What is FIRPTA and how does it affect foreign sellers and US buyers of US realty?

FIRPTA is the Foreign Investment in Real Property Act. It authorizes the United States to tax
foreign persons on dispositions of U.S. Real Property. As of February 17, 2016, all Buyers of US
real property, sold by foreign persons, are required to withhold 15% on the amount realized on
the sale, and remit it to the IRS.

Even though the tax is on the foreign person selling the US property, it is the buyer who is
considered the withholding agent and is responsible for withholding and remitting the required
15% tax to the IRS. Therefore, upon transfer of the US realty, the foreign seller’s 15%
withholding usually goes to the buyer, for immediate remittance to the IRS.

If an escrow account is available, the seller’s 15% withholding can alternatively be held in trust,
until such a time as it should be remitted to the IRS. This is particularly helpful when the foreign
seller is eligible to a reduction or waiving of the 15% tax.

When exceptions and reductions to the 15% tax apply, a withholding certificate should be
applied for from the IRS. While the IRS makes a determination on this, the 15% tax would be
ideally held in trust in the escrow account, offering a safety net to the seller and buyer.
Within 20 days of the IRS mailing their determination: a withholding certificate or a notice of
denial; the correct tax is sent to the IRS from the escrow account, using Forms 8288 & 8288-A.

Robert Atkins Walker PC offers a full FIRPTA compliance service, with tiers of service and fees
to meet your individual needs.

Do I also need to file Form 8938, Statement of Specified Foreign Financial Assets, in addition to the FBAR?

Form 8938, Statement of Specified Foreign Financial Assets, is a reporting requirement for all holders of foreign financial assets with aggregate balances as low as $50,000 for single filers and $100,000 for married filing jointly filers (see higher thresholds for expatriates and complete filing instructions at  http://www.irs.gov/pub/irs-pdf/i8938.pdf).  Aggregate balances mean the balances of all your foreign financial assets added together.

Foreign financial assets include all accounts covered by the FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), except for accounts on which you only have signature authority, and also extends to foreign securities and financial instruments.   Foreign financial assets do not include real estate, although they possibly may include leases on real estate.

Form 8938 is filed with your Form 1040 individual income tax filing.  Entities are not required to file Form 8938.   Congress mandated the filing of Form 8938 beginning with the 2011 tax year.

There is a stiff  penalty for failing to file Form 8938 with your Form 1040 tax return.  You may be subject to a $10,000 civil penalty for non-filing.  If you receive a failure-to-file notice from the IRS for Form 8938, the penalty can rise to as high as $50,000 for continued delays in filing.  But be encouraged that we have not yet seen the US Treasury Department impose the $10,000 penalty on delinquent Forms 8938 if you are proactive and get them filed before they contact you.  We can help you with this.  If you retain us to help, we will amend your Forms 1040 back to 2011 if necessary to include the missing Forms 8938.

Please see our separate article titled, I have a foreign bank account. Do I have to file an FBAR, Report of Foreign Bank and Financial Accounts?

For a comparison of Form 8938 and FBAR, please go to: https://www.irs.gov/Businesses/Comparison-of-Form-8938-and-FBAR-Requirements

 

I have a foreign bank account. Do I have to file an FBAR, Report of Foreign Bank and Financial Accounts?

If you are a US citizen or resident or a US entity (corporation, partnership or trust) and are the owner of or have signature authority on any foreign bank or depository accounts whose aggregate balances altogether exceed $10,000 at any point during the prior year, you are required to report such ownership or signature authority on FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR)*.  Reportable accounts include checking, savings, securities, brokerage, investment, insurance (including life insurance), mutual fund and pension accounts; they are reportable to the United States Treasury Department on an annual basis using FinCEN Form 114 which is efiled using the BSA E-filing system.**  The filing deadline is April 15 of the following year with a six-month extension until October 15 available upon request.

All earnings from such accounts such as interest, dividends and capital gains are reportable on your individual income tax return (or entity tax return).  There is no tax due on an FBAR.  It is merely reporting to the US treasury that you own or have some control over foreign bank or depository accounts.

There are severe penalties for not reporting including a $10,000 civil penalty for non-willful filing and more draconian penalties for willful non-filing.  But be encouraged that we have not yet seen the US Treasury Department impose the $10,000 non-willful-filing penalty on delinquent FBARs if you are proactive and get them filed before they contact you.   We can help you with this.  If you retain us for help, we typically will need to help you file the past 6 years of delinquent FBARs.

