report the correct amount of tips, Correspondence Exam will issue a report reflecting the increase in income tax and FICA taxes (which includes Social Security and Medicare) based on the unreported tip income. All other unreported income as identified on IRPTR should be addressed and included on the examination report per normal procedures.

  2. The following conditions will apply:

    • The inventory will also include cases where the tipped employee has not filed a return.

    • In all cases normal non-Batch case processing procedures will be used.

    • Penalties will be asserted as required or deemed appropriate.

    • The terms "taxpayer" and "employee" are used interchangeably in this section.

    • All correspondence to the taxpayer should contain the name and telephone number of the examiner who prepared the report.

    • References in this section to FICA taxes are assumed to include Social Security and Medicare taxes.

    • If a taxpayer has reached the wage base for Social Security wages, he or she is still subject to Medicare tax on all wages (including tips) received. There is no income wage base for Medicare wages.

    • All forms that are specific to the Tip Program and are not currently available through RGS will be loaded onto workstations and attached to the taxpayer’s file. These forms include Form 886-A1 (Tip Income Computed Using an Hourly Rate), and Form 886-A1 (Tips Computed Using % of Gross Sales), Form 886-A2 (For Information Purpose Only), and Form 886-A (Explanation of Items), with an explanation that is specific to the Tip Program. If the examination is based on the percentage of gross sales method, Form 886-MC should be used to demonstrate how the unreported tip income was computed using the McQuatter's Formula. These forms can be found in the Exhibit section of 4.19.15.

  3. The program will consist of the following types of cases:

    • Non-participating filers who under-reported their tip income

    • Non-participating non-filers

    • Participating non-filers

    Gaming Industry cases will be assigned Project Code 0360 if they are from Casino’s other than Indian Tribal Casinos. If they are from Indian Tribal Casinos they will be assigned Project Code 0916, and Food and Beverage Industry cases will be assigned Project Code 0364. Non-filer cases will be assigned the same Project Codes, however, Source Code 24 is used for these cases.

  4. Original returns will not be ordered. RTVUE will be used unless it is necessary to review the original return during audit. If the taxpayer filed a Form 4137, Social Security and Medicare Tax on Unreported Tip Income, with his or her individual income tax return, follow the instructions in the table below to determine the under-reported tip income. On joint returns where both taxpayers are tip earners and have unreported tips, make a separate calculation for each taxpayer.

    If And Then
    The payer on the extension report matches a payer on IRPTR That employer is the only one on IRPTR from whom the taxpayer would have received tip income Consider the amount of tips reported on Form 4137 when determining the unreported tip income.
    The payer on the extension report matches a payer on IRPTR There is more than one employer on IRPTR from whom the taxpayer would have received tip income Do not consider the amount of tips reported on Form 4137 when determining the unreported tip income.
    Instruct the taxpayer to provide a copy of Form 4137 and a breakdown on tips reported for each employer with the response to the letter.

    Note:

    Beginning in 2007, Form 4137 will contain a breakdown of reported tips by employer.
    It cannot be determined that the employer on Form 4137 is the same employer on the extension report There is one or more than one employer on IRPTR from whom the taxpayer would have received tip income When determining the unreported tip income for each employer, do a pro- ratio allocation of the tip income reported on Form 4137 and apply the ratios to each employer.

  5. The Tip Extension database will contain the following:

    1. Participating Employees:

      On joint returns where both are tipped employees and their participant status is different, an extension report will be generated for the employee who has under reported their tip income regardless of participation status.
      For taxpayers who worked for several employers and had different participation statuses with each employer, an extension report will only be generated for employers where the taxpayer under reported tip income.
      If the tipped employee is shown as participating but has reported tip income less than the amount on the agreement, the taxpayer will be treated as a non-participant.

    2. Primary and Secondary SSNs will be identified.

    3. Amounts reported on Form 4137 will be identified.

  6. The Excel spreadsheets, and/or allocation sheets prepared by the field agents for the Food and Beverage Industry are computed by establishing a tip rate based on both charged and cash sales and allocated to each employee based on position and hours worked. A stiff ratio percentage and a tip out rate may also be factored into the computation.

  7. Tip extension reports are not provided for either the Food and Beverage Industry Tip or Indian Tribal Casino cases. These cases are usually delivered on Excel spreadsheets. These spreadsheets will contain the % of gross sales or an hourly rate, the venue, the position, hours worked, and shift. This information will be loaded onto the Form 886-A1 which will then be used as the allocation sheet.

4.19.15.29.1  (12-12-2008)
Commonly Used Terms

  1. The following table lists terms used in the Tip Income Program:

    Term Definition/Description
    (1) Tip Agreement/Closing Agreement Form 906. Agreement between an employer of tipped employees and the IRS.
    (2) Participating Employee A tipped employee who states in writing that he or she will report to his or her employer at or above the tip rate established for his or her worker category or as stated in the appendix of the agreement.
    (3) Non-participating Employee A tipped employee who does not sign the declaration stating that he or she will report the actual tip income to his or her employer or stated that they would participate, but, reported less than the agreed upon rate.
    (4) Venue Location where employee works, (i.e. Sunrise Cafe, Pool or Slots).
    (5) Job Classification/Position Employee’s job title i.e. food, server, maitre d’, bellman, bartender, etc.
    (6) Tip Rate/Gaming Amount of tips per hour, shift, drink, car, etc., that is assigned to each employee, based on their job classification and venue. The RAs or the ROEs review information provided by the employer and determine this amount. These rates are part of the tip agreement. The tip rate is multiplied by the number of hours, etc., the employee worked to determine the minimum amount of tips the employee should have reported as income to their employer.
    (7) Tip Rate/Food and Beverage For the Food and Beverage Industry, the tip income is based on the employer’s records. McQuatters v. Commissioner, T.C. Memo 1973-240 specifically addresses the factors that must be addressed. These factors were incorporated into a computation known as the McQuatter’s Formula.
    (8) Reported Tips The amount of tips an employee reports to his or her employer and is included on the taxpayer’s Form W-2.
    (9) Unreported Tips The difference between the employee’s reported tips and the amount of tips determined to be earned based on the tip rate. Additional tip income information may be shown on the Form W-2.
    (10) Allocated Tips Additional tip income on an employee’s Form W-2. If the amount of tips the employee reported to the employer is less than 8% (or the approved lower rate) of the employee’s tipped sales, an amount will be entered in Box 8 of the Form W-2. The employee should include this amount on their tax return and on Form 4137. This amount should not be considered for casinos/establishments that the IRS has an agreement with or has conducted an examination and tip income has been determined.
    (11) Form 4137 This form is used to report tip income and related FICA taxes on the tax return that were not reported to the employer(s) during the year.
    (12) Tip Extension Summary and Report/ Gaming Industry Information from the Tip Program databases for each selected employee. This report includes employer’s name, employee’s position, shift, hours worked, tips reported, and tip rate. This information is used to determine the amount of unreported tip income.
    (13) Allocation/and or the Excel spreadsheet/Food and Beverage Industry The allocation sheet is used to report the tip income that should have been reported to the employer. The allocation sheet will contain the taxpayer’s job and the area of the business in which he or she worked, (i.e., restaurant name, room service, etc.). It provides details of the computation of the tip rate and the overall unreported tips based on the McQuatter’s Formula.
    (14) Excel spreadsheet for the Tribal Gaming Casinos The Excel spreadsheet will contain all of the same information as stated above but may have tip income computed on an hourly rate as well as on the percentage of gross sales. If all of the tip income is based on the McQuatter’s Formula, the information used to compute the percentages will be provided.
    (15) Form 886-A1, Employee Tip Examination Worksheet and Tracking Sheet Form 886-A1, Employee Tip Examination Worksheet, is used to assess the employer’s share of FICA taxes after the employee’s share has been assessed. There are two Form 886-A1s. One is titled: "Tips computed Using % of Gross Sales" , and the other one is titled: "Tip Income Computed Using an Hourly Rate" . These Forms can be found in the Exhibits for 4.19.15.

4.19.15.29.2  (12-12-2008)
Contents of Case File

  1. Tip Income Information – The Area Offices will accumulate employer and employee data from the employers and determine which employees require an examination. For employee audits that are referred by the Area Offices, the data will be available on the Tip Match database based on the GITCA (Gaming Industry Tip Compliance Agreements). The Tip Match database and the list of selected employees will be provided to W & I Headquarters. The Food and Beverage tipped employee audits that are referred from Area Offices will contain a tip allocation worksheet or will be entered into an Excel spreadsheet.

  2. The following information will be available for taxpayers who have been selected for examination:

    • Employee’s name and SSN.

    • Employee’s position, venue and shift.

    • Number of hours worked.

    • Form 886-A1, Employee Tip Examination Worksheet.

    • Employer’s name.

    • Tip agreement date and RTVUE of tax return, if filed.

    • Tip rate for employee’s position, venue and shift per the Tip Agreement.

    • Fact of filing.

  3. Other Case File Information — Case files will include the following information for all taxpayers:

    • AMDISA for the selected year(s).

    • IMFOLT for the selected tax year(s).

    • IRPTR information for the selected year(s).

    • McQuatter's allocation sheet for the Food and Beverage cases.

    • Tip Rate Extension Summary and Report.

