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IRS instructions are just that, not the law

Jim HamillIn one of my many rants I complained about the IRS introducing novel interpretations of the tax law in instructions to forms.

For many of you this may not be disconcerting. It should be.

The problem is that someone who practices in the tax area knows that many issues do not have clear answers. For this reason it is acceptable to challenge the IRS’ interpretation of the law provided the position you advance has “substantial authority.”

To make this a fair debate it is best if the IRS view is expressed in some formal manner that cites a specific authoritative source of the law and why the IRS believes that source supports its position. A tax adviser may then disagree.

When instructions to a required tax form simply say this is how you will report there is no actual statement of why the law requires that reporting. Taxpayers often just assume they must follow the instructions.

So the rant that I reference is reporting the qualified business income deduction (QBID). This is the 20% deduction allowed for qualified business income.

Instructions to the form used to report the QBID in 2019 said that the otherwise qualified income must be reduced by charitable contributions made by a business operated as a partnership or S corporation.

Charitable contributions are not claimed as business deductions. Therefore it was illogical and without authority to reduce income qualifying for the QBID by charitable donations.

The 2020 instructions no longer require that income be reduced by charitable deductions. This is now a proper set of instructions.

So congratulations, I suppose, to the IRS for getting this right. But what happens to those who followed the instructions in the past?

I wrote an article last filing season saying that the QBID should not be reduced by the charitable donations. This is how I reported for clients last season.

I am certain that many readers thought that I was a crazed rule breaker to boldly claim that IRS instructions should be ignored. Maybe even a tax cheat.

We are often told to know your rights. If an airline wants to bump you from its flight, know your rights. Someone improperly charges your credit card, know your rights.

You also have rights to not pay more than the proper amount of taxes that you owe. We have a law that establishes your tax obligations. We have judicial interpretations of that law.

IRS instructions are not the law. If they are written in a plain fashion, consistent with the law, they are to be celebrated for the assistance they provide to taxpayers.

If you don’t already know it, IRS does not make the law. Interpretations found only in instructions to forms need to be treated for what they are.

Q: I recently refinanced my home mortgage and paid $6,440 in points. Can this be deducted in 2020 as interest?

A: It can be deducted as interest, but the deduction must be spread evenly over the term of the refinanced loan.

Points represent prepaid interest. The tax law generally requires that otherwise deductible interest that is prepaid must be spread over the term to which it relates.

The law allows one exception to this rule. If the points are paid on a loan used to acquire, construct, or improve the taxpayer’s principal residence, the prepaid interest may be deducted in the year paid.

This exception to the timing of the deduction is one of many benefits allowed for a principal residence. It may help offset some of the cost of acquiring the home.

Congress chose not to extend this timing benefit to a refinance of a principal residence loan. The reason is that a refinance is viewed as a personal financial decision and not tied to the acquisition of the property.

It may be a challenge to remember to deduct a portion of your points each year. If you use tax software, or a professional tax preparer, the software remembers the 2020 points in future years and will deduct the proper amount each year.

If you later sell the home or refinance again the remaining points may be deducted in the year the 2020 loan is paid off.

James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

 

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