If the balances in your foreign accounts are high enough, the accounts will also need to be reported on Form 8938, Statement of Specified Foreign Financial Assets, which is required to be filed with your US individual income tax return Form 1040.   Note that the assets reportable on Form 8938 also include foreign securities (these are not reportable on the FBAR), but, unlike on the FBAR, Form 8938 reporting does not include accounts over which you have signature authority only.  Please see our separate article titled, Do I also need to file Form 8938, Statement of Specified Foreign Financial Assets, in addition to the FBAR?

* For more specific instructions, go to: https://www.irs.gov/pub/irs-utl/irsfbarreferenceguide.pdf and https://www.irs.gov/businesses/small-businesses-self-employed/report-of-foreign-bank-and-financial-accounts-fbar

** http://bsaefiling.fincen.treas.gov/NoRegFBARFiler.html

Form 5471 Filing Requirement Examples

Form 5471 Filing Requirement Examples
by Rob Walker, CPA, PhD
Updated October 1, 2015

Below are 12 situations of a US person’s ownership of a foreign corporation where, unless otherwise specified, the US person is not an officer or director of the foreign corporation nor do any other US persons own stock in the foreign corporation.

In the cases where the US person is described by more than one filing category, the information requested in the Form 5471 instructions for both categories must be provided but not duplicated where the same information is requested by each category.

1. A US person acquires 5% of the foreign corporation during year 1.  He has not owned any shares in the foreign corporation previously.  
There is no Form 5471 filing requirement.

2. In year 2 he acquires an additional 6% ownership raising his ownership to 11%.
He must file as a Category 3 filer for year 2 because he meets the at-least 10% ownership requirement.  The filing is only to report the transaction and not to report income.

3. In year 3 his stock ownership does not change and remains at 11%.  
He is not required to file Form 5471 for year 3 because there has been no change in his ownership even though he still meets the at least 10% ownership requirement.

4. In year 4 his stock ownership does not change and remains at 11% but he becomes an officer or director of the foreign corporation on July 1, year 4.  
He must file as a Category 2 filer for year 4 because he meets the filing requirement as an officer or director owning at least 10% of the foreign corporation.

5. In year 5 he acquires an additional 22% ownership raising his ownership to 33% and ceases to be an officer or director of the corporation on June 30, year 5.  
He must file as a Category 2 filer because he was an officer or director for part of year 5 and as a Category 3 filer for year 5 because he acquired an additional 10% stock interest.

6. In year 6 he acquires an additional 3% ownership raising his ownership to 36%.  
He must file as a Category 3 filer for year 6 because the first provision in the Category 3 instructions says, “A U.S. person who acquires stock in a foreign corporation which, when added to any stock owned on the date of acquisition, meets the at least 10% stock ownership requirement with respect to the foreign corporation.”  In other words, even though his stock ownership only increases by 3%, he is a Category 3 filer because he has acquired stock and he meets the at least 10% ownership requirement.

7. On June 30, year 7 he divests himself of 9% reducing his ownership to 27%.  
He is not required to file Form 5471 for year 7.
If, instead, he were to divest himself of 12% reducing his ownership to 24%, he would not be required to file Form 5471 for year 7.

8. On June 30, year 8 he divests himself of 18% reducing his ownership to 9%.  
He must file as a Category 3 filer for year 8 because he has disposed of sufficient stock to reduce his interest below the at least 10% ownership requirement.  The filing is only to report the transaction and not to report income.

9. In year 9, his ownership remains at 9% but he becomes an officer or director of the foreign corporation.
He is not required to file Form 5471 for year 9.

10. In year 10, his ownership remains at 9% and is an officer or director of the foreign corporation and another US person acquires 15% ownership of the foreign corporation.  
He must file as a Category 2 filer for year 10.

Each of the next 5 types of acquisitions is independent of the other, and each follows directly on situation 10.

11a. In year 11 he acquires an additional 42% ownership raising his ownership to 51%.  
He must file as a Category 4 filer because he owns more than 50%.  He also files as a Category 5 filer for year 11 because the corporation has become a CFC; 66% of the ownership is by US shareholders (a US shareholder is defined as a US person owning at least 10%).