    • Tracking sheet. Form 886-A1, Employee Tip Examination Worksheet. (Two copies are required: one copy is to be used as a tracking sheet and another copy as part of the administrative file).

4.19.15.29.3  (12-12-2008)
Case Processing –General Information

  1. The following information describes procedures that are specific to the Tip Income Program. Unless otherwise stated, normal case processing procedures should be followed.

  2. Due to the specific procedures for assessing FICA taxes, all cases in the Tip Program should be filed separately from other cases or flagged for easy identification.

  3. Adjustments to tip income involve both income tax and FICA taxes. Therefore, two sets of report forms are required:

    Type of Tax Report Form Agreement Form
    Income tax Form 4549/ Form 4549-EZ Form 4549/ Form 4549-EZ
    Social Security Form 885-T Form 2504
    Medicare Form 885-T Form 2504

  4. As the chart shows, three forms must be prepared and sent to the taxpayer (tipped employee): Form 4549/ Form 4549-EZ, Form 885-T, and Form 2504 . Form 886-A, Explanation of Items, and Form 886-A1, Employee Tip Examinations Worksheet, must also be sent. If the examination was based on the percentage of gross sales, a Form 886-MC will need to be completed and sent to the taxpayer. This form shows how the tip income was computed using the McQuatter's Formula. This provides the taxpayer with a detailed computation of the unreported tip income. Make sure that your workpapers clearly explain how you arrived at your adjustments. This information will be extremely important if the taxpayer requests a transfer to an Area Office, requests an Appeals conference, or petitions the court.

  5. Research AIMS to determine if another tax year is open for examination. If so, the cases should be worked by the same examiner.

4.19.15.29.3.1  (12-12-2008)
Filed Returns – Initial Contact

  1. Compare the tip income reported on Form 1040, including amounts reported on Form 4137, to the tip income identified by the Area Office.

    If And Then
    The tip income identified by the Area Office exceeds the amount reported on the tax return, including Form 4137   Include the unreported amount in the examination report.
    The taxpayer worked for more than one employer where tips were received The taxpayer participates in the tip agreement at one employer but does not participate at another Only the tip income reported by the employer for which the employee under-reported tip income should be included.
    Both the taxpayer and the spouse on a joint return worked in a tipped occupation and a joint return was filed There is tip income information for one taxpayer but not the other Perform the necessary research to determine if there is unreported tip income for the other taxpayer and include all unreported tip income in the report.

  2. Follow the instructions below when allocated tips are shown on the taxpayer’s Form W-2:

    If And Then
    The payer is the same payer as shown on the tip extension report or other source document The taxpayer included the allocated tip amount from Form W-2 as income on Form 1040 Give the taxpayer credit for the A-tips reported on Form 1040 when determining the unreported tip amount.
    The payer is the same payer as shown on the tip extension report or other source document The taxpayer did not include the allocated tip amount from Form W-2 as income on Form 1040 Disregard the A-tip amount. Use the information from the extension report to determine the unreported tip income.
    The payer is not the same payer as shown on the extension report or other source document The taxpayer did not include the allocated tip amount from Form W-2 as income on Form 1040 Include the A-tips as a separate issue when determining the u/r tip income.
    The payer is not the same payer as shown on the extension report or other source document The taxpayer included the allocated tip amount from Form W-2 as income on Form 1040 Assert the FICA penalty on the reported A-tips.
    Instructions for non-filers:

    • If the payer is the same payer as shown on the tip extension report or other source document, disregard the allocated tip amount. Use the information from the extension report or other source document to determine the unreported tip income.

    • If the payer is not the same payer as shown on the extension report or other source document, include the allocated tips as a separate issue when identifying the unreported tip income.

  3. Use the following table to determine other audit issues:

    If Then
    The information on IRPTR shows allocated tips from a different type of property than the one that generated the unreported tip income. That amount should be included in the unreported income, with the appropriate explanation(s) on Form 886-A. For example – if the unreported tips are from a casino venue and IRPTR shows allocated tips from a restaurant, include the allocated tips from the restaurant as unreported tip income on the exam report.
    Any other items on the return require examination Include them on the report with the appropriate explanation(s) on Form 886-A.

  4. RGS categorization for unreported tip income is: AGI Adjustment/Taxable Earned or Personal Service Income/Unreported Tips from Form 4137. Choose "Primary Taxpayer" or "Secondary Taxpayer" as appropriate and answer "Yes" to the "Assert FICA Penalty" question. This categorization will generate the preparation of Form 2504 and the proper transaction codes on Form 5344.

    • Form 2504 will reflect a late filing penalty if it is applicable.

    • The taxpayer is subject to the 50% FICA penalty for all FICA taxes including the unreported tips reported on Form 4137 filed with the return. Write in and identify the applicable amount on the Form 2504 generated by RGS and recompute the total penalty amount shown on the Form 2504. Change the TC 310 amount on Form 5344 to reflect the correct amount.

    • Proper categorization of the tip income will generate Reference Codes 891, 892, 898 and 899 as necessary for the Primary or Secondary taxpayers on Form 5344 and on the Examination Closing Input Document (ECID). Do not delete the Reference Codes as they are required entries for the partial assessment and may need to be adjusted.

  5. Use the following standard explanations for the tip income issues in your initial contact with the taxpayer and in subsequent contacts as necessary.

    Explanation Description
    1101 Tips are includible in income
    8107 IRC 6652(b) penalty – 50% of the FICA taxes on the unreported tip income
    8201 IRC 3101 – employee’s share of the FICA taxes on the unreported tip income.
    Custom Explanation Explanation of tip income examination, examination reports and options available to the taxpayer. This is not currently an RGS paragraph. It is attached to the RGS file through MS Word.

  6. Prepare the Form 886-A1, Employee TIP Examination Worksheet. Enter the name(s) of the employer, taxpayer’s position, location worked, shift, hours, tip rate, amount of tips reported to the employer and reported on Form 4137. The remaining calculations will be completed by the formulas built into the spreadsheet. The amount on the "Unreported Tips" line should be the same amount shown on Form 4549/ Form 4549-EZ and Line 2 of Form 885-T as unreported tip income.

    • Taxpayers contacted in this program have been advised of their reporting requirements by their employers and were given the opportunity to participate in the tip agreement. Choosing not to participate in the general agreement and continuing to under-report tip income constitutes intentional disregard of rules and regulations, as defined by IRC 6662(b) (1).

  7. Assert the Accuracy Related Penalty for Negligence, IRC 6662(b) (1), on the amount of unreported tip income based on facts and circumstances surrounding the case. Assert IRC 6662(d) if requirements for the Substantial Underpayment Penalty are met.

  8. Letter 525 is the initial contact letter for these cases. Prepare the mail-out package using normal procedures and include Form 886-A (Unreported Tip Income) and the custom explanation.

    • RGS auto-populates the deficiency, penalty and interest from Form 4549/ Form 4549-EZ as the balance due on Letter 525 . Correct this amount to include the Form 4549/ Form 4549-EZ amount plus the taxes and penalty shown on Form 2504.

  9. Follow normal Letter 525 procedures for mail-out and suspense.

  10. Prepare a Form 886-A1 for each employee. This form can hold up to 6 venues. Leave a copy of each Form 886-A1 that has been completed loose in the case file to be used as a tracking sheet. If multiple tracking sheets are prepared please staple them together so that they can be forwarded as one package.

    • On joint returns, enter the SSN of the taxpayer who received the tip income on the Form 886-A1.

    • If the unreported tip income per the information provided by the Area Office was included on Form 4137 filed with the return, you must still complete a tracking sheet for the tips and FICA taxes shown on Form 4137 so the corresponding employer’s share of FICA taxes can be assessed. Attach the Form 4137 filed with the return to the tracking sheet. No other documents or reports should be attached to the tracking sheet.

    • When the case is ready to close, the tracking sheet Form 886-A1 should match the closing actions and determination on Form 5344. These tracking sheets will be sent to the originating Area Offices’ Tip Coordinator on a monthly basis and quarterly basis to Indian Tribal Gaming (ITG) Tip Compliance Coordinator from TEGE. See IRM 4.23.7-1 (Tip Compliance Program Checksheet) for the specific information that should be forwarded.

  11. Tip cases will include two partial Forms 5344, one Form 5344 for the FICA taxes, penalty, and reference codes, and one for the income tax and related penalties and reference codes. Both forms are to be input at the time of closure, so Posting Delay Codes are needed to prevent unpostable transactions and for audit trail purposes.

    Disposal Code and Closure Posting Delay Codes
    DC 04 (agreed) before 90-day All transactions can be entered on one Form 5344. No PDC needed.
    DC 04 but IRC 6404(g) applies Same as above but input PDC 1.
    DC 09 (agreed) after 90-day FICA taxes and related actions will have to be processed on the partial Form 5344 and Income tax on the closing Form 5344. Both will be processed at the same time. Input PDC 1 on the final.
    DC 09 (agreed) after 90-day and IRC 6404(g)applies The partial will use a PDC 1 but the Closure will use PDC 2.
    DC 10 (Default) and DC 13 (Undeliverable) Follow instructions for DC 09 above.

