Tax Q&A

Answers to your tax questions

• Stock options • Trust income • Tax penalties • 10-year averaging

By Lawrence Farber, Senior Editor

Q:Last August, I bought a three-month put option on a stock I'd owned since September 1999. The option, which was good for 90 days, gave me the right to sell my stock at the August price. I exercised the option in November. Is my gain long term?

A: No. The rules don't permit you to turn a short-term gain into a long-term one by using a put to extend your holding period. Even though you kept the stock longer than a year, your holding period was suspended at less than 12 months, when you bought the put. So any gain on the sale is considered short term.

Q:After my father died last year, I became a beneficiary of a trust set up in his will. How do I report the income I received?

A: Treat each item of income the same way the estate or trust would treat it. For example, if you shared in the trust's dividend income, report the distribution with your other dividends on Schedule B. The same rule applies to distributions of tax-exempt interest and capital gains. You must report all trust income you were entitled to on your return for 2000, even if you didn't get some of it.

Q:I'm thinking of claiming a sizable deduction that the IRS might dispute. How large a penalty would I be risking?

A: The penalty would be 20 percent of the amount you should have paid but didn't. However, the IRS might waive the penalty if you can prove that you acted in good faith and had a sound reason for treating the item the way you did. It would help if you could back up your position by citing relevant rulings and court opinions.

Q:I made some gifts in 2000, as a means of promoting my practice. Can I claim them as business expenses?

A: Yes, but the most you can deduct for presents to any one person during the year is $25. You can't get around this restriction, even if you made separate gifts to members of that person's family or if your spouse made some of the gifts. But in addition to the $25, you can claim "incidental" costs such as engraving on jewelry, and gift wrapping, insuring, and mailing the gifts.

Q:My widowed mother lives with me, and I formerly claimed her as a dependent. Last year, each of my two brothers contributed about 30 percent to her support. Can I still take an exemption for her, even though I provided less than half her support?

A: Any one of the three of you can claim the exemption, since you each furnished more than 10 percent of your mother's support during the year, and together you contributed more than half of her support. But the other two have to give you signed statements (Form 2120) agreeing not to claim the exemption for that year. You must file the forms with your 2000 return. If you wish, the three of you can take turns claiming the exemption in future years.

Q:I received a lump-sum distribution from my pension plan last year and rolled over part of it into an IRA. Now I'm told that this makes me ineligible to use 10-year averaging to figure the tax on the remainder, even though I'd otherwise qualify for it because I was born before 1936. Can I cancel the rollover and use averaging on the full amount?

A: No, you're out of luck. Once you've exercised your option to roll pension money into an IRA by notifying the plan trustee or IRA sponsor accordingly in writing, you can't revoke that choice. This bars you from 10-year averaging, because it can be done only with a full lump-sum distribution.

Q:When we moved last summer, a painting we'd had for years didn't fit in with the decor of our new home, so we sold it to a dealer for a sizable profit. Should we lump this in with our stock gains and losses?

A: No. Gains on collectibles like antiques or art objects are taxed at 28 percent, rather than the more usual 20 percent. Schedule D makes you account for such gains separately.

Q:On Sept. 1, 2000, I bought $10,000 worth of bonds paying 6 percent interest, and I was credited with $300 of semiannual interest in December. How should I report this on my return?

A: Your purchase price included two months of interest ($100) already accrued, so you owe tax on only $200 for the four months you owned the bond. On Schedule B of your Form 1040, show the full $300 and deduct $100 (labeled "accrued interest") on a separate line.

Q:Early last year, I loaned a relative $10,000, interest-free, to help him buy a new car. Is any tax due on this transaction?

A: No. In general, a lender who charges less than the market rate on a loan owes tax on the forgone interest. But this is waived for loans of $10,000 or less when, as in this case, the borrower doesn't use the money to buy or carry income-producing assets.

Q:As part of our divorce settlement, several years ago I paid my wife $25,000 to transfer a property to me that had originally cost her $40,000. In 2000, I sold it for $75,000. Am I right in figuring that my tax cost basis is $65,000 ($25,000 plus $40,000), giving me a net taxable gain of $10,000?

A: No. You must use your ex-spouse's basis—$40,000—to determine your gain, so you owe tax on $35,000 ($75,000 minus $40,000). The IRS won't allow you to add your payment to her basis, and the Tax Court supports that position. The rule would be the same even if the two of you were still married.

 

Lawrence Farber. Answers to your tax questions. Medical Economics 2001;5:36.