11b. In year 11 he acquires an additional 41% ownership raising his ownership to 50%.  Either his wife or son acquires a 22% ownership.
He must file as a Category 4 filer because he owns more than 50% directly and constructively under the constructive ownership rules (see Treas. Reg. §§ 1.6038-2(b)(c) and IRC § 318(a)).  He also files as a Category 5 filer for year 11 because the corporation has become a CFC; 87% of the ownership is by US shareholders (a US shareholder is defined as a US person owning at least 10%).

Note that constructive ownership under section 318(a)(1)(A) includes spouse, children, and parents, but not great-grandchildren, grandparents or siblings.

11c. In year 11 his father (a US citizen) acquires a 42% ownership.
Because his father is a US person, per section 958(b) he constructively owns his father’s 42% thus raising his ownership to 51% under the attribution rules of section 318.  He must file as a Category 5 filer for year 11 because the corporation has become a CFC; 66% of the ownership is by US persons who are US shareholders (a US shareholder is defined as a US person owning at least 10%).

But he does not file as a Category 4 filer because the constructive ownership rules do not apply to Category 4 (nor to Categories 2 or 3) and he does not personally have more than 50% ownership.

11d. In year 11 his father (a nonresident alien) acquires a 42% ownership.   
Because nonresident aliens are not US persons per section 958(b), the constructive ownership rules do not apply to his father’s ownership.  Therefore he does not constructively own his father’s 42% and the corporation has not become a CFC.  He does not file as a Category 5 filer for year 11.  Only 15% of the ownership is by US shareholders (a US shareholder is defined as a US person owning at least 10%).

Nor does he file as a Category 4 filer because he does not personally have more than 50% ownership.

Note that ownership by nonresident alien members of a family as listed under section 318(a)(1)(A) (spouse, children, parents, and grandparents) is not treated as constructively owned by a US-person family member.

11e. In year 11 he acquires an additional 42% ownership raising his ownership to 51%.  In that same year, the foreign corporation (hereinafter referred to as FC-A) acquires 100% of the shares of FC-B.
He must file as a Category 4 filer because he owns more than 50% of FC-A.  He also files as a Category 5 filer for year 11 because FC-A has become a CFC; 66% of the ownership is by US shareholders (a US shareholder is defined as a US person owning at least 10%).

He also must file a separate Form 5471 for year 11 as both a Category 4 and a Category 5 filer for FC-B because, per section 958(a)(2), he is treated as owing 51% of the shares of FC-B.

The following type of acquisition is independent of the types under 11, and it follows directly on situation 9.

12. In year 11 his brother (a US citizen) acquires a 42% ownership.   
Even though his brother is a US person per section 958(b), the constructive ownership rules do not apply to the sibling’s ownership.  Therefore he does not constructively own his brother’s 42%.  The corporation has not become a CFC because his 9% ownership does not count as a US owner under section 958(b) because ownership shares that are less than 10% are not counted (a US shareholder is defined as a US person owning at least 10%).  He does not file as a Category 5 filer for year 11.
Nor does he file as a Category 4 filer because he does not personally have more than 50% ownership.

But he must file as a Category 3 filer because he increased his ownership to 10% or more by constructively owning his brother’s shares.  The constructive ownership provisions applying to acquisitions and divestitures of ownership fall under section 6046(c) rather than section 958(b).  Under section 6046(c), constructive ownership includes one’s spouse, children, siblings, ancestors and lineal descendants only if they are US citizens or residents (section 6046(a)).

I want to thank Tom Williams, CPA, and Gary Gauvin, EA, for their assistance and input.

Gold At The End Of The Rainbow: Medical Expenses and Below-Market-Rate Loans In Continuing Care Retirement Communities.

Residents of continuing care retirement communities (CCRCs) may take a medical expense deduction for a significant portion of both their entrance fee and monthly fees.  For the entrance fee, this usually results in a large medical expense deduction in the year the fee is paid.  In the first part of the article, we track the history of the CCRC medical expense deduction and examine its tax effects on residents of independent living, assisted living, and nursing care units.

Many CCRCs agree to refund a portion or all of the entrance fee without interest when the resident moves out or dies.  In the second part of the article, we examine two potentially significant tax effects of a guaranteed refund.  First, the refund may be subject to the below-market-rate loan rules and as such may produce imputed interest income for the resident and interest expense for the CCRC.   Second, the refund may reduce the deductible amount of the medical portion of the entrance fee.