  12. If the Assessment Statute Expiration Date (ASED) is imminent and there is a concern that the assessment might be barred, follow the instructions below:
    The FICA taxes and the related penalties cannot be included on the Statutory Notice of Deficiency. These assessments will be made prior to the issuance of the 90 Day Letter. In order to ensure that the assessments are input timely and properly, prepare Form 5344 whenever you prepare a report and make the following notations (see table below) on the Examination Closing Input Document (ECID) or Form 3198. Attach the ECID to the inside of the case folder. Attach Form 3198 to the outside of the case folder.
    Send the Form 886-A2 (For Information Only) with the 90-day package. This will inform the taxpayer that the income tax and the FICA taxes are both due.

    If Then And Enter These Amounts
    You are issuing the report with Letter 525 Annotate the ECID or Form 3198

    • Assess FICA taxes$ XX.XX (TC 300)

    • Assess FICA Penalty $XX.XX (TC 310)

    • Assess Delinquency Penalty $XX.XX (TC 160) (if applicable)

    • Enter TC 470/CC 90

    • Enter Hold Code 4

    		 On

    • Form 2504 — Total Amount of Tax

    • Form 2504 — § 6652(b) Penalty

    • Form 2504 — § 6651 Penalty
    Change the TC 300 shown on Form 5344 TC 300 entered by RGS less the total amount of tax on Form 2504. (Deficiency shown on Form 4549)
    If applicable, change the TC 160 shown on the Form 5344 TC 160 entered by RGS less the delinquency penalty shown on Form 2504

4.19.15.29.3.2  (12-12-2008)
Non-Filers

  1. Follow the procedures beginning at IRM 4.19.17.3.

  2. The AIMS database should be created with the following information:

    Item Value
    Status 06
    Source Code 24
    Project Code The Gaming Industry cases generating from non-Indian Tribal Casinos will have Project Code 0360. Indian Tribal Gaming cases will have Project Code 0916. Food and Industry Non-Gaming cases will have Project Code 0364.
    Org Code 5XXX
    Push Code 036

  3. After you have verified that the "dummy" TC 150 and TC 420 have posted to Master File, prepare Form 4549/ Form 4549-EZ based on all available IRP information and the tip income information in the case file.

  4. RGS categorization for unreported tip income is: AGI Adjustment/Taxable Earned or Personal Service Income/Unreported Tips from Form 4137. Choose "Primary Taxpayer. " The Filing Status on these cases will be either "Single " or "MFS" . Answer "Yes" to the "Assert FICA Penalty" question. This categorization will generate the preparation of Form 2504 and the proper Transaction Codes on Form 5344.

  5. Follow the instructions under Filed Returns for standard explanations, asserting penalties and the preparation of Examination Closing Input Document (ECID) or Form 3198, Form 886-A (Unreported Tip Income) and the tracking sheet.

  6. Use Letter 1862 (SC) (Rev.12-2002) as the initial contact letter and follow normal procedures for preparation, mail-out and suspense.

4.19.15.29.4  (12-12-2008)
Case Processing – Revised Reports and Responses to 90-day Letters

  1. If the taxpayer replies to the Letter 525 or Letter 1862 and a revised report is prepared, issue Letter 692 with the reports listed at IRM 4.19.15.30.3. Prepare a new ECID as shown at IRM 4.19.15.30.1 and below. Follow normal procedures for mail out and suspense of the letter.

    If Then And Enter These Amounts
    You are issuing the report with Letter 692 Annotate the ECID or Form 3198:

    • Assess FICA taxes $ XX.XX(TC 300)

    • Assess FICA Penalty $XX.XX (TC 310)

    • Assess Delinquency Penalty $XX.XX (TC 160) (if applicable)

    • Enter Hold Code 4

    		 On

    • Form 2504 – Total Amount of Tax

    • Form 2504 – IRC 6652(b) Penalty

    • Form 2504 - IRC 6651 Penalty
    Change the TC 300 shown on Form 5344 TC 300 entered by RGS less the total amount of tax on Form 2504. (Deficiency shown on Form 4549)
    Annotate the ECID or Form 3198 TC 160 entered by RGS less the Delinquency Penalty shown on Form 2504
    If the case falls under the provision of IRC 6404, input TC 971 AC 064 with dollar amount  

  2. Check the ASED to see if the assessments for FICA tax and related penalties should be made before the 90 Day Letter is issued. If you are evaluating a response to a 90 Day Letter and have reduced the amount of under-reported tip income, prepare the ECID or Form 3198 as shown in the table after the next paragraph to ensure that the taxpayer is not over-assessed for FICA taxes and the penalty.

  3. Send Letter 555 and follow the normal procedures for mail-out and suspense. Keep in mind the restrictions on increasing the assessment and requesting documentation after the Statutory Notice has been issued. See IRM 4.19.13.12.

    Direction Transaction/Reference Code Amount
    Abate FICA taxes TC 301 Difference between the FICA taxes already assessed and the amount shown on the corrected Form 2504
    Abate FICA Penalty TC 311 Difference between the FICA penalty already assessed and the amount shown on the corrected Form 2504.
    Abate Delinquency Penalty (if applicable) TC 161 Difference between the delinquency penalty already assessed and the amount shown on the corrected Form 2504.
    Input Reference Codes 891 and 898 (for Primary taxpayer) Difference between the Primary taxpayer’s unreported tip income shown on Form 4549/ Form 4549-EZ that accompanied the 90 Day Letter and the Primary taxpayer’s unreported tip income shown on your revised report. (Show this amount in brackets.)
    Input Reference Codes 891 and 898 (for Secondary taxpayer) Difference between the Secondary taxpayer’s unreported tip income shown on the Form 4549/ Form 4549-EZ that accompanied the 90 Day Letter and the Secondary taxpayer’s unreported tip income shown on your revised report. Show this amount in brackets.

4.19.15.29.5  (12-12-2008)
Case Processing – Closing Actions and Other Information

  1. There are special rules for assessing FICA taxes and the 50% FICA Penalty. FICA tax and the associated penalties may have to be assessed prior to issuing the 90 Day Letter. In order to ensure that assessments are input timely and properly, follow the instructions for the Examination Closing Input Document or Form 3198.

  2. Unless otherwise instructed, follow normal closing procedures. Refer to the table to determine the action to take and to IRM 4.4, AIMS Processing.

    If Then
    The taxpayer agrees to the 15/30 day letter Input all transaction codes per the ECID, Form 3198, or Form 5344 as printed by RGS. Disregard handwritten notations, except for changes to the TC 310 amount.
    The taxpayer does not respond to the 15/30 day letter Do a partial assessment if the case has a short statute. If not, input the partial assessments at the time of closing. Use AMCLSF and input the following:

    • TC 300 per the examiner’s instructions

    • TC 310 per the examiner’s instructions.

    • TC 160 per the examiner’s instructions. This will not occur on all cases.

    • Reference Codes 891, 892, 898 and 899 as shown on Form 5344.

    • If partial is input at closing use Posting Delay Code 1.

    • Hold Code 4

    • TC 470 with Closing Code 90 on IDRS using Command Codes REQ77/FRM77 if partial is input prior to 90-day.
    Prepare the 90 Day Letter for the income tax deficiency and penalties shown on Form 4549/ Form 4549-EZ.
    The taxpayer agrees to the 90 Day Letter or the 90 Day Letter defaults. Using AMCLSE input:

    • TC 300, TC 350/Ref. 680, TC 160 per the Form 4549/ Form 4549-EZ issued with the 90 Day Letter.

    • Input all other transactions and references per Form 5344, if they have not been previously input.
    A revised report and Letter 555 adjusting the tip income were issued after the 90 Day Letter and the taxpayer agrees or the case defaults. Do a partial abatement using AMCLSF and input the following:

    • TC 301 per the examiner’s instructions.

    • TC 311 per the examiner’s instructions

    • TC 161 per the examiner’s instructions. This will not occur on all cases.

    • Reference Codes 891, 892, 898 and 899 per the examiner’s instructions.
    Using AMCLSE input:

    • TC 300, TC350/Ref. 680, TC 160 per the revised Form 4549/ Form 4549-EZ issued with the Letter 555.

    • Input all other transactions and references per Form 5344, if they have not been previously input.

  3. Requests for Transfers to an Area Office and Statute Extensions

    • A case should not be transferred if there are less than 13 months remaining on the statute of limitations.

    • Refer to IRM 4.19.17 for information on the statute of limitations for non-filers and the returns they file in response to the initial contact letter or subsequent letter.

    • In cases where the time constraints do not allow for transferring the case, contact the taxpayer, explain the situation and ask the taxpayer to explain what his or her concerns are. Try to resolve the issues via correspondence. If the taxpayer insists on transferring his case and the Statutory Notice has not yet been issued and there are less than 13 months remaining on the statute of limitations, the statute of limitations must be extended.

    • If the taxpayer filed Form 4137 with the tax return, prepare two sets of Form 872 to extend the statute of limitations on both the income tax and the FICA taxes. Follow normal procedures for mail out and suspense of the request to extend the statutes. Refer to IRM 25.6, Statute of Limitations.

    • If Form 4137 was not filed with the return, prepare Form 872 for the income tax only.

  4. Other Processing Guidelines

    • If the taxpayer states that he or she disagrees with the report and you cannot clearly determine the basis of the disagreement, follow normal procedures for contacting the taxpayer to get clarification.

    • If necessary, the unreported tip income as shown on the original report can be adjusted. However, do not change the taxpayer’s hours, shift, position or venue unless the taxpayer has provided information from the employer.

    • Obtain as much information as possible from the taxpayer and document it in detail on your workpapers.

    • Access any additional information that is available from the Tip Match database and other employer driven resources.

    • If the taxpayer disagrees with an adjustment that is not related to the tip income use normal procedures to evaluate the information the taxpayer provides. Tip diaries must meet specific requirements in order to be accepted.

    • If the taxpayer states he or she agrees with the adjustment to the tip income, but provides information about employee business expenses the taxpayer may be entitled to, evaluate that information and make the necessary determination based on the information provided.

    • If the taxpayer responds to the Letter 1862 with a tax return, review the return for accuracy and process the return as instructed in IRM 4.19.17.3 .

    • If the taxpayer’s response results in a revision to Form 4549 / Form 4549-EZ and Form 2504 make sure you make the corresponding changes to the tracking sheet.

    • If the taxpayer wishes to have a representative conduct the examination on his or her behalf, Form 2848 must give the representative authority to handle the income tax and the FICA tax issues.

4.19.15.30  (12-12-2008)
10% Premature Distributions Tax

  1. The 10% premature distributions additional tax/penalty is an income tax which is assessed on the Individual Master File and taken into account when the total corrected income tax is determined by the tax examiner. Returns included in this program should all have taxable premature distributions from qualified retirement plans, Individual Retirement Accounts (IRA), or annuity contracts.

  2. To encourage taxpayers to save for retirement, Congress enacted a premature distributions tax that requires taxpayers to pay an amount equal to 10% or 25% of the entire distribution amount taken out of the retirement plan before they were eligible to do so which is generally after the age of 591/2. The 25% additional tax applies to premature distributions from a SIMPLE IRA account that occur within 2 years from the first contribution made by the employer. Distributions subject to the 25% tax are reported on Form 1099-R with a Distribution Code S in Box 7. The tax is 10% or 25% (if applicable) of the amount of taxable distribution reported on Lines 15b or 16b of the 1040 return.

  3. There are a number of exceptions to these penalties. Tax examiners will be required to determine if the taxpayer meets one of the exceptions, or if the taxpayer simply failed to report the proper amount. See Table A and B for details regarding exceptions. Generally, the plan Procedural Instructions Administrator (individual or entity who is responsible for preparing Form 1099-R ) will not know if a taxpayer is using the distribution for a first time home purchase, qualified medical expenses or qualified higher education expenses. Therefore, they will code the Form 1099-R Box 7 as 1 (early distribution, no known exception.) These exceptions to the 10% additional tax will be the most common response from the taxpayer.

  4. The Katrina Tax Relief Act of 2005 (KETRA) enacted on September 23, 2005, and the Gulf Opportunity (GO) Zone Act of 2005, enacted on December 21, 2005, provides tax-favored withdrawals, re-contributions, and loans for taxpayers with funds in certain retirement plans. These legislative acts were enacted for taxpayers impacted by Hurricanes Katrina, Rita and Wilma. Refer to IRM 21.6.5.1 for details regarding these enactments.

4.19.15.30.1  (12-12-2008)
Procedural Instructions

  1. Tax Examiners who work these cases should take the following Basic Income Tax Training lessons: IRA, Pensions and Annuities and IRA Deductions.

  2. Tax examiners must conduct the following research before contacting the taxpayer to determine if the case should be surveyed and to ensure the audit report is correct.

    IDRS Command Codes If Then
    INOLES to determine taxpayer’s age. At time of distribution 59 1/2 survey, close on AIMS using DC 31
    55 and meets exception per TABLES A and B survey, close on AIMS using DC 31
    TXMOD to verify if taxpayer amended Form 1040 and reported 10/25% additional tax reported survey case and close on AIMS using DC 31.
    IRPTR

    1. to verify if payer filed amended Form 1099-R for the distribution(s) that is (are) subject to the 10% or 25% additional tax,

    2. to verify that all taxable pension, IRA distributions, or any other taxable income have been reported on the return. Include in income any unreported taxable income determined, and

    3. to determine if pension or IRA distributions are substantially equal to distributions received in the prior or subsequent tax years. These should be surveyed and closed DC 31 if criteria is met.

    		Form 1099-R Box 7 Code is:

    1. 2 (early distribution, exception applies and under 59 1/2)

    2. 3(Disability), or

    3. 4 (Death)

    		survey, close on AIMS using DC 31.
    Form 1099-R Box 7 Code is:

    1. G (Direct Rollover to IRA), or

    2. H (Direct Rollover to qualified plan or tax-sheltered annuity or a transfer from a conduit IRA to a qualified plan.)

    		survey, close on AIMS using DC 31.

  3. 10% IRA cases are opened on AIMS in Project Code 0123, Source Code 06.

  4. For the initial contact, Letter 525, Form 886-A and Form 4549 / Form 4549-EZ (audit report) will be prepared systemically using Batch Processing. The prepared letters, audit reports and Form 886-A are sent to a printer at the assigned campus (B2 processing within Batch). A 100% review of these cases is required to identify cases that should be surveyed prior to contacting the taxpayers and to ensure audit reports are correct, (based on the required research shown above). If it is determined the taxpayer meets one of the exceptions and is not liable for the 10% additional tax, the case should be surveyed and letter and forms not issued to the taxpayer. Also, the audit reports are being reviewed to ensure the 10% additional tax is only being applied to applicable distributions and to include any unreported income.

  5. The standard explanation included in Form 886-A is determined by whether an amount is reported on Lines 15b and/or 16b on Form 1040, or 11b and/or 12b on Form 1040A. Use the following standard explanations if an entry is on Line 16b (pensions and annuities taxable amount) but there is no entry on Line 15b (IRA distribution taxable amount) of the Form 1040. Also, an entry is on Line 12b (pensions and annuities taxable amount) and there is no entry on Line 11b (IRA distribution taxable amount) of the Form 1040A:

    Added tax of 10% due to the premature distribution made from your qualified retirement plan.
    We adjusted your tax by 10 percent of the premature distribution made from your qualified retirement plan because you received the distribution before you reached age 591/2, or you did not qualify for one of the allowable exceptions:

    • paid on account of death

    • disability

    • substantially equal payments over your (or joint) life expectancies

    • certain medical expenses

    • Qualified Domestic Relations Order (QDRO)

    • IRS levy

    • payment was made to you if you separated from service after age 55

    • to correct certain excess contributions or deferrals, or

    • you separated from service and began receiving benefits from a qualified plan as of March 1, 1986.
    Please provide us with documentation that shows you meet one of the above exceptions. Examples of acceptable documents include:

    • corrected Form 1099-R from the issuing entity

    • a statement from your plan administrator explaining why you meet the exception

    • a statement from your medical practitioner explaining your disability

    • copies of cancelled checks or receipts showing when and what qualified expenses were made, or

    • a copy of the QDRO (generally part of your divorce decree).

    Additional tax of 10% due to the premature distribution made from your annuity contract.
    We adjusted your tax by 10 percent of the premature distribution made from your annuity contract because you received a distribution before you reached age 59 1/2, or you did not qualify for one of the allowable exceptions:

    • paid on account of death

    • disability

    • substantially equal payments over your (or joint) life expectancies

    • the distribution was allocable to an investment in deferred annuity contract before August 14, 1982

    • paid under a qualified personal injury settlement

    • under an immediate annuity contract, or

    • under a deferred annuity contract purchased by your employer upon termination of a qualified plan that is held by your employer until you separate from service.

    Please provide us with documentation that shows you meet one of the above exceptions. Acceptable documents include:

    • corrected Form 1099-R from the issuing entity, or

    • statement from your annuity holder explaining why you meet the exception, or

    • statement from your medical practitioner explaining your disability

  6. Use the following standard explanations if an entry is on Form 1040 Line 15b (IRA distribution taxable amount), but there is no entry on Line 16b (pensions and annuities taxable amount), or if an entry is on Line 11b (IRA distribution taxable amount), but there is no entry on Line 12b (pensions and annuities taxable amount) for Form 1040A.

    Added tax of 10% due to the premature distribution made from your Individual Retirement Account (IRA).
    We adjusted your tax by 10 percent of the premature distribution made from your Individual Retirement Account (IRA) because you received the distribution before you reached age 59 1/2, or you did not qualify for one of the allowable exceptions:

    • paid on account of death

    • disability

    • substantially equal payments over your (or joint) life expectancies

    • certain medical expenses

    • certain higher education expenses

    • first time home purchase, or

    • IRS levy
    Please provide us with documentation that shows you meet one of the above exceptions. Examples of acceptable documents include:

    • corrected Form 1099-R from the issuing entity

    • statement from your plan administrator explaining why you meet the exception

    • statement from your medical practitioner explaining your disability, or

    • copies of cancelled checks or receipts showing when and what qualifying expenses were made.

  7. Use the following table when reviewing the taxpayer’s reply.

    If Then
    There is an entry on Line 15b (IRA distribution taxable amount) and/or 16b (pensions and annuities taxable amount) on Form 1040 [Line 11b (IRA distribution taxable amount) and/or 12b (pensions and annuities taxable amount) on Form 1040A.]