Finally, CCRCs are responsible for accurately informing their residents as to the deductible medical portion of the fees.  The computational methods used in practice – the expense category method and the actuarial method – are often inconsistently or illogically applied, resulting in advice that shortchanges the residents and is open to IRS challenge.  In the third part of the article, we critique the two methods and recommend that CCRCs use the expense category method to determine the deductible portion of the monthly fees and the actuarial method for entrance fees.

See full article.

So Your Employer Made You An Independent Contractor and Didn’t Pay Any FICA Tax: How To Have Your Cake And Eat It Too.

Employees who have been misclassified as self-employed independent contractors need to know how to correct the misclassification and how to avoid paying excessive taxes. This paper focuses on four issues: (1) how misclassified workers may avoid paying any self-employment tax, (2) how they possibly may avoid paying the employee’s half of FICA tax as well, (3) how they may secure reclassification as employees through the help of the IRS, and (4) how they may have their earnings record updated to obtain maximum Social Security benefits after retirement despite paying neither self-employment nor FICA tax on the misclassified earnings. Recommendations are based on recent case law and administrative pronouncements. See full research article.

Can I use my foreign tax credit carryover if I have returned to the US?

Yes, if you work outside of the US occasionally. You may treat the proportionate income you earn during your work days in foreign countries as foreign-sourced income for purposes of the foreign tax credit.

Although there is no definition of the type of income to include in gross income on the foreign tax credit form in the Internal Revenue Code (IRC) sections 901 through 905 dealing with the foreign tax credit, the 2008 instructions for Form 1116, Foreign Tax Credit, on page 13, column 1, under the heading, Lines 1a and 1b — Foreign Gross Income, say, “You must include income even if it is not taxable by that foreign country. Identify the type of income on the dotted line next to line 1a. Do not include any earned income excluded on Form 2555.” It refers to earned income, and, since you have not excluded that earned income on Form 2555, it needs to be included on the gross income line of Form 1116.

Instead, the income-sourcing rules are found in IRC sections 861 through 865. They support reporting your foreign earned income on Form 1116. IRC section 862(a)(3) states that gross income from “compensation for labor or personal services performed without the United States” is foreign-sourced income. Treasury Regulation section 1.861-4(a)(1) says that the residence of the recipient, the place of contracting, and the time and place of payment are irrelevant. This regulation deals with US-sourced earned income, though. There is no similar regulation with respect to foreign-sourced earned income. But in the absence of specific guidance or anything to the contrary, I believe you may safely rely on IRC section 862(a)(3) to report your foreign work days yielding foreign-sourced earned income on the foreign tax credit form and to take advantage of your unused foreign tax credit carryovers.

Note: The instructions for calculating the foreign earned income exclusion (Form 2555 and IRS Publication 54) state that you cannot include foreign earned income in the calculation unless your tax home is outside of the US. There is no reference that the foreign-tax-home restriction applies to the foreign tax credit. This restricted definition of foreign earned income is only for the purpose of calculating the foreign earned income exclusion. See Internal Revenue Code section 911 (the section that allows the foreign earned income exclusion), subsection (a)(1), which states, “Definition. For purposes of this section — (A) In general. The term “foreign earned income” …” It goes on to cite the foreign tax home restriction referenced in Publication 54. Therefore I conclude the foreign tax home restriction does not proscribe including foreign-sourced gross earned income on Form 1116 for computing the foreign tax credit.

As an H-2B visa holder, do I have to pay payroll taxes? What about my employer’s responsibility? Which form should I file – Form 1040 or Form 1040NR?

1. Social Security Taxes (FICA/Medicare)

All H visa holders are subject to social security taxes per Internal Revenue Code § 3121. The only visa types exempted from social security taxes are nonresident aliens temporarily in the US under an F, J, M, or Q visa (IRC § 3121(b)(19) and Rev. Rul. 92-106, situation 3 (1992-2 C.B. 258)). Note: There is one minor exception as if you cared. :) H visa holders who are residents of the Philippines performing services in Guam are exempt from social security taxes (IRC § 3121(b)(18)).

Their employers are also subject to paying their half of social security taxes per IRC §§ 3111(a) and (b) and 3301.

No refunds are available to either employers or employees, but the employees can eventually draw social security benefits if they have paid in for the requisite quarters of coverage (40). Note that a quarter of coverage is defined as earnings of $920. So, for example, earnings of $3,680 ($920 x 4) in January 2005 would yield four quarters of coverage for the year.

2. Federal Unemployment Taxes (FUTA)

All employers of H visa holders are subject to Federal unemployment taxes per IRC §§ 3111(a) and (b), 3301 and 3306. The only visa types that are exempted from unemployment taxes are nonresident aliens temporarily in the US under an F, J, M, or Q visa (§ 3306(c)(19) and Rev. Rul. 92-106, situation 3 (1992-2 C.B. 258)).

3. Federal Withholding Taxes

The wages paid to nonresident aliens including those under H-2B visas for services performed in the US are considered effectively connected with the conduct of a trade or business in the US. Therefore the wages are subject to graduated tax withholding rates under IRC § 871(b) and to income tax withholding under § 3402(a).

There is an exception under § 864(b) which applies if the services are performed for a nonresident alien individual or a foreign corporation by a nonresident alien individual temporarily in the US for 90 days or less during the tax year and whose compensation is $3,000 or less.

See also Rev. Rul. 92-106 (1992-2 C.B. 258), titled Withholding of Income, FICA and FUTA Taxes, and IRS Publication 515, titled Withholding of Tax on Nonresident Aliens and Foreign Entities, which explain things in more detail.

4. US Tax Return Filing Status – which form to file: 1040 or 1040NR?

H visa holders are treated as Resident Aliens for income tax purposes and must file Form 1040 if they are physically present in the US on at least 183 days during the 3-year period including the current tax year and the two preceding tax years, aka the Substantial Presence Test. For the 183 day requirement, days are counted by counting all days of presence in the current tax year plus 1/3 of the days of presence in the first preceding tax year plus 1/6 of the days of presence in the second preceding tax year.

If their physical presence in the US is less than the 183-day requirement, they are treated as Nonresident Aliens for income tax purposes and must file Form 1040NR.

Most H-2B visa holders will be better off filing a regular 1040. If for some reason like not wanting to have to include their non-US-sourced income on their 1040, they could avail themselves of the Closer Connection exception to the Substantial Presence Test by filling out Form 8840, Closer Connection Exception Statement for Aliens. On this form they answer a number of questions about the location of their property, social and family ties, income sources, etc. If their position is reasonable that they are more closely connected to their homeland rather than the US, they can file using Form 1040NR with the Form 8840 attached. The IRS will ultimately decide.

If an H-2B visa holder is married, I recommend filing the 1040 return under the Married Filing Jointly status and attaching a properly filled out W-7 for the wife along with the requisite copies of documents such as a certified copy of her passport. If the tax return is filed with the W-7 attached, it must be filed with ITIN Operations, Austin. The specific address is in the W-7 instructions.

The W-7 requires the wife’s signature and proof of her information such as a certified copy of her passport or other documents as specified in the instructions for the W-7. This could be a hassle for the H-2B holder to get this, but it could save the couple a lot of tax. The same is true for the H-2B holder’s children. W-7s and the required documents would need to be attached for them, although the father could sign for them as their delegate if they are under age 14.

Note, however, that in order to file jointly, the visa holder will have to choose to treat his nonresident wife as a U.S. resident. This means that the visa holder and his wife will be treated as U.S. residents for the entire year in the first year that the visa holder qualifies as a U.S. resident under the substantial presence test. It also means that the spouse will have to report all her world-wide income for the year on their joint 1040 return in addition to her husband’s worldwide income. This could be a problem for some H-2B visa holders whose wives are working in México, for example.

If the visa holder is married and chooses not to file jointly because, e.g., the documentation for his wife is too hard to get or he doesn’t want to report his wife’s income on their joint return, he will need to file under the status Married Filing Separately. In that case there is a further complication involving community property. Because Texas is a community property state, the visa holder filing under the Married Filing Separately status will report half his income and expenses as a U.S. resident on his Form 1040 and will need to report the other half of his income and expenses as a U.S. resident on a Form 1040NR return for his spouse.

If he is single or is married and chooses to file under the Married Filing Separately status, in the first year of residence, the visa holder will have dual status and be a nonresident alien for part of the year and be a resident for the remainder of the year as explained in more detail next.