    1. Use all of the standard explanations (per above) on Form 886-A.

    2. Suspend case (for 45 days) and wait for taxpayer reply.
    The taxpayer signs the report or pays the full amount Close case using normal procedures.
    The taxpayer submits verification in response to the Letter 525 and you need additional information

    1. If the taxpayer provides a phone number, attempt to call the taxpayer and notate the phone call in your case file.

    2. If the attempt to contact the taxpayer is unsuccessful, follow procedures in IRM 4.19.13.9.1. (Taxpayer Response – Additional Information Needed).

    The taxpayer submits verification in response to the 90 Day Letter and information does not change the audit report Send Letter 555, Form 886-A, and copy of report. (See IRM 4.19.13.9.1, Taxpayer Response – Additional Information Needed)
    The taxpayer submits sufficient documentation (refer to tables A and B below) to verify the exception Close no change using normal procedures.

  8. Table A provides the category of plan and in what tax year the exception is available. Verify that the correct plan applies to the correct exception. For example, a distribution from a 401(k) Plan is not available for the first time home buyer exception. The distributions made after separation from service after age 55 exception is not available for an IRA distribution.

    TABLE A
    Exceptions to premature distribution tax IRA Pension Plan Annuity Tax Year
    Payments made on or after the date you reach age 59 1/2. x x x ALL
    Payment made to beneficiary upon death. x x x ALL
    Payment made based on total and permanent disability. x x x ALL
    Distribution made as a part of a series of substantially equal payments. x x x ALL
    Distribution used for certain higher education expenses. x     Starting 1998
    Distributions used for first time home purchase (Up to $10,000). x     Starting 1998
    Distributions made after separation from service after age 55.   x x Starting 1998
    Distributions made to the extent of deductible medical expenses that can be claimed on Line 4 of Schedule A ( Form 1040. (Does not apply to annuity contracts or modified endowment contracts.) x After 1996 x   ALL
    Distributions made to unemployed (at least 12 weeks) individuals for health insurance premiums. x     After 1996
    Paid to alternate payees under qualified domestic relations order QDRO.   x   ALL
    Made to you if, as of March 1, 1986, you separated from service and began receiving benefits from a qualified plan.   x x ALL
    Payments made to correct excess deferrals, Excess contributions, or excess aggregate contributions.   x   ALL
    Allocable to investment in a deferred annuity contract before August 14, 1982.     x ALL
    Payments from an annuity contract under a qualified personal injury settlement.     x ALL
    Payments made under a deferred annuity contract purchased by your employer upon the termination of a qualified retirement plan or qualified annuity and that is held by your employer until you separate from service.     x ALL
    Payments made under an immediate annuity contract.     x ALL
    The distribution is due to an IRS levy of a qualified plan. x x x Starting in 2000
    Qualified hurricane distributions (up to $100,000). x x x Starting in 2005 and before January 1, 2007
    Distribution to qualified reservists. x x x After September 11, 2001 and before December 31, 2007

  9. The following bullets apply to Table A

    • A 5% rate may apply to certain annuity distributions – see IRM 4.19.3.14.3 entitled 10% Tax On Early Distributions From Qualified Retirement Plans/25% Tax on Early Distributions From SIMPLE IRA’s for more information.

    • Individual Retirement Accounts (IRA) include: Traditional, Roth, and SIMPLE IRAs.

    • Pension Plans include: Employee Stock Option Plan (ESOP), 401(k) Plan, Federal Thrift Savings Plan, Tax sheltered annuity plan for employees of public schools or tax-exempt organizations, state or local governmental plans, or any tax favored deferred compensation plan that is not an IRA or annuity.

    Table B
    If taxpayer claims one of the following exceptions: Then acceptable verification is:

    Note:

    Always accept a corrected Form 1099-R. Do not accept Form 5329 submitted after filing as verification.

    Payments made on or after the date you reach age 59 1/2 . Taxpayer’s age verified using IDRS CC INOLES.
    Payment made to beneficiary upon death (of IRA holder or pension plan participant). Does not apply to modified endowment contracts. Death certificate, plan beneficiary form or statement from plan administrator.
    Payment made based on total and permanent disability . Taxpayer provides a Schedule R or letter from medical practitioner containing a statement of taxpayer’s permanent and total disability.
    Distribution made as a part of a series of substantially equal payments.

    • Review prior or subsequent year IRP documents, tax returns or RTVUE for amounts distributed and/or reported.

    • Confirm math is correct by method described in Publication 590 or Publication 575.

    • Rev. Rul. 2002-62 will affect some 2002 and beyond distributions.
    Distribution used for certain higher education expenses (tuition, fees, books, supplies and equipment required by the school for enrollment or attendance of a student). Eligible expenses should be reduced by scholarships and any other tax-free awards.

    Reminder:

    The distribution and payments must be within the same tax year.

    		Copies of cancelled checks/money orders used to pay or statement from school showing dates and payment amounts of higher education expenses.

    Reminder:

    Do not accept direct payments from taxpayer to student.
    Distributions used for a first time home purchase, up to $ 10,000 (this is a lifetime limit). The distribution must be used for this purpose within 120 days after the distribution. Must be principal residence

    • Acceptable costs include expenses to acquire, construct or reconstruct a residence, reasonable settlement, financing, or other closing costs.

    • First time defined as no home ownership in the past two years before closing.

    • Rollover period (see below) is extended for 120 days if the taxpayer does not close due to delay or cancellation of the purchase or construction of the residence.

    		To verify if first time purchase, use IDRS and research prior years mortgage interest or real estate tax payments for first time purchase.

    • Copies of cancelled checks or money orders, contracts, or closing (settlement) statements showing how the money was used.

    • Letter from financial institution or seller explaining reason for delay or cancellation of closing.
    Distributions made after separation from service after age 55.

    • Use IDRS CC INOLES to verify taxpayer’s age

    • Check taxpayer’s current and prior years Form W-2s to verify separation from service.
    Distributions made to the extent of deductible medical expenses that can be claimed on Line 4 of Form 1040Schedule A. (Does not apply to annuity contracts or modified endowment contracts.) See Schedule A verification procedures.
    Distributions made to unemployed (at least 12 weeks) individuals for health insurance premiums. Verify unemployed from Form 1099-G or statement from employee, e.g. copies of cancelled checks, money order for insurance payments or statement of account from insurance agent/company
    Paid to alternate payees under qualified domestic relations order. QDRO. Divorce decree or statement from plan administrator.
    Made to you if, as of March 1, 1986, you separated from service and began receiving benefits from a qualified plan. Statement from plan administrator.
    Payments made to correct excess deferrals, excess contributions, or excess aggregate contributions. Statement from plan administrator.
    Allocable to investment in a deferred annuity contract before August 14, 1982. See Publication 575 for more information and accept statement from plan administrator.
    Payments from an annuity contract under a qualified personal injury settlement. See Publication 575 for more information and accept statement from plan administrator.
    Payments made under an immediate annuity contract. See Publication 575 for more information and accept statement from plan administrator.
    Payments made under a deferred annuity contract, purchased by your employer upon the termination of a qualified retirement plan, or qualified annuity that is held by your employer until you separate from service. See Publication 575 for more information and accept statement from plan administrator.
    The distribution is due to an IRS levy of a qualified plan. Copy of IRS Levy showing account levied.
    Rollover – This is a tax-free distribution of assets from one eligible retirement plan that is reinvested in another eligible retirement plan or the same plan. The rollover must be completed within 60 days from the date of receipt of the distribution. The amount rolled over is not subject to the 10% additional tax. (Or income tax.) See Publication 590 for the frozen deposit exception to this rule. Statement from administrator of new plan.
    Transfer –If the taxpayer instructs the plan trustee to transfer funds directly to another plan, the transferred amount is not taxable or subject to the premature distributions tax. Statement from plan administrator.

  10. The following bullets apply to Table B

    • The tax on premature distributions does not apply to any part of the distribution that is tax free, such as amounts that represent a return of the taxpayer’s cost or amounts rolled over/transferred (see above) to another retirement plan.

    • To avoid the 25% additional tax on an early distribution from a SIMPLE IRA Plan, the distribution must be rolled over/transferred into another SIMPLE IRA Plan.

    • Certain Roth IRA distributions are not subject to the 10% additional tax, see 2001 Instructions for Form 5329, Page 2 and Publication 590 for more information. Rev. Rul. 2002-62 allows certain taxpayers who began receiving fixed payments from their IRA or retirement plan based on the value of their account at the time they started receiving payments to switch – without penalty – to a method of determining the amount of their periodic payments based on the value of their account as it changes from year to year. If the taxpayer elects to do this, it may result in a lower periodic payment. See Rev. Rul. 2002-62 for more details.

    • Rev. Proc. 2003-6 provides guidance for applying to the IRS for a waiver of the 60-day rollover requirement. It also provides for an automatic waiver under certain circumstances. The Procedure is effective for distributions after 12/31/01. See Rev. Proc. 2003-16 for more information.

  11. For more information consult Publication 590 Individual Retirement Arrangements (IRA)s, Publication 575 Pension and Annuity Income, Instructions for Form 5329 and Instructions for Form 1099-R.