Once a single individual or a married individual who chooses to file under the Married Filing Separately status is granted a visa and such individual meets the physical presence test in the U.S., the visa holder needs to file two returns in the first year in which he becomes a U.S. resident under the substantial presence test. Similarly he will also need to file two returns in the last year when he ceases to be a U.S. resident under the substantial presence test:

  1. Form 1040NR or 1040NR-EZ labeled at the top, “Dual Status Statement,” reporting only U.S. source income for the part of the year that he is not a U.S. resident under the substantial presence test, and
  2. Form 1040 labeled at the top, “Dual Status Return,” and on which his worldwide income is reported for the remaining part of the year that he is a U.S. resident under the substantial presence test.

Between the dual status years, file Form 1040 as long as the physical presence test continues to be met.

Note: If the substantial presence test isn’t met for the first year such individual is in the U.S. but is met is the next year, he can make a “first year choice” to be treated as a resident for tax purposes in that first year. See IRS Publication 519, U.S. Tax Guide for Aliens, Chapter 1, for details.

Further note: There is considerable misguidance or lack of clarity on the Internet about which form to file. Some sites advise filing Form 1040NR without any further clarification. Other sites, e.g., http://www.visapro.com/, imply filing Form 1040NR by stating, e.g., “As a nonresident alien in the U.S. on a H-2B visa, you must file income tax returns.

If I surrender a life insurance policy at a loss, may I deduct the loss? If so, is it an ordinary or capital loss?

Most of the litigation on this issue occurred in the 1930s and 1940s, and there has been little since then. The weight of legal authority leans against deducting a loss on surrender of a life insurance policy. The primary reasons are:

  1. The transaction (purchase of the policy) was not entered into with the intent to make a profit.
  2. The loss is not deductible because the policy contains two features – insurance protection and investment – and “[t]here was no separation of the premiums … as one part paid for protection only and the balance as a reserve investment.” London Shoe Co. v. Commissioner, 80 F.2d 230 (3rd Cir, 1935).
  3. Genworth Financial opined recently (without offering any judicial support) that the loss is non-deductible because it is a personal rather than business or investment asset. Losses on personal assets such as houses are not deductible, although losses on personal investments are deductible.

But, in a case where separation of the amounts paid for insurance protection and for investment was possible, a capital loss was allowed on surrender of the policy. Cohen v. Commissioner, 44 BTA 709 (1941). See the relevant text from the case below.

I think Cohen provides good precedent. There is support for calculating the loss on the investment portion. The insurance protection portion of the policy may be computed by totaling the term life premiums that would have been charged on a term-only policy. For example, say that the premiums paid on the life insurance policy total about $346K. Assuming the term premiums that would have been paid since inception in 2002 would have been $60K, the adjusted cost basis of the investment portion of the policy would be about $286K. Subtracting the adjusted cost basis from the $239K cash surrender value yields a $47K capital loss. Also, I believe there is an intent to profit on the investment portion. Hence, I would deduct the loss on the investment portion.

MOSES COHEN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT, 44 B.T.A. 709 (1941): “Therefore, in the instant proceeding we do not think we should overlook or fail to take into account the dual factors of investment and insurance protection which are inherent in the policies here involved. That portion of the premiums paid for mere insurance protection is of course a personal expense and as such is not deductible. Sec. 24(a)(1), Revenue Act of 1936. That portion of the premiums paid by reason of the investment feature of the contract is a capital expenditure and as such is not deductible. Sec. 24(a)(2). Petitioner is not contending for the deduction of any of the premiums paid. He contends that he lost a part of his capital investment, namely, $3,556.86 of the cash surrender value of the policies, and that such loss is deductible under section 23(e)(2), supra. For reasons above stated, we sustain this contention.” (Emphasis added.)

How may I deduct a loss on a variable annuity?

This is a gray area in the tax law that you may use to your advantage. IRS Publication 575 says that you must report the loss as a Schedule A miscellaneous itemized deduction subject to the 2%-of-adjusted-gross-income limit. The IRS is on thin ice here, I believe, because the U.S. 5th Circuit Court of Appeals has held in McIngvale v. Commissioner that a loss on a private annuity is a capital loss, hence deductible on Schedule D.

Because the IRS and the Court are split on the treatment of a loss on a variable annuity, I recommend deducting the loss either on Schedule A as a miscellaneous itemized deduction or on Schedule D as a capital loss depending on where you’ll receive the greater tax benefit.

As published in Austin Monthly, April 2003 (amended February 2005)