4.19.15.31  (12-12-2008)
Gambling Issues (Income and Losses) — General

  1. Taxpayers may deduct gambling losses as itemized deductions on Line 28 of Schedule A. The amount of gambling losses may not exceed the amount of the gambling income reported on Form 1040. Gambling losses cannot be netted against gambling winnings before the computation of the Adjusted Gross Income on the front of the Form 1040. Each item, winning or loss, must be reported on the appropriate line or form.

  2. The Initial Contact Letter 566 (CG) will be used to inquire about the income and/or deductions. The Corporate Exam Toll Free telephone number will be used on these letters. Normal suspense periods will be applied to all letters issued.

  3. The following table shows examples of documentation taxpayers may provide to support their deduction for gambling losses. This is not an all-inclusive table. For returns with unreported IRPTR gambling income, the taxpayer may provide information that supports the deduction on the return and allows an additional deduction to offset the unreported winnings. Use good judgment when evaluating any information the taxpayer provides, including the possible inclusion of additional income.

    Gambling Documentation – Examples
    Documentation or wagering activity Information provided
    Diary of winnings and losses Date and type of wager or wagering activity
    Name and address or location of the gambling establishment.
    Names of other persons present at the gambling establishment.
    Amount(s) won or lost.
    Canceled checks, credit records, bank withdrawals; copies of casino credit records, copies of casino check cashing records Location of the gambling establishment; date of the wager.
    Keno Date the keno tickets were validated by the gambling establishment.
    Slot machines A record of the machine number and all winnings by date and time the machine was played.
    Table games (twenty-one, blackjack, craps, poker, baccarat, roulette, wheel of fortune, etc.)

    • The number of the table at which the taxpayer was playing.

    • Casino credit data indicating whether the credit was issued in the pit or at the cashier’s cage.
    Bingo

    • A record of the number of games played, cost of tickets purchased, and amounts collected on winning tickets.

    • Supplemental records include any receipts from the casino, parlor, etc.
    Racing (horse, harness, dog, etc.)

    • A record of the races, amounts of wagers, amounts collected on winning tickets and amounts lost on losing tickets.

    • Supplemental records include unredeemed tickets and payment records from the racetrack.
    Lotteries

    • A record of ticket purchases, dates, winnings and losses.

    • Supplemental records include unredeemed tickets, payment slips, and winnings statements.

  4. Taxpayers with whom telephone contact is made should be encouraged to respond in writing with all documentation related to their gambling activities.

4.19.15.31.1  (12-12-2008)
Initial Contact for Gambling Income

  1. Issue Letter 566 (CG) as the initial contact letter to the taxpayer. Check "Schedule A Itemized Deductions" . Identify the issue by typing " Gambling Losses" . Identify income as an issue if there is unreported income.

4.19.15.31.2  (12-12-2008)
Evaluating Gambling Issue Responses

  1. Use the following guidelines when evaluating response to gambling issues.

4.19.15.31.2.1  (12-12-2008)
Gambling Losses

  1. Carefully examine all documentation for losses to ensure they are for the year related to the win. Notate the workpapers with the amount of losses and winnings from the documentation.

  2. Receipts provided to support losses may also include gambling Income not included on the return. Carefully review all documentation for income as well as losses. Subsequent reports (except for cases where the statutory notice has been issued) must include the income as well as the losses.

  3. Examine unredeemed (losing) tickets carefully to ensure that they are for the correct year and that they had not been previously discarded prior to being acquired by the taxpayer.

  4. Use sound judgment when considering taxpayer replies. All aspects of the case, including credibility of the taxpayer, additional burden, and tax must be considered when pursuing for more documentation.

4.19.15.31.2.2  (12-12-2008)
Gambling Income

  1. Form 5754 is completed by the taxpayer and given to the payer of the gambling winnings to ensure that the Form W-2G issued is correctly prepared when the taxpayer receives gambling winnings on behalf of another person or as a member of a group of winners on the same winning ticket.

    1. A signature is required on Form 5754 only if federal income tax was withheld from the winnings.

    2. Form 5754 should not be accepted as proof the income was distributed to other taxpayers. If the amount of disputed winnings exceeds $500, research the accounts of other taxpayers using Command Code IRPTR to determine if a Form W-2G was issued to that payee. If a Form W-2G was issued, then consider this an acceptable explanation.

    3. If Form W-2Gs were not issued, correspond with the taxpayer and explain that the income is to be reported by the person to whom the Form W-2G is issued. Advise the taxpayer that a statement from the payer is required in order to accept the Form 5754.

  2. Follow normal procedures for evaluating the information the taxpayer provides regarding the unreported gambling income. Make all necessary adjustments to gambling losses and income and issue a report, and the appropriate explanations and cover letter. Refer to the table below for letter sequencing.

4.19.15.31.2.3  (12-12-2008)
Replies – General Processing

  1. Use the following table when processing replies.

    Processing Taxpayer Replies to Letter 566 (CG) and Subsequent Letters
    If And Then
    The taxpayer replies to Letter 566 (CG) , Letter 525, Letter 692 or the 90 Day Letter with information to support gambling losses You are able to determine that he is entitled to the entire deduction Close the case "no change."
    The taxpayer replies to Letter 566 (CG) or Letter 525 with information to support gambling losses You are able to verify that the taxpayer is entitled to part of the amount claimed Issue Letter 525 or Letter 692 with Form 4549, allowing the partial amount verified and an appropriate explanation.
    The taxpayer replies to Letter 566 (CG) or Letter 525 with information to support gambling losses You are able to determine that the taxpayer is not entitled to any part of the deduction Issue Letter 525 or Letter 692 with Form 4549 and an appropriate explanation.
    The taxpayer replies to Letter 566 (CG), Letter 525 or Letter 692 with information to support gambling losses You are able to determine that the Line 28 amount belongs on another line Issue Letter 525 with Form 4549 and an appropriate explanation.
    The taxpayer replies to the 90 Day Letter with information to support gambling losses You are able to verify that the taxpayer is entitled to part of the amount claimed Issue Letter 555 with a revised Form 4549 and an appropriate explanation to the taxpayer.
    The taxpayer replies to the 90 Day Letter with verification of his deduction You are able to determine that the taxpayer is not entitled to any part of the deduction Issue Letter 555 with the latest Form 4549.
    The taxpayer replies to the 90 Day Letter with verification of his deduction You are able to determine that the Line 28, Schedule A, amount belongs on another line Issue Letter 555 with a revised Form 4549 and an appropriate explanation to the taxpayer. Do not increase the deficiency as shown on the 90 Day Letter.

4.19.15.31.2.4  (12-12-2008)
No Response Cases

  1. Take the following action if the taxpayer has not replied to the most recent letter by the normal purge date:

    Latest Letter Issued Action
    Letter 566 (CG) Prepare Letter 525 and Form 4549 disallowing the gambling losses and adding the unreported gambling winnings. Use Standard Explanations #1407 and/or #9412.
    Letter 525 or Letter 692 , and the Form 4549 reflects a deficiency Follow normal procedures to have Statutory Notice issued based on the adjustments shown on Form 4549.
    Letter 525 or Letter 692 , and the Form 4549 reflects an overpayment Close the case DC 08.
    90 Day Letter Close the case DC 10.

4.19.15.31.3  (12-12-2008)
Special Gambling Closing Procedures

  1. When closing cases consideration must be given to the disposition of receipts to the taxpayers. Receipts will not be returned to the taxpayer as a matter of practice. All verification of losses must be retained with the case file. If the verification is not substantial, for example a statement from a casino, it can be retained in the closed case file. If the documentation would be difficult to file, retain the records in a retrievable method for a period of nine months.

  2. Provided the IRS and the Taxpayer agree as to the amount of the losses verified on the documentation, there is no reason to retain the receipts. If the taxpayer requests the receipts be returned, contact the taxpayer by telephone to confirm his request. Explain that there is no longer a tax requirement to retain the receipts. If the taxpayer insists, the tickets must be stamped before they are returned.

  3. If the taxpayer does not address the disposition of unredeemed tickets, retain them for a period of nine months after the case closes.

4.19.15.32  (12-12-2008)
Health Coverage Tax Credit

  1. Health Coverage Tax Credit (HCTC) is a fully refundable prepayment credit available to two distinct groups of taxpayers:

    1. Workers who have been displaced by foreign trade and who are eligible to receive Trade Adjustment Assistance (TAA) or Alternative Trade Adjustment Assistance (ATAA) benefits, and

    2. Pension recipients covered by the Pension Benefit Guaranty Corporation (PBGC).

    3. The term eligible individual in this text refers to a person meeting a) or b) above.

  2. HCTC is computed on Form 8885 and

    1. Is equal to 65% of the premiums paid by an eligible individual for qualifying health insurance covering that person and any qualifying family member.

    2. Eligibility is determined on a month-by-month basis. An eligible coverage month is any month that a person is deemed to be an eligible individual by either a state workforce agency or the PBGC.

    3. December 2002 was the first month that HCTC became available.

  3. Advance HCTC became available in 2003.

    1. The HCTC Processing Center forwards payment of 100% of the cost of health insurance coverage for a person enrolled in the advance payment option directly to the insurer or health care provider.

    2. Department of Treasury pays 65% of the premiums (TC 971 AC 171).

    3. The eligible individual reimburses the HCTC Processing Center 35% (TC 971 AC 170).

    4. Advance HCTC payments are reported on Form 1099-H.

  4. For more information concerning this credit, refer to Publication 502, Medical and Dental Expenses, and the following web site:
    http://win.web.irs.gov/hctc.htm

4.19.15.32.1  (12-12-2008)
HCTC Procedures – Project Code 0505

  1. Procedures for the program are dependent on whether other issues are classified and whether the credit has been posted to the taxpayer’s account.

  2. Returns are classified for HCTC and related issues such as Medical and Dental Expenses on Schedule A, Self-employed Health Insurance Deduction (SEHID), and Archer Medical Savings Account (MSA) Deduction. Refer to:

    1. Publication 502, Medical and Dental Expenses

    2. Publication 535, Business Expenses

    3. Publication 969, Medical Savings Accounts (MSAs)

    4. See IRM 4.19.15.23 for information about related medical issues.

  3. Consult your manager concerning any large, unusual or questionable items not previously classified on the return.

  4. Unallowable 89. See IRM 3.12.3.3.9 and IRM 3.12.3.75.2.6. Unallowable 89 will be coded if HCTC claimed was equal to or greater than $10,000 and was not disallowed during return processing for any of the following:

    1. A tax year prior to 2002.

    2. Taxpayers age 66 or older.

    3. Form 8885 not attached.

    4. The taxpayer did not check any boxes on Form 8885.

    Note:

    See IRM 4.19.15.18 for Unallowable procedures.

  5. Returns are categorized as a "Processed Claim" if HCTC is posted to the account. TXMOD of a Processed Claim should include Transaction Code TC 766 in an amount equal to the HCTC claimed on Form 8885.

    1. Beginning with processing year 2004, TC 766 should include credit reference number (CRN) 250.

    2. Consult the work leader if HCTC was adjusted in some other manner (example: TC 291, TC 806, TC 766 with CRN 336).

  6. Returns are worked as an "Unprocessed Claim" if the credit is not posted to the account.

    Exception:

    If HCTC is posted to the account and the erroneous amount is frozen or was offset to another tax year and/or to Debtor Master File (DMF), then follow the instructions for Unprocessed Claim until case closure. When closing the case, follow the procedures for Processed Claim, however send a certified claim disallowance letter unless "no changing" the return or the taxpayer signs the waiver.

  7. The HCTC Program Office provides a database of eligible individuals with Processed claims selected for examination. The database is located on the Austin Examination web site. Access the HCTC Eligibility Database to determine:

    1. The eligible coverage months, and

    2. Whether potential eligibility was based on TAA/ATAA or PBGC benefits.

    3. See your work leader if the eligible individual is not in the database.

4.19.15.32.2  (12-12-2008)
HCTC Taxpayer Initial Contact

  1. Consider any health insurance records filed with the return, HCTC Eligibility Database information, and IDRS account prior to contacting the taxpayer.

    1. Use Form 886-H HCTC to request information the taxpayer could provide to verify his entitlement to HCTC.

  2. If HCTC is the only issue, the total credit is clearly unallowable and there is no information the taxpayer could provide to verify his entitlement for one of the reasons listed below, send the appropriate disallowance letter with Form 886-H HCTC/D. Use custom explanations as appropriate to provide the taxpayer with as much information as possible about the reason for the disallowance or adjustment and the options available.

    1. Participation in a non-qualifying plan.

    2. Enrollment in Medicare Part B, Medicaid, State Children's Health Insurance Program, Federal Employees Health Benefits Program, or TRICARE.

    3. Entitlement to Medicare Part A.

    4. Enrollment in or eligible for enrollment in an employer-sponsored health insurance plan for ATAA eligible individuals.

  3. Unprocessed Claim — Source Code 30

    1. Send Letter 566D (HCTC).

    2. Include Form 886-H HCTC and any other Forms 886 applicable for classified issues.

    3. Update to Status 10 and suspend the case for 45 days.

    4. Follow general claim procedures in IRM 4.19.16 through case closure.

  4. Processed Claim — Source Code 06

    1. Send Letter 566D (HCTC).

    2. Include the appropriate Form 886-H HCTC and any other Form 886 applicable for classified issues.

    3. Update to Status 10 and suspend the case for 45 days.

    4. Follow instructions for disallowing all examined issues under HCTC Responses, Processed Claim if the taxpayer does not respond.

4.19.15.32.3  (12-12-2008)
HCTC Responses

  1. Follow procedures in the table below to process replies.

    If Then
    The eligible individual did not have qualifying coverage as of the first day of the eligible coverage month Do not allow premiums paid for anyone’s coverage for that month in HCTC computation.
    The eligible individual had other specified coverage as of the first day of an eligible coverage month Do not allow premiums paid for anyone’s coverage for that month in HCTC computation
    An otherwise qualified family member had other specified coverage as of the first day of an eligible coverage month Do not allow premiums paid to cover the family member for that month in the computation of HCTC.
    A family member did not have qualifying coverage as of the first day of an eligible coverage month Do not allow premiums paid to cover the family member for that month in the HCTC computation.
    The taxpayer is a non-custodial parent Do not allow premiums covering the child of divorced or separated parents in the computation of HCTC.
    Health insurance premiums were paid to cover a family member who was not claimed as a dependent Do not allow premiums paid for the non-qualifying member in the computation of HCTC unless the taxpayer is the custodial parent who has waived the right to claim the exemption over to the non-custodial parent on Form 8332 or a similar statement.
    Premiums covering ineligible months were used to compute the HCTC claimed Do not allow payments for ineligible coverage months in HCTC computation.
    Advance HCTC payments were not included on Form 8885 Re-compute allowable HCTC.
    A Health Savings Account (HSA) or an Archer MSA distribution ( Form 1099-MSA) was not included on Form 8885 Subtract the distribution from allowable premiums and re-compute the HCTC.
    The eligible individual was a PBGC recipient under age 55 as of the first day of an eligible coverage month Do not allow premiums paid for coverage for that month in the HCTC computation.
    The taxpayer requests a meeting with an Appeals officer Consult the manager. Appeal rights are generally not applicable to HCTC.
    Documentation is incomplete Disallow HCTC and any other unsubstantiated issues under examination.
    Verified payments for health insurance premiums are unallowable for HCTC but qualify as a Schedule A, Self-employed Health Insurance, HSA, or Archer MSA deduction Advise the taxpayer to file an amended return to claim the disallowed premiums as a deduction from income unless a double tax benefit was previously claimed.
    HCTC and other classified issues are fully substantiated Allow all issues and close the case.

    Note:

    Math verify Form 8885.

    If the taxpayer does not have a qualified plan but would meet the other requirements for HCTC Inform the taxpayer they may wish to investigate a State Qualified Plan. The IRS maintains a listing by state at irs.gov, (keyword/search term: HCTC).

  2. Processed Claim — HCTC only disallowed

    1. Send Letter 510 (HCTC) and Form 9465.

    2. Include the appropriate Form 886 explaining the reason for the adjustment. See IRM 4.19.15.32.2.

    3. Include an explanation that we are not adjusting other examined issues if other issues were checked on Letter 566 (HCTC).

    4. Include an interest computation schedule.

    5. Update to Status 22 and suspend the case for 45 days.

    6. Follow instructions for disallowing HCTC under Case Closure, Processed Claim if no response is received.

    7. If the taxpayer responds to the Letter 510 with incomplete documentation, and it can be determined the taxpayer may qualify if additional information is submitted, send Letter 692-H. Update status to 25, or Status 23 if changes were made to our original proposal. Suspend the case for 15 days.

      Note:

      HCTC is not subject to deficiency procedures.

  3. Processed Claim — Allowing HCTC but disallowing other classified issues

    1. Send Letter 525 with an examination report.

    2. Include an explanation that we are not adjusting HCTC.

    3. Follow normal deficiency procedures in IRM 4.19.13 through case closure.

  4. Processed Claim — Disallowing both HCTC and other classified issues

    1. Send Letter 525 with an examination report.

    2. Include Form 886-A explaining the HCTC adjustment and soliciting payment.

    3. Follow normal deficiency procedures in IRM 4.19.13 through case closure.

4.19.15.32.4  (12-12-2008)
Case Closure

  1. A completed data-gathering instrument (DGI) is required prior to case closure or transfer. Follow procedures in the table below for case closure.

  2. Unprocessed Claim — Allowing HCTC.

    1. Use Credit Reference Number (CRN) 250 with the allowable amount in Block 15 of Form 5344.

  3. Unprocessed Claim — Disallowing HCTC in whole or in part.

    1. Provide a detailed explanation on Letter 105-C or Letter 106-C.

  4. Follow steps in chart below for appropriate conditions with Processed Claim:

    If And Then
    Allowing HCTC Form 5344 does not include changes to tax, income, or other credits

    1. Use DC 02 in Block 13 of Form 5344.

    2. Input "no change" Issue Code 61065 in Block 41.

    Disallowing HCTC TC 766 does not include a CRN

    1. Input CRN 767 with the unallowable amount and a minus sign (-) in Block 15 of Form 5344

    2. Use Disposal Code (DC) 08 in Block 13 unless assessing a deficiency.
    TC 766 includes CRN 250

    1. Input CRN 250 with the unallowable amount and a minus sign (-) in Block 15 of Form 5344

    2. Use DC 08 in Block 13 unless assessing a deficiency.
    HCTC is posted to the account in any other manner (see above)

    1. Consult the work leader for the appropriate reversal code.

    2. Use Hold Code 3 in Block 7 of Form 5344 to prevent a notice.

    3. Use DC 08 in Block 13 unless assessing a deficiency.
    Some portion of the unallowable HCTC was offset to the Debtor Master File (TC 898) or another tax year (TC 826)

    1. Complete Form 3465 instructing Special Handling to reverse the credit transfer.

    2. Use Hold Code 4 in Block 7 of Form 5344 to hold the notice.

    3. Issue Letter 105-C or Letter 106-C.
    The taxpayer has fully repaid an erroneous refund (TY 2003 and subsequent)

    1. Input TC 270 for $0.00 in Block 12 of Form 5344.

    2. Input history items on TXMOD indicating the erroneous refund amount.
    Full payment of erroneous refund has not been received (TY 2003 and subsequent)

    1. Follow Category D erroneous refund procedures (taxpayer error):

    2. Use Hold Code 3 in Block 7 of Form 5344 unless Hold Code 4 is required for a payment transfer.

    3. Input TC 844 with the refund date using Command Code (CC) REQ77.

    4. Input TC 470 with Closing Code 93 and Posting Delay Code 1 using CC REQ77.

    5. Complete Form 12356 and attach a copy of the case file.

    6. Input history items on TXMOD indicating the erroneous refund amount after CC AMCLSE.

    7. Attach a TXMOD print to the Form 12356 package and refer it to Accounting via Form 3210.

    8. Open a Status M control on TXMOD showing the referral.

    9. Close the TXMOD control on receipt of Form 3210 acknowledgement from Accounting.

    10. Refer to IRM 21.4.5.6 for additional information.
    A refund is frozen with TC 576 Issue Letter 105-C or Letter 106-C.
      The tax year is 2002 and/or HCTC was claimed due to IRS error Consult your work leader or manager for instructions.

4.19.15.33  (12-12-2008)
Self-Employed Health Insurance Deduction

  1. A taxpayer may be able to deduct part or all of the amount paid for health insurance, if the taxpayer is one of the following:

    • A self-employed individual and has a net profit for the tax year from a Schedule C-EZ, or F

    • A shareholder owning more than 2% of the outstanding stock of an S Corporation (or is considered as owning more than 2% by reason of the attribution rules under IRC 318) with wages reported on Form W-2, or

    • A partner with net earnings from self-employment reported on Line 15a of Schedule K-1 (TY 2003 Form 1065). For TY 2004, the net earning is reported on Line 14 of Schedule K-1 (TY 2005 and TY 2007 Form 1065).

  2. For tax years prior to 2003, the employee-shareholder may claim 70% of the amount paid as an adjustment to income; the taxpayer may take the remaining 30% on Schedule A if they itemize. (See (4) below for reductions).

  3. Beginning in 2003 and thereafter, employee-shareholder may claim 100% of the amount paid (See (4) below).

  4. In calculating the deductible amount, taxpayer should use the Self-Employed Health Insurance Worksheet in the Instructions for Form 1040 which indicates the deduction is the lesser of

    1. the amount paid for health insurance coverage, or

    2. net profit or earned income from the business under which the insurance plan is established, minus any deductions claimed on the Form 1040 for one-half of the Self-employment Tax and contributions to Self-Employed SEP, SIMPLE, and Qualified Plans.

  5. Taxpayers may receive a Form 1099-MISC for self-employed income. Generally, the taxpayer prepares a Schedule C to report this income but it may appear on the "Other Income" line. Ensure the taxpayer has reduced this income by any expenses applicable to the earning of this income to arrive at net income. Taxpayers who are in business as a self-employed writer, inventor, artist, etc. should report their income on Schedule C, and apply appropriate expenses to obtain net income.

  6. Earned income includes net earnings and gains from the sale, transfer, or licensing of property the taxpayer created. It does not include capital gain income. If the taxpayer was a more-than-2% shareholder in the S Corporation under which the insurance plan is established, earned income is his wages from that corporation.

  7. Constructive ownership of stock under IRC 318 applies to taxpayer’s spouse, his children, grandchildren and parents.

  8. For purposes of the deduction, a two-percent-plus shareholder’s wages from the S Corporation are treated as the shareholder’s earned income. No deduction is allowed in excess of an individual’s earned income derived from the trade or business with respect to which the plan providing the health insurance coverage is established.

  9. For employee-shareholders, the health insurance premiums must be paid in the current year by the corporation and included in the wages (generally shown in Box 14 of the Form W-2) of the employee-shareholder. The amount may include payments for insurance covering the taxpayer, his/her spouse, and dependents. If the benefits were not included in the employee-shareholder’s wages, the employee-shareholder may not deduct them.

  10. The taxpayer may not claim the Health Care Tax Credit (for which additional qualifications apply) for the same expenses as he/she is claiming for the Health Insurance Deduction.

  11. A taxpayer may not take this deduction if he/she participated, or is eligible to participate in any subsidized health plan maintained by his/her or spouse’s employer.

4.19.15.33.1  (12-12-2008)
Self-Employed Heath Insurance Deduction

  1. Cases are worked to determine if taxpayers are erroneously claiming health insurance payments on the front of the return because they had insufficient expenses to overcome the offset or are unable to itemize. In addition, taxpayers may be taking this deduction when they have no self-employment or earned income. Procedures are as follows:

    • The Initial Contact Letter 566 will be used to inquire about the income and/or deductions. The Corporate Exam Toll Free telephone number will be used on these letters. Normal suspense periods will be applied to all letters issued.

    • Rule 914: Taxpayer claiming self-employed health insurance deduction with no apparent self-employment income.

4.19.15.33.2  (12-12-2008)
Initial Contact Letter

  1. The following table shows the initial contact letter to be sent to the taxpayer

    Rule(s) Broken Letter to Issue Amount to Disallow
    914 Letter 566 with the appropriate box checked None

4.19.15.33.3  (12-12-2008)
Evaluating Responses

  1. Use the following guidelines when evaluating response to Self-Employed Health Insurance Deduction:

    • Carefully examine all documentation to determine if all or some of the amounts were paid for qualifying insurance. If the taxpayer was eligible to participate in his/her spouses or his/her own employer’s subsidized health plan he cannot deduct premiums for any month in which he was eligible.

    • Determine if taxpayer had sufficient earned income for the claimed self-employed health insurance deduction. (Note: deduction is limited to the profit from the business.) Review Form 1099-MISC or other documentation to ensure the taxpayer was self-employed. If the income is unreported, include additional income in the report and compute self-employment tax, if appropriate.

    • If taxpayer indicates income is from an S Corporation, review Schedule K-1 and/or other documentation (i.e. Form W-2) to establish they received and reported wages from an S Corporation in which they were more than a 2 percent shareholder. If IDRS information is used to link a taxpayer to a corporation, examiners may use judgment in accepting the taxpayer’s statement as verification that he/she has more than 2% ownership.

    • Ensure the taxpayer has reduced his earned income by any deduction he claimed for One-Half of Self-Employment Tax and a deduction he claimed for Self-Employed SEP, SIMPLE, and Qualified Plans (when applying lesser of earned income reduced by these deductions and amount paid).

    • If the taxpayer does not have a Form W-2 from a Subchapter S Corporation, a quick way to determine if the taxpayer is self-employed may be to review the taxpayer’s Schedule SE. The amount of income on which he paid SE tax can be used as the amount of income from net self-employment income.

    • Responses involving the concept of material participation generally relate to the allowance of a loss rather than income and are unlikely to be applicable here.

    • Since our taxpayers are "cash basis" taxpayers, all deductible expenses must be incurred by them in the current year. Income must be distributed to them and/or reported by them when earned.

4.19.15.33.4  (12-12-2008)
Potential Documentation

  1. Request a copy of the health insurance policy indicating the payment was made for qualifying individuals, i.e., the taxpayer, spouse, or dependents.

  2. If the insurance premiums were paid by the corporation, verify premiums were included in the taxpayer’s wages from the corporation (most generally will appear on Form W-2).

  3. If premiums were paid by the taxpayer, request cancelled checks, receipts, payroll deductions, etc. to support the deduction.

  4. The Schedule K-1 and/or BMFOL or BMFOLT for the S Corporation may be used to establish the taxpayer is linked to that corporation. In determining whether the taxpayer is a more-than-2%-shareholder, copies of the articles of incorporation, stock certificates or similar documentation may be used to establish this. If the taxpayer indicates he qualifies by reason of attribution rules, ask the taxpayer about his relationship to the shareholder. Common sense may be applied in this area since small corporations often do not have all the formal trappings of a publicly held corporation. A taxpayer’s statement may be sufficient to establish this fact if other issues have been satisfactorily resolved.

  5. If the taxpayers are claiming payments for long-term care insurance, request birth certificates if the taxpayer’s age can not be determined from IDRS. See Publication 535, Business Expense, to determine the aged-based limitations.

  6. If the taxpayer paid the expenses to the insurance company, cancelled checks, documentation to show payroll deduction, etc. should be adequate to support the deduction